When one thinks of the applicability of the Transfer Pricing (‘TP’) provisions of the Income-tax Act, 1961 (‘Act’), the first thing that comes to mind is a situation where an Indian company has transactions with its group entities outside India or vice versa.
A situation where the applicability of TP provisions is generally not envisaged is where an Indian company is operating its branch office (‘BO’) outside India. On first glance, the said assumption seems reasonable since: (a) a BO is nothing but an extension of the Indian entity outside India and is not a separate legal entity in itself; and (b) the global income of the Indian entity is taxable in India, which would mean that the entire income of the branch office is included in the said global income by default.
However, the taxpayers may have to re-examine this position in light of the recent judgment of the Hon’ble Gujarat High Court (‘Gujarat HC’) in the case of Axis Bank Limited[1] (‘Axis’).
Decision in the case of Axis
In the said case, Axis, an Indian banking company engaged in the financial services sector, had a BOs in Sri Lanka, Singapore and Dubai. During the year under consideration, Axis’ case was referred by the Assessing Officer (‘AO’) to the Transfer Pricing Officer (‘TPO’) with respect to the transactions between the head office (‘HO’) and the BOs.
Aggrieved by it, Axis challenged the said reference inter-alia on the grounds that its BO could not be considered to be its associated enterprise (‘AE’) in terms of Section 92B of the IT Act as there was no income element involved in the transactions between the HO and BO. Axis reasoned that this was the case as the HO and the BO were the same entity and also because it was an Indian resident whose global income (which would include the BO’s income) was chargeable to tax in India. In order to support its position, Axis placed reliance on the decisions of the ITAT in Elder Exim (P.) Ltd.[2] and Aithent Technologies (P.) Ltd.[3].
While rendering its judgment, the Gujarat HC rejected Axis’ arguments and noted that the said contentions had been dealt with by the TPO in Axis’ case for another assessment year whose facts were identical to the year under consideration. Considering the TPO’s said order, the HC held that it was apparent that Axis had failed to report the international transactions between its HO and BO and the determination of ALP for such transactions would have an impact on its income. Accordingly, the HC concluded that the AO was correct in making the reference to the TPO.
From the perusal of the judgment, it appears that Gujarat HC has affirmed the following findings made by the TPO:
* The term ‘enterprise’ as defined in Section 92F of the IT Act includes within its ambit the permanent establishment (‘PE’) of an assessee. Thus, an assessee’s BO would be considered to be its AE for the purposes of TP regulations and consequently, any transaction between the HO and BO would be an ‘international transaction’.
* Even though the profits of the PE would be taken into account while computing the global income of the resident company, the credit for taxes paid in the other country would be provided in India. Consequently, transfer of higher profits to PE would result in a loss of taxes to India on account of the inflated tax credit claim by the assessee.
* In the case of banking companies, Double Taxation Avoidance Agreements (‘DTAAs’) provide that interest expenses paid to HO would be allowed while computing the income of the BO/PE. Hence, such transactions between HO and BO must be benchmarked.
* The reliance place by Axis on the decisions in Aithent Technologies (P.) Ltd. (supra) and Elder Exim (P.) Ltd. (supra) was incorrect as those cases were factually different.
Upon perusing the observations made by the TPO, the Gujarat HC held that the Assessee had failed to disclose international transaction with its overseas branches and that the TPO can exercise jurisdiction to determine ALP of the said transactions.
However, considering that the Assessee was not provided an adequate opportunity before making such reference, the Court quashed the reference made by AO and remitted the proceedings to AO for passing fresh order after hearing the Assessee.
Ramifications of the Gujarat HC decision
Even though the Court ultimately remanded the matter back to the file of Assessing Officer, the Court did validate TPO’s jurisdiction to examine the pricing of transaction between the India HO and its foreign branches. It follows from the said finding that if Indian company has its BO outside India, the latter would be considered to be its AE and consequently, any transactions between them would be considered to be ‘international transactions’ as per Section 92B of the IT Act that would have to be reported in Form 3CEB. In case the same is not done, it would inter-alia result in a penalty of 2% of the value of such ‘international transactions’ under Section 271AA of the IT Act. Further, it also seems that the ALP determined by the TPO could be considered for validating the tax credit claimed by the taxpayer.
Analysis of the Gujarat HC decision
Considering the implications of the position laid down by the Gujarat HC with respect to overseas BOs under the TP provisions, it is important to analyse the reasoning given to arrive at the aforesaid conclusions.
While reference has been made to the definition of the term ‘enterprise’ in Section 92F of the IT Act to state that a BO or PE of an Indian company would fall within its ambit, the meaning given to the terms ‘associated enterprise’ and ‘international transaction’ in Sections 92A and 92B of the IT Act respectively seems to have been overlooked.
