International Taxation

Case Law Update

(A) HIGH COURT

1. Non-resident assessee – Head Office expenditure u/s. 44C – Head office at Singapore and a branch office in India – Incurred certain expenses at its Head office and claimed deduction – AO disallowed claim – Assessee did not carry on any business outside India – Entire Head Office expenses attributable to business in India had to be allowed

Director of Income-tax, Delhi vs. Ravva Oil (Singapore) (P.) Ltd. – [2008] 167 Taxman 177 (Delhi)

Entire Head Office expenses attributable to business in India had to be allowed u/s. 44C where the assessee did not carry on any business outside India.

Facts

1. The assessee, a non-resident company, had its Head Office at Singapore and a sole branch office in India in connection with the exploration of oil.

2. The finding returned by the CIT(A) and the ITAT was that the expenses incurred by the assessee at its head Office on account of administration, accounting and management services were wholly related to the Indian operations. It was, accordingly, been held that section 44C of the Income-tax Act, 1961 will not apply.

3. Before the Assessing Officer, the assessee contended that since it did not carry on any business outside India, the entire Head Office expenses attributable to the business in India had to be allowed.

4. The CIT(A) held in favour of the assessee. The further appeal by the revenue was dismissed by the ITAT.

Judgment

The Hon’ble High Court dismissed the departmental appeal by following the Hon’ble Calcutta High Court and Hon’ble Bombay High Court in Rupenjuli Tea Co. Ltd. vs. CIT [1990] 186 ITR 301 : [1991] 54 Taxman 269 (Cal.); and CIT vs. Emirates Commercial Bank Ltd. [2003] 262 ITR 55 (Bom.) respectively, wherein it was held that section 44C is applicable only if the assessee has branches in India as well as outside India. The question of apportioning the Head Office expenses ‘attributable’ to the business in India as contemplated by section 44C(c) of the Act would not arise where the assessee’s operations are restricted only to India and no part of the expenses is allocable to operations outside India.

Cases referred to

Rupenjuli Tea Co. Ltd. vs. CIT [1990] 186 ITR 301 : [1991] 54 Taxman 269 (Cal.);

CIT vs. Emirates Commercial Bank Ltd. [2003] 262 ITR 55 (Bom.);

CIT vs. Shapoorji Pallonji Mistry [1962] 44 ITR 891 (SC); and

CIT vs. Balkrishnan Malhotra [1971] 2 SCC 547

(B) TRIBUNAL DECISIONS

I. Non Resident Co – Income from use of Global Computerized Reservation System (CRS) – Whether U.S. Co. had PE in India – Computation of profits attributable to P.E’s activities in India – Circular No. 23 dated 23-7-1969 – India – U.S.A. DTAA

Galileo International Inc. vs. Dy. CIT [2008] 19 SOT 257 (Delhi) Assessment years 1995-96 to 1998-99

Assessee, a US company, developed a global computerized reservation system (CRS) through which subscriber travel agents could check availability of seats/rooms in participant airlines, hotels, cab operators, etc. and book them. Assessee had to maintain master computer system in US, which was connected to servers of participant hotels and airlines. Assessee engaged an Indian company as distribution agent in India. Indian agent entered in subscriber’s agreement with travel agents to provide them computer, connectivity, access code and support service. Assessee paid all expenses for installation of computer at premises of travel agents - Assessee’s CRS was capable of processing information of various airlines for display at one place and enabled subscriber travel agents to book tickets. It was a system originating from desk of Indian subscribers’ computers, and ending at their computers too. Only when booking was completed at desks of computers of subscriber travel agents in India, income generated to assessee. Thus, a continuous seamless process was involved, at least part of which was in India. Assessee received income from airlines outside India, and not from subscriber travel agents in India. Assessee contended that it had neither any operation in India nor had any Permanent Establishment (PE) in India and hence, no part of its income would be taxable in India. It was held that computers at subscribers’ desks were not dumb or in nature of kiosk incapable of performing any function and computers being supplied either by assessee or through its agent and connectivity by assessee enabling subscribers to perform ticketing and booking functions, there was a direct business connection established in India. Therefore, in terms of section 9(1)(i) income in respect of booking which took place from equipment in India, could be deemed to accrue or arise in India and, hence, taxable in India. Since work in India through CRS involved generation of request and receipt of end result of booking only, and major functions like collecting data and maintaining data base as well as track records of hotels, airlines, etc., worldwide was kept continuously at assessee’s host computer in US, 15% of revenue accruing to assessee in respect of booking made in India could, in absence of any guideline, be reasonably attributed as income accruing or arising in India. However, it was held that since remuneration paid to Indian agent consumed entire income accruing or arising in India, in view of Circular No. 23, dated 23-7-1969, no income would be available to be charged to tax in India.

