The Special Bench of the Income-tax Appellate Tribunal (ITAT), Ahmedabad on 11 November 2024 issued a decision holding that a transaction between a foreign enterprise and its permanent establishment (PE) in India is an international transaction, thereby subject to evaluation from the standpoint of arm’s length price.
The court ruled that the provisions of Chapter X of the Income-tax Act, 1961 (the act), which mandate that transactions with associated enterprises must adhere to the arm’s length standard, would be applicable in such cases, given the fact that under the act, as well as under the Income-tax Rules, 1962 (the rules), applicability of the transfer pricing provisions depends on whether the home office (HO) and the PE qualify as distinct “enterprises.”
TBEA Shenyang Transformer Group Company Limited (TBEA China/HO), incorporated in and tax resident of China, was awarded a contract by Power Grid Corporation of India Limited (PGCIL) to build substations in India. The contract covered offshore supply, onshore supply, and onshore services covered under separate agreements.
Under the agreement pertaining to onshore services, TBEA China was to provide services encompassing inland transportation and civil work within India. Pursuant to the same, TBEA China set up a project office (PO) in India. This PO constituted a fixed place permanent establishment (PE) of TBEA China in India as per Article 5(1) of the India-China double tax agreement (DTA).
The HO was responsible for executing the offshore portion of the contract, whereas the PO was responsible for the onshore portion. The PO subcontracted a portion of the onshore work to independent third-party contractors in India. The HO received payments in relation to all the contracts, and it passed on the portion relating to the onshore work to the PO subsequently, as the PO did not have a bank account in India at the relevant time.
India’s tax authorities adopted the stance that the PO’s action carrying out execution of the contract by providing services and thereby incurring expenses, which were subsequently passed on by the HO, was an international transaction between the HO and the PO. Section 92B of the act defines an international transaction as a transaction between two or more associated enterprisess, either or both of whom are non-residents, in the nature of, inter alia, provision of services.
Accordingly, the Transfer Pricing Officer (TPO) subjected the transaction under consideration to the arm’s length standard and observed that the rate per unit of civil work received by the PO from the HO (which in turn was received by the HO from PGCIL) was lower than the rate paid by the PO to third-party subcontractors. Hence, the TPO opined that the PO was not adequately compensated for services rendered by it, resulting in losses.
The question before the court was whether the transactions between a foreign enterprise and its Indian PE are international transactions within the purview of Section 92B of the act, and consequently subject to an arm’s length price adjustment under the transfer pricing regulations.
Under the act and the rules, the applicability of India’s transfer pricing provisions depends on whether an entity qualifies as an “enterprise” as defined under Section 92F of the act.
“Enterprise” is defined as “a person (including a permanent establishment of such person) who is, or has been, or is proposed to be, engaged in any activity, relating to the production, storage, supply, distribution, acquisition or control of articles or goods, or know-how, patents, copyrights, trade-marks, licences, franchises or any other business or commercial rights of similar nature, or any data, documentation, drawing or specification relating to any patent, invention, model, design, secret formula or process, of which the other enterprise is the owner or in respect of which the other enterprise has exclusive rights, or the provision of services of any kind, or in carrying out any work in pursuance of a contract, or in investment, or providing loan or in the business of acquiring, holding, underwriting or dealing with shares, debentures or other securities of any other body corporate, whether such activity or business is carried on, directly or through one or more of its units or divisions or subsidiaries, or whether such unit or division or subsidiary is located at the same place where the enterprise is located or at a different place or places.”
Given that the definition explicitly includes PEs, the court ruled that that the PE in this case qualified as an enterprise.
The court also observed that under Article 7(2) of the India-China DTA (which governs attribution of business profits), it is clear that a PE will be attributed profits that it would be reasonably expected to earn in its capacity as a distinct and separate enterprise.
The court further observed that Article 9 of the DTA, which deals with associated enterprises, is limited to only confirming that broadly similar rules exist in domestic law, and Article 9(1) by itself does not fulfil any necessary function as it only formulates rules that may already exist in domestic laws. Hence, even if the taxpayer’s contention that the provisions of the DTA override the act were to be accepted, under Article 7 of the DTA profits must be attributed to the PE.
The court specifically held that the taxpayer’s contention that there are only fund movements between the HO and PO is not acceptable, as in an unrelated scenario an enterprise would not permit its receipts and payments to be routed through a third party.
The revenue of the PO is influenced by the agreement signed by the HO with PGCIL and hence, the taxable income in the hands of the PE is dependent on the HO.
The definition of transaction under Section 92F(v) of the act includes arrangement, understanding, or action in concert. Thus, the arrangement/understanding between two enterprises giving rise to income or loss may be subject to transfer pricing.
Given this, the transaction between the HO and the PE would qualify as a transaction between two associated enterprises, which should be subject to an arm’s length price determination under the transfer pricing regulations.
To give effect to the order and take the matter forward, the court placed the matter to the Division Bench.
While the judgement provides insights on the applicability of transfer pricing provisions for transactions undertaken between a foreign enterprise and its Indian PE, there are several unanswered questions:
Jagat Mehta
Prateik Sachdev
BDO in India
The court ruled that the provisions of Chapter X of the Income-tax Act, 1961 (the act), which mandate that transactions with associated enterprises must adhere to the arm’s length standard, would be applicable in such cases, given the fact that under the act, as well as under the Income-tax Rules, 1962 (the rules), applicability of the transfer pricing provisions depends on whether the home office (HO) and the PE qualify as distinct “enterprises.”
