TMI Blog2007 (1) TMI 91X X X X Extracts X X X X X X X X Extracts X X X X ..... ed Natural Gas (LNG) receiving storage and degasification facility at Dahej in the State of Gujarat. A supplementary agreement was entered into by the parties on 19.03.2001. The contract envisaged a turnkey project. Role and responsibility of each member of the consortium was specified separately. Each of the member of the consortium was also to receive separate payments. Appellant was to develop, design, engineer and procure equipment, materials and supplies, to erect and construct storage tanks of 5 MMTPA capacity, with potential expansion to 10 MMTPA capacity at the specified temperatures i.e. -200 degree Celsius. The arrangement also was to include marine facilities (jetty and island break water) for transmission and supply of the LNG to purchasers; to test and commission the facilities relating to receipt and unloading, storage and re-gasification of LNG and to send out of re-gasified LNG by means of a turnkey fixed lump-sum price time certain engineering procurement, construction and commission contract. The project was to be completed in 41 months. The contract indisputably involved : (i) offshore supply, (ii) offshore services, (iii) onshore supply, (iv) onshore servi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... before the Authority was that the contract being a divisible one, it did not have any liability to pay any tax in regard to offshore services and offshore supply. Revenue, on the other hand, contended that the contract being a composite and integrated one, they were so liable. 7. The Authority referred to a large number of decisions governing the field and opined that having regard to the provisions contained in Section 5 read with Section 9 of the Act, following propositions of law would emerge : "(1) In a case of sale of goods simpliciter by a non-resident to a resident in India, if the consideration for sale is received abroad and the property in the goods also passes to the purchaser outside India, no income accrues or arises or deemed to accrue or arise to the seller in India. (2) In a case of transaction of sale of goods by the non-resident to an Indian resident which is a part of a composite contract involving various operations within and outside India, income from such sale shall be deemed to accrue or arise in India if it accrues or arises through or from any business connection in India. (3) In the case of a business of which all operations are not carried ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... supply of equipment and materials is liable to be taxed in India under the provisions of the Act and the India-Japan Treaty. (ii) Question No.2 that in view of the Explanation (a) to section 9(1)(i) of the Act and/or Article 7(1) read with the Protocol of the India-Japan Treaty the amounts that would be taxable in India is so much of the profit as is reasonably attributable to the operations carried out in India, we decline to answer the other part of the question in regard to quantification of the amount taxable in India as the parties produced no evidence and did not address in this regard. (iii) Question No. 3 that the amount received/receivable by the applicant from Petronet LNG for offshore services is liable to be taxed in India both under the provisions of the Act as well as under Indo-Japan Treaty. (iv) Question No.4 that the entire amount received for offshore services is chargeable to tax under the Act and under the Treaty but at the rate not more than 20% of the gross amount. (v) Question No. 5 that the applicant would not be able to claim any deduction in computing the income from offshore service under the Act, and/or under the Indo-Japan Treaty." 11. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... come for the "offshore supply" or "offshore services" is received in India, the Authority misdirected itself in passing the impugned judgment; (vii) A legal fiction raised under the Act cannot be pushed too far. Also, as all operations in connection with the offshore supply are carried out outside India, the question of any portion of the consideration to be regarded as deemed to accrue or arise in India would not arise; (viii) The requirement of the appellant to perform certain services in India, such as unloading, port clearance, transportation of the equipments supplied would not render the appellant eligible to tax as the consideration thereof is embedded in the consideration for the offshore supply; (ix) Although the appellant was required to carry out certain activities in India, the consideration for offshore services had separately been provided for. (x) Assuming that the income from the offshore supply is chargeable to tax in India on the premise that Section 9(1)(i) applies, it was required to be examined by the Authority as to whether it would also be chargeable in accordance with the provisions of the Double Taxation Avoidance Agreement (DTAA) in terms wh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the appellant. Contract : The Material Part : 14. Petronat LNG Limited, on the one hand, and five members of the consortium, on the other, are parties to the contract. The contract contained broad items. It has its own interpretation clauses. Clause 2.1 provides for scope of the work in the following terms : "2.1 The Work Except as otherwise expressly provided in this Contract, Contractor shall provide, furnish and perform, or cause to be provided, furnished and performed, on a turnkey basis all necessary