Civil Appeal No 89 of 1975
From the Judgment and Order dated the 4th May 1973 of the Madras High Court in Tax Case No 183 of 1967
NA Palkhivala R Balasubramanian LB
Dadachanji AC Moneses Mrs AK Verma CR Dun Ravinder Narain and OC Mathur for the appellant
RM Mehta and RN Sachthey for the respondent
KR Ramamani and 1
Ramamurthi for the Intervener
The Judgment of the Court was delivered by UNTWALIA J
This is an appeal by certificate from the decision of the Madras High Court in a Reference made by the Income tax Appellate Tribunal under section 661 of the Income Tax Act 1922 hereinafter referred to as the Act
Ms Carborandum Co of the United States of America hereinafter called the American  Company or the Assessee Company is the appellant
The Central Board of Revenue has declared it a Company under section 25A of the Act
It has specialized in the manufacture of bonded abra sive and coated abrasive products
For the improvement and advancement in the line of its manufacture it has a Re search Wing also
The results of the research are incorpo rated in pamphlets prepared from time to time
The Assessee Company entered into an agreement dated June 22 1955 with Ms Carborandum Universal Ltd hereinaf ter called the Indian company having its registered office at Madras
As per the terms of the agreement the American Company was to render and did render to the Indian Company certain technical and know how services of the following nature  i furnishing of technical information and know how with respect to the manufacture of bonded abrasive and coated abrasive products ii providing technical management including factory design and lay out plant and equipment production purchase of mate rials manufacturing specifications and quali ty of product 4 502 SCI77 478 iii furnishing comprehensive technical information of all developments in the manu facture of the special products iv providing the Indian company With a resident factory manager for starting the plant and superintending its operations during its initial production stages as also other technical personnel necessary for the operation of the plant v training Indian personnel to replace the foreign technical personnel as quickly as possible
In lieu of all the services aforesaid as per the agreement the American company was to receive from the Indian company an annual service fee equal to 3 per centum on the net sale proceeds of the products manufactured by the latter each year
During the year of account relevant to the assessment year 1957 58 the assessee company received a sum of Rs 95762 from the Indian company as its service fee
A good slab of it was deducted at source by the Indian company on account of income tax and super tax payable on the said sum
The American company filed a Return of income for the year in question with an application for refund of the entire tax deducted at source
The Income tax Officer took the view in his assessment order that 5 of the technical fee paid to the American company was earned by it in India and Only that small amount was assessable to income tax
Consequently he directed the refund of a major portion of the tax deducted at source to the assessee company
The Commissioner of Income tax in exercise of his power under section 338 of the Act revised the order of the Income tax Officer and took the view that at least 75  of the techni cal fee earned by the assessee company during the year of account had accured or arisen in India
In the main the basis of his order was that even though the technical infor mation was supplied by the assessee company from outside India the information received by the Indian company was put to use only in the taxable territory and the technical fee paid by it was mainly on account of such use
The Commissioner was also of the view that the technical person nel furnished by the assessee company to the Indian company although worked under the control of and was paid for by the latter the situs of the services so rendered was in India
Treating the technical fee in the nature of royalty paid it directed the Income tax Officer to revise the assessment on the basis that 75 of it should be taken as income accruing or arising in India to the assessee company
The American company went up in appeal to the Appellate Tribunal from the revisional order of the Commissioner
The Tribunal Set aside the said order and restored that of the Income tax Officer even though it seems to be of the view that even 5 of the technical fee could not be taken as income of the assessee company taxable under the Act
But since the assessee company had not gone in appeal because of the smallness of the amount of tax payable on the basis of 5 the Tribunal was obliged to maintain the order of the Income tax Officer
479 The Tribunal took some new materials into consider ation at the appellate stage in order to ascertain the true nature of the service rendered by the American company to the Indian company as per the term of the agreement and the place of rendering such service
The findings of the Tribu nal are 1 The American company rendered service to the Indian company for the starting of the factory in India in the shape of exami nation of the factory design and lay out prepared by the latter and sending its advice by post
These services were not proved to have been rendered in India
2 The pamphlets and bulletins incorporating the results of research made by the American company were also furnished to the Indian company by post and thus
the said service was also rendered outside India
3 That the services of the foreign technical personnel were made available to the Indian company by the American company outside the country
