Introduction
The case of TBEA Shenyang Transformer Group Company Ltd. v. Deputy Commissioner of Income-tax, International Taxation[i], adjudicated by the Special Bench of the Income-tax Appellate Tribunal, Ahmedabad, addresses critical questions pertaining to the definition of ‘international transactions’ under s. 92B of the Income-tax Act, 1961 (‘Act’), and the interplay between domestic tax law and the India-China Double Taxation Avoidance Agreement (‘said DTAA’).
This case highlights the unique dynamics between a permanent establishment (‘PE’) in India and its head office (‘HO’) in China, particularly emphasizing whether transactions between the two can be classified as ‘international transactions’ under the transfer pricing (‘TP’) regime. The Tribunal’s ruling carries significant implications for multinational enterprises operating in India through branch or project offices and the application of arm’s length principles (‘ALP’) in such arrangements.
Brief Facts
The assessee, TBEA Shenyang Transformer Group Company Ltd., is a company incorporated in China with a project office (‘PO’) in India, which constitutes a PE under a. 5 of the said DTAA. The Power Grid Corporation of India Ltd. (‘PGCIL’) awarded a contract to TBEA, which included three components: offshore supply, onshore supply, and onshore services – each governed by a separate agreement.
Onshore services, mainly inland transportation and civil works, were provided by TBEA through its Indian PE. Some of these services were subcontracted to independent third-party contractors. The HO in China received payments directly from PGCIL and managed the funds of the Indian PE. At the same time, the PE did not have a bank account in India, and the HO made payments to subcontractors on behalf of the PE.
The transfer pricing officer (‘TPO’ ) treated the arrangement between the HO and the PE as an ‘international transaction’ under s. 92B of the Act. It argued that the execution of the onshore service contract and the resulting expenses represented a transaction between associated enterprises. The TPO also noted that the rate per unit for civil works charged by the PE to PGCIL was lower than those paid to subcontractors, leading to substantial losses for the PE.
The assessee contended that transactions between an HO and its PE cannot be deemed ‘international transactions’ as they occur within the same legal entity. The assessee also relied on a. 9 of the said DTAA, arguing that neither the HO nor the PE qualified as residents, thereby exempting them from TP regulations.
Issue
The Special Bench of the Tribunal considered the question: Whether transactions between a foreign enterprise and its Indian PE qualify as ‘international transactions’ under s. 92B of the Act and are subject to arm's length pricing adjustments
Decision
The Tribunal ruled in favour of the Revenue and held that transactions between the HO and the Indian PE qualify as international transactions under s. 92B and, accordingly, referred the matter to the Division Bench for computation of the arm’s length price and necessary adjustments. The reasoning behind this decision can be understood as follows:
Applicability of TP Provisions to PE-HO Transactions: The Tribunal ruled that a PE must be treated as a distinct and separate entity from its HO under a. 7(2) of the said DTAA. For TP purposes, transactions between the HO and PE were held to be ‘international transactions,’ which fell within the ambit of s. 92B of the Act. It was further clarified that a. 7(2) of the said DTAA aligns with the ALP, ensuring that profits attributable to the PE are calculated as if it were a separate enterprise engaging in transactions with unrelated parties.
Control over Funds and Revenue: It was observed that the HO exercised complete control over the funds of the Indian PE, and the revenue generated by the PE was determined through agreements executed by the HO with PGCIL. Thus, it was noted that the PE’s losses were not merely incidental but stemmed from the arrangement structured by the HO, thereby triggering TP scrutiny.
Definition of ‘International Transactions’: It was observed that as per s. 92F(v) of the Act, a ‘transaction’ includes any arrangement, understanding, or coordinated action, even if it is informal or not legally enforceable. Therefore, it was held that the HO-PE transactions met the statutory definition of ‘international transactions’ under s. 92B of the Act.
Rejection of Assessee’s Argument under A. 9: The Tribunal rejected the argument that a. 9 of the said DTAA overrides domestic TP provisions. It was clarified that a. 7(2) of the said DTAA governs profit attribution for PEs, preventing the misuse of the said DTAA provisions to evade domestic TP rules. Hence, this case had no conflict between a. 9 and the domestic TP provisions.
Applicability of s. 92B(2) of the Act: The Tribunal emphasized that s. 92B(2) creates a deeming fiction for international transactions influenced by associated enterprises. In this case, since the HO-PE transactions were influenced by a pre-existing arrangement, they were subject to arm’s length pricing adjustments.
Our Analysis
The decision of the Special Bench is a landmark ruling in TP jurisprudence concerning HO-PE transactions. It affirms that, for tax purposes, a PE must be treated as a separate entity from its HO under both domestic law (ss. 92B and 92F of the Act) and a. 7(2) of the said DTAA.
By applying ALP to HO-PE transactions, the Tribunal emphasized the importance of substance over form. The HO’s control over the PE’s funds and operations and the financial losses borne by the PE due to contractual terms dictated by the HO reflect the need for TP adjustments. The Tribunal also correctly rejected the assessee’s reliance on a. 9 of the said DTAA, clarifying that a. 7(2) governs profit attribution in such cases. This interpretation ensures that DTAA provisions are not exploited to circumvent domestic tax laws.
This decision serves as an important precedent for multinational enterprises operating in India through POs or BOs. It highlights the obligation to comply with arm’s length standards in HO-PE transactions to prevent artificial profit shifting or understatement. Thus, the Tribunal’s ruling aligns with both domestic tax principles and international best practices, reinforcing India’s commitment to fair and equitable taxation of cross-border transactions. The Division Bench’s computation of the arm’s length price will provide further guidance in finalizing the quantum of adjustments, setting a benchmark for future disputes in similar contexts.
End Note
[i] [2024] 169 taxmann.com 145 (Ahmedabad - Trib.) (SB).
Authored by Sanyam Aggarwal, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinions.