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TMI Blog2006 (8) TMI 330X X X X Extracts X X X X X X X X Extracts X X X X ..... by erred in holding that profits arising to the assessee from such activities performed outside India are not chargeable to tax in India. Additional grounds of appeal vide letter dated 9th November, 1991 1.On the facts and in the circumstances of the case and in law, the learned CIT(A) erred in allowing the assessee's claim in respect of receipts of Rs. 25,61,29,696 attributable to the activities performed outside India as not chargeable to tax in India, and simultaneously directing the Assessing Officer to look into article 7 of the DTAA between India and Finland, both the decisions being self- contradictory. 2.On the facts and in the circumstances of the case and in law, the learned CIT(A) erred in interpreting the provisions of article 7 of DTAA between India and Finland which is very wide in scope and is not restricted to profits attributable to the permanent establishment for taxation of a company of Finland in India. 3.Without prejudice to the above, on the facts and in the circumstances of the case and in law, the learned CIT(A) erred in treating the receipts of Rs. 25,61,29,696 by the assessee from supplies outside India as distinct and separate activities and therefore ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e is required to supply certain equipments to Nava Sheva Port Trust authorities but the assessee has not included the gross profit pertaining to supplies effected outside India, in the profit and loss account filed along with the return of income. It was in this background that the Assessing Officer made an addition of Rs. 5,12,25,939 by observing as follows: "As per terms of contract, the assessee was required to execute turnkey scope of work, i.e. supply of certain equipments and its installation in India. The supply is essentially linked to erection of the installation activities in India. This is also a fact that without the supply of equipment, there cannot be any installation work carried out in India. The supply of equipment is invariably linked to the work performed inside India. The CBDT has, in the case of oil and gas exploration companies operating in India executing turnkey contracts, which also earn certain amount on account of work to be performed outside India, recognized that a certain portion of supply of equipment and other work performed outside India should also be liable to tax in India. This means that in turnkey contract there would be certain work performe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 assessee for supplies from outside India are taxable in India in terms of the provisions of section 9(1)(i) of the Income-tax Act. It is also contended that the scope of Article 7 in India Finland Double Taxation Avoidance Agreement is much larger than many other tax treaties. It is submitted that under Article 7 of the India Finland DTAA, not only the profits attributable to the permanent establishment (PE, in short) are taxable in the source country but this article also extends to the profits attributable to (a) sales in the other State of goods or merchandise of the same or similar kind as those sold through that PE; and (b) other business activities carried on in that other State of the same or similar kind as those effected through that PE. It is contended that article 7 of the India Finland treaty is based on the 'force of attraction' rule, and that under the force of attraction rule once an enterprise of one of the Contracting States has PE in the other Contracting State, all profits out of the transactions with the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y 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 Trust authorities but the assessee has not included the gross profit pertaining to supplies effected outside India. It was for this reason that the impugned addition of Rs. 5,12,25,939 was made. We must, therefore, confine ourselves to the core question whether or not, on the facts of this case, the assessee was liable to tax in India in respect of income attributable to supply of the equipments in question. 9. Learned counsel's preliminary objection is that it was not open to revenue to challenge the restoration of matter to the file of the Assessing Officer when the Assessing Officer himself has given relief as a result of the matter being restored to his file. We are not impressed with this plea. Even on a cursory reading of the terms of the matter being set aside to the file of the Assessing Officer, it is difficult to miss the fact that, in his brief or rather cryptic order, the Commissioner (Appeals) has, on one hand, categorically held that "the claim of the appellant is allowable", that "from the relevant details, I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ax 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 of the law of the United Kingdom regarding the imposition of United Kingdom excess profits tax and national defence contribution in the case of inter-connected companies. (3) Where an enterprise of one of the contracting Parties is engaged in trade or business in the territory of the other contracting Party through a permanent establishment situated therein, there shall be attributed to such permanent establishment the industrial or commercial profits which it might be expected to derive if it were an independent enterprise engaged in the same or similar activities under the same or similar conditions and dealing at arm's length with the enterprise of which it is a permanent establishment, and the profits so attributed shall, subject to the law of such other contracting Party, be deemed to be income from sources within the territory of such other contracting Party. (4) In determining the industrial or commercial profits from sources within the territory of one of the contracting Parties of an enterprise of the oth ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ctivities 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 above model article was drafted, the Commentary on UN Model Convention observes as follows: "This paragraph reproduces article 7, paragraph 1, of the OECD Model Convention, with the addition of the provisions contained in clauses (b) and (c). In the discussion preceding the adoption by the Group of Experts of this paragraph, several members from developing countries expressed support for the "force of attraction" rule, although they would limit the application of that rule to business profits covered by article 7 of the OECD Model Convention and not extend it to income from capital (dividends, interest and royalties) covered by other treaty provisions. The members supporting the application of the "force of attraction" rule also indicated that neither sales through independent commission agents nor purchase activities would become taxable to the principal under that rule. Some members from developed countries pointed out that the "force of attraction" rule had been found unsatisfactory and abandoned in recent tax ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... similar kind as those effected through that permanent establishment. 