JUDGMENT judgment of court was delivered by S. H. Kapadia J. Leave granted. In these civil appeals we are concerned with articles in Double Tax Avoidance Agreement ( DTAA ) between India and United States which have implication on transfer pricing legislation. said Treaty either advocates application of arm s length principle or provides mechanism for avoiding double taxation on income. Morgan Stanley Group (MS Group) is one of world s largest diversifying financial services companies. It is world wide leader in investment banking and it is ranked amongst top institutions in merger and acquisitions, underwriting of equity and equity and related transactions. It has major presence in major securities markets, with traders in numerous countries around world offering unique distribution of products. It has three main lines of business, namely securities investment management and investment banking and credit services. Morgan Stanley and Company (for short, MSCo ) is investment bank engaged in [1991] 187 ITR (St.) 102. business of providing financial advisory services, corporate lending and securities underwriting. One of group companies of Morgan Stanley, Morgan Stanley Advantages Services Pvt. Ltd. (for short, MSAS ) entered into agreement for providing certain support services to MSCo. MSCo outsourced some of its activities to MSAS. said MSAS was set up to support main office functions in equity and fixed income research, account reconciliation and providing IT enabled services such as back office operations, data processing and support centre to MSCo. On May 5, 2005, MSCo (applicant) filed its advance ruling application in Form No. 34-C inviting its advance ruling on points enumerated hereinbelow. basic question relating to transaction between applicant and MSAS on which advance ruling was sought was two fold namely, whether applicant was having P.E. in India under article 5(1) of DTAA on account of services rendered by MSAS under services agreement dated April 14, 2005 entered into by MSAS with applicant and if so, amount of income attributable to such P.E. By impugned ruling delivered on February 13, 2006, by Authority for Advance Rulings (for short, AAR ) it was held, inter alia, that applicant cannot be regarded as having fixed place of business P.E. under article 5(1) of DTAA; that MSAS cannot be regarded as agency P.E. under article 5(4) of DTAA; that applicant would be regarded as having P.E. in India under article 5(2)(l) if it were to send some of its employees to India as stewards or as deputationists in employment of MSAS. Against this ruling of AAR applicant and Department have come to this court in appeal by way of special leave petition. According to Department applicant should be regarded as having fixed place in India under article 5(1) as applicant proposes to carry on its business through MSAS in India. According to Department MSAS was P.E. of MSCo in India. They had fixed place of business in Mumbai. According to Department nature of activities proposed to be performed by MSAS in Mumbai indicated that said company represented business presence of MSCo in India. Department also submitted that MSAS was legally and financially dependent upon applicant and consequently MSAS constituted agency P.E. of applicant under article 5(4) of DTAA. Both these contentions were rejected by AAR vide above impugned ruling. However, it has been ruled by AAR that MSAS should be regarded as constituting service P.E. under article 5(2)(l) as it proposed to send its employees to India for undertaking stewardship activities and for undertaking to send some of its employees to Morgan Stanley and Co., In re [2006] 284 ITR 260. India as deputationists in employment of MSAS. It is against this ruling of AAR that applicant has come to this court by way of appeal. On second question AAR ruled that transactional net margin method (TNMM) was most appropriate method for determination of arm s length price (ALP) in respect of service agreement dated April 14, 2005. between applicant and MSAS and as said method meets test of arm s length as prescribed under section 92C of 1961 Act, no further income was attributable in hands of MSAS in India. said ruling of AAR on question of income attributable MSAS in India. said ruling of AAR on question of income attributable to P.E. is subject matter of challenge by Department. Existence of P.E. in India With globalization, many economic activities spread over to several tax jurisdiction. This is where concept of P.E. becomes important under article 5(1). There exists P.E. if there is fixed place through which business of enterprise, which is multi-national enterprise (MNE), is wholly or partly carried on. In present case MSCo is multi-national entity. As stated above it has outsourced some of its activities to MSAS in India. general definition of P.E. in first part of article 5(1) postulates existence of fixed place of business whereas second part of article 5(1) postulates that business of MNE is carried out in India through such fixed place. One of questions which we are called upon to decide is whether activities to be undertaken by MSAS consist of back office operations of MSCo and if so whether such operations would fall within ambit of expression place through which business of enterprise is wholly or partly carried out in article 5(1). We quote herein below articles 5 and 7 of DTAA: Article 5 Permanent establishment 1. For purposes of this Convention, term permanent establishment means fixed place of business through which business of enterprise is wholly or partly carried on. 2. term permanent establishment includes especially: (a) place of management; (b) branch; (c) office; (d) factory; (e) workshop; See [1991] 187 ITR (St.) 102, 106. (f) mine, oil or gas well, quarry or any other place of extraction of natural resources; (g) warehouse, in relation to person providing storage facilities for others; (h) farm, plantation or other place where agriculture, forestry, plantation or related activities are carried on; (i) store or premises used as sales outlet; (j) installation or structure used for exploration or exploitation of natural resources, but only if so used for period of more than 120 days in any twelve month period; (k) building site or construction, installation or assembly project or supervisory activities in connection therewith, where such site, project or activities (together with other such sites, projects or activities, if any) continue for period of more than 120 days in any twelve month period; (l) furnishing of services, other than included services as defined in article 12 (royalties and fees for included services), within Contracting State by enterprise through employees or other personnel, but only if; (i) activities of that nature continue within that State for period or periods aggregating more than 90 days within any twelvemonth period; or (ii) services are performed within that State for related enterprise (within meaning of paragraph 1 of article 9 (associated enterprise)). 