IN THE HIGH COURT OF JUDICATURE AT MADRAS DATE: 12-01-2009 CORAM: THE HONOURABLE MRS. JUSTICE PRABHA SRIDEVAN AND THE HONOURABLE MR. JUSTICE K. K. SASIDHARAN Tax Case No.1303 of 2007 M/s. Ansaldo Energia SPA Represented by its Authorised Signatory Mr. Lorenzo Pesenti TPL House, II Floor No.3, Cenotaph Road Teynampet, Chennai – 600 018 ... Appellant Vs. 1. The Income Tax Appellate Tribunal Chennai Bench "A" Shastri Bhavan Haddows Road Chennai – 600 006 2. The Commissioner of Income Tax (Appeals) XI Uttamar Gandhi Salai Nungambakkam Chennai – 600 034 3. The Assistant Director of Income Tax International Taxation 121, Uttamar Gandhi Salai Chennai – 600 034 ... Respondents Tax Cases (Appeal) filed under Section 260-A of the Income Tax Act 1961 against the order of the Income Tax Appellate Tribunal (Chennai Bench "A") in I.T.A.No.411/Mds/2006 dated 11-05-2007 arising out of orde passed in ITA.No.9 & 10/2004-05/CIT(A)XI dated 16.12.2005 on the file of the Commissioner of Income Tax (Appeals) XI, 12, Mahatma Gandhi Salai, Chennai-34 arising out of order passed in P.A.N./G.I.R.No.:-AACCA41511/3-A dated 27.02.2004 on the file of the Assistant Director of Income Tax (International Taxation) Chennai. https://hcservices.ecourts.gov.in/hcservices/ For Petitioner : Mr. N.Venkataraman, Senior Counsel for Mr. R. Karthikeyan For Respondent : Ms. Pushya Sitaraman Senior Standing Counsel for Income Tax JUDGMENT (PRABHA SRIDEVAN,J.) The assessee is a non-resident Company; its business consists inter alia of selling and setting of power plants. In 1995, with the necessary statutory approvals the assessee set up a company in India called Ansaldo Services Private Ltd. (ASPL hereafter). In 1997, the Neyveli Lignite Corporation(NLC in short) floated a single-bid tender for its expansion plan of setting up two thermal plants at Neyveli. The assessee applied for the bid in response to NLC's advertisement. It did so as a single bidder. 2. According to the assessee, it had communicated to NLC right from the beginning that NLC should award the Indian portions of the turnkey contract to other legal entities to be selected by the assessee. According to the assessee, this condition was imposed since the assessee had no business presence in India. The assessee assured NLC that it would take the overall responsibility of the entire turnkey contract in its capacity as a single bidder. After the technical and financial evaluation of the bids, NLC awarded the turnkey contract to the assessee on a single bidder basis. 3. Thereafter, the contract was divided into four contracts. Contract I dealt with the off shore supply of equipments along with designing and engineering (Contract price DM 224,40028). Contract II dealt with the offshore services of supervision of erection, testing and commissioning (Contract price DM 197,900.00). Contract III dealt with the onshore supply of equipments executed by ASPL (contract price Rs.270,08,46,700/-). Contract IV Civil Construction, Erection, Testing and the Commissioning. (Contract price Rs.277,53,29,495/-). 4. Contract III and Contract IV which dealt with the on-shore supply and on-shore services were loss making contracts. The income on Contract II has been offered to tax at 20%. With regard to Contract I, the income on designing and engineering has been offered to tax at 20%. This appeal is therefore restricted to the taxability of the income on offshore supply of equipments. 5. The assessing officer treated the receipts as fees for technical services and quantified the tax accordingly. On appeal, the Commissioner of Income-Tax (Appeals)-XI (CIT in short) found that the consideration under Contract I was intended to provide a cushion; and to achieve this, the value of each contract was unilaterally fixed by the assessee; and that neither NLC nor ASPL https://hcservices.ecourts.gov.in/hcservices/ had any say in the matter. CIT (Appeals) found that "the entire nature of the contract, the terms involved and the conduct of the parties clearly show that only for the tax purposes, the contract was split up." He found that there is uniformity of control in respect of all the four contracts, and that the price of Contract I and II is likely to be loaded higher, to take care of the other responsibilities and risks of the assessee with respect to Contract III and IV on account of the single bidder responsibility. The CIT (Appeals) found that there was a "permanent establishment" and also that there was a "business connection". The CIT ( Appeals) estimated the profits on the entire project taking into consideration the losses of contract III and IV and also profit attributable to Permanent Establishment('PE' in short). 