ITA No.703/2009 Page 1 of 40 REPORTED * IN THE HIGH COURT OF DELHI AT NEW DELHI + ITA No. 703/2009 DIRECTOR OF INCOME TAX, NEW DELHI ..... Appellant Through: Mr. Sanjeev Sabharwal, Advocate versus LG CABLE LTD. ..... Respondent Through: Mr. N. Venkatraman, Sr. Advocate with Mr. Satish Kumar, Advocate % Date of Decision : December 24, 2010 CORAM: HON’BLE MR. JUSTICE A.K. SIKRI HON'BLE MS. JUSTICE REVA KHETRAPAL 1. Whether reporters of local papers may be allowed to see the judgment? 2. To be referred to the Reporter or not? 3. Whether judgment should be reported in Digest? : REVA KHETRAPAL, J. 1. This is an appeal under Section 260-A of the Income-Tax Act, 1961 („the Act‟) admitted on the following substantial questions of law:- (1) Whether the Income Tax Appellate Tribunal is justified in not holding that the contract in question is not a composite one and, therefore, the assessee is not liable to pay tax in India in respect of offshore service? (2) Whether the levy of interest under Section 234B for short deduction of TDS is mandatory and is leviable automatically? 2. Briefly the factual matrix giving rise to the present appeal is as follows. The respondent LG Cable Ltd. (“LGCL”) is a company incorporated under the laws of South Korea having its registered office ITA No.703/2009 Page 2 of 40 at ASEM Tower (19-20F), 159 Samsung Dong, Gangnam-gu, Seol 135- 090 Korea. LGCL was awarded two contracts on February 26, 2001 by the Power Grid Corporation of India Limited (“PGCIL”). The first was for onshore execution of the Fibre Optic Cabling System Package Project under the System Coordination and Control Project for the Eastern Region involving onshore services, including erection/installation, testing and communicating, etc. of the fibre of the cabling system. The second contract was for offshore supply of equipment and offshore services. During the financial year 2001-02, LGCL had set up a “project office” in India after obtaining requisite approval from the Reserve Bank of India. The services under the onshore contract were rendered by LGCL through its project office in India for which separate books of account were maintained by the assessee. The income attributable to the activities carried out in India in connection with onshore contract was offered to tax on a net income basis in the return of income filed by the assessee in terms of Articles 5 and 7 of the Double Taxation Avoidance Agreement (“DTAA”) between India and Korea. As regards offshore supply contract, however, it was claimed by the assessee that this income was not liable to tax in India as the income wholly accrued or arose in Korea. It was also claimed that the entire contract was carried out in Korea and was subject to income- tax in Korea. The transfer of title along with the attendant risks had entirely passed on to PGCIL outside India. ITA No.703/2009 Page 3 of 40 3. Thus, the return filed by the assessee on October 31, 2002 showed a loss of ` 85,69,828/- for the assessment year 2002-03 and was only in respect of the onshore contract. The said return was processed under Section 143(1) of the Act and refund of tax deducted at source along with interest under Section 244A of the Act was granted. Subsequently, the return was taken up for assessment under Section 143(3) of the Act by the Deputy Director of Income Tax, Circle 1(1), International Taxation, New Delhi („AO‟). 4. In the course of the assessment proceedings, the contention of the LGCL, as stated above, was that income from the offshore supply was not taxable in India. Several judicial precedents and circulars of the Central Board of Direct Taxes („CBDT‟) in support of the said contention were cited. The AO, however, did not accept the claim of the assessee relating to offshore supply of equipment in the light of the decision of the Authority for Advance Ruling in the case of Ishikawajma-Harima Heavy Industries Co. Ltd., 271 ITR 193, wherein it was held that such offshore supply of material resulting from engineering procurement and construction contract is taxable in India. The AO according held the income accruing to LGCL from the offshore supply contract with PGCIL to be taxable in India. The AO found that the total revenue from the offshore supply contract in the relevant year was US $ 73,25,665. Since the assessee did not produce the profitability statement for the offshore supply as the assessee was not maintaining ITA No.703/2009 Page 4 of 40 separate books of account for the same, the AO held that for deciding the profitability of the project, recourse could be taken to Section 44BBB of the Act, which examines the profits arising from contracts of more or less similar nature. Ten percent of the amount paid was deemed to be the gains of such business chargeable to tax. Hence, using this criterion, the AO held that