Adobe Systems Inc. v. ADIT, W.P.(C) 2384/2013 (Delhi High Court)

The taxpayer, which was a U.S.-resident corporation not having any business operations in India, received software-related research and development (R&D) services on a cost plus 15% basis from its wholly-owned Indian subsidiary ("Adobe India"). For the third assessment year in question (2006-2007), Adobe India had successfully appealed, to the Income Tax Appellate Tribunal, an assessment made on it on the basis that its cost-plus pricing for its services did not accord with the arm’s length standard, and an appeal of this decision before the High Court of Delhi was pending.

In rejecting the assessment officer’s position that the activities carried on by Adobe India were part of the taxpayer’s core business activities carried on through Adobe India as its permanent establishment, and that the taxpayer was subject to Indian income tax on a portion of its global profits based on the fraction of global R&D expenditures represented by those expended in India, Bakhru J stated (at paras. 23):

[T]here is no dispute that Adobe India - which according to the AO is the Assessee’s PE – has been independently taxed on income from R&D services and such tax has been computed on the basis that its dealings with the Assessee are at arm’s length (that is, at ALP). Therefore, even if Adobe India is considered to be the Assessee’s PE, the entire income which could be brought in the net of tax in in the hands of the Assesee has already been so taxed in the hands of Adobe India … Thus…the facts in this case do not provide the AO any reason to believe that any part of the Assessee’s income has escaped assessment under the Act.

A wholly owned Indian subsidiary of the taxpayer (“Adobe India”) provided software related research and development (R&D) services on a cost plus 15% basis to the taxpayer, which was a U.S.-resident corporation not having any business operations in India. The R&D services rendered by Adobe India were paid for by the taxpayer on cost plus basis. For the third assessment year in question (2006-2007), Adobe India had successfully appealed to the Income Tax Appellate Tribunal an assessment made on it on the basis that its cost-plus pricing for its services did not accord with the arm’s length standard, and an appeal of this decision before the High Court of Delhi was pending.

After finding that even if the taxpayer had a permanent establishement in India, the assessment officer no ability to tax the taxpayer on the fee income of Adobe India, as such income already was subject to tax in accordance with the arm's length pricing standard, Bakhru J went on to find that the taxpayer did not have a PE in India under Article 5(1) (fixed place of business), 5(2)(l) (services PE) or 5(5) (dependent agent) of the India-U.S. Double Taxation Avoidance Agreement (“DTAA”).

The exercise by the taxpayer of management over Adobe India did not make it a PE, in light of Art. 5(6) of the DTAA, which provided:

The fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State, or which carries on business in that other State (whether through a permanent establishment or otherwise), shall not of itself constitute either company a permanent establishment of the other."

Respecting Art. 5(1), Bakhru J stated (at para 32):

[I]n Director of Income Tax v. E-Funds IT Solution: [2014] 364 ITR 256 (Delhi)… this Court held that "[t]he term 'through' postulates that the taxpayer should have the power or liberty to control the place and, hence, the right to determine the conditions according to its needs". … There is no evidence that the Assessee has any right to use the premises or any fixed place at its disposal.

Respecting the absence of a service PE, Bakhru J stated (at para 35):

Clause 5.5 of the agreement referred to by the AO indicates that the Assessee is authorized to audit the Indian subsidiary (Adobe India), so as to ensure that Adobe India adheres to the standards required by the Assessee. The same cannot possibly lead to the inference that the Assessee has been rendering services to Adobe India.

Respecting the absence of dependent agent status of Adobe India, he stated (at para. 37):

[T]here is no allegation that Adobe India is authorised to conclude contracts on behalf of the Assessee or has been habitually doing so.