Delhi High Court
Director Of Income Tax vs Ericsson A.B.,New Delhi. on 23 December, 2011
Author: A.K.Sikri
* IN THE HIGH COURT OF DELHI AT NEW DELHI
+ ITA 504/2007, ITA 507/2007
ITA 508/2007,ITA 511/2007
ITA 397/2007
JUDGMENT RESERVED ON:22.7.2011
JUDGMENT DELIVERED ON:23.12.2011
(1) ITA 504/2007
DIRECTOR OF INCOME TAX ..... APPELLANT
Through: Mr. Mohan Prasaran, ASG with
Mr. Sanjeev Sabharwal, Sr.
Standing Counsel
Versus
ERICSSON A.B.,NEW DELHI. ....RESPONDENT
Through: Mr. Soli Dastur, Mr. Percy
Perdiwalla, Ms. Pratibha Singh,
Mr. Sudeep Chatterjee and Ms.
Meghna Sudha Panda, Advocates
(2) ITA 507/2007
DIRECTOR OF INCOME TAX ..... APPELLANT
Through: Mr. Mohan Prasaran, ASG with
Mr. Sanjeev Sabharwal, Sr.
Standing Counsel
Versus
ERICSSON RADIO SYSTEM A.B.,NEW DELHI. .RESPONDENT
Through: Mr. Soli Dastur, Mr. Percy
Perdiwalla, Ms. Pratibha Singh,
ITA 504/2007, ITA 507/2007, ITA 508/2007,ITA 511/2007, ITA 397/2007 Page 1 of 75
Mr. Sudeep Chatterjee and Ms.
Meghna Sudha Panda, Advocates
(3) ITA 508/2007
DIRECTOR OF INCOME TAX ..... APPELLANT
Through: Mr. Mohan Prasaran, ASG with Mr.
Sanjeev Sabharwal, Sr. Standing
Counsel
Versus
ERICSSON RADIO SYSTEM A.B.,NEW DELHI. .RESPONDENT
Through: Mr. Soli Dastur, Mr. Percy Perdiwalla,
Ms. Pratibha Singh, Mr. Sudeep
Chatterjee and Ms. Meghna Sudha
Panda, Advocates
(4) ITA 511/2007
DIRECTOR OF INCOME TAX ..... APPELLANT
Through: Mr. Mohan Prasaran, ASG with
Mr. Sanjeev Sabharwal, Sr.
Standing Counsel
Versus
ERICSSON RADIO SYSTEM A.B.,NEW DELHI. ..RESPONDENT
Through: Mr. Soli Dastur, Mr. Percy
Perdiwalla, Ms. Pratibha Singh,
Mr. Sudeep Chatterjee and Ms.
Meghna Sudha Panda,
Advocates.
ITA 504/2007, ITA 507/2007, ITA 508/2007,ITA 511/2007, ITA 397/2007 Page 2 of 75
(5) ITA 397 of 2007
DIRECTOR OF INCOME TAX ..... APPELLANT
Through: Mr. Sanjeev Sabharwal, Advocate
Versus
M/S METAPATH SOFTWARE
INTERNATIONAL LTD. . ..RESPONDENT
Through: Mr. R. Satish Kumar, Advocate
with Mr. Parivesh Singh,
Advocate.
CORAM:
HON'BLE THE ACTING CHIEF JUSTICE
HON'BLE MS. JUSTICE REVA KHETRAPAL
A.K.SIKRI, ACTING CHIEF JUSTICE:
1. The assessee M/s. Ericsson Radio Systems A.B. is a company
incorporated in Sweden and is a tax resident of Sweden. The company
is a 100% subsidiary of Telefonakitiebolaget L.M. Ericsson. The main
business of the assessee company is the supply of hardware and software
which is used in the business of rendering telecommunication services
and for this purpose, it undertakes projects on turnkey basis. In
ITA 504/2007, ITA 507/2007, ITA 508/2007,ITA 511/2007, ITA 397/2007 Page 3 of 75
telecommunication projects, the activities involved are supply of
hardware and software, installation and commissioning of the two and
after sales service. In the assessment year 1997-97, the assessee
company entered into agreements with ten cellular operators collectively
called "operators" as follows:-
"1. Huchinston Max Telecom Limited : 07-04-1995
2. RPG Cellular Services Limited : 27-06-1995
3. Bharti Cellular Limited : 15-12-1994
4. Birla AT & T Communication Ltd. : 05-04-1996
5. Cellular Communication India Ltd.
(RPG Cellecom Ltd.) : 29-05-1996
6. J.T. Mobile Limited : 02-07-1996
7. Bharti Televentures Limited : 23-08-1996
8. Hexacom India Limited : 25-09-1996
9. Huchinstom Max Telecom Ltd. : 29-10-1996
10. Reliance Telecom Private Ltd. : 13-02-1997"
2. Pursuant to the aforesaid contracts, the assessee has supplied
various hardware and software to the above mentioned cellular
operators during the relevant assessment year. In regard to tax liability
in India, the assessee claimed that it is not liable to tax under the
provisions of the Income-Tax Act, 1961 and the Double Taxation
ITA 504/2007, ITA 507/2007, ITA 508/2007,ITA 511/2007, ITA 397/2007 Page 4 of 75
Avoidance Agreement between Sweden and India (the "DTAA"). It is
necessary to highlight that the assessee, as stated above, is a wholly
owned subsidiary of the L.M. Group of Companies with whom the
cellular operators had entered into supply agreements. The Ericsson
Telephone Corporation India AB is also a foreign company with a
branch in India and is a subsidiary of the parent company of the
assessee, viz., Telefonakitiebolaget L.M. Ericsson. There is one more
entity, namely, Ericsson Communications Limited, which is an Indian
company and is a wholly owned subsidiary of the parent company. For
the purpose of brevity, Ericsson Radio System AB is referred to as the
assessee, whereas Ericsson Telephone Corporation India AB is referred
to as EFC and Ericsson Communications Limited is referred to as ECL
and the company Telefonakitiebolaget L.M. Ericsson is referred to as
LME.
