Case: Ishikawajma-Harima Heavy Industries Ltd Vs. Director Of Income Tax, Mumbai

Appellant herein is a company incorporated in Japan. It is a resident of the said country. It pays its taxes in Japan. It is engaged, inter alia, in the business of construction of storage tanks as also engineering etc. It formed a consortium along with Ballast Nedam International BV, Itochu Corporation, Mitsui & Co. Ltd., Toyo Engineering Corporation and Toyo Engineering (India) Ltd. With the said consortium members, it entered into an agreement with Petronet LNG Limited (hereinafter referred to as "the Petronet") on 19.01.2001 for setting up a Liquefied Natural Gas (LNG) receiving storage and degasification facility at Dahej in the State of Gujarat. A supplementary agreement was entered into by the parties on 19.03.2001. The contract envisaged a turnkey project. Role and responsibility of each member of the consortium was specified separately. Each of the member of the consortium was also to receive separate payments. Appellant was to develop, design, engineer and procure equipment, materials and supplies, to erect and construct storage tanks of 5 MMTPA capacity, with potential expansion to 10 MMTPA capacity at the specified temperatures i.e. -200 degree Celsius. The arrangement also was to include marine facilities (jetty and island break water) for transmission and supply of the LNG to purchasers; to test and commission the facilities relating to receipt and unloading, storage and re-gasification of LNG and to send out of re-gasified LNG by means of a turnkey fixed lump-sum price time certain engineering procurement, construction and commission contract. 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 that of onshore supply as also onshore services and construction and erection partly in US dollars and partly in Indian rupees.Liability to pay income tax in India by the appellant herein being doubtful, an application was filed by the same before the Authority for advance Rulings (Income Tax) (hereinafter referred to as the Authority) in terms of Section 241(Q)(1) of the Income Tax Act, 1961 (hereinafter referred to as the Act). The following questions were proposed by the appellant for determination:"1. On the facts and circumstances of the case, whether the amounts, received/receivable by the applicant from Petronet LNG for offshore supply of equipments, materials, etc. are liable to tax in India under the provisions of the Act and India-Japan tax treaty?2. If the answer to (1) is in the affirmative in view of Explanation (a) to section (1)(i) of the Act and/or Article (1) read together with the protocol of the India-Japan tax treaty, to what extent are the amounts reasonably attributable to the operations carried out in India and accordingly taxable in India?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?4. If the answer to (3) above is in the affirmative, to what extent would be amounts received/receivable for such services be chargeable to tax in India under the Act and/or the India-Japan tax treaty?5. If the answer to (3) above in the affirmative, would be applicant be entitled to claim deduction for expenses incurred in computing the income from offshore services under the Act and/or the India-Japan treaty?Before the Authority no issue was raised as regards the liability of the appellant to pay income tax on onshore supply and onshore services and on its activities relating to construction and erection. The dispute centered round its exigibility to pay tax in respect of offshore supply and offshore services.It is also not in dispute that the Government of India and the Government of Japan entered into a by-lateral treaty in regard to the tax liabilities.Contention of the appellant before the Authority was that the contract being a divisible one, it did not have any liability to pay any tax in regard to offshore services and offshore supply. Revenue, on the other hand, contended that the contract being a composite and integrated one, they were so liable.The Authority referred to a large number of decisions governing the field and opined that having regard to the provisions contained in Section 5 read with Section 9 of the Act, following propositions of law would emerge :"(1) In a case of sale of goods simpliciter by a non-resident to a resident in India, if the consideration for sale is received abroad and the property in the goods also passes to the purchaser outside India, no income accrues or arises or deemed to accrue or arise to the seller in India.(2) In a case of transaction of sale of goods by the non-resident to an Indian resident which is a part of a composite contract involving various operations within and outside India, income from such sale shall be deemed to accrue or arise in India if it accrues or arises through or from any business connection in India.(3) In the case of a business of which all operations are not carried out in India, the deemed accrual or arising of income shall be only such part of the income as is reasonably attributable to the operations carried out in India.