Ishikawajma-Harima Heavy Industries Ltd V. Director of Income Tax, Mumbai 
Insc 8 (4 January 2007)
Sinha & Dalveer Bhandari [Arising
out of SLP (Civil) No.5318 of 2005] S.B. SINHA, J :
herein is a company incorporated in Japan. It is a resident of the said country. It pays its taxes in Japan. It is engaged, inter alia, in the
business of construction of storage tanks as also engineering etc. It formed a
consortium along with Ballast Nedam International BV, Itochu Corporation,
Mitsui & Co. Ltd., Toyo Engineering Corporation and Toyo Engineering (India) Ltd. With the said consortium
members, it entered into an agreement with Petronet LNG Limited (hereinafter
referred to as "the Petronet") on 19.01.2001 for setting up a Liquefied
Natural Gas (LNG) receiving storage and degasification facility at Dahej in the
State of Gujarat.
supplementary agreement was entered into by the parties on 19.03.2001.
contract envisaged a turnkey project. Role and responsibility of each member of
the consortium was specified separately. Each of the member of the consortium
was also to receive separate payments. Appellant was to develop, design,
engineer and procure equipment, materials and supplies, to erect and construct
storage tanks of 5 MMTPA capacity, with potential expansion to 10 MMTPA
capacity at the specified temperatures i.e. -200 degree Celsius. The
arrangement also was to include marine facilities (jetty and island break
water) for transmission and supply of the LNG to purchasers; to test and
commission the facilities relating to receipt and unloading, storage and
re-gasification of LNG and to send out of re-gasified LNG by means of a turnkey
fixed lump-sum price time certain engineering procurement, construction and
commission contract. The project was to be completed in 41 months. The contract
indisputably involved :
erection. The price was payable for offshore supply and offshore services in US
dollars, whereas that of onshore supply as also onshore services and
construction and erection partly in US dollars and partly in Indian rupees.
to pay income tax in India by the appellant herein being doubtful, an
application was filed by the same before the Authority for Advance Rulings
(Income Tax) (hereinafter referred to as 'the Authority') in terms of Section
241(Q)(1) of the Income Tax Act, 1961 (hereinafter referred to as 'the Act').
The following questions were proposed by the appellant for determination:
facts and circumstances of the case, whether the amounts, received/receivable
by the applicant from Petronet LNG for offshore supply of equipments,
materials, etc. are liable to tax in India under the provisions of the Act and
India- Japan tax treaty?
If the answer to
(1) is in the affirmative in view of Explanation (a) to section (1)(i) of the
Act and/or Article (1) read together with the protocol of the India-Japan tax
treaty, to what extent are the amounts reasonably attributable to the
operations carried out in India and accordingly taxable in India?
On the facts and
circumstances of the case, whether the amounts received/receivable by the
applicant from Petronet LNG for offshore services are chargeable to tax in India under the Act and/or the
India-Japan tax treaty?
If the answer to
(3) above is in the affirmative, to what extent would be amounts
received/receivable for such services be chargeable to tax in India under the Act and/or the
India-Japan tax treaty?
If the answer to
(3) above in the affirmative, would be applicant be entitled to claim deduction
for expenses incurred in computing the income from offshore services under the
Act and/or the India- Japan treaty? Before the Authority no issue was raised as
regards the liability of the appellant to pay income tax on onshore supply and
onshore services and on its activities relating to construction and erection.
The dispute centered round its exigibility to pay tax in respect of 'offshore
supply' and 'offshore services'.
also not in dispute that the Government of India and the Government of Japan
entered into a by-lateral treaty in regard to the tax liabilities.
of the appellant before the Authority was that the contract being a divisible
one, it did not have any liability to pay any tax in regard to offshore
services and offshore supply. Revenue, on the other hand, contended that the
contract being a composite and integrated one, they were so liable.
Authority referred to a large number of decisions governing the field and
opined that having regard to the provisions contained in Section 5 read with
Section 9 of the Act, following propositions of law would emerge :
"In a case
of sale of goods simpliciter by a non- resident to a resident in India, if the consideration for sale is
received abroad and the property in the goods also passes to the purchaser
outside India, no income accrues or arises or
deemed to accrue or arise to the seller in India.
In a case of
transaction of sale of goods by the non-resident to an Indian resident which is
a part of a composite contract involving various operations within and outside India, income from such sale shall be
deemed to accrue or arise in India if it
accrues or arises through or from any business connection in India.
In the case of a
business of which all operations are not carried out in India, the deemed
accrual or arising of income shall be only such part of the income as is
reasonably attributable to the operations carried out in India.
Whether there is
business connection in India or/and whether all operations of
the business are not carried out in India are questions of fact which have to be determined on the facts of each
case." Applying the said principles to the facts of the present case, the
Authority opined that the appellant was liable to pay direct tax even under the
Treaty having regard to Articles 5 and 7 thereof as also Clause 6 of the
Protocol. It was held :
substance of the protocol quoted above, represents the consensus reached between
the parties to the treaty in regard to the meaning of the phrase "directly
or indirectly attributable to that permanent establishment" employed in
paragraph 1 of article 7.
profits shall also be regarded as attributable to the permanent establishment
to the extent indicated in the said protocol even when the contract or order
relating to the sale or provision of goods or services in question is made or
placed directly with the overseas head office of the enterprise rather than
with the permanent establishment.
would be clear that having regard to provisions of article 7(1) of the Treaty
read with para 6 of the protocol supply of equipment of machinery (sale of
which was completed abroad, having placed the order directly overseas office of
the enterprise) the same should be within the meaning of the phrase directly or
indirectly attributable to that permanent establishment." As regards
taxability of the amounts 'received' and 'receivable' by the appellant from
Petronet for offshore services, it was held :
so far as the Treaty is concerned, both section 115A(1)(b)(B) and para 2 of
Article 12 of the Treaty clearly indicates that the whole technical fee without
any deduction is chargeable to tax, however, the tax so charged shall not
exceed 20% of the gross amount of the royalty or fee for technical
services." Question Nos. 4 and 5 were held to be the consequential ones.
It was opined :
the light of the above discussions we rule on :
that on the facts and in the circumstances of the case, the amounts
received/receivable by the applicant from Petronet LNG in respect of offshore
supply of equipment and materials is liable to be taxed in India under the
provisions of the Act and the India-Japan Treaty.
that in view of the Explanation (a) to section 9(1)(i) of the Act and/or
Article 7(1) read with the Protocol of the India-Japan Treaty the amounts that
would be taxable in India is so much of the profit as is reasonably
attributable to the operations carried out in India, we decline to answer the
other part of the question in regard to quantification of the amount taxable in
India as the parties produced no evidence and did not address in this regard.