6. The aggrieved assessee went before the Tribunal. The Tribunal took the view that the contract in question was a composite contract, that the assessee had a common site in the premises of ASPL and had absolute control and management for all contracts and that, there was a permanent establishment in India, and also "that there existed a business connection with ASPL." The Tribunal held that, "Taking into consideration the entire conspectus of the case, we are of the opinion that ASPL was a facade created for the purpose of taxation ex consequent its corporate veil be lifted for consolidating the four contracts." The Tribunal, however, did not agree with CIT in its estimation of profits. The Tribunal held that for the activities which are not conducted in India, tax cannot be levied in India. The Tribunal agreed with the estimation made by the CIT that only 25% of activity could have been done outside India particularly in view of the various clauses of contract I indicating that many plant and equipment were fabricated in India also. Then by taking into account the profit margins of similar companies for the year 2002, the Tribunal directed that the profit shall be taxed at 7% in the context of contracts I, III and IV and that with regard to contract I, 7% profit shall be taken in relation to 75% receipts only, as balance receipts can be attributed towards activities conducted outside India. This order is under challenge here. 7. The substantial questions of law that arise for consideration in this tax case (appeal) is as follows: "1. Whether on facts and circumstances of the case, the Tribunal erred in not applying the ratio of the Honourable Apex Court in the case of IHHI case especially when the tests laid down by the Apex Court namely (a) https://hcservices.ecourts.gov.in/hcservices/ passing of property outside India (b) payment of consideration outside India have been clearly satisfied? 2. Whether on facts and circumstances of the case the Tribunal is right in holding that the 75 percent of the offshore supply activities have happened in India given the fact that the entire manufacturing activity has happened outside India which has not been disputed by the ITAT? 8. The learned Senior Counsel appearing for the assessee would submit that in view of 2007 (288) ITR 408 (SC) (Ishikawajima- Harima Heavy Industries Ltd., Vs. Director of Income-tax, Mumbai (IHHI in short), all the questions must be answered in favour of the assessee. He submitted that factually there is no evidence that there is "a business connection" or "a permanent establishment in India". When contracts III and IV are loss making contracts the whole contract cannot still be estimated for profits. The learned senior counsel submitted that the finding that ASPL is a facade or a dummy company is incorrect. It had entered into contracts with other parties even prior to the contract with NLC. The clause relating to transfer of title in the present case is identical to the one in IHHI . The fact that the contract was entered into in India is not relevant. What is relevant is when the title to the goods supplied offshore passed to NLC. When the supply was effected outside India and the consideration was paid outside India, the ratio in IHHI case would clearly apply. The learned Senior Counsel submitted that if ASPL is only a facade, then there could be no business connection. As in IHHI, the different components of the contract had been segregated and compartmentalised, so only that income that arose in India can be taxed. There is absolutely no finding that the business connection or the permanent establishment had any role to play insofar as contract I is concerned. The learned Senior counsel submitted that the consideration in the other three contracts could not have been loaded on to Contract I, nor could Contract I be so drafted as to provide a cushion, since NLC is a statutory corporation and subject to audit and it cannot enter into sham transactions. In any event, when dealing with a statutory corporation like NLC the appellant cannot fix the value of the contract unilaterally and there is no scope for manipulation of the prices. Each contract was signed by the parties to the contract. The learned Senior Counsel relied on Section 114 of the Evidence Act for raising the presumption regrding official acts. 9. The learned Senior Standing Counsel submitted that the Tribunal was right in its findings. She submitted that the CIT had on the basis of the evidence concluded that "there was a permanent establishment" and a "business connection". These factual findings cannot be lightly disturbed. She also submitted that there are major https://hcservices.ecourts.gov.in/hcservices/ differences on facts between IHHI and this case. There, the Contractor was a consortium consisting of several equal players and the consideration was fixed by the consortium. Here the second contractor namely ASPL had no independent say in settling contract III and IV and it had "signed on the dotted lines" as directed by the assessee. What was conceived was a single contract. There was only a single bidder. There would have been only a single contract with, may be sub-contractors, but for tax