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India rules on profits attributed to permanent establishments

A tribunal in India has ruled that payment of the arm’s length price to a dependent agent does not remove the tax liability of a foreign entities’ permanent establishment in India.

The Delhi Bench of the Income-tax Appellate made this decision following a case against Rolls Royce.

The case dates back to 2007 when the tribunal ruled that Rolls Royce had a business connection and permanent establishment in India and that 35% of the global profits from sales made in India were attributable to Rolls Royce in India.

Rolls Royce contested this decision on the grounds that payment of the arm’s-length price to the dependent agent in India would eliminate the company's tax liability having a foreign entity in India. It also challenged the fact that the Revenue had attributed profit to the permanent establishment and taxed the profits.

The company also contended that the Delhi Tribunal had ignored Madras High Court’s ruling in the case of Annamalais Timber Trust & Co which stated that 10% of profits are to be considered as profits to be attributed to India.

After considering Rolls Royce's arguments, the tribunal held that the tax liability of the non-resident in India could be eliminated only where the profits attributable to the permanent establishment equal the payments to the agent in India.

It was also decided that Rolls Royce’s transfer pricing analysis did not adequately reflect the functions performed and risks assumed by the agent and they would need to attribute profits to the permanent establishment for the risks and functions that were not considered in the analysis for determining the arm’s-length price.

A press release by KPMG's tax group in India said: “This decision has reiterated that income attribution for PE in India would depend on the facts and circumstances of each case.”

It was decided that if some activities are carried out outside India for which no profit could be attributable to the activities in India, then such profit could not be taxed there.

Similarly, losses arising from activities carried out outside India should not be considered while computing the profit. Since the activities of Rolls Royce in India consist of marketing and sales, expenses should be reduced while R&D activities which result in losses to the appellant (which are not carried out in India) should be ignored while computing global profits to be attributed to the Indian operations.

Rolls Royce was unavailable for comment at the time of press.

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