design, engineering, procurement, supplies, installation, erection, construction, testing, commissioning, operation and turning over services, activities and work (including all rectification and remedial services, activities and work relating to defects and deficiencies) for the Equipment and Materials and the Facilities in accordance with the Scope of Work (Exhibit A) and the other terms, provisions and requirements of this Contract, including the Contract Schedule, and shall provide all necessary and sufficient Contractor's Equipment and experienced personnel having the requisite expertise for such purposes. After Mechanical Completion of the Facilities ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or to satisfy the Completion and Performance Guarantees and the warranties set forth, in this Contract and to make the Facilities operable and capable of performing as specified in the Technical Documents or as otherwise necessary in order to comply with the requirements of this Contract. Without limitation to the foregoing, wherever this Contract describes any portion of the Work in general terms, but not complete in detail, Contractor agrees that the Work shall include any incidental work, activities and services which may be reasonably inferred as required or necessary to complete and render operable the Facilities in accordance with the terms and conditions of the Contract, and owner shall have no obligation or responsibility whatsoever (except as specifically set forth in this Contract) with respect to the completion of the Facilities. The contractor shall ensure that the Facilities shall be fit and suitable for its intended purpose (including attaining the Completion and Performance Guarantees) as evidenced by, or reasonably to be inferred from, this Contract, and shall fully comply with the Contract. Work undertaken, Equipment and Materials (including components thereo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... "Indian Rupee Portion"), which shall be subject to adjustment only as provided under Clause 13.4 (the US Dollar Portion and the Indian Rupee Portion, as the same may be so adjusted, together, the "Contract Price")." 18. The contract envisages that the appellant may do the job itself or get the same done by sub-contracting. It may only do a part of the job itself. 19. The contract splits in dollar and rupee components separately. Clause 14.8 provides for general terms of payment, effect of payment and methodology of payment. Pursuant to or in furtherance whereof separate payment in US dollars and Indian rupees is to be made depending upon the nature of supply viz. offshore supply and offshore services and onshore supply and onshore services. 20. Clause 22.1 deals with passing of title to the goods supplied in the following terms : 22.1 Title to Equipment and Materials and Contractor's Equipment : The contractor agrees that title to all Equipment and Materials shall pass to Owner from the Supplier or Subcontractor pursuant to Section E of Exhibit H (General Project Requirements and Procedures). Contractor shall, however, retain care, custody, and contro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 1 to 2.3.3) 1,869,978,658 Nil IHI, BNI TEIL D-2.4 Onshore Services (Total of 2.4.1 to 2.4.3) 1,774,353,282 12,780,467 IHI, BNI TEIL D-2.5 Construction and erection (Total of 2.5.1. to 2.5.3) 3,958,464,384 36,795,623 IHI, BNI TEIL D-2.0 Total (D-2.1 to D-2.5) (See Note 9 ) 7,602,796,324 151,044,192 Treaty : Double Taxation Avoidance Agreement (DTAA) : Article 5 of the Double Taxation Avoidance Agreement (DTAA) between India and Japan, inter alia, provides as under : "1. For the purposes of this Convention, the term 'permanent establishment' means a fixed place of business through which the business of an enterprise is wholly or partly carried on. 2. The term "permanent establishment" includes especially : (a) a place of management; (b) a branch; (c) an office; (d) a factory; (e) a workshop; (f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources; (g) a warehouse in relation to a person providing s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... onvention, it is understood that by using the term "directly or indirectly attributable to the permanent establishment", profits arising from transactions in which the permanent establishment has been involved shall be regarded as attributable to the permanent establishment to the extent appropriate to the part played by the permanent establishment in those transactions. It is also understood that profits shall be regarded as attributable to the permanent establishment to the above-mentioned extent, even when the contract or order relating to the sale or provision of goods or services in question is made or placed directly with the overseas head office of the enterprise rather than with the permanent establishment." Statutory provisions : 27. Sections 5(2), Section 9(1)(i), Section 9(1)(vii) of the Act, which are relevant for our purpose, read as under : "5(2) Subject to the provisions of this Act, the total income of any previous year of a person who is a non-resident includes all income from whatever source derived which - (a) is received or is deemed to be received in India in such year by or on behalf of such person; or (b) accrues or arises or is deem ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oject. The contract may also be a turnkey contract, but the same by itself would not mean that even for the purpose of taxability the entire contract must be considered to be an integrated one so as to make the appellant to pay tax in India. The taxable events in execution of a contract may arise at several stages in several years. The liability of the parties may also arise at several stages. Obligations under the contract are distinct ones. Supply obligation is distinct and separate from service obligation. Price for each of the component of the contract is separate. Similarly offshore supply and offshore services have separately been dealt with. Prices in each of the segment are also different. 