3. The assessee, a non-resident company, supplies equipment to the
operators, while the other two companies (EFC and ECL) are in the
business of installation of the equipment and granting marketing
ITA 504/2007, ITA 507/2007, ITA 508/2007,ITA 511/2007, ITA 397/2007 Page 5 of 75
support to the assessee. Thus, for the first three months, the work of
installation and marketing support was done by the EFC, and for the
remaining nine months, the same work was done by ECL. The
contracts undertaken by EFC, which were pending on 30th June, 1996
were assigned to ECL, which was incorporated in India.
4. The basic structure of the companies is tabulated by the Assessing
Officer as follows:-
Ericsson Radio Ericsson Telephone Ericsson
System A.B. Corporation India Communication
(ERA) AB Ltd.
Subsidiary of Subsidiary of LME Subsidiary of LME
LME (Installation (Installation
(Equipment contractor & contractor &
supplier to and marketing support marketing support
Indian Customer) to ERA before July after July 1996)
1996)
Non-Resident N.R. Company Indian Company
Company having Branch in
India
5. Before the contract was signed in India, a number of employees of
the assessee company and other associated companies visited India for
the purpose of network survey and to negotiate the terms of the contract,
which was a continuous process spread over a long period of time. It is
ITA 504/2007, ITA 507/2007, ITA 508/2007,ITA 511/2007, ITA 397/2007 Page 6 of 75
a matter of record that during the visits of those employees, the branch
office of EFC provided office, telephone and other facilities to the
aforesaid employees. The employees of the branch office used to attend
the meetings and undertook follow-up work with the customers
afterwards. In this regard, there was a market support agreement entered
into between the assessee and EFC.
6. The supply of the equipment significantly was a continuous
process. In accordance with the contract, the equipment was not to be
accepted till it was finally tested through a test known as Acceptance
Test (A.T.). Such Acceptance Test was to be carried out by EFC in the
first three months and by the ECL in the last nine months of the relevant
year. The contracts were signed in India and till delivery to the port in
India was the responsibility of the supplier. The supply was on CIP
basis and after supply, the defective parts were to be replaced by the
assessee.
7. On the aforesaid facts, the Assessing Officer after considering the
provisions of the Income-Tax Act, 1961, and in particular Section 9
ITA 504/2007, ITA 507/2007, ITA 508/2007,ITA 511/2007, ITA 397/2007 Page 7 of 75
thereof, held that the assessee had a business connection in India and
income of the assessee must be deemed to accrue or arise in India and as
such was taxable in India.
8. The Assessing Officer also considered the question whether the
assessee‟s income was taxable in India in view of Article 7 read with
Article 5 of the Double Taxation Avoidance Agreement between India
and Sweden and concluded as follows:-
"1. The assessee has a permanent establishment
in the form of a dependent agent establishment
which is EFC.
2. The assessee also has a permanent
establishment in the form of a dependent agent PE
which is ECI in the later part of the year i.e. after
July 1996.
3. It has PE in the form of a branch which was
providing a fixed place of business to the assessee.
4. The office of ECI was a fixed place of
business for the assessee company.
5. The employees of the assessee company were
coming to India and signing contracts and were
staying in India and using various facilities which
clearly shows that the assessee had a fixed place of
business."
9. The A.O. then proceeded to render detailed findings in respect of
each of the aforesaid matters, to which we shall presently advert before
ITA 504/2007, ITA 507/2007, ITA 508/2007,ITA 511/2007, ITA 397/2007 Page 8 of 75
proceeding to deal with the software supply contract entered between the
cellular operator and the assessee and Article 13 of the DTAA between
India and Sweden dealing with royalties and fees for technical services.
After considering the matter from all angles, the A.O. concluded that the
assessee had provided the software to the cellular operators under a
license and the income which arose therefrom was to be taxed as royalty
as per Article 12 of the Indo-Sweden treaty. Since, however, the
assessee had a permanent establishment in India, the same was to be
taxed as business profits at a flat rate of 30% as provided in the Indian
Income-Tax Act.
10. The A.O. then proceeded to give the computation as follows:-
"The total supplies made during the year for
hardware in US $ 3,80,74,540/- and software is US $
1,10,72,708/-. A perusal of the balance sheet filed by
the assessee shows that for the year ending 1997, the
company has earned a gross margin of 47%. This
comes from the annual report for the year 1997 where
the assessee has earned 20142157 thousand Swedish
Corner gross margin on the net sale of 42797901
thousand Swedish Corner. This is 47% over and
above the assessee has claimed selling expenses,
administrative expenses and R&D expenses in the
global balance sheet. The assessee has submitted that
ITA 504/2007, ITA 507/2007, ITA 508/2007,ITA 511/2007, ITA 397/2007 Page 9 of 75
it has reimbursed to the Indian company commission
plus other costs which amounts to 21% of the total
turnover and therefore out of this gross profit of 47%,
21% is allowed as expenditure directly attributable to
Indian Operations. The administrative expenses and
R&D expenses are covered under the overall sealing
of Section 44C of the I.T. Act and therefore the net
taxable income of the assessee is computed as follow:
-
1. Total Sales of hardware = US $ 3,80,74,540/-
converting into INR
@ 36.15 = 38074540 * 36.15 = 137,63,94,621/-
Taxable profit @ 26% = 35,78,62,601/-
Less:
H.O. expenses allowed
u/s 44C @ 5% = 1,78,93,130/-
Taxable Income = 33,99,69,471/-
Tax @ 55% = 18,69,83,209/- ................ I
Total consideration for software - US $ 1,10,72,708/-
Converted into INR @ 36.15 - 40,02,78,394/-
Tax @ 30% = Rs/12.00.83.513/- ............... II
Total tax = (I) + (II) = 30,70,66,727/-
Assessed. Issue necessary forms. Charge
interest Penalty proceedings u/s 271 (1) (c) is
initiated separately."
