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Tax Publishers Mitsui & Co. Ltd. v. DDIT [ITA No. 4377/Del/2016, dt. 22-9-2020] : 2020 TaxPub(DT) 3790 (Del-Trib) Attribution of profits in the hands of the non-resident -- Dependent Agency PE (DAPE) alleging Exclusive agency relationship *Facts:* Assessee a non-resident of Japan had contracted for certain Erection, commissioning contracts which was subject to tax under section 44BBB. They also had an Indian subsidiary called Mitsui India Pvt. Ltd. (MIPL) to whom commission was paid for sourcing such Indian contracts. It was the case of the revenue that MIPL constituted a Dependent Agency Permanent Establishment by alleging that MIPL was habitually and exclusively concluding contracts for the assessee and thus attribution of profits were made in the hands of the assessee in India. On appeal the Commissioner (Appeals) concurred with the views of the assessing officer but allowed the commission payment to MIPL as an expenditure on the attributed income in India. On higher appeal -- Held in favour of the assessee that their Indian subsidiary did not constitute a DAPE-- Dependent Agent PE. Payment of remuneration at arm's length with the Indian agent absolves further attribution of income. *Editorial Note:* The prime allegiance of the revenue was that MIPL was an exclusive agent of the assessee in India. This aspect has been well dealt in this decision where in mere exclusiveness of an agency relation cannot trigger a DAPE. Besides this, the principle that if an agent is remunerated at arm's length price then there cannot be any further attribution in India has also been dealt in. "The assessing officer has not brought any other material to substantiate his allegation that may demonstrate that MIPL has secured orders for the assessee. It is to be noted that this clause (c) uses the word 'habitually secures orders'. Thus, there has to be procurement of orders habitually. As against this the assessee's contention has been that MIPL is only providing support services and it is not securing order on behalf of assessee company. It may be relevant to further mention that the expression 'has' shall mean a legal existence. Whereas 'habitually secures orders' shall mean a systematic conduct on the part of the agent. Thus it is not only a legal right to secure order but also it is to be found, as a matter of fact that agent has habitually secured order. 4.2 Further, in this case the TP study of MIPL was subject matter of examination by the TPO. The FAR (Function performed, Assets deployed and Risk assumed) analysis has been accepted by the TPO. These agreement on the basis of which assessing officer has levied the allegation were also before the TPO. Thus, there cannot be any allegation that MIPL has performed any function beyond what has been stated. Functional and economic analysis of the transactions entered into having been examined nothing further can be imputed. The services of MIPL to assessee company were support services similar to the activities of a Liaison offices. This fact gets also supported from the finding recorded by the assessing officer himself in the assessment order on page 26 whereby it has been stated by the assessing officer that MIPL is functioning in the same manner as the LOs of the assessee are functioning in India. It has already been held that LOs do not constitutes PE in India. Thus, the functioning of MIPL though a subsidiary and a company incorporated in India but its activities vis-a-vis assessee company were akin to liaison office. It does not have authority to conclude contract, it was not maintaining any stocks of goods and merchandise nor it was securing order for the assessee company. In view of the above facts we reject the contention of the learned CIT/DR that MIPL habitually secures order for the assessee company. And accordingly, none of the condition prescribed in Article 5(7) are fulfilled. 4.3 The second contention of the learned DR was that MIPL is economically dependent on assessee-company as major revenue of MIPL is from assessee company. We are of the view that this per se cannot be ground to hold that MIPL is a Dependent Agent. For invoking this clause, first one of the three conditions needs to be fulfilled. As we have held hereinabove that MIPL does not get covered as PE under Article 5(7), it cannot be considered to be a Dependent Agent. The learned DR also made a reference to Conventions on Double Taxation by Klaus Vogel to support its contention that where a person works only for one principle such person is economically dependent on the principal, in "these circumstances the agent though not legally but will be bound to obey his principal's instructions and be regarded as being Dependent Agent. This contention of the learned CIT/DR again ignores the basic requirement, i.e., fulfilling one of the three conditions. It is also important to note that the DTAA provide for treating a person as Dependent Agent. The DTAA has to be strictly interpreted. The DTAA having prescribed the conditions, no further conditions can be read. What learned CIT-DR is canvassing will mean adding new condition in the DTAA. Further, it may be relevant to note that as per Para 9 of this Article 5 in DTAA, it has been specifically provided that if a company in the contracting state is controlled by a company in the other contracting state that itself shall not itself constitute either of company a permanent establishment of the other. Thus, the fact that MIPL is controlled by the assessee company shall not mean that MIPL is a PK of the assessee company. 