TMI Blog2006 (8) TMI 330X X X X Extracts X X X X X X X X Extracts X X X X ..... rough the PE. It is also important to appreciate that although India Finland tax treaty provides for force of attraction clause, such clause is restrictive in nature as the words same and similar have been used in clause ( b ) of Article 7(1). Accordingly, not all the profits of the assessee-company from its business connection in India would be taxable in India, but only so much of profits as have economic nexus with PE in India, would be taxable in India. This economic nexus should be in relation to sale of goods or merchandises of same or similar nature as sold or effected through the PE. This condition, in our considered opinion, is not satisfied in the case before us. We are of the considered view that under the provisions of Article 7(1)( b ), on the facts of this case, sale of equipment directly by the head office of the foreign enterprise directly to NSPT does not lead to taxability of profits thereon in India. We now take up the provisions of Article 7(1)( c ). The issue before us is only of taxability of profit on sale of equipment and not, as is the scope of Article 7(1)( c ), profits on any business activities carried on in the source State . Therefore, the provisions o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... acts of this case, were not taxable in India. We, therefore, see no reasons to interfere in the matter. In the result, the appeal is dismissed. - PRAMOD KUMAR AND RAJPAL YADAV, JJ. P.K. Das for the Appellant. A.V. Sonde for the Respondent. ORDER Per Pramod Kumar, Accountant Member. - The neatly identified legal issue that we are required to adjudicate in this revenue s appeal is whether or not the profits on sale of equipments supplied by the assessee-company for a consideration of Rs. 25,61,29,696 on the facts of this case, are liable to be taxed in India. 2. This grievance has been raised by the revenue by way of following grounds of appeal: " Ground of appeal as set out in the memorandum of appeal : On the facts and in the circumstances of the case and in law, the learned CIT(A) failed to appreciate that the receipt of Rs. 25,61,29,696 by the assessee formed part of execution of turnkey project with Nava Sheva Port Trust and that being one integrated contract, it could not be split up as constituting separate activities and thereby erred in holding that profits arising to the assessee from such activities performed outside India are not chargeable to tax in India. Additional g ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... This consortium originally consisted of Klochner Industries Anlagen GmbH, Kone Corporation and Hyundai Corporation, but, as a result of the assignment deed dated 12th January, 1987 ( supra ), the assessee-company was substituted for Kone Corporation. It was pursuant to these arrangements that the assessee-company was engaged in executing a contract with Nava Sheva Port Trust. Under this contract, the assessee-company supplied the required equipments and also sent its employees for erection, commissioning and training purposes. The assessee-company filed its income-tax return showing the profits attributable to the permanent establishment in India at a negative figure i.e. loss of Rs. 2,49,55,710. In the course of the scrutiny assessment proceedings, the Assessing Officer, amongst other things, noted that the assessee had not taken into account the remittance of gross receipts in respect of income earned outside India aggregating to Rs. 25,61,29,696. The Assessing Officer noted that as per the terms of the contract, the assessee is required to supply certain equipments to Nava Sheva Port Trust authorities but the assessee has not included the gross profit pertaining to supplies eff ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... are not chargeable to tax in India. It is also brought to my notice that the Department has accepted similar treatment in the cases of Nippon Kokan KK for the assessment year 1989-90 and Zonon Verstoep NV for the assessment year 1989-90. In view of the above, the claim of the appellant is allowable and the Assessing Officer would look into Article 7 of the Double Taxation Avoidance Agreement, which overrides the other IT provisions and decide the matter afresh. I find that the provisions of the DTAA have not been discussed at all, and, from the relevant details, I would hold that profits outside India, under the circumstances are not chargeable to tax." 6. Revenue is aggrieved of the order so passed by the Commissioner (Appeals) and is in appeal before us. 7. The contention of the revenue is that as per the terms of contract, the assessee-company was required to execute turnkey work i.e. supply certain equipments and install the same in India. The supply is essentially linked to its installation in India. Thus, there is a business connection and the supplies are linked to the project in India. For this reason, according to the revenue appellant, the consideration received by the as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pted the contentions of the assessee vide appeal effect order dated 31st October, 1991. A copy of the said appeal effect order was also filed before us. Learned counsel contended that once the revenue itself accepts the contentions of the assessee, it is not open to the revenue to challenge the same in these appellate proceedings. Learned counsel also took us through the order of the CIT(A), vehemently supported and justified the same, and reiterated the elaborate contentions raised therein. We were thus urged to confirm the order of the CIT(A) and decline to interfere in the matter. The case was subsequently refixed and both the parties were heard at length on the scope article 7 of the India Finland DTAA and on the impact of applicability of force of attraction rule in the present case. The rival contentions are conscientiously heard, material on record is carefully perused and factual matrix of the case as also the applicable legal position duly considered. 