11. In an appeal filed against the aforesaid order of the DCIT, Non-
Resident Circle, New Delhi on 28.03.2000, the Commissioner of
Income-Tax (Appeals) examined the matter. The appellant had taken
five grounds of appeal, apart from taking up two additional grounds
subsequently as follows:-
(i) Ground No.1 was that the learned A.O. had erred in
holding that the income chargeable to tax in India
accrued or arose to the assessee. This ground was
held to be too general in nature by the CIT(A).
(ii) Ground No.2 dealt with the assessee‟s business
connection in India and the existence of permanent
establishment in India. The CIT(A) decided the
aspect of business connection against the appellant,
but the additional ground taken up by the assessee on
21.07.2000 against existence of PE of the assessee in
India, was decided in favour of the assessee.
(iii) Ground No.3 mentioned that the assessee incurred, a
loss during the year as certified by Price Water House
Cooper, Sweden and, therefore, the A.O. erroneously
brought to tax the impugned income of
`74,02,47,865/- consisting of business income of
`33,99,69,471/- and royalties of `40,02,78,394/-. The
CIT(A) partly allowed this ground, and held that
while no business profit can be computed in the
absence of PE of the assessee in India, the assessee
was liable to pay tax on royalties received by it from
the operators in India.
(iv) In ground No.4, the assessee assailed the finding of
the A.O. that income from licencing of software
amounted to receipt of royalty. Without prejudice to
this ground, it was mentioned that once it was held
that the appellant had PE in India, the royalties
obtained the character of business profits. It was also
submitted that the A.O. had failed to appreciate that
royalties are taxable at the rate of 20% under Article
12 of the DTAA. The CIT(A) decided this ground for
treating license fees received by the assessee as
royalties against the assessee. However, he directed
the A.O. to verify the rate of tax chargeable on the
receipt of the royalties and pass a speaking order in
this behalf.
(v) Ground No.5 sought to challenge the A.O.‟s finding
regarding charging of interest under Section 234A and
234B on the ground that the revenues were liable for
tax deduction at source. This ground was allowed by
the CIT(A).
(vi) The additional ground regarding invalidity of notice
issued by the assessing officer under Section 142(1),
taken on 05.12.2000, was dismissed. The CIT(A)
thus partly allowed the appeal of the assessee.
12. The assessee was not satisfied with the partial relief granted to it
by the CIT (A). That part of the order which went against the assessee
was challenged by it by filing appeal before the ITAT. Likewise, the
Revenue also challenged other part of the order of the CIT (A) whereby
the relief was granted to the assessee. These appeals and cross-appeals
alongwith cases of other assessees namely Nokia and Motorola were
referred to the Special Bench. The Special Bench has decided the issues
in favour of the assessee resulting in dismissal of the appeals of the
Revenue and allowing the appeal of the assessee. Challenging that order
of the Special Bench, the Revenue has filed appeal which is registered as
ITA 507/2007. ITA 508/2007 arises from the order passed by the
Tribunal disposing of the cross-objections of the assessee and ITA
511/2007 arises from the order of the Tribunal disposing of the appeal of
the Revenue. Thus ITA 507/2007, ITA 508/2007 and ITA 511/2007
relate to one assessment year i.e. 1997-98. In the next assessment year,
the ITAT followed the aforesaid order and challenging that order ITA
504/2007 is filed by the Revenue. These first three appeals were
admitted on the following questions of law:-
ITA 507/2007
"1.Whether in law, the Ld. Delhi Tribunal was
justified in holding that the assessment was invalid
inasmuch as it was framed pursuant to a notice issued
under Section 142 91)(i) of the Income-Tax Act,
1961, which notice was issued beyond the period of
limitation?
2. Whether in law, the Ld. Delhi Tribunal was
justified in holding that the assessee did not have a
business connection in India?
3. Whether in law, the Ld. Delhi Tribunal was
justified in holding that the consideration for supply
of software was not a payment by way of royalty, and
hence, was not assessable both under Section
9(1)(vi) of the Double Taxation Avoidance
Agreement between the government of India and
Sweden?"
ITA 508/2007
"1.Whether in law, the Ld. Delhi Tribunal was
justified in holding that the assessee did not have a
business connection in India.?"
ITA 511/2007
"1.Whether in law, the Ld. Delhi Tribunal was
justified in holding that the assessee did not have a
permanent establishment in India?
2. Whether in law, the Ld. Delhi Tribunal was
justified in deleting the levy of interest charged under
Section 234B of the Income Tax Act, 1961?"
13. We may first deal with the two incidental issues before coming to
the main issues. First issue pertains to the validity of notices issued
under Section 142 of the Income-Tax Act. The Tribunal has concluded
that this notice was issued after the end of the assessment year i.e. after
31st March, 1998 and, therefore, it was invalid. Consequently, it held
that the Assessing Officer had no jurisdiction to complete the assessment
and, therefore, assessment framed by him on 28th March, 2000 was also
invalid. However, subsequent to this decision of the Tribunal, by
Finance Act, 2006, the Legislature has added proviso in Section 142 (i)
of the Act. The effect thereof is that an assessment framed pursuant to a
notice issued under Section 142 after the end of the assessment year
would also be valid. Conceding this position, it was accepted by the
assessed that the notice issue was not beyond the period of limitation.
Question No.1 of ITA 507/2007, is thus decided in favour of the
Revenue.
