TMI Blog1983 (6) TMI 31X X X X Extracts X X X X X X X X Extracts X X X X ..... Ministry of Shipping and Transport, Govt. of India. The Visakhapatnam Port exports a large amount of iron ore. In order to speed up the export operations, the Port Trust felt it necessary to install a plant known as " Bucket Wheel Reclaimer ". The purpose of this was to remove iron ore mechanically from the wharfs and put it on a conveyor belt which takes the ore directly into the ship. Global tenders were called for by the Port Trust in June, 1967. A German company known as M/s. Maschinenfabrik Buckau R. Wolf (hereinafter called the " German company ") tendered contract for supply of the Bucket Wheel Reclaimer on June 26, 1967. After several negotiations the contract was finalised on 12th September, 1968. The terms of the lengthy contract dated September 12, 1968, may be briefly noticed. The German company, (i) undertook to supply and deliver to the Port Trust one Bucket Wheel Reclaimer as per drawing, and (ii) to delegate one engineer-erector for supervising the total erection and one special fitter for installation of, electrical equipment. It is not in dispute that the engineer-erector delegated was Mr. Bremer and that no special fitter was delegated. The period of contract ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nformed that the items were ready. (iii) Rs. 22,000 was to be paid for the erecting supervising staff. Out of this 20% was to be paid at the commencement of the erection and 80% in monthly instalments as demanded by the German engineer. (iv) In case of delayed payments, cl. 12(c) provided that the German company shall be entitled to claim interest on arrears at 6% p.a. Thus there were two different types of interest charged at 6% p.a. which are specified in the contract and we are concerned with the tax on the interest in cl. 12(a). The German company had to supply the mechanical equipment, the structural steel-work, the lubrication system, the rubber-belting, the electrical equipment, ballast and spares. Clause 10 of the contract provided that the German company could delegate the erection work to the supervising staff as stated earlier. The Port Trust was to provide suitable skilled and unskilled labour, scaffolds, etc., water and electricity and the Port Trust alone had to pay for these items. Clause 11 provided the price variation formula and it was to be applied to, (i) for DM 1,610,276 (DM 1,399,860 for items of supply and DM 210,416 for spares); (ii) for DM ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... el outside India) and Rs. 22,000 for erection (i.e., wages and travelling expenses) in India. The German company's engineer-erector, Mr. Bremer was, according to it, only in charge of supervision. Documentary evidence has been filed by the Port Trust which shows that the amount payable in DM including DM 90,000 is to be paid in Germany as per the terms of the contract. After the contract was signed on September 12, 1968, letters of credit were opened in Germany to enable the German company to receive from a German bank (the Deutsche Bank, Cologne) payments of the price in instalments for each export consignment, by sea or air. Eight export consignments of the component parts of the Bucket Wheel Reclaimer including spare parts were despatched on May 15, 1969 (to Bombay), August 20, 1969 (to Bombay), September 13, 1969 (to Visakhapatnam), December 22, 1969 (to Bombay), November 6, 1969, (to Visakhapatnam), November 6, 1969 (to Visakhapatnam). These are covered by bills issued by the German company and these bills refer to the import licence dated June 5, 1968, taken out by the Port Trust and irrevocable letters of credit dated May 17, 1969, and May 22, 1969, State Bank of India, Visa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ven appeals against the finding of the appellate authority that only interest was liable to be charged to tax. That was how, in all, the Tribunal had 21 appeals before it. For the first time before the Tribunal the assessee raised the question that the tax was not payable in India in view of the Indo-German Double Taxation Avoidance Agreement (hereinafter called " the Agreement " for brevity). The Tribunal thought it fit to consider the question of the applicability of the Agreement inasmuch as it would be unnecessary to decide all other questions in the event of the assessee obtaining the benefit of the said agreement. There was no objection on behalf of the Revenue before the Tribunal for considering the applicability or otherwise of the said Agreement to the facts of the case. The Tribunal firstly rejected the preliminary objection raised by the Department regarding the jurisdiction of the Tribunal relying upon art. XVIII of the agreement. The Tribunal then considered the rival contentions on facts and summarised its findings as follows: (i) that the actual installation work or erection work or assembly work was not undertaken by the German company to be done at thei ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... self and was not an independent source of income on any indebtedness of the Port Trust. In our view, the points that arise for consideration are the following: " (1) Whether, under art. XVIII of the Agreement, the remedy of moving the Competent Authority specified therein was in substitution of the ordinary remedies of appeal, etc., available under the Income-tax statutes of the respective countries ? (2) Whether the German company is liable to income-tax in India on the basis that income is deemed to accrue or arise in India, directly or indirectly, through or from any 'business connection' in India or otherwise through an agent, the Poona company, in view of section 9(1)(i) of the Income-tax Act, 1961, and, if so, what is the effect of the first part of art. III of the Agreement on such income ? (3) Whether the German company can be said to have a permanent establishment in India by itself or through the Poona company or through Mr. Bremer so as to attract the levy of income-tax with reference to the latter part of art. III read with art. II(1)(i) of the Agreement ? (4) Whether the interest payable to the German company along with each of the twenty instalments