31. The very fact that in the contract, the supply segment and service segment have been specified in different parts of the contract is a pointer to show that the liability of the appellant thereunder would also be different. 32. The contract indisputably was executed in India. By entering into a contact in India, although parts thereof will have to be carried out outside India would not make the entire income derived by the contractor to be taxable in India. We ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ld be taxable in India. 39. Territorial nexus doctrine, thus, plays an important part in assessment of tax. Tax is levied on one transaction where the operations which may give rise to income may take place partly in one territory and partly in another. The question which would fall for our consideration is as to whether the income that arises out of the said transaction would be required to be proportioned to each of the territories or not. 40. Income arising out of operation in more than one jurisdiction would have territorial nexus with each of the jurisdiction on actual basis. If that be so, it may not be correct to contend that the entire income 'accrues or arises' in each of the jurisdiction. The Authority has proceeded on the basis that supplies in question had taken place offshore. It, however, has rendered, its opinion on the premise that offshore supplies or offshore services were intimately connected with the turnkey project. 41. The learned Additional Solicitor General in support of his contention that the contract is a composite one, has relied upon the following decisions : N. Khadervali Sahib v. N. Gudu Sahib [2003] 261 ITR 1 (SC) ; [(2003) 3 S ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... must stipulate that the equipment would be supplied on CRF basis. It spells out the price for supply of goods, in which event, for the purpose of sales tax, the contract would involve sale of goods. The principle of Gannon Dunkerly [1958] 9 STC 353 (SC) ; [1959 SCR 379], does not appear to be of much relevance in the instant case. 46. The decisions of this court under the Sales Tax Laws referred to by the learned counsel, moreover, may have to be considered on a different footing. 47. In this case, we are faced with a different situation. It is only for the purpose of taxability that the terms of the contract are required to be construed. A turnkey contract may involve supply of materials used in the execution of the contract for price as also for use of the materials by works and labour; but the same may not have any relation with the taxability part of it. 48. It is interesting to note that Instruction No.1829 issued by the Central Board of Direct Taxes on 21.09.1989 provides for certain guidelines having regard to the possibility of undertaking of Hydro Electric Power Project by a consortium of a foreign company, stating : "The concept of turnkey execution ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed in connection with the installation are under a separate contract or are incidental to the execution of the contract of sale." 61. In Patnaik and Co. [1986] 161 ITR 365 (SC) ; [1986] 4 SCC 16, whereupon reliance has been placed by the learned Additional Solicitor General, the question which arose for consideration was as to whether the investment in the loan by the assessee out of the advance payment made by the Government departments was a capital asset and the loan was a capital loan or not. We are not herein concerned with such a situation. The said decision, therefore, cannot be said to have any application at all. 62. In BSES Ltd. [2006] 130 Comp Cas 8 (SC) ; [2006] 2 SCC 728, (supra), this Court was concerned with the construction of bank guarantees. The question which arose for consideration therein was as to whether in the fact situation of the case, customer faced irretrievable injuries so as to obtain an order of injunction. In view of the terms and conditions of the contract, it was opined, although for the sake of convenience, the same had been split up into four sub-contracts, it constituted a composite contract executable on a turnkey basis. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or arise at the place of the source or may accrue or arise elsewhere, but it does not follow that the income cannot accrue or arise at the place where the source exists. Therefore it is necessary to ascertain whether that part of the business which is capable of being treated as one separate unit in the Hyderabad State has given rise to the income or profit sought by the assessee to be exempted from taxation in the present case" 57. Patanjali Sastri, J. approved the application of the principle underlying the decision in Commissioner of Taxation v. Kirk [(1900 AC 588], namely, the principle of apportioning profits as between different processes employed in producing those profits and the different places where they were employed. 