TMI Blog1995 (8) TMI 315X X X X Extracts X X X X X X X X Extracts X X X X ..... rote to the Authority on June 10, 1995, stating that X and Y (hereinafter compendiously referred to as XY ) had not so far awarded any contract to ABC, but that the scope of the work and the terms and conditions of their execution had since been formalised. Revised versions of annexure I (statement of relevant facts), annexure II (the applicant s interpretation of the facts and law) and annexure III (questions on which advance ruling is required) have been submitted in substitution of annexures I , II and III submitted with the original application. These annexures are more elaborate and detailed and now 13 questions are posed for advance ruling in place of the original four questions. It is on the basis of these revised annexures that the Authority has to give its ruling. ABC is a company incorporated under the laws of the France with affiliates in several countries. For the purposes of the Act, it is a nonresident foreign company . It is in the business of engineering and construction management, providing project development services and construction of industrial plants. It is stated that the company is engaged in the execution of large infrastructure projects, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g) Project Management Services Agreement (MSA) One set of such agreements will be with X and another with Y. Although ABC has requisite expertise, knowledge, capability, manpower and infrastructure to render effectively and properly all services, i.e., engineering, project management, procurement and site services and assistance, etc., time being the essence of the contract to erect and commission the plant, ABC may by way of sub-contract get part of the work relating to engineering and buying services done through their affiliate office/third parties while retaining the overall responsibility with them. As stated above the work to be done by ABC under all the agreements except USA and SA will involve activities in India as well as outside India. Such a bifurcation, however, is stated to be unnecessary for the USA and SA because no separate payment will be stipulated in these two agreements for the services to be rendered thereunder. Against the background of this proposed transaction, the questions posed by ABC before the Authority for its ruling have been formulated as follows : Question No. 1 : Whether ABC w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... India in respect of engineering services and buying services which may be sub-contracted by the head office to its worldwide affiliates and third parties, will be considered as reimbursements and, therefore, will be deductible in computing the profits of the permanent establishment in India ? Question No. 12 : Whether the head office of ABC would be liable to withhold taxes under the Income-tax Act of India in respect of payments made to foreign suppliers (including ABC affiliates and sub-contractors) of goods, services and technologies ? Question No. 13 : Whether the profits of the permanent establishment in India will be computed under the head Profits and gains of business or profession as described in Chapter IV, Part D, of the Act and brought to tax at the rates applicable to a foreign company or the gross receipts will be subjected to tax at the rates prescribed under section 115A of the Act ? The DTAA mentioned in the above questions (and hereinafter so referred to) is the convention between India and France for the avoidance of double taxation with respect to taxes on income and capital. It came into force on August 1, 1994. A Protocol entered into between the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... enterprise of one of the Contracting States shall be taxable only in that Contracting 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 Contracting State but only so much of them as is attributable to that permanent establishment. (2) Subject to the provisions of paragraph 3, where an enterprise of one of the Contracting States 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. In any case where the correct amount of profits attributable to a permanent establishment is incapable of determination or the determination thereof presents exceptional difficulties, the profits attributable to the perman ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ay of royalties, fees or other similar payments in return for the use of patents or other rights, or by way of commission for specific services performed or for management, or, except in the case of a banking enterprise, by way of interest on moneys lent to the head office of the enterprise or any of its other offices . . . (6) 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. (d) Royalties and fees for technical services and payments for the use of equipment. Of particular relevance to this case is the mode of taxation of royalties and fees for technical services . This article also needs to be set out almost in full here (see [1994] 209 ITR (St.) 130 209 ITR (St.) 143 ): Article 13. Royalties and fees for technical services and payments for the use of equipment. (1) Royalties, fees for technical services and payments for the use of equipment arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other Contracting State. (2) However, such royalties, fees and pay ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fees for technical services or the payments for the use of equipment, whether he is a resident of a Contracting State or not has in a Contracting State a permanent establishment or a fixed base in connection with which the contract under which the royalties, fees for technical services or the payments for the use of equipment, are paid was concluded and such royalties, fees