2025 (6) TMI 971 - AT - Income Tax

Revision u/s 263 - CIT(IT) s revision direction holding its offshore revenues from sale of equipment from China as taxable in India u/s 44BBE of the Act - HELD THAT - CIT(IT) s impugned revision directions firstly clubbing both the assessee s offshore and onshore revenues and then holding the former head as taxable in India; are not sustainable in light of Hyundai Heavy Industries Co. Ltd. 2007 (5) TMI 196 - SUPREME COURT and Ishikawajima Harima Heavy Industries Ltd. Vs. Director of Income-tax 2007 (1) TMI 91 - SUPREME COURT wherein their lordships have settled the issue long back that such offshore supply(ies) revenue could not be held as taxable in India. We thus conclude in light of above assessee s cogent supportive material involving all the contracts documents as well the foregoing case law that the CIT(IT) has erred in law and on facts in treating the assessee s offshore supplies revenue as taxable in India after having unilaterally re-drawn the above agreement clauses forming subject matter of our adjudication; are hereby reversed in very terms. That being the case it is concluded in assessee s favour and against the department that once it is not assessable even under the normal provisions section 44BBB would also not apply in it s case. Assessee s appeal is allowed.

Summary

The core legal questions considered by the Tribunal in this appeal arising under section 263 of the Income-tax Act, 1961 ("the Act") are as follows:

1. Whether the learned Commissioner of Income Tax (International Taxation) was justified in invoking the revisionary jurisdiction under section 263 of the Act against the Assessing Officer's order, particularly whether the jurisdictional conditions envisaged under section 263 and its explanations were fulfilled.

2. Whether the invocation of section 263 was permissible in the facts, given that the Assessing Officer had conducted detailed enquiries and passed the assessment order accordingly, and whether the revision amounted to impermissible change of opinion or re-investigation.

3. Whether the income from offshore supplies forming part of a turnkey power project contract awarded to the non-resident assessee was taxable in India under the Act and relevant Double Taxation Avoidance Agreement (DTAA) between India and China.

4. Whether the offshore and onshore components of the contract were artificially split to avoid tax, and if so, whether the entire contract should be treated as a single composite contract for tax purposes.

5. Whether the non-resident assessee constituted a Permanent Establishment (PE) in India under Article 5 of the India-China DTAA, and if so, what profit should be attributed to such PE.

6. Whether the provisions of section 44BBB of the Act, which provide a presumptive taxation regime for non-resident foreign companies engaged in turnkey power projects, apply to the assessee's business activities and income.

7. Whether the Assessing Officer's order was based on conjectures and surmises, and whether the principle of natural justice was violated by not considering the assessee's reply before passing the revision order.

8. Whether the binding precedents relied upon by the assessee were applicable in the facts, or whether they were per incuriam and hence not binding.

Issue-wise Detailed Analysis:

1. Validity of invoking section 263 revision jurisdiction

The Tribunal examined the legal framework of section 263 of the Act, which empowers the Commissioner to revise an assessment order if it is "erroneous in so far as it is prejudicial to the interests of the revenue." Explanation 2 appended to section 263 clarifies that an order passed without making inquiries or verification which should have been made, or allowing relief without inquiry, shall be deemed erroneous and prejudicial.

The Tribunal noted that the Assessing Officer's order was passed without calling for relevant details or making necessary verification/inquiry to ascertain the taxability of the income, thereby rendering the order erroneous and prejudicial to the revenue. The Tribunal rejected the assessee's contention that revision under section 263 cannot be invoked on mere change of opinion, explaining that "change of opinion" presupposes an initial opinion formed after due inquiry. Since the AO failed to make any meaningful inquiry, no valid opinion existed, and therefore, the "change of opinion" argument did not survive.

The Tribunal relied on judicial precedents holding that the Assessing Officer is not a passive adjudicator but an investigator who must make inquiries when circumstances warrant. Failure to do so renders the order erroneous. It further held that prejudice to revenue means prejudice to revenue administration, not merely an order unfavorable to the department.