The former employed such person nel in India on the basis of the various agreements of employment entered between the Indian company and such personnel
They were the employees of the Indian company under its Control for their day today working
4 The training of the Indian per sonnel directly by the employees of the asses see company was imparted outside India
The Tribunal did not agree with the views of the Commissioner that the payment of the teChniCal fee of 3 was dependent upon the use of the information in India or on the volume and extent of such use
The use of the technical assistance and knowhow given by the American Company and made use of by the Indian Company in the taxable territory could not make the former liable to payment of income tax on the amount of technical fee received by it nor was it any royalty
A new stand taken before the Tribunal on behalf of the Revenue that the assessee company must be deemed to be working in conjunction with the Indian company in the manufacture of the products in question was also rejected
The Commissioner of Income tax the respondent in this appeal asked for a reference and the Tribunal referred the following question of law for the opinion of the High Court Whether on the facts and in the circumstances of the case the technical fee in excess of 5 per cent received by the asses see company from the Indian company during the account year relevant to the assessment year 1957 58 has accrued or arisen in India Before the High Court on behalf of the Revenue the point of conjunction between the American company and the Indian company in the manufacture of abrasive products was put in the fore front
480 Finding this stand unsustainable in face of the agreement between the two companies and in absence of any other mate rial in support of it the High Court rejected this stand outright
It however felt persuaded to permit the Revenue to change its stand even at the reference stage and to urge that the agreement Clearly established a business connection between the two companies the technical fee received by the assessee company had accrued or arose from such business connection and hence it was assessable to income tax under section 41  c read
with section 42 of the Act
The objection of the assessee company to the entertainment of the new point at the reference stage that it did not arise out of the Tribunal s order was over ruled by the High Court on the ground that the question referred was in general terms and comprehensive enough to embrace within its ambit the point of applicability of section 421 of the Act to the transactions in question1 Upholding this stand taken on behalf of the Revenue the High Court answered the ques tion referred to  it in its favour and against the assessee company
Hence this appeal
Mr NA Palkhivala learned counsel for the appellant company urged the following four points in support of this appeal  1 That the High Court could not go into the matter of business connection between the two companies when such a question was never raised or in issue at any earlier stage
2 That the High Court was wrong in founding the tax liability of the assessee company on the basis of the alleged business connection
Its finding or view in that regard is wholly erroneous
3 That even assuming that the High Court was right in its view of basing the tax li ability of the assessee company on the alleged business connection it failed to examine the question of apportionment under section 423 of the Act
4 That apportionment under section 423 and determination of the tax liability of the assessee company in pursuance thereof could not be more than the liability to pay tax on 5 of the total technical fee as found by the Income tax Officer and upheld by the Tribunal
Certain other companies have intervened in this appeal and some argument was advanced on their behalf too in sup port of the main argument of Mr Palkhivala Section 41 of the Act provides  Subject to the provisions of this Act the total income of any previous year of any person includes all income profits and gains from whatever source derived which       c if such person is not resident in the taxable territories during such year accrue or arise or are deemed to
accrue or arise to him in  the taxable territories during such year  481 The income assessable to income tax therefore is of two kinds viz i accruing or arising in the taxable territories and ii deemed to accrue or arise to the non resident in the taxable territory
The concept of actual accrual or arising of income in the taxable territories although not dependent upon the receipt of the income in the taxable territories is quite distinct and apart from the notion of deemed accrual or arising of the income
The High Court does not appear to have kept this distinction inview and mixed the one with the other while deciding the reference in question
Section 42 of the Act concerns itself with a deemed accrual or arising of the income within the taxable territories
Under sub section 1 All income profits or gains accruing or arising whether directly or indirectly through or from any business connection in the taxable territories    shall be deemed to be income accruing or arising within the taxable territories and where the person entitled to the income profits or gains is not resident in the taxable territories shall be chargeable to income tax either in his name or in the name of his agent and in the latter case such agent shall be deemed to be for all the purposes of this Act the assessee in re spect of such income tax  If the whole of the deemed income can be roped in for the levy of tax under section 1 of section 42 no question of any apportionment arises
If not sub section  3  is attracted
It says
In the case of business of which all the operations are not carried out in the taxable territories the profits
