Foreign Company's PE Cannot Be Presumed From Indian Affiliate's Activities: ITAT Mumbai

The Income Tax Appellate Tribunal (ITAT), Mumbai, on 16 October held that tax authorities cannot presume that a foreign enterprise has a Permanent Establishment (PE) in India merely because its Indian associated enterprise carries out business activities. They must examine the actual contractual arrangements, the parties' conduct and the applicable tax treaty provisions.

A Bench comprising Judicial Member Beena Pillai and Accountant Member Arun Khodpia remanded the PE determination and profit attribution issues in the case of Cornerstone OnDemand International Limited to the Assessing Officer for fresh examination, holding that the authorities must support any profit attribution with a reasoned analysis rather than an ad hoc percentage. The Tribunal observed:

“The determination of the existence of a PE requires an examination of the substance of the arrangement and the actual conduct of the parties, rather than merely the nomenclature employed in the agreements or the manner in which the transactions are recorded in the books of account.”

Cornerstone OnDemand International Limited, a UK-incorporated company engaged in developing cloud-based learning and talent-management software, operated alongside its Indian group entity, Cornerstone OnDemand Services India Private Limited (CSOD India).

CSOD India provided software development support services and resold software to Indian customers. It received cost-plus remuneration at 17% for support services and earned a 5% margin on software sales.

For Assessment Year 2020-21, the Assessing Officer treated CSOD India as a Dependent Agent Permanent Establishment (DAPE) of the UK company. The officer relied on CSOD India's activities, including identifying customers, marketing software, raising invoices and collecting payments. He attributed 30% of Indian software sales of Rs. 7,57,35,200 to the foreign company.

The Dispute Resolution Panel upheld the DAPE finding and additionally held that CSOD India constituted a fixed-place PE and a service PE. The Assessing Officer consequently added Rs. 2,27,20,560 to the company's income.

Cornerstone OnDemand International Limited argued that CSOD India operated as an independent reseller and lacked the authority to conclude contracts or secure orders on its behalf. It submitted that CSOD India had received arm's-length remuneration without any transfer-pricing adjustment. It also argued that an assessment accepted by another group company could not automatically determine its tax liability.

The Tribunal found that the authorities had not adequately examined the contractual terms or the actual functions CSOD India performed. It directed the Assessing Officer to determine whether CSOD India acted as an independent reseller or performed functions covered by the treaty's dependent-agent provisions.

It directed that the officer must examine who determined customer prices, bore credit risk, assumed contractual obligations and was responsible for fulfilling them. He must also verify the company's contention that CSOD India had not acquired any new customers during the relevant year.

Further, the Bench held that an assessment accepted by another group entity did not, by itself, prevent Cornerstone OnDemand International Limited from contesting its own tax liability. The authorities must determine the existence of a PE independently under the applicable treaty and the facts of the relevant assessment year. They must also separately examine whether CSOD India constituted a fixed-place PE or a service PE under the relevant treaty provisions.

On profit attribution, it found that the authorities had adopted the 30% rate largely by following the approach taken in another group company's case, without independently analysing the functions performed, assets employed and risks assumed. It observed:

“It is, therefore, necessary to examine the functional profile of CSOD India and determine whether the remuneration received by it fully captures the functions performed and risks assumed that are relevant to the alleged PE. If the remuneration is found to adequately reflect all such functions and risks, the implications of the principle laid down in Morgan Stanley shall be duly considered. Any attribution, if warranted, must be supported by a reasoned analysis and cannot be made on an ad hoc basis.”

Accordingly, the ITAT remanded the PE determination and profit attribution issues to the Assessing Officer for fresh examination and allowed all three appeals for statistical purposes.

Counsel for Appellant: Hiten Thakkar, Authorised Representative

Counsel for Respondent: Sridhar G. Menon, Senior Departmental Representative