By GEETA JANI I DHISHAT B. MEHTA
Chartered Accountants
Article 5 of
India-Japan DTAA – marketing activities of Indian distributor constitutes
dependent agent PE (DAPE) for the Japanese parent in India; additional profits
were to be attributed to the DAPE by taking into account the functions and risks
that were not considered for TP analysis of the agent (distributor).
Facts
Taxpayer, a Japanese
company was engaged in the business of development, manufacture, assembly and
supply of air conditioning and refrigeration equipment. During the year, Taxpayer
sold air-conditioners in India directly to third party Indian customers (direct
sale) as well as to an Indian distributor, I Co who was the wholly owned
subsidiary of Taxpayer in India.
In addition to acting as
the distributor of Taxpayer’s products in India, I Co entered into a commission
agreement with the Taxpayer to act as a communication channel between the
Taxpayer and its customers in India. As per the agreement, I Co was responsible
for forwarding customer’s request to the Taxpayer as well as forwarding
Taxpayer’s quotations and contractual proposals to the customers in India. In
consideration of the said services, I Co charged a commission of 10% on direct
sales made by the Taxpayer in India.
As the Taxpayer failed to
produce the evidence showing its involvement in the marketing of products sold
by way of direct sales in India, AO held that the activities of identifying
customers, approaching, presentation, demonstration, price catalogue,
negotiation of prices and finalisation of prices etc. were carried on by I Co
on behalf of the Taxpayer in India, in addition to the activities set out in
commission agreement. Consequently, it was held that I Co constituted a DAPE of
the Taxpayer in India under India-Japan DTAA.
The CIT(A) upheld AO’s contention.
Aggrieved, the Taxpayer filed an appeal before the Tribunal.
Held
On DAPE
– The air-conditioning and refrigeration
industry in which the Taxpayer was involved was highly competitive and
tremendous efforts are required for effecting sales in such market. This is
also evident by the fact that I Co had to incur huge selling and distribution
expenses for selling the same products in its capacity as a distributor. It is
hard to comprehend that the Taxpayer managed to make direct contact with customers,
scattered all over India for effecting sales to them directly, without any
marketing efforts.
– The contents of the emails exchanged between
the Taxpayer and I Co demonstrate that the entire deal was negotiated and
finalised by Indian customers with I Co and the role of I Co was not confined
merely to a communication channel as contended by the Taxpayer.
– In absence of any evidence indicating direct
involvement of Taxpayer in marketing activities in relation to direct sales in
India and the emails indicating the involvement of I Co in finalising the deals
with customers in India, the inescapable conclusion is that the entire activity
starting from identification of customers, approaching them, negotiating prices
with them and finalisation of prices was done by I Co in India not only for the
products sold by them as distributor, but also for the direct sales made by the
Taxpayer.
– Although I Co did not have authority to
finalise the contract of direct sales in India, the substantial activities of any
sale transaction like the activities of negotiating and finalising the
contracts were performed by I Co.
– Thus I Co was habitually exercising an
authority to conclude contracts in India on behalf of the Taxpayer. The mere
fact that the Taxpayer was formally signing the contract of sale does not alter
this position in any manner.
– Also, I Co was securing orders in India
‘almost wholly’ for the Taxpayer as all the substantive parts of the key
activities in making sales were carried on by I Co in India.
– Exclusion of independent agent activities is
not applicable as the Taxpayer had not contested the dependent status of I Co.
On Attribution of profits
on determination of ALP
– Since the Taxpayer did not maintain TP
documentation nor did it furnish the TP report with respect to commission
payments to I Co, its contention that the payment of commission is at arm’s
length cannot be accepted.
– SC in the case of Morgan Stanley (292 ITR
416) held that, if the independent agent is remunerated at arm’s length by
taking account all the risk-taking functions of the enterprise, there can be no
further attribution to DAPE. SC further held that if the TP analysis does not
reflect the functions performed and risks assumed by the enterprise, then
additional profits are to be attributed to the PE by taking into account the
functions and risks that are not considered for TP analysis.
– The commission of 10% was paid to I Co only
towards the services rendered as per the commission agreement. However,
evidences in the form of emails correspondences between Taxpayer and I Co as
well as I Co and customer supported the contention of the revenue that the
functions performed by I Co were beyond the services covered by the commission
agreement and included all the activities in relation to negotiation and
finalisation of the price and other contractual terms of the customer
contracts.
– Hence, the determination of arm’s length
commission of 10% did not reflect the functions performed and the risks assumed
by the PE. Therefore, as held by SC in Morgan Stanley (292 ITR 416), additional
profits should be attributed to the DAPE (i.e., I Co) for the additional
functions undertaken by DAPE in India. 