Question No. 3
that the amount received/receivable by the applicant from Petronet LNG for
offshore services is liable to be taxed in India both under the provisions of
the Act as well as under Indo-Japan Treaty.
that the entire amount received for offshore services is chargeable to tax
under the Act and under the Treaty but at the rate not more than 20% of the
Question No. 5
that the applicant would not be able to claim any deduction in computing the
income from offshore service under the Act, and/or under the Indo-Japan
Treaty." Before us, the following findings of the Authority are not
has a business connection in India;
accrues only for supply of goods and the sale is completed outside India no
profits can accrue in India;
however, if a
contract envisages a composite consideration for the various obligations to be
performed and if certain operations are to be performed by or through the
business connection, then, profits would be deemed to accrue in India;
property in the
goods, which were the subject matter of the offshore supply, passed outside
has a permanent establishment in India within the meaning of the said term in
paragraph 3 of Article 5 of the Double Taxation Avoidance Agreement entered
into between the Governments of India and Japan (hereinafter referred to as
"the DTAA")." Mr. Harish N. Salve, the learned Senior Counsel
appearing on behalf of Appellant, urged :
misconstrued and misinterpreted the contract in arriving at its aforementioned
findings, as from a bare perusal thereof, it would appear that the payments
were made in US dollars in respect of 'offshore supply' and 'offshore services'
and furthermore title to the goods passed on to Petronate outside the
territories of India and services had also been rendered outside India;
The fact that
the contract signed in India was of consequences as converse could not have
made the appellant not liable to pay the tax;
committed a manifest error in arriving at its findings insofar as it failed to
properly construe Explanation-2 appended to Section 9(1)(vii) of the Act as it
was nobody's case that the consideration related to a construction, assembly,
mining or like project so as to fall outside the scope thereof;
received by Appellant is effectively connected to the contract but it is not
attributable to the permanent establishment and, therefore, Article 12(5) of
the Double Taxation Avoidance Agreement (DTAA) is not attracted;
a non-resident in terms of Section 5(2) of the Act, it would be chargeable to
tax in India only in the event income accrues or arises in India or is deemed
to accrue or arise in India or income is received or is deemed to be received
in India and not otherwise;
As no part of
the income for the 'offshore supply' or 'offshore services' is received in
India, the Authority misdirected itself in passing the impugned judgment;
A legal fiction
raised under the Act cannot be pushed too far. Also, as all operations in
connection with the offshore supply are carried out outside India, the question
of any portion of the consideration to be regarded as deemed to accrue or arise
in India would not arise;
of the appellant to perform certain services in India, such as unloading, port
clearance, transportation of the equipments supplied would not render the
appellant eligible to tax as the consideration thereof is embedded in the
consideration for the offshore supply;
appellant was required to carry out certain activities in India, the consideration
for offshore services had separately been provided for.
the income from the offshore supply is chargeable to tax in India on the
premise that Section 9(1)(i) applies, it was required to be examined by the
Authority as to whether it would also be chargeable in accordance with the
provisions of the Double Taxation Avoidance Agreement (DTAA) in terms whereof
no charge to tax in India was leviable in respect of the consideration for
Mohan Parasaran, the learned Additional Solicitor General appearing on behalf
of the respondent, on the other hand, submitted :
The question as
to whether terms of the contract constitute a composite contract or not is
essentially a question of fact and the findings of the Authority being final,
therefore, should not ordinarily be interfered with;
having found in favour of the Revenue two primary tests to determine as to
whether the contract in question was a composite one for execution of a turnkey
project viz :
whether the 'offshore'
and 'onshore' elements of the contract are so inextricably linked that the
breach of the 'offshore' element would result in the breach of the whole
dominant object of the contract is the execution of a turnkey project and the
question whether the title to the goods supplied passes offshore or within
India is secondary to the execution of the contract, the impugned judgment
should not be interfered with;
of the contract was directly relatable to the performance of the integrated
contract as violation and/or breach on the part of the parties thereto would
affect the entire contract;
itself providing for milestone dates, the breach of any of the terms thereof
would result in the breach of the entire contract and not just the particular
project contemplated a permanent establishment and in that view of the matter
Explanation appended to Section 9(1)(i) of the Act is directly applicable.
has business connection in India and in that view of the matter the causal
connection between the offshore supply and offshore services being interlinked
with the entire project, the opinion of the Authority cannot be faulted;
By reason of
DTAA, the parties thereto can always allocate the jurisdiction to tax the
entire income attributable to such permanent establishment to the country in
which it is established;
Supply of goods
whether offshore or onshore as well as rendition of service whether offshore or
onshore are attributable to the turnkey project and, thus, it would be wrong to
contend that in terms of Article 7 of DTAA, no tax could be levied upon the
: The Material Part :
LNG Limited, on the one hand, and five members of the consortium, on the other,
are parties to the contract. The contract contained broad items. It has its own
interpretation clauses. Clause 2.1 provides for scope of the work in the
following terms :
The Work Except as otherwise expressly provided in this Contract, Contractor
shall provide, furnish and perform, or cause to be provided, furnished and
performed, on a turnkey basis all necessary design, engineering, procurement,
supplies, installation, erection, construction, testing, commissioning,
operation and turning over services, activities and work (including all
rectification and remedial services, activities and work relating to defects
and deficiencies) for the Equipment and Materials and the Facilities in
accordance with the Scope of Work (Exhibit A) and the other terms, provisions
and requirements of this Contract, including the Contract Schedule, and shall
provide all necessary and sufficient Contractor's Equipment and experienced
personnel having the requisite expertise for such purposes.
Mechanical Completion of the Facilities, Contractor shall carry out
Commissioning, start-up and testing of the Facilities and, if requested by
Owner, shall provide advisory assistance in connection with the operation and
maintenance of the Facilities and shall provide all necessary and sufficient
experienced personnel having the requisite expertise for the prompt performance
of any rectification and remedial work required until Final Acceptance of the
Facilities, in accordance with this Contract.
Parties acknowledge and agree that this Contract is a lump-sum firm fixed price
time certain turnkey contract and Contractor's obligation to provide, furnish
and perform its services, activities and work under this Contract includes
Contractor providing Owner with the operating and completed Facilities,
complete in every detail within the time and for the purposes specified in this
Contract and to do and furnish Owner everything necessary in connection
foregoing obligations, work, services, activities and responsibilities of Contractor
are more fully set forth in this Contract, including the Scope of Work (Exhibit
Technical Documents and the obligations under Clause 2.2. are herein
collectively referred to as the "Work".
as otherwise expressly provided in this Contract, Contractor agrees and
acknowledges that Contractor shall perform all of its obligations and
responsibilities under this Contract at its own risk, cost and expense."
Clause 2.2. provides for additional responsibilities of the appellant, which
reads as under :.
Additional Responsibilities Except as otherwise expressly provided in this
Contract, Contractor shall be responsible for providing, or causing the
provision of, design, engineering, procurement, erection, construction and
commissioning and testing services, activities and work, and personnel and
labour, and all Equipment and Materials (and components thereof) and
Contractor's Equipment, and any other items not specifically described in the
Scope of Work (Exhibit- A) and/or the Technical Documents if (a) it reasonably
may be inferred in accordance with Good Industry Practice that the providing,
or causing the provision, of such additional items was contemplated as part of
the Work (including the Technical Documents) or (b) the providing, or causing
the provision, of such additional items is necessary in order for Contractor to
satisfy the Completion and Performance Guarantees and the warranties set forth,
in this Contract and to make the Facilities operable and capable of performing
as specified in the Technical Documents or as otherwise necessary in order to
comply with the requirements of this Contract. Without limitation to the
foregoing, wherever this Contract describes any portion of the Work in general
terms, but not complete in detail, Contractor agrees that the Work shall
include any incidental work, activities and services which may be reasonably
inferred as required or necessary to complete and render operable the
Facilities in accordance with the terms and conditions of the Contract, and
owner shall have no obligation or responsibility whatsoever (except as
specifically set forth in this Contract) with respect to the completion of the
shall ensure that the Facilities shall be fit and suitable for its intended purpose
(including attaining the Completion and Performance Guarantees) as evidenced
by, or reasonably to be inferred from, this Contract, and shall fully comply
with the Contract.
undertaken, Equipment and Materials (including components thereof), Contractor's
Equipment, labour and personnel, and additional items provided pursuant to this
Clause 2.2 shall not give rise to any adjustment in this Contract Price, the
Contract Schedule or any other terms of this Contract, and shall be included in
and comprise the Work for all purposes of this Contract.
