tax notes international - Tuck School of Business - Dartmouth College

SPECIAL REPORTS
such a case, the treaty could have simply stated
that a dependent agent or agency shall be deemed
to be PE of the enterprise; there was no need to
say, as has actually been said, that an enterprise
shall be deemed to have a PE by the virtue of
having a dependent agent and meeting one of
tests set out in the relevant sub article. Dependent
Agent and the Dependent Agent PE, therefore,
cannot be one and the same thing. 86
Regarding the determination of the profits of the
agency PE, the court relied on the OECD ‘‘Report on
the Attribution of Profits to Permanent Establishments’’
and followed the functionally separate entity
approach by stating that:
the profit computations of the PE have to proceed
on the basis that the PE is wholly independent
of its GE [General Enterprise], which from a
purely accounting and commercial point of view,
generally means nothing more than the hypothesis
that intra organization transactions are to be
taken into account at arm’s length price. 87
According to the court:
the DAPE and DA88 has to be, therefore, treated
as two distinct taxable units. The former is a hypothetical
establishment, taxability of which is on
the basis of revenues of the activities of the GE
attributable to the PE, in turn based on the
FAR89 analysis of the DAPE, minus the payments
attributable in respect of such activities, in
simple words, whatever are the revenues generated
on account of functional analysis of the
DAPE are to be taken into account as hypothetical
income of the said DAPE, and deduction is
to be provided in respect of all the expenses incurred
by the GE to earn such revenues, including,
of course, the remuneration paid to the DA.
The second taxable unit in this transaction is the
DA itself, but this taxability is in respect of the
remuneration of the DA. 90
Regarding the AAR’s ruling in Morgan Stanley, the
court stated that this argument was not persuasive as it
is ‘‘well settled in law that these rulings have binding
value only on the assessee and on the Commissioner
with reference to that particular transaction.’’ 91
The court went on to conclude:
86 Id. at para. 8.
87 Id. at para. 10.
88
DAPE stands for ‘‘dependent agent permanent establishment,’’
and DA means ‘‘dependent agent.’’
89
The court uses this acronym to refer to functions performed,
assets used, and risks assumed.
90
Indian Income Tax Appellate Tribunal, Apr. 20, 2007, decision
535/Mum/04 and 205/Mum/04, para. 11.
91
Id. at para. 17.
We are of the considered view that in addition of
the taxability of the DA in respect of remuneration
earned by him, which is in accordance with
the domestic law and which has nothing to do
with the taxability of the foreign enterprise of
which he is dependent agent, the foreign enterprise
is also taxable in India, in terms of the provisions
of Article 7 of the tax treaty, in respect of
the profits attributable to the dependent agent
PE. 92
SET Satellite is an important case because it involves
the effective application of the conclusions of the ‘‘Report
on the Attribution of Profits to Permanent Establishments,’’
despite the arguments raised by the taxpayer
against its legal status and applicability while no
change in the wording of the OECD model convention
or its commentary has been put in place. The judges
had to reconcile the interpretation that seemed to be
more appropriate with the relevant arguments raised by
the taxpayer, especially the legal status of the report,
which, at the time of the judgment, was not part of
the commentary to the current OECD model convention.
The report was not part of the commentary in
place at the time of the conclusion of the India-
Singapore treaty, which creates an additional argument
for those that defend a static, rather than an ambulatory,
interpretation of the commentary to the OECD
model convention.
As shown below, I believe this decision is correct
and provides for the most appropriate interpretation of
article 7 regarding the attribution of profits to PEs.
However, this decision was made by the Indian Income
Tax Appellate Tribunal, so it is unclear whether
the Supreme Court of India will uphold the decision or
whether it will clarify its earlier ruling in Morgan Stanley
and rule in favor of the taxpayer.
V. The Most Suitable Approach
It seems safe to conclude that the authorized OECD
approach is indeed the most appropriate approach to
attribute profits to PEs.
A. Adequate Allocation of Risks
The single taxpayer approach is quite attractive at
first sight, as it provides for an outcome that is apparently
quite logical: As the dependent agent is remunerated
on an arm’s-length basis, both home and host
states seem to get their fair share of the income that
arises in a particular transaction. 93 The home state
taxes the profits of the enterprise, while the host state
is entitled to tax the income paid to the dependent
92 Id. at para. 11.
93 Para. 272 of the ‘‘Report on the Attribution of Profits to
Permanent Establishment,’’ Part I (General Considerations),
(2006).
440 • FEBRUARY 2, 2009 TAX NOTES INTERNATIONAL
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