Attribution of Profits to a PE to be Based on Independent Entity Approach, Irrespective of Losses Incurred at Entity Level – Full Bench of the Delhi High Court

In the instant case, Hyatt International Southwest Asia Ltd (Taxpayer), relied upon the decision of the Delhi High Court in Nokia Solutions and Networks OY, (2022 SCC OnLine Del 5088) (Nokia Solutions), and claimed that since the Taxpayer incurred a global loss, no profit or income could be attributed to its alleged PE in India. In Nokia Solutions, the Delhi High Court affirmed the order of the Income Tax Appellate Tribunal (2005 SCC OnLine ITAT 1) and upheld the attribution of profits to a PE of an enterprise on the basis of the foreign entity’s global profitability.

A second Division Bench of the Delhi High Court disagreed with the view expressed in Nokia Solutions and took a view that the profits of a PE should be assessed and chargeable to tax in India irrespective of losses incurred at overall entity level. In light of the divergent views expressed on the issue by two Division Benches of Delhi High Court, a reference was made to a Full Bench of the Delhi High Court to adjudicate on the issue whether profit / income could be attributed to a PE of an enterprise in India if the enterprise incurs losses (Hyatt International Southwest Asia Ltd v Additional Director of Income Tax, 2023 SCC OnLine Del 8474).

The Taxpayer contended that under Article 7 of the India-UAE Tax Treaty, profits of a UAE-based enterprise are taxable only in the UAE (and not India). The Taxpayer contended that a foreign enterprise can only be taxed in India if the following three conditions are cumulatively met:

the enterprise is making a profit,

it has a PE in India and

part of that profit is attributable to the PE.

The Revenue argued that Article 7 of the Tax Treaty treats a PE as a separate and distinct enterprise, thus requiring profit attribution based solely on independent activities of the PE, irrespective of the global profits or losses of the enterprise. 

Article 7 of the Tax Treaty stipulates that the profits of an enterprise should only be taxed in the state of its residence. However, if the enterprise operates in the other state through a PE, the profits attributable to that PE can also be taxed in that other state. Article 7(2) treats the PE as a distinct and separate entity for the purposes of determining its profits.

Profits of a PE are treated as independently taxable in the state where it is located, even though the PE is part of a global enterprise.

The Court rejected the argument that taxation should be based on the overall profitability or income of the enterprise as a whole. It ruled that only the profits arising from the activities of the PE within the state where it operates should be taxed (independent of the global financials).