7.1 provides for shipment in the following terms :
Notice of Shipment Contractor shall comply with and follow the procedures for
shipment set forth in Section E of Exhibit H (General Project Requirements and
Procedures). In particular, at least prior to arrival of each shipment in
India, Owner and Owner's insurance company providing insurance will receive
from the Contractor, the notice of shipment, such notice shall set forth the
following information concerning such shipment : (a) a reference to the date,
parties and subject matter of this Contract; (b) a description of, or that part
of, the Equipment and Materials contained in such shipment; (c) the date of
embarkation and departure, (d) the port of origin, (e) the means of shipment
(air or sea); (f) the estimated date of arrival in India; (g) the port of entry
in India; (h) the value of the shipment; (i) the approximate weight and volume
(gross and net); (j) the name, flag and owner of the vessel if shipment by sea
or the designation of aircraft if ship is by air; and (k) the number and value
of bill of lading or airfreight bill. Contractor shall ensure that a provision
similar to this Clause 7.1 is included in all agreements with Suppliers.
shall be responsible for packing, loading, transporting, receiving, unloading,
storing and protecting all Equipment and Materials and/or Contractor's
Equipment and other things required for the Works." Price is specified
under Clause 13.1 in the following terms :
Contract Price The total price to be paid by or on behalf of Owner to
Contractor in full consideration for the performance by Contractor of its
obligations and responsibilities under this Contract, including the Work, shall
be a fixed and firm lump sum price of US$ 151,044.192 (One hundred fifty one
million forty four thousand one hundred ninety two US Dollars) (the "US
Dollar Portion) and Rs.7,602,796,324 (Seven billion six hundred two million
seven hundred ninety six thousand three hundred twenty four Indian Rupees) (the
"Indian Rupee Portion"), which shall be subject to adjustment only as
provided under Clause 13.4 (the US Dollar Portion and the Indian Rupee Portion,
as the same may be so adjusted, together, the "Contract
Price")." The contract envisages that the appellant may do the job
itself or get the same done by sub-contracting. It may only do a part of the
contract splits in dollar and rupee components separately. Clause
provides for general terms of payment, effect of payment and methodology of
payment. Pursuant to or in furtherance whereof separate payment in US dollars
and Indian rupees is to be made depending upon the nature of supply viz.
offshore supply and offshore services and onshore supply and onshore services.
22.1 deals with passing of title to the goods supplied in the following terms :
Title to Equipment and Materials and Contractor's Equipment Contractor agrees
that title to all Equipment and Materials shall pass to Owner from the Supplier
or Subcontractor pursuant to Section E of Exhibit H (General Project
Requirements and Procedures).
shall, however, retain care, custody, and control of such Equipment and
Materials and exercise due care thereof until (a) Provisional Acceptance of the
Work or (b) termination of this Contract, whichever shall first occur. Such
transfer of title shall in no way affect Owner's rights under any other
provision of this Contract." The interpretation of different components of
contract has been dealt within Annexure-A appended thereto. So far as 'offshore
services work items' are concerned, the same has been defined to mean the items
of work set forth as item numbers D-2.2.1, 2.2.2 and 2.2.3 of the Contract
Price Schedule; details whereof have been mentioned in the said Annexure,
which, inter alia, provides :
xxx xxx xxx
(Exhibit D-2.1) is the price of Equipment & Material (including cost of
engineering, if any, involved in the manufacture of such Equipment &
Material) supplied from outside India on CFR basis, and the property therein
shall pass on to the Owner on high seas for permanent incorporation in the
Works, in accordance with the provisions of the Contract.
Services (Exhibit D-2.2) is the price of design and engineering including
detail engineering in relation to supplies, services and construction &
erection and cost of any other services to be rendered from outside India.
(Exhibit D-2.3 is the price of Equipment & Material supplied from within
India for direct delivery at Site and permanent incorporation in the Works.
(Exhibit D-2.4) is the price of design engineering, detail engineering, customs
clearance, inland transportation, procurement services, supervision services,
project management, testing and commissioning and any such service in relation
to the Works rendered in India." The break down of contract price is as
of Scope In Indian Rupees In US Dollars Name and address of Contracting entity
D-2.1 Offshore Supply (Total of 2.1.1., 2.1.2 and 2.1.3 Nil 81,711,877 IHI, BNI
& TEIL D-2.2 Offshore Services (Total of 2.2.2 to 2.2.3) Nil 19,756,225
IHI, BNI & TEIL D-2.3 Onshore Supply (Total of 2.3.1 to 2.3.3)
1,869,978,658 Nil IHI, BNI & TEIL D-2.4 Onshore Services (Total of 2.4.1 to
2.4.3) 1,774,353,282 12,780,467 IHI, BNI & TEIL D-2.5 Construction and
Erection (Total of 2.5.1. to 2.5.3) 3,958,464,384 36,795,623 IHI, BNI &
TEIL D-2.0 Total (D-2.1 to D- 2.5) (See Note 9 7,602,796,324 151,044,192 Treaty
: Double Taxation Avoidance Agreement (DTAA) :
5 of the Double Taxation Avoidance Agreement (DTAA) between India and Japan,
inter alia, provides as under :
" For the
purposes of this Convention, the term "permanent establishment" means
a fixed place of business through which the business of an enterprise is wholly
or partly carried on.
"permanent establishment" includes especially :
a place of
a mine, an oil
or gas well, a quarry or any other place of extraction of natural resources;
a warehouse in
relation to a person providing storage facilities for others;
plantation or other place where agriculture, forestry, plantation or related
activities are carried on;
a store or other
sales outlet; and (j) an installation or structure used for the exploration of
natural resources, but only if so used for a period of more than six months.
Clause 1 of Article 7 of the said agreement reads as under :
profits of an enterprise of a Contacting State shall be taxable only in that
Contracting State unless the enterprise carries on business in the other
contracting State through a permanent establishment situated therein. If the
enterprise carries on business as aforesaid, the profits of the enterprise may
be taxed in that other Contracting State but only so much of them as is
directly or indirectly attributable to that permanent establishment."
Clauses 1, 2 and 5 of Article 12 which are relevant for the purpose of this
case, read as under :
"Royalties and fees for technical services arising in a Contracting State and
paid to a resident of the other Contracting State may be taxed in that other
royalties and fees for technical services may also be taxed in the Contracting
State in which they arise and according to the laws of that Contracting State,
but if the recipient is the beneficial owner of the royalties or fees for
technical services, the tax so charged shall not exceed 20 per cent of the
gross amount of the royalties or fee for technical services.
of paragraphs 1 and 2 shall not apply if the beneficial owner of the royalties
or fees for technical services, being a resident of a Contracting State, carries
on business in the other Contracting State in which the royalties or fees for
technical services arise, through a permanent establishment situated therein,
or performs in that other Contracting State independent personal services from
a fixed base situated therein, and the right, property or contract in respect
of which the royalties or fees for technical services are paid is effectively
connected with such permanent establishment or fixed base. In such case, the
provisions of article 7 or article 14, as the case may be, shall apply."
