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2010 (6) TMI 517

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....ount of short term capital gain, on sale of rig. We will, therefore, address ourselves to these two main issues one by one. 3. We will first take up assessee's challenge to the validity of reassessment proceedings which has been negated by the authorities below. 4. The assessee before us is a company registered under the laws of Cyprus on 15th January 1990, which was later registered as a foreign company in Mauritius on 9th June 1993. Based on this registration in Mauritius, though as a foreign company, the assessee was issued as tax residency certificate by the Commissioner of Income Tax, Mauritius, on 23rd June 1993. On the strength of this certificate, the assessee claimed protection of India Mauritius Double Taxation Avoidance Agreement1, which was duly granted to him by the Assessing Officer. 5. The assessee company owned a 300 ft cantilever type jack up rig which is used for drilling, prospecting and production of hydrocarbons in the offshore oil fields. The assessee had given this barge on charter basis to Amer Ship Management Limited which, in turn, had leased it out to Oil & Natural Gas Commission. During the relevant previous year, this arrangement came ....

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....rig during the assessment year for USD 35 million and has earned capital gains on the same. The written down value of the rig as on 1.4.1997, as per the income tax return, was USD 6,428,027. Thus capital gains chargeable to tax of USD 28,571,973 (INR 102,94,48,187 using 1USD = 36.03 INR) has escaped assessment. I have reasons to believe that income to the extent of Rs 102,94,48,187 chargeable to tax has escaped assessment for the assessment year 1998-99 as above. ............" 9. The assessee objected to the initiation of these reassessment proceedings but none of the authorities below upheld these objections. While the Assessing Officer simply brushed aside these submissions, the CIT(A) discussed these objections at length and then rejected the same on merits. It was noted by the CIT(A) that on 13th May 2004 a tax evasion petition was received by the Director of Income Tax (International Taxation) and this petition contained information about evasion of capital gains tax on sale of rig for US $ 3,50,00,000 . This tax evasion petition was examined by the Assessing Officer who ultimately recommended that the case for assessment year 1998‐99 be reopened for examining the....

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....its assets, this omission cannot be construed as a lapse on the part of the assessee which is a sine qua non for initiating the reassessment proceedings after end of four years from the end of the relevant assessment year. Learned counsel submits that there was no failure on the part of the assessee, and as such the reassessment proceedings could not have initiated in the present case. It is emphasized that the sale has taken place outside Indian territorial waters and it has no tax implications in India. We are thus urged to quash the reassessment proceedings. Learned Departmental Representative, on the other hand, submits that merely because the assessee has closed his business in India does not imply that his entire taxability in India comes to an end. The cessation of permanent establishment is relevant only for the purposes of taxability of business profits, and has no impact on the taxability of capital gains of alienation of the PE or its assets. It is pointed out that the assessee was taxable in India in the relevant previous year and had duly filed its income tax return as well. It is also not in dispute that the assessee had sold its jack up rig in the relevant previous y....

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....ome from chartering this rig. The cessation of permanent establishment is relevant only for the taxability of business profits and, even after the cessation of permanent establishment in India, a non resident assessee can still be liable to its taxability under other heads, including under capital gains, in India. The assessee was taxable in India in respect of its PE, and therefore, the assessee was under an obligation to share all the facts relevant to its Indian PE - whether in respect of business profits or under any other head of income. An income tax return was indeed filed by the assessee but this income tax return had to mention about sale of PE assets on which depreciation was claimed. Whether the sale of PE asset has taken place in India or outside India, even if that can be considered relevant for ascertaining taxability of gains on such sales, can only be ascertained upon examination of relevant facts which the assessee was duty bound to share. It is not really material that the assessee genuinely believed that sale of such an asset of the permanent establishment will have no tax implications in India, because, as per the compliance requirements of filing of the income ....