14. Second question, which we take up for consideration relates to the
levy of interest charged under section 234B of the Act. The Tribunal has
deleted this addition and the Revenue is questioning this decision of the
Tribunal. The question of law No.2 is framed on this issue in ITA
511/2007. Perusal of the order of the Tribunal would reflect that it has
followed its earlier decision of Delhi Bench and Mumbai Bench on the
basis of which it is held by the Tribunal that levy of interest was not
justified, inasmuch as the assessee had no obligation to pay any advance
tax as tax was deductable at source on its income that was chargeable to
tax in India. This very issue has been discussed in detail by this Court in
CIT Vs. Mitsubishi Corporation in ITA 491/2008. Relying upon the
judgment of Bombay High Court in DIT Vs. N.G.C. Network Asia
LLC, 313 ITR 187, this Court reached the conclusion that no interest
can be levied.
15. The circumstances of the present case are virtually similar. In
fact, we may record that there was hardly any resistance by the Revenue
to the aforesaid position. We thus answer this question in favour of the
assessee and against the Revenue.
16. It is now the stage to deal with the basic issues raised in these
appeals which are:-
(1) Whether the assessee has business connection in India?
(2) Whether the assessee has permanent establishment in
India?
(We may clarify that if the assessee has business
connection in India, then this question may not even
need to be considered).
(3) Whether hardware and software components of the
equipment can be segregated for the purpose of Section
(1)(vi) of the Act?
17. The issue as to whether any income can be brought to tax in terms
of the Act is dealt with in paras 103 to 123 of the Tribunal‟s order. The
Tribunal has come to the conclusion that no part of the income accrues
or arises in India because having regard to the terms of Article 13 of the
Supply Contract it is clear that property in the goods has passed outside
India. In this regard, the Tribunal has held that the mere fact that the
contract was signed in India is an irrelevant circumstance and the
reliance by the revenue on the judgment of the Supreme Court in the
case of 20th Century Finance Corporation is misplaced. The Supreme
Court in that case was concerned with the issue as to where the situs of
the taxable event of a contract to transfer a right to use goods was
located. It was in that context that the Supreme Court held that the situs
of the taxable event in such a deemed sale was the place where the
contract for the transfer of the right to use the goods was made.
According to the Tribunal having regard to the provisions of Section 19
and 20 of the Sale of Goods Act, the property in the goods passes when
the parties intend it to pass, and the intention of the parties was
manifested in Article 13 of the Supply Contract. The Tribunal also held
that the mere fact than an Acceptance Test was carried out in India was
an irrelevant circumstance and in this regard relied on its earlier
decisions as well as in the judgment of the Andhra Pradesh High Court
in Additional CIT Vs. Skoda Export Praha, 172 ITR 358. According to
the Tribunal, the mere fact that an acceptance test had to be performed
did not in any way mean that the title had not passed from the assessee to
the Cellular operator outside in India.
18. The Tribunal noted that it was not uncommon that in execution of
such large projects the various components of a turnkey project namely
planning and designing, supply of equipment, civil works and
installation, testing and commissioning of the equipment may be handled
by a consortium of companies. Separate agreements would be entered
into to carry out each of the aforesaid obligations and each contractor
would be responsible for its obligations under its contract although there
may be an overall responsibility. Two separate independent contracts
were entered into: one between the assessee and the cellular operator for
the supply of the goods and the other between the installation contractor
and the cellular operator and the Tribunal for the reasons given in para
118 of its order found, on a construction of the relevant provisions of the
two agreements, that the contracts could not be treated as turnkey or a
works contract. The Tribunal also did not accept the argument that by
virtue of the overall agreement the income that arose to the assessee was
chargeable to tax in India. As regards the overall agreement, the
Tribunal held that the overall agreement was executed as a matter of
commercial prudence as the cellular operator needs to be instilled with
confidence that the project would ultimately take off and, therefore, he
would insist on a single point responsibility. The Tribunal also noted
that this was a common practice and Instruction No. 1829 issued by the
Central Board of Direct Taxes which was in force on the first day of the
assessment year also takes cognizance of the commercial necessity for
having such overall responsibility. The Tribunal further found that no
payment accrued either to the assessee or the installation contractor
under the overall agreement, but the overall agreement merely ensured
supervision and guaranteed the performance of all the contracts in a co-
ordinated manner. The Tribunal further noted that the installation
contractors and the assessee were separate independent entities and there
was no evidence brought on record to disclose that any one is dependent
on the other, either financially or in any other manner. The Tribunal
further held that the finding of the Commissioner of Income-Tax (A) that
the various entities were formed for the purpose of business and were
doing business independently as per their instruments of incorporation
was not disputed by the Revenue. The Tribunal found that both EFC as
well as ECI were separately assessed to tax in India. The Tribunal thus
came to the conclusion that there was no business connection with the
assessee in India having regard to the nature of the arrangement that the
assessee had with either EFC or ECI. Further, as no operations were
formed by the assessee in India no income could be charged to tax in
India. The Tribunal, therefore, ultimately concluded that no part of the
income accrued to the assessee in India and that as the assessee did not
have a business connection in India no part of the income could be
regarded as deemed to accrue in India also; and that income from the
supply of equipment accrues outside India, where the equipment is
manufactured outside India and the property therein passes outside India
and the place of execution of the contract is not relevant. In this regard
reliance was placed by the Tribunal on the judgment of the Supreme
Court in Ishikawajma Harima heavy Industries Ltd. Vs. DIT, 288 ITR
408 where the Court has held that the fact that the contract was signed
in India is of no material consequence since all activities in connection
with the off shore supply were carried on outside India.
19. It would thus be proper to first deal with the issue of business
connection.