3. Notwithstanding preceding provisions of this article, term permanent establishment shall be deemed not to include any one or more of following: (a) use of facilities solely for purpose of storage, display, or occasional delivery of goods or merchandise belonging to enterprise; (b) maintenance of stock of goods or merchandise belonging to enterprise solely for purpose of storage, display, or occasional delivery; (c) maintenance of stock of goods, or merchandise belonging to enterprise solely for purpose of processing by another enterprise; (d) maintenance of fixed place of business solely for purpose of purchasing goods or merchandise, or of collecting information, for enterprise; (e) maintenance of fixed place of business solely for purpose of advertising, for supply of information, for scientific research or for other activities which have preparatory or auxiliary character, for enterprise. 4. Notwithstanding provisions of paragraphs 1 and 2, where person other than agent of independent status to whom paragraph 5 applies is acting in Contracting State on behalf of enterprise of other Contracting State, that enterprise shall be deemed to have permanent establishment in first- mentioned State if: (a) he has and habitually exercises in that first-mentioned State authority to conclude contracts on behalf of enterprise, unless his activities are limited to those mentioned in paragraph 3 which, if exercised through fixed place of business, would not make that fixed place of business permanent establishment under provisions of that paragraph; (b) he has no such authority but habitually maintains in firstmentioned State stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of enterprise, and some additional activities conducted in that State on behalf of enterprise have contributed to sale of goods or merchandise; or (c) he habitually secures orders in first-mentioned State, wholly or almost wholly for enterprise. 5. enterprise of Contracting State shall not be deemed to have permanent establishment in other Contracting State merely because it carries on business in that other State through broker, general commission agent, or any other agent of independent status, provided that such persons are acting in ordinary course of their business. However, when activities of such agent are devoted wholly or almost wholly on behalf of that enterprise and transactions between agent and enterprise are not made under arm s length conditions, he shall not be considered agent of independent status within meaning of this paragraph. 6. fact that company which is resident of Contracting State controls or is controlled by company which is resident of other Contracting State, or which carries on business in that other State (whether through permanent establishment or otherwise), shall not of itself constitute either company permanent establishment of other... Article 7 Business profits 1. profits of enterprise of Contracting State shall be taxable only in that State unless enterprise carries on business in other Contracting State through permanent establishment situated therein. If enterprise carries on business as aforesaid, profits of enterprise may be taxed in other State but only so much of them as is attributable to (a) that permanent establishment; (b) sales in other State of goods or merchandise of same or similar kind as those sold through that permanent establishment; or (c) other business activities carried on in other State of same or similar kind as those effected through that permanent establishment. 2. Subject to provisions of paragraph 3, where enterprise of Contracting State carries on business in other Contracting State through permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment profits which it might be expected to make if it were distinct and independent enterprise engaged in same or similar activities under same or similar conditions and dealing wholly at arm s length with enterprise of which it is permanent establishment and other enterprises controlling, controlled by or subject to same common control as that enterprise, in any case where correct amount of profits attributable to permanent establishment is incapable of determination or determination thereof presents exceptional difficulties, profits attributable to permanent establishment may be estimated on reasonable basis. estimate adopted shall, however, be such that result shall be in accordance with principles contained in this article. 3. In determination of profits of permanent establishment, there shall be allowed as deductions expenses which are incurred for purposes of business of permanent establishment, including reasonable allocation of executive and general administrative expenses, research and development expenses, interest, and other expenses incurred for purposes of enterprise as whole (or part thereof which includes permanent establishment), whether incurred in State in which permanent establishment is situated or elsewhere, in accordance with provisions of and subject to limitations of taxation laws of that State. However, no such deduction shall be allowed in respect of amounts, if any, paid (otherwise than towards reimbursement of actual expenses) by permanent establishment to head office of enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for use of patents, know-how or other rights, or by way of commission or other charges for specific services performed or for management, or, except in case of banking enterprises, by way of interest on moneys lent to permanent establishment. Likewise, no account shall be taken, in determination of profits of permanent establishment, for amounts charged (otherwise than toward reimbursement of actual expenses), by permanent establishment to head office of enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for use of patents, know-how or other rights, or by way of commission or other charges for specific services performed or for management, or, except in case of banking enterprise, by way of interest on moneys lent to head office of enterprise or any of its other offices. 4. No profits shall be attributed to permanent establishment by reason of mere purchase by that permanent establishment of goods or merchandise for enterprise. 5. For purposes of this Convention, profits to be attributed to permanent establishment as provided in paragraph 1(a) of this article shall include only profits derived from assets and activities of permanent establishment and shall be determined by same method year by year unless there is good and sufficient reason to contrary. 6. Where profits include items of income which are dealt with separately in other articles of Convention, then provisions of those articles shall not be affected by provisions of this article. 