Feb 16, 2024

Permanent Establishment – Attribution of Profits When There Are Losses

The recent decision[1] of the Hon’ble Delhi High Court has re-ignited the issue of profit attribution to a Permanent Establishment (‘PE’) under the Double Taxation Avoidance Agreement(s) (‘DTAA’) in a situation where the foreign company had reported a net loss. Briefly put, before this decision, there was a concurrence on the view that in case of net loss there can be no attribution of profits to PE.

The Three Member Bench of the Income Tax Appellate Tribunal (‘Tribunal’) in the case of Motorola Inc. v. DCIT[2], had inter alia observed that for the purpose of attribution of profit to PE, net profit earned by the foreign entity will be considered for such attribution. When this order was appealed by the Income Tax Department (owing to some adverse findings), this finding with respect to attribution of profits was not challenged before the High Court. For subsequent tax years, the taxpayer took the plea before the Tribunal that since the taxpayer suffered net loss on global basis, no profit / income could be attributed to PE in India. Accepting this plea, the Tribunal (in the case of Nokia Solutions and Networks OY v. ACIT[3]) held that no profit / income could be attributed to PE in India if the foreign entity incurred net loss on an entity level. Whilst holding so, the Tribunal noted that the findings of the Special Bench as mentioned above were not challenged before the High Court and thus, such findings of the Tribunal that the profit on net basis will be considered whilst attributing profit to PE stood accepted by the Revenue Department. Hence, in view of the same, the Tribunal held that no income could be attributed to PE in India since the taxpayer suffered loss on global basis. Consequently, the Income Tax Department challenged the decision passed by the Tribunal before the High Court of Delhi.

The High Court by way of its Order dated December 02, 2022, in the case of CIT v. Nokia Solutions and Network OY[4], categorically ruled that in terms of Article 7(1) of the DTAA, the issue of taxability would only arise when the profit has accrued to the taxpayer and only to that extent, it could be attributable to PE in India. Thus, in the absence of any profit earned by the taxpayer, any attribution of profit to PE in India would be impermissible. Hence, the finding of the Tribunal that the question of attribution does not even arise in a scenario where the taxpayer incurred net loss on an entity level was upheld.

Recently, the High Court of Delhi in the case of Hyatt International Southwest Asia Ltd.[5] doubted the observations made by the High Court in Nokia’s case. In view of the High Court, attribution of profit to PE in India must be determined on the footing that the PE is an independent taxable entity and profits should be computed basis India operations. The bench further observed that it is possible for a foreign entity to suffer net loss on an entity level owing to losses suffered by group companies despite earning profit from activities carried through PE in India. Further, the High Court noted that this aspect was not dealt with by the coordinate bench and hence, referred the issue to a larger bench of the High Court for consideration.

In view of this development, the issue of profit attribution in case where the foreign entity has suffered a loss is a subject matter of consideration before the Delhi High Court, and position is ambiguous which until now was certain in terms of the observation made in Nokia’s case.

[1] Hyatt International Southwest Asia Ltd. v. ACIT, [2023 DHC 9320 – DB] (Delhi High Court).

[2] Motorola Inc. v. DCIT, [2005] 95 ITD 269 (Delhi – Special Bench – Tribunal).

[3] Nokia Solutions and Networks OY v. ACIT, [2022] 97 ITR(T) 79 (Delhi Tribunal).

[4] CIT v. Nokia Solutions and Network OY, [2023] 445 ITR 157 (Delhi High Court).

[5] Supra note 1.




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