1 mpt IN THE HIGH COURT OF JUDICATURE AT BOMBAY ORDINARY ORIGINAL CIVIL JURISDICTION WRIT PETITION NO.448 OF 1994 1. Grasim Industries Ltd. Bombay a Public Limited Company having its regd.office at Birlagram Nagda, M.P and having its place of business at Vikram Ispat (Unit 91) Sakhar Bhavan, 230 Nariman Point, Bombay 400 021. 2. Davy MCKEE Corporation a Co. incorporated under the laws of Delaware having its principle place of business at One Oliver Plaza, Pittsburg 3. B.R. Nahar, Indian Inhabitant, having his place of residence at Maheshwar Niketan Flat No.1, 5-B, Peddar Road, Bombay 400 026. .. Petitioners versus 1. S.M. Mishra, Commissioner of Income tax, Special Range 12, having its office at Pratyaksha Kar Bhavan, Bandra(E) Bombay 400 051. 2. Binoy Gupta, Commissioner of Income Tax (Appeals) XXIV, having its office at K.G. Mittal Building, Charni Road, Bombay-4. 3. Ms.S. Ramamurty, Assistant Commissioner of Income tax, Central Circle I, Bombay, having her office at Central Govt. Offices Building Annexe, 9 th floor, 101, Maharshi Karve, Rd, Bombay 400 020. 2 4. Union of India through advocate of the Central Govt. at Bombay, Aayakar Bhavan Annexe, 2 nd floor, New Marine Line, Bombay 400 020. .... Respondents Mr. J.D. Mistri with Mr.A.K. Jasani for the petitioner. Mr.D.J. Khambatta, Addl. Solicitor General for Attorney General for respondents. Mr.Suresh Kumar with Mr. P.S. Sahadevan for respondent nos.1 to 3. CORAM : F. I. REBELLO AND D.G. KARNIK, JJ JUDGMENT RESERVED ON : 10th September 2009 JUDGMENT DELIVERED ON : 5th May 2010 ORAL JUDGMENT: (Per D.G. Karnik, J):- 1. The short question that arises for our consideration in this petition is whether the amount paid by the petitioner no.1 to the petitioner no.2 outside India as consideration in terms of Basic Engineering and Training Agreement dated 22 nd October 1989 is liable to Indian Income tax as income deemed to have accrued to the petitioner no.2 in India in view of section 9(1)(vii) of the Income Tax Act 1961? 2. Petitioner no.1 is a company incorporated in India in which 3 public is substantially interested and has principal place of business at Bombay. Petitioner no.2 is a company incorporated under the laws of Delaware and has principal place of business in Pennsylvania, USA. Petitioner no.2 does not have any office or place of business in India and is not resident in India. The petitioner no.1 being desirous of setting up a Sponge Iron Plant approached petitioner no.2 for technical assistance. By an agreement dated 22 nd October 1989 (for short “the BEAT Agreement”), the petitioner no.2 agreed to render to the petitioner no.1 outside India certain engineering and other related services in relation to the Sponge Iron Plant. By another agreement (the Supervisory Agreement), the petitioner no.2 agreed to provide certain supervisory services to the petitioner no.1 in India. By the BEAT agreement that petitioner no.2 was to prepare basic engineering drawings specifications, calculations and other documents and design and also prepare monthly schedule of non-Indian activities outside India. The petitioner no.2 was to deliver to the authorized representative of the petitioner no.1 the designs, drawings and data outside India. The petitioner no.2 also agreed to train outside India certain number of employees of the petitioner no.1 in order to make available to such employees scientific knowledge, technical information, expertise and technology necessary for commissioning, 4 operation and maintenance of the Sponge Iron Plant. As a consideration, the petitioner no.1 agreed to pay to the petitioner no.2 a sum of US$ 16,231,000, net of Indian Income tax, if any, leviable. Other terms and conditions of the agreement are not material for the purpose of this petition. Government of India vide its letter dated 28 th September 1989, as amended by a letter dated 14 th December 1989, approved the terms of the technical collaboration. Both the letters were superseded and substituted by another approval letter dated 6 th February 1990. Reserve Bank of India also approved the terms and conditions of the BEAT agreement by its letter dated 28 th November 1989 and payment of US$ 16,231,000/- subject to the condition that a “No Objection Certificate/Tax Clearance Certificate” issued by the Income tax department should be produced at the time of each remittance. In accordance with the BEAT agreement, the petitioner no.2 delivered the total Basic Engineering Package to the representative of the petitioner no.1 in Pennsylvania (USA) between November 1989 and August 1990. The petitioner no.2 also imparted training to the 22 key personnel of petitioner no.1 at HYL’s plant in Mexico as provided in the BEAT agreement. 