and gains of the business deemed under this section to accrue or arise in the taxable territories shall be only such profits and gains as are reasonably attributable to that part of the operations carried out in the taxable territo ries
 In Commissioner of Income Tax Bombay vs Scindia Steam Navigation Co Ltd1 it has been pointed out that when a question of law was neither raised before the Tribunal nor considered by it it will not be a question arising out of its order notwithstanding that it may arise on the findings given by it
In the instant case the question of law based upon the theory of business connection was neither raised before the Tribunal nor considered by it nor did it arise on the findings of fact recorded by it
The High Court therefore was wrong in entertaining this new point at the reference stage on the basis of the allegedly general and compendious nature of the question referred to it by the Tribunal
But we do not propose to rest our judgment only on this technical aspect of the matter as we find that even on merits the assessee company has a good case to succeed before us
The High Court agreed with the Tribunal that the techni cal information furnished by the assessee company by post was aservice which could not be said to have been rendered in India putting it to use in India is not relevant as opined by the Commissioner
But in regard to the fact of the foreign technicians having been lemployed by the 142 ITR 589
482 Indian company on payment of salary in India it took the view that the service was rendered in India as foreign technicians were deputed by the assessee company
In the opinion of the High Court it did amount to some activity or service in India
Then the High Court proceeds to say Therefore we are of the view that the assessee having rendered at least some services in India which amounts to a business activity the technical fee should be taken to have accrued through or from its business Connection in India
 Even though according to the High Court the finding aforesaid was sufficient to rope in the entire receipts of the assessee company as income having accrued or arisen in India as a result of its business connection it felt obliged to make the apportionment to the extent of 75 because of the apportionment so made by the Commissioner
In our judgment the High Court went wrong in its approach to the question raised before it and did not quite correctly appreciate the scope and applicablity of section 42 of the Act
On a plain reading of sub sections 1 and 3 of section 42 it would appear that income accruing or arising from any business connection in the taxable territories even though the
income may accrue or arise outside the taxable territories will be deemed to be income accruing or arising in such territory provided operations in connection with such business either all or a part are carried out in the faxable territories
If all such opera tions are carried out in the taxable territories sub sec tion 1  would apply and the entire income accruing or arising outside the taxable territories but as a result of the operations in connection with the business giving rise to the income would be deemed to accrue or arise in the taxable territories
If however all the operations are not carried out in the taxable territories the profits and gains of the business deemed to accure or arise in the taxable territories shall be only such profits and gains as are reasonably attributable to that part of the operations carried out in the taxable territories
Thus comes in the question of apportionment under sub section 3 of section 42
In Commissioner of Income lax Punjab vs BD Aggarwal and Co and another1 Shall J as he then was speaking for this Court said at page 24 A business connection in section 42 involves a relation between a business carried on by a non resident which yields profits or gains and some activity in the taxable ferri tories which contributes directly or indirect ly to the earning of these profits or gains
It predicates an element of continuity
be tween the business of the non resident and the activity in the taxable territories a stray or isolated transaction is normally not to be regarded as a business connection
Business
connection may take several forms it may include carrying on a part of the main busi ness or activity incidental to the main busi ness of the non resident through an agent or it may merely be a relation between the busi ness of the nonresident and the
activity in the taxable territories which facilitates or  assists the carrying on of that business
In each case the  question whether there is a business connection 1 483 from or through which income profits or gains arise or accrue to non resident must be determined upon the facts and circumstances of the case
 The learned Judge says further A relation to be a business connec tion must be real and intimate and through or from which income must accrue or arise whether directly or indirectly to the nonres ident
But it must in all cases
be remem bered that by section 42 income profit or gain which accrues or arises to a non resident outside the taxable territories is sought to be brought within the net of the income tax law and not income profit or gain which accrues or arises or is deemed to accrue or arise within the taxable territories
Income received or deemed to be received or accruing or arising or deemed to be accruing or arising within the taxable territories in the previous year is taxable by section 41 a and c of the Act whether the person earning is a resident or non resident
If the agent of a non resident receives that income or is enti tled to receive that income it may be taxed in the hands of the agent by the machinery provision enacted in section 40 2
