DCIT (IT) -4(3)(1), MUMBAI vs. VITK0VICE MACHINERY A.S.(CRECH REPUBLIC), MUMBAI

Order u/s.254(1)of the Income-tax Act,1961(Act) लेखा सद�य सद�य राजे�� राजे�� केकेकेके अनुसार अनुसार /PER RAJENDRA, AM- लेखा लेखा लेखा सद�य सद�य राजे�� राजे�� अनुसार अनुसार Challenging the directions,dated 23/12/2014,of the Dispute Resolution Panel (DRP)-II, Mumbai, the Assessing Officer(AO)has filed the present appeal.Assessee,a non-resident foreign company, filed its return of income on 26/11/2011,declaring total income of Rs. 55.15 lakhs, the AO completed the assessment u/s.144C(13) r.w.s.143(3)of the Act,on 21/01/2015,assessed its income at Rs. 55, 15, 418/-.

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3.Aggrieved by the additions proposed in the draft assessment order, the assessee filed objections before the DRP and made detailed submissions. After considering the draft assessment order and the objections of the assessee,the DRP deliberated upon the judgment of the Hon’ble Delhi High Court in the case of Linde AG and referred to the instruction number 1829, dated 21/09/1989, issued by the CBDT.With regard to taxability of income in India,it held that principle of apportionment of income on the basis of territorial nexus was a well accepted principle, that Explanation 1 (a) to section 9 (1) (i) of the Act specified that only that part of income which was attributable to operations in India would be deemed to accrue or arise in India which had territorial nexus, that the assessees could not be liable for the part of their income that would arise from operations conducted outside India, that in such cases the income from the venture would have to be appropriately apportioned,that merely because a project was a turnkey project would not necessarily imply that for purpose of taxability the entire contract had to be considered as an integrated one,that where the equipment and material was manufactured and procured outside India the income attributable to supply thereof would not be brought to tax if it was found that the said income therefrom arose through or from a business connection in India, that it could not be concluded that contract provided a business connection in India, that the offshore supplies could not be brought to tax under the provisions of the Act. The DRP referred to the cases of Ishikawajima Harima Heavy Industries (288 ITR 408) and Hyundai Heavy Industries (291 ITR 482) of the Hon’ble Supreme Court and stated that facts of the case of consideration were similar to the facts Ishikawajima (supra) wherein the Hon’ble apex court had held that offshore supplies were not taxable in India,that it was not having a business connection in India, that the offshore supplies could not be taxable in India.

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4.Before us, the Departmental Representative (DR) stated that the matter could be decided on merits.The Authorised Representative(AR)contended that the assessee and BEC had agreed to cooperate on exclusive basis as the consortium for bidding,that the aim was to procure the contract for the project, that each party was fully responsible and liable for its respective scope of work including the necessary technical and performance guarantees(Article2(f) of the memoran - dum),that separate scope of work was identified by the assessee and BEC, that both the members of the consortium were individually responsible for their scope of work, that separate contract fee was identified for each party, that in the event of any default liquidated damages was to be deducted from the contract price of defaulting party only and not from the total contract price, that the man and material used for any work were under the risk and control of the respective consortium member, that the control and management of the consortium was not unified, that the common management was only for the intersect coordination between the members for administrative convenience, that the sale of goods was on FOB basis, that the property and risk in the goods was transferred at a place outside India, that same could not be taxed in India.

5.We have heard the rival submissions and perused the material before us.We find that the AO had held that the actual taxable entity in the case under consideration was an AOP comprising of the assessee and BEC-a resident of India,that no benefit of India Czech Republic could be allowed to the AOP,that service and supply contracts were indivisible,that the revenues emanating from the offshore supply contract were liable to taxed in India in the hands of the AOP,that he had relied upon the rulings of the Authority for Advance Rulings, that the DRP found that the Hon’ble Delhi High Court had reversed the ruling of the AAR in the case of Linde AG (supra). We find that there was a clear demarcation in the work and cost between the consortium members, that the assessee was responsible for design, engineering, supply,commissioning,guar - antees,supervision services of all the main and critical of equipments, that BEC was responsible for supply of all indigenous equipment and auxiliaries,education of site, civil and erection work and providing assistance during commissioning and performance tests that site,that each member was incurring expenditure only in its specified area of work,that both the members of consortium had to provide bank guarantee to steel authority of India Ltd in the same currency or currencies

