Case: DIRECTOR OF INCOME TAX-II (INTERNATIONAL TAXATION) NEW DELHI &amp; ANR Vs. M/S SAMSUNG HEAVY INDUSTRIES CO. LTD

2. On 28.02.2006, the Oil and Natural Gas Company ( ONGC) awarded a turnkey contract to a consortium comprising of the Respondent/Assessee, i.e. Samsung Heavy Industries Co. Ltd. (a Company incorporated in South Korea), and Larsen & Toubro Limited, being a contract for carrying out the Work, inter alia, of surveys, design, engineering, procurement, fabrication, installation and modification at existing facilities, and start-up and commissioning of entire facilities covered under the Vasai East Development Project ( Project).3. On 24.05.2006, the Assessee set up a Project Office in Mumbai, India, which, as per the Assessee, was to act as a communication channel between the Assessee and ONGC in respect of the Project. Pre- engineering, survey, engineering, procurement and fabrication activities which took place abroad, all took place in the year 2006. Commencing from November, 2007, these platforms were then brought outside Mumbai to be installed at the Vasai East Development Project. The Project was to be completed by 26.07.2009.4. With regard to Assessment Year 2007-2008, the Assessee filed a Return of Income on 21.08.2007 showing nil profit, as a loss of INR 23.5 lacs had allegedly been incurred in relation to the activities carried out by it in India.5. On 29.08.2008, a show-cause notice was issued to the Assessee by the Income Tax authorities requiring it to show cause as to why the Return of Income had been filed only at nil, which was replied to in detail by the Assessee on 02.02.2009. Being dissatisfied with the reply, a draft Assessment Order was then passed on 31.12.2009 ( Draft Order) by the Assistant Director of Income Tax International Transactions at Dehradun ( Assessing Officer). This Draft Order went into the terms of the agreement in great detail, and concluded that the Project in question is a single indivisible turnkey project, whereby ONGC was to take over a project that is completed only in India. Resultantly, profits arising from the successful commissioning of the Project would also arise only in India. This Courts judgment in Commissioner of Income Tax and Another v. Hyundai Heavy Industries Co. Ltd., (2007) 7 SCC 422, was distinguished by the learned Assessing Officer stating that, in that case, the project was in two separate parts, unlike the Project in the present case. Referring then to the Mumbai Project Office, the Assessing Officer held:It is evident from the above that the work relating to fabrication and procurement of material was very much a part of the contract for execution of work assigned by ONGC. The work was wholly executed by PE in India and it would be absurd to suggest that PE in India was not associated with the designing or fabrication of materials.. Having so held, the Draft Order then went on to attribute 25% of the revenues allegedly earned outside India (which totalled INR 113,43,78,960) as being the income of the Assessee exigible to tax, which came to INR 28,35,94,740. The Dispute Resolution Panel, by its order dated 30.9.2010, after considering objections to the Draft Order by the Assessee, then held:The Assessing Officer has given a specific finding that the assessee had a project office in India, when it was given the contract. The assessee has not contested the existence of the Project office in India but it has only contested that the project was used merely for preparatory and auxiliary activities. This submission of the assessee does not hold merit because if it wanted to perform only preparatory and auxiliary activities then it could have opened a liaison office. The opening of a project office clearly shows that the assessee was doing something more than what would have been done through liaison office. In any case nature and purport of activities undertaken in India determine the existence of PE. Considering the nature of activities undertaken in India it is clear that PE existed in the case of assessee.. It then confirmed the finding contained in the Draft Order that the agreement was a turnkey project which could not be split up, as a result of which the entire profit earned from the Project would be earned within India. Basing itself on data obtained from the database Capital Line, the Panel picked up four similar projects executed by companies outside India, and found the average profit margin to be 24.7%, which, according to the Panel, would therefore justify the figure of 25% arrived at in the Draft Order. The Panel having dismissed the Assessees objections, the Draft Order was made final by the Assessing Officer on 25.10.2010. The Assessee then filed an appeal against the Assessment Order before the Income Tax Appellate Tribunal ( ITAT).8. The decision of the ITAT on 30.08.2011 went into the establishment of the Project Office at Mumbai in much more detail than had been gone into either in the Draft Order or the Dispute Resolution Panels decision. The ITAT referred to and relied upon an application dated 24.04.2006, which had been submitted by the Assessee to the Reserve Bank of India ( RBI) for opening the Project Office, which in turn referred to a Board Resolution of the Company dated 03.04.2006 for opening the Project Office in India. It further referred to correspondence showing that