in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the present Agreement, he shall be entitled to present his case to the Competent Authority of the territory of which he is a resident. Should his claim be deemed worthy of consideration, the Competent authority to which the claim is made shall endeavour to come to an agreement with the Competent Authority of the other territory with a view to avoiding double taxation." The above article is called the " mutual agreement procedure " and corresponds to art. XXV of the O.E.C.D. Model (Simon's Taxes, p. 369) and it has come up for consideration in various countries. From the article by John Avery Jones and others " The Legal Nature of the Mutual Agreement Procedure under the O.E.C.D. Model Convention-I " (British Tax Review (1979) p. 333), we have obtained useful material on this question which is mentioned below. The German Federal Supreme Tax Court has held that the existence of the 'mutual agreement procedure ' does not prevent the court from proceeding with the case. (German Federal Supreme Tax Court 1-2-67, 1220/64 (B. St. B 1, 1967 III 495). The same view has been taken by the Swiss Federal Tribunal (Swiss Federal Tribunal, 17-3-67, BGE 93 I-189). This was in 1967 even befor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he industrial or commercial profits of an enterprise of the other territory unless profits are derived in the first mentioned territory through a permanent establishment...." In para. 3 of art. III are enumerated certain specified items of income, i.e., rents, royalties, interest, dividends, etc., which are excluded from the " industrial or commercial profits " of the foreign enterprise. It is contended that in this case the German company must be taken to have derived its profits in India even though the money might have been paid in West Germany and further that the Poona company which has prepared the steel plate and has assembled items 13 to 17 thereupon must be taken to have a " business connection " with the German company and that the income must be taken to have been derived in India. It is true that under s. 9(1)(i) of the Act all income accruing or arising whether directly or indirectly, through or from any " business connection " in India, or other income mentioned in that section shall be deemed to accrue or arise in India. But the charging provision, s. 4, as well as s. 5 of the Act defining the " total income " of either a resident or a non-resident are expre ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y " business connection " in India which is deemed to arise or accrue in India, being part of the total income specified in s. 5 and chargeable to income-tax under s. 4, is also subject to the provisions of the Agreement to the contrary. Therefore, even assuming for a moment that all the profits of the German company are to be deemed to have accrued or arisen in India by virtue of s. 9 Of the Act, the terms of art. III of the Agreement prevail over s. 9 of the Act. In effect, the industrial or commercial profits of the German company are not liable to tax under s. 9 of the Act except to the extent permitted by art. III. We shall deal with these exceptions separately under points Nos. 3 and 4. The second point is, therefore, held against the Department and in favour of the assessee. We shall now deal with the exceptions mentioned in art. III of the Agreement separately under points Nos. 3 and 4. The third point that arises is whether the German company can be said to be deriving profits in India through a " permanent establishment " which can be taxed in India in view of the latter part of art. III of the Agreement ? That leads us to art. (II)(1)(i) of the Agreement. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... me Court of Belgium (judgment of the Supreme Court of Belgium on French-Belgium Treaty) has held that a Belgian subsidiary of a French parent company was not the parent's " permanent establishment ", notwithstanding the very tight control exercised by the parent company over the sales-territory and product lines allocated to the subsidiaries notwithstanding the considerable amount of management and financial reporting which was required of the subsidiary. This decision of the Belgium Supreme Court, if regarded as persuasive in other countries, is of immense relief to multinational corporations (MNC) which often do lay down strict guidelines for the operations of their subsidiaries : (vide Michael Edwardes-Ker's Book, The International Tax Treaty Service published by In Depth Publishing Ltd., 1978 Dublin (13)). The Swiss Bundesgericht (judgment of the Swiss Bundesgericht dt. 17-9-77 on Swiss-Spanish Treaty) had to interpret the Swiss-Spain treaty and decide whether the " representative-office " of a Spanish bank constituted a " permanent establishment " in Switzerland. The Bundesgericht, whilst it cited the commentary of the 1963 O.E.C.D. model, held that it was not such a " perm ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ust. We have no difficulty whatsoever in holding that sub-cl. (aa) is not attracted. The submission for the Department under sub-cl. (bb) is in several parts which we shall now consider. (A) It was urged that by virtue of the deeming provision in subcl. (bb) the German company was to be treated as having a " permanent establishment " in India as it was, according to the Department, duty bound to manufacture and instal and assemble the Reclaimer as a single unit in India and, therefore, the German enterprise must be deemed to have had a " permanent establishment " in India. We are of the firm opinion that the contract between the parties did not contemplate any work of installation or assembly or the like to be performed by the German company. As already stated, the contract was limited to the supply of the items from Germany and to the delegation of an expert engineer to supervise the installation or assembly work to be conducted by the Port Trust. Apart from this, we are of the view that cl. 10 of the contract entered into between the parties is absolutely clear and that it clinches the issue. It states that it is the duty of the Port Trust to provide suitable it skill ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... travelling