The Treaty contains the Japanese notes, clause 6 whereof reads as under :
reference to paragraph 1 of article 7 of the Convention, it is understood that
by using the term "directly or indirectly attributable to the permanent
establishment", profits arising from transactions in which the permanent
establishment has been involved shall be regarded as attributable to the
permanent establishment to the extent appropriate to the part played by the
permanent establishment in those transactions. It is also understood that
profits shall be regarded as attributable to the permanent establishment to the
above-mentioned extent, even when the contract or order relating to the sale or
provision of goods or services in question is made or placed directly with the
overseas head office of the enterprise rather than with the permanent
establishment." Statutory provisions :
5(2), Section 9(1)(i), Section 9(1)(vii) of the Act, which are relevant for our
purpose, read as under :
Subject to the provisions of this Act, the total income of any previous year of
a person who is a non- resident includes all income from whatever source
derived which (a) is received or is deemed to be received in India in such
year by or on behalf of such person; or (b) accrues or arises or is deemed to
accrue or arise to him in India during such year." "9(1). The
following incomes shall be deemed to accrue or arise in India :
accruing or arising, whether directly or indirectly, through or from any
business connection in India, or through or from any property in India, or
through or from any asset or source of income in India or through the transfer
of a capital asset situate in India.
income by way of
fees for technical services payable by (a) the Government; or (b) a person who
is a resident, except where the fees are payable in respect of services
utilized in a business or profession carried on by such person outside India or
for the purposes of making or earning any income from any source outside India;
a person who is a non-resident, where the fees are payable in respect of
services utilized in a business or profession carried on by such person in
India or for the purposes of making or earning any income from any source in
that nothing contained in this clause shall apply in relation to any income by
way of fees for technical services payable in pursuance of an agreement made
before the 1st day of April, 1976, and approved by the Central
Government." Analysis :
the purpose of taxation, the authority had proceeded on the basis that the
element of tax consisted of :
and onshore services; and
construction of offshore supply and offshore services. It is not denied or
disputed, as indicated hereinbefore, that in respect of the first element of
onshore supply and onshore service, and construction tax would be payable in
basic issues which, thus, arise for our consideration are :
contract is a complex arrangement. Petronat and Appellant are not the only
parties thereto, there are other members of the consortium who are required to
carry out different parts of the contract. The consortium included an Indian
company. The fact that it has been fashioned as a turnkey contract by itself
may not be of much significance. The project is a turnkey project. The contract
may also be a turnkey contract, but the same by itself would not mean that even
for the purpose of taxability the entire contract must be considered to be an
integrated one so as to make the appellant to pay tax in India. The taxable
events in execution of a contract may arise at several stages in several years.
The liability of the parties may also arise at several stages. Obligations
under the contract are distinct ones.
obligation is distinct and separate from service obligation. Price for each of
the component of the contract is separate. Similarly offshore supply and
offshore services have separately been dealt with. Prices in each of the
segment are also different.
very fact that in the contract, the supply segment and service segment have
been specified in different parts of the contract is a pointer to show that the
liability of the appellant thereunder would also be different.
contract indisputably was executed in India. By entering into a contact in
India, although parts thereof will have to be carried out outside India would
not make the entire income derived by the contractor to be taxable in India. We
would, however, deal with this aspect of the matter a little later.
of work is contained in clause 2.1 of Ex. A appended to the contract which
includes supply of equipment, materials and facilities. The said exhibit spells
out different systems to be set in place. It imposes an obligation on the
contractor to supply equipments required therefor. It was to arrange for the
engineering services in relation thereto. It was also required to render
various other services within India. Ex. D, however, provides for the prices to
be paid in respect of offshore supplies and offshore services, onshore supply
and onshore services, construction and erection.
schedule has also been separately specified in respect of each of the
not in dispute that title in the equipments supplied was to stand transferred
upon delivery thereof outside India on high-sea basis as provided for in
Article 22.1. Similarly, Article 13.1. provides for a lump sum contract price,
whereas Article 13.3.2. specifically refers to the cost of offshore supplies.
The provisions with regard to offshore supplies and offshore services were to
be read with the provisions contained in Ex. D which formed the basis of
customs duty. Clause 13.4 refers to Ex. D as the basis for price escalation.
question of imposition of tax on income arising from a business connection may,
thus, have to be considered keeping in view the aforementioned factual
9(1)(i) of the Act states that income accruing or arising whether directly or
indirectly, through or from any business connection in India shall be deemed to
accrue or arise in India. Appellant is a non-resident assessee.
9 raises a legal fiction; but having regard to the contextual interpretation
and furthermore in view of the fact that we are dealing with a taxation statute
the legal fiction must be construed having regard to the object it seeks to
achieve. The legal fiction created under Section 9 of the Act must also be read
having regard to the other provisions thereof. [See Maruti Udyog Ltd. v. Ram
Lal and Others, (2005) 2 SCC 638] For our benefit we may notice the provisions
of Section 42 of the Income Tax Act, 1922. It provided that only such part of
income as was attributable to the operations carried out in India would be
taxable in India.
nexus doctrine, thus, plays an important part in assessment of tax. Tax is
levied on one transaction where the operations which may give rise to income
may take place partly in one territory and partly in another. The question
which would fall for our consideration is as to whether the income that arises
out of the said transaction would be required to be proportioned to each of the
territories or not.
arising out of operation in more than one jurisdiction would have territorial
nexus with each of the jurisdiction on actual basis. If that be so, it may not
be correct to contend that the entire income 'accrues or arises' in each of the
jurisdiction. The Authority has proceeded on the basis that supplies in
question had taken place offshore. It, however, has rendered, its opinion on
the premise that offshore supplies or offshore services were intimately
connected with the turnkey project.
learned Additional Solicitor General in support of his contention that the
contract is a composite one, has relied upon the following decisions :
Khadervali Sahib (Dead) by L.Rs. and Another v. N. Gudu Sahib (Dead) and Others
[(2003) 3 SCC 229]; Hindustan Shipyard Ltd. v. State of A.P.
6 SCC 579]; State of Rajasthan v. M/s Man Industrial Corporation Ltd. [(1969) 1
SCC 567], K.S. Subbiah Pillai v. Commissioner of Income Tax [(1999) 3 SCC 170];
M/s Patnaik and Co. Ltd. v. Commissioner of Income Tax, Orissa [(1986) 4 SCC
16]; BSES Ltd. (Now Reliance Energy Ltd.) v. Fenner India Ltd. and Another
[(2006) 2 SCC 728]. The said decisions, in our considered view, are not
Khadervali Sahib (supra), the question which arose for consideration was
whether an award amounted to creation of or transfer of any fresh rights in
respect of movable or immovable properties so as to require registration under
Section 17 of the Registration Act, when the same related to the properties of
a partnership firm. Therein by reason of an award, the residue upon settlement
of accounts on dissolution of the partnership firm was allocated to the
partners. It was held that the award did not require any registration.
Hindustan Shipyard (supra), the question which arose for consideration was
whether a contract constituted a sale or works contract.
down the tests therefor, having regard to the terms and conditions contained
therein, it was opined that a contract of sale of goods was separate from a
contract for works and labour. In regard to the categories of contract, it was
the contract may
be for work to be done for remuneration and for supply of materials used in the
execution of the work for a price;
it may be a
contract for work in which the use of the materials is accessory or incidental
to the execution of the work; and
it may be a
contract for supply of goods where some work is required to be done as
incidental to the sale." Whereas the first contract was held to be a
composite contract, the second was held to be a contract for work and labour
not involving the sale of goods; and the third was held to be a contract of
sale where the goods were sold as chattels and the work done was merely
view taken in State of Madras v. Gannon Dunkerley & Co.
Ltd. [1959 SCR 379] is sought to be applied. The contract in such a case must
stipulate that the equipment would be supplied on CRF basis. It spells out the
price for supply of goods, in which event, for the purpose of sales tax, the
contract would involve sale of goods. The principle of Gannon Dunkerly (supra),
does not appear to be of much relevance in the instant case.
of this court under the Sales Tax Laws referred to by the learned counsel,
moreover, may have to be considered on a different footing.
this case, we are faced with a different situation. It is only for the purpose
of taxability that the terms of the contract are required to be construed. A
turnkey contract may involve supply of materials used in the execution of the
contract for price as also for use of the materials by works and labour; but
the same may not have any relation with the taxability part of it.
interesting to note that Instruction No.1829 issued by the Central Board of
Direct Taxes on 21.09.1989 provides for certain guidelines having regard to the
possibility of undertaking of Hydro Electric Power Project by a consortium of a
foreign company, stating :
concept of turnkey execution of the project involves total and complete
responsibilities of the persons undertaking the contracts for commissioning the
project and they are accordingly required to furnish performance guarantees for
timely completion." It was further stated :
from the separate contracts for the jobs mentioned in Para 4 above, there would
be an overall co- ordination agreement between the public sector company on the
one hand and the foreign contracting parties referred to in Paragraph 4 on the
other hand to ensure guaranteed performance of all the contracts in a
coordinated manner, and within an agreed time frame and for undertaking to meet
necessary liabilities and responsibilities including payments of liquidated
damages for delays etc. One of the companies would, for this purpose, act as
leader to ensure supervision and coordination of inter-related tasks." In
M/s Man. Industrial Corporation Ltd. (supra), this Court held :
Our attention was invited to a judgment of the Court of Appeal in Love v.