one Mr. Sangsoon Park, the General Manager of the Assessee Company, had been appointed as a representative of the Company to sign documents for opening of the Project Office and a bank account in India, 6 and to look after operations of the Project Office. After setting out the Board Resolution dated 03.04.2006 in detail, the ITAT concluded:70. It can be seen from all the above documents that the scope of Mumbai Project Office has neither been restricted by the assessee company itself or it has also not been restricted by RBI in any terms. This is relevant for the reason that in Hyundai Heavy Industries case, it is a matter of record that project office opened by the said assessee, according to permission given by the RBI, was to work only as a liaison office and was not authorised to carry on any business activity. This is the vital difference between the two cases namely the case of the assessee and Hyundai Heavy Industries case.71. There is a force in the contention of the ld. DR that the words That the company hereby open one project office in Mumbai, India for coordination and execution of Vasai East Development Project for Oil and Natural Gas Corporation ( ONGC), India used by the assessee company in its resolution of Board of Directors meeting dated 3 rd April, 2006 makes it amply clear that project office was opened for coordination and execution of impugned project. In absence of any restriction put by the assessee in the application moved by it to RBI, in the resolutions passed by the assessee company for the opening of the project office at Mumbai and the permission given by RBI, it cannot be said that Mumbai project office was not a fixed place of business of the assessee in India to carry out wholly or partly the impugned contract in India within the meaning of Article 5.1 of DTAA. These documents make it clear that all the activities to be carried out in respect of impugned contract will be routed through the project office only. Pre-surveys were to be first conducted which will determine the nature of the designing on the basis of which pre-engineering and pre-designing was to be done with respect to the entire project. The next main condition of the contract was that, as a condition precedent, the assessee had to obtain insurance with respect to the entire project which has been in fact obtained by the assessee in India for which the assessee has received major payment during 7 the year under consideration itself. The said policy has not been shown to be restricted only with regard to activities of the assessee outside India.9. The ITAT thus confirmed the decisions of the Assessing Officer and the Dispute Resolution Panel that the contract was indivisible. It then went on to deal with the argument on behalf of the Assessee that the Project Office was only an auxiliary office, and did not involve itself in any core activity of business, as accounts that were produced would show that there was no expenditure which related to execution of the project. This argument was disposed of as follows:The way the terms of the contract are described and the way the work on contract has to proceed clearly describe that in all the activities of contract there will be the role of Mumbai project office as the same has to work as a channel between assessee company and ONGC. If PE of the assessee exists within the meaning of Article 5.1 and 5.2 and assessee claims that despite there being PE in terms of clause 5.1 and 5.2, it falls under exclusionary Article 5.4 then onus is on assessee to prove that activities of its PE are in the nature of preparatory or auxiliary in nature. No material has been brought on record by the assessee to prove the said fact. The arguments put forward in this respect are only by inference such as the accounts maintained by the assessee in India through which it is the argument of the ld. Counsel of the assessee that it does not contain any expenditure relating to execution of the contract. But such argument is not acceptable as the maintenance of account is in the hands of assessee and mere the mode of maintaining the accounts alone cannot determine the character of PE as the role of PE only will be relevant to determine what kind of activities it has carried on. As pointed out earlier the way the contract has to proceed, 8 Mumbai project office of the assessee has to play a vital role in the execution of entire contract and if assessee wants to contend otherwise, the onus is on assessee and not on the revenue.. Having so held, the ITAT found that there was a lack of material to ascertain as to what extent activities of the business were carried on by the Assessee through the Mumbai Project Office, and therefore it was considered just and proper to set aside the attribution of 25% of gross revenue earned outside India – which was attributed as income earned from the Mumbai project office – the matter being sent back to the Assessing Officer to ascertain profits attributable to the Mumbai project office after examining the necessary facts. An appeal from the ITAT was filed in the High Court at Uttarakhand by the Assessee. Five substantial questions of law were framed by the High Court in the appeal as follows:(i) Whether, on the facts and in the circumstances of the case, the Tribunal erred in law in holding that the appellant had a fixed place Permanent Establishment (PE) in India under Article 5(1)/(2) of the Double Taxation Avoidance Agreement between India and Korea (the Treaty), in the form of project office in Mumbai?