Valid and commercially justifiable presence of recipient of income in treaty favourable jurisdiction cannot be disregarded to tax income in the hands of another ent

The assessee, a Netherlands company, is a wholly-owned
subsidiary of a Hong Kong Company (HKCo) and a second-generation subsidiary of a
company based in British Virgin Islands. The assessee was granted exclusive
right to sell advertising time in India on channels of TV network owned by HKCo.
The assessee engaged an Indian company (ICo) to procure business from Indian
advertisers by paying commission of 15% of receipts from business procured from
India. Based on the CBDT Circular No. 742, dated 2-5-1996, which was applicable
for the year in question, the assessee offered 10% of the advertisement revenues
to tax in India.

The AO held that the assessee was a conduit company and not a
resident of the Netherlands and that the advertisement revenues were taxable in
the hands of HKCo. As a protective measure, the
AO assessed the revenue in the hands of the assessee by estimating 20% of
revenues as income earned in India.

In support of its claim, the assessee submitted that it is
registered in, assessed to tax, and domiciled in, the Netherlands, and all its
business is conducted from the Netherlands. The assessee had also filed tax
resident certificate (TRC) issued by the Netherlands tax authorities, and
submitted that it earned revenue not only from India, but also from other
countries.

The AO contended that the assessee was appointed to sell
advertising time in India because the Netherlands had a favourable tax treaty
with India, whereas there is no tax treaty entered into between India and Hong
Kong, where the parent HKCo is located. The tax treaty between India and the
Netherlands is entered to give benefit and relief to bona fide taxpayers and not
to encourage creation of non-genuine taxpayers for the purpose of tax avoidance.
The Tax Department justified its action by contending that it was a clear case
of treaty shopping and TRC was not sufficient to justify that the assessee had
not been created with a motive to avoid taxes. The AO concluded that the
assessee is a conduit and its real residence is not in the Netherlands. In any
case, HKCo also had permanent establishment (PE) in India though ICo was
ostensibly appointed as an agent of the assessee justifying actual assessment in
the name of HKCo.

The CIT(A) concurred with the AO’s order.

On further appeal, the ITAT held :

The Department could not disregard the existence of the
assessee and proceed to tax HKCo. The ITAT noted the main contention of the Tax
Department was that the assessee is used as a commercially irrelevant entity
(commonly referred as PE blocker) so as to reduce the tax exposure of HKCo in
India and that as per the Department HKCo is deriving tax advantage by inserting
the assessee as a link in its chain entities was also unacceptable. The ITAT
concluded that the Department’s contention is based on incorrect perception that
HKCo is deriving tax advantage by interposing the assessee. The advertisement
revenues are derived through a commission agent, ICo. ICo has been paid a fair
remuneration for its services. In terms of the CBDT Circular No. 23, dated
23-7-1969, no further income could be taxable in India. Withdrawal of the
Circular in October 2009 is only prospective and does not impact the year in
question.

The group to which the assessee belongs had chosen to
centralise sale of advertisement time to the assessee on a global basis and the
choice was not driven solely by tax considerations.

The evidence produced by the assessee commercially justified
its appointment for selling advertising time and hence its existence could not
be disregarded.

In the assessment proceedings of the assessee, the Tax
Authority cannot determine taxability of the advertisement revenues in hands of
HKCo, which could be decided only after taking into account material on records
available with HKCo.