Dependent Agent Permanent Establishment [DAPE] – Attribution of Profits

Glossary:

PE – Permanent Establishment?????????????????????????????????

DAPE – Dependent Agent Permanent Establishment?????????????????????????????????

DA – Dependent Agent????????????????????

DTAA – Double Taxation Avoidance Agreement????????????????????????????

TP – Transfer Pricing

ALP – Arm's Length Price?????????????????????????????

ITAT – The Income Tax Appellate Tribunal

Introduction: In taxation of non-residents carrying on business in India or with India, Permanent Establishment (PE) often comes into focus. A PE is a place of business in India from which a non-resident carries on business in India and hence becomes liable for taxes on income attributable to the PE (even business with India can attract taxation). Sometimes, however, the definition of PE is enlarged in order to take care of situations where a non-resident carries on business even without a place of business. One example is Dependent Agent Permanent Establishment (DAPE). A Dependent Agent (DA) whose substantial activities comprise acting for a non-resident principal is known as DAPE. A DAPE is an extension of the non-resident and deemed to be a PE of the non-resident (Alert: this is not a definition but a statement explaining a DAPE in simpler terms). Double Taxation Avoidance Agreements (DTAAs) define in detail in Article 5 "Permanent Establishment" of the DTAA who constitutes a DAPE.

The Settled Law: When it comes to "attribution of profits" to non-residents in India for the purpose of taxation, the judiciary has held that so long as the income earned by a DAPE for its services as remunerated by the non-resident satisfies the requirements of the statute relating to Transfer Pricing (TP) and is accepted as Arm's Length Price (ALP), the matter should end there. In other words, there can be no further examination of attribution of profits to the non-resident. For example, if the ALP is determined at Rs.100 for services rendered, and the DAPE is paid a sum of Rs.90, then the income assessable in the hands of the non-resident in India would be Rs.10. This is how the judiciary has seen it.

There are two recent Income Tax Appellate Tribunal (ITAT) decisions on the matter and both have upheld the current legal position as described above. However, the ITAT went on to express its doubts about whether it is correct in a fascinating manner. The judgments pit two of the finest legal minds on the subject at opposing ends. The legal minds that I am referring to are Mr.Philip Baker and Prof.Klaus Vogel and the cases are (1) Micro Focus Software Inc. v. Deputy Commissioner of Income Tax (IT), Circle 3(2)(2), Mumbai, [2022] reported in 139 taxmann.com 107 (Mumbai - Trib.) and (2) UPS Asia Group Pte. Ltd. v. Assistant Commissioner of Income-tax, (International Taxation)*, [2022] reported in 138 taxmann.com 505 (Mumbai - Trib.). Both were decided by the ITAT Mumbai, and the Judicial Member is common to both the judgments and therefore, unsurprisingly, the orders are similar.

The complications: As regards the remark above " The judgments pit two of the finest legal minds on the subject at opposing ends.", there is no better way to explain it than quote a passage from the decision in UPS Asia Group Pte. Ltd.(supra). "…?there are two approaches to it?i.e.,?to borrow the terminology employed by International Tax Law Reports (see 2007, Volume 9; Part 5; at pages 963-964), first- a "single taxpayer" or "zero-sum approach", and, second- "two taxpayers" or "non zero-sum approach". While Philip Baker, a well known international tax lawyer, has all along advocated zero-sum approach, late Klaus Vogel touched a different chord, in his column 'Tax Treaty Monitor' in the 'Bulletin for International Taxation (November 2007 at page 475) and given his approval for "two taxpayers approach". The latter is also in consonance with Authorised OECD Approach of the OECD. On materially similar facts of dependent agency permanent establishment for a similarly placed foreign telecasting company as in this case, in the case of?DDIT?v.?Set Satellite (Singapore) Pte. Ltd. [(2007) 106 ITD 175 (Mumbai), a coordinate bench, speaking through one of us, (i.e.?the Vice President), had upheld the "two taxpayer approach", in computation of DAPE profits,….".

The decision in DDIT v. Set Satellite (Singapore) Pte Ltd [(2007) 106 ITD 175 (Mum)] is that of the ITAT, Mumbai. However, the jurisdictional High Court, reversed the decision in favour of the assessee in Set Satellite?(Singapore) Pte. Ltd. v. Deputy Director of Income-tax, International Taxation, Rg. 2(1), [2008] 307 ITR 205 (Bombay) taking the view that -

(i) the sales were made on a principal-to-principal basis;

(ii) Circular No.23 dated 23rd July, 1969 and Circular No.742 dated 2nd May, 1996 issued by the Central Board of Direct Taxes (CBDT) were applicable; and

(iii) the assessee had remunerated the DA at an ALP basis.

Please note that Circular No.23 dated 23rd July, 1969 was withdrawn by Circular No.7/2009 [F.NO.500/135/2007-FTD-I]. Circular No.742 was issued for the purposes of Section 28(i) of the Act and was withdrawn subsequently.

Noting that the two ITAT decisions i.e. Micro Focus Software Inc. (supra) and UPS Asia Group Pte. Ltd (supra) are both by the ITAT, Mumbai, one understands that notwithstanding the misgivings, the ITAT (Mumbai) had no choice but to follow the jurisdictional High Court's decision. Having expressed its reasoning why assessment should be done on both the DAPE and the non-resident separately for two different streams of income, the ITAT (Mumbai) gave its verdict in favour of assessment of DAPE alone signifying that there was only a single stream of income i.e. the remuneration earned by the DAPE. However, the ITAT made sure it to be known where its sympathies lay. As regards the "misgivings" the following passage in paragraph 14 explains succinctly:

"…These aspects, however, cannot come in the way of the binding force of judicial precedents from Hon'ble Courts above. The Special Leave Petition (SLP) against this decision is said to be pending before Hon'ble Supreme Court, but that does not, in any way, dilute the binding nature of this binding judicial precedent….". One can clearly see the ITAT's belief in the matter although legally bound to take the contrary view. Given the fact that there is an SLP pending before the Supreme Court, we probably havn't seen the last of the subject. ?

Conclusion: There is a lingering peripheral issue. The entire judgment depends on the compensation paid to the DA satisfying the requirements of ALP. The TP proceedings involving the DA and the assessment of the non-resident are two different procedures in law and there is no certainty that the findings of the Transfer Pricing Officer (TPO) will be available to the assessing authorities assessing the non-resident. In such cases, how should one proceed? There are no suggestions to make since there are no reported precedents on the subject. Or, even if TP assessments are over, given the history of TP in India and the litigious nature of the subject, the assessment of non-residents with DA will no doubt take a tortuous route. The solution probably lies in adopting the APA (Advance Pricing Agreement) route.