purposes or other reasons, it was split up into four contracts. While discounts were given for contracts II, III and IV no discount was given to contract I. The learned Senior Standing counsel relied on [2007] 291 ITR 482 (Commissioner Income-Tax and another Vs. Hyundai Heavy Industries Co. Ltd.). The learned Senior Standing Counsel submitted that there is no doubt that for the income on offshore supply outside India no tax could be levied. In this case, because of the permanent establishment and business connection, a percentage of the profits on contract fell under Section 9 of the Income Tax Act and were held to be 'deemed income'. So the authorities made an estimate of this. The learned Senior Standing Counsel also submitted that the clause in this contract relating to passing of title was different from the clause in IHHI case. The learned Senior Standing Counsel submitted that no substantial question of law arose for consideration. Written submissions were also filed by both sides. 10. Article 5(j) of DTAA defines what "permanent establishment” is, “(i) For the purpose of this convention, the term Permanent Establishment means a fixed place of business through which the business of the enterprises is wholly or partly carried on (ii) The term Permanent Establishment includes especially (a) to (l).................... (j) a building site or construction, installation or assembly project or supervisory, activities in connection therewith, where such site, project or activities (together with other such sites, project or activities, if any) continues for a period of more than 6 months or when such project or supervisory activity, being incidental to sale of machinery or equipment, continues for a period not exceeding 6 months and the charges payable for the project or supervisory activity exceed 10% of the sale price of the machinery and equipment." 11. As regards 'business connection' Section 9(1)(i) of the Income Tax Act states that "all income accruing or arising, through https://hcservices.ecourts.gov.in/hcservices/ or from any business connection in India is to be subjected to tax under the Act." That is there should be (a) a business in India (b) a connection between the assessee and the business (c) the assessee must have directly or indirectly earned income by virtue of or through that connection. 12. Since the IHHI case was relied on, we will extract the relevant paragraphs. "The appellant there was a Company incorporated in Japan, a resident of the country, and assessed to tax in that country. It was engaged, inter alia, in the business of construction of storage tanks as also engineering etc. It formed a consortium along with other Corporations and entered into an agreement with Petronet LNG Limited for setting up a LNG storage and degasification facility at Dahej. The role and responsibility of each member of the consortium was specified separately. Each of the members of the consortium was also to receive separate payments. The project was to be completed in 41 months. The contract indisputably involved: (i) offshore supply, (ii) offshore services, (iii) onshore supply (iv) onshore services and (v) construction and erection. The price was payable for offshore supply and offshore services in US dollars, whereas for onshore supply and also onshore services and construction and erection partly in US dollars and partly in Indian rupees. .........Before the Authority the issue raised was not with regard to the on- shore components but only with regard to the off shore components. The Authority held that the amount that is receivable from Petronet in respect of off shore supply of equipment, materials, etc., is liable to tax in India under the provisions of the Income-tax Act, 1961. The matter was taken to the Supreme Court. .................. One of the crucial factors that has to be decided relates to passing of title to the goods supplied in the following terms: 22.1. Title to equipment and materials and contractor’s equipment Contractor agrees that title to all equipment and materials shall pass to owner from the supplier or sub-contractor pursuant to Section E of Exhibit H (General Project Requirements and Procedures). Contractor shall, however, retain care, custody, and control of such equipment and materials and exercise due care thereof until (a) provisional acceptance of the work, or (b) termination of this contract, whichever shall first occur. Such transfer of title shall in no way affect owner’s https://hcservices.ecourts.gov.in/hcservices/ rights under any other provision of this contract.” Notes General 1. * * * 2. Offshore supply (Exhibit D-2.1) is the price of equipment and material (including cost of engineering, if any, involved in the manufacture of such equipment and material) supplied from outside India on CFR basis, and the property therein shall pass on to the owner on high seas for permanent incorporation in the works, in accordance with the provisions of the contract. 