it would reasonable to fix the profit element from the offshore supply contract at 10% of receipts, i.e., at US $ 7,32,567. The AO further held that since the bulk of activities, including manufacturing, were taking place outside India, it would be reasonable to attribute 30% of these profits to India. Hence, the income chargeable to tax in India was worked out at US $ 2,19,770, i.e., at ` 1,05,48,950/-. The above amount was added to the income of the assessee in the assessment order. The AO also levied interest under Section 234B and 234C of the Act. 5. The assessee impugned the above assessment in appeal before the CIT(A), reiterating its submission that the transfer of title in the equipment supplied by it had taken place in favour of PGCIL outside India and hence income of offshore supply equipment could not be said to accrue or arise in India. After comparing and contrasting both the agreements and in particular Article 6 thereof, the CIT(A) held as under:- “4.1 From the combined reading of Article 6 of both the agreements, the following facts emerge: (1) Notwithstanding the award of work under two separate agreements, the contractor (the ITA No.703/2009 Page 5 of 40 appellant) has the overall responsibility for the execution of all the work right from the beginning till the end. (2) Notwithstanding the award of work under two separate agreements, in case of default or breach under one contract the same shall automatically be deemed to be a default or breach under both the contracts. This means that if there is a default in any part of one contract by the appellant, both the contracts are liable to be cancelled. (3) Notwithstanding the award of work under two separate agreements, it was agreed by the appellant that the equipment/material supplied by it to PGCIL under the first contract, when erected and commissioned by the appellant under the second contract shall give satisfactory performance in accordance with the provisions of the contract. This condition has been specified in Article 6 of the Onshore erection contract. This clearly shows that even in the Onshore erection contract it is the responsibility of the appellant that the materials/equipment supplied by it under the offshore equipment supply contract shall give satisfactory performance. The same responsibility has been cast on the appellant in Article 6 of the Offshore supply of equipment also. (4) Notwithstanding the award of contract under two separate agreements, the contractor (appellant) shall achieve successful completion of the project under both contracts and successful taking over the project by PGCIL.” 6. The CIT(A) held that it was clear from the foregoing that the two contracts were not independent of each other as claimed by the assessee, that there was inter-relation and inter-dependence between the two agreements and that one could not exist without the other. Thus, the CIT(A) concluded that though there were two agreements, in fact, it was ITA No.703/2009 Page 6 of 40 a composite contract for supply of equipment as well as execution, erection and installation of equipment in India. He further observed that a colourable device had been adopted by the assessee to conceal its real tax liability. The supply of offshore equipment was inextricably linked with the operations to be carried in India. He, therefore, held that the decision of the Authority for Advance Ruling in the case of Ishikawajima-Harima Heavy Industries Co. Ltd. (supra) was applicable to the facts of the case. Applying Article 7 of the DTAA, the CIT(A) held that the income from the offshore sale of goods could be deemed to be accrued to assessee in India and was taxable in India in terms of Section 9(1)(i) of the Act. The computation of income of the assessee at ` 1,05,48,950/- made by the Assessing Officer as well as the levy of interest under Section 234B and 234C by the Assessing Officer was also upheld. Resultantly, the appeal filed by the assessee was dismissed. 7. Aggrieved by the aforesaid dismissal of its appeal, the assessee preferred a second appeal before the Appellate Tribunal. The Tribunal after a detailed consideration of the matter held that the income from the offshore contract taken at ` 1,05,48,950/- was not taxable in the hands of the assessee and directed the deletion thereof. The Tribunal further ruled that the assessee was not liable to pay any tax under Section 234B of the Act. It was now the turn of the Department to feel aggrieved and hence the present appeal under Section 260A of the Act has been filed ITA No.703/2009 Page 7 of 40 by the Department to challenge the order of the Tribunal dated 8th August, 2008. 8. The focal point of controversy between the parties is whether the income from the offshore contract between the parties would be taxable in India under the provisions of Section 9 of the Act, the relevant portion whereof reads as under:- “Income deemed to accrue or arise in India. 