expenses. Secondly, this is also made explicit in cl. 11 of the contract. The word " erection " is clearly described as being equivalent to " wages and travelling expenses ". Thirdly, the word " wages " here cannot be understood to mean the wages of the workmen at Visakhapatnam for which the responsibility is in that regard, as already pointed out by us, rested on the Port Trust alone under cl. 10 of the contract. Therefore, there is no force in this submission either. (B) It is then vehemently contended that even so, the German company would fall under cl. (bb) inasmuch as, according to the Department, the said company carried the work of construction, installation or assembly or the like through its agent (i.e., Poona company) and that the German company must, therefore be deemed to have had a " permanent establishment " through such agent in India This submission is based on an assumption that the word " it " in cl. (bb) can be applied not only to the German company but also to its agent. It is based on a further assumption that the Poona company is an agent of the German company. In our view the Agreement has made special provision in cl. (dd) in respect of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ted that its own agent in India or (the contractor's Indian agents) will be appointed to negotiate the said question. Clause 12(b) also deals with appointment of an agent. The contract itself, therefore, draws a clear distinction between " agents " of the German company on the one hand and a " sub-contractor " on the other. (Contrast cls. 7, 17 with cls. 11(c) and 12(b)). There is also no proof that the Poona company is to transmit the profit it made to the German company or that it had drawn any commission. As submitted on behalf of the Port Trust, there is neither any identity of interest nor identity of character nor of personality, nor is there any unity in profit making between the Poona company and the German company. They were in the position of principal to principal and were dealing with each other at arm's length. The German company had no control nor could it interfere with the performance of the sub-contract by the Poona company. We are of the opinion that the Poona company cannot, therefore, be treated as an " agent " of the German company, and, therefore, the "assembly " and " installation ", in so far as the work relating to the steel-plate at Pimpri is concerned, ca ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... viz., Mr. Ritacher, on behalf of M/s. Carl Schenck of West Germany in respect of erection and commissioning of a plant at Hyderabad did not amount to the German manufacturer having a " permanent establishment " in India-vide Bharat Heavy Electricals Ltd. v. ITO [1982] 65 Taxation (sec. 6) p. 12, (Appellate Tribunal decision). We are, therefore, of the opinion that the German company cannot be brought within cl. (bb) of art. II(1)(i) by reason of any of the submissions made on behalf of the Department. (D) The next argument of the learned counsel for the Department is that the German company falls within cl. (dd) inasmuch as the Poona company must be treated as an agent of the German company within subcl. (1) of cl. (dd). No submission has, however, been made under subcls. (2) and (3) of cl. (dd). We have already held while dealing with cl. (bb) that the Poona company cannot be treated as an agent of the German company but that it is in the position of an independent contractor dealing, at arm s length, with the German company on a principal to principal basis. Further, cl. (dd) requires that the agents shall exercise a general authority in India to negotiate and enter into ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the latter part of art. III. Sub-clause (3) has relevance only to the first part of art. III(1). Further, in our opinion, the items : rents, royalties, dividends, interest, etc., are taxable only when they satisfy the conditions mentioned for their liability to tax as envisaged in the various specific articles such as arts. V, VI, VII, VIII, etc. Article VIII refers to the taxability of interest in India. In all OECD models, these items in sub-cl. (3) in art. 111 are normally dealt with separately in the Agreement (Simons Taxes, 3rd Edn., para. F. 1.212 (para., 147)). Lord Radcliffe has also held in Ostime's case [1960] AC 459 ; 39 ITR 210 (HL), that except and in so far as art. VI dealing with dividends (in the Australian treaty) makes certain special stipulations about double taxation of dividends, the taxation of these items is not otherwise permissible see also Harvey Mcgregor's article (British Tax Review, 1978, p. 394), dealing with this interpretation and the unjust departure therefrom by some countries). Therefore, we have to look to the first part of art. III and cl. (3) of art. III, and then refer to art. VIII alone and decide whether the interest paid along wit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... interest is merely in name but constitutes part of the compensation or part of the damages, it is not " interest " chargeable to income-tax. As an integral part of such compensation it may be either slumped-up with the other elements in the gross sum or may be separately stated but treated as part of the gross sum. IRC v. Ballantine [1924] 8 TC 595 (C. Sess). Mere description of the amount as interest which in fact is part of the compensation does not have the effect of altering the true character of the compensation. Simpson v. Executors of Bonner Maurice as Executor of Edward Kay [1929] 14 TC 580 (CA). That, in fact, is also the position with regard to unpaid purchase money coupled with a liability to pay interest along with each of the instalments. Where as here, parties enter into an agreement to accept a portion of the purchase money immediately and the balance to be paid in certain instalments along with interest on the instalment of purchase money, the agreement though it invested the property agreed to be sold in the purchaser, does not have the effect of converting the price due into I loan. The intrinsic nature of the money due to the vendor is as unpaid purchase money ..... X X X X Extracts X X X X X X X X Extracts X X X X
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