Income not taxable under section 4 of the Act of a non resident becomes taxable under section 42 1  if there subsists a connection between the activity in the taxable territories and the business of the non resident and if throug or from that connection income directly or indirectly arises
 The High Court was wrong in its view that activities
of the foreign personnel lent or deputed by the American compa ny amounted to business activity carried on by that company in the taxable territory
The finding of the Tribunal in that regard was specific and clear and was unassailable in the reference in question
The American company has made the services of the foreign personnel available to the Indian company outside the taxable territory
The latter took them as their employees paid their salary and they worked under the direct control of the Indian company
The service rendered by the American company in that connection was wholly and solely rendered in the foreign territory
Even assuming however that there was any business connec tion between the earning of the income in the shape of the technical fee by the American company and the affairs of the Indian company yet no part of the activity or operation could be said to have been carried on by the American compa ny in India
And in absence of such a sustainable finding by the High Court the provision of section 42 either of sub section 1 or of sub section 3 were not attracted at all
The judgment of the High Court under appeal reported in Commissioner of Income Tax Madras J vs Carborandum Compa ny1 is not correct
It has rightly been pointed out by the Bombay High Court in Commissioner of Income Tax Bombay City I vs Tara Chemicals Ltd2 with reference to the similar or almost  484 identical provisions in section 91 of the Income tax Act 1961 that in order to rope in the income of a non resident under the deeming provision it must be shown by the Depart ment that some of the operations were carried out in India in respect of which the income is sought to be assessed
The finding of fact recorded by the Tribunal being against the department in that connection the Bombay High Court refused to call for a reference
For the reasons stated above we hold that on the facts and in the circumstances of the case the technical service fee received by the Assessee company from the Indian company during the accounting year relevant to the assessment year 1957 58 did not accrue or arise in India nor could it be deemed to have accrued or arisen in India
But since 5  of the technical service fee was brought to tax by the Income Tax Officer and no appeal was filed against it on behalf of the Assessee Company we cannot interfere with
the addition of this 5 but if must be held that the technical leo in excess of 5  was not taxable
We accordingly allow the appeal set aside the judgment of the High Court and answer the question referred by the Tribunal in favour of the assessee and against the Revenue
The Commissioner will pay the costs of the appeal as also of the reference to the assessee
SR Appeal allowed


Summary:
The appellant a foreign company within the meaning of section 25A of Income Tax Act entered into an agreement with Ms Carborandum Universal Ltd having its registered office at Madras on June 22 1955 and rendered certain technical and knowhow services
In view of the said serv ices it was to receive from the Indian company an annual service fee equal to 3 per centum of the net sale proceeds of the products manufactured by the latter
During the year of account relevant to the assessment year 1957 58 the appellant company received a sum of Rs 95762 from the Indian company as its service fee
A good slab of it was deducted at source on account of incometax and super tax
The appellant company fried its return of income for the year in question with an application for refund of the entire tax deducted at source
The income tax officer took the view in his assessment order that 5 of the technical fee paid to the American company was earned by it in India and only that small amount was assessable to in come tax and directed the refund of major portion of the tax deducted at source to the assessee company
The Commission er of Income tax in exercise of his revisional powers under section 33B of the Act took the view that at least 75 of the technical fee earned by the assessing company during the year of account had accrued or arisen in India even though the technical information was supplied by the assessee company from outside India and the technical personnel furnished by the assessee company to the Indian company although worked under the control of and was paid for by the latter inasmuch as the situs of the services so rendered was in India
Treating the technical fee in the nature of royalty paid it directed the Income tax Officer to revise the assessment on the basis that 75 of it should be taken as income accruing or arising in India to the assessee company
On appeal the Appellate Tribunal set aside the said order and restored that of the Income tax Officer even though it was of the view that even 5 of the technical fee could not be taken as income of the assessee
company taxa ble under the Act
The Tribunal held that the use of the technical assistance and know how given by the American Company and made use of by the Indian Company in the taxable territory could not make the former liable to payment of income tax on the amount of technical fee received by it nor was it any royalty
It also rejected a new stand taken by the Revenue that the assessee company must be deemed to be working in conjunction with the Indian Company in the manu facture of its products
On reference under section 66 1 