9. (1) The following incomes shall be deemed to accrue or arise in India :— (i) all income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India. [Explanation 1].—For the purposes of this clause— (a) in the case of a business of which all the operations are not carried out in India, the income of the business deemed under this clause to accrue or arise in India shall be only such part of the income as is reasonably attributable to the operations carried out in India.” 9. It was submitted by Mr. Venkatraman, the learned counsel for the assessee that the supply of equipment in this case was made on principal to principal basis and, therefore, the income from supply of equipment was not taxable in India. In this regard, reliance was placed on the circular of CBDT Circular No.23 dated 23.07.2009. Reliance was also placed on the decisions of the Supreme Court rendered in Income tax Officer and Ors. vs. Sri Ram Bearings Ltd. and Ors., (1997) 224 ITR ITA No.703/2009 Page 8 of 40 724 (SC) and Mahabir Commercial Co. Ltd. vs. Commissioner of Income-Tax West Bengal, (1972) 86 ITR 417 (SC) to submit that income from the offshore supply of equipment was not covered under Section 5(2) of the Act. 10. At the outset Mr. Sajeev Sabharwal, the learned counsel for the Revenue contended that a plain reading of the two contracts would show that they were integrated contracts. Relying heavily upon Article 6 of both the contracts, the contention of Mr. Sabharwal was that any default or breach in one contract was not to relieve the respondent-assessee of its obligation under the other contract. Mr. Sabharwal emphasized that a reading of Clause 6 of both the agreements was by itself sufficient to bear out his contention that in terms thereof, the equipment/material supplied by the assessee in the first contract when erected and commissioned by the assessee under the second contract was required to give satisfactory performance in accordance with the terms of the agreements. Any default in supply or in erection would be taken as a default in the other agreement so that one agreement could not work without the other. It is expedient at this juncture to reproduce clause 6 of both the onshore and offshore agreements in juxtaposition with each other, which read as under: - (2nd Contract) (1st Contract) Offshore agreement C-42101- S858-1/CA-II/787 Offshore agreement C-42101- S858-1/CA-II/778 The Contract agreement No. C- 42101-S858-1/CA-I/788 has also The Contract Agreement No. C- 42101-S858-1/CA-I/787 has also ITA No.703/2009 Page 9 of 40 been made on 26th February 2001, between the Employer and the Contractor for On-shore Erection Contract (hereinafter referred to as the „Second Contract‟) for the subject package which includes performance of all activities within India, inter-alia port handling and custom clearance of supplies from abroad, inland transit insurance, handling and transportation to site, unloading at site, storage, preservation, insurance, erection/installation (including Survey, planning field engineering activities, tower analysis and strengthening as required), testing and commissioning and demonstration for acceptance (with the equipment and services being separately provided by POWERGRID AS LISTED IN SPECIFICATION, Vol.II, of the Bidding Documents including its subsequent amendments) at site of the complete Fiber Optics system including associated equipment/civil works etc. for complete execution of the Fibre Optic Cabling System Package under Eastern Region System Coordination & control project, training of employer‟s personnel within India and maintenance of the Fibre Optic Cabling System as per technical specifications. Notwithstanding the award of work under two separate contracts in the aforesaid manner, the contractor shall be overall responsible to ensure the execution of both the two contracts to achieve successful completion and taking over of the project by Power Grid as per the requirements stipulated in the contract. It is expressly understood been made on 26th February 2001, between the Employer and the Contractor for Off-shore Contract (hereinafter referred to as the „First Contract‟) for the subject package which includes all works to be performed in countries outside India covering, inter-alia, design, engineering, manufacture, testing and CIF supply of all offshore equipment & materials including mandatory spares and training of employer‟s personnel outside India etc. required for the complete execution of Fibre Optic Cabling System Package under Eastern Region System Coordination and Control Project. Notwithstanding the award of work under two separate contracts in the aforesaid manner, the contractor shall be overall