for technical services or payments for the use of equipment are borne by such permanent establishment or fixed base, then such royalties, fees for technical services or payments for the use of equipment shall be deemed to arise in the Contracting State in which the permanent establishment or fixed base is situated . . . (e) Protocol : Reference may now be made to paragraph (3) of the Protocol which, as already mentioned, is part of the Convention and has been considerably relied upon by counsel for ABC. It reads (see [1994] ) : (3) In respect of paragraphs 1 and 2 of Article 7, where an enterprise of one of the Contracting States sells goods or merchandise or carries on business in the other Contracting State through a permanent establishment situated therein, the profits of that permanent establishment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... be said to be resident also in India within the meaning of Article 4(1) of the DTAA, its residence for the purposes of the DTAA has to be attributed to France in view of the clarification contained in paragraph 3 of Article 4. There can, therefore, be no doubt that, for the purposes of the DTAA, ABC has to be treated as a person resident in France. There is no controversy between the parties on this. This is the answer to question No. 1. Question No. 2 The answer to question No. 2 is equally clear and simple. Under the contract, ABC is to maintain not one, but two offices in India which will also be places from which the execution of the contract will be looked after, managed and overseen. It is, therefore, clear that ABC will be having a permanent establishment in India once these offices are set up and the activities of ABC in India are commenced. The wording of the question, however, which lays stress on whether ABC can be said to have a permanent establishment in India from the first day of commencement of its business in India seems to have derived inspiration from the language of paragraph 3 of Article 5 of the DTAA. This question, however, proceeds on an erroneous ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... trademarks, designs, models, plans, secret formula or processes which belong to ABC or are acquired by it from others or for information concerning industrial, commercial or scientific experience or in consideration for services of a managerial, technical or consultancy nature . Hence, there can be no manner of doubt that the payments received by ABC under the agreements answer the description of royalties or technical fees as defined in paragraphs 3 and 4 of Article 13 of the DTAA. On behalf of the Department, it is contended that ABC s receipts under the contract are in the nature of the profits of a business of setting up a plant and an industrial complex in India and are assessable under Article 7 of the DTAA. But the question whether the receipts are in the nature of royalties and technical services has to be answered with reference to the terms of the agreement under which they arise. There is no incompatibility between recognising the receipts as royalties and fees for technical services which they are under the agreements and looking upon them also as the profits of a business assessable under Article 7. Judicial decisions have recognised this principle in regard t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erform efficiently the services expected of it under the ESA and BSA though the abstract of these agreements supplied by the applicant makes no specific reference to this aspect. Naturally, for acquiring or utilising the process technologies or expertise of others, ABC will have to make payments to the affiliates or other suppliers who make such technologies or expertise available to it. Naturally, ABC would have taken into account the cost of acquisition or hire of such technologies and special knowledge in arriving at the consideration it should receive from XY under each of the several agreements. The position, thus, will be that a good part of the payments received by ABC from XY under these agreements may either go in reimbursement of the payments made by ABC to its suppliers for the acquisition or utilisation of their processes or expertise or will be utilised by ABC to make such payments. The question raised, apparently, is whether this feature of the payments by XY to ABC will disentitle ABC from claiming to be the beneficial owner of the royalties and technical fees received by it from XY to the extent they get passed on, in turn, to its own suppliers. The questions, as fr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tive expenses so incurred will be allowed as deduction but in accordance with the provisions of and subject to the limitations of the taxation laws of India. The underlined phrase governs not merely executive and administrative expenses (limitation on the deductibility of which is dealt with by section 44C of the Act) but also all other expenses in respect of which deduction is sought in the computation of the profits of the establishment. Having said this, the proviso seeks to grant a relaxation in respect of the deductibility of executive and administrative expenses where such relaxation is permitted by subsequent DTAA agreements entered into by either of the two countries. This proviso does not cut down the generality of the rule enunciated in the first sentence of the sub-paragraph that the deductibility of all expenses (and not merely the head office administrative expenses referred to in section 44C) shall be in accordance with and subject to the limitations laid down in the Act. Question No. 9 has to be answered accordingly. Questions Nos. 10 and 11 Questions Nos. 10 and 11 relate to the interpretation of sub-paragraph (b) of paragraph 3 of Article 7 of the DTAA and