Norman Wright (Builders) Ltd.
1 K.B. 484 In that case the respondents contracted with the Secretary of State
for War to do the work and supply the material mentioned in the Schedules to
the contract, including the supply of black-out curtains, curtain rails and
battens and their erection at a number of police stations. It was held by the
Court of Appeal that the respondents were liable to pay purchase-tax. Reliance
was placed upon the observations made by Godiard, L.J.
one orders another to make and fix curtains at his house the contract is one of
sale though work and labour are involved in the making and fixing, nor does it
matter that ultimately the property was to pass to the War Office under the
head contract. As between the plaintiff and the defendants the former passed
the property in the goods to the defendants who passed it on to the War
Office." We do not think that these observations furnish a universal test
that whenever there is a contract to "fix" certain articles made by a
manufacturer the contract must be deemed one for sale and not of service. The
test in each case is whether the object of the party sought to be taxed is that
the chattel as chattel passes to the other party and the services rendered in
connection with the installation are under a separate contract or are
incidental to the execution of the contract of sale." In M/s Patnaik and
Co. (supra), whereupon reliance has been placed by the learned Additional
Solicitor General, the question which arose for consideration was as to whether
the investment in the loan by the assessee out of the advance payment made by
the Government departments was a capital asset and the loan was a capital loan
or not. We are not herein concerned with such a situation. The said decision,
therefore, cannot be said to have any application at all.
BSES Ltd. (supra), this Court was concerned with the construction of bank
guarantees. The question which arose for consideration therein was as to
whether in the fact situation of the case, customer faced irretrievable
injuries so as to obtain an order of injunction. In view of the terms and
conditions of the contract, it was opined, although for the sake of convenience,
the same had been split up into four sub-contracts, it constituted a composite
contract executable on a turnkey basis. The question which arose for
consideration, thus, was whether in terms of the contract having been reduced
into writing by the "wrap around agreement", Appellant therein had a
right to negotiate any or all the guarantees for any breach of any of the four
contracts. The said decision again has no application in the facts of the
under the Act has to be assessed under different heads. Income under one head
may be subject to exemption; under same head, deductions may be claimed; yet
under another, no tax may be payable at all. Whether a part of the income of
the assessee would be taxable or not depends upon the fact of each case. Even
there is nothing to prevent the income accruing or arising at the sources.
Union of India and Another v. Azadi Bachao Andolan and Another (2004) 10 SCC
1], this Court was dealing with a double taxation treaty. It was held :
The Agreement provides for allocation of taxing jurisdiction to different
contracting parties in respect of different heads of income. Detailed rules are
stipulated with regard to taxing of dividends under Article 10, interest under
Article 11, royalties under Article 12, capital gains under Article 13, income
derived from independent personal services in Article 14, income from dependent
personal services in Article 15, directors' fees in Article 16, income of
artists and athletes in Article 17, governmental functions in Article 18,
income of students and apprentices in Article 20, income of professors,
teachers and research scholars in Article 21 and other income in Article 22.
Commissioner of Income Tax, Bombay v. Ahmedbhai Umarbhai & Co., Bombay
[(1950) SCR 335], this Court, having regard to the provisions contained in
Section 42 of the Income Tax Act, 1922, held that profits accrued to the
assessee of a part of the business in an Indian State having accrued out of
such business carried on in such State are exempted under the third proviso to
Section 5 of the Excess Profit Tax Act.
that the source of income can never be the place where the income accrues or
arises, Kania, CJ, stated :
my opinion there is nothing to prevent income accruing or arising at the place
of the source. The question where the income accrued has to be determined on
the facts of each case. The income may accrue or arise at the place of the
source or may accrue or arise elsewhere, but it does not follow that the income
cannot accrue or arise at the place where the source exists.
it is necessary to ascertain whether that part of the business which is capable
of being treated as one separate unit in the Hyderabad State has given rise to
the income or profit sought by the assessee to be exempted from taxation in the
present case" Patanjali Sastri, J. approved the application of the
principle underlying the decision in Commissioner of Taxation v. Kirk [(1900 AC
588], namely, the principle of apportioning profits as between different
processes employed in producing those profits and the different places where
they were employed.
J. held :
instance, where a person carries on manufacture, sale, export and import, it is
not possible to say that the place where the profits accrue to him is the place
profits received relate firstly to his business as a manufacturer, secondly to
his trading operations, and thirdly to his business of import and export.
Profit or loss has to be apportioned between these businesses in a businesslike
manner and according to well-established principles of accountancy. In such
cases it will be doing no violence to the meaning of the words
"accrue" or "arise" if the profits attributable to the
manufacturing business are said to arise or accrue at the place where the
manufacture is being done and the profits which arise by reason of the sale are
said to arise at the place where the sales are made and the profits in respect
of the import and export business are said to arise at the place where the
business is conducted. This apportionment of profits between a number of
businesses which are carried on by the same person at different places
determines also the place of the accrual of profits. To hold that though a
businessman has invested millions in establishing a business of manufacture,
whether in the nature of a textile mill or in the nature of steel works, yet no
profits are attributable to this business or can accrue or arise to the
business of manufacture because the produce of his mills is sold at a different
place and that it is only the act of sale by which profits accrue and they
arise only at that place is to confuse the idea of receipt of income and
realization of profits with the idea of the accrual of profits. The act of sale
is the mode of realizing the profits. If the goods are sold to a third person
at the mill premises no one could have said that these profits arose merely by
reason of the sale. Profits would only be ascribed to the business of
manufacture and would arise at the mill premises. Merely because the mill owner
has started another business organization in the nature of a sales depot or a
shop, that cannot wholly deprive the business of manufacture of its profits,
though there may have to be apportionment in such a case between the business
of manufacture and business of shop keeping. In a number of cases such
apportionment is made and is also suggested by the provisions of Section 42 of
the Indian Income Tax Act, reference to which has also been made in Proviso (2)
of Section 5 of the Excess Profits Tax Act." In Anglo-French Textile Co.
Ltd. v. Commissioner of Income Tax, Madras (1954) SCR 523], the question which
arose for consideration, inter alia, was :
(2) Can the income received in India be said to arise in India within the
meaning of Section 4-A(c)(b) of the Act? If not, should only those profits
determined under Section 42(3) as attributable to the operations carried out in
India be taken into account for applying the test laid down in Section 4-A(c)(b),
and remanded the case to the High Court with the direction that it should give
its opinion on these two questions." In regard to the first question, it
was opined that Section 42(3) had nothing to do with the determination of the
income arising in the taxable territories as distinguished from the income
arising without taxable territories as understood in Section 4A(c)(b) of the
Act, it was held "The phraseology of Section 42(3) of the Act also repels
the contention insofar as the profits and gains of the business which are
referred to therein and which are capable of apportionment as therein mentioned
are deemed to accrue or arise in the taxable territories thus using the words
"accrue" and "arise" as synonymous with each other.