4.4 Our view gets supported by the judgment of Hon'ble Delhi High Court in the case of Director of Income Tax and others v. M/s. E Funds IT Solution and Others 364 ITR 256 (Delhi), where the Hon'ble court has held as under :-- 31. Paragraphs 4 and 5 of Article 5 relate to creation of agency PE in the second contracting country. Agency replaces fixed place with personal connection. Arvid K. Skaar in his work "Permanent Establishment" has opined that primacy of 'location test" of the basic rule is consistent with the conceptual structure of the PE clause itself. An agency will constitute a PE only when a PE cannot be found according to those conditions in the basic rule which are altered or replaced by the agency clause. OECD and UN Model Treaties recognize agency PE. The principle being, that a foreign enterprise may choose to perform business activities itself or through a third, person in the other States. An agent is a representative who acts on behalf of another with third persons. International taxation laws recognize and accept two distinct types of agency PE, dependent and independent Every agent by very nature of principle of agency is to follow principal's instructions. But this principle is not squarely applicable to DTAAs, as third parties may not be strictly an agent under the domestic law. Further, the aforesaid dependency cannot be the distinguishing factor which determines whether the agency is dependent or an dependent agency for the purpose of Article 5 paragraphs 4 and 5 respectively. A dependent agency is one which is bound to follow instructions and is personally dependent on the enterprise he represents. Such dependency must not be isolated or once in a while transaction but should be of comprehensive nature. 32. The "dependency test" as per Arvid A. Skaar requires examination and answer whether the business interest of the principal and the agency have merged. When there is evidence of merging of interest, then power to instruct the agent exceeds a certain level. In such cases the Principal regularly participates in the process of settling current business problems or exercises discretionary power in the said respects. OECD Commentary does not accept dependency based on financial support, supply of patents etc. as itself creating agency PE. Klaus Vogel on Double Taxation Conventions, Third Edition at page 345 in paragraph 170 states that interdependence must exist in both legal and. economic respects but the independence is the main criteria. The expression "independent agent" is used with the words "brokers and general commission 7 agents" in paragraph 5 of Article 5 will, therefore, normally not include agents who have power to conclude contracts. Paragraph 38.1 of the OECD Commentary has been quoted above (see paragraph 15). The commentary elucidates and gives illustrations and tests. 33. Earlier U.N. commentary had deviated in some respect from the OECD commentary and had observed that an agent who was wholly or almost wholly engaged by one principal shall be considered to be a dependent agent. This initial position stated in UN commentary has, however, not been accept in subsequent commentaries. The essential criteria being arms length relationship though engagement with one or a group might serve as an indicator of absence of independence of an agent. 34. Subsidiary by itself cannot be considered to be a dependent agent PE of the Principal, otherwise it would negate the overriding effect of paragraph 6 to Article 5, a provision which precedes and seeks to give recognition to separate legal entity principle associated with juristic incorporated enterprises. However, a subsidiary may become dependent or an independent PE agent provided the tests as specified in paragraphs 4 and 5 are satisfied. A dependent agent is deemed to be PE of the principal establishment under paragraph 4, if one of the three conditions specified in sub-clause (a) to (c) are satisfied. Under sub-clause (a), a dependent agent should have authority and should habitually exercise the said authority to conclude contracts on behalf of the foreign enterprise. What is meant by the term "authority to conclude contract" has been subject matter of controversy on whether participation in negotiations by the agent is sufficient or not. However, this is not relevant for the decision of the present appeals in view of the factual matrix of the present case. Sub-clause (b) refers to an agent who habitually maintains stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the Principal enterprise. 8 In such cases, the agent should also perform some additional activities in its country on behalf of the foreign enterprise which has contributed to the sale of goods or merchandise. Sub-clause (c) applies when the agent habitually secures orders in the said country i.e. where he is located, almost wholly or wholly for the foreign enterprise. 35. Transactions between a foreign enterprise and an independent agent, do not result in establishment of a permanent establishment under paragraph 5 to Article 5 if the independent agent is acting in ordinary course of their business. The expression "ordinary course of their business has reference to activity of the agent tested by reference to normal customs in the case in issue. It has. reference to normal practice in the line of business in question. However as per paragraph b of Article 5, an agent is not considered to be an independent agent if his activities are wholly or mostly wholly on behalf of foreign, enterprise and the transactions between the two are not made under arrays' length conditions. The twin conditions have to be satisfied to deny cm agent character of an independent agent. In case the transactions between an agent and the foreign principal are under arm's length conditions the second stipulation in paragraph 5 of Article 5 would not be satisfied, even if the so dependent agent is devoted wholly or almost wholly to the foreign enterprise. 36. In Morgan Stanley (supra) Supreme Court rejected the contention of the Revenue that dependent agency was created after recording that Indian subsidiary had no authority to enter into or conclude contracts on behalf of the foreign establishment/agency. The contracts were entered into in America arid, were concluded there. Only implementation of those contracts to the extent of back office operations were carried out in India. This legal position is relevant in the present case."