1673/M/15 M/s.Vitkovice Heavy Machinery A.S. for a period of twelve months from the date of release of the payment against commissioning charges,that the assessee and BEC were raising separate invoices for the piece of work done by them (clause 1.3 of Appendix-3, page 204 of the PB),that steel authority of India Ltd was making separate payments directly to the assessee and BEC (page 318 of the PB), that both the members of the consortium were earning profits and were incurring losses based on performance of the contract falling within their respective scope of work. 5.1.With regard to offshore supply of design and engineering and offshore supply of plant and equipment,we would like to state that the equipment and material was manufactured and procured outside India and therefore the income attributable to the supply thereof could only be brought to tax if it was found that the said income therefrom arose through or from a business connection in India. 5.2.Here,we would like to refer to the judgment of Ishikawajima(supra) of the Hon’ble Apex Court.Fact of the matter were that the assessee, a non-resident company incorporated in Japan, along with five other enterprises formed a consortium.The consortium was awarded by Petronet a turnkey project for setting up a liquefied natural gas (LNG) receiving, storage and regasifica - tion facility in Gujarat.The contract specified the role and responsibility of each member of the consortium and the consideration to be paid separately for the respective work of each member. The appellant was to develop,design,engineer, procure equipment, materials and supplies to erect and construct storage tanks including marine facility (jetty and island breakwater) for transmit - ssion and supply of LNG to purchasers, to test and commission the facilities, etc. The contract involved : (i) offshore supply, (ii) offshore services, (iii) onshore supply, (iv) onshore services and (v) construction and erection. The price for offshore supply and offshore services was payable in US dollars, that for onshore supply and onshore services and construction and erection partly in US dollars and partly in Indian rupees. The payment for offshore supply of equipment and materials supplied from outside India was received by the appellant by credit to a bank account in Tokyo and the property in the goods passed to Petronet on the high seas outside India.Though the appellant unloaded the goods, cleared them from Customs and transported them to the site, it was for and on behalf of Petronet and the expenditure including the customs duty was reimbursed to it. The price of offshore services for design and engineering including detailed engineering in relation to the supplies, services and construction and erection and the cost of any other services to be rendered from outside India, was also paid in US dollars in 1673/M/15 M/s.Vitkovice Heavy Machinery A.S.

Tokyo. On these facts the appellant applied to the Authority for Advance Rulings (Income-tax) for a ruling on the following points : (a) whether the amounts received/receivable by the appellant from Petronet for offshore supply of equipment, materials, etc., were liable to tax in India under the provisions of the Act and the Double Taxation Avoidance Convention between India and Japan ;(b) whether the amounts received/receivable from Petronet for offshore services were chargeable to tax in India under the Act and the Convention ; and (c) would the appellant be able to claim deduction for expenses incurred in computing the income from offshore services.The Authority ruled (i) that, though property in the goods passed to Petronet while the goods were on the high seas, and in so far as the activities of the appellant for taking delivery of the goods from the ship, payment of customs duty and transportation of the goods to the site were concerned, the applicant could be said to be acting as an agent of Petronet, these facts did not militate against the property in the goods passing to the appellant.In connection with the offshore supply, certain operations were inextricably interlinked in India, such as, signing of the contract in India which imposed liability on the appellant to procure equipment and machinery in India and receiving, unloading, storing and transporting, paying demurrage and other incidental charges on account of delay in clearance.The price of the goods covered not only their price but also of all these operations which were carried out in India and from which income accrued to the appellant.Therefore, income accrued to the appellant from the offshore supply through business connection in India and some operations of the business were carried out in India. Profits were deemed to accrue/ arise to the applicant in India from offshore supply of equipment/machinery but the profits deemed to accrue/arise in India would be only such part of the profits as was reasonably attributable to the operations carried out in India. (ii) That having regard to article 7(1) of the Convention for Avoidance of Double Taxation and Fiscal Evasion with respect to Taxes on Income between India and Japan read with paragraph 6 of the Protocol supply of equipment or machinery (sale of which was completed abroad, the order having been placed directly by the overseas office of the enterprise) would be within the meaning of the phrase “directly or indirectly attributable to that permanent establishment” and, therefore, so much of the amount received or receivable by the appellant as was directly or indirectly attributable to the permanent establishment as postulated in paragraph 6 of the Protocol would be taxable in India. The price of the offshore services would be deemed to accrue or arise u/s. 9(1) (vii)of the Act and inasmuch as fees for technical services were specifically provided in Article