7. For purposes of Convention, term business profits means income derived from any trade or business including income from furnishing of services other than included services as defined in article 12 (royalties and fees for included services) and including income from rental of tangible personal property other than property described in paragraph 3 (b) of article 12 (royalties and fees for included services). In our view, second requirement of article 5(1) of DTAA is not satisfied as regards back office functions. We have examined terms of agreement along with advance ruling application made by MSCo inviting AAR to give its ruling. It is clear from reading of above agreement/application that MSAS in India would be engaged in supporting front office functions of MSCo in fixed income and equity research and in providing IT enabled services such as data processing support centre and technical services as also reconciliation of accounts. In order to decide whether P.E. stood constituted one has to undertake what is called functional and factual analysis of each of activities to be undertaken by establishment. It is from that point of view, we are in agreement with ruling of AAR that in present case article 5(1) is not applicable as said MSAS would be performing in India only back office operations. Therefore to extent of above back office functions second part of article 5(1) is not attracted. Lastly, as rightly held by AAR there is no agency P.E. as P.E. in India had no authority to enter into or conclude contracts. contracts would be entered into in United States. They would be concluded in US. implementation of those contracts only to extent of back office functions would be carried out in India, and therefore, MSAS would not constitute agency P.E. as contended on behalf of Department. In DTAA, term P.E. means fixed place of business through which business of MNE is wholly or partly carried out. definition of word P.E. in section 92F(iii) is inclusive, however it is not under article 5(1) of Treaty. It is for this reason that article 5(2) of DTAA herein refers to places included as P.E. of MNE. One such place is mentioned in article 5(2)(l) which deals with furnishing of services. concept of P.E. was introduced in 1961 Act as part of statutory provisions of transfer pricing by Finance Act of 2001. In section 92F(iii) word enterprise is defined to mean person including P.E. of such person who is proposed to be engaged in any activity relating to production . Under Central Board of Direct Taxes Circular No. 14 of 2001 it has been clarified that term P.E. has not been defined in Act but its meaning may be understood with reference to DTAA entered into by India. Thus intention was to rely on concept and definition of P.E. in DTAA. However, vide Finance Act, 2002, definition of P.E. was inserted in Income-tax Act, 1961 (for short, I.T. Act ) vide section 92F(iiia) which states that P.E. shall include fixed place of business through which business of MNE is wholly or partly carried on. This is where difference lies between definition of word P.E. in inclusive sense under Income-tax Act as against definition of word P.E. in exhaustive sense under DTAA. This analysis is important because it indicates intention of Parliament in adopting See [2001] 252 ITR (St.) 65, 107. inclusive definition of P.E. so as to cover service P.E., agency P.E., software P.E., construction P.E., etc. There is one more aspect which needs to be discussed namely, exclusion of P.E under article 5(3). Under article 5(3)(e) activities which are preparatory or auxiliary in character which are carried out at fixed place of business will not constitute P.E. Article 5(3) commences with non obstante clause. It states that notwithstanding what is stated in article 5(1) or under article 5(2) term P.E. shall not include maintenance of fixed place of business solely for advertisement, scientific research or for activities which are preparatory or auxiliary in character. In present case we are of view that abovementioned back office functions proposed to be performed by MSAS in India fall under article 5(3)(e) of DTAA. Therefore, in our view in present case MSAS would not constitute fixed place P.E. under article 5(1) of DTAA as regards its back office operations. However, question which arises for determination in present case is nature of activities performed by stewards and deputationists deployed by MSCo to work in India as employees of MSAS. Under article 5(2)(l) furnishing of services through fixed place in India can constitute P.E. AAR in impugned ruling has held that stewards and deputationists are proposed to be sent by MSCo from U.S. According to AAR there is flow of service from MSCo to MSAS when former deputes its own employees to work in India in MSAS. Therefore, according to AAR service agreement between MSCo and MSAS dated April 14, 2005, would fall under article 5(2)(l) and consequently transfer pricing regulation would apply for evaluating charges payable by MSCo to MSAS in India for such service contract. This ruling has been challenged by applicant. Article 5(2)(l) of DTAA applies in cases where MNE furnishes services within India and those services are furnished through its employees. In present case we are concerned with two activities namely stewardship activities and work to be performed by deputationists in India as employees of MSAS. customer like MSCo who has world wide operations is entitled to insist on quality control and confidentiality from service provider. For example in case of software P.E. server stores data which may require confidentiality. service provider may also be required to act according to quality control specifications imposed by its customer. It may be required to maintain confidentiality. Stewardship activities involve briefing of MSAS staff to ensure that output meets requirements of MSCo. These activities include monitoring of outsourcing operations at MSAS. object is to protect interest of MSCo. These stewards are not involved in day to day management or in any specific services to be undertaken by MSAS. management or in any specific services to be undertaken by MSAS. stewardship activity is basically to protect interest of customer. In present case as held hereinabove MSAS is service P.E. It is in sense service provider. customer is entitled to protect its interest both in terms of confidentiality and in terms of quality control. In such case it cannot be said that MSCo has been rendering services to MSAS. In our view MSCo is merely protecting its own interests in competitive world by ensuring, quality and confidentiality of MSAS services. We do not agree with ruling of AAR that stewardship activity would fall under article 5(2)(l). To this extent we find merit in civil appeal filed by appellant (MSCo) and accordingly its appeal to that extent stands partly allowed. As regards question of deputation, we are of view that employee of MSCo when deputed to MSAS does not become employee of MSAS. deputationist has lien on his employment with MSCo. As long as lien remains with MSCo said company retains control over deputationist's terms and employment. concept of service P.E. finds place in U.N. Convention. It is constituted if multinational enterprise renders