Onus on AO to show foreign co has a PE in India. Under India-France DTAA, even dependent agent is not PE in absence of finding that transactions are not at ALP

Delmas, France vs. ADIT (ITAT Mumbai)

The assessee, a French company, engaged in the operation of ships in international traffic, claimed that it did not have a PE in India and that no part of its income was chargeable to tax in India. The AO & DRP held that as the assessee had an agent in India which concluded contracts, obtained clearances and did the other work, there was a PE in India under Articles 5(5) & 5(6) of the DTAA. On appeal by the assessee, HELD allowing the appeal:

(i) In order to constitute a PE under Article 5(1) & 5(2), three criteria are required to be satisfied viz; physical criterion (existence), functionality criterion (carrying out of business through that place of physical location) & subjective criterion (right to use that place). There must exist a physical “location”, the enterprise must have the “right” to use that place and the enterprise must “carry on” business through that place. An “agency” PE will not satisfy this condition because the enterprise will not have the “right” to use the place of the agent. Under Article 5(6) of the India-French DTAA (which is at variance with the UN & OECD Model Conventions), even a wholly dependent agent is to be treated as an independent agent unless if it is shown that the transactions between him and the enterprise are not at arms’ length. The Department’s argument that as the AO had not examined whether the transactions were done in arm’s length conditions, the matter should be restored to him is not acceptable because the onus was on the Revenue to demonstrate that the assessee had a PE. The onus is greater where the very foundation of DAPE rested on the negative finding that the transactions between the agent and the enterprise were not made under at arms length conditions. A negative finding about transactions with the dependent agent not being at ALP is sine qua non for existence of a DAPE under the India-France DTAA. The AO could not be granted a fresh inning for making roving and fishing enquiries whether the transactions were at arm’s length conditions or not (Airlines Rotables 44 SOT 368 followed);

(ii) (Observed, on a conceptual note, taking note of revenue’s plea but without deciding) If as a result of a DAPE, no additional profits, other than the agent’s remuneration in the source country – which is taxable in the source state anyway de hors the existence of PE, become taxable in the source state, the very approach to the DAPE profit attribution seems incongruous. Further, before accepting the DAPE profit neutrality theory, as per Morgan Stanley 292 ITR 416 (SC), the arm’s length remuneration paid to the PE must take into account ‘all the risks of the foreign enterprise as assumed by the PE’. In an agency PE situation, a DAPE assumes the entrepreneurship risk in respect of which the agent can never be compensated because even as DAPE inherently assumes the entrepreneurship risk, an agent cannot assume that entrepreneurship risk. To this extent, there may be a subtle line of demarcation between a dependent agent and a dependent agency PE. The tax neutrality theory, on account of existence of DAPE, may not be wholly unqualified at least on a conceptual note.