8. We find that in the course of assessment proceedings, the only objection raised by the Assessing Officer was that as per the terms of the contract, the assessee is required to supply certain equipments to Nava Sheva Port T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eated, as taxable of that another country. This principle, in its pure form, probably has no takers so far as the current tax treaties are concerned but, only to give an example of a typical treaty on the basis of force of attraction rule , we may refer to Article III of United Kingdom - United States of America Income Tax Convention, 1945 which was as follows : "Article III (1) A United Kingdom enterprise shall not be subject to United States tax in respect of its industrial or commercial profits unless it is engaged in trade or business in the United States through a permanent establishment situated therein. If it is so engaged, United States tax may be imposed upon the entire income of such enterprise from sources within the United States. (2) A United States enterprise shall not be subject to United Kingdom tax in respect of its industrial or commercial profits unless it is engaged in trade or business in the United Kingdom through a permanent establishment situated therein. If it is so engaged, United Kingdom tax may be imposed upon the entire income of such enterprise from sources within the United Kingdom : Provided that nothing in this paragraph shall affect any provisions ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... "restricted force of attraction" rule, in essence, additionally expands source State taxation by permitting States where non-residents maintain traditional PEs to tax other income that is attracted to the PE, even though that income is not directly related to the PE. In UN Model Convention (1979 draft), this newer version of the force of attraction rule, finds place. It is implicit in the following provision in Article 7(1) of the UN Model Convention : "The profits of an enterprise of a Contracting State shall be taxable only in that 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 the other State but only so much of them as is attributable to ( a ) that permanent establishment; ( b ) sales in that other State of goods or merchandise of the same or similar kind as those sold through that permanent establishment; or ( c ) other business activities carried on in that other State of the same or similar kind as those effected through that permanent establishment." 12. Explaining the background in which the ab ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and the same or similar activities are performed without any connection with the permanent establishment ." [Emphasis supplied] 13. We find that Article 7 of the applicable Indo Finnish tax treaty is based on the UN Model Convention and, to that extent, incorporates restricted force of attracted rule. The relevant treaty provision is reproduced below for ready reference : " Article 7 - Business profits : 1.The profits of an enterprise of a Contracting State shall be taxable only in that 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 the other State but only so much of them as is attributable to ( a ) that permanent establishment; ( b ) sales in that other State of goods or merchandise of the same or similar kind as those sold through that permanent establishment; or ( c ) other business activities carried on in that other State of the same or similar kind as those effected through that permanent establishment. 2.Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carrie ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... method of apportionment adopted shall, however, be such that the result shall be in accordance with the principles contained in this Article. 5.No profits shall be attributed to a permanent establishment by reason of the mere purchase by that permanent establishment of goods or merchandise for the enterprise. 6.For the purposes of the preceding paragraphs, the profits to be attributed to the permanent establishment shall be determined by the same method year by year unless there is good and sufficient reason to the contrary. 7.Where profits include items of income which are dealt with separately in other articles of this convention, then the provisions of those articles shall not be affected by the provisions of this article. 14. The main distinguishing feature of Article 7 of India Finland DTAA, vis-a-vis Indian tax treaties with most other countries, which are on OECD Model Convention, is that it incorporates a limited force of attraction rule inasmuch as not only the profits attributable to permanent establishment are taxable in the source State, but also the profits on direct transactions entered into by the head office of the PE in the State in which is situated to the extent ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e said to be attributable to the PE because PE comes into existence after the transaction given rise to supplies materialized. The installation or construction PE, in such a case, is a stage posterior to the conclusion of transaction giving rise to the supplies. Such an installation or construction PE can come into existence after the contract for turnkey project, of which supplies are integral part is, concluded. The profits