above passage is also sufficient in our opinion to establish that the
apportionment of income, profits or gains between those arising from business
operations carried on in taxable territories and those arising from business
operations carried on without the taxable territories is based not on the
applicability of Section 42(3) of the Act but on general principles of
apportionment of income, profits or gains" While the first question was
answered in negative, question no.2 was answered in the following terms :
2The income received in British India cannot be said to wholly arise in India
within the meaning of Section 4-A(c)(b) of the Act and that there should be
allocation of the income between the various business operations of the
assessee company demarcating the income arising in the taxable territories in
the particular year from the income arising without the taxable territories in
that year for the purposes of Section 4-A(c)(b) of the Act." In
Carborandum Co. v. Commissioner of Income-Tax, Madras [(1977) 108 ITR 335 :
(1977) 2 SCC 862], this Court referring to its earlier decision in Commissioner
of Income Tax, Punjab v. R..D. Aggarwal and Co.& Another [(1965) 56 ITR
20], opined :
"On a plain reading of
sub-sections (1) and (3) of Section 42 it would appear that income accruing or
arising from any business connection in the taxable territories even though
the income may accrue or arise outside the taxable territories will be deemed
to be income accruing or arising in such territory provided operations in
connection with such business, either all or a part, are carried out in the
taxable territories. If all such operations are carried out in the taxable
territories, sub- section (1) would apply and the entire income accruing or
arising outside the taxable territories but as a result of the operations in
connection with the business giving rise to the income would be deemed to
accrue or arise in the taxable territories. If, however, all the operations are
not carried out in the taxable territories the profits and gains of the
business deemed to accrue or arise in the taxable territories shall be only
such profits and gains as are reasonably attributable to that part of the
operations carried out in the taxable territories. Thus comes in the question
of apportionment under sub-section (3) of Section 42." In CIT v. Mitsui
Engineering and Ship Building Co. Ltd. [259 ITR 248], on which reliance was
placed; the contention was that the finding that the contract for designing,
engineering, manufacturing, shop testing and packing up to f.o.b port of
embarkation could not be split up since the entire contract was to be read
together and was for one complete transaction. It was in the said fact
situation held that it was not possible to apportion the consideration for
design on one part and the other activities on the other part.
price paid to the assessee was the total contract price which covered all the
stages involved in the supply of machinery.
case is clearly distinguishable from the facts of the present case, since the
payment for the offshore and onshore supply of goods and services was in itself
clearly demarcated and cannot be held to be a complete contract that has to be
read as a whole and not in parts.
principle of apportionment is also recognized by Clause (a) of Explanation I.
Thus, if submission of the learned Additional Solicitor General is accepted
that the contract is a composite one, then offshore supply would be of
equipment designed and manufactured in one territory (Japan), and then sold in
another tax territory, leading to division of profits arising in two tax
territories, which is not envisaged under our taxation law.
gives rise to the question as to what would be the meaning of the phrase
'business connection in India'. Mere existence of business connection may not
result in income of the non-resident assessee from transaction with such a
business connection accruing or arising in India.
Mazagaon Dock Ltd. v. CIT and Excess Profits Tax [34 ITR 368], whereupon again
reliance placed is distinguishable. In that case a non- resident carried on
business with a resident, and the issue adjudicated upon by the Court was that
whether there was a clear and close connection between them that produced
profits or not, and whether any such income generated by the non-resident
company sending its ships for repairs to the resident company is taxable, if it
amounted to business. The Court answered both questions affirmatively.
principle laid down therein has no application to the current fact situation because
there was an extremely close connection between the appellant company and non
residents in that the two non-resident (British) companies beneficially owned
the entire share capital of the appellant company. In the present situation
there is no such connection, which can be said to give rise to a business
connection between the permanent establishment in India and the transaction
that is sought to be taxed.
again in Anglo French Textile Co. Ltd. v. CIT Madras [23 ITR 101], in the fact
situation obtaining therein, it was held that when there was a continuity of
business relationship between the person in India who helps make the profits
and the person outside who receives or realizes this profit, a business
that case, the Assessee company incorporated in the UK, owned a textile company
in French Pondichery and had appointed another limited company in Madras to act
as its constituted agents. The same was held to be a business connection within
British India. Such a close connection cannot be envisaged in the present case
since it does not involve any such principle- agent relationship between the PE
and the non residents.
Prasad Ray v. ITO [129 ITR 295] whereupon reliance has been placed, is not
apposite. Therein, the Court held that the professional relationship of a
solicitor, who was a non-resident, with an Indian firm will be a business
connection. There was a connection between the Indian firm and the British
solicitor which was real and intimate and not just a casual one and the fees
earned by the solicitor was only through this connection, and could not have
done so without associating himself with the firm. Thus, the income earned by
the solicitor was subject to tax in India, and payable by the firm as agents of
principle of this case, is again not applicable in the present scenario since
the nature of the relationship between the permanent establishment, the foreign
firms and the Indian firms are evidently contractual and not professional. And
the transaction of sale and supply of goods offshore have not taken place with
the involvement of the permanent establishment, therefore excluding this
transaction from the scope of taxation in India.
Commissioner of Income-Tax, A.P. v. Toshoku Ltd. [(1980) 125 ITR 525 : (1980)
Supp. SCC 614], this Court interpreted Section 9(1)(i) and the Explanation
thereto on the factual matrix obtaining therein that the statutory agent
exported his goods to Japan and France where they were sold through the
assessee and the entire sales price was received in India by the said agent who
made credit entries in his accounts books regarding the commission amounts
payable to the assessees and remitted the commission amounts to them
subsequently. Having regard to the fact that the Japanese company was a
non-resident company, distinguishing the case Raghava Reddi & Another v.
Commissioner of Income Tax, A.P. [(1962) 44 ITR 720] , it was held :
is not possible to hold that the non-resident assessees in this case either
received or can be deemed to have received the sums in question when their
accounts with the statutory agent were credited, since a credit balance without
more only represents a debt and a mere book entry in the debtor's own books
does not constitute payment which will secure discharge from the debt. They
cannot, therefore, be charged to tax on the basis of receipt of income actual
or constructive in the taxable territories during the relevant accounting
period." A Division Bench of the Karnataka High Court presided over by
Venkataramiah, J., in VDO Tachometer Werke, West Germany etc. v.
of Income-Tax, Karnataka-I etc. [(1979) 117 ITR 804] following Carborandum Co.
(supra), held that notwithstanding the amendment of Section 9 of the Act by the
addition of Clauses (vi) and (vii), the cases continued to be governed by the
provisions of Section 9 of the Act.
Commissioner of Income-Tax v. Atlas Steel Co. Ltd. [(1987) 164 ITR 401], a
Division Bench of the Calcutta High Court following Carborandum (supra) and
other decisions held :
"The expression "business
connection" in the context of the Income-tax Act has come to acquire a
special meaning as laid down by the Supreme Court in R.
Aggarwal & Co.'s case. A business connection contemplated under Section 42
of the Indian Income-tax Act, 1922 (corresponding to Section 9 of the
Income-tax Act, 1961, involved "a relation between a business carried on
by a non-resident and some activity in the taxable territories which are
attributable directly or indirectly to the earnings, profits or gains of such
business". It was laid down by the Supreme Court that there must be
trading activity both outside and within the taxable territory. In the facts of
this case, for the supply of inventions, patents, application for patents,
secret knowledge and know-how, no trading activity had been or was required to
be carried on by the assessee within the taxable territory. Further, on a
consideration of the agreement, it cannot be said that the trading activity
which was intended to be carried on by the assessee as production adviser of
Hindustan Steel Ltd., in future was relatable to or connected with the past
supply of the said know-how and other items.
also Income-Tax Officer and Others v. Shriram Bearings Ltd. (1987) 164 ITR
419] A similar view was taken, when the matter came before this Court in
Income-Tax Officer and Others v. Shriram Bearings Ltd. [(1997) 224 ITR 724 :
(1997) 10 SCC 332], wherein B.P. Jeevan Reddy, J. speaking for the Division
Bench, opined :
are not prepared to agree that the High Court has not correctly understood the
purport of the agreement between the respondent and M/s Nippon Seike Kabushiki
Kaisha (NSK). The agreement is in two parts. It is true that the two parts are
interdependent but yet the consideration for the sale of trade secrets and
consideration of technical assistance is separately provided for and mentioned
under separate sections. So far as the consideration for the technical
assistance is concerned, its taxability is not in doubt. The only controversy
is with respect to the taxability of 1,65,000 US Dollars which is stipulated as
the consideration for sale of trade secrets. The agreement specifically says
that the said sale is effected in Japan. We are unable to see on what basis it
can be said that any part of the said amount has been earned in India." In
construing a contract, the terms and conditions thereof are to be read as a
whole. A contract must be construed keeping in view the intention of the
parties. No doubt, the applicability of the tax laws would depend upon the
nature of the contract, but the same should not be construed keeping in view
the taxing provisions.