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.... view of the these discussions, we are of the considered view that (i) there was a failure on the part of the assessee to make true and proper disclosure about sale of rig, which was part of the PE assets and on which depreciation was claimed in India, in its income tax return, and thus there was a failure of not "disclosing fully and truly all the material facts necessary for his assessment for that particular year", that (ii) the Assessing Officer had sufficient reason to believe that income on such sale of this jack up rig, which was used as PE asset in India and on which depreciation was claimed in India, has escaped assessment in India, and that (iii) the Commissioner (Appeals) was thus justified in upholding the validity of the impugned reassessment proceedings under section 147. The assessee's grievances against initiation of reassessment proceedings are, accordingly, rejected. 12. That takes us to the core issue regarding taxability of gains, on alienation of jack up rig, in India. As we have noted above, the assessee is a non resident company which owned a 300 ft cantilever type jack up rig which is used for drilling, prospecting and production of hydrocarbons in the offs....

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....acts, the Assessing Officer held that the gains on sale of this rig were taxable in India as the asset sold was used for PE on which depreciation was claimed in India all along. The Assessing Officer took not of assessee's contention that since the assessee was a non resident, since operations of the PE have already come to an end, and since the sale was effected outside the Indian territory i.e., at sea in International waters at a distance from the Indian west coast exceeding 200 nautical miles, profit on such sale could not be brought to tax in India. The Assessing Officer was of the view that "a PE is usually controlled by the foreign principal as a non‐resident under the I.T. Act 1961" and that " a foreign parent company would be taxed in India only in respect of those profits which are attributed to the activities of subsidiary in the capacity of the PE". It was also noted that " Even by assessee's own submission in its Return of income, it has stated its status as 'Non‐resident with Permanent Establishment' thereby not denying it has no PE in India" and that, "therefore, there is no dispute that the assessee is having PE in India". The Assessing Officer also note....

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.... 1998-99 after applying the provisions of section 44BB. However, the appellant had filed appeal and succeeded in A.Y. 1994-95, 1995-96, 1996-97 & 1997-98 before the ITAT, Mumbai, that the income of the appellant should not be assessed by applying section 44BB, but in accordance with the Article 7 of the DTAA after allowing deduction for all expenses including depreciations. In accordance with the direction of ITAT, depreciation was allowed and the order giving effect to the order of CIT(A) for A.Y. 1997-98 was passed on 22.3.2004 by ADIT(IT)-1(2) in which the cost of rig as on 1.4.1993 was taken at Rs.51,21,12,236/-. Depreciation was allowed @ 25% on WDV basis for A.Y. 1994-95 to 1997-98 ad the WDV as on 1.4.1997 was computed at Rs.16,20,35,512/-. Assessment of A.Y. 1998-99 was completed u/s 143(3) after once again applying section 44BB. Appellant filed appeal before the learned CIT(A) which was dismissed being late. Accordingly the assessment order passed by the A.O. had become final.  4.5 The appellant had filed return of A.Y 1998-99; the fact of sale of rig was not disclosed. The appellant had informed the A.O vide letter dated 5.10.1997 that the PE was closed down w.....

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....or the delivery. Clause-20 provides for the confidentiality and provides that the buyer shall have the exclusive right to bid the rig to clients / customers after this agreement has been signed and the deposit has been placed. The name of the rig is to be revealed only after the buyer has paid the deposit as per Clause-3, Clause-20 reads as under:-"20. This Agreement shall be strictly confidential between the parties. No information concerning this Agreement can be released by either party or their servants or agents without the written permission of the other party, subject only to Buyers disclosure requirements as a public company or in both cases save as required by any governmental, administrative or revenue authorities of any jurisdiction or to either parties professional advisers. Buyers to have the exclusive Right to bid the Rig to clients/customers after this agreement has been signed and the deposit has been placed. The name of the rig to be revealed only after Buyers have paid the Deposit as per Clause 2 except in the case of Premier."  4.8 In accordance with the agreement, Foramer S.A. had nominated Pride Global Ltd. as the purchaser. The appellant company had draw....