58. Mahajan, J. held : "For instance, where a person carries on manufacture, sale, export and import, it is not possible to say that the place where the profits accrue to him is the place of sale. The profits received relate firstly to his business as a manufacturer, secondly to his trading operations, and thirdly to his business of import and export. Profit or loss has to be apportioned between these businesses in a businesslike manner an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Section 42(3) as attributable to the operations carried out in India be taken into account for applying the test laid down in Section 4-A(c)(b)?" and remanded the case to the High Court with the direction that it should give its opinion on these two questions. 60. In regard to the first question, it was opined that Section 42(3) had nothing to do with the determination of the income arising in the taxable territories as distinguished from the income arising without taxable territories as understood in Section 4A(c)(b) of the Act, it was held (page 49) "The phraseology of Section 42(3) of the Act also repels the contention insofar as the profits and gains of the business which are referred to therein and which are capable of apportionment as therein mentioned are deemed to accrue or arise in the taxable territories thus using the words "accrue" and "arise" as synonymous with each other. The above passage is also sufficient in our opinion to establish that the apportionment of income, profits or gains between those arising from business operations carried on in taxable territories and those arising from business operations carried on without the taxable territories is bas ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... be split up since the entire contract was to be read together and was for one complete transaction. It was in the said fact situation held that it was not possible to apportion the consideration for design on one part and the other activities on the other part. The price paid to the assessee was the total contract price which covered all the stages involved in the supply of machinery. 64. This case is clearly distinguishable from the facts of the present case, since the payment for the offshore and onshore supply of goods and services was in itself clearly demarcated and cannot be held to be a complete contract that has to be read as a whole and not in parts. 65. The principle of apportionment is also recognized by Clause (a) of Explanation 1. Thus, if submission of the learned Additional Solicitor General is accepted that the contract is a composite one, then offshore supply would be of equipment designed and manufactured in one territory (Japan), and then sold in another tax territory, leading to division of profits arising in two tax territories, which is not envisaged under our taxation law. 66. It gives rise to the question as to what would be the meanin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sh solicitor which was real and intimate and not just a casual one and the fees earned by the solicitor was only through this connection, and could not have done so without associating himself with the firm. Thus, the income earned by the solicitor was subject to tax in India, and payable by the firm as agents of the solicitor. 72. The principle of this case, is again not applicable in the present scenario since the nature of the relationship between the permanent establishment, the foreign firms and the Indian firms are evidently contractual and not professional. And the transaction of sale and supply of goods offshore have not taken place with the involvement of the permanent establishment, therefore excluding this transaction from the scope of taxation in India. 73. In CIT v. Toshoku Ltd. [(1980) 125 ITR 525 : (1980) Supp. SCC 614], this Court interpreted Section 9(1)(i) and the Explanation thereto on the factual matrix obtaining therein that the statutory agent exported his goods to Japan and France where they were sold through the assessee and the entire sales price was received in India by the said agent who made credit entries in his accounts books regarding t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the trading activity which was intended to be carried on by the assessee as production adviser of Hindustan Steel Ltd., in future was relatable to or connected with the past supply of the said know-how and other items." [See also Income-Tax Officer and Others v. Shriram Bearings Ltd . - (1987) 164 ITR 419] 76. A similar view was taken, when the matter came before this Court in Income-Tax Officer and Others v. Shriram Bearings Ltd. [(1997) 224 ITR 724 : (1997) 10 SCC 332], wherein B.P. Jeevan Reddy, J. speaking for the Division Bench, opined (page 726) : "We are not prepared to agree that the High Court has not correctly understood the purport of the agreement between the respondent and M/s Nippon Seike Kabushiki Kaisha (NSK). The agreement is in two parts. It is true that the two parts are interdependent but yet the consideration for the sale of trade secrets and consideration of technical assistance is separately provided for and mentioned under separate sections. So far as the consideration for the technical assistance is concerned, its taxability is not in doubt. The only controversy is with respect to the taxability of 1,65,000 US Dollars which is stipulate ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gh a Permanent Establishment, they clearly fall out of the applicability of Article 12(5) of the DTAA and into the ambit of Article 7. The Protocol to the DTAA, in paragraph 6, discusses the involvement of the permanent establishment in transactions, in order to determine the extent of income that can be taxed. It is stated that the term 'directly or indirectly attributable' indicates the income that shall be regarded on the basis of the extent appropriate to the part played by the permanent establishment in those transactions. The permanent establishment here has had no role to play in the transaction that is sought to be taxed, since the transaction took place abroad. 