of the Act the Revenue
took another new plea that the agree ment clearly established a business connection between the two companies and as such technical fee received by the assessee company had accrued or arose from such business connection assessable to income tax under section 41c read with section 42 of the Act
The objection of the assessee
company to the entertainment of the new point at the refer ence stage that it did not arise out of the Tribunal s order was over ruled by the High Court on the ground that the question referred to was in general terms and comprehensive enough to embrace within its ambit the point of applicabili ty of section 421 of the Act to the transactions in question
Upholding the stand taken on behalf of the Revenue the High Court answered the question referred to it in its favour against the assessee company
On appeal by certificate the appellant contended 476 1 That the High Court could not go into the matter of business connection between the two companies when such a question was never raised or in issue at any earlier stage 2 That the High Court was wrong in rounding the tax liability of the assessee company on the basis of the alleged business connection
Its finding or view in that regard is wholly erroneous
3 That even assuming that the High Court was right in its view of basing the tax li ability of the assessee company on the alleged business connection it failed to examine the question of apportionment under section 423 of the Act
4 That apportionment under section 423 and determination of the tax liability of the assessee company in pursuance thereof could not be more than the liability to pay tax on 5 of the total technical fee as found by the Income taxOfficer and upheld by the Tribunal HELD 1 The technical service fee received by the assessee company from the Indian company during the accounting year relevant to the assessment year 1957 58 did not accrue or arise in India
Since 5 of the technical service fee was brought to tax by the ITO and no appeal was filed against it on behalf of the assessee company the technical fee in excess of 5 was not taxable
484 B D 2 The High Court did not keep in view the distinction between the concept of actual accrual and the notion of deemed accrual evidenced from section 41 c  section 42 but mixed the one with the other while answering the reference in question
The income assessable to income tax section 41c is of two kinds viz 1 accruing or arising in the taxable territories and ii deemed to accrue or arise to the non resident in the taxable territory
The concept of actual accrual or arising of income in the taxable territories although not depending upon the receipt of the income in the taxable territories is quite distinct and apart from the notion of deemed accrual or arising of the income
481 A B
3 The High Court was wrong in entertaining at the reference stage on the basis of the alleged general and compendious nature of the question referred to it by the Tribunal the new point based upon the theory of business connection which was neither raised before the Tribunal nor considered by it nor did it arise on the findings of fact recorded by it
481 F G Commissioner of Income Tax Bombay vs Scindia Steam Navigation Co Ltd   followed
4 The High Court went wrong in its approach to the question raised before it and did not quite correctly appre ciate the scope and applicability of section 42 of the Act
On a plain reading of sub sections 1 and 3 of section 42 it would appear that income accruing or arising from any busi ness connection in the taxable territories even though the income may accrue or arise outside the taxable territories will be deemed to be income accruing or arising in such territory provided operations in connection with such business either all or a part are carried out in the taxable territory
If all such operations are carried out in the taxable territory sub section 1 would apply and the entire income accruing or arising outside the taxable territory but as a result of the operations in connection with the business giving rise to the income would be deemed to accrue or arise in the taxable territories
If however all the operations are not carried out in the taxable terri tories the profits and gains of the business deemed to accrue or arise in the taxable territories shall be only such profits and gains are reasonably attributable to that part of the operations carried out in the taxable territo ries
Thus comes in the question of apportionment under subsection 3 of section 42
482 C F Commissioner of Income Tax Punjab vs RD Aggarwal  Co and Anr56 ITR 20 referred to
5 In the instant case the High Court was wrong in its view that activities of the foreign personnel lent or deput ed by the American company amounted to a business activity carried on by that company in the taxable territory
The service rendered by the American company in that connection was wholly and 477 solely rendered in the foreign territory
No part of the activity or operation could be said to have been carried on by the American company in India even if there was any business connection between the earning of the income in the shape of the technical fee by the American company and the affairs of the Indian company
In the absence of such a sustainable finding the provisions of section 42 either of sub section 1 or of sub section 3were not attracted at all
In order to rope in the income of a non resident under the deeming provision it must be shown by the Department that some of the operations were carried out in India in respect of which the income is sought to be assessed
483 E H Commissioner of Income Tax Madras I vs Carborandum Co overruled
CIT Bombay City IV
Tata Chemicals Ltd  approved