32. The contract indisputably was executed in India. By entering into a contract in India, although parts thereof will have to be carried out outside India would not make the entire income derived by the contractor to be taxable in India. .............. 34. It is not in dispute that title in the equipments supplied was to stand transferred upon delivery thereof outside India on high-sea basis as provided for in Article 22.1. Similarly, Article 13.1 provides for a lump sum contract price, whereas Article 13.3.2 specifically refers to the cost of offshore supplies. The provisions with regard to offshore supplies and offshore services were to be read with the provisions contained in Ext. D which formed the basis of customs duty. Clause 13.4 refers to Ext. D as the basis for price escalation. ... 39. Territorial nexus doctrine, thus, plays an important part in assessment of tax. Tax is levied on one transaction where the operations which may give rise to income may take place partly in one territory and partly in another. The question which would fall for our consideration is as to whether the income that arises out of the said transaction would be required to be proportioned to each of the territories or not. ... 40. Income arising out of operation in more than one jurisdiction would have territorial nexus with each of the jurisdiction on actual basis. If that be so, it may not be correct to contend that the entire income “accrues or arises” in each of the jurisdiction. The Authority has proceeded on the basis that supplies in question had taken place offshore. It, however, has rendered its opinion on https://hcservices.ecourts.gov.in/hcservices/ the premise that offshore supplies or offshore services were intimately connected with the turnkey project. ... 62. In CIT v. Mitsui Engg. and Ship Building Co. Ltd.16 on which reliance was placed, the contention was that the finding that the contract for designing, engineering, manufacturing, shop-testing and packing up to f.o.b. port of embarkation could not be split up since the entire contract was to be read together and was for one complete transaction. It was in the said fact situation held that it was not possible to apportion the consideration for design on one part and the other activities on the other part. The price paid to the assessee was the total contract price which covered all the stages involved in the supply of machinery. 63. This case is clearly distinguishable from the facts of the present case, since the payment for the offshore and onshore supply of goods and services was in itself clearly demarcated and cannot be held to be a complete contract that has to be read as a whole and not in parts. 64. The principle of apportionment is also recognised by clause (a) of Explanation 1. Thus, if submission of the learned Additional Solicitor General is accepted that the contract is a composite one, then offshore supply would be of equipment designed and manufactured in one territory (Japan), and then sold in another tax territory, leading to division of profits arising in two tax territories, which is not envisaged under our taxation law. 65. It gives rise to the question as to what would be the meaning of the phrase “business connection in India”. Mere existence of business connection may not result in income of the non-resident assessee from transaction with such a business connection accruing or arising in India.... 79. Since the appellant carries on business in India through a permanent establishment, they clearly fall out of the applicability of Article 12(5) of DTAA and into the ambit of Article 7. The Protocol to DTAA, in para 6, discusses the involvement of the permanent establishment in transactions, in order to determine the extent of income that can be taxed. It is stated that the term “directly or indirectly attributable” indicates the income that shall be regarded on the basis of the extent appropriate to the part played by the permanent establishment in those transactions. The permanent establishment here has had no role to play in the transaction that is sought to be taxed, since the transaction took place abroad. https://hcservices.ecourts.gov.in/hcservices/ 80. Clause 1 of Article 7, thus, provides that if an income arises in Japan (contracting State), it shall be taxable in that country unless the enterprise carries on business in the other contracting State (India) through a permanent establishment situated therein. What is to be taxed is profit of the enterprise in India, but only so much of them as is directly or indirectly attributable to that permanent establishment. All income arising out of the turnkey project would not, therefore, be assessable in India, only because the assessee has a permanent establishment. ... 