46.  ‘X’ Ltd. is an Indian subsidiary of an American company manufacturing and selling copier machines. The Indian company among other things purchases and sells these copier machines also. Does any part of the profits of the sales of American company to the Indian company accrue or arise in India? Discuss.

1. Facts of the Case

• ‘X’ Ltd. is an Indian subsidiary of an American company.
• The American parent company manufactures copier machines and sells them to ‘X’ Ltd., which then sells these in the Indian market.
• The key transaction involves export by the foreign parent to its Indian subsidiary.
• The issue is whether any part of the profit made by the American parent company on these transactions “accrues or arises” in India and hence, becomes taxable in India under the Income Tax Act, 1961.

2. Issues in the Case [Questions]

1. Does the profit earned by the American company on the sale of goods to the Indian subsidiary accrue or arise in India under Section 5 and Section 9 of the Income Tax Act?
2. Would the profits be deemed to accrue or arise in India if the American company has a business connection or Permanent Establishment (PE) in India?
3. Can the transfer pricing provisions under Indian tax law affect the taxable profits?

3. Legal Principles Covered

A. Section 5 of the Income Tax Act, 1961

• Taxable income of a non-resident includes only that which is:
  • Received or deemed to be received in India, or
  • Accrues or arises in India, or is deemed to accrue or arise in India.

B. Section 9 – Income Deemed to Accrue or Arise in India

• Income is deemed to accrue or arise in India if it results from:
  • A business connection in India, or
  • Through or from any property, asset, or source of income in India, or
  • Transfer of a capital asset situated in India.

However, mere purchase of goods by an Indian company from a foreign supplier does not constitute a business connection, unless:

• There is a Permanent Establishment (PE) of the foreign company in India, or
• The foreign company is controlling business operations through the Indian company.

C. Judicial Precedents

• DIT vs. Morgan Stanley & Co. (2007) 292 ITR 416 (SC): The Supreme Court held that a business connection or PE in India is required for a foreign entity’s income to be taxed in India.
• Ishikawajma-Harima Heavy Industries Ltd. v. DIT (2007): It was held that mere sale of goods to an Indian company does not result in income accruing in India, unless the source of income is located in India.

D. Transfer Pricing (Section 92 to 92F)

• If the American parent and the Indian subsidiary are associated enterprises, transfer pricing rules apply.
• Transactions must be at Arm’s Length Price (ALP), and any excess profit shifting can be added back in India.

4. Possible Judgement

Based on the above facts and legal principles:

• The American company’s sale of copier machines to ‘X’ Ltd. is an international transaction, but unless the American company has a Permanent Establishment or business connection in India, no portion of its profits can be taxed in India under Section 9.
• If the pricing of transactions is at arm’s length, and there is no PE or agent of the American company conducting business operations in India, then no income is deemed to accrue or arise in India.
• However, the Indian subsidiary will be taxed on its own business profits from selling these copier machines in India.
• In case the transfer pricing officer finds the transaction not at arm’s length, an adjustment can be made under Section 92C, impacting the Indian subsidiary’s taxable income, not the American parent directly.