RE: BUSINESS CONNECTION:
20. Mr. Mohan Parasharan, learned ASG opened the argument on this
aspect by submitting that it was an integrated business arrangement for
supply of GSM system for which three agreements were entered into
viz., the Supply Agreement, the Installation Agreement and the Overall
Agreement with JT MOBILES, which together form an Integrated
Business Arrangement that is governed by the Overall Agreement. The
said Integrated Business Arrangement is for the setting up of a GSM
system and the same could not have been set up without the overall
supervision, direction and decision making power exercised by the
assessee. It was the submission of Mr. Prasaran that a plain reading of
the terms and conditions of the three contracts, all entered into on the
same day and at the same place in India, viz., Bangalore, indicates that
they are all interlinked, inter-twined and inseparable. He pointed out
that the assessee and its associated sister concerns had entered into
contracts with the Indian buyers for the setting up of a GSM system in
India. For the aforesaid purpose, the hardware and software was to be
supplied/licensed by the assessee, the installation through a sister
concern of the assessee was to be overseen by the assessee and the
overall responsibility of the three contracts also was upon the assessee.
He drew our attention to the salient features of the three Agreements
which according to him conclusively show that they are, in effect, one
integrated business arrangement. He specifically referred to the
following features of these Agreements:
Supply Agreement
* Preamble: Agreement for supply of hardware and
software license.
* Article 5: Scope of the contract. The said clause
uses the phrase "turn key basis".
* Article 18: Acceptance Test and Acceptance
certificate issued by the Installation Contractor will
bind on the assessee.
* Article 20: Provides for the license to use software
for the purposes of setting up of a system.
* Article 21: Assignment of the contract may be done
whereby the hardware may be assigned to anyone by
the Indian supplier, but the software may be assigned
only after due permission of the assessee.
* Article 31: Provides for termination of the supply
contract.
Installation Agreement
* Preamble: Agreement for installation of hardware
supplied and software for which license has already
been granted.
* Article 15: Acceptance Test made by the installation
contractor includes the integrity of the whole system
and certificate binds the assessee.
* Article 17: The installation contractor warranties to
rectify defects in both hardware and software (which
are provided by the assessee).
* Article 25: Provides for termination of the contract.
* Article 29: Assignment of the contract may be done
at anytime at the option of the Installation Contractor
to any subsidiary company of LME.
Overall Agreement
* Preamble: Clearly indicates that the parties are
setting up a system and not just supply of goods or
installation separately.
* Clause 2: Clearly outlines that the overall
responsibility for the supply agreement and the
installation agreement rests with the assessee.
* Clause 5: Clearly shows that the termination of both
the contracts is simultaneous and that where only the
installation contract is terminated, the prerogative is
that of the assessee to find the replacement for the
installation contractor.
* Clause 6: Provides that the Overall Agreement has
precedence over the other two agreements and in case
of any conflict in interpretation with the other two, will
prevail.
21. Mr. Prasaran submitted that in the light of the above, the
Assessing Officer as well as CIT (A) were entirely justified in coming to
the conclusion that the contracts formed an Integrated Business
Arrangement on the part of the assessee to provide the Indian buyers
with a GSM system. The assessing officer made the following pertinent
findings with respect to the integrated nature of the contract:-
* Overall responsibility was on the assessee for supply,
erection and after sales services as evidenced by the
Responsibility Matrix between the assessee company
and JT MOBILES (as well as the other customers):
Responsibility Matrix between Ericsson and JT
MOBILES s per their contract
JT Ericsson
Mobiles
Shipment CIP to agreed port
in India x
Management of Store x *
Site packing in the store x *
Delivery of documentation
according to Annex 11. x
Delivered on CD-ROM only
as built documentation,
MSC/BSC & BTSs x
Delivered as hard copies only
correction of remarks on as
built documentation x
Digitalization of maps
(MSI format) x
Development of nominal
cellpan x
Development normal coverage x
Preparation of frequency plan x
Drive test (when found
necessary) for checking * x
Suitability of chosen sites,
preferably in conjunction with
site survey
Develop acceptance plan * x
Provision of equipment and
material x
Performance and reliability in
accordance to agreed to
specifications x
* Even if the Installation Contract is terminated, the Supply
Contract is not terminated and the assessee is responsible
for making an alternative arrangement. However, if the
Supply Contract is terminated, the Installation Contract also
stands terminated as evidenced by Clause 5.5 of the Overall
Agreement, which reads thus:
"5.5 In the event that the Supply
Contractor terminates his contract, by
notice in writing to JT MOBILES, the
Installation Contractor may also terminate
his contract by notice in writing to JT
MOBILES. In the event that the
Installation Contractor terminates his
contract by notice in writing to JT
MOBILES, the Supply Contractor shall
locate a party acceptable to JT MOBILES
for taking up the work under the
Installation Contract on the same terms
and conditions and without any extra
expense and JT MOBILES shall sign the
Installation Contract with that party."
* The Overall Agreement was "not a matter of comfort,
but an overall guarantee provided by the supplier right
from the supply upto the testing and proper
functioning of the system". In fact, the assessee
company thereby took responsibility of the work of
installation carried out by the Indian company. The
Acceptance Test was, however, to be carried out by
the Indian company and the said test was to be
binding on the assessee. There was thus an intimate
and close relationship between the assessee and its
associate company EFC and subsequently between the
assessee and the Indian company i.e. ECL.
* The assessee had complete control over the
management, affairs and functioning of its associate
companies. Neither EFC nor ECL can operate as
independent agents on an arms length basis.
22. In the light of above, Mr. Prasaran questioned the findings of the
Income Tax Appellate Tribunal regarding the interpretation of the
Supply Agreement, Installation Agreement and the Overall Agreement
entered into between the assessee, its associate companies and Indian
customers. His submission in this behalf was that the scope of the
agreement has been decided and interpreted by the ITAT on the basis of
the Preambles to the Supply Contract and the Installation Contract,
without giving adequate weight to the preamble of the Overall
Agreement, which indubitably shows that there was only one integrated
agreement whereunder: "The Supply Contractor and the Installation
Contractor have agreed to work on a coordinated basis under two
separate contracts, being one between JT MOBILES and the Supply
Contractor for Hardware and Software Supply and the other between JT
MOBILES and the Installation Contractor for the Installation of the
system" so as to supply the system and install and commission the
system.
