From The Judiciary

Should profits attributed to a Permanent Establishment in India be taxed independently of the parent company's overall profitability?

Hyatt International Southwest Asia Ltd [TS-693-HC-2024(DEL)]

Facts

Hyatt International Southwest Asia Ltd (the assessee) was involved in an income tax dispute relating to profit attribution to its Permanent Establishment (PE) in India. The dispute centers on whether the assessee is liable to tax in India for profits attributable to its PE, even though the assessee incurred losses at the global level. The assessee argued that under Article 7 of the Double Taxation Avoidance Agreement (DTAA) between India and the UAE, profits attributable to a PE should only be taxed if the enterprise as a whole has earned profits.

The Revenue argued that the assessee’s PE in India should be treated as an independent taxable entity. Even if the enterprise incurred losses globally, profits attributable to the Indian PE should be taxed. The Revenue contended that Article 7 of the DTAA requires profits attributable to a PE to be taxed independently of the overall performance of the enterprise.

The same matter was earlier decided by the division bench of the Delhi High Court in case of Nokia Solutions [TS- 960-HC-2022(DEL)]¹, in favor of Nokia by stating that the issue of taxability could arise only if profits had accrued to Nokia and that too only to the extent attributable to its PE in India. The decision in case of Nokia was made by the Income Tax Appellate Tribunal (ITAT) by relying on the Special Bench’s decision in case of Motorola [TS-21- ITAT-2005(DEL)]²

Held

The Court ultimately decided that having a PE in India could lead to the taxation of any profits generated there, even if the company is experiencing losses elsewhere. It stressed that the rules allow for taxing profits connected to a PE in the host country, independent of the overall success of the foreign company.

The Court mentioned that it is of the firm opinion that the argument of global income or profit being relevant or determinative is totally unmerited and misconceived. Further, on the prior rulings, the court commented that the observations of ITAT’s special bench in the Motorola case have been misconstrued as enunciating a legal principle of global loss being pertinent for the purposes of considering whether income is allocable to the PE.

Our Comments

This ruling underscored the importance of treating profits from a PE as if it were a separate business, ensuring that profits earned in India are taxed, regardless of the parent company's overall financial performance.

Can an LLC qualify for the lower tax rate under the India-US Double Taxation Avoidance Agreement (DTAA) despite being treated as a fiscally transparent entity in the US?

General Motors Company USA [TS-659-ITAT-2024(DEL)]

Facts

General Motors Company (the assessee) challenged the Assessing Officer’s (AO) decisions regarding incorrectly taxing the income at 25% instead of the lower 15% allowed under the India-US Double Taxation Avoidance Agreement (DTAA).

A significant point of dispute was the classification of the assessee, a Limited Liability Company (LLC), as ineligible for DTAA benefits because it was deemed not liable for tax in the US. The assessee stressed that its status as a US resident, backed by a Tax Residency Certificate, should qualify it for the lower treaty rate. It argued that being "liable to tax" includes entities that are subject to tax laws, even if they are not taxed directly. The Assessee also contended that the concept of disregarded entities like LLCs should be included in the interpretation of the treaty, even though it was not recognized when the treaty was created.

Held

The Tribunal ruled in favor of the assessee, stating that the tax authorities made a mistake by denying treaty benefits to the LLC. It explained that the AO's classification of the LLC as a corporation under US law led to a wrong understanding of "liable to tax" under the India-US DTAA. The Tribunal noted that LLCs can be classified as partnerships or disregarded entities based on their structure, and income from a single-member LLC is taxed through its owner. It highlighted that having a Tax Residency Certificate shows that the entity complies with US tax laws, qualifying it as a resident for treaty purposes. The Tribunal also referenced past court decisions³, which indicated that even entities treated as fiscally transparent can receive treaty benefits if their income is ultimately taxed in the US. Therefore, the tribunal confirmed that the LLC is considered a "person" under the treaty, allowing it to access the benefits.

Our Comments

This case shows how important it is to understand tax residency and rules in international tax treaties. The ruling confirms that an entity’s legal status and following tax laws matter for getting treaty benefits, even if it’s seen as fiscally transparent. It also highlights how the definitions of entities like LLCs are evolving in these agreements.

DRP direction not complied by the AO, the final assessment order quashed by the ITAT

Comparex India P Ltd TS-399-ITAT-2024(DEL)-TP

Assessment Year 2018-19

Facts

The Transfer Pricing Officer (TPO) during the course of the assessment proceedings made total upward adjustment amounting to INR 22,436,553 in three segments of international transactions. After providing the assessee an opportunity to respond, the draft assessment order was issued. The assessee objected against the adjustments made by the TPO before the Dispute Resolution Panel (DRP), which upheld the adjustments for intra-group services (one segment) but deleted adjustments for back office support services and sourcing fees (the other two segments) thereby reducing the adjustment to INR 18,552,925.

The jurisdictional Assessing Officer (AO) passed the final assessment order wherein the additions as per the draft assessment order were sustained. The AO failed to comply and follow the directions of the DRP while passing the final assessment order.