th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... prise. The question raised, however, is whether the payments made by the permanent establishment of ABC to the head office : (a) for procuring the licence technology and basic engineering ; and (b) in respect of engineering services and buying services which may be sub-contracted by the head office to its world-wide associates and third parties will be considered as such reimbursements and, therefore, become deductible in computing the profits of the permanent establishment in India. This issue has been basically answered while dealing with questions Nos. 5 and 6. It has been pointed out there that the beneficial ownership of the royalties and technical fees received by the ABC under these agreements vests in ABC and is not affected by the fact that ABC, in its turn, may have to pay other parties for the expertise acquired by it. By the same token, the payments made by the permanent establishment to the head office or other offices for the technology supplied by it or the services rendered by it cannot be said to be by way of reimbursement of the expenses incurred by the head office or other offices for acquiring such technology or services. In fact, the two sets of activi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ) that the persons to whom the payments are made are non-residents under the Act ; (b) that the payments are made outside India ; and (c) that the payments are in the nature of royalties or fees for technical services. Ex facie, such payments accrue or arise outside India and will not be chargeable under the Act in the hands of the nonresident recipients and since section 195 enforces the obligation of tax deduction only from payments which will constitute income chargeable to income-tax in the hands of the recipient, there will be no requirement on the part of ABC to withhold the Indian income-tax appropriate to the payments while making the same. However, an answer to question No. 12 cannot be furnished without considering two relevant provisions, one of the Act and one contained in the DTAA. The Act contains a very far-reaching provision which seems to impose an obligation on the head office of ABC for tax deduction even in respect of such payments. The relevant provision of the Act is section 9(1) [clauses (vi) and (vii)] which may be extracted here as they are relevant for our present purposes : Section 9. (1) The following income shall be deemed to accrue or arise in I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e-tax in the hands of the payee in the circumstances set out above. Counsel for the applicant says that there are several difficulties in imposing an Indian tax liability on a foreigner in respect of a transaction entered into by him outside India with another foreigner merely because the right, property, information or service in respect of which the payment is made happens to be used at some point of time for the purpose of carrying on a business, or for earning income from a source, in India. The acquisition of the right, property, information or services may have been made in different kinds of situations. The transaction may have been effected and the full payments also made long before the utilisation in India takes place ; the payee supplier of the technology or expertise or services may not have intended or anticipated or even known that such expertise, technology or services would be used in India ; the payment may have been made in respect of technology or services which are considerably added to, improved upon, updated or even changed beyond recognition by the payer before using it in his Indian business or source of income ; the utilisation may not be confined to India ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... alties and fees for technical services in question. Though ABC is not a resident of India, it has a permanent establishment in India in connection with which it proposes or expects to enter into the contracts under which it will have to pay the royalties and fees for technical services. This circumstance that the royalties or fees for technical service are paid in respect of information or services put to use in India is sufficient, under section 9(1)(vi) and (vii) of the Act, to consider them as accruing or arising in India. But para 7 of Article 13 of the DTA requires the fulfilment of a further condition before such royalties and fees for technical services can be deemed to arise in India where it has a permanent establishment, viz., that the royalties or fees for technical services are borne by such permanent establishment. It is this condition that is not fulfilled in the present case. As has been discussed while dealing with earlier questions, the burden of payment of the royalties and fees for technical services in question is borne by the head office of ABC : such royalties or fees as ABC may receive from XY under the various agreements between them are received by it in it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion (3) of that section precludes the application of sections 28 to 44C and section 57 of the Act and renders certain types of income taxable at a specified rate, but subject to certain conditions. It will be appropriate, therefore, to consider the provisions of section 115A first. Section 115A(1) consists of two clauses. Clause (a) applies to foreign companies as well as other categories of non-resident assessees and it covers a case where such assessee derives income by way of dividends or interest on monies lent in a foreign currency to the Government or to an Indian concern or income from units of certain mutual funds purchased in foreign currency. The present case does not fall in this category. Clause (b) deals with foreign companies whose income