services through its employees in India provided services are rendered for specified period. In this case, it extends to two years on request of MSAS. It is important to note that where activities of multinational enterprise entails it being responsible for work of deputationists and employees continue to be on payroll of multinational enterprise or they continue to have their lien on their jobs with multinational enterprise, service P.E. can emerge. Applying above tests to facts of this case we find that on request/requisition from MSAS applicant deputes its staff. request comes from MSAS depending upon its requirement. Generally, occasions do arise when MSAS needs expertise of staff of MSCo. In such circumstances, generally, MSAS makes request to MSCo. deputationist under such circumstances is expected to be experienced in banking and finance. On completion of his tenure he is repatriated to his parent job. He retains his lien when he comes to India. He lends his experience to MSAS in India as employee of MSCo as he retains his lien and in that sense there is service P.E. (MSAS) under article 5(2)(l). We find no infirmity in ruling of ARR on this aspect. In above situation, MSCo is rendering services through its employees to MSAS. Therefore, Department is right in its contention that under above situation there exists service P.E. in India (MSAS). Accordingly, civil appeal filed by Department stands partly allowed. Income attributable to P.E. Under article 7, taxability is of MNE. What is to be taxed under article 7 is income of MNE attributable to P.E. in India. income attributable to said P.E. is income attributable to foreign company s operations in India, which in terms, implies income attributable to activities carried on by MNE through its P.E. in India. Therefore, there is difference between taxability of P.E. in respect of its income earned by it in India which is in accordance with Income-tax Act, 1961 and which has nothing to do with taxability of MNE, which is also taxable in India under article 7, in respect of profits attributable to its P.E. Under article 7, taxability is of MNE. What is tax able under article 7 is profits earned by MNE. Under said Incometax Act, taxable unit is foreign company, though quantum of income taxable is income attributable to P.E. of said foreign company in India. important question which arises for determination is whether AAR is right in its ruling when it says that once transfer pricing analysis is undertaken there is no further need to attribute profits to P.E. Computation of income arising from international transactions has to be done keeping in mind principle of arm s length price. Charges paid or payable by MSCo to MSAS under service contract have to be accounted as income at arm s length price. There are different methods for determining appropriate transfer pricing. Under section 92C(1) of Income-tax Act, arm s length price in relation to international transactions has to be determined by any of following methods: (a) Comparable uncontrolled price method (CUPM) (b) Resale price method (RPM) (c) Cost plus method (CPM) (d) Profit split method (PSM) (e) Transactional net margin method (TNMM) (f) Such other method as may be prescribed by Central Board of Direct Taxes taxpayer is required to compute arm s length price for transaction(s) using one of five methods stipulated in Income-tax Rules. Rule 10C(1) of Income-tax Rules defines most appropriate method as method which is best suited to facts and circumstances of each particular international transaction. As per rule 10C(2) most appropriate method has to be selected having regard to number of factors which are enumerated therein. arm s length price has to be computed by application of methods mentioned in section 92C(1) of Incometax Act. In present case, applicant has taken opinion of Earnest and Young (for short, E & Y ), consultants, as experts who have suggested, keeping in mind various activities undertaken by MSCo and MSAS in India, TNMM as most appropriate method for determination of arm s length price in respect of transactions between MSCo and MSAS. applicant sought ruling from AAR on appropriateness of said method. On adequacy of mark- up applicant relied upon transfer pricing review undertaken by E & Y, independent consultant, for benchmarking transaction between applicant and MSAS and as per that review, average mark-up (on costs) of comparable companies providing similar services, was taken into account at 29 per cent. This was agreed upon by MSAS and applicant (MSCo). It has been accepted by Transfer Pricing Officer and by Assessing Officer. It has not been disputed by T.N. Chopra & Associates, consultants appointed by Department. Accordingly, applicant (MSCo) preferred application to AAR on following issues: (i) Appropriateness of TNMM for determination of arm s length in respect of transaction between MSCo and MSAS. (ii) Adequacy of mark-up charged by MSAS for provision of service to MSCo based on arm s length principle. (iii) Attribution of further profits in hands of P.E. of MSCo where transaction is at arm s length. (iv) Appropriateness of remuneration based on margin on total operating cost of P.E. for determining profit attributable to service P.E. As stated above, one of main points which arises for determination in present case is: whether AAR was right in ruling that as long as MSAS was remunerated for its services at arm s length, there should be no additional profits attributable to applicant or to MSAS in India. To answer above question one has to examine provisions of Income-tax Act as well as provisions of DTAA between India and U.S.A. Sections 92 to 92E of Income-tax Act contain transfer pricing provisions in Income-tax Act with effect from financial year commencing from April 1, 2001. With enactment of said sections rules for interpretation and implementation of said provisions were also amended so as to include rules 10A to 10E in Income-tax Rules. Sections 92A and 92B provide meanings of expressions associated enterprise and international transaction respectively with reference to which income is to be computed under section 92 of Income-tax Act. We quote hereinbelow sections 92A and 92B of Income-tax Act: Section 92A. Meaning of associated enterprise. (1) For purposes of this section and sections 92, 92B, 92C, 92D, 92E and 92F, associated enterprise , in relation to another enterprise, means enterprise (a) which participates, directly or indirectly, or through one or more intermediaries, in management or control or capital of other enterprise; or (b) in respect of which one or more persons who participate, directly or indirectly, or through one or more intermediaries, in its management or control or capital, are same persons who participate, directly or indirectly, or through one or more intermediaries, in management or control or capital of other enterprise. (2) For purposes of sub-section (1), two enterprises shall be deemed to be associated enterprises if, at any time during