Direct Tax Alert - SC holds that determination of profit attributable to a PE is a question of fact


As per section 90 of the Income-tax Act, 1961 (IT Act), taxation of income of a non-resident taxpayer is governed either under the provisions of the IT Act or the Double Taxation Avoidance Agreement (DTAA), whichever is more beneficial. Where a non-resident taxpayer earns business income, the same shall be taxable in India only if it has a Permanent Establishment (PE) or Business Connection in India. Where a non-resident has a PE in India, then only the profit which is attributable to such PE shall be taxed in India. A question may arise as to whether the determination of profit attributable to PE is a question of fact or a question of law. In this regard, recently, the Supreme Court1 had an occasion to interpret whether the issue pertaining to the attribution of profit in India is a question of fact or law. We at BDO in India have summarised the ruling of the Supreme Court and provided our comments on the impact of this decision.  


Taxpayer, a foreign company, is in the business of providing electronic global distribution services to Airlines through a ‘Computerised Reservation System’ (CRS). The taxpayer maintains and operates a Master Computer System consisting of several mainframe computers and servers located in various countries. This Master Computer System is connected to airline servers, to and from which data is continuously sent and obtained regarding flight schedules, seat availability etc. In order to market and distribute the CRS services to travel agents in India, the taxpayer had appointed and entered into a distribution agreement with Indian entities. The taxpayer earned an amount of USD 3 or Euro 3 per booking made in India for providing CSR services and paid amount to Indian distribution entities ranging from USD/Euro 1-1.8 per booking i.e., 33.33% to 60% of their total earnings. The tax officer concluded that the entire income earned out of India by a taxpayer is taxable in India on the basis that the income was earned through the hardware installed by a taxpayer in the premises of the travel agents. The order was upheld by the First Appellate Authority. Aggrieved by such an order, the taxpayer filed an appeal before the Delhi Tax Tribunal which held that the taxpayer constituted fixed place PE and Dependent Agent PE (DAPE). It noted that the lion’s share of activities was processed in USA/ Europe and activities in India were only minuscule. Accordingly, based on Functions, Assets and Risk (FAR) analysis, 15% of revenue was attributed towards activities conducted by PE in India. It further noted that since the payment made to distribution agents in India was more than the said percentage, no further income was taxable in India.  Aggrieved by such order, tax authorities filed an appeal before the Delhi High Court which was dismissed on the ground that no question of law arose and it was also observed that the Delhi Tax Tribunal had adopted a reasonable approach. Hence, tax authorities filed an appeal before the Supreme Court.


The question for consideration before the Supreme Court was whether attributing 15% of the revenue as income accruing/ arising in India within the meaning of section 9(1) of the IT Act is correct? While ruling in favour of the taxpayer, the Supreme Court made the following observations:

  • The Delhi Tax Tribunal arrived at the quantum of revenue attributed to the activities carried out in India based on FAR analysis.
  • The commission paid to the distribution agents was more than twice the amount of attribution, which has already been taxed. Therefore, the Delhi Tax Tribunal rightly concluded that the same had extinguished the assessment in the taxpayer’s case.
  • The question as to what proportion of profits arose or accrued in India is essentially one of the facts. Under explanation 1(a) of section 9(1) of the IT Act, what is reasonably attributable to the operations carried out in India alone can be taken as the income of business deemed to arise or accrue in India. The question as to what proportion of profits arose or accrued in India is essentially one of the facts and the Delhi Tax Tribunal has taken into account relevant factors.
  • Tax authorities' contention of taxing the entire income of taxpayers as per Article 7 of the India-USA DTAA is dismissed because section 9(1) of the IT Act confines the taxable income to that proportion attributable to operations carried out in India.


The Supreme Court ruling reiterates the principle that profit attributable to operations carried out in India is essentially a question of fact.

While Profit Attribution Rules are yet to be notified, it is pertinent to note that the Central Board of Direct Taxes (CBDT) constituted a committee in April 2019 to bring clarity, consistency and predictability in profit attributable to PE in India. The Committee in its report had recommended a fractional apportionment method for profit attribution. However, since the CBDT is yet to come up with the changes in profit attribution rules, taxpayers must maintain robust documentation to demonstrate FAR analysis before the tax tribunal as it is the last fact-finding authority. It is pertinent to note that recently the Supreme Court in the case of SAP Labs India Private Limitedhas held that it is always open for the High Court to examine in each case whether while determining the arm’s length price, the guidelines laid down under the IT Act and the Income-tax Rules, 1962 are followed or not and whether the determination of the arm’s length price and the findings recorded by the Tribunal while determining the arm’s length price are perverse or not. While this decision is not relied on/ referred to by SC, it may have a bearing while determining whether the question of profit attribution is a question of fact or a question of law.


1 DIT. vs. Travelport Inc., Civil Appeal No. 6511-6518/2010 (Supreme Court)

2 SAP Labs India Private Limited vs ITO and Ors., Civil Appeal no. 8463 of 2022 (Supreme Court). To read our analysis on this decision, please click here

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