Commissioner of Income-Tax, Tamil Nadu-V v. Fried Krupp Industries [(1981) 128
ITR 27], a Division Bench of the Madras High Court opined :
we have what are called turnkey projects, and in such projects until the
machinery is actually run and proves its performance, the responsibility of the
foreigner would continue. But in the present case the contract cannot be
equated to a turnkey contract. The operations in India for the erection of the
machinery are only the responsibility of the Indian company. It is only any
defect in the machinery or any negligence in the performance of the foreign
engineer, that may give rise to a claim for damages. But that is not the same
as the foreign company performing any operation in pursuance of this contract
in India. Whatever we have said above would apply also to deputation of foreign
personnel for procuring Indian spare parts. It was obviously considered
necessary to get foreign personnel from abroad for this purpose only because
the type of spare parts required for the foreign machinery could be better
picked up by these personnel, who have experience in running the machinery. It
is merely an assistance provided to the Indian company, the foreign personnel
being treated as the employees of the Indian company. Having gone through the
terms of the agreement in full, we are satisfied that there are no operations
in India attributable to the foreign company which can give rise to any profits
being earned in India. The agreement itself says that the terms of the payments
were in Germany. Thus, there is absolutely no operation in India which would
give rise to tax liability in India as far as the foreign company is concerned"
The term 'permanent establishment' has not been defined in the Income Tax Act.
the appellant carries on business in India through a Permanent Establishment,
they clearly fall out of the applicability of Article 12(5) of the DTAA and
into the ambit of Article 7. The Protocol to the DTAA, in paragraph 6,
discusses the involvement of the permanent establishment in transactions, in
order to determine the extent of income that can be taxed. It is stated that
the term 'directly or indirectly attributable' indicates the income that shall
be regarded on the basis of the extent appropriate to the part played by the
permanent establishment in those transactions. The permanent establishment here
has had no role to play in the transaction that is sought to be taxed, since
the transaction took place abroad.
1 of Article 7, thus, provides that if an income arises in Japan (Contracting
State), it shall be taxable in that country unless the enterprise carries on
business in the other Contracting State (India) through a permanent
establishment situated therein. What is to be taxed is profit of the enterprise
in India, but only so much of them as is directly or indirectly attributable to
that permanent establishment. All income arising out of the turnkey project
would not, therefore, be assessable in India, only because the assessee has a
relevant to note that the tax treaty between India and Japan is essentially
based on OECD model, providing :
of a resident, including of the kind that would fall under would be table under
Section 9, would be taxed in the State of residence, save and except the income
attributable to a Permanent Establishment, and
even in the case
of a permanent establishment, income from business would be taxable in the
State of residence." In Klaus Vogel on Double Taxation Conventions, it is
of attraction principle : The second sentence of Art. 7 (1) allows the State of
the permanent establishment to tax business profits, 'but only so much of them
as is attributable to that permanent establishment'. The MC has thus decided
against adopting the so-called 'force of attraction of the permanent
establishment', i.e. against the principle that, where there is a permanent
establishment, the State of the permanent establishment should be allowed to
tax all income derived by the enterprise from sources in that State
irrespective of whether or not such income is economically connected with the permanent
establishment. In line with the domestic law then prevailing in the USA, such a
'force of attraction' was, for instance, incorporated in Germany's 1954 DTC
with USA (second sentence of Art. III (I). In contrast, the second sentence of
Art. 7(1) MC allows the State of the permanent establishment to tax only those
profits which are economically attributable to the permanent establishment,
i.e. those which result from the permanent establishment's activities, which
arise economically from the business carried on by the permanent establishment
(cf. also para 5 MC Comm. Art. 7, supra m. no. 10). As regards the profits made
by the enterprise in the State of the permanent establishment, a distinction
must always be made between those profits which result from the permanent
establishment's activities and those made, without any interposition of the
permanent establishment, by the head office or any other part of the enterprise
(also for mere assembly permanent establishment :BFH 37 RIW 258 (1991). It is only
when there is a connection with the permanent establishment that the State of
the permanent establishment is entitled to impose tax.
losses incurred in connection with direct transactions may not be set off
against a permanent establishment's profits. Since a DTC may not increase tax
liability, the USA, it is true, imposes tax at the lower amount that would
ensue if the permanent establishment's business and direct transactions were
combined and treated as if no DTC existed (of course, the taxpayer may, in such
event, not only set off the result of individual direct transactions, which
amounted to a loss against the permanent establishment's positive operating
result :I.R.S. Rev. Rul. 84-17, 1984-I Cum. Bull. 308).
to that ruling, the taxpayer is in such cases entitled to elect taxation which
discounts the DTC. (see surpa Art. I, at m. no.44)." We generally agree
with the said statement law.
distinction between the existence of a business connection and the income
accruing or arising out of such business connection is clear and explicit. In
the present case, the permanent establishment's non- involvement in this
transaction excludes it from being a part of the cause of the income itself,
and thus there is no business connection.
5.3 provides that a person is regarded as having a permanent establishment if
he carries on construction and installation activities in a Contracting State
only if the said activities are carried out for more than six months. Paragraph
6 of the Protocol to India Japan Tax Treaty also provides that only income
arising from activities wherein the permanent establishment has been involved
can be said to be attributable to the permanent establishment. It gives rise to
two questions, firstly offshore services are rendered outside India; the
permanent establishment would have no role to play in respect thereto in the
earning of the said income.
entire services having been rendered outside India, the income arising
therefrom cannot be attributable to the permanent establishment so as to bring
within the charge of tax.
attracting the taxing statute there has to be some activities through permanent
establishment. If income arises without any activity of the permanent
establishment, even under the DTAA the taxation liability in respect of oversea
services would not arise in India. Section 9 spells out the extent to which the
income of non-resident would be liable to tax in India.
9 has a direct territorial nexus. Relief under a Double Taxation Treaty having
regard to the provisions contained in Section 90(2) of the Income Tax Act would
arise only in the event a taxable income of the assessee arises in one
Contracting State on the basis of accrual of income in another Contracting
State on the basis of residence. Thus, if Appellant had income that accrued in
India and is liable to tax because in its State all residents it was entitled
to relief from such double taxation payable in terms of Double Taxation Treaty.