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12 of the Convention, they would not fall under Article 7. Therefore, the price of the offshore services was taxable in India under the Act as well as the Convention. (iii) That, however, in view of section 115A(1)(b)(B) of the Act and article 12(2) of the Convention, tax was payable at the fixed rate of 20% of the gross amount of fees for technical services and the applicant would not be able to claim any deduction from the gross amount. The appellant preferred an appeal by way of special leave to the Supreme Court.Deciding the matter the Hon’ble Court held as under : “…..section 9 of the Income-tax Act, 1961, raises a legal fiction ; but, having regard to the contextual interpretation and in view of the fact that the court is 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 must also be read having regard to the other provisions thereof. (ii) That since the appellant carried on business in India through a permanent establishment it would clearly fall out of the applicability of article 12(5) of the Convention and fall within the ambit of article 7. In the Protocol to the Convention it was stated that the term “directly or indirectly attributable” indicated the income that should be regarded on the basis of the extent appropriate to the part played by the permanent establishment in those transactions. The permanent establishment in this case had no role to play in the transaction of offshore supply, sought to be taxed, since the transaction took place abroad. (iii) That the second sentence of article 7(1) which allowed the State of the permanent establishment to tax business profits, but only so much of them as was attributable to the permanent establishment excluded the applicability of the principle that where there was a permanent establishment, the State of the permanent establishment should be allowed to tax all income derived by the enterprise from sources in the State irrespective of whether or not such income was economically connected with the permanent establishment. The State of the permanent establishment was allowed to tax only those profits which were economically attributable to the permanent establishment, i.e., those which resulted from the permanent establishment’s activities, which were economically from the business carried on by the permanent establishment. In this case, the permanent establishment’s non-involvement in the transaction of offshore supply, excluded it from being a part of the cause of the income itself and thus there was no business connection. (iv) That for attracting the tax there had to be some activities through the permanent establishment. If income arose without any activity of the permanent establishment, even under the Convention the taxation liability in respect of overseas services would not arise in India. Section 9 spelled out the extent to which the income of a non-resident would be liable to tax in India. Section 9 had a direct territorial nexus. Relief under a Double Taxation Avoidance Treaty, having regard to the provisions contained in section 90(2), would arise only in the event taxable income of the assessee arose in one Contracting State on the basis of accrual of income in another Contracting State on the basis of residence. So far as accrual of income in India was concerned taxability must be read in terms of section 4(2) read with section 9, where-upon the question of seeking assessment of such income in India on the basis of the Double Taxation Treaty would arise. Paragraph 6 of the Protocol to the Convention was 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. (v) That the fact that the contract was signed in India was of no material consequence, since all activities in connection with the offshore supply were outside India, and therefore income could not be deemed to accrue or arise in the country. 6

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(vi) That where different severable parts of a composite contract were performed in different places, as in this case, the principle of apportionment could be applied to determine which fiscal jurisdiction could tax that particular part of the transaction. This principle helped determine where the territorial jurisdiction of a particular State lay and to determine its capacity to tax an event. Applying it to composite transactions which had some operations in one territory and some in the other, was essential to determine the tax-ability of various operations. Therefore, the concepts of profits of business connection and permanent establishment should not be mixed up. Whereas business connection was relevant for the purpose of application of section 9, the concept of permanent establishment was relevant for assessing the income of a non-resident under the Convention. (vii) That in this case the entire transaction was completed on the high seas and, therefore, the profits on sale did not arise in India. Once excluded from the scope of taxation under the Income- tax Act application of the Double Taxation Avoidance Treaty would not arise. (viii) That, in relation to offshore services, section 9(1)(vii)(c) required two conditions to be met : to be taxable in India the services which were the source of the income sought to be taxed had to be rendered in India as well as utilized in India. In this case, both these conditions were not satisfied simultaneously, thereby excluding the income from the ambit of taxation in India. Thus for a non-resident to be taxed on income for services, such a service had to be rendered within India, and had to be part of a business or profession carried on by such person in India. The appellants had provided services to persons resident in India, and though they had been used here, they had not been rendered in India. (ix) That whatever was payable by a resident to a non-resident by way of technical fees would not always come within the purview of section 9(1)(vii). It must have sufficient territorial nexus with India so as to furnish a basis for imposition of tax. (x) That even in relation to such income, viz., income from offshore services, the provisions of article 7 of the Convention would be applicable, as services rendered outside India would have nothing to do with the permanent establishment in India. Thus, if any services had been rendered by the head office of the appellant outside India, only because they were connected with the permanent establishment, even in relation thereto the principle of apportionment would apply. (xi) There exists a distinction between a business connection and a permanent establishment. 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 Act. Clause (a) of Explanation 1 to section 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 taxing the 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. 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. The concepts of 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, the 1673/M/15 M/s.Vitkovice Heavy Machinery A.S. concept of permanent establishment is relevant for assessing the income of a non-resident under the Double Taxation Avoidance Agreement.” 5.3.We would also like to discuss the indivisibility of the contract.The contract entered into by the consortium with the SAIL provided for consideration to be paid member wise as well as component wise, that the segregation of the contract revenue between the members of the consortium and into offshore and onshore activities was made an agreed-upon between the assessee BEC and SAIL at the stays of awarding the contract and not after awarding the contract. Therefore,in our opinion the contract was clearly divisible.The contractors had to submit complete and correct separate invoices and documents for supplies and services both for payments to be made in foreign currency and Indian currencies.Thus,the facts of the case under appeal and of Ishikawajima(supra)are almost similar as observed by the DRP. We have taken note of the fact that the backbone of the order of the AO was the Ruling of AAR in the case of Linde AG(supra).As the Hon’ble Delhi High Court has reversed the Ruling,so, the basis of the order would not survive.On the other hand both the cases,Hundai and Ishikawajima (supra),relied upon by the DRP are in favour of the assessee. Considering the above,we are of the opinion that the order of the DRP does not suffer from any legal or factual infirmity.So,upholding the same,we dismiss all the grounds raised by the AO.