1. For a place of business to constitute a PE, enterprise using it must be carrying on its business wholly or partly through it, it is not necessary that whole of business should be carried on through such PE or fixed place.

2. A PE will nevertheless exist if business of an enterprise is carried on mainly through automatic equipment and activities of personnel being restricted to setting up and operating such equipment; a PE will still exist if enterprise which sets up machine also operates and maintains them for its own account irrespective of fact as to whether machines are operated by itself or by a dependent agent.

3. Premises of subscribers would amount to a fixed place of business for carrying on business of enterprise in India and assessee could be said to have established a PE within meaning of Article 5(1) and exception provided in Article 5(3) would not apply.

4. Since (i) business of Indian company appointed as agent of assessee in India, was to provide data processing and software development services together with relative distribution of CRS to subscribers in India and (ii) Indian company had an authority to enter into agreements with subscribers and it installed and configured computers for accessing CRS and also provided connectivity, functionally as well as financially Indian agent was dependent entirely on assessee and it could, therefore, be said that assessee’s agent was a dependent agent of assessee, who had habitually exercised authority to conclude contracts on behalf of assessee and to that extent assessee had a PE in India.

5. Since computers supplied by assessee’s distribution agent in India to travel agents were not dealt with by assessee or which was by itself source of revenue, clause (b) of Article 5(4) would not apply to consider dependent agent as PE of assessee in India as said Article would apply only where dependent agent habitually maintains stock of goods from which he regularly delivers goods on behalf of enterprise.

Facts

1. The assessee-company, a resident of USA, was engaged in the business of maintaining and operating the system for providing electronic global distribution services to airlines, hotels, tour and cab operators by connecting to Travel Agents (TAs) utilising a Computerized Reservation System (CRS). The said system would receive, process, store and disseminate data about flight schedules, room availability, fare information and provision for booking capabilities, etc.

2. The assessee entered into a Participating Carrier Agreement (PCA) with various participating airlines for providing them with said CRS services. For the said purpose, it maintained and operated a huge Master Computer System (MCS) in USA, which was connected, inter alia, to airlines’ servers to/from which relevant data regarding flight schedules, seat availability, fare structures, flight connections, availability of facilities, etc., on a real-time basis was continuously sent and obtained.

3. To market and distribute the CRS services to the travel agents (TAs) in India, the assessee entered into a Distribution Agreement (DA) with an Indian company ‘I’. ‘I’, in turn, entered into a subscribers agreement with various TAs to provide them with access codes, equipment, communications link and support services.

4. The master computer system of the assessee in USA was connected to TAs in India through a communication network arranged by a separate organization (‘SITA’). The assessee at its own cost, had obtained connectivity services from its Data Centre in USA to the nodes of SITA in India.

5. The assessee paid remuneration to ‘I’ for acting as distributor, and also paid SITA for the communication services which it provided. The assessee was remunerated outside India by the airlines and it did not receive any remuneration from the travel agents.

6. For the assessment years 1995-96 to 1998-99, the assessee filed its return declaring nil income on the ground that no income accrued or arose to it in India nor could any such income be deemed to accrue or arise in India as it had no operations in India which gave rise to taxable income under section 5(2) or section 9(1)(i).

7. The assessee further contended that it did not have any Permanent Establishment (PE) in India within the meaning of Article 5 of the DTAA between India and USA and, therefore, the booking fees received by it from the airlines outside India, being business profits, were not liable to tax in India under Article 7(1) of said DTAA.

