2007 (1) TMI 91 - SC - Income Tax

Accrual of income u/s 9 offshore supply onshore services business connection must be established if no operation is carried out in India not taxable in India provision of DTAA limited to tax from the operation of PE advance ruling is modified

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Court were:

(a) Whether the amounts received or receivable by the appellant, a non-resident foreign company, from Petronet LNG for offshore supply of equipment and materials are liable to tax in India under the Income Tax Act, 1961 and the India-Japan Double Taxation Avoidance Agreement (DTAA).

(b) If such income is taxable, to what extent are the amounts reasonably attributable to operations carried out in India and thus taxable in India.

(c) Whether the amounts received or receivable for offshore services rendered by the appellant are chargeable to tax in India under the Act and/or the India-Japan DTAA.

(d) If offshore services income is taxable, what portion of such income is chargeable to tax in India and at what rate.

(e) Whether the appellant is entitled to claim deductions for expenses incurred in computing income from offshore services under the Act and/or the DTAA.

2. ISSUE-WISE DETAILED ANALYSIS

Issue (a) and (b): Taxability of Offshore Supply Income

Relevant legal framework and precedents: The Court examined Sections 5(2) and 9(1)(i) of the Income Tax Act, 1961, which provide that income of a non-resident is taxable in India if it is received or deemed to be received in India or accrues or arises or is deemed to accrue or arise in India, including income accruing through or from a business connection in India. Explanation (a) to Section 9(1)(i) and Article 7 of the India-Japan DTAA were also considered, which restrict taxation to profits attributable to a permanent establishment in India. The Court reviewed precedents interpreting business connection and permanent establishment, as well as principles of territorial nexus and apportionment of income.

Court's interpretation and reasoning: The Court found that the contract was a turnkey project with distinct components for offshore supply, offshore services, onshore supply, onshore services, and construction/erection, each with separately specified prices and payment terms. The title to goods supplied offshore passed outside India on the high seas, and payments for offshore supply were made in US dollars. The Court emphasized that the contract components were severable and that the offshore supply was completed outside India.

The Court held that mere execution of the contract in India or existence of a permanent establishment in India does not render the entire income taxable in India. Taxation requires a territorial nexus between the income and India. The legal fiction under Section 9 must be interpreted in light of the object of the statute and international tax principles. The Court distinguished the concepts of business connection (relevant for Section 9) and permanent establishment (relevant under DTAA). It held that only income attributable to operations carried out in India can be taxed in India, and since the offshore supply was completed outside India, no income from such supply could be deemed to accrue or arise in India.

Key evidence and findings: The contract terms, including Clause 22.1 on passing of title, Clause 13.1 on contract price, and Exhibit D detailing prices for offshore supply, were critical. The contract explicitly separated offshore supply and services from onshore activities, with different currencies for payments. The appellant had a permanent establishment in India, but it was not involved in the offshore supply transactions.

Application of law to facts: Applying the territorial nexus doctrine and apportionment principles, the Court concluded that offshore supply income was not taxable in India as the supply and transfer of title occurred outside India. The permanent establishment in India was not involved in the offshore supply transactions; hence, profits from offshore supply were not attributable to the permanent establishment and not taxable in India under the DTAA.

Treatment of competing arguments: The Revenue argued the contract was composite and integrated, making the entire income taxable in India. The Court rejected this, noting the contract's explicit segregation of components and separate pricing. The appellant contended that offshore supply and services occurred outside India and payments were made abroad, negating tax liability. The Court agreed with the appellant on offshore supply.

Conclusion: Only such part of income as is attributable to operations carried out in India is taxable. Offshore supply income, completed outside India with title passing offshore, is not taxable in India.

Issue (c) and (d): Taxability of Offshore Services Income

Relevant legal framework and precedents: Section 9(1)(vii) of the Income Tax Act, which deals with fees for technical services, was examined along with Article 12 of the DTAA. Article 12 provides that royalties and fees for technical services may be taxed in the source state but limits tax to 20% of the gross amount. Article 12(5) excludes taxation if the beneficial owner carries on business through a permanent establishment and the income is effectively connected to that establishment, in which case Article 7 applies.

Court's interpretation and reasoning: The Court held that for offshore services income to be taxable in India, the services must be rendered in India and utilized in a business or profession carried on in India. Both conditions must be satisfied simultaneously. In this case, offshore services were rendered outside India and thus lacked sufficient territorial nexus to India for taxation. The permanent establishment in India was not involved in the offshore services, so Article 7 rather than Article 12 applied, limiting taxability to income attributable to the permanent establishment.

Key evidence and findings: The contract defined offshore services as design and engineering activities rendered outside India. The appellant received payments in US dollars for offshore services. No evidence was produced to show that offshore services were rendered or utilized in India.

Application of law to facts: The Court applied the plain language of Section 9(1)(vii)(c) and Article 12 of the DTAA, concluding that offshore services income was not taxable in India because the services were not rendered in India nor effectively connected to the permanent establishment.

Treatment of competing arguments: The Revenue argued that the entire technical fee was taxable in India at 20%. The appellant argued that offshore services were rendered outside India and not attributable to the permanent establishment. The Court accepted the appellant's contentions.

Conclusion: Offshore services income is not taxable in India as the services were rendered outside India and not effectively connected to the permanent establishment. Even if taxable, tax would be limited to 20% of gross fees under Article 12.

Issue (e): Deductibility of Expenses in Computing Offshore Services Income

Relevant legal framework and precedents: The Court considered the Income Tax Act provisions and the DTAA, particularly the treatment of fees for technical services and the limitation on deductions.

Court's interpretation and reasoning: The Court held that the appellant would not be entitled to claim any deductions in computing income from offshore services under the Act or the DTAA, consistent with the provisions limiting tax on gross receipts.

Conclusion: No deduction for expenses is allowable against offshore services income for tax computation purposes.

3. SIGNIFICANT HOLDINGS

"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."

"There exists a distinction between a business connection and a permanent establishment. The permanent establishment cannot be said to be involved in the transaction, and therefore the provisions relating to permanent establishment will have no application."

"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."

"Section 9(1)(vii)(c) clearly states that the fees are taxable only where the services are both rendered and utilized in India. Both conditions must be satisfied simultaneously."

"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."

"The principle of apportionment, wherein the territorial jurisdiction of a particular state determines its capacity to tax an event, has to be followed."

"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 entire income attributable to the permanent establishment."

"The distinction between the existence of a business connection and the income accruing or arising out of such business connection is clear and explicit."

"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."

The Court finally allowed the appeal in part, holding that offshore supply income was not taxable in India, and offshore services income was taxable only to the extent connected with operations in India, which in this case was nil.