3. The petitioner no.1 through its letter dated 5 th December 1989 5 requested to the Assistant Commissioner of Income Tax (respondent no.3 herein) to issue a “No Objection Certificate” as required by the RBI sanction for payment of first instalment of consideration payable by it to the petitioner no.2. In the said letter, the petitioner no.1 emphasized that the provisions of section 9(1)(vii) of the Income Tax Act (for short “the Act”) which deems the payment of fees for technical services to a non resident by a resident were not applicable as no part of the activity for earning the technical fees was carried out in India and therefore, the income did not accrue or arise to the petitioner no.2 in India. Respondent no.3, however, by his reply dated 5 th December 1989 expressed a view that considering the provisions of section 9(1) (vii) of the Act, the fees payable by the petitioner no.1 to the petitioner no.2 were taxable as income deemed to have been accrued to petitioner no.2 in India. Thereupon, the petitioner no.1 effected Tax Deduction at Source (TDS) on the first instalment of US$ 5,356 million and paid as tax Rs.2,73,73,084/- under protest on 6 th December 1989. Again as insisted by the respondent no.3, petitioner no.1 effected Tax Deduction at Source and paid under protest as tax Rs.2,81,83,272/- on the second instalment of US$ 5.356 million under protest on 5 th September 1990. For the Assessment Year 1990-91, petitioner no.2 submitted its return of income on 31 st March 1992 6 under the Act declaring the total income at “NIL” contending that income earned by it under the BEAT agreement was not deemed to have accrued or arisen in India as it had no territorial nexus with India. The petitioner no.2 took credit for TDS of Rs.2,73,73,084/- and claimed its refund. By an order dated 31 st November 1992, the respondent no.3 negatived the contention of the petitioner no.2 and charged it to tax holding that the amount received by it under the BEAT agreement was an income deemed to have arisen in India. Similarly, for the Assessment Year 1991-92 petitioner filed its return of income on 27 th October 1992 declaring income of Rs.83,54,810/- for Supervisory Services in terms of the Supervisory Agreement and declaring “NIL” income in respect of the amount received by it under the BEAT agreement as it did not arise in India. The petitioner no.2 claimed credit of the TDS of Rs.2,81,83,272/- and claimed its refund. By an order dated 16 th March 1993, the respondent no.3 rejected the claim of petitioner no.2 for refund in respect of the TDS deducted by petitioner under the BEAT agreement and completed the assessment. 4. Aggrieved by the said assessment order dated 30 th November 1992 for the Assessment Year 1990-91, the petitioner no.2 preferred an appeal u/s.246 of the Income Tax Act before the respondent no.2. 7 Similarly aggrieved by the order of assessment dated 16 th March 1993 for the Assessment Year 1991-92, the petitioner no.2 filed another appeal u/s.246 of the Income Tax before the respondent no.2. By an order dated 7 th July 1993, the respondent no.2 dismissed the appeal filed by the petitioner no.2 regarding the Assessment Year 1991-92. It is not clear what happened to the other appeal filed by the petitioner no.2 regarding the Assessment Year 1990-91 though we proceed on the assumption that the same must also have been rejected on similar grounds. 5. The petitioners have approached this court inter alia challenging the constitutional validity of section 9(1)(vii) of the Act. The petitioners have also challenged the orders of assessment passed by the respondent no.3 and the order in appeal passed by the respondent no.2. At the hearing of the petition, Mr. Mistry appearing for the petitioner did not press the challenge to the constitutional validity of clause (vii) of sub-section (1) of section 9 of the Act. Mr.Mistry, learned counsel for the petitioner, however submitted that in respect of the offshore services rendered by petitioner no.2 to the petitioner no.1 under the BEAT agreement no income tax was payable. In support, he relied on a decision of the Supreme Court in the case of Ishikavajima 8 Harima. Heavy Industries Ltd. Vs. Director of Income Tax, (2007) 288 ITR 408. For section 9(1)(vii) to be applicable, submitted Mr.Mistry, it is necessary that the services of a non-resident are not only utilised in India but also rendered in India or have a live link with India so that the entire income from the fees earned by the non-resident becomes taxable in India. Since the services under the BEAT agreement were rendered by the petitioner no.2 to the petitioner no.1 wholly outside India, the amount paid by the petitioner no.1 and received by the petitioner no.2 outside India could not be treated as an income of petitioner no.2 taxable in India. 