previous year, (a) one enterprise holds, directly or indirectly, shares carrying not less than twenty-six per cent. of voting power in other enterprise; or (b) any person or enterprise holds, directly or indirectly, shares carrying not less than twenty-six per cent. of voting power in each of such enterprises; or (c) loan advanced by one enterprise to other enterprise constitutes not less than fifty-one per cent. of book value of total assets of other enterprise; or (d) one enterprise guarantees not less than ten per cent. of total borrowings of other enterprise; or (e) more than half of board of directors or members of governing board, or one or more executive directors or executive members of governing board of one enterprise, are appointed by other enterprise; or (f) more than half of directors or members of governing board, or one or more of executive directors or members of governing board, of each of two enterprises are appointed by same person or persons; or (g) manufacture or processing of goods or articles or business carried out by one enterprise is wholly dependent on use of know-how, patents, copyrights, trade-marks, licences, franchises or any other business or commercial rights of similar nature, or any data, documentation, drawing or specification relating to any patent, invention, model, design, secret formula or process, of which other enterprise is owner or in respect of which other enterprise has exclusive rights; or (h) ninety per cent. or more of raw materials and consumables required for manufacture or processing of goods or articles carried out by one enterprise, are supplied by other enterprise, or by persons specified by other enterprise, and prices and other conditions relating to supply are influenced by such other enterprise; or (i) goods or articles manufactured or processed by one enterprise, are sold to other enterprise or to persons specified by other enterprise, and prices and other conditions relating thereto are influenced by such other enterprise; or (j) where one enterprise is controlled by individual, other enterprise is also controlled by such individual or his relative or jointly by such individual and relative of such individual; or (k) where one enterprise is controlled by Hindu undivided family, other enterprise is controlled by member of such Hindu undivided family, or by relative of member of such Hindu undivided family, or jointly by such member and his relative; or (l) where one enterprise is firm, association of persons or body of individuals, other enterprise holds not less than ten per cent. interest in such firm, association of persons or body of individuals; or (m) there exists between two enterprises, any relationship of mutual interest, as may be prescribed. Section 92B. Meaning of international transaction. (1) For purposes of this section and sections 92, 92C, 92D and 92E, international transaction means transaction between two or more associated enterprises, either or both of whom are non-residents, in nature or purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having bearing on profits, income, losses or assets of such enterprises and shall include mutual agreement or arrangement between two or more associated enterprises for allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with benefit, service or facility provided or to be provided to any one or more of such enterprises. (2) transaction entered into by enterprise with person other than associated enterprise shall, for purposes of sub-section (1), be deemed to be transaction entered into between two associated enterprises, if there exists prior agreement in relation to relevant transaction between such other person and associated enterprise; or terms of relevant transaction are determined in substance between such other person and associated enterprise. (emphasis supplied) Section 92B defines international transaction to mean transaction between two or more associated enterprises which are, either or both of whom are non-residents. said transaction covers purchase, sale or lease of tangible or intangible property or provision of services or lending or borrowing money or any other transaction having impact on profits, income, losses or assets of such enterprises and shall include mutual arrangement between two or more associated enterprises for allocation or apportionment of any cost or expense incurred in connection with benefit, service or facility provided to any one or more of associated enterprises. Determination of arm s length price in relation to international transactions is provided for in section 92C to Income-tax Act read with rule 10B. We quote herein below section 92C of Income-tax Act read with rules 10B and 10C of Income-tax Rules which read as under: Section 92C. Computation of arm s length price. (1) arm s length price in relation to international transaction shall be determined by any of following methods, being most appropriate method, having regard to nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as Board may prescribe, namely: (a) comparable uncontrolled price method; (b) resale price method; (c) cost plus method; (c) cost plus method; (d) profit split method; (e) transactional net margin method; (f) such other method as may be prescribed by Board. (2) most appropriate method referred to in sub-section (1) shall be applied, for determination of arm s length price, in manner as may be prescribed: Provided that where more than one price is determined by most appropriate method, arm s length price shall be taken to be arithmetical mean of such prices, or, at option of assessee, price which may vary from arithmetical mean by amount not exceeding five per cent. of such arithmetical mean. (3) Where during course of any proceeding for assessment of income, Assessing Officer is, on basis of material or information or document in his possession, of opinion that (a) price charged or paid in international transaction has not been determined in accordance with sub-sections (1) and (2); or (b) any information and document relating to international transaction have not been kept and maintained by assessee in accordance with provisions contained in sub-section (1) of section 92D and rules made in this behalf; or (c) information or data used in computation of arm s length price is not reliable or correct; or (d) assessee has failed to furnish, within specified time, any information or document which he was required to furnish by notice issued under sub-section (3) of section 92D, Assessing Officer may proceed to determine arm s length price in relation to said international transaction in accordance with sub-sections (1) and (2), on basis of such material or information or document available with him: Provided that opportunity shall be given by Assessing Officer by serving notice calling upon assessee to show cause, on date and time to be specified in notice, why arm s length price should not be so determined on basis of material or information or document in possession of Assessing