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....lause-13 (Buyers' default) also provides that the seller can cancel the agreement when the buyer fails to make the deposit of or fails to make payment of purchase price. The buyer had made payment of both these amounts prior to 3.10.1997 when the rig was in India. Sale bill had also been drawn on 19.9.1997. I, therefore, agree with the A.O. that at the time of sale of the rig, rig was in India. A mere deliver of rig in international waters cannot mean that the asset was not situated in India. On the contrary, at the time of sale agreement, drawing of sale bill, payment of purchase price and the deposit, rig was in India and was part of the movable property of the appellant's PE in India. It is solely for the purpose of showing the delivery of rig in International water that the process was started of disengaging the rig from Bombay High platform on 27.9.1997. All legs were clear of seabed or underway on 3.10.1997, from the Bombay High platform. The AR has argued that since the delivery of rig has been made in international water, sale has taken place outside India. I do not agree with the argument. The study of the sale agreement, the sale bill clearly reveals that most of the righ....

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....the income which are deemed to accrue or arise in India. Section 9(1)(i) reads as under:-  "9. Income deemed to accrue or arise in India. (1) the following incomes shall be deemed to accrue or arise in India:-(i) all income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India. Explanation - For the purpose of this clause - (a) in the case of a business of which all the operations are not carried out in India, the income of the business deemed under this clause to accrue or arise in India shall be only such part of the income as is reasonably attributable to the operations carried out in India; (b) in the case of a non-resident, no income shall be deemed to accrue or arise in India to him through or from operations which are confined to the purchase of goods in India for the purpose of export; (c)  in the case of a non-resident, being a person engaged in the business of running a news agency, or of publishing newspapers, magazines or journals, no income s....

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....e examined whether any relief can be given under the DTAA. Article-7 of the DTAA refers to the provision of business profits of PE. Article-13 refers to capital gain and reads as under:- "ARTICLE 13 CAPITAL GAINS 1. from the alienation of immovable property, as defined in paragraph 2 of Article 6, may be taxed in the Contracting State in which such property is situated Gains from the alienation of movable property forming part of the business property of a permanent establishment which an enterprise of a contracting State has in the other contracting state or of movable property pertaining to a fixed base available to a resident of a contract State in the other contracting state for the purpose of performing independent personal services, including such gains from the alienation of such a permanent establishment (alone or together with the whole enterprise) or of such a fixed base, may be taxed in that other State. 3. Notwithstanding the provisions of paragraph 2 of this Article, gains from the alienation of ships and aircraft operated in international traffic and movable property pertaining to the operation of such ships and aircraft, shall be taxable only in the Cont....

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....al gains in case of depreciable assets. Notwithstanding anything contained in clause (42A) of section 2, where the capital asset is an asset forming part of a block of assets in respect of which depreciation has been allowed under this Act or under the Indian Income Tax Act, 1922 (11 of 1922), the provisions of sections 48 and 49 shall be subject to the following modifications:-(1) where the full value of the consideration received or accruing as a result of the transfer of the asset together with the full value of such consideration received or accruing as a result of the transfer of any other capital asset falling within the block of the assets, during the previous year, exceeds the aggregate of the following amounts, namely - (i) expenditure incurred wholly and exclusively in connection with such transfer or transfers:-(ii) the written down value of the block of assets at the beginning of the previous year; and (iii) the actual cost of any asset falling within the block of assets acquired during the previous year; such excess shall be deemed to be the capital gain arising from the transfer of short term capital assets; (2) where any block of assets ceases to exist as such, f....

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....ace on a date earlier than 6th October 1997. Our attention is also pointed out to the fact that once rig itself moves out of Indian territorial waters or is not operational, the assessee cannot be said to have a permanent establishment in India, and once the PE itself comes to an end, it ceases to be of concern to the Indian tax authorities as to what the assessee does to its assets. The only live link and nexus of assessee's taxability in India is its 'permanent establishment' and once the 'permanent establishment' ceases to exist in India, the assessee's taxability in India also ceases. Learned counsel contends that if under the terms of agreement, an asset of the non resident is to be handed over to an offshore buyer outside Indian territory, the gains on such sale can never be taxed in India. As for the claim of depreciation, it is submitted by the assessee that the depreciation was claimed so as to work out the profits attributable to the permanent establishment - which is necessary for ascertaining the quantum of income taxable in India. Merely because the depreciation is claimed, it cannot imply that whenever this asset is sold anywhere in the world, profits or gains on such....