6. In view of the challenge to constitutional validity of the section 9(1)(vii) having been given up, learned Addl. Solicitor General did not address us. 7. Mr.Suresh Kumar, learned counsel for the respondents submitted that in Ishikavajima (supra), the Hon’ble Supreme Court has only interpreted section 9(1)(vii)(c) of the Income Tax Act and that decision was not applicable to the present case as the income earned by way of a fee by the petitioner no.2 from the petitioner no.1 was taxable u/s.9(1)(vii)(b) of the Act. The respondents were therefore 9 right in treating the amount paid by the petitioner no.1 to petitioner no.2 under the BEAT agreement as an income deemed to be received by the petitioner no.2 as taxable under section 9(1)(vii)(b) of the Act. He further submitted that all income received by a non-resident by way of a fee for technical services payable by a resident would be deemed to be earned by the non-resident in India unless it fell within the exception provided in clause (b) of section 9(1)(vii) itself. 8. Before we proceed to consider the rival submissions of the parties, it is necessary to clarify that the petitioners are not challenging the assessment to tax the income received by way of fee by the petitioner no.2 from the petitioner no.1 under the Supervisory Services agreement. They do not dispute that the services under Supervisory Services were rendered by the petitioner no.2 in India and as such the income received therefrom is liable to income tax. The dispute relates only to the amount paid by the petitioner no.1 to the petitioner no.2 under the BEAT agreement dated 22 nd October 1989. 9. Section 4 of the Income Tax Act is the charging section. It creates a charge in respect of total income of a person. The total income has been defined u/s 5 of the Act differently in respect of a 10 person who is a resident in India and a person who is not resident in India. Sub-section (1) of section 5 provides that the total income of a person who is resident in India shall include all income from whatever source derived which (a) is received or deemed to be received in India, or (b) accrues or arises to him in India, or (c) accrues or arises to him outside India during the year. Sub-section (2) of section 5 provides that the total income of a person who is non resident shall include all income from whatever source derived which (a)is received or deemed to be received in India by or on behalf of such person, or (b) accrues or arises or deemed to accrue or arise to him in India during the year. Clause (c) present in sub-section (1) is conspicuously absent in sub- section (2) of section 5 of the Act. The distinction in computing total income of a person who is resident in India and a person who is not resident in India is obvious. In respect a resident Indian, his global income (that is whether earned or received in India or out of India) is subject to the Indian income tax. But in respect of a non resident person only his income which is received or accrued or deemed to be received or accrued in India is subject to Indian income tax. This is because Indian Parliament does not have a power to tax income of a non resident, non citizen earned outside India. In order to tax any income of a non resident, there must be a territorial nexus of receipt 11 or accrual of the income with the Indian territory. Reference in this connection may be made to the following observations of the Supreme Court in Ishikiwajima (supra). “The global income of a resident although is subjected to tax, the global income of a non-resident may not be. The answer to the question would depend upon the nature of the contract and the provisions of the DTAA. What is relevant is receipt or accrual of income, as would be evident from a plain reading of section 5(2) of the Act. The legal fiction created although in a given case may be held to be of wide import, but it is trite that the terms of a contract are required to be construed having regard to the international covenants and conventions. In a case of this nature, interpretation with reference to the nexus to tax territories will also assume significance. Territorial nexus for the purpose of determining the tax liability is an internationally accepted principle. 