Officer. (4) Where arm s length price is determined by Assessing Officer under sub-section (3), Assessing Officer may compute total income of assessee having regard to arm s length price so determined: Provided that no deduction under section 10A or section 10B or under Chapter VI-A shall be allowed in respect of amount of income by which total income of assessee is enhanced after computation of income under this sub-section: Provided further that where total income of associated enterprise is computed under this sub-section on determination of arm s length price paid to another associated enterprise from which tax has been deducted or was deductible under provisions of Chapter XVIIB, income of other associated enterprise shall not be recomputed by reason of such determination of arm s length price in case of first mentioned enterprise. Rule 10B. Determination of arm s length price under section 92C. (1) For purposes of sub-section (2) of section 92C, arm s length price in relation to international transaction shall be determined by any of following methods, being most appropriate method, in following manner, namely: (a) comparable uncontrolled price method, by which, (i) price charged or paid for property transferred or services provided in comparable uncontrolled transaction, or number of such transactions, is identified; (ii) such price is adjusted to account for differences, if any, between international transaction and comparable uncontrolled transactions or between enterprises entering into such transactions, which could materially affect price in open market; (iii) adjusted price arrived at under sub- clause (ii) is taken to be arm s length price in respect of property transferred or services provided in international transaction; (b) resale price method, by which, (i) price at which property purchased or services obtained by enterprise from associated enterprise is resold or are provided to unrelated enterprise, is identified; (ii) such resale price is reduced by amount of normal gross profit margin accruing to enterprise or to unrelated enterprise from purchase and resale of same or similar property or from obtaining and providing same or similar services, in comparable uncontrolled transaction, or number of such transactions; (iii) price so arrived at is further reduced by expenses incurred by enterprise in connection with purchase of property or obtaining of services; (iv) price so arrived at is adjusted to take into account functional and other differences, including differences in accounting practices, if any, between international transaction and comparable uncontrolled transactions, or between enterprises entering into such transactions, which could materially affect amount of gross profit margin in open market; (v) adjusted price arrived at under sub-clause (iv) is taken to be arm s length price in respect of purchase of property or obtaining of services by enterprise from associated enterprise; (c) cost plus method, by which, (i) direct and indirect costs of production incurred by enterprise in respect of property transferred or services provided to associated enterprise, are determined; (ii) amount of normal gross profit mark-up to such costs (computed according to same accounting norms) arising from transfer or provision of same or similar property or services by enterprise, or by unrelated enterprise, in comparable uncontrolled transaction, or number of such transactions, is determined; (iii) normal gross profit mark-up referred to in sub-clause (ii) is adjusted to take into account functional and other differences, if any, between international transaction and comparable uncontrolled transactions, or between enterprises entering into such transactions, which could materially affect such profit mark-up in open market; (iv) costs referred to in sub-clause (i) are increased by adjusted profit mark-up arrived at under sub-clause (iii); (v) sum so arrived at is taken to be arm s length price in relation to supply of property or provisions of services by enterprise; (d) profit split method, which may be applicable mainly in international transactions involving transfer of unique intangibles or in multiple international transactions which are so interrelated that they cannot be evaluated separately for purpose of determining arm s length price of any one transaction, by which (i) combined net profit of associated enterprises arising from international transaction in which they are engaged, is determined; (ii) relative contribution made by each of associated enterprises to earning of such combined net profit, is then evaluated on basis of functions performed, assets employed or to be employed and risks assumed by each enterprise and on basis of reliable external market data which indicates how such contribution would be evaluated by unrelated enterprise performing comparable functions in similar circumstances; (iii) combined net profit is then split amongst enterprises in proportion to their relative contributions, as evaluated under subclause (ii); (iv) profit thus apportioned to assessee is taken into account to arrive at arm s length price in relation to international transaction: Provided that combined net profit referred to in sub-clause (i) may, in first instance, be partially allocated to each enterprise so as to provide it with basic return appropriate for type of international transaction in which it is engaged, with reference to market returns achieved for similar types of transactions by independent enterprises, and thereafter, residual net profit remaining after such allocation may be split amongst enterprises in proportion to their relative contribution in manner specified under sub- clauses (ii) and (iii), and in such case aggregate of net profit allocated to enterprise in first instance together with residual net profit apportioned to that enterprise on basis of its relative contribution shall be taken to be net profit arising to that enterprise from international transaction; (e) transactional net margin method, by which, (i) net profit margin realized by enterprise from international transaction entered into with associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by enterprise or having regard to any other relevant base; (ii) net profit margin realized by enterprise or by unrelated enterprise from comparable uncontrolled transaction or number of such transactions is computed having regard to same base; (iii) net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account differences, if any, between international transaction and comparable uncontrolled transactions, or between enterprises entering into such transactions, which could materially affect amount of net profit margin in open market; (iv) net profit margin realized by enterprise and referred to in sub- clause (i) is established to be same as net profit margin referred to in sub-clause (iii); (v) net profit margin thus established is then taken into account to arrive at arm s length price in relation to international