23. According to him, another error in the order of the Tribunal was
that while interpreting the scope of the contracts, even the other
provisions of the Overall Agreement were not given adequate weight
especially Article 6 of the Overall Agreement, which reads as follows:-
"6. PRECEDENCE
This Agreement shall prevail over the Contracts,
notwithstanding anything to the contrary
contained therein."
24. His submission was that this clause clearly shows that the Overall
Agreement between JT MOBILES (the cellular operator) and the Supply
Contractor (the assessee) and the EFC (the Installation Contractor)
"concerning some additional terms and conditions due to the Supply and
Installation of a Mobile Telephone System" was to prevail over the
Supply Contract and the Installation Contract, which, in itself goes to
show that it was integrated business arrangement between the parties.
25. Mr. Prasaran further argued that the Income Tax Appellate
Tribunal could not have held that the Supplier, i.e., the assessee was not
liable for faulty installation in the teeth of the declaration in the
Preamble to the Overall Agreement read with Clause 2 of the said
Agreement, which vests the responsibility for the proper installation with
the assessee:
"And whereas the Supply Contractor and
the Installation Contractor have agreed to
act in a co-ordinated manner so as to supply
the System and install and commission the
System.
Now therefore, it is hereby agreed by and
between the parties hereto as
follows...............
1. Interpretation: ...............
2. Execution: "The Supply Contractor
shall have overall responsibility to
ensure that the System is supplied in
accordance with the Supply Contract
and installed in accordance with the
Installation Contract and
commissioned as per Annex 18 (Time
Schedule)."
26. He also stressed that the Income-Tax Appellate Tribunal
erroneously held that the responsibility of installing the system was not
upon the assessee, and in comparing the responsibility of the assessee
under the Overall Agreement to that of the Polish company in the case of
CIT vs. Hindustan Shipyard Ltd., 109 ITR 158 (AP), where it was held
that the services offered with the contract of sale were merely incidental
to the contract by way of guarantee for the efficient working of the
products of sale. In the instant case, by no stretch it can be said that the
services offered by the Supply Contractor were merely incidental to the
sale of hardware and the license to use software. On the contrary, such
services were integral to the proper installation of the entire GSM
system. The assessee was not merely selling machinery and software but
had contracted to provide the full system which required supervision
over the Installation Contractor and other services necessary to set up
and maintain the GSM System. Accordingly, the ratio of the judgment
of the Supreme Court in Hindustan Shipyard Ltd. (supra) is clearly
inapplicable. The consequential finding that no income accrued to the
assessee either from the Overall Agreement or from the Installation
Agreement or from the Marketing and Business Promotion Agreement
and thus it cannot be said that there was "intimate connection between
the parties" is also erroneous.
27. His next proposition, on this aspect, was that under the above
contracts income had accrued and arisen to the assessee in India and
therefore it was taxable in India. In this behalf Mr. Prasaran made
following submissions:-
(a) Under Section 5 (2) (b) the income of a non-
resident is includible in that income subject to tax
under section 4 if the said income accrues or arises
or is deemed to accrue or arise in India.
(b) Income is said to accrue or arise in India to an
assessee if the assessee had a right to receive the
money that can be traced to India.
(c) Whether or not the right to receive the money has
arisen in India is dependent on the facts of each
case. Relevant factors in this regard will include
inter alia the place where the contract is entered
into, the place where the contract has to be
performed, where a given right can be exercised
and what sort of rights are granted in India.
(d) In the present case, it is undisputed that:-
All the vendeees are based in India
The GSM systems are being set up India.
The software is licensed for use in India
The hardware is being supplied for
setting up of a system in India
The acceptance test to confirm the
successful installation is done in India.
The responsibility to ensure successful
installation in India rests with the
assessee.
(e) The assessee‟s obligations therefore cannot be said
to end once the title of the goods has passed to the
Indian buyer. In addition, valuable rights are
granted by the assessee which can only be
exercised in India and the relationship between the
assessee and its Indian customers is more than just
that of mere seller and buyer of goods simpliciter.
(f) In the alternative, income from the contracts
amount to a source of the income that constitutes a
"business connection" for the purposes of Section
9 (1)(i) of the Income Tax Act, 1961 and therefore
income is deemed to accrue or arise in India.
(g) The business connection must be real and intimate
and income should arise as a result of the same
within the territory of India. Further, such
connection must be continuous and not just a one
off.
(h) Further, the transfer of a license to use an asset in
India, with an agreement to share profits thereof,
itself can amount to the existence of a business
connection as has been held by the High Court of
Bombay in CIT Vs. Metro Goldwyn Mayer, 7 ITR
28. Mr. Soli Dastur, learned Senior Counsel appearing for the
assessee refuted the aforesaid submissions of Mr. Prasaran, heavily
relying upon the contention that in a well reasoned decision rendered by
the Tribunal the factual aspects were rightly culled out from the
agreements and the Tribunal was justified in its conclusion that the
assessee had no business connection in India and in any case no income
had accrued or could be deemed to accrue or had arisen in India which
was taxable in this Country. He submitted that the assessee was a non-
resident and, therefore, could be subjected to tax only of that income
which was covered by Section 5 (2) of the Act. Mr. Dastur argued that
the income from the supply of equipment accrues outside India where
the equipment is manufactured outside India and the property therein
passes outside India and the place of execution of the contract is not
relevant.
29. In this regard reliance was placed by him on the judgment of the
Supreme Court in Ishikawajma Harima heavy Industries Ltd. Vs. DIT,
288 ITR 408 where the Court has held that the fact that the contract was
signed in India is of no material consequence since all activities in
connection with the off shore supply were carried on outside India. This
judgment has been followed by the Authority of Advance Rulings in
Hyosung Corporation, 314 ITR 343, where the fact situation was even
less favourabe than the assessee‟s case.