10. Section 9 (1) of the Income tax Act lists the incomes which shall be deemed to accrue or arise in India. For the purpose of ascertaining which incomes accrue or arise or is deemed to have accrued or arisen to a non resident in India, aid would have to be taken of section 9 of the Act. The relevant clause, for our purpose is clause (vii) of sub- 12 section (1) of section 9 of the Act which reads thus:- 9(1) The following incomes shall be deemed to accrue or arise in India:- ............... ................ (vii) income by way of fees for technical services payable by (a) the Government; or (b) a person who is resident, except where the fees are payable in respect of services utilised in a business or profession carried on by such person outside India or for the purposes of making or earning any income from any source outside India; or (c) a person who is a non-resident, where the fees are payable in respect of services utilised in a business or profession carried on by such person in India or for the purposes of making or earning any income from any source in India: Provided that nothing contained in this clause shall apply in relation to any income by way of fees for technical services payable in pursuance of an agreement made before the 1 st day of April, 1976 and approved by the Central Government. 13 Explanation 1 – For the purposes of the foregoing proviso, an agreement made on or after the 1 st day of April, 1976, shall be deemed to have been made before that date if the agreement is made in accordance with proposals approved by the Central Government before that date. Explanation 2. - For the purposes of this clause, “fees for technical services” means any consideration (including any lump sum consideration) for the rendering of any managerial, technical or consultancy.” Section 9 of the Act creates a fiction under which certain incomes are deemed to have arisen or accrued in India. Fiction created by section 9 is to be considered having regard to the other provisions of the Act and also keeping in view the fact that while the legislative competence of the Parliament extends to enact a law taxing global income of an Indian so far as the income of a non resident is concerned it can tax his income only to the extent it arises or accrues in India. The Parliament, of course, can define what income of a non resident accrues or arises or deemed to accrue or arise in India, but the definition cannot be stretched so far as to treat the income of a non- resident which has no nexus with the Indian territory as deemed to have accrued or arisen in India. In Ishikawajima, the Supreme Court 14 has held that the territorial nexus doctrine plays an important part in the assessment of tax (see paragraphs 37 to 39 of 28 ITR 408) 11. Section 9(1)(vii) of the Act says that the income by way of fees for technical services payable by three classes of persons shall be deemed to have accrued or arisen to the recipient in India. The three classes of payees are described in three sub-clauses, viz. (a), (b) and (c) of clause (vii). Clause (a) is in respect of an income received by way of fees payable by the Government. Clause (b) is regarding the income by way of fees payable by a person who is a resident in India and clause (c) is in respect of an income by way of fees payable by a person who is a non resident. So far as clause (a) is concerned, it admits of no exception and every rupee received as an income by way of fees for technical services paid by the Government to him is deemed to have accrued or arisen to the recipient in India. So far as clause (b) is concerned, income by way of fees for technical services payable by a person who is a non resident is deemed to have accrued or arisen to the recipient in India “except where the fees are payable in respect of services utilized in a business or profession carried on by such person outside India or for the purpose of making or earning any income from any source outside India. The expression “by such person” appearing 15 in section 9(1)(vii)(b), in our opinion refer to the recipient of the income and not to the person making the payment. This would be clear if one looks to the opening words of sub-section (1) of section 9 which reads “the following income shall be deemed to accrue or arise in India”. Section 9(1) refers to the income which is deemed to have accrued or arisen in India by the recipient of the income. The expression “such person” appearing in clause (b) of section 9(1)(vii) therefore refer to the recipient because one has to consider whether the income received by him (the recipient) is deemed to have accrued or arisen in India. Section 9 does not contemplate taxing the payer but contemplates taxing the recipient for the income received by him. In our considered view, the