responsible to ensure the execution of all the two contracts to achieve successful completion and taking over the project by the Power Grid as per the requirements stipulated in the contract. It is expressly understood and agreed by the contractor that any default or breach under the „first contract‟ shall automatically be deemed as a default or breach of this „second contract‟ also and vice-versa and any such default or breach or occurrence giving the employer a right to terminate the „first contract‟, either in full or in part and/or recover damages under that contract, shall give the employer an absolute right to terminate this contract at the contractor‟s risk cost and responsibility, either in full or in part &/or recover damages under this „second contract‟, as well. However, such default or breach or occurrence in ITA No.703/2009 Page 10 of 40 and agreed by the contractor that any default or breach under the „second contract‟ shall automatically be deemed as a default or breach of this „first contract‟ also and vice-versa and any such default or breach or occurrence giving the employer a right to terminate the „second contract‟, either in full or in part and/or recover damages under that contract, shall give the employer an absolute right to terminate this contract, at the contractor‟s risks cost and responsibility, either in full or in part &/or recover damages under this „first contract‟, as well. However, such default or breach or occurrence in the second contract shall not automatically relieve the contractor of any of its obligations under this „first contract‟. It is also expressly understood and agreed by the contractor that the equipment/materials supplied by the contractor under the „first contract‟, when erected & commissioned by the contractor under this „second contract‟ shall give satisfactory performance in accordance with provisions of the contract. the first contract shall not automatically relieve the contractor of any of its obligations under this „second contract‟. It is also expressly understood and agreed by the contractor that the equipment/materials supplied by the contractor under the „first contract‟, when erected & commissioned by the contractor under this „second contract‟ shall give satisfactory performance in accordance with provisions of the contract. 11. It was contended by the learned counsel for the Revenue that a reading of the terms of the offshore supply contract clearly showed that the property in equipment passed to the buyer only in India and that such property did not pass till the equipment was erected and yielded satisfactory performance in India. Thus, 10% of the amount paid for ITA No.703/2009 Page 11 of 40 offshore supply should be deemed to have accrued and chargeable to tax in India. 12. The contention of the learned senior counsel for the assessee, Mr. N. Venkataraman, on the other hand was that the sale transaction had taken place outside India since the property in goods/equipments was transferred outside India. The Bill of Lading in respect of the equipment sold was issued in Korea in favour of PGCIL, i.e., the buyer, and the notified party was also the PGCIL. The Bill of Entry clearly showed that the importer was PGCIL and the goods were directly transferred to the site of PGCIL and not to that of LGCL. In terms of the contract, the ownership of the equipment and materials supplied to the PGCIL was transferred to PGCIL in the country of origin, i.e., in Korea. PGCIL was also the co-insurer under the insurance policy pertaining to the equipment. It was further submitted that the property in goods got transferred to the buyer outside India in terms of clause 31.2 of the contract which clarifies that the assessee and the PGCIL intended to transfer the title in the property/goods as soon as the goods were loaded on to the ship at the port of shipment and the shipping documents were handed over to the nominated bank where the letter of credit was opened. There was no other term in the contract which was inconsistent with clause 31.2. 13. It was submitted that sequentially, with the completion of the sale, income accrued outside India. The accrual of such income was not ITA No.703/2009 Page 12 of 40 attributable to any operation carried out in India. As regards the Permanent Establishment (P.E.) of the assessee in India, it was submitted that there was no material on record to show that the said permanent establishment had any role to play in the offshore supply of equipment. In such a situation, Section 9(1)(i) of the Act had no application as income could not be said to have accrued or arisen in India unless the income was attributable to such permanent establishment. Mere existence of a permanent establishment could not constitute sufficient business connection to take the P.E. as a taxable entity