PE Profits Taxable Even if ALP Met; AO Cannot Use Draft Rules for Attribution: ITAT Ahmedabad on Sec 9(1)(i) & Rule 10 - 2025-05-28

ITAT Ahmedabad: Profit Attribution to PE Mandatory Even if Transactions at ALP; AO Erred in Using Draft Rules

Ahmedabad: The Income Tax Appellate Tribunal (ITAT), Ahmedabad Bench, in a significant ruling, has held that profits attributable to a Permanent Establishment (PE) in India are taxable, even if international transactions with Associated Enterprises (AEs) are determined to be at Arm's Length Price (ALP). The Tribunal also found that the Assessing Officer (AO) erred in computing such profit attribution using a formula proposed in draft CBDT rules not yet incorporated into law.

The bench, comprising Ms. Suchitra Kamble (Judicial Member) and Shri Narendra Prasad Sinha (Accountant Member), delivered the common order for Assessment Years 2012-13 and 2016-17 in appeals filed by the Deputy Commissioner of Income-Tax against Best Oasis Limited. The cases (IT(SS).A. Nos. 48 & 49/Ahd/2024) were remanded to the AO for re-computation of profit attribution in accordance with existing rules.

Case Background: Hong Kong Subsidiary , Indian Operations

Best Oasis Limited, a Hong Kong registered company and a wholly-owned subsidiary of India's Priya Blue Industries Pvt. Ltd. (PBIPL), was found to be carrying out its business operations in India through PBIPL employees. A search on the Priya Blue group in November 2019 revealed that PBIPL's Mumbai office also functioned as a key office for Best Oasis , performing significant functions.

The AO concluded that these activities constituted a business connection and a PE in India, making its income taxable in India under Section 9(1)(i) of the Income Tax Act, 1961. The AO attributed profits of Rs. 4,98,11,358 for AY 2012-13 and Rs. 1,57,90,918 for AY 2016-17 using a "Profit Attribution Theory" read with Rule 10 of the IT Rules.

The Transfer Pricing Officer (TPO), while examining international transactions, found that transactions concerning receipt of services and corporate guarantee were not at ALP. However, since the revision of ALP would reduce the assessee's income, no adjustment was proposed, citing Section 92(3) of the Act.

The Commissioner of Income-Tax (Appeals) [CIT(A)] deleted the additions, reasoning that since the TPO made no upward adjustment to the ALP of transactions with AEs, no further profit attribution could be made to the PE, even if one existed.

Revenue's Appeal and Assessee's Defence

Revenue's Arguments: The Revenue, represented by Shri Abhay Thakur, Ld. CIT.DR, argued that the assessee had a clear business connection and PE in India, as evidenced by employee statements. Therefore, income accruing from such connection was taxable in India. The AO had correctly attributed profits using Rule 10. The CIT(A) allegedly erred in deleting the addition, especially since the CIT(A) upheld the AO's finding of a PE.

Assessee's Arguments: Shri Tushar Hemani, Ld. Sr. Counsel for Best Oasis , contended that since the TPO made no ALP adjustment, no further profit attribution was warranted, even if a PE existed. He relied on several Supreme Court decisions, including Morgan Stanley & Co. (2007) 292 ITR 416 (SC) .

Tribunal's Key Findings and Reasoning

1. Existence of Permanent Establishment (PE) Upheld: The ITAT concurred with the lower authorities that Best Oasis had a PE in India. The Tribunal noted: > "It is thus evident that the critical business operations of the assessee were carried out from Mumbai Office of PBIPL, which were not in the nature of preparatory or auxiliary character, and in that sense the assessee had a PE in India." The Tribunal also referenced the Supreme Court's decision in Morgan Stanley regarding service PE, stating, "Following the same analogy, the services rendered by the employees of the holding company would also constitute a PE in this case." The assessee had not challenged this finding of a PE.

2. Profit Attribution to PE Even if Transactions at ALP: The Tribunal disagreed with the CIT(A)'s interpretation of the Morgan Stanley case and other precedents. It clarified: > "The Apex Court had held that if the international transaction was at ALP, there was no requirement for any further profit attribution... The judgment nowhere stipulates that under such circumstances the profit of PE will not be taxable in India. In fact, the question of taxability of the profit of the PE was not at all in dispute before the Hon’ble Supreme Court."

Furthermore, the ITAT pointed out a factual inaccuracy in the CIT(A)'s order: > "The finding of Ld. CIT(A) that the transaction of the assessee with its AE was at ALP, was also not correct. The TPO had held in his order...that the transaction of the assessee with its AEs in respect of receipt of services and corporate guarantee was not at ALP." The Tribunal emphasized that Article 7 of the India-Hong Kong DTAA mandates taxation of PE profits attributable to it, determined as if the PE were a distinct and separate enterprise. > "Therefore, the decision of ld. CIT(A) that the assessee was not liable to pay tax in respect of profit of its PE, as the transaction between the enterprise and its PE was at ALP, is not found correct and this finding is reversed."

3. Method of Profit Attribution by AO Incorrect: The Tribunal found that the AO's method of attributing profit was flawed as it relied on a formula proposed by a CBDT committee (letter dated 18th August, 2019) which had not been incorporated into the Income Tax Act or Rules. > "Since, the proposed Rules were not finalized and incorporated in the statute/rules, the AO was not correct in working out of the profit of PE by adopting the formula suggested by the Expert Committee. Even if the proposed formula was approved by CBDT and incorporated in the Rules, the same could not have been applied retrospectively..."

Final Decision and Implications

The ITAT allowed the Revenue's appeals for statistical purposes. The matter was set aside to the file of the AO with a direction to: > "...re-allocate the profit attributable to the PE in accordance of the Rules. The AO will be at liberty to apply one of the methodologies as prescribed in Rule-10, which is found to be most suitable for profit attribution to the PE..."

The AO is also directed to examine the assessee's proposed methodology based on "cost incurred by the assessee for its Indian operators" after providing an opportunity of being heard.

This ruling reiterates the principle that a PE's profits are independently taxable in India and clarifies that the determination of ALP for transactions with AEs does not absolve the PE from taxation of its attributable profits. It also underscores that tax authorities must apply existing legal provisions for computation and cannot rely on draft or proposed rules, especially retrospectively.