transaction. (2) For purposes of sub-rule (1), comparability of international transaction with uncontrolled transaction shall be judged with reference to following, namely: (a) specific characteristics of property transferred or services provided in either transaction; (b) functions performed, taking into account assets employed or to be employed and risks assumed, by respective parties to transactions; (c) contractual terms (whether or not such terms are formal or in writing) of transactions which lay down explicitly or implicitly how responsibilities, risks and benefits are to be divided between respective parties to transactions; (d) conditions prevailing in markets in which respective parties to transactions operate, including geographical location and size of markets, laws and Government orders in force, costs of labour and capital in markets, overall economic development and level of competition and whether markets are wholesale or retail. (3) uncontrolled transaction shall be comparable to international transaction if (i) none of differences, if any, between transactions being compared, or between enterprises entering into such transactions are likely to materially affect price or cost charged or paid in, or profit arising from such transactions in open market; or (ii) reasonably accurate adjustments can be made to eliminate material effects of such differences. (4) data to be used in analyzing comparability of uncontrolled transaction with international transaction shall be data relating to financial year in which international transaction has been entered into: Provided that data relating to period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have influence on determination of transfer prices in relation to transactions being compared. Rule 10C. Most appropriate method. (1) For purposes of subsection (1) of section 92C, most appropriate method shall be method which is best suited to facts and circumstances of each particular international transaction, and which provides most reliable measure of arm s length price in relation to international transaction. (2) In selecting most appropriate method as specified in subrule (1), following factors shall be taken into account, namely: (a) nature and class of international transaction; (b) class or classes or associated enterprises entering into transaction and functions performed by them taking into account assets employed or to be employed and risks assumed by such enterprises: (c) availability, coverage and reliability of data necessary for application of method; (d) degree of comparability existing between international transaction and uncontrolled transaction and between enterprises entering into such transactions; (e) extent to which reliable and accurate adjustments can be made to account for differences, if any, between international transaction and comparable uncontrolled transaction or between enterprises entering into such transactions; (f) nature, extent and reliability of assumptions required to be made in application of method. (emphasis supplied) methods, quoted above, namely, CUPM, RPM, CPM, PSM, TNMM etc. are mentioned in section 92C read with rule 10B. most appropriate method has to be applied for computation of arm s length price. It will depend on facts and circumstances of each particular international transaction (see rule 10C). Section 92C inter alia provides that if Assessing Officer, during course of any proceedings for assessment of income, is of opinion on basis of material or information or document that price charged or paid in international transaction has not been determined on arm s length basis or if he finds that assessee has not maintained proper documents relating to international transaction in accordance with provisions of Income-tax Act or if he finds that data used in computation of arm s length price is not reliable, Assessing Officer may proceed to determine arm s length price in relation to said transaction. Rules 10B, 10C and 10D explains determination of ALP under each of above methods. At this stage, it may be noted that on question of appropriateness of said TNMM, AAR did not give its ruling as transfer pricing proceedings had commenced before tax officer before MSCo could seek ruling. However, after impugned ruling, Transfer Pricing Officer and Assessing Officer have found said method (TNMM) to be appropriate. In our view, apart from orders passed by Assessing Officer and Transfer Pricing Officer, said method (TNMM) is appropriate method in case of service P.E. as TNMM apportions total operating profit arising from transaction on basis of sales, costs, assets, etc. As regards determination of profits attributable to P.E. in India (MSAS) is concerned on basis of arm s length principle we have quoted article 7(2) of DTAA. According to AAR where there is international transaction under which non-resident compensates P.E. at arm s length price, no further profits would be attributable in India. In this connection, AAR has relied upon Circular No. 23 of 1969 issued by Central Board of Direct Taxes as well as Circular No. 5 of 2004 also issued by Central Board of Direct Taxes. This is key question which arises for determination in these civil appeals. To answer above question we quote article 7 of U.N. Model Convention which reads as under: Article 7 Attribution of business profits Article 7 of UN Model Convention states as under: Business profits 1. profits of enterprise of Contracting State shall be taxable only in that State unless enterprise carries on business in other Contracting State through permanent establishment situated therein. If enterprise carries on business as aforesaid, profits of enterprise may be taxed in other State but only so much of them as is attributable to (a) that permanent establishment; (b) sales in that other State of goods or merchandise of same or similar kind as those sold through that permanent establishment; or (c) other business activities carried on in that other State of same or similar kind as those effected through that permanent establishment. 2. Subject to provisions of paragraph 3, where enterprise of Contracting State carries on business in other Contracting State through permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment profits which it might be expected to make if it were distinct and separate enterprise engaged in same or similar activities under same or similar conditions and dealing wholly or independently with enterprise of which it is permanent establishment. 