2.Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment 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. 3.In determining the profits of a permanent establishment, there shall be allowed a deductions expenses which are incurred for the purposes of the permanent establishment, including executive and general administrative expenses so incurred, whether in the State in which the permanent establishment is situated or elsewhere, which are allowed under the provisions of the domestic law of the Contracting State in which the permanent establishment is situated. However, no such deduction shall be allowed in respect of amounts, if any, paid (otherwise than towards reimbursement of actual e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t 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 these transactions are of the same or similar kind, are as well liable to be taxed in the source State. In other words, once a PE of a resident of a Contracting State is involved in certain activity in the other Contracting State, whether the head office of the PE enters into transactions relating to that activity directly or through the PE, in that other State, the profits on such transactions continue to be liable to be taxed in the source State. Article 7(1) is divided into three segments. Under Article 7(1)(a), the profits attributable to the PE are taxed in the source State. Under Article 7(1)(b), profits attributable to sales of such merchandise or goods, in that other State, as is sold through the PE is also liable to be taxed in the source State. Under Article 7(1)(c), profits attributable to business activities carried out in such other State, as is same or similar kind as those effected through the PE, is also taxable in the source State. The scope of Article 7 thus extends to only same or similar activiti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hus 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 PE. Therefore, even if it is assumed that the supplies were necessary for the purpose of the activities of the PE and were integral part of the activities thereof, unless it is established that the supplies were not at an arm's length price to the PE, no part of profits on such supplies cannot be treated as attributable to the PE. The arm length price is best indicated by the price at which enterprise is selling the same to the customer. The hypothetical sale to and the hypothetical sale by the PE being at the same price, there cannot be any profits on account of the transaction. No such taxability can therefore arise in the case before us because the sales are directly billed to the Indian customer and also because there is no suggestion that the prices at which billing is done includes any element for services rendered by the PE. The last reason is this. There are protocol clauses in certain recent Indian treaties, such as German treaty (223 ITR Stat 130). French treaty (155 CTR Stat 22) and Netherlands treaty (177 I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 Commentary on UN Model Convention extracted earlier in this order. It is interesting to note that this Commentary states that, by way of Article 7(1)(b). "it was proposed that the 'force of attraction' rule, should be limited so that it would apply to sales of goods or merchandise . . . . in the following manner : if an enterprise has a permanent establishment in the other Contracting State for the purpose of selling goods or merchandise, sales of the same or a similar kind may be taxed in that State even if they are not conducted through the permanent establishment. . . ." [Emphasis supplied]. The commentary thus envisages that direct sales by an enterprise of the one Contracting State to customers in the other Contracting State will be covered by the force of attraction rule only when that enterprise has a PE in the other State 'for the purpose of selling goods or merchandise' and the direct sales by the enterprise is of the same or similar kind of goods or merchandise. The installation PEs are thus to be excluded ab initio so fa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of Treaties, which governs the interpretation of international treaties, undoubtedly states that a treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of treaty in their context, and in the light of its objects and purpose but Article 32 of the said Vienna Convention, also does add that a recourse may be had to supplementary means of interpretation, including the preparatory work of the treaty, which, to our mind, includes the scope of commentary on the Model Convention on which the relevant treaty is based, and the circumstances of its conclusion, inter alia, "to determine the meaning such an interpretation (a) leaves the meaning ambiguous or obscure; or (b) leads to a result which is manifestly absurd or unreasonable". In such a situation, as was also the case before a co-ordinate Bench of this Tribunal in the case of Hindalco Industries Ltd. v. Asstt. CIT [2005] 94 TTJ (Mum.) 9441, an interpretation leading such incongruity is to be avoided. In our considered view, due to operation of force of attraction principle, a transaction between an enterprise and PE State cannot be held to be taxable in source State when such a tran ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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. 22. In the light of the above discussions, 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. 23. 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'. Theref ..... X X X X Extracts X X X X X X X X Extracts X X X X
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