Q : What is the position, in light of Court rulings, on attribution of income to a Dependent Agent Permanent Establishment ("DAPE") when the Indian entity is compensated through commission etc? 

Kunj Vaidya (Partner and Leader, Transfer Pricing, PwC India)

With regard to additional profit attribution, the Supreme Court in Morgan Stanley ruling had earlier held that additional profit attribution would not be required if the Indian entity's remuneration is at arm's length, after considering all functions performed and risks assumed in India.

In the recent ruling of the Delhi Bench (Tribunal) in Daikin Industries Ltd Vs ACIT [TS-274-ITAT-2018(DEL)],the Tribunal observed that Daikin India performed incremental selling functions and was not merely a communication channel between the third party Indian customer and Daikin Japan, as stated in the inter-company agreement. The Tribunal observed that Daikin India performs entire activities of identifying customers, negotiating and finalizing prices with the Indian customers not only for products sold by it in the capacity of a distributor, but also for Daikin Japan’s direct sales in India. Thus, the Tribunal concluded that Daikin India is a DAPE of Daikin Japan and held that Daikin India's commission income is not commensurate to its true functional profile resulting in further attribution of income to the PE.

The above ruling underline the need for an arm's length compensation for the marketing activities carried out in India, which is supported by a robust TP document that adequately captures the functional and risk profile of the entities involved. If not, there would be an additional attribution of income to the PE over and above the compensation paid to the marketing entity in India.

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