3. In determination of profits of permanent establishment, there shall be allowed as deductions expenses which are incurred for purposes of business of permanent establishment including executive and general administrative expenses so incurred, whether in State in which permanent establishment is situated or elsewhere. However, no such deduction shall be allowed in respect of amounts, if any, paid (otherwise than towards reimbursement of actual expenses) by permanent establishment to head office of enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for use of patents or other rights, or by way of commission, for specific services performed or for management, or, except in case of banking enterprise, by way of interest on moneys lent to permanent establishment. Likewise, no account shall be taken, in determination of profits of permanent establishment, for amounts charged (otherwise than towards reimbursement of actual expenses), by permanent establishment to head office of enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for use of patents or other rights, or by way of commission for specific services performed or for management, or, except in case of banking enterprise by way of interest on moneys lent to head office of enterprise or any of its other offices. 4. In so far as it has been customary in Contracting State to determine profits to be attributed to permanent establishment on basis of apportionment of total profits of enterprise to its various parts, nothing in paragraph 2 shall preclude that Contracting State from determining profits to be taxed by such apportionment as may be customary; method of apportionment adopted shall, however, be such that result shall be in accordance with principles contained in this article. 5. For purposes of preceding paragraphs, profits to be attributed to permanent establishment shall be determined by same method year-by-year unless there is good and sufficient reason to contrary. 6. Where profits include items of income which are dealt with separately in other articles of this Convention, then provisions of those articles shall not be affected by provisions of this article. Note: question of whether profits should be attributed to permanent establishment by reason of mere purchase by that permanent establishment of goods and merchandise for enterprise was not resolved. It should therefore be settled in bilateral negotiations. Article 7 of U. N. Model Convention inter alia provides that only that portion of business profits is taxable in source country which is attributable to P.E. It specifies how such business profits should be ascertained. Under said article, P.E. is treated as if it were independent enterprise (profit centre) de hors head office and which deals with head office at arm s length. Therefore, its profits are determined on basis as if it is independent enterprise. profits of P.E. are determined on basis of what independent enterprise under similar circumstances might be expected to derive on its own. Article 7(2) of U. N. Model Convention advocates arm s length approach for attribution of profits to P.E. object behind enactment of transfer pricing regulations is to prevent shifting of profits outside India. Under article 7(2) not all profits of MSCo would be taxable in India but only those which have economic nexus with P.E. in India. foreign enterprise is liable to be taxed in India on so much of its business profit as is attributable to P.E. in India. quantum of taxable income is to be determined in accordance with provisions of Income-tax Act. All provisions of Income-tax Act are applicable, including provisions relating to depreciation, investment losses, deductible expenses, carry-forward and set-off losses etc. However, deviations are made by DTAA in cases of royalty, interest etc. Such deviations are also made under Income-tax Act (for example: sections 44BB, 44BBA etc.). Under impugned ruling delivered by AAR, remuneration to MSAS was justified by transfer pricing analysis and, therefore, no further income could be attributed to P.E. (MSAS). In other words, said ruling equates arm s length analysis (ALA) with attribution of profits. It holds that once transfer pricing analysis is undertaken; there is no further need to attribute profits to P.E. impugned ruling is correct in principle in so far as associated enterprise, that also constitutes P.E., has been remunerated on arm s length basis taking into account all risk-taking functions of enterprise. In such cases nothing further would be left to be attributed to P.E. situation would be different if transfer pricing analysis does not adequately reflect functions performed and risks assumed by enterprise. In such situation, there would be need to attribute profits to P.E. for those functions/risks that have not been considered. Therefore, in each case data placed by taxpayer has to be examined as to whether transfer pricing analysis placed by taxpayer is exhaustive of attribution of profits and that would depend on functional and factual analysis to be undertaken in each case. Lastly, it may be added that taxing corporates on basis of concept of economic nexus is important feature of attributable profits (profits attributable to P.E.). Conclusion: To conclude, we hold that AAR was right in ruling that MSAS would be service P.E. in India under article 5(2)(l), though only on account of services to be performed by deputationists deployed by MSCo and not on account of stewardship activities. As regards income attributable to P.E. (MSAS) we hold that transactional net margin method was appropriate method for determination of arm s length price in respect of transaction between MSCo and MSAS. We accept as correct computation of remuneration based on cost plus mark-up worked out at 29 per cent. on operating costs of MSAS. This position is also accepted by Assessing Officer in his order dated December 29, 2006 (after impugned ruling) and also by Transfer Pricing Officer vide order dated September 22, 2006. As regards attribution of further profits to P.E. of MSCo where transaction between two are held to be at arm s length, we hold that ruling is correct in principle provided that associated enterprise (that also constitutes P.E.) is remunerated on arm s length basis taking into account all risk-taking functions of multinational enterprise. In such case nothing further would be left to attribute to P.E. situation would be different if transfer pricing analysis does not adequately reflect functions performed and risks assumed by enterprise. In such case, there would be need to attribute profits to P.E. for those functions/risks that have not been considered. entire exercise ultimately is to ascertain whether service charges payable or paid to service provider (MSAS in this case) fully represent value of profit attributable to his service. In this connection, Department has also to examine whether P.E. has obtained services from multinational enterprise at lower than arm s length cost. Therefore, Department has to determine income, expense or cost allocations having regard to arm s length prices to decide applicability of transfer pricing regulations. Economic nexus is important aspect of principle of attribution of profits. In light of what is stated above, impugned ruling by AAR stands modified to extent indicated hereinabove. Accordingly, both civil appeals filed by applicant (MSCo) and by Department are partly allowed with no order as to costs. *** DIT (International Taxation) v. Morgan Stanley and Co. Inc