Tax Publishers

Mitsui & Co. Ltd. v. DDIT [ITA No. 4377/Del/2016, dt. 22-9-2020] : 2020 TaxPub(DT) 3790 (Del-Trib)

Attribution of profits in the hands of the non-resident -- Dependent Agency PE (DAPE) alleging Exclusive agency relationship

Facts:

Assessee a non-resident of Japan had contracted for certain Erection, commissioning contracts which was subject to tax under section 44BBB. They also had an Indian subsidiary called Mitsui India Pvt. Ltd. (MIPL) to whom commission was paid for sourcing such Indian contracts. It was the case of the revenue that MIPL constituted a Dependent Agency Permanent Establishment by alleging that MIPL was habitually and exclusively concluding contracts for the assessee and thus attribution of profits were made in the hands of the assessee in India. On appeal the Commissioner (Appeals) concurred with the views of the assessing officer but allowed the commission payment to MIPL as an expenditure on the attributed income in India. On higher appeal --

Held in favour of the assessee that their Indian subsidiary did not constitute a DAPE-- Dependent Agent PE. Payment of remuneration at arm's length with the Indian agent absolves further attribution of income.

Editorial Note: The prime allegiance of the revenue was that MIPL was an exclusive agent of the assessee in India. This aspect has been well dealt in this decision where in mere exclusiveness of an agency relation cannot trigger a DAPE. Besides this, the principle that if an agent is remunerated at arm's length price then there cannot be any further attribution in India has also been dealt in.

"The assessing officer has not brought any other material to substantiate his allegation that may demonstrate that MIPL has secured orders for the assessee. It is to be noted that this clause (c) uses the word 'habitually secures orders'.

Thus, there has to be procurement of orders habitually. As against this the assessee's contention has been that MIPL is only providing support services and it is not securing order on behalf of assessee company. It may be relevant to further mention that the expression 'has' shall mean a legal existence. Whereas 'habitually secures orders' shall mean a systematic conduct on the part of the agent. Thus it is not only a legal right to secure order but also it is to be found, as a matter of fact that agent has habitually secured order.

4.2 Further, in this case the TP study of MIPL was subject matter of examination by the TPO. The FAR (Function performed, Assets deployed and Risk assumed) analysis has been accepted by the TPO. These agreement on the basis of which assessing officer has levied the allegation were also before the TPO. Thus, there cannot be any allegation that MIPL has performed any function beyond what has been stated. Functional and economic analysis of the transactions entered into having been examined nothing further can be imputed. The services of MIPL to assessee company were support services similar to the activities of a Liaison offices. This fact gets also supported from the finding recorded by the assessing officer himself in the assessment order on page 26 whereby it has been stated by the assessing officer that MIPL is functioning in the same manner as the LOs of the assessee are functioning in India. It has already been held that LOs do not constitutes PE in India.

Thus, the functioning of MIPL though a subsidiary and a company incorporated in India but its activities vis-a-vis assessee company were akin to liaison office. It does not have authority to conclude contract, it was not maintaining any stocks of goods and merchandise nor it was securing order for the assessee company. In view of the above facts we reject the contention of the learned CIT/DR that MIPL habitually secures order for the assessee company. And accordingly, none of the condition prescribed in Article 5(7) are fulfilled.

4.3 The second contention of the learned DR was that MIPL is economically dependent on assessee-company as major revenue of MIPL is from assessee company. We are of the view that this per se cannot be ground to hold that MIPL is a Dependent Agent.

For invoking this clause, first one of the three conditions needs to be fulfilled. As we have held hereinabove that MIPL does not get covered as PE under Article 5(7), it cannot be considered to be a Dependent Agent. The learned DR also made a reference to Conventions on Double Taxation by Klaus Vogel to support its contention that where a person works only for one principle such person is economically dependent on the principal, in "these circumstances the agent though not legally but will be bound to obey his principal's instructions and be regarded as being Dependent Agent. This contention of the learned CIT/DR again ignores the basic requirement, i.e., fulfilling one of the three conditions. It is also important to note that the DTAA provide for treating a person as Dependent Agent. The DTAA has to be strictly interpreted. The DTAA having prescribed the conditions, no further conditions can be read. What learned CIT-DR is canvassing will mean adding new condition in the DTAA. Further, it may be relevant to note that as per Para 9 of this Article 5 in DTAA, it has been specifically provided that if a company in the contracting state is controlled by a company in the other contracting state that itself shall not itself constitute either of company a permanent establishment of the other. Thus, the fact that MIPL is controlled by the assessee company shall not mean that MIPL is a PK of the assessee company.

