US resident carrying on business activity through PE in India is to be treated at par with resident Indian enterprises carrying on similar business activity for the purpose of taxation.
US resident can invoke PE non-discrimination clause of the treaty and is entitled to claim tax holiday u/s.80HHE for export of software outside India.
Facts:
The taxpayer was an individual tax resident of the USA and a non-resident (NR) in India. The taxpayer was engaged in the business of software export through its Permanent Establishment (PE) situated in India.
Relying on the PE non-discrimination clause under Article 26(2) of the DTAA, the taxpayer contended that PE of an American enterprise cannot be treated less favourably than Indian resident enterprise and thus, claimed deduction u/s.80HHE in respect of the profits earned by PE.
The Tax Department rejected the contention of the taxpayer and held:
Tax holiday u/s.80HHE specifically permitted deduction only to residents or Indian companies. As the taxpayer was a NR, such deduction was not permissible.
In the case of Automated Security Clearance Inc4 (Automated), Pune ITAT has held that NR taxpayers were not entitled to tax holiday provisions as they were restricted to resident Indian enterprises. Such differentiation was reasonable as section 80HHE deduction was granted to augment foreign exchange reserves and while residents will receive and retain export proceeds in India, a non-resident will be able to remit funds outside India.
The OECD Model Convention Commentary too supports that NRs are not entitled to tax advantages attached to activities which are reserved on account of national interest, defense, protection of the national economy to resident Indian enterprises and that there can be a reasonable discrimination.
The taxpayer contended that: (a) If a US tax resident carried on business in India in the same line in which a resident Indian enterprise carried on business and if tax holiday was available to the Indian enterprise, then the US tax resident too should be permitted to claim the tax holiday.
(b) Once US enterprise is permitted to carry on business through PE, US enterprise cannot be denied the deduction on any count. In fact, sections 10A/10B benefits are extended to all assessees including non-residents. Also, OECD model commentary relied on by tax authority supports that non-discrimination is restricted only to critical activities of national importance where NR cannot even carry on the business.
Considering divergent views taken by Mumbai5 and Pune ITAT6 on PE non-discrimination, ITAT constituted a Special Bench to examine whether taxpayer was entitled to invoke the PE non-discrimination clause under Article 26(2) of the DTAA.
Held:
The Tribunal held as follows:
Article 26(2) of the DTAA provides that taxation of PE of an American enterprise shall not be less favourable than the taxation of resident Indian enterprise carrying on the same activities. It follows automatically that exemptions and deductions available to Indian enterprises would also be granted to the US enterprises if they are carrying on the same activities.
The fact that the taxpayer has been allowed to export software shows that the business does not fall in the prohibited category. Accordingly, the taxpayer’s case has to be compared with the case of an Indian enterprise engaged in the business of exporting software. If this is done, the taxpayer would be entitled to deduction/ tax holiday under the Act on the same footing and in the same manner as the deduction is admissible to a resident taxpayer.
The decision of the Pune ITAT in the case of Automated is not in conformity with the provisions contained in Article 26(2) as more importance was placed on the Commentary of the OECD MC and the Technical Explanation. The plain meaning of the provisions was not considered.
The decision of the Mumbai ITAT in Metchem, though rendered in the context of HO expenses, harmonised the provisions of the Act and the relevant DTAA. Similar exercise is involved in the current case as the provisions of the Act and the DTAA are required to be interpreted in a harmonious manner. Therefore the ratio of the decision is applicable to the facts of the present case.
As a result, taxpayer is entitled to deduction/ tax holiday u/s.80HHE of Act on the same footing as it is available to a person resident in India.