more so, as the clause (a) of Explanation 1 to Section 9(1)(i) of the Act emphasizes that only such part of the income as is attributable to the operations carried out in India could be taxed in India. It was contended that there was a subtle but clear-cut distinction between the existence of „business connection‟ and the income accruing or arising out of such business connection, which was required to be borne in mind as no activity relating to the offshore supply of goods was carried out in India, what to speak of income accuring or arising out of such business connection. Dealing with the contention of the learned counsel for the Revenue that one of the conditions imposed by the RBI while permitting the assessee to have a project office as per letter dated 11th April, 2001 was that the office expenses will be met in India only from the remittance received from the head office and that this showed a business connection of the ITA No.703/2009 Page 13 of 40 project office with the head office, it was stated that such a contention was altogether meaningless. 14. A look now at the relevant provisions of the offshore agreement entered into on 26th February, 2001, which have been reproduced by the Tribunal as under: - “10.4 .… In Article 1, there is description of contract documents. Article 2 provides for contract price and terms of payment. The assessee was to receive US$ 7,282,069 as CIF price component including testing and training charges. The amount also includes Indian agent‟s commission (IAC) @ 1.01%. Article 3 provides for effective date for determining time for completion of the Contract. Article 4 provides that this contract is between the assessee and Power Grid and not with Government of India. Article 5 refers to the list of Appendices, which shall form integral part of the agreement. Article 6 on which revenue has laid lot of emphasis specifically states that notwithstanding award of work under two separate contracts, the contractor shall be overall responsible to ensure the execution of both the two contracts to achieve successful completion and taking over of the project by POWERGRID. It further provides that “any default or breach under the „Second Contract‟ shall automatically be deemed as a default or breach of this „First contract‟ and also vice-versa. 10.5 Appendix 1 relating to “Terms and Procedures of Payment” is s under:- “1.0 Terms of Payment In addition to the Conditions stipulated under clause GCC Clause 12, the following terms and conditions will apply. 1.1 CIF Price Component (excluding Indian Agent‟s Commission (IAC) of the Contract Price for all the equipment and materials excluding „Mandatory spares and Tools & Tackles for Off-line maintenance‟. 1.1.1 Advance Payment ITA No.703/2009 Page 14 of 40 Ten percent (10%) of the CIF price component (excluding IAC) of the Contract Price for all the equipment and materials excluding „Mandatory spares and Tools & Tackles for Off-line maintenance‟, amounting to US$ 637,302 (US Dollars Six Hundred Thirty Seven Thousand Three Hundred and Two only) shall be paid within 30 days of signing of Contract Agreement, Submission of claim, Advance Payment Security/Bank Guarantee for equivalent amount valid at least till 90 days after issuance of Operational Acceptance Certificate, and Performance Security of 10% of the Total Contract Price i.e. US$ 728,207 (US Dollars Seven Hundred Twenty Eight Thousand Two Hundred and Seven), with a validity upto 60 days beyond the Defect Liability Period for this Off-shore Contract and the Performance Security for the On-shore Erection Contract as mentioned in the Contract Agreement for the same. The Advance Payment Security and the Performance Securities for both the Contracts, to be furnished as per the Contract in the specified format, shall be kept valid initially at least upto 31.10.2003 and 30.9.2004, respectively, and shall be extended from time to time as may be required under the Contract. 1.1.2 Progressive Payment Seventy Five per cent (75%) of the CIF price component (excluding IAC) for all the equipment and materials excluding „Mandatory spares and Tools & Tackles for Off-line maintenance‟ shall be paid as follows: i) Fifty five per cent (55%) of the CIF price component (excluding IAC) for all the equipment and materials excluding „Mandatory spares and Tools & Tackles for Off-line maintenance‟ shall be paid on pro-rata basis through ITA No.703/2009 Page 15 of 40 irrevocable confirmed Letter of Credit established in favour of contractor and on shipment of equipment and submission of documents specified in Clause SCC 18.1. ii) Twenty percent (20%) of the CIF price component (excluding IAC) for all the equipment and materials excluding „Mandatory spares and Tools & Tackles for Off-line maintenance‟ shall be paid on pro-rata basis within 30 days