8. The Assessing Officer, however, held that all the activities in respect of bookings made by the TAs in India were completed in India through the hardware installed by assessee at travel agents premises; that on that basis income accrued or arose in India under section 5; that even under the DTAA, the assessee had a PE in India under Article 5 and so the income was taxable as business income under Article 7; that the assessee earned income on each segment booked through the computers installed in India and, therefore, the same constituted a PE.

9. The A.O. further held that ‘I’ was a PE of the assessee within the meaning of Article 5(4) because it was economically dependent on the assessee for its source of business and its activities were devoted wholly and exclusively for the assessee, and further, it entered into and concluded contracts on the assessee’s behalf.

10. On appeal, the Commissioner (Appeals) upheld the impugned findings. He, however, accepted that under Article 7(5) only that portion of the assessee’s income which could be regarded as derived from the assessee’s assets and activities in India, could be taxed in India.

Decision

On appeal , the Tribunal has as under:

1. Re: Taxability of income

The contention of the assessee that the whole of the processing work was carried out at host computer situated in USA and only the display of information was in India for the proposition that there was no business connection in India, could not be accepted. There was a business connection in India. The existence of business connection could be summarized thus:

1. The assessee hired independent agency (SITA) nodes in most major cities in India together with 800 landlines for maintaining telecommunication network in India.

2. The assessee secured the provision of the operation of the communication network from SITA node to travel agent.

3. By the Distribution Agreement, the assessee specifically authorized its Indian agent to conclude agreements with the travel agents in India in accordance with the model Subscriber Agreement.

4. The assessee laid down targets and closely supervised and reviewed the performance of its Indian agent on day-to-day basis in accordance with the Annual Plan and the service manual.

5. The assessee allotted access code to the travel agents for using the CRS.

6. The assessee’s business comprised of :

1. Maintenance and running of CRS;

2. Providing computer modem and software to the travel agents in India so that they could use the CRS for making the bookings which generate charge on the airlines;

3. Assessee hired from SITA and maintained and operated telecommunication network in India so that travel agents could make the bookings.

All these activities are integral part of the core business carried on by the assessee and these are not auxiliary or preparatory in nature.

Whether the contract for sale of ticket was completed in India or outside was irrelevant for the purpose of present discussion as it was not necessary to determine the taxability of income of various airlines accruing as a result of sale of tickets through the CRS in India. Thus, whether the availability of the tickets displayed through the CRS at the desk of travel agents in India was offer for sale or an invitation to an offer was not a deciding factor. What one finds is that part of the CRS system existed in India in the form of configuration and connectivity of such system through which booking activities could be performed in India. In the instant case, the assessee operates the CRS system which was the source of revenue and part of such system existed in India.

Thus, there was a direct business connection established in India and, hence, in terms of section 9(1)(i), the income in respect of the booking which took place from the equipment in India could be deemed to accrue or arise in India and, hence, taxable in India.

2. Re : Quantum of taxable income

In the instant case, only part of CRS operated or functioned in India. The extent of work in India was only to the extent of generating request and receiving end result of the process in India. The major functions like collecting the database of various airlines and hotels, which had entered into PCA with the assessee took place outside India. The computer in USA processed various data like schedule of flights, timings, pricing, availability, connection, meal preference, special facility, etc., and that too on the basis of neutral display real time on line took place outside India. The computers at the desk of TA in India were merely connected or configured to the extent that it could perform a booking function but were not capable of processing the data of all the airlines together at one place. Such function required huge investment and huge capacity, which was not available to the computers installed at the desk of subscriber in India. The major part of the work was processed at the host computer in USA. The activities in India were only minuscule portion. The assessee’s computer in Germany (sic) was also responsible for all other functions like keeping data of the booking made worldwide and also keeping track of all the Airlines and hotels worldwide that had entered into PCA. Though no guidelines were available as to how much should be income reasonably attributable to the operations carried out in India, the same had to be determined on the factual situation prevailing in each case. However, broadly to determine such attribution one has to look into the factors like functions performed, assets used and risk undertaken. On the basis of such analysis of functions performed, assets used and risk shared in two different countries, the income can be attributed. In the instant case, the majority of the functions were performed outside India. Even the majority of the assets, i.e., host computer which was having very large capacity which processed information of all the participants was situated outside India. The CRS as a whole was developed and maintained outside India. The risk in that regard entirely rested with the assessee and that was in USA outside India. However, it was equally important to note that but for the presence of the assessee in India and the configuration and connectivity being provided in India, the income would not have generated. Thus, the initial cause of generation of income was in India also. On the basis of said facts, 15% of the revenue accruing to the assessee in respect of bookings made in India, could be reasonably attributed as income accruing or arising in India and chargeable under section 5(2) read with section 9(1)(i).