84. The distinction between the existence of a business connection and the income accruing or arising out of such business connection is clear and explicit. In the present case, the permanent establishment’s non-involvement in this transaction excludes it from being a part of the cause of the income itself, and thus there is no business connection. 85. Article 5.3 provides that a person is regarded as having a permanent establishment if he carries on construction and installation activities in a contracting State only if the said activities are carried out for more than six months. Para 6 of the Protocol to India-Japan Tax Treaty also provides that only income arising from activities wherein the permanent establishment has been involved can be said to be attributable to the permanent establishment. It gives rise to two questions, firstly, offshore services are rendered outside India; the permanent establishment would have no role to play in respect thereto in the earning of the said income. Secondly, entire services having been rendered outside India, the income arising therefrom cannot be attributable to the permanent establishment so as to bring within the charge of tax. ... 87. In cases such as this, where different severable parts of the composite contract are performed in different places, the principle of apportionment can be applied, to determine which fiscal jurisdiction can tax that particular part of the transaction. This principle helps determine, where the territorial jurisdiction of a particular State lies, to determine its capacity to tax an event. Applying it to composite transactions which have some operations in one territory and some in others, it is essential to determine the taxability of various operations. 88. Therefore, in our opinion, the concepts of profits of business connection and permanent establishment should not be mixed up. Whereas business connection is relevant for https://hcservices.ecourts.gov.in/hcservices/ the purpose of application of Section 9; the concept of permanent establishment is relevant for assessing the income of a non-resident under DTAA. There, however, may be a case where there can be overlapping of income; but we are not concerned with such a situation. The entire transaction having been completed on the high seas, the profits on sale did not arise in India, as has been contended by the appellant. Thus, having been excluded from the scope of taxation under the Act, the application of the Double Taxation Treaty would not arise. The Double Taxation Treaty, however, was taken recourse to by the appellant only by way of an alternate submission on income from services and not in relation to the tax of offshore supply of goods." Finally, we have the Supreme Court's conclusion with regard to offshore supply which alone is relevant to us. "(A) Re: Offshore supply (1) That only such part of the income, as is attributable to the operations carried out in India can be taxed in India. (2) Since all parts of the transaction in question i.e. the transfer of property in goods as well as the payment, were carried on outside the Indian soil, the transaction could not have been taxed in India. (3) The principle of apportionment, wherein the territorial jurisdiction of a particular State determines its capacity to tax an event, has to be followed. (4) The fact that the contract was signed in India is of no material consequence, since all activities in connection with the offshore supply were outside India, and therefore cannot be deemed to accrue or arise in the country. (5) There exists a distinction between a business connection and a permanent establishment. As the permanent establishment cannot be said to be involved in the transaction, the aforementioned provision will have no application. The permanent establishment cannot be equated to a business connection, since the former is for the purpose of assessment of income of a non-resident under a Double Taxation Avoidance Agreement, and the latter is for the application of Section 9 of the Income Tax Act. (6) Clause (a) of Explanation 1 to Section 9(1)(i) states that only such part of the income as is attributable to the operations carried out in India, is taxable in India. (7) The existence of a permanent establishment would not constitute sufficient “business connection”, and the permanent establishment would be the taxable entity. The https://hcservices.ecourts.gov.in/hcservices/ fiscal jurisdiction of a country would not extend to the taxing of entire income attributable to the permanent establishment. (8) There exists a difference between the existence of a business connection and the income accruing or arising out of such business connection. (9) Para 6 of the Protocol to DTAA is not applicable, because, for the profits to be “attributable directly or indirectly”, the permanent establishment must be involved in the activity giving rise to the profits." 13. In (2007) 291 ITR 482(SC) (cited supra) a non-resident foreign company incorporated in South Korea entered into an agreement with ONGC for designing, fabrication, hook-up and