(ii) Whether, on the facts and circumstances of the case and in law, the finding of the Tribunal that the project office was opened for co-ordination and execution of the VED project and all activities to be carried out in relation to the said project were routed through the project office only, is perverse inasmuch as the same is based on selective and/or incomplete reference to the material on record, irrelevant considerations and incorrect appreciation of the role of the project office?(iii) Without prejudice, whether, on the facts and the circumstances of the case and in law, the Tribunal erred in not holding that even if the appellant had fixed place PE in India, no income on account of offshore activities, i.e. the operations carried out outside India (viz., designing, engineering, material procurement, fabrication, transportation activities) was attributable to the said PE, instead, in setting the issue to the file of the assessing officer?(iv) Without prejudice, whether, on the facts and circumstances of the case and in law, the Tribunal erred in not holding that even if the appellant had fixed place PE in India, no income could be brought to tax in India since the appellant had incurred overall losses in respect of the VED project?(v) Whether, on the facts and circumstances of the case, the contract was divisible/distinguishable pertaining to the activities associated with designing, fabrication and installation of platforms and, if so, whether the activities pertaining to designing and fabrication took place in any part of India?11. By the impugned judgment dated 27.12.2013, the High Court found that the order of the Assessing Officer had been confirmed by the ITAT, and concerned itself only with the following question:In other words, can it be said that the Agreement permitted the India Taxing Authority to arbitrarily fix a part of the revenue to the permanent establishment of the appellant in. The High Court held that the question as to whether the Project Office opened at Mumbai cannot be said to be a permanent establishment within the meaning of Article 5 of the DTAA would be of no consequence. The High Court then held that there was no finding that 25% of the gross revenue of the Assessee outside India was attributable to the business carried out by the Project Office of the Assessee. According to the High Court, neither the Assessing Officer nor the ITAT made any effort to bring on record any evidence to justify this figure. This being the position, the appeal of the Assessee was allowed in the following terms:10. That being the situation we allow the appeal, set aside the judgment and order under appeal as well as the assessment order insofar as the same relates to imposition of tax liability on the 25% of the receipt upon the appellant in the circumstances mentioned above, and observe that the questions of law formulated by us, while admitting the appeal, have not, in fact, arisen on the facts and circumstances of the case, but the real question was, whether the tax liability could be fastened without establishing that the same is attributable to the tax identity or permanent establishment of the enterprise situate in India and the same, we think, is answered in the negative and in favour of the appellant.

Reasoning:
17. Some of the judgments of this Court have dealt with similar double taxation avoidance treaty provisions and therefore need to be mentioned at this juncture. In Morgan Stanley & Co. Inc. (supra), the Double Taxation Avoidance Agreement (1990) between India and the United States of America was construed. The facts in that case made it clear that the Morgan Stanley Group is one of the worlds largest diversifying financial services companies. Morgan Stanley and Company, which is a part of the Morgan Stanley Group, is an investment bank engaged in the business of providing financial advisory services, corporate lending and securities underwriting. One of the group companies of Morgan Stanley Group, namely, Morgan Stanley Advantages Services Pvt. Ltd. ( MSAS) entered into an agreement for providing certain support services to Morgan Stanley and Company. MSAS, being an Indian Company, was set up to support the main office functions in equity and fixed income research, account reconciliation and providing IT enabled services such as back office operation, data processing and support centre to Morgan Stanley and Company. Tackling the question as to whether a fixed place permanent establishment existed on the facts of that case under Article 5 of the India-US treaty – which is similar to Article 5 of the present DTAA – this Court held:10. In our view, the second requirement of Article 5(1) of DTAA is not satisfied as regards back office functions. We have examined the terms of the Agreement along with the advance ruling application made by MSCo inviting AAR to give its ruling. It is clear from reading of the above Agreement/application that MSAS in India would be engaged in supporting the front office functions of MSCo in fixed income and equity research and in providing IT enabled services such as data processing support centre and technical services as also reconciliation of