3. Re: Taxable income after consumption

The activities of the assessee in India were entirely routed through the efforts of its Indian agent ‘I’. ‘I’ was responsible for monitoring the activities of the subscribers enrolled in India. The request originated from the computers at the desk of TA was once again routed through the facility of processing such information at ‘I’. If ‘I’ would find that the subscriber accessing the CRS was authorised to do so, the request was further forwarded. ‘I’ was also responsible for establishing connectivity of the computers of the subscribers and maintaining them and for training of the subscribers in respect of use of CRS. For all those services rendered by ‘I’ to the assessee, it was being paid remuneration in terms of distribution agreement. Broadly the assessee received three ‘Euros’ as fees per ‘net booking’, i.e., gross booking minus cancellation. The assessee passed one dollar to ‘I’ for each net booking processed through CRS by subscriber. Thus, in respect of the activities carried out in India and considering the income accruing in India, remuneration paid to the Indian agents consumed the entire income accruing or arising in India. It was also to be noted that the entire payment made by assessee to ‘I’ had been allowed as expenses while computing its total income. In such a situation in view of Circular No. 23 dated 23-7-1969, no income could be further charged to tax in India. Therefore, in view of the said facts, no income was taxable in India.

4. Re: Existence of Permanent Establishment

What is to be seen is whether there is existence of a place of business, i.e., a facility such as a premises or in certain instances machinery or equipment. The place of business must be fixed, i.e., it must be established at a distinct place where a certain degree of permanence can be attached. Carrying on of the business of the enterprise should be through such fixed place of business. This means that the person who is in one way or the other dependent on the enterprise, conducts the business of the enterprises in which such fixed place is situated. The term ‘place of business’ covers any premises, facility or installation used, for carrying on the business of the enterprise, whether or not they are used exclusively for that purpose. A place of business may also exist where no premises are available or required for carrying on the business of the enterprise and it simply has a certain amount of space at its disposal. It is immaterial whether the premises, facilities or installations are owned or rented or are otherwise at the disposal of the enterprise. What is to be seen is that in fact an enterprise has a certain amount of space at its disposal, which is used for business activities and then it is sufficient to constitute a place of business. No formal legal right to use that place is visualized or required. A PE can exist even where an enterprise unauthorizingly or illegally occupies certain locations where it carried on its business. For a place of business to constitute a PE, the enterprise using it must be carrying on its business wholly or partly through it. It is not necessary that whole of the business should be carried on through such PE or fixed place. It would be appropriate to presume that each part of the activities carried on contributes to the productivity of the whole. Thus, even if some contribution is made in carrying on the business as a whole, it can be said that the business of an enterprise would partly be carried on from such place and, accordingly, it is a PE of such enterprise. Where the business of an enterprise is carried on mainly by the entrepreneur or employees who receive instructions from the enterprise, the rights of such persons in its relationship with third parties are irrelevant. So far as Article 5(1) is to apply, whether or not the dependent agent is authorized to conclude contracts, is irrelevant, so long as he operates from the fixed place of business. The PE will nevertheless exist if the business of the enterprise is carried on mainly through automatic equipment and the activities of the personnel being restricted to setting up and operating such equipment. A PE will still exist if the enterprise which sets up machine also operates and maintains them for its own account — whether operated by itself or by a dependent agent.