However, so far as accrual of income in India is concerned, taxability must be
read in terms of Section 4(2) read with Section 9, whereupon the question of
seeking assessment of such income in India on the basis of Double Taxation
Treaty would arise.
cases such as this, where different severable parts of the composite contract
is performed in different places, the principle of apportionment can be
applied, to determine which fiscal jurisdiction can tax that particular part of
the transaction. This principle helps determine, where the territorial
jurisdiction of a particular state lies, to determine its capacity to tax an
it to composite transactions which have some operations in one territory and
some in others, is essential to determine the taxability of various operations.
therefore, in our opinion, the concepts profits of business connection and
permanent establishment should not be mixed up. Whereas business connection is
relevant for the purpose of application of Section 9;
concept of permanent establishment is relevant for assessing the income of a
non-resident under the DTAA. There, however, may be a case where there can be
over-lapping of income; but we are not concerned with such a situation. The
entire transaction having been completed on the high seas, the profits on sale
did not arise in India, as has been contended by the appellant.
having been excluded from the scope of taxation under the Act, the application
of the double taxation treaty would not arise. Double Tax Treaty, however, was
taken recourse to by Appellant only by way of an alternate submission on income
from services and not in relation to the tax of offshore supply of goods.
would in the aforementioned context consider the question of division of
taxable income of offshore services. Parties were ad idem that there existed a
distinction between onshore supply and offshore supply. The intention of the
parties, thus, must be judged from different types of services, different types
of prices, as also different currencies in which the prices are to be paid.
9(1)(vii)(c) of the Act states that "a person who is a non- resident,
where the fees are payable in respect of services utilized in a business or
profession, carried on by such person in India, or for the purposes of making
or earning any income from any source in India".
the provision in its plain sense, it can be seen that it requires two
conditions have to be met the services which are the source of the income that
is sought to be taxed, has to be rendered in India, as well as utilized in
India, to be taxable in India. In the present case, both these conditions have
not been satisfied simultaneously, therefore excluding this income from the
ambit of taxation in India. Thus, for a non-resident to be taxed on income for
services, such a service needs to be rendered within India, and has to be a
part of a business or profession carried on by such person in India. The
Petitioners in the present case have provided services to persons resident in
India, and though the same have been used here, it has not been rendered in
9(1)(vii) of the Act whereupon reliance has been placed by the learned
Additional Solicitor General, must be read with Section 5 thereof, which takes
within its purview the territorial nexus on the basis whereof tax is required
to be levied, namely, : (a) resident; and (b) receipt or accrual of income.
income of a resident although is subjected to tax, global income of a
non-resident may not be. The answer to the question would depend upon the
nature of the contract and the provisions of DTAA.
is relevant is receipt or accrual of income, as would be evident from a plain
reading of Section 5(2) of the Act.. The legal fiction created although in a
given case may be held to be of wide import, but it is trite that the terms of
a contract are required to be construed having regard to the international
covenants and conventions. In a case of this nature, interpretation with
reference to the nexus to tax territories will also assume significance.
Territorial nexus for the purpose of determining the tax liability is an
internationally accepted principle. An endeavour should, thus, be made to
construe the taxability of a non-resident in respect of income derived by it.
Having regard to the internationally accepted principle and DTAA, it may not be
possible to give an extended meaning to the words 'income deemed to accrue or
arise in India' as expressed in Section 9 of the
Act. Section 9 incorporated various heads of income on which tax is sought to
be levied by the Republic of India. Whatever is payable by a resident to a non-resident by way
of fees for technical services, thus, would not always come within the purview
of Section 9(1)(vii) of the Act. It must have sufficient territorial nexus with
India so as to furnish a basis for
imposition of tax. Whereas a resident would come within the purview of Section
9(1)(vii) of the Act, a non resident would not, as services of a non-resident
to a resident utilize in India may not have much relevance in determining
whether the income of the non-resident accrues or arises in India. It must have
a direct live link between the services rendered in India, when such a link is established,
the same may again be subjected to any relief under DTAA. A distinction may
also be made between rendition of services and utilization thereof.
9(1)(vii)(c) clearly states "where the fees are payable in respect of
services utilized in a business or profession carried on by such person in
India" It is evident that Section 9(1)(vii), read in its plain, same
envisages the fulfillment of two conditions : services, which are source of
income sought to be taxed in India must be (i) utilized in India and (ii)
rendered in India. In the present case, both these conditions have not been
provisions of Section 9(1)(vii) of the Act are plain and capable of being given
a meaning. There, therefore, may not be any reason not to give full effect
thereto. However, even in relation to such income, the provisions of Article 7
of the DTAA would be applicable, as services rendered outside India would have nothing to do with
permanent establishment in India. Thus,
if any services have been rendered by the head office of Appellant outside India, only because they were connected
with permanent establishment.
in relation thereto, principle of apportionment shall apply.
Authority, in our opinion, has committed an error in this behalf, as if
services rendered by the head office are considered to be the services rendered
by the permanent establishment, the distinction between Indian and foreign
operations and the apportionment of the income of the operations shall stand
would be contrary to the intent and purport of the Double Taxation Convention
which is a part of the scheme under the Income Tax Act.
therefore, hold as under :
Offshore Supply :
That only such
part of the income, as is attributable to the operations carried out in India can be taxed in India.
Since all parts
of the transaction in question, i.e. the transfer of property in goods as well
as the payment, were carried on outside the Indian soil, the transaction could
not have been taxed in India.
The principle of
apportionment, wherein the territorial jurisdiction of a particular state
determines its capacity to tax an event, has to be followed.
The fact that
the contract was signed in India is of no
material consequence, since all activities in connection with the offshore
supply were outside India, and therefore cannot be deemed to
accrue or arise in the country.
There exists a
distinction between a business connection and a permanent establishment. As the
permanent establishment cannot be said to be involved in the transaction, the
aforementioned provision will have no application. The permanent establishment
cannot be equated to a business connection, since the former is for the purpose
of assessment of income of a non-resident under a Double Taxation Avoidance
Agreement, and the latter is for the application of Section 9 of the Income Tax
Clause (a) of
Explanation 1 to S. 9(1)(i) states that only such part of the income as is
attributable to the operations carried out in India, are taxable in India.
The existence of
a permanent establishment would not constitute sufficient 'business
connection', and the permanent establishment would be the taxable entity. The
fiscal jurisdiction of a country would not extend to the taxing entire income
attributable to the permanent establishment.
There exists a
difference between the existence of a business connection and the income
accruing or arising out of such business connection.
Paragraph 6 of
the Protocol to the DTAA is not applicable, because, for the profits to be
'attributable directly or indirectly', the permanent establishment must be
involved in the activity giving rise to the profits.
Offshore Services :
territorial nexus between the rendition of services and territorial limits of India is necessary to make the income
contract would not be attributable to the operations in India viz. the place of execution of the
contract, assuming the offshore elements form an integral part of the contract.
of the Act read with Memo cannot be given a wide meaning so as to hold that the
amendment was only to include the income of non-resident taxpayers received by
them outside India from Indian concerns for services rendered outside India.
The test of
residence, as applied in international law also, is that of the taxpayer and
not that of the recipient of such services.
9(1)(vii) to be applicable, it is necessary that the services not only be
utilized within India, but also be rendered in India or have such a "live
link" with India that the entire income from fees as envisaged in Article
12 of DTAA becomes taxable in India.
'effectively connected' and 'attributable to' are to be construed differently
even if the offshore services and the permanent establishment were connected.
9(1)(vii)(c) of the Act in this case would have no application as there is
nothing to show that the income derived by a non-resident company irrespective
of where rendered, was utilized in India.
Article 7 of the
DTAA is applicable in this case, and it limits the tax on business profits to
that arising from the operations of the permanent establishment. In this case,
the entire services have been rendered outside India, and have nothing to do with the permanent establishment,
and can thus not be attributable to the permanent establishment and therefore
not taxable in India.
principle of apportionment to composite transactions which have some operations
in one territory and some in others, is essential to determine the taxability
of various operations.
The location of the source of income
within India would not render sufficient nexus
to tax the income from that source.
If the test applied by the Authority
for Advanced Rulings is to be adopted here too, then it would eliminate the
difference between the connection between Indian and foreign operations, and
the apportionment of income accordingly.
The services are inextricably linked
to the supply of goods, and it must be considered in the same manner.
the reasons aforementioned, the appeal is allowed in part and to the extent
mentioned hereinbefore. No costs.