It is a settled position of law that for two ‘enterprises’ to be classified as AEs under Section 92A, it is necessary that the conditions laid down sub-sections (1) and (2) thereof must be satisfied concurrently. In this regard, it should be noted that an overseas BO is merely an extension of an Indian company and not a separate legal entity having its own existence. Therefore, most of the scenarios laid down in Section 92A of the IT Act may not be satisfied in the case of an overseas BO of an Indian company. Thus, it can be argued that while an overseas BO may satisfy the definition of ‘enterprise’ under Section 92F, it would still not qualify as an AE under Section 92A, which is a sine qua non for a transaction between two ‘enterprises’ to be an ‘international transaction’.
Furthermore, even if it were to be argued that an overseas BO would qualify as an AE under Section 92A, a transaction between the Indian company and such BO would still have to cross the threshold of being an ‘international transaction’ under Section 92B of the IT Act. Section 92B clearly provides that for a transaction between AEs to qualify as an ‘international transaction’, the overseas BO has to be a non-resident. The term ‘non-resident’ has been defined in Section 2(30) of the IT Act in a negative manner to mean a person who is not a ‘resident’ as per section 6 of the IT Act. Averting to Section 6 of the IT Act, it becomes apparent that the test of residency can only be applicable in case of a ‘person’, whose definition in Section 2(31) only includes a ‘company’ and not a BO. Since a BO is a not a separate legal entity and rather an extension of the Indian company, there is no question of it separately being treated as a ‘non-resident’ under the IT Act. Thus, any transaction between an Indian company and its BO cannot be considered to be an ‘international transaction’.
The said view is further buttressed by the fact that the global income of an Indian company, which would include the income earned by all of its overseas BOs, is chargeable to tax in India. The said view has been discussed in detail by the ITAT in the cases of Aithent Technologies (P.) Ltd. (supra) and Elder Exim (P.) Ltd. (supra). However, this aspect has not been properly dealt with in the case of Axis Bank Limited (supra).
Moreover, while reference has been made to the provisions of DTAAs in Axis Bank Limited (supra), the TPO’s order fails to address the fact that by way of the constitution of a PE, it is not the BO of the Indian company which would be taxed in the other jurisdiction but the Indian company itself. Moreover, it is only for the purposes of computing the extent of an Indian company’s taxable income in the other jurisdiction that profits have to be attributed to the PE/BO and thus, a notional exercise of benchmarking the ‘transactions’ between them needs to be carried.
The rationale of TPO’ order (which has ultimately been accepted by the Gujarat HC) rests on examination of quantum of foreign tax credit claimed by the taxpayer as the premise to justify the TPO reference of transaction between Indian HO and foreign branch. It is without a doubt that the tax officer has the power to examine the quantum of foreign tax credit claimed by the taxpayer. This is because as per Rule 128 of the Income-tax Rules, 1962 (‘IT Rules’) foreign tax paid in excess of the tax payable as per the DTAA is to be ignored for the purpose of granting tax credit. However, the problem with this approach is that Rule 128 of the IT Rules does not authorize a reference to the TPO for determining foreign tax credit.
The established principle for permanent establishments is that the source state determines income under the Business Profits Article of the relevant treaty. Adherence by the source state to these principles obligates the resident state to grant treaty-based credits without re-computing branch income. Adopting the TPO’s interpretation would require the resident state (India, in Axis’ case) to re-determine branch income for credit purposes. Given the subjective nature of arm’s length profit determination and potential divergence between states, this interpretation would create a chaotic system, forcing taxpayers to justify branch profits in both jurisdictions and risk losing credits. Consistent application would necessitate frequent Mutual Agreement Procedure recourse to ensure credit availability.
Conclusion
As is apparent from the scheme of provisions of the IT Act, it is debatable if the Legislature ever intended to bring the transactions between Indian companies and their overseas BOs into the ambit of the TP provisions. However, till the time the decision of Gujarat HC in Axis remains the only HC decision on the issue, the Department is unlikely to accept any position to the contrary taken by taxpayers. Non-reporting of the transaction can result in a potential penalty of 2% of the value of the transaction. Therefore, considering the financial impact that non-reporting such transactions can have under the IT Act, the taxpayers may have to re-evaluate their reporting obligations in the light of the decision of Gujarat HC.
Furthermore, considering the comments of the TPO in Axis’s case, taxpayers should also be cognizant of the fact that the Department may seek to deny credit for the taxes paid in the jurisdiction in which the BO is situated basis a re-computation of the business profits attributable to such BO.
[The authors are Partner and Principal Associate, respectively, in Direct Tax practice at Lakshmikumaran & Sridharan Attorneys, New Delhi]
[1] Axis Bank Limited v. ACIT, Judgment dated 18 March 2025 in Special Civil Application No. 1717 of 2021, Gujarat HC.
[2] Elder Exim (P.) Ltd. v. DCIT, [2017] 167 ITD 208 (Mumbai).
[3] Aithent Technologies (P.) Ltd. v. DCIT, [2015] 154 ITD 285 (Delhi - Trib.).