In the instant case, it was seen that the CRS, which was the source of revenue was partially existent in the machines, namely, various computers installed at the premises of the subscribers. In some cases, the assessee itself had placed those computers and in all the cases the connectivity in the form of nodes leased from SITA were installed by the assessee through its agent. The computers so connected and configured which could perform the function of reservation and ticketing was a part and parcel of the entire CRS. The computers so installed required further approval from the assessee, ‘I’ who allowed the use of such computers for reservation and ticketing. Without the authority of the assessee such computers were not capable of performing the reservation and ticketing part of the CRS. The computer so installed could not be shifted from one place to another even within the premises of the subscriber, leave apart the shifting of such computer from one person to another. Thus, the assessee exercised complete control over the computers installed at the premises of the subscribers, which would amount to a fixed place of business for carrying on the business of the enterprise in India. But for the supply of computers, the configuration of computers and connectivity which were provided by the assessee or its agent ‘I’ would amount to operating part of its CRS through such subscribers in India and, accordingly, PE in the nature of a fixed place of business in India. Thus, the assessee could be said to have established a PE within the meaning of article 5(1).

5. Re: Exception provided in Article 5(3) of DTAA

The case of the assessee was that the existence of such computers were merely for the purpose of advertising and the activities were preparatory or auxiliary in character and, hence, there was no fixed place PE in India in view of the exception provided in Article 5(3). The said contention could not be accepted. The function of PE in India was not to advertise its products. The activity of the assessee was developing and maintaining a fully automatic reservation and distribution system with the ability to perform comprehensive information, communication, reservation, ticketing, distribution and related function on a worldwide basis. The computers installed at the premises of the subscribers were connected to the global CRS owned and operated by the assessee. Using part of the CRS, the subscribers were capable of reserving and booking a ticket. Thus, it could not be considered as ‘solely for the purpose of advertising’ of such CRS. Similarly it was not in the nature of ‘preparatory or auxiliary’ character. It is difficult to distinguish between the activities which are ‘preparatory or auxiliary’ character and those which are not. The decisive criterion is whether or not the activity of the fixed place of business in itself forms an essential and significant part of the activity of the enterprise as a whole. Since part of the booking function was operated in India which directly contributed to the earning of revenue, the activities carried out by the assessee in India were in no way of ‘preparatory or auxiliary’ character. Thus, the exception provided in Article 5(3) would not apply and the assessee would be deemed to have a PE in India.

6. Re: Existence of PE in form of dependent agent

In the instant case, the assessee availed the service of ‘I’ to promote the use or CRS in India and for that purpose to appoint subscribers in India, ‘I’, was authorised to enter into contract with the subscribers in terms of authority generated under DA. The assessee bound itself in respect of booking made by the subscriber using the CRS. Thus, what could have been done directly by the assessee was achieved through the service of ‘I’. Hence, ‘I’ was to be treated as agent of the assessee in India. Even though in the agreement between the assessee and ‘I’, the existence of agency was denied, yet that would not be conclusive if on facts it was found to be agency. That would be relevant only for the limited purpose of agreement between those two parties but not relevant for third parties if on facts the existence of agency was found. However, all the persons other than agent of an independent status cannot be deemed to be a PE of the enterprise. The agents can be considered as PE only and only if when a person other than agent of an independent status, (i) has and habitually exercises in that State an authority to conclude contract or (ii) though he has no such authority but habitually maintains stock of goods from which he regularly delivers goods on behalf of the enterprise. Thus, the first question to be decided is whether the agent is of a dependent status or of an independent status. In the instant case, ‘I’ was totally dependent on the assessee in respect of rendering services to subscribers in India. Thus, that part of activities of ‘I’ which earned its revenue by rendering services to the subscribers was carried on solely for the assessee. Though ‘I’ might be carrying on any other activities, like a full-fledged travel agency business, yet the activity relating to installing CRS of the assessee at subscribers’ computers providing connectivity, configuring the computers to enable it to access CRS, train the subscribers, etc., was only and only for the assessee. Such type of activities were not carried on for any other person. Hence, the assessee and ‘I’ were interdependent in that regard. The business of ‘I’ was to provide data processing and software development services together with relative distribution of the CRS to the subscribers in India. ‘I’ had also an authority to enter into agreements with the subscribers. ‘I’ installed the computers, configured the computers for accessing the CRS and also provided connectivity through SITA nodes. Thus, functionally as well as financially it was dependent entirely on the assessee. It could, therefore, be said that ‘I’ was a dependent agent of the assessee.