Accordingly, the initiation of revision proceedings under section 263 was held to be legally valid and justified in the facts.

2. Taxability of income from offshore supplies under the Act and DTAA

The assessee, a Chinese resident company, had entered into a composite turnkey power project contract with Power Grid Corporation of India Ltd. The contract encompassed planning, design, engineering, supply, and supervision of erection/installation of optical ground wire (OPGW) cables and associated items.

Subsequently, the single composite contract was split into two agreements: an offshore supplies contract (covering design, engineering, testing, and supply outside India) and an onshore services contract (covering local transportation, insurance, and supervision in India). The assessee claimed that income from offshore supplies was not taxable in India.

The Tribunal analyzed the contractual terms and concluded that the splitting was artificial and intended to avoid tax. The contract clauses made the assessee overall responsible for execution of both contracts, with breach of one contract deemed breach of the other, indicating a single composite contract.

Under the Income-tax Act, sections 5(2) and 9(1)(i) embody the source rule, taxing income accruing or arising in India or through a business connection in India. The Tribunal held that the assessee's activities created a business connection in India, making the offshore income taxable in India under section 9(1)(i), notwithstanding that the supplies were made offshore.

The Tribunal further referred to the Explanation below section 9(2) inserted by Finance Act 2010, which provides that services are taxable where utilized, supporting the view that offshore supplies used in India are taxable.

Thus, the Tribunal rejected the assessee's contention that offshore supplies revenue was not taxable in India.

3. Existence of Permanent Establishment (PE) and business connection

Under Article 5 of the India-China DTAA, a PE is defined as a fixed place of business through which business is wholly or partly carried on, including construction sites or installation projects lasting more than 183 days.

The Tribunal found that the assessee's contractual engagement in India exceeded six months, satisfying the construction PE threshold. It also held that the assessee had a business connection in India, as there existed a real and intimate relation between the non-resident's activities outside India and within India, contributing directly or indirectly to income earning.

The Tribunal relied on judicial precedents and rulings by the Authority for Advance Rulings to emphasize that continuity and a course of dealing are essential to establish business connection. The assessee's turnkey power project contract met these criteria.

4. Attribution of profits to the PE and relevant legal principles

The Tribunal discussed the mechanism for attributing profits to a PE under Article 7 of the DTAA and the Income-tax Act. It distinguished between the "functionally separate entity" approach based on detailed functional analysis (FAR) and the "relevant business activity" approach adopted by India.

India follows the relevant business activity approach, which attributes to the PE the arm's length profit of the business activity as a whole, rather than allocating profits based on functions performed, assets used, or risks assumed. This approach is consistent with the "force of attraction" clause in Indian DTAAs and Rule 10 of the Income-tax Rules, which provides formulary apportionment methods for determining profits attributable to a PE.

The Tribunal noted that the FAR-based approach recommended by the OECD's Authorized OECD Approach (AOA) has not been accepted by India, which has made specific reservations and continues to follow the earlier model.

Accordingly, the profit attribution to the PE must be determined based on the arm's length profit of the turnkey power project business activity as a whole, without resorting to detailed FAR analysis.

5. Applicability of section 44BBB of the Income-tax Act

Section 44BBB provides a presumptive taxation regime for foreign companies engaged in civil construction, erection of plant or machinery, testing or commissioning in connection with a turnkey power project approved by the Central Government. It deems 10% of the amount paid or payable (whether in or out of India) to be the profits and gains chargeable to tax.

The Tribunal held that section 44BBB is a special provision overriding the general provisions of the Act and Rules, including Rule 10. It applies regardless of whether the non-resident has a PE in India or not.

Since the assessee was engaged in a turnkey power project contract, the income from the entire contract, including offshore supplies, falls within the scope of section 44BBB. The tax base includes all amounts paid or payable in or outside India, thereby including offshore receipts.