expression “such person” appearing in clause (b) of section 9(1) (vii) refers to the recipient of the income and not to the payee. If we were to construe the expression “such person” appearing in section 9(1)(vii)(b) as to the person who makes the payment for technical services it would give rise to a startling results. We would demonstrate this by means of an illustration. Take a case where a resident Indian goes abroad, falls sick, and avails services of a pathological laboratory for testing his blood and pays the fees to the laboratory for the technical services of blood analysis performed by it. Obviously, the payment made by the Indian resident 16 for the technical services payable to the owner of the laboratory who is a non resident would fall in the first part of clause (b) of section 9(1) (vii) of the Act and the fee received by the owner of the laboratory would be subject to the Indian income tax unless it falls within the exception provided under clause (b) itself. If we were to read the expression “such person” in the clause (b) to refer the person making the payment i.e the resident Indian, then obviously case would not fall within the exception because the fees were not payable in respect of any business or profession carried on by “such resident Indian” outside India. Consequently, the income received by the owner of the pathology laboratory would be subject to Indian Income Tax. By any stretch of imagination, the owner of the pathology laboratory who is non resident Indian can be subjected to income tax because the Parliament obviously would have no legislative competence to tax him in respect of services rendered by him (who is non-resident and non- citizen) outside Indian territory. However, if the expression “such person” appearing in clause (b) of section 9(1)(vii) is construed to refer to the recipient of the fees, then he would be covered by the exception and not liable to pay Indian income tax. 12. If we apply sub-clause (b) of section 9(1)(vii) of the Act so 17 construed to the facts of the case at hand, the fees received by the petitioner no.2 for technical services from petitioner no.1 would fall within the exception carried out by clause (b) of section 9(1)(vii) of the Act and not taxable in India. 13. Mr. Suresh Kumar, learned counsel for the respondents submitted that in Ishikawajima, the Supreme Court had only considered clause (c) of section 9(1)(vii) of the Act. Inviting our attention to the observations made in paragraph no.91 and 95 (at pages 444 and 445 of ITR) as also observations made in sub-para no.7 (at pages 447 of the ITR) he submitted that the decision in Ishikawajima is no authority for interpretation of clause (b) of section 9(1)(vii) of the Act and we cannot apply the ratio of the decision of Ishikawajima to the facts of the present case. We are unable to agree. 14. In Ishikawajima, facts were that Ishikawajima, the appellant therein, was to develop, design, engineer and procure equipment, materials and supplies to erect and construct storage tanks for liquified natural gas ( LNG) at the specified temperatures i.e. (-) 200 degrees Celsius, to an Indian company. The contract involved (i) offshore supply, (ii) offshore services, (iii) onshore supply, (iv) onshore services 18 and (v) construction and erection. The price was to be paid for offshore supply and offshore services. An application was filed by the appellant before the Authority for Advance Ruling for determination of several questions including question no.3 which was as follows:- 3. On the facts and circumstances of the case, whether the amounts received/receivable by the applicant from Petronet LNG for offshore services are chargeable to tax in India under the Act and/or the India-Japan tax treaty? The authority for advance rulings answered the question no.3 by holding that the amount received by the appellant from the Petronet LNG for offshore services was liable to be taxed in India both under the provisions of the Income Tax Act as well as under the Indo Japan Treaty. Aggrieved appellant was in appeal before the Supreme Court. Allowing the appeal of the appellant the Supreme Court held that for section 9(1)(vii) to be applicable, it was necessary that the services not only be utilized within India, but also be rendered in India or have such a live link with India that the entire income of the fees becomes taxable in India. The Supreme Court adopted a twin test of (i) services being utilized in India and (ii) rendered in India or to have such a live link with India for taxing in India the income earned by a 19 non resident for technical services rendered outside India. Though