(4) Whether there is business connection in India or/and whether all operations of the business are not carried out in India are questions of fact which have to be determined on the facts of each case."Applying the said principles to the facts of the present case, the Authority opined that the appellant was liable to pay direct tax even under the Treaty having regard to Articles 5 and 7 thereof as also Clause 6 of the Protocol. It was held :"The substance of the protocol quoted above, represents the consensus reached between the parties to the treaty in regard to the meaning of the phrase "directly or indirectly attributable to that permanent establishment" employed in paragraph 1 of article 7. Further, profits shall also be regarded as attributable to the permanent establishment to the extent indicated in the said protocol even when the contract or order relating to the sale or provision of goods or services in question is made or placed directly with the overseas head office of the enterprise rather than with the permanent establishment.It would be clear that having regard to provisions of article 7(1) of the Treaty read with para 6 of the protocol supply of equipment of machinery (sale of which was completed abroad, having placed the order directly overseas office of the enterprise) the same should be within the meaning of the phrase directly or indirectly attributable to that permanent establishment."As regards taxability of the amounts received and receivable by the appellant from Petronet for offshore services, it was held :"In so far as the Treaty is concerned, both section 115A(1)(b)(B) and para 2 of Article 12 of the Treaty clearly indicates that the whole technical fee without any deduction is chargeable to tax, however, the tax so charged shall not exceed 20% of the gross amount of the royalty or fee for technical services."Question Nos. 4 and 5 were held to be the consequential ones. It was opined :"In the light of the above discussions we rule on :(i) Question No.1 that on the facts and in the circumstances of the case, the amounts received/receivable by the applicant from Petronet LNG in respect of offshore supply of equipment and materials is liable to be taxed in India under the provisions of the Act and the India-Japan Treaty.(ii) Question No.2 that in view of the Explanation (a) to section 9(1)(i) of the Act and/or Article 7(1) read with the Protocol of the India-Japan Treaty the amounts that would be taxable in India is so much of the profit as is reasonably attributable to the operations carried out in India, we decline to answer the other part of the question in regard to quantification of the amount taxable in India as the parties produced no evidence and did not address in this regard.(iii) Question No. 3 that the amount received/receivable by the applicant from Petronet LNG for offshore services is liable to be taxed in India both under the provisions of the Act as well as under Indo-Japan Treaty.(iv) Question No.4 that the entire amount received for offshore services is chargeable to tax under the Act and under the Treaty but at the rate not more than 20% of the gross amount.(v) Question No. 5 that the applicant would not be able to claim any deduction in computing the income from offshore service under the Act, and/or under the Indo-Japan Treaty."Before us, the following findings of the Authority are not disputed :"(i) the Petitioner has a business connection in India;(ii) if consideration accrues only for supply of goods and the sale is completed outside India no profits can accrue in India;(iii) however, if a contract envisages a composite consideration for the various obligations to be performed and if certain operations are to be performed by or through the business connection, then, profits would be deemed to accrue in India;(iv) property in the goods, which were the subject matter of the offshore supply, passed outside India; and(v) the petitioner has a permanent establishment in India within the meaning of the said term in paragraph 3 of Article 5 of the Double Taxation Avoidance Agreement entered into between the Governments of India and Japan (hereinafter referred to as "the DTAA")."

Court's reasoning:
The test of residence, as applied in international law also, is that of the taxpayer and not that of the recipient of such servicesFor Section 9(1)(vii) to be applicable, it is 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 from fees as envisaged in Article 12 of DTAA becomes taxable in IndiaThe terms effectively connected and attributable to are to be construed differently even if the offshore services and the permanent establishment were connectedSection 9(1)(vii)(c) of the Act in this case would have no application as there is nothing to show that the income derived by a non-resident company irrespective of where rendered, was utilized in IndiaArticle 7 of the DTAA is applicable in this case, and it limits the tax on business profits to that arising from the operations of the permanent establishment. In this case, the entire services have been rendered outside India, and have nothing to do with the permanent establishment, and can thus not be attributable to the permanent establishment and therefore not taxable in IndiaApplying the principle of apportionment to composite transactions which have some operations in one territory and some in others, is essential to determine the taxability of various operationsThe location of the source of income within India would not render sufficient nexus to tax the income from that sourceIf the test applied by the Authority for Advanced Rulings is to be adopted here too, then it would eliminate the difference between the connection between Indian and foreign operations, and the apportionment of income accordinglyThe services are inextricably linked to the supply of goods, and it must be considered in the same manner.