includes income by way of royalties and fees for technical services received from the Government or an Indian concern under an agreement entered into after March 31, 1976, as in the present case. However, before section 115A could apply to such agreement, where it is with an Indian concern, it should either be one approved by the Central Government or where the agreement relates to a matter included in the industrial policy of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... echnology agreements has been forwarded to ABC by X together with the remark that the present case will be governed by subpara (iii) of para 39C and that for our agreements to fall within the Industrial Policy of the Government of India, we require specific approval under the general procedures in force and that, on receipt of the necessary approvals, the said agreements will meet the conditions required under section 115A of the Act. The above communication places the authority in an unenviable position. The agreements do not fulfill the requirements of section 115A as on date and so the applicability of that section is out of question at present. But it is to be borne in mind that the formal agreements are yet to be executed and it is possible that the parties may seek to obtain, and succeed in obtaining, the approval of the Government and thus bringing the case within the scope of section 115A of the Act. Question 13 has, therefore, to be answered in the alternative as to what the position would be in either event. In case section 115A does not apply, the answer to the question is simple and straightforward. The royalties and technical fees will be assessable in accordan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 1)(b), for these receipts do not lose the character of being royalties or fees for technical services as defined in that section. They will, therefore, have to be charged, on the gross amount, at 30 per cent. thereof. In other words, the gross amount of royalties and fees for technical services would be charged to tax at 30 per cent. Pausing here, it will be noticed that the above conclusion results in a somewhat anomalous situation. If the applicant s receipts had been assessed as royalties and fees for technical services simpliciter under Article 13 of the DTAA, the applicant could have insisted that they cannot be charged at a rate exceeding 20 per cent. However, the applicant will not be able to avail itself of this privilege or concession because the royalties and technical fees, having been derived in the course of a business carried on through a permanent establishment, have specifically been taken out of the purview of Article 13(1) and (2). The anomaly is one which arises, unfortunately, from the terms of the DTAA and cannot be helped. The net result of the discussion is that- (a) if the provisions of section 115A are not applicable to the present case, the profits a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... use (vii).-Explanation 2.-For the purposes of this clause, fees for technical services means any consideration (including any lump sum consideration) for the rendering of any managerial, technical or consultancy services (including the provision of services of technical or other personnel) but does not include consideration for any construction, assembly, mining or like project undertaken by the recipient or consideration which would be income of the recipient chargeable under the head Salaries . While the definitions of the expression royalty under the Act as well as the DTAA are not materially different in their application to the facts of the present case, there is a variation between the definitions of fees for technical services contained in the Act and the DTAA which has some significance for the present case. If these definitions are compared, it will be seen that though the statutory definition of fees for technical services takes in consideration of any kind for the rendering of any managerial, technical or consultancy services, it does not include consideration for any construction, assembly, mining or like project undertaken by the recipient, a limitation wh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f such income. This aspect has become important since we find, on a perusal of the abstract of contents of the various agreements as stated by the applicant, that the site services and assistance agreement as well as the project management services agreement relate to the assembly and construction of the manufacturing plant and the industrial complex to be set up by ABC for XY. The consideration stipulated for these agreements will, therefore, fall outside the purview of the definition of fees for technical services under Explanation 2 to section 9(1)(vii). In view of this, the answer given to question No. 13 in para 28 (at page 517) above will need to be modified by the addition of the following paragraph thereto : (c) However, in either of the above events, the provisions of sections 44D and 115A shall not be applicable in respect of that part of the receipts of ABC which represent payments in consideration of services under the agreements referred to at (f) and (g) of para 5 (at page 495) supra which relate to construction, assembly or like project with the result that only the net amount of such part of the receipts (after deduction of expenses permissible against ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... all, while all the activities of the applicant under the LBEA will be only outside India. In regard to the SSA, all the activities will admittedly be in India while the services under the other three agreements will be rendered partly in India and partly outside India. It is, therefore, contended that the profits attributable to the activities carried