7. Re: Exercises of authority by Indian agent to conclude contract

Under the distribution agency agreement entered into by the assessee with ‘I’, it was responsible for effecting and contracting with subscribers in the Indian territory and was to use reasonable efforts to provide access to all, the CRS out of Indian territory. Though the assessee and even the participating airlines were not party to the agreement entered into by ‘I’ with the subscribers, yet the assessee through the PCA had ensured that the subscribers were authorised to use the CRS. Under an authority granted to them, subscribers used such products. The reservations and ticketing done using the CRS product were being honoured by the participants and for which the remuneration was payable by the participants to the assessee. Thus, ‘I’ could be said to have and having exercised an authority to conclude contracts on behalf of the assessee. What the assessee could have done directly by entering into an agreement with the subscribers, was done through ‘I’. The subscribers agreement were entered into by ‘I’ under an authority available to it in view of the DA. What could have been done directly was done indirectly through the offices of ‘I’ under an authority granted to it. The phrase ‘authority to conclude contracts on behalf of the enterprise’ does not confine to application of paragraph 4 to an agent who enters into contract literally in the name of enterprise. The paragraph applies equally to an agent who concludes contracts which are binding on the enterprise even if those contracts are not actually in the name of enterprise. What is relevant is that such contract shall have a nexus with the business operations as such and not merely contracts for hiring employees, premises, etc. What is taxable in the Contracting State is the income accruing to such enterprise and the activities are carried on either through the PE, namely, fixed place or through a dependent agent. The dependent agent is not to be considered as PE unless he has authority to conclude contract on behalf of such enterprise. The authority to conclude contracts must be in respect of contracts relating to operations, which constitute the business proper of the enterprise. The assessee in the instant case in order to enhance its business operations had appointed ‘I’ as its agent who promoted the CRS in India. ‘I’ in its turn had appointed various subscribers for use of the CRS. Though the revenue flowed only from participants who had entered into PCA with the assessee yet the revenue could not have been generated but for the subscribers using the CRS. In a way, the revenue was generated from the participants but only on the basis of use of CRS by the subscribers. But for such use no revenue would accrue to the assessee.

8. Re: PE within meaning of Article 5(4)(b)

Clause (b) of said article would apply only where the dependent agent habitually maintains stock of goods from which he regularly delivers goods on behalf of the enterprise. In the instant case, the assessee was not dealing in any stock of goods. Since the assessee was not dealing in any goods, the question of delivery of such goods did not arise. The contention of the revenue that ‘I’ maintained stock of computers which were delivered to the subscribers should be treated as delivery of goods, could not be accepted. In the instant case the computers supplied by ‘I’ to the TAs were not dealt with by the assessee or which was by itself the source of revenue. Thus, said clause would not apply to consider the dependent agent as PE of the assessee in India.

