Taxability of FTS/Royalty accruing to Foreign Company having PE in India

As per Section 9(i) it can be said that all income accruing or arising whether directly or indirectly through or from any business connection [1] in India or from any property in India or through any assets or source of income in India or through transfer of capital assets situated in India, shall be deemed to accrue or arise in India. Further, Clause (a) of the Explanation , states that where the business of which all the operations are not carried out in India, the income of the business deemed under this clause to accrue or arise in India shall be only such part of the income as is reasonably attributable to the operations carried out in India.

From the cases like CIT v. R.D. Aggarwal & Co. [1965] 56 ITR 20 (SC), Anglo-French Textile Co. Ltd. v. CIT [1953] 23 ITR 101 (SC), Supreme court has elucidated the expression "Business Connection" as below:

(a)?a real and intimate relation must exist between the trading activities carried on outside India by a non-resident and the activities within India;

(b)?such relation shall contribute, directly or indirectly, to the earning of income by the non-resident in his business;

(c)?a course of dealing or continuity of relationship and not a mere isolated or stray nexus between the business of the non-resident outside India and the activity in India, would furnish a strong indication of 'business connection' in India.

As per Article 7 of the DTAA of UN, Article 7(1) provides that when an enterprise has a PE in the other contracting state, profits of the enterprise shall be taxed in that other state but "only so much of them as is directly or indirectly attributable to that PE". Accordingly, Article 7 would prevail over Article 12 which is more specific only in a situation where the royalty is effectively connected with the permanent establishment. This expression in fact narrows down the scope of taxability in that other contracting state by excluding profits derived by such enterprise in the source state independently of the permanent establishment.

The basic philosophy underlying a force of attraction rule is that when an enterprise sets up a permanent establishment in another country, it brings itself within the fiscal jurisdiction of that another country, to such a degree that such another country can properly tax all profits that the enterprise derives from that country.

Therefore under the force of attraction rule, mere existence of PE in another country, leads all profits, which can be said to be derived from that another country, being treated as taxable of that another country.

Thus, from various ruling like in case of JC Bamford Excavators Ltd. [2014] 343 (Delhi - Trib.), Linde Ag, Linde Engineering Division ... vs Deputy Director Of Income Tax on 23 April, 2014 ; Booz & Company (Australia) (P.) Ltd., In re, [2014] 362 ITR 134 (AAR - New Delhi. It can be concluded that FTS/Royalty accrued to PE in India is considered as business income and the same shall be taxable as business profits.

I would appreciate hearing your thoughts on the aforementioned, as well as any questions, if you have for us.

[1] definition given in explanation 2 to section 9(1)(i)