out outside India under the ESA, BSA and MSA alone can be brought to tax in the hands of ABC. The applicant s counsel, representing ABC, virtually reiterates this argument but with a slight legal refinement based on Article 7 read with Article 13 of the agreement. He points out that Article 13(6) lifts out of the purview of Article 13 and transposes to Article 7 all payments received as royalties or technical fees which are effectively connected with the permanent establishment in India. He says that all the royalties, etc., that may be received by ABC under the agreements, either for services, etc., in India or outside India, are effectively connected with the permanent establishment and are to be considered for assessment under Article 7. Article 7, however, provides for a bifurcation of the profits thus emerging into profits att ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... this regard need to be noticed : Section 9(1)(i) of the Act brings into the Indian tax net, all income of a non-resident which has some nexus in India which gives rise to the income such as a business connection, a property, an asset or source of income or a capital asset. Taking up the question of a business, a business connection is postulated where the non-resident does not carry on all the operations that give rise to the accrual or arisal of profits in India itself (i.e., where the entire business is in India) but carries on some systematic operations in India which, in a tangible and reasonable sense, can be treated as contributing to the accrual or arisal of the ultimate profits of the business. This concept has been fully explained by the Supreme Court in CIT v. R. D. Aggarwal and Co. [1965] 56 ITR 20. The question as to the place or places of accrual of the profits of such a business had been one of some controversy in the past but the principles are fairly well established now. The earlier concept that profits of a business arise only at the place where the sales take place was too simplistic and can no longer hold good, particularly in conditions of modern business which ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... table to the permanent establishment will be not only the profits attributable to its operations in India but also the profits which are effectively connected with the permanent establishment, though such operations of the permanent establishment may be carried on outside India. It is, at this juncture, that the Protocol which is part of the DTAA between India and France assumes great significance. Clause (3) of the Protocol restricts the taxability of the business profits to that part thereof as is attributable only to the operations carried out by the permanent establishment in India. The net effect will practically be the same as of the application of section 9(1)(i) read with its Explanation. (b) The DTAA also proceeds to lay down separate rules for the assessability of payments in the nature of royalties and technical fees. The definitions of those expressions are analogous to, though not identical with, those contained in the Explanation to section 9(1)(vi) and (vii) but for the purposes of the present case these definitions are not materially different. Both the definitions encompass the payments received by ABC from XY as consideration for various services. Article 13 pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mentioned in annexure I to the application, all these services, expertise and knowledge may be available with one person or may be acquired from different persons and it is not necessary, though perhaps very likely, that should XY s contract to ABC fructify, it should involve the rendering of all the services envisaged under the different agreements. The segmentation of the contract into agreements providing for various kinds of services is not artificial. As urged on behalf of the applicant, in the context of the globalisation of trade and restrictions imposed under the GATT, all international agreements are sectionalised so as to define and segregate the part to be played by different areas of speciality involved in the execution of a project. It is difficult to accept the plea of the Department that this contract should be viewed as the simple one of putting up a project in India and that the analysis of the various kinds of operations involved therein and their location is artificial or meaningless. Even viewed as a business contract for the putting up of a plant in India, its execution involves operations involving rendering of services at various places in different areas of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fees received by it from XY in respect of engineering services and buying services which it would sub-contract to its world-wide affiliates and/or third parties. Question No. 7 : The payments under the agreements will be taxable under Article 7 read with Article 13(6) of the DTAA. Question No. 8 : In view of Articles 7.1 and 7.2 of the DTAA read with paragraph 3 of the Protocol, only the profits of ABC attributable to the operations carried out by its permanent establishment in India will be liable to tax. Question No. 9 : The words in accordance with the provisions of and subject to the limitations of the taxation laws of the Contracting State used in Article 7.3(a) of the DTAA, would attract, in the computation of the profits under Article 7, the limitations and restrictions not merely of section 44C of the Act but of all other provisions contained in the Act as well. Question No. 10 : In view of Article 7(3)(b) of the DTAA, the payments made by the permanent establishment to the head office for procuring licence technology and ba ..... X X X X Extracts X X X X X X X X Extracts X X X X
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