9. Re: Attribution of profits

It is clear from Article 7 that the profit of an enterprise will be taxable only to the extent as is attributable to that permanent establishment. This is in pari materia with clause (a) of Explanation 1 to section 9(1)(i). Article 7(5) prescribes as to how the profits to be attributed to the PE is to be arrived at. It provides that only the profits derived from assets and activities of the PE shall be treated as attributable to the permanent establishment. The wordings in the treaty are not to be interpreted like a provision of the statute. In a way there should be some rational connection between existence of PE and the profits from the asset and activities of the PE which can be brought to tax and no further artificial meaning should be given to the clause ‘derived from’. In all circumstances only that much of the profit as are arising due to the assets and activities of the PE can be brought to tax and if whole of the activities of the business are not carried out in India, the profit should be apportioned between that arising in India and that arising outside India. Thus, where the entire activity of an enterprise is not carried out in a contracting State where the PE is situated, then only so much of the profit as is attributable to the functions carried through the PE can be taxable in such source State. While dealing with the question as to what was such part of income as was reasonably attributable to the operations carried out in India, it had been held that only 15 per cent of the revenue generated from the booking made within India was taxable in India. The same proportion had to be adopted while computing profit attributable to the PE. It had also been held that since the payment to the agent in India was more than what was the income attributable to the PE in India, it extinguished the assessment as no further income was taxable in India. Further, even in the first assessment framed by the Assessing Officer, the entire expenses in the form of remuneration paid to ‘I’ was held as allowable deduction and was reduced while computing the income of the assessee. If that be the case, the income attributable to PE in India being less than the remuneration paid to the dependent agent, it extinguished the assessment and required no further exercise for computation of income. Accordingly, the income of the assessee would be NIL.

The Tribunal referred to and relied upon a number of judicial decisions.

II. Non Resident U.K. Co. – Sale of Goods manufactured in U.K. to various customers in India through a 100% subsidiary Co. in India – Whether, on facts, there is existence of a P.E. or Business Connection in India – Computation of Profits attributable to P.E. in India- Provisions of India – U.K. DTAA

Rolls Royce Plc vs. D.D.I.T [2008] 19 SOT 42 (Delhi) assessment years 1997-98 to 2000-01, 2002-03 and 2003-04

Assessee, a non-resident company incorporated in U.K., supplied aero-engines and spare parts manufactured by it to many Government organizations in India. Assessee entered into an agreement with ‘R’ whereby ‘R’ was to render various services, to assessee, viz., procure orders, organization of event and conference in India, media relation and administration support. A survey conducted upon ‘R’ further revealed that ‘R’ was not only assessee’s 100 per cent subsidiary, but it also maintained a permanent office in India to undertake all such activities which were contained in said agreement. Further, it was also found that no customers in India were directly to send orders to assessee in U.K. and such orders were required to be routed only through ‘R’. On facts, it could be concluded that assessee not only had a business connection in India within meaning of section 9(1)(i), but also had a permanent establishment (PE) in India within meaning of Article 5(1) of DTAA between India and U.K. Therefore, income arising to assessee from its operation in India would be chargeable to tax in India.

Facts

1. The assessee, a non-resident company incorporated in the U. K., supplied aero-engines and spare parts manufactured by it to many Government organizations in India including ‘HAL’, but it did not file its returns.

2. On scrutiny of records, the Assessing Officer came to the conclusion that the assessee was having a business connection in India under section 9 as well as permanent establishment (PE) under Article 5 of the DTAA between India and UK; that the said business connection and PE were in existence in India in the form of an Indian subsidiary company ‘R’, which was having its offices in India; and that the marketing and sale of goods to Indian customers were carried out by the assessee through said ‘R’.

3. Consequently, the A.O. framed the assessee’s assessments under section 147 after issuing notice under section 148. Subsequently, survey operations were conducted at R’s premises to find out the exact nature of business activities carried out by ‘R’ and the assessee in India, which also substantiated the Assessing Officer’s said conclusion.

4. On appeal, the Commissioner (Appeals) held that the issue of notice under section 148 for framing assessment under section 147 was valid; that there was business connection in India and also that the assessee had a PE in India within the meaning of Articles 5(1), 5(2)(f) and 5(4) of the DTAA between India and U.K. so its income was taxable in India; and that out of the global profits, in respect of sales effected in India, profit could be attributed to such Indian sales which would be 75 per cent of the profit attributable to such sales. The Commissioner (Appeals) also upheld interest levied by the Assessing Officer under sections 234A and 234B on that account.

Decision:

On Second Appeal, the Tribunal held as follows:

1. The assessee had a business connection in India within the meaning of section 9(1)(i) and under the Act, its income was chargeable to tax in India arising out of such business connections.