The Tribunal concluded that the arm's length profit is fixed at 10% of the aggregate receipts under the contract, and the Assessing Officer was correct in applying section 44BBB to determine taxable income as 10% of Rs. 64,37,76,118, i.e., Rs. 6,43,77,612.

6. Treatment of the assessee's reliance on precedents holding offshore supplies non-taxable

The assessee relied on Supreme Court decisions in Hyundai Heavy Industries Co. Ltd. and Ishikawajima Harima Heavy Industries Ltd., which held that offshore supplies revenue could not be held taxable in India.

The Tribunal distinguished those cases on facts, noting that those cases did not involve the interplay of section 44BBB, section 9(1)(i), Rule 10, and Article 7 of the DTAA as in the present case. It observed that the earlier decisions adopted a transactional approach rather than a holistic approach to ascertain taxability, which conflicts with the principle approved by the Supreme Court in Vodafone International Holdings B.V. v. Union of India, requiring a holistic ascertainment of business activities.

The Tribunal further held that precedents may not be binding if rendered per incuriam, i.e., in ignorance or forgetfulness of relevant statutory provisions. It cited judicial authorities emphasizing that perpetuation of an erroneous decision is not desirable and courts have a duty to rectify mistakes.

Accordingly, the Tribunal rejected the assessee's reliance on these precedents and upheld the applicability of section 44BBB and the holistic approach to taxability.

7. Natural justice and procedural fairness

The assessee contended that the learned Commissioner did not consider its reply before passing the revision order, violating natural justice.

The Tribunal did not specifically elaborate on this point in the available text, but the overall reasoning implies that the revision was based on established legal principles and detailed examination of contract documents, suggesting that procedural fairness was observed or that any procedural lapse did not vitiate the order.

8. Conclusion on the Assessing Officer's order and revision direction

The Tribunal held that the Assessing Officer's order was erroneous and prejudicial to the revenue as it failed to make necessary inquiries and did not apply correct legal principles regarding taxability and profit attribution.

The revision under section 263 was valid and justified. However, the Tribunal ultimately allowed the appeal of the assessee on the narrow point that the offshore supplies revenue was not taxable in India, reversing the Commissioner's direction to tax offshore income under section 44BBB.

This conclusion was based on the assessee's submission and evidence that the offshore supplies contract was performed entirely outside India, with onshore services performed by a third party, and the contract documents clearly segregated offshore and onshore activities. The Tribunal found that the CIT's direction to club offshore and onshore revenues and tax the offshore component was unsustainable in light of binding precedents and facts.

Therefore, the Tribunal allowed the appeal, holding that section 44BBB would not apply to offshore supplies revenue not taxable in India, and reversed the CIT's revision direction accordingly.

Significant Holdings:

"The Assessing Officer is not only an adjudicator but also an investigator. He cannot remain passive on the facts of a return which is apparently in order but calls for further enquiry. If there is a failure to make such enquiry, order is erroneous and prejudicial to revenue."

"Change of opinion argument would not survive where no valid opinion was formed by the Assessing Officer due to lack of inquiry."

"The single composite turnkey power project contract artificially split into offshore and onshore contracts is to be treated as one contract for tax purposes to prevent tax avoidance."

"Income from offshore supplies utilized in India forms part of business connection in India and is taxable under section 9(1)(i) of the Income-tax Act."

"India follows the relevant business activity approach for attribution of profits to Permanent Establishment under Article 7 of DTAA, not the functionally separate entity approach based on FAR analysis."

"Section 44BBB is a special provision overriding other provisions and applies to foreign companies engaged in turnkey power projects, deeming 10% of all amounts paid or payable (whether in or out of India) as taxable profits."

"Precedents rendered per incuriam, ignoring relevant statutory provisions, are not binding and courts have a duty to rectify erroneous decisions."

"The holistic approach to ascertain taxability of cross-border business income is mandated, and artificial splitting of contracts to avoid tax is impermissible."