Taxpayer's contention before the ITAT

The assessee appealed before the ITAT against the final assessment order stating that the AO erred by not passing the final assessment order in conformity with the DRP’s directions and Order Giving Effect to DRP directions passed by the TPO which is direct violation of Section 144C(13) of the Income-tax Act (ITA or the Act). The assessee submitted that it is a clear cut violation wherein the whole assessment order is bad in law and shall be quashed.

The assessee also placed reliance on the ruling of Hon’ble Bombay High Court in Hexaware Technologies Ltd vs. ACIT⁴ wherein it was held that when an authority acts contrary to the law, the said act of the authority is required to be quashed and set aside as invalid and bad in law. It had also opined that an action is not required to establish prejudice to the assessee.

Revenue's contention before the ITAT

The Revenue argued that the order passed by the AO was a mere mistake and requested the case be remitted back to the AO for rectification. The Revenue placed reliance on the decision of the Hon’ble Supreme Court in the case of Sugandhi vs. P. Rajkumar⁵ and case of ITO vs. M. Pirai Choodi⁶.

Held by the ITAT

The ITAT held that the case laws relied upon by the Revenue are distinguishable to the facts of the case and are not relevant to the issues raised by the assessee. The ITAT observed that the AO failed to adhere to the DRP's directions as mandated by section 144C(13) of the Act. The ITAT relied on the ruling in the case of Hexaware Technologies Ltd, emphasizing that actions contrary to law should be quashed. AO’s oversight constituted a gross violation of statutory requirements, which invalidated the final assessment order and hence the assessment order was deemed invalid and quashed due to non-compliance with legal standards and procedural requirements.

The ITAT further held that the Revenue should have acted upon to rectify the mistake within a reasonable time and there were no records shown of any efforts taken by the AO.

Our Comments

This decision underscores the importance of adherence to statutory guidelines in the assessment process, particularly regarding the necessity to follow DRP directives. The ruling highlights that failure to do so can result in quashing the assessment order, protecting the rights of the assessee while ensuring compliance with tax laws. Therefore, it is of utmost importance on the part of the taxpayer to appropriately check whether the assessment order passed by the AO is in conformity with Order Giving Effect issued by the TPO and DRP directions as non- conformity in the same might result in order being quashed.

Whether Notification No 9/2023-Central Tax and 56/2023-Central Tax extending the time limit for passing order under Section 73(10) of the CGST Act for FYs 2017-18, 2018-19 and FY 2019-20 were ultra vires the parent enactment?

Barkataki Print and Media Services and Others vs. Union of India and Others [TS-588-HC(GAUH)-2024-GST]

Facts

• In a batch of writ petitions, the adjudication orders passed under Section 73(10) of the CGST Act as well as Assam GST Act were challenged before the Gauhati HC on the following grounds:
  • Notification No. 9/2023-CT: In the absence of force majeure, the Government could not have exercised power under Section 168A;
  • Notification No. 56/2023-CT: The twin conditions for issuance of Notification i.e. existence of recommendation of the GST Council and due to force majeure , were absent.
• On the other hand, Revenue argued that all the recommendations of the GST Council are not binding and as such, even without the recommendation, the Government could exercise powers under Section 168A.

Ruling

• Perusing the Constitutional framework of GST, HC observed that the recommendations to be made by the GST Council, if required as per the provisions of CGST and SGST Acts, have to be construed to be sine qua non for exercise of power by the Union or State Governments.
• The fact that GST recommendation is not binding cannot be construed to mean that the Government can act without a recommendation, if the enactment so stipulates.
• In terms of Section 168A, the Government had power to extend the time limit:
  • On the recommendation of the GST Council;
  • By issuance of a Notification;
  • In respect of actions which cannot be completed or complied; and
  • Due to force majeure.
• Therefore, HC held that issuance of Notification No. 56/2023-CT was a colorable exercise of power. In this regard, the Court noted that the Notification mentioned that it was issued on the recommendations of the GST Council, while there was none.
• Moreover, the GST Council had no occasion to consider existence of force majeure as the same was never placed before it.
• In view of the above, HC concluded that the impugned Notification was ultra vires to Section 168A and accordingly, quashed the same.
• However, it clarified that since the Government has power to issue retrospective Notification as per Section 168A(2), this decision shall not prejudice the government to take steps in the manner provided under law.

Our Comments

• While the verdict provides relief to the taxpayers, it needs to be seen whether the Government initiates action by issuing retrospective notifications upon the recommendation of GST Council.
• It may be pertinent to note that, Allahabad HC in the case of Graziano Trasmissioni and Others vs. Union of India and Others [2024 (6) TMI 233 – Allahabad High Court] and Kerala HC in the case of Faizal Traders vs. Deputy Commissioner, CT & CE [2024 (5) TMI 1183 – Kerala High Court] have upheld the validity of similar extension Notifications issued prior to Notification No. 56/2023-CT. Hence, given the divergent views of the HCs, this issue is expected to be resolved by the Apex Court.