By Geeta Jani, Dhishat B. Mehta
Chartered Accountants
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(i) On facts, income for provision of services through independent person was effectively connected to, and chargeable in hands of, PE.
(ii) If receipt is effectively connected with PE, Article 12(5) excludes it from Article 12(1) and 12(2) and hence, it is subject to Article 7.
Facts:
The taxpayer, a Japanese entity, was engaged in the business of providing inspection and certification services to marine industry for classification of ships. The taxpayer had set up branches in India at Mumbai and Chennai. The branches carried out a survey and issued reports. The branches constituted PE in terms of Article 5 of India-Japan DTAA.
Sometimes when employees of PE were not available for the survey, the taxpayer engaged an independent surveyor. The independent surveyor was directly appointed by the HO in Japan and the HO directly raised invoices on customers. The HO collected the invoice amount, paid 55% to the independent surveyor and retained 45%. Since under such circumstances the branch did not render substantial services or play active role, entire fee was retained at the HO and no portion of survey fee was recognised in profit and loss account of the branch.
The AO accepted the contention of the taxpayer that the survey carried out through independent surveyors could not be attributed to PE in India. Accordingly, he held that the amount received from such survey should be treated as FTS under Article 12 and taxable @20% on the gross amount in terms of Article 12(2).
In appeal, the CIT(A) observed that when PE could not undertake the survey, it directed the independent surveyor to carry out the survey and therefore, PE played a procedural role. Since FTS was effectively connected with PE in terms of Article 12(5), its income was to be dealt with under Article 7. Accordingly, the CIT(A) determined 10% of the fee as the income attributable to PE as business income and directed that no further expenditure other than allowance for HO expenditure u/s.44C should be allowed. Before the Tribunal, the issues were:
- Whether FTS was effectively connected with the PE?
- If part of the amount was taxable as business profits under Article 7, whether balance amount could be taxed as FTS under Article 12(2)?
Held:
The Tribunal observed and held as follows.
(i) In case of FTS, the test to be applied is activity test or functional test. Surveys, whether through own staff or through independent surveyors, should not be treated differently. As per Article 7(1), profits directly or indirectly attributable to PE were to be taxable in India. The CIT(A) had estimated these to be 10% of gross receipts, which was not disputed by the tax authority. Hence, this amount was to be treated as attributable to PE.
(ii) If the receipt is effectively connected with PE, Article 12(5) excludes entire receipts from Article 12(1) and 12(2). Thus, DTAA does not contemplate taxing of balance (excluding 10%) receipt under Article 12(2).