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....thus confined to mainly to legal issues arising out of by and large undisputed facts. We are urged to hold that the gains on sale of rig have no tax implications in India. 16. On the other hand, learned Departmental Representative vehemently relies upon the orders of the authorities below and takes us through the same. It is emphasized that a series of steps have taken place, during the period when the assessee had a permanent establishment in India and when this asset was being used by the said permanent establishment, to effect the sale of rig - right from initial agreement, inspection, deposit of earnest money, drawing of bill of sale, obtaining clearance for movement of rig, termination of contract, and allowing access to the surveyors to monitor movement of rig to international waters. It cannot, therefore, be said that sale has not taken place during assessee's having a permanent establishment in India and during the period when the rig was so used as an asset of the permanent establishment. Merely because one last step is completed outside Indian territory, i.e. handing over of the rig in international waters, it cannot be said that the sale of rig has taken place outside I....

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.... Section 4 of the Act it is the total income of every "person" which is taxable. A foreign company which is not wholly controlled or managed in India is a non-resident so far as its residential status is concerned. Section 5(2) of the Act lays down that as far as a non-resident assessee is concerned scope of total income of such an assessee is confined to an income which accrues or arises in India or is deemed to accrue or arise in India and which income is received or deemed to be received by such foreign company. Therefore, it is clear that under the Act, a taxable unit is a foreign company and not its branch or PE in India. A non-resident assessee may have several incomes accruing or arising to it in India or outside India but so far as taxability under Section 5(2) is concerned, it is restricted to incomes which accrue or arise or is deemed to accrue or arise in India. The scope of this deeming fiction is mentioned in Section 9 of the Act. Therefore, as far as the income accruing or arising in India, an income which accrues or arises to a foreign enterprise in India can be only such portion of income accruing or arising to such a foreign enterprise as is attributable to its bus....

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....vations of the Hon'ble Supreme Court, is like this. Its taxability in India in respect of profits of such PE is limited to only such profits as accrue or arise in India, or are deemed to accrue or arise in India. As regards the income accruing or arising in India, as observed by the Hon'ble Supreme Court, "an income which accrues or arises to a foreign enterprise in India can be only such portion of income accruing or arising to such a foreign enterprise as is attributable to its business carried out in India" and "since there is no specific provision under the Act to compute profits accruing in India in the hands of the foreign entities, the profits attributable to the Indian PE of foreign enterprise are required to be computed under normal accounting principles and in terms of the general provisions of the Income‐tax Act". Their Lordships have further observed that, "This demarcation is necessary in order to earmark the tax jurisdiction over the operations of a company. Unless the PE is treated as a separate profit centre, it is not possible to ascertain the profits of the PE which, in turn, constitutes profits arising to the foreign GE in India". It is important to bear in....

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....pothetical independence requires recognition of the PE as independent of the non resident. Accordingly, the assets of the PE are also to be recognized as such. Viewed from this perspective, profit or gains on sale of assets of the PE are to be treated as profits of the PE - under whichever head of income these profits and gains may be taxed under the law. It will perhaps be absurd to suggest that this hypothesis of PE independence and PE being a separate profit centre is valid only for amounts taxable as 'profits and gains from business or profession' and not for amounts taxable under the other heads of income. When a PE ceases to exist, either there can be a transfer of asset back to the non resident or there can be an alienation of such an asset to an outsider. There can not any gains on transfer of assets back to the non resident, as no consideration is attached to such a transfer. However, when PE assets are being alienated to an outsider, the gains or losses on such alienations are to be treated as gains or losses to the PE with consequent tax implications. The gains or losses on sale of PE assets, in view of the above discussions, are to be treated as "accruing or arising in ....

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.... the asset sold was a part of the assets of Indian business operations of the assessee, and it, therefore, has a direct business connection in India. The gains on sale of rig is also deemed to accrue or arise in India because this rig was 'an asset in India' as also ' a source of income in India'. This rig was owned by the assessee and was used for the purposes of business of the assessee in India, as evident from the fact depreciation was claimed and, therefore, conditions of Section 32(1) were satisfied. The rig was a source of income in India, and there cannot be any dispute about this factual aspect either. The gains on sale of rig are, therefore, also covered by the fiction of income deemed to have accrued or arisen under Section 9(1)(i) in India. None of the exclusion clauses, that we have briefly touched upon earlier in our discussions, are applicable on the facts of the present case. In view of these discussions, in our considered view, the profits or gains on sale of assets of the Indian PE, or even the Indian PE itself, are taxable in India under the provisions of the Indian Income Tax Act. 22. As we uphold the taxability of income on sale of rig in India in terms of the....

