From The Judiciary

Can AO deny treaty benefits solely based on suspicion and raise questions over the authenticity of the TRC?

SC Lowy P.I. (LUX) S.A.R.L. [TS-972-ITAT-2024(DEL)]

Facts

RSC Lowy P.I. (LUX) S.A.R.L. (assessee) was an LLC incorporated in Luxembourg and a Category II Foreign Portfolio Investor registered with SEBI. It was a subsidiary of SC Lowy (Incorporated in Cayman Island). The assessee had invested in securities in India and claimed interest income taxable at the rate of 10%, claimed benefit of exempted business income and capital gains under Articles 11, 7, and 13(6) respectively of the India-Luxembourg tax treaty.

The AO contended that the assessee was a conduit company which was established for evading tax and the beneficial owner of the income should be in fact the Cayman Islands Holding Company. The AO did not bring on record any evidence to substantiate such a claim.

Held

Based on the grounds submitted by the assessee and considering the various rulings the Tribunal held that the treaty benefit should not be denied to the assessee due to the following reasons:

• The business activities of the assessee are beyond Indian jurisdiction, and it has also filed tax returns and paid tax in Luxemburg on its worldwide income.
• The assessee continues to exist in Luxembourg, holds substantial investments, and controls its assets and income independently, not as a conduit.
• Assessee's Tax Residency Certificate (TRC) was considered conclusive, and cannot be questioned unless it is backed with standard proof.
• The AO failed to provide sufficient evidence to indicate that the appellant was, in substance, a conduit except for expressing his views and presumptions.

Referred cases

• Tiger Global International III Holdings
• Union of India vs. Azadi Bachao Andolan
• Bid Services Division (Mauritius) Ltd. v. Authority for Advance Rulings

Our Comments

The case highlights the importance of conducting genuine economic activity and control to claim DTAA benefits, emphasizing that mere allegations of treaty shopping without sufficient evidence cannot deny tax benefits, further recognising TRC as conclusive evidence.

Does the secondment of employees to an Indian subsidiary result in the creation of a Permanent Establishment (PE) for the foreign company under a tax treaty?

Samsung Electronics Co. Ltd. [TS-21- HC-2025(DEL)]

Facts

The assessee, a company, was a tax resident of South Korea. It had a subsidiary in India to which some of its employees were deputed to

The AO contended that the deputed employees resulted in the creation of a PE of the assessee in India through its Indian subsidiary. The Dispute Resolution Panel (DRP) also concurred with the AO’s view.

The Tribunal, on appeal, found that the seconded employees were primarily posted to India under a tripartite agreement between the assessee, the Indian company, and the employees.

It noted that although some discussions related to the Indian market were held, the activities of the seconded employees did not involve conducting the business of Samsung Korea in India. The Tribunal further noted that the employees’ activities were for the benefit of Samsung India Electronics (SIEL) and not the global business of the assessee. Thus, it overturned the DRP’s decision that a PE had been created.

Held

The High Court upheld the Tribunal’s decision, which rejected the DRP’s finding that the secondment of employees created a deemed PE in India.

The Court referred to principles from the Progress Rail⁴ case and the OECD/UN Model Commentaries, noting that secondment within a group does not automatically create a PE unless the employees are involved in the foreign enterprise's business in India.

Since the seconded employees' activities (market research, data collection, etc.) benefited the India entity, and not the assessee, no Fixed Place PE, Dependent Agent PE (DAPE), or Service PE was created. Furthermore, the Court emphasized that activities such as market research and information collection for the Indian entity fell outside the scope of Article 5(3)(d) of the India-Korea DTAA, which excludes such activities from creating a PE.

The High Court dismissed the Revenue's appeal and upheld the Tribunal's decision that no PE was created by the secondment of employees.

Our Comments

The case is relevant for scenarios where the secondment of employees to an Indian subsidiary is alleged to create aPE for the foreign parent company without the activities directly relating to the parent’s business in India.

Bangalore ITAT reinforces the importance of Annual Accounts while selecting AE as the tested party – admits additional evidence

Decathlon Sports India Private Limited⁵

Facts of the case

The taxpayer imported branded goods from its Associated Enterprises (AEs) and local vendors to resell in India. The taxpayer identified its AE as the tested party under the Transactional Net Margin Method (TNMM), stating that it was the least complex entity with lower functional risks. However, the Transfer Pricing Officer (TPO) rejected this approach, stating that the foreign AE’s financials weren’t available with the taxpayer and were also not publicly available, making it difficult to conduct a reliable benchmarking analysis. Instead, the TPO selected the taxpayer as the tested party since its financial statements were available and verifiable and thereby proposed an adjustment. Citing the OECD Transfer Pricing Guidelines, the TPO reasoned that the tested party should be the entity with the least complexity and accessible financial data. The Dispute Resolution Panel (DRP) upheld the TPO’s rejection of the foreign AE as the tested party. Aggrieved by the order the taxpayer appealed to the Income tax appellate tribunal (ITAT).

Held by ITAT

The ITAT observed that at the time of preparing the transfer pricing study report and also before the TPO and DRP, the taxpayer did not have this information available and hence neither the taxpayer nor the TPO had a complete and well-substantiated justification for selection of their tested party. ITAT found additional evidence of audited accounts critical and noted that it needed further examination. Accordingly, ITAT remanded the selection of the tested party issue back to the TPO, directing the taxpayer to substantiate the Arm's Length Price (ALP) by showing sufficient data about the foreign AE as the tested party.

Our Comments

The tested party should be the entity with the least complex and most reliable financial data to ensure an accurate and defensible benchmarking analysis. Taxpayers should be proactive in ensuring that financial information for their chosen tested party is available at the time of preparing the TP study to validate the function, assets and risk undertaken and gathering the necessary information to demonstrate strong documentation.

Specified Domestic Transaction Applicability (92BA) independent from the claim of deduction

Sanghi Industries Limited⁶

Facts of the case

The taxpayer is a cement manufacturer, engaged in a specified domestic transaction involving the supply of electricity from its power plant to 14 related parties through power purchase agreements. The taxpayer contended that since it did not claim deductions under Section 80IA, the transaction should not be subject to the provisions of Section 92BA. The TPO noted that the taxpayer’s arrangement of purchasing electricity at higher rates from its power-generating unit led to a shifting of profits. The TPO rejected the taxpayers' use of internal comparable rates as per the Gujarat State Electricity Board (GSEB) tariff rates as comparable for the ALP determination, highlighting significant differences in the risk profile, functions, and assets between GSEB and the taxpayer power plant – as GSEB operates under different conditions compared to the taxpayer internal transactions with its power unit.

Held by ITAT

• The relationship between the taxpayer’s power-generating unit and its business operations was clearly covered under Section 80IA(8) and Section 80IA(10), making the transaction a qualified one within the scope of Section 92BA.
• It was not necessary for the taxpayer to have claimed a deduction under Section 80IA for the provisions of Section 92BA to apply.
• The taxpayer was shifting profits by purchasing power at a higher rate, which reduced its taxable income.
• Upheld the TPO’s rejection of the GSEB tariff as a comparable for determining the ALP as the taxpayer had not sold electricity in the open market, nor was it involved in selling electricity to a State Utility or an electricity exchange. Instead, the FAR profile of the taxpayer power plant was materially different from those of the State Utility, making GSEB an unsuitable external comparable.

Our Comments

In relation to specified domestic transactions - Sections 80IA(8) and 80IA(10) apply regardless of whether the taxpayer claims the 80IA deduction