accounts. In order to decide whether a PE stood constituted one has to undertake what is called as a functional and factual analysis of each of the activities to be undertaken by an establishment. It is from that point of view, we are in agreement with the ruling of AAR that in the present case Article 5(1) is not applicable as the said MSAS would be performing in India only back office operations. Therefore to the extent of the above back office functions the second part of Article 5(1) is not attracted.xxx xxx xxx14. There is one more aspect which needs to be discussed, namely, exclusion of PE under Article 5(3). Under Article 5(3)(e) activities which are preparatory or auxiliary in character which are carried out at a fixed place of business will not constitute a PE. Article 5(3) commences with a non obstante clause. It states that notwithstanding what is stated in Article 5(1) or under Article 5(2) the term PE shall not include maintenance of a fixed place of business solely for advertisement, scientific research or for activities which are preparatory or auxiliary in character. In the present case we are of the view that the abovementioned back office functions proposed to be performed by MSAS in India falls under Article 5(3)(e) of DTAA. Therefore, in our view in the present case MSAS would not constitute a fixed place PE under Article 5(1) of DTAA as regards its back office operations.18. The Court then went on to hold that activities performed by stewards who were deployed by the American Company to work in India as employees of the Indian company were so employed merely to protect the American companies interests in a competitive world, by ensuring quality and confidentiality of services performed in India. It was therefore found that so far as stewardship was concerned, this activity would fall within Article 5(2)(l) of the US-India treaty, and therefore would be outside the term permanent establishment as defined. On the deputation of certain employees of the American Company to work as employees of the Indian Company, it was found, however, that the American Company was rendering services through its employees to the Indian Company, as a result of which a service permanent establishment would stand established on this count.23. A reading of the aforesaid judgments makes it clear that when it comes to fixed place permanent establishments under double taxation avoidance treaties, the condition precedent for applicability of Article 5(1) of the double taxation treaty and the ascertainment of a permanent establishment is that it should be an establishment through which the business of an enterprise is wholly or partly carried on. Further, the profits of the foreign enterprise are taxable only where the said enterprise carries on its core business through a permanent establishment. What is equally clear is that the maintenance of a fixed place of business which is of a preparatory or auxiliary character in the trade or business of the enterprise would not be considered to be a permanent establishment under Article 5. Also, it is only so much of the profits of the enterprise that may be taxed in the other State as is attributable to that permanent establishment.27. A reading of the Board Resolution would show that the Project Office was established to coordinate and execute delivery documents in connection with construction of offshore platform modification of existing facilities for ONGC . Unfortunately, the ITAT relied upon only the first paragraph of the Board Resolution, and then jumped to the conclusion that the Mumbai office was for coordination and execution of the project itself. The finding, therefore, that the Mumbai office was not a mere liaison office, but was involved in the core activity of execution of the project itself is therefore clearly perverse. Equally, when it was pointed out that the accounts of the Mumbai office showed that no expenditure relating to the execution of the contract was incurred, the ITAT rejected the argument, stating that as accounts are in the hands of the Assessee, the mere mode of maintaining accounts alone cannot determine the character of permanent establishment. This is another perverse finding which is set aside. Equally the finding that the onus is on the Assessee and not on the Tax Authorities to first show that the project office at Mumbai is a permanent establishment is again in the teeth of our judgment in E-Funds IT Solution Inc. (supra).28. Though it was pointed out to the ITAT that there were only two persons working in the Mumbai office, neither of whom was qualified to perform any core activity of the Assessee, the ITAT chose to ignore the same. This being the case, it is clear, therefore, that no permanent establishment has been set up within the meaning of Article 5(1) of the DTAA, as the Mumbai Project Office cannot be said to be a fixed place of business through which the core business of the Assessee was wholly or partly carried on. Also, as correctly argued by Shri Ganesh, the Mumbai Project Office, on the facts of the present case, would fall within Article 5(4)(e) of the DTAA, inasmuch as the office is solely an auxiliary office, meant to act as a liaison office between the Assessee and ONGC. This being the case, it is not necessary to go into any of the other questions that have been argued before us.