LG Electronics Inc vs. ADIT (Allahabad High Court)

S. 147: Fact that TPO has examined international transactions in payer’s hands and found them to be at arm’s length does not mean the PE of payee cannot be assessed

The assessee, a South Korean company, entered into transactions with its wholly owned subsidiary named LG Electronics India Pvt. Ltd relating to sale of raw materials, finished goods and received royalty, fees for technical services, etc. The assessee did not file any return of income. The subsidiary deducted TDS as per the provision of the Double Taxation Avoidance Agreement between India and Korea (DTAA) on such payments. The AO conducted a survey which according to him showed that the Indian subsidiary company did not function as an independent corporate entity and is totally dependent on the assessee. He found that that the employees of the assessee were using the office of the subsidiary as a front for conducting their own business and, consequently, held that the office of the Indian company was functioning as a permanent establishment and was a fixed place of business available to the assessee as per article 6(1) of the DTAA. He accordingly issued a notice u/s 148 seeking to assess the income of the assessee. The assessee filed a Writ Petition to challenge the s. 148 notice inter alia on the ground that (i) as the Indian subsidiary had disclosed the international transactions and the same had been evaluated for transfer pricing purposes the AO was barred from , there was no fresh material and (iii) there was no application of mind by the AO before issuing the s. 148 notice. HELD by the High Court dismissing the Petition:

(i) There is a rational and live nexus between the reasons recorded and the belief that income had escaped assessment. Once the AO comes to the conclusion that the assessee has a permanent establishment and is carrying out its business activities through this permanent establishment for the purpose of supply of raw materials and finished products and that the permanent establishment was available to the employees of the assessee, who were either permanently stationed or came to India for business purposes, we are of the view that the AO has given valid reasons to believe that income had escaped assessment;

(ii) The contention that there was no fresh material before the AO is patently erroneous. The analysis made from the survey report and the documents so impounded has led the AO to reasonably believe that income had escaped assessment on account of the fact that the petitioner was carrying on business operation in India through a permanent establishment. The contention that there was no application of mind is also patently erroneous because the reasons clearly show that an in-depth study and analysis was made and reasons were recorded in detail;

(iii) The contention that as the Indian subsidiary had, in terms of s. 92E, disclosed all the transactions with the assessee relating to purchase of raw materials, finished goods etc and the TPO had found then to be at arm’s length, the AO was precluded from drawing any inference that any further income of the assessee from the same transactions was chargeable to tax had escaped assessment is erroneous and cannot be accepted. The TPO’s order will not come in the way for the reason that the TPO’s order is in relation to the transactions between a subsidiary company and the petitioner. The situation becomes different when the subsidiary company also works as a permanent establishment of the petitioner. Once a permanent establishment is established, the petitioner becomes liable to be taxed in India on so much of its business profits as is attributable to the permanent establishment in India. The order of the TPO is in relation with the subsidiary company and not in relation with the permanent establishment of the petitioner. The transfer pricing analysis is to be undertaken between the petitioner and its permanent establishment which has not taken place as yet. Once a transfer pricing analysis is done, the computation of income arising from international transaction has to be done keeping in mind the principle of arm’s length price. Once this is done, there is no further need to attribute profits to a permanent establishment. However, where the transfer pricing analysis does not take into account all the risk taking functions of the enterprise and it does not adequately reflect the function performed and the risk assumed by the petitioner, the situation would be different and, in such a situation, there would be a need to attribute profits to the permanent establishment for those functions/risk that have not been considered. This is precisely what was considered in Morgan Stanley 292 ITR 416 (SC)