4.4 Our view gets supported by the judgment of Hon'ble Delhi High Court in the case of Director of Income Tax and others v. M/s. E Funds IT Solution and Others 364 ITR 256 (Delhi), where the Hon'ble court has held as under :--

31. Paragraphs 4 and 5 of Article 5 relate to creation of agency PE in the second contracting country. Agency replaces fixed place with personal connection. Arvid K. Skaar in his work "Permanent Establishment" has opined that primacy of 'location test" of the basic rule is consistent with the conceptual structure of the PE clause itself. An agency will constitute a PE only when a PE cannot be found according to those conditions in the basic rule which are altered or replaced by the agency clause. OECD and UN Model Treaties recognize agency PE. The principle being, that a foreign enterprise may choose to perform business activities itself or through a third, person in the other States. An agent is a representative who acts on behalf of another with third persons. International taxation laws recognize and accept two distinct types of agency PE, dependent and independent Every agent by very nature of principle of agency is to follow principal's instructions. But this principle is not squarely applicable to DTAAs, as third parties may not be strictly an agent under the domestic law. Further, the aforesaid dependency cannot be the distinguishing factor which determines whether the agency is dependent or an dependent agency for the purpose of Article 5 paragraphs 4 and 5 respectively. A dependent agency is one which is bound to follow instructions and is personally dependent on the enterprise he represents. Such dependency must not be isolated or once in a while transaction but should be of comprehensive nature.

32. The "dependency test" as per Arvid A. Skaar requires examination and answer whether the business interest of the principal and the agency have merged. When there is evidence of merging of interest, then power to instruct the agent exceeds a certain level. In such cases the Principal regularly participates in the process of settling current business problems or exercises discretionary power in the said respects. OECD Commentary does not accept dependency based on financial support, supply of patents etc. as itself creating agency PE. Klaus Vogel on Double Taxation Conventions, Third Edition at page 345 in paragraph 170 states that interdependence must exist in both legal and. economic respects but the independence is the main criteria. The expression "independent agent" is used with the words "brokers and general commission 7 agents" in paragraph 5 of Article 5 will, therefore, normally not include agents who have power to conclude contracts. Paragraph 38.1 of the OECD Commentary has been quoted above (see paragraph 15). The commentary elucidates and gives illustrations and tests.

33. Earlier U.N. commentary had deviated in some respect from the OECD commentary and had observed that an agent who was wholly or almost wholly engaged by one principal shall be considered to be a dependent agent. This initial position stated in UN commentary has, however, not been accept in subsequent commentaries. The essential criteria being arms length relationship though engagement with one or a group might serve as an indicator of absence of independence of an agent.

34. Subsidiary by itself cannot be considered to be a dependent agent PE of the Principal, otherwise it would negate the overriding effect of paragraph 6 to Article 5, a provision which precedes and seeks to give recognition to separate legal entity principle associated with juristic incorporated enterprises. However, a subsidiary may become dependent or an independent PE agent provided the tests as specified in paragraphs 4 and 5 are satisfied. A dependent agent is deemed to be PE of the principal establishment under paragraph 4, if one of the three conditions specified in sub-clause (a) to (c) are satisfied. Under sub-clause (a), a dependent agent should have authority and should habitually exercise the said authority to conclude contracts on behalf of the foreign enterprise. What is meant by the term "authority to conclude contract" has been subject matter of controversy on whether participation in negotiations by the agent is sufficient or not. However, this is not relevant for the decision of the present appeals in view of the factual matrix of the present case. Sub-clause (b) refers to an agent who habitually maintains stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the Principal enterprise.

8 In such cases, the agent should also perform some additional activities in its country on behalf of the foreign enterprise which has contributed to the sale of goods or merchandise. Sub-clause (c) applies when the agent habitually secures orders in the said country i.e. where he is located, almost wholly or wholly for the foreign enterprise.

35. Transactions between a foreign enterprise and an independent agent, do not result in establishment of a permanent establishment under paragraph 5 to Article 5 if the independent agent is acting in ordinary course of their business. The expression "ordinary course of their business has reference to activity of the agent tested by reference to normal customs in the case in issue. It has. reference to normal practice in the line of business in question. However as per paragraph b of Article 5, an agent is not considered to be an independent agent if his activities are wholly or mostly wholly on behalf of foreign, enterprise and the transactions between the two are not made under arrays' length conditions. The twin conditions have to be satisfied to deny cm agent character of an independent agent. In case the transactions between an agent and the foreign principal are under arm's length conditions the second stipulation in paragraph 5 of Article 5 would not be satisfied, even if the so dependent agent is devoted wholly or almost wholly to the foreign enterprise.

36. In Morgan Stanley (supra) Supreme Court rejected the contention of the Revenue that dependent agency was created after recording that Indian subsidiary had no authority to enter into or conclude contracts on behalf of the foreign establishment/agency. The contracts were entered into in America arid, were concluded there. Only implementation of those contracts to the extent of back office operations were carried out in India. This legal position is relevant in the present case."