Facts of the Case
TBEA Shenyang Transformer Group Company Limited (TBEA China/HO), incorporated in and tax resident of China, was awarded a contract by Power Grid Corporation of India Limited (PGCIL) to build substations in India. The contract covered offshore supply, onshore supply, and onshore services covered under separate agreements.Under the agreement pertaining to onshore services, TBEA China was to provide services encompassing inland transportation and civil work within India. Pursuant to the same, TBEA China set up a project office (PO) in India. This PO constituted a fixed place permanent establishment (PE) of TBEA China in India as per Article 5(1) of the India-China double tax agreement (DTA).
The HO was responsible for executing the offshore portion of the contract, whereas the PO was responsible for the onshore portion. The PO subcontracted a portion of the onshore work to independent third-party contractors in India. The HO received payments in relation to all the contracts, and it passed on the portion relating to the onshore work to the PO subsequently, as the PO did not have a bank account in India at the relevant time.
India’s tax authorities adopted the stance that the PO’s action carrying out execution of the contract by providing services and thereby incurring expenses, which were subsequently passed on by the HO, was an international transaction between the HO and the PO. Section 92B of the act defines an international transaction as a transaction between two or more associated enterprisess, either or both of whom are non-residents, in the nature of, inter alia, provision of services.
Accordingly, the Transfer Pricing Officer (TPO) subjected the transaction under consideration to the arm’s length standard and observed that the rate per unit of civil work received by the PO from the HO (which in turn was received by the HO from PGCIL) was lower than the rate paid by the PO to third-party subcontractors. Hence, the TPO opined that the PO was not adequately compensated for services rendered by it, resulting in losses.
The question before the court was whether the transactions between a foreign enterprise and its Indian PE are international transactions within the purview of Section 92B of the act, and consequently subject to an arm’s length price adjustment under the transfer pricing regulations.
Court Decision
Under the act and the rules, the applicability of India’s transfer pricing provisions depends on whether an entity qualifies as an “enterprise” as defined under Section 92F of the act.“Enterprise” is defined as “a person (including a permanent establishment of such person) who is, or has been, or is proposed to be, engaged in any activity, relating to the production, storage, supply, distribution, acquisition or control of articles or goods, or know-how, patents, copyrights, trade-marks, licences, franchises or any other business or commercial rights of similar nature, or any data, documentation, drawing or specification relating to any patent, invention, model, design, secret formula or process, of which the other enterprise is the owner or in respect of which the other enterprise has exclusive rights, or the provision of services of any kind, or in carrying out any work in pursuance of a contract, or in investment, or providing loan or in the business of acquiring, holding, underwriting or dealing with shares, debentures or other securities of any other body corporate, whether such activity or business is carried on, directly or through one or more of its units or divisions or subsidiaries, or whether such unit or division or subsidiary is located at the same place where the enterprise is located or at a different place or places.”
Given that the definition explicitly includes PEs, the court ruled that that the PE in this case qualified as an enterprise.
The court also observed that under Article 7(2) of the India-China DTA (which governs attribution of business profits), it is clear that a PE will be attributed profits that it would be reasonably expected to earn in its capacity as a distinct and separate enterprise.
The court further observed that Article 9 of the DTA, which deals with associated enterprises, is limited to only confirming that broadly similar rules exist in domestic law, and Article 9(1) by itself does not fulfil any necessary function as it only formulates rules that may already exist in domestic laws. Hence, even if the taxpayer’s contention that the provisions of the DTA override the act were to be accepted, under Article 7 of the DTA profits must be attributed to the PE.
The court specifically held that the taxpayer’s contention that there are only fund movements between the HO and PO is not acceptable, as in an unrelated scenario an enterprise would not permit its receipts and payments to be routed through a third party.
The revenue of the PO is influenced by the agreement signed by the HO with PGCIL and hence, the taxable income in the hands of the PE is dependent on the HO.
The definition of transaction under Section 92F(v) of the act includes arrangement, understanding, or action in concert. Thus, the arrangement/understanding between two enterprises giving rise to income or loss may be subject to transfer pricing.
Given this, the transaction between the HO and the PE would qualify as a transaction between two associated enterprises, which should be subject to an arm’s length price determination under the transfer pricing regulations.
To give effect to the order and take the matter forward, the court placed the matter to the Division Bench.
Conclusion and insights
While the judgement provides insights on the applicability of transfer pricing provisions for transactions undertaken between a foreign enterprise and its Indian PE, there are several unanswered questions:
- In this case, there was only one transaction between the HO and PE. In cases where multiple transactions occur between an enterprise and its PE, if the overall profit attribution made to the PE is found to be in line with the arm’s length standard basis comparable analysis, would there still be a transfer pricing analysis on a transaction-by-transaction basis?
- If the answer I yes, and as a result one or more individual transactions are not found to be at arm’s length, would this necessitate transfer pricing adjustment even when on an overall basis the PE has been attributed profits consistent with the arm’s length standard?
- If the funds had not been routed through the HO, but rather had been paid directly to the PE, would transfer pricing still apply? Would the fact that the HO negotiated the contract price for the onshore portion (before the PE was constituted) be influence enough for it to be treated as a deemed related party transaction?
Jagat Mehta
Prateik Sachdev
BDO in India