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....ective Contracting States." 24. The scheme of allocation of capital gains taxability rights is thus like this. While the gains on alienation of immoveable property are taxable in the tax jurisdiction in which immovable property is situated, gains on sale of ships and aircrafts, which are used in international traffic, as also moveable property relatable thereto, are taxed in which the effective place of management is situated. The common thread in this approach is that in whichever tax jurisdiction the income from the asset is taxed, gains on sale of such assets are also taxed in the same jurisdiction. The income from immoveable property under Article 6(1) is taxed in the tax jurisdiction in which immoveable property is situated. Article 13(1) as an extension of this provision seeks to tax on alienation of such assets also in the tax jurisdiction in which immovable property is situated. Likewise, under Article 8 (1), profits from operations of ships and aircraft are taxed in the tax jurisdiction in which effective management of the enterprise engaged in such operations of ships and aircrafts is situated, and Article 13(3) provides for taxability of gains on sale of such aircr....

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....s, it cannot be open to the assessee now to turn around and avoid corollaries of that status. 26. Learned counsel has laid a lot of emphasis on the contention that at the point of time when sales took place, the PE did not exist. That proceeds on the assumption that the date which is relevant for sale is not the date on which the sale invoice is drawn up, not even the date on which possession of rig comes in the hands of an independent surveyor for ultimate handover to the buyer at a specified offshore location, but the only relevant date is the date on which the rig is handed over to the end buyer in international waters. The correctness of this assumption, apart, it is also important to bear in mind that so far as continuity of the permanent establishment is concerned, the continuity of business operations through the PE are at best relevant only for the purposes of taxability of business profits in the source country and for no other purposes. A PE may not continue to exist during the period when its winding up is in progress, but that does not obliterate the treaty provisions to the effect that gains on such alienation of PE or PE's moveable assets will be taxed in the ta....

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....ction as long as the transaction otherwise leads to taxability in India. That apart, even on merits, it cannot be said that sales has taken place on 6th October, 1997. Learned counsel for the assessee has relied upon the surveyor's report to the effect that the delivery was handed over to Pride Global Limited of British Virgin Islands on 6th October 1997. It is, however, important to bear in mind the fact that this surveyor came to picture to facilitate the transfer of rig to the buyer, and came to board the rig on 15th September 1997 and started the process of moving the ship to international waters and at the specific place where rig was to be handed over to the buyer. While assessee has filed the extracts from surveyor's log, reflecting activities from 1st October 1997 to 6th October 1997, there was no compliance to our requisition of filing entire surveyor's log in respect of activities on this ship i.e. from 15th September 1997 to 6th October 1997. 28. We have noticed that immediately upon sale invoice being drawn up i.e. 17th September 1997, the process of moving the rig to international waters had started. The process of moving rig to the international waters is thus a resu....

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....f sale of rig. It cannot therefore be said that the business came to an end, rig was moved to international waters and then it was an unconnected event that the rig was sold. On the contrary, the correct sequence of events appears to be like this - the rig was sold, since rig was sold, the contract had to be terminated, and, as a part of the seller's obligations under the contract of sale, the rig was moved to international waters. As a matter of fact, assessee's intimation about discontinuance of business9 is somewhat misleading inasmuch as it states that , " ...the assessee company, although would be doing business elsewhere in international waters, has discontinued its business operations in India and has moved out the aforesaid rig from Indian territorial waters to international waters". The movement of rig to the international waters 9 Letter dated 5th October 1997 addressed to the Assessing Officer - at page 29 of the compilation of papers was not for the purposes of doing business, as this intimation suggests, but for the purposes of selling the rig itself - a fact which was clearly and unambiguously known to the assessee. 29. It is thus clear that the movement of rig....