2. Paragraph 1 of Article 5 of Indo-UK DTAA gives a general definition of the term ‘permanent establishment’ which brings on its essential characteristics of a permanent establishment in the sense of the Convention; i.e., a distinct ‘situs’, a ‘fixed place of business’. The paragraph defines the term ‘permanent establishment’ as a fixed place of business, through which the business of an enterprise is wholly or partly carried on. This definition, therefore, contains the following conditions :

1. the existence of a ‘place of business’, i.e., a facility such as premises or, in certain instances, machinery or equipment;

2. this place of business must be ‘fixed’, i.e., it must be established at a distinct place with a certain degree of permanence;

3. the carrying on of the business of the enterprise through this fixed place of business. This means usually that persons who, in one way or another, are dependent on the enterprise (personnel) conduct the business of the enterprise in the State in which the fixed place is situated.

3. The term ‘place of business’ covers any premises, facilities or installations used for carrying on the business of the enterprise whether or not they are used exclusively for that purpose. A place of business may also exist where no premises are available or required for carrying on the business of the enterprise and it simply has a certain amount of space at its disposal. It is immaterial whether the premises, facilities or installations are owned or rented by or are otherwise at the disposal of the enterprise. A place of business may thus be constituted by a pitch in a market place. Again, the place of business may be situated in the business facilities of another enterprise. This may be the case for instance where the foreign enterprise has at its constant disposal certain premises or a part thereon owned by the other enterprise.

4. The mere fact that an enterprise has a certain amount of space at its disposal which is used for business activities is sufficient to constitute a place of business. No formal legal right to use that place is, therefore, required. Thus, for instance, a permanent establishment could exist where an enterprise illegally occupied a certain location where it carried on its business. Article 5(1) does not refer that the premises should belong to the assessee but if it is able to use the same, it is an identified and distinct location and on which he exercises the control, will be considered as a PE within the meaning of Article 5(1) of the DTAA. In the instant case, it was found that the premises though in the name of ‘R’ were being occupied for the business operation in India. The cost of maintenance of such premises were being paid for by the assessee. The premises were also available to all the employees of the assessee in respect of any business operations in India. Accordingly, it could be said that the assessee had a PE in India within the meaning of article 5(1) of the DTAA.

5. Since the assessee had a business connection in India as well as PE in India, the income arising from its operation in India was chargeable to tax in India.

6. As per section 9(1)(i), income accruing or arising whether directly or indirectly through or from any business connection in India shall be deemed to accrue or arise in India. As per clause (a) of Explanation 1, in a case of a business of which all the operations are not carried out in India, the income of the business deemed to accrue shall be only such part as is reasonably attributable to the operations carried out in India. Article 7 of the Indo-UK DTAA provides a mechanism as to how the business profits of the permanent establishment are to be computed.

7. As per para 4 of Article 7, when the profits are to be attributed to the PE, it can be according to the law of the State where the PE is established. The assessee had not maintained separate books of account for the activities carried out in India. However, it was seen that the goods dealt with or traded in India were not manufactured in India. The manufacturing operation was carried on outside India. Manufacturing is one of the important and integral parts of the total activities which contribute to the earning of income. The extent of assets used was irrelevant as in the instant case, the activity comprised of manufacturing and marketing. The marketing was in India. Therefore, the profit accruing directly or indirectly in respect of the marketing activities in India should be taxable in India.

8. 50 % of the profits was to be allocated towards manufacturing activity which could not be taxed in India as no such manufacturing activity was carried out in India. In respect of other activities apart from marketing of goods in India, the assessee had also carried out research and development activities outside India. Said activities were on an ongoing basis, which resulted into development of newer products. Therefore, 15 per cent of the profits was to be allocated to such research and development activities. Balance of the profit could be attributable to the marketing activities which were in India. Though contracts were signed outside India, yet the negotiations and other discussions were in India and, hence, all other profits could be said to accrue or arise into directly or indirectly through the operations of PE in India. Therefore, the Assessing Officer should adopt 35 per cent of the profits as against 75 per cent of the global profits in respect of sales effected in India as chargeable to tax in India.

The Tribunal referred to and relied upon a number of judicial decisions.