81. Clause 1 of Article 7, thus, provides that if an income arises in Japan (Contracting State), it shall be taxable in that country unless the enterprise carries on business in the other Contracting State (India) through a permanent establishment situated therein. What is to be taxed is profit of the enterprise in India, but only so much of them as is directly or indirectly attributable to that permanent establishment. All income arising out of the turnkey project would not, therefore, be assessable in India, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es incurred in connection with direct transactions may not be set off against a permanent establishment's profits. Since a DTC may not increase tax liability, the USA, it is true, imposes tax at the lower amount that would ensue if the permanent establishment's business and direct transactions were combined and treated as if no DTC existed (of course, the taxpayer may, in such event, not only set off the result of individual direct transactions, which amounted to a loss against the permanent establishment's positive operating result :I.R.S. Rev. Rul. 84-17, 1984-I Cum. Bull. 308). According to that ruling, the taxpayer is in such cases entitled to elect taxation which discounts the DTC. (see surpa Art. I, at m. no.44)." 84. We generally agree with the said statement law. 85. The distinction between the existence of a business connection and the income accruing or arising out of such business connection is clear and explicit. In the present case, the permanent establishment's non-involvement in this transaction excludes it from being a part of the cause of the income itself, and thus there is no business connection. 86. Article 5.3 provides that a person is regarded ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... osite transactions which have some operations in one territory and some in others, is essential to determine the taxability of various operations. 89. It is, therefore, in our opinion, the concepts profits of business connection and permanent establishment should not be mixed up. Whereas business connection is relevant for the purpose of application of Section 9; the concept of permanent establishment is relevant for assessing the income of a non-resident under the DTAA. There, however, may be a case where there can be over-lapping of income; but we are not concerned with such a situation. The entire transaction having been completed on the high seas, the profits on sale did not arise in India, as has been contended by the appellant. Thus, having been excluded from the scope of taxation under the Act, the application of the double taxation treaty would not arise. Double Tax Treaty, however, was taken recourse to by Appellant only by way of an alternate submission on income from services and not in relation to the tax of offshore supply of goods. 90. We would in the aforementioned context consider the question of division of taxable income of offshore services. Parti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iability is an internationally accepted principle. An endeavour should, thus, be made to construe the taxability of a non-resident in respect of income derived by it. Having regard to the internationally accepted principle and DTAA, it may not be possible to give an extended meaning to the words 'income deemed to accrue or arise in India' as expressed in Section 9 of the Act. 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. Whereas a resident would come within the purview of Section 9(1)(vii) of the Act, a non resident would not, as services of a non-resident to a resident utilize in India may not have much relevance in determining whether the income of the non-resident accrues or arises in India. It must have a direct live link between the services rendered in India, when such a link is established, the same may again be subjected to any relief ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... herefore cannot be deemed to accrue or arise in the country. (5) There exists a distinction between a business connection and a permanent establishment. As the permanent establishment cannot be said to be involved in the transaction, the aforementioned provision will have no application. The permanent establishment cannot be equated to a business connection, since the former is for the purpose of assessment of income of a non-resident under a Double Taxation Avoidance Agreement, and the latter is for the application of Section 9 of the Income Tax Act. (6) Clause (a) of Explanation 1 to S. 9(1)(i) states that only such part of the income as is attributable to the operations carried out in India, are taxable in India. (7) 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 the taxing entire income attributable to the permanent establishment. (8) There exists a difference between the existence of a business connection and the income accruing or arising out of such business connection. (9) Paragraph 6 of t ..... X X X X Extracts X X X X X X X X Extracts X X X X
|