on such supplies cannot, therefore, be said to be attributable to the PE. The second reason is this. As per Article 7(2) profits attributable to a PE are the profits "which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment". Thus, the profits of the PE are to be calculated as if the PE is hypothetically independent of the enterprise of which it is a PE. The profits to be taxed in the source country are thus not the real profits made by the enterprise but hypothetical profits which the PE would have earned if it was wholly independent of the enterprise of which it is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hout the supply of equipment there cannot be any installation work carried out in India . It was on this basis that the Assessing Officer had held that the supply of equipment being invariably linked to the work performed inside India, has also given rise to the income taxable in India. By no stretch of logic Article 7(1)( b ) would cover such a situation. The other aspect of the matter is that as per contract with NSPT, the assessee-company s work in was to supply equipment and render services, and the same work was carried out from India as well as outside India. In other words, PE was engaged in supply of equipment and in rendering services. The same work, i.e., supply of equipment and rendering of services, was also done by the foreign company directly in respect of the same customer was carried out by the head office of the foreign concern directly. As the scope of Article 7(1)( b ) is confined to sale of same or similar goods, we need to adjudicate upon taxability of profits from supply of equipments directly by the head office of foreign concern, to the Indian customer, i.e., NSPT. 19. To understand the scope of Article 7(1)( b ), it could be useful to refer to the Commentar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... omputation of PE profits in general. Therefore, in the case of a turnkey contract, which includes offshore supply of machineries etc., the profits which are to be taxed will only be the profits which can be attributed to the work effectively carried out by the PE. Now, in this light let us see the effect of the interpretation canvassed by the revenue. If we are to hold that the supplies by the foreign enterprise directly to Indian customer will be taxable in India in view of the provisions of Article 7(1)( b ), it will result in an absurdity that while direct sales by Indian PE to Indian customer will not be taxable because of the scope of Article 7(1)( a ) in general, supply by foreign enterprise to the Indian PE will be taxable because it will be deemed to be actually attributable to Indian PE though not routed through a PE. That results in a situation in which direct transactions are not taxable but indirect transactions are taxable. That is clearly an unintended incongruity Article 31(1) of the Vienna Convention on the Law of Treaties, which governs the interpretation of international treaties, undoubtedly states that a treaty shall be interpreted in good faith in accordance wi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ment really that installation PE comes into existence. In these circumstances, setting up of a PE, by any stretch of logic, cannot result in earlier direct transactions being held as taxable in the source country. In the present case, it is not in dispute that the PE came into existence only after the sale was completed outside India. 21. In any case, this clause could have been invoked only if the Indian PE was found to be engaged in selling the equipment which is same or similar to the equipment sold by the assessee-company to Indian customer. That admittedly is not the case here. Just because some equipments were locally procured and used in installation and commissioning of the equipment sold by the assessee-company, one cannot come to the conclusion that the assessee was engaged in selling same or similar goods or merchandise through the PE. There is no material whatsoever to even suggest that the equipments sold by the enterprise directly to the customer were same or similar to the equipments sold through the PE. It is also important to appreciate that although India Finland tax treaty provides for force of attraction clause, such clause is restrictive in nature as the words ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... planation to section 9(1)( i ) of the Act, where a non-resident has business connection in India, only so much of profits could be taxed in India which could reasonably be attributed to the operations carried on in India by the non-resident. It is pointed out that provisions of the Act, in the light of the provisions of section 90(2) of the Act, continue to be applicable to the extent these provisions are more beneficial to the assessee vis-a-vis the provisions of the applicable tax treaty. 26. In the light of the conclusions that we have arrived at, earlier in this order, to the effect that the assessee does not have any tax liability in respect of its Finland based head office directly exporting equipment to NSPT in India, we see no reasons to adjudicate on this alternate plea which would have been relevant only in the event of taxability being upheld on the basis of tax treaty provisions. We, therefore, reject this plea as infructuous and not calling for any adjudication at this stage. 27. For the detailed reasons set out above, we hold that the profits from sale of equipments in question, on the facts of this case, were not taxable in India. We, therefore, see no reasons to int ..... X X X X Extracts X X X X X X X X Extracts X X X X
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