30. He also submitted that the decision in Ishikawajima's case
completely covers the issue as to whether any part of the profit arising
from the supply of the equipment by the assessee is chargeable to tax.
He further submitted that in the instant case the title to the system as
well as risk therein passed to the cellular operator at the part of
establishment in Sweden and in fact this position was not seriously
disputed by the Revenue at the time of arguments. He relied upon
Section 19 of the Sale of Goods Act which makes it clear that property
in goods passes when the parties intend it to pass and in the present case,
according to him, the intention of the parties was manifested in Article
13 of the Supply Contract and the provisions of Article 15 relating to the
Acceptance Test could not militate against such intention.
31. Refuting the contention of Mr. Prasaran that merely because the
acceptance test of the GSM system was carried out in India by ECI/EFC,
the income must be regarded arising in India, Mr. Datur submitted that
the fact that the acceptance test was performed in India by the
installation contractor is not relevant for determining where the title in
the equipment passes and consequently where income accrues. The
terms of the contract make it clear that the acceptance test is not a
material event for the passing of the title and risk in the equipment
supplied. The acceptance test is an act which is performed for the benefit
of the cellular operator and although the assessee would be bound by
such test performed by the installation contractor, the same is not an act
on behalf of the assessee. According to Mr. Dastur, the overall
agreement entered into between the parties also does not in any manner
result in the accrual of income in India. The overall agreement does not
result in any income accruing in India as no income arises to the assessee
in terms of the overall agreement. The overall agreement merely casts a
responsibility on the assessee to ensure the functioning of a duly
installed system even though different obligations are to be undertaken
by different parties.
32. Referring to the provisions of Section 9(1)(i) of the Act, he
submitted that it provides that income accruing or arising whether
directly or indirectly through or from any business connection in India is
deemed to accrue or arise in India. Clause (a) Explanation-1 further
provides that in the case of a business of which all the operations are not
carried out in India, the income of the business that is deemed to accrue
or arise in India in terms of clause (i) shall be only such part of the
income as is reasonably attributable to operations carried out in India. It
is submitted that the assessee has no business connection in India and in
any event has not earned any income in India through or from any
business connection. The cellular operators, who are independent
contracting parties, can never be regarded as the assessee‟s business
connection. The law is well settled that there must be something more
than a mere transaction of sale and purchase between principal and
principal to spell out a business connection such as management control
or financial control or by way of sharing of profits for a business
connection to come into existence. In support, he referred to the
decision in the case of CIT Vs. Hindustan Shipyard Ltd. 109 ITR 158,
CIT Vs. Gulf Oil Great Britain Ltd. 108 ITR 874 and Circular No.23
dated 23rd July, 1979.
33. His further submission was that the installation contractor also
cannot be regarded as a business connection through which the assessee
has earned any income in India, as the income of the assessee arises as a
consequence of the supply contracts entered into with the cellular
operator. There is no contract between the assessee and the installation
contractor and, therefore no profit arises therefrom. The mere fact that
the installation contractor is a subsidiary of the assessee‟s holding
company would not, by itself, give rise to a business connection of the
assessee as held in Gulf Oil Great Britain Ltd. (supra).
34. His alternate submission was that even assuming the assessee is
regarded as having a business connection in India, either in the form of
the installation contractor or in the form of the cellular operators,
nevertheless, by virtue of clause (a) of Explanation-1 to Section 9 (1) (i)
no part of the income arising to the assessee from the supply of
equipment can be deemed to accrue or arise in India as the material
operations in connection with such supply viz, the manufacture and the
transfer of property of the goods supplied, were completed outside India.
35. Mr. Dastur went to the extent of arguing that even if one treats
the contracts as a composite contract, as alleged by the Revenue, the
consideration attributable to the work performed in India, namely, the
marketing activity and the installation activity is already assessed to tax
in India in the assessments made on EFC and ECI and as no authority
has disputed that the installation contractor and the marketing agent are
remunerated on an arm‟s length basis the charge to tax, if any, in India
would stand exhausted. In support, he relied upon the judgment of this
Court in DIT Vs. Galileo International Ltd. 224 CTR 251.
36. In order to decide the issue at hand, let us recapitulate some of
the salient features. The assessee is a foreign Company. Its activities
involved supply of hardware and software as well as installation and
commissioning of the two and also after sale services. It entered into
agreements with various Cellular Operators and entered into three
contracts with them namely (1) Overall Agreement, (2) the Supply of
Agreement and (3) the Installation Agreement.
37. In the present case, we are concerned with the income earned by
the assessee as a result of supply of hardware and software licence under
the Supply Agreement. If this Supply Agreement is taken as standalone
Agreement, the facts on record show that such supplies under this
agreement were made overseas. The property in goods had passed on to
the buyer under the Supply Contract outside India where the equipment
was manufactured. As per the judgment of Supreme Court in
Ishikawajima's (supra), such agreement would not be taxable in India.
In Ishikawajima's, the Supreme Court held that no part of profit arising
from the supply of equipment outside India would be chargeable to tax
in India. Mr. Dastur is right in his analysis of the present case on the
basis of the ratio of Ishikawajima's inasmuch as:-
(i) In both the cases the property in the equipment
passed outside India and in the assessee‟s case even
the risk passed outside India;
(ii) In the case of Ishikawajima's even though it was
to perform onshore services including the erection and
commissioning of the equipment supplied by it,
nevertheless, the Supreme Court held that no part of
the profit on the offshore supply of the equipment was
taxable in India as a consequence of the performance
of such activities in India. In the assessee‟s case the
assessee does not perform any service in India in
connection with the installation of the equipment or
otherwise;
(iii) the performance of the acceptance test in India
was not considered a relevant circumstance whilst
determining whether any part of the profit on the
offshore supply was chargeable to tax in India in the
case of Ishikawajima, so also in the assessee‟s case.
(iv) although admittedly a permanent establishment
existed in the case of Ishikawajima, nevertheless, the
Court held that no part of the profit arising from the
supply of the equipment was chargeable to tax in
India as the permanent establishment had no role to
play in the transaction sought to be taxed as it took
place abroad, whilst in the case of the assessee, it has
been found as a fact by both the appellate authorities
that no permanent establishment existed;
(v) the mere signing of the contract pursuant to which
the supply was made in India, in both cases does not
result in giving rise to a tax liability in India;
(vi) the existence of the overall responsibility clause
was held to be irrelevant in Ishkawajima‟s case and
likewise the overall agreement executed in the
assessee‟s case should not make any difference to the
taxability of the equipment supplied;
(vii)giving the nomenclature of a turnkey project or
works contract is not relevant in determining whether
any profit arising from the supply of equipment
pursuant to such contract was chargeable to tax in
India;
(viii) the Supreme Court relied upon Instruction No.
1829 to come to the conclusion that the existence of
an overall responsibility clause was not material in
determining the tax liability arising from the offshore
supply of equipment and as the said instruction
continues to be in force for the assessment year
relevant to the present appeals, the existence of an
overall agreement should make no difference to the
taxability of the equipment supplied by the assessee.
38. We may add that Section 19 of the Sale of Goods Act makes it
clear that property in goods passes when the parties intend it to pass and
in the present case, the intention of the parties is manifested in Article 13
of the supply contract and the provisions of Article 15 in no manner
militate against such intention. Further, there is nothing in the conduct of
the parties which would suggest that the express provisions of Article
13 have been given a go-by.
39. No doubt, the contract in question was signed in India. However,
that may not be a relevant circumstance to determine the taxability of
such an income in view of the judgment of Andhra Pradesh High Court
in Skoda Export (supra).
40. We may point out that the learned Additional Solicitor General
was conscious of the aforesaid legal position and, therefore, the
limitation of Revenue‟s case if the same was to be determined on the
examination of the Supply Contract per se and de hors the Installation
Agreement and Overall Agreement. It is for this reason that his line of
argument proceeded on the basis that the three agreements are to be
taken to form an „Integrated business arrangement‟ between the parties
which was governed by the Overall Agreement. As noticed above, this
submission proceeded on the basis that the assessee had entered into
contracts with cellular operators in India for setting up of GSM system
in India, the hardware and software for which was supplied by the
assessee, and the installation thereof was also over-seen by the assessee
who was to ensure that it was carried out to the satisfaction of Indian
buyer in accordance with the terms of the contract. Various clauses of
Overall Agreement as well as Installation Agreement have been relied
upon as already noticed above. Article 15 of the Installation Agreement
deals with acceptance test made by the Installation contractor which
"includes the integrity of whole system and certificate binds the
assessee". Article 17 provides warranties to rectify the defects in both
hardware and software provided by the assessee. On this basis it was
argued that the Assessing Officer rightly concluded that overall
responsibility was on the assessee for supply, erection and after sale
services and the assessee had complete control over the management,
functions and the associates. The question that falls for consideration is
as to whether this acceptance test, which was performed in India, would
be relevant for determining as to whether income accrued in India in
terms of Section 5 (2)(b) of the Act.
41. We, find that the terms of contract make it clear that acceptance
test is not a material event for passing of the title and risk in the
equipment supplied. It is because of the reason that even if such test
found out that the system did not conform to the contractive parameters,
as per article 21.1 of the Supply Contract, the only consequence would
be that the Cellular Operator would be entitled to call upon the assessee
to cure the defect by repairing or replacing the defective part. If there
was delay caused due to the acceptance test not being complied with,
Article 19 of the Supply Contract provided for damages. Thus, the
taxable event took place outside India with the passing of the property
from seller to buyer and acceptance test was not determinative of this
factor. The position might have been different if the buyer had the
right to reject the equipment on the failure of the acceptance test carried
out in India. In Skoda Export (supra), the Andhra Pradesh High Court
dealt this issue in the following manner:-
"We may also mention that learned standing
counsel for the Department challenged the finding
of the Tribunal that the sale of machinery was
completed outside India; According to him, the
sale was completed only in India, inasmuch as the
assessee was entitled to inspect and satisfy itself
about the quality and standard of the machinery
supplied. We do not see any substance in this
contention. The various clauses in the agreement
referred to above make it clear that the sale of
machinery was F. O. B., European port, and the
time of fulfilment of delivery was prescribed as the
date of the bills of lading. The payment was also to
be made outside India. The agreement further
makes it clear that the insurance risk during the
course of the journey was that of the assessee and
it paid for the same : even the freight charges from
the European port to the place of destination were
paid by the assessee. Thus, judged from any angle,
the sale of machinery, which are "goods" within
the meaning of the Sale of Goods Act, was
completely outside India. A mere provision in the
agreement that the assessee is entitled to satisfy
itself about the quality and standard of the
machinery in India cannot, in the circumstances of
this case, detract from the fundamental position
that the sale took place outside India. In such a
situation, one has to apply the test of
predominance and decide where the sale took
place ? On a combined reading of the clauses of
the agreement, we have no doubt that the sale of
machinery did take place outside India."
42. We may also usefully referred to the judgment of the High Court
in Mahavir Commercial Company Vs. CIT, 86 ITR 147 wherein
following principle was enunciated:
"Even though the property in the goods may pass
to the buyer when the documents are handed over,
the buyer may yet retain the right to examine and
repudiate the goods but this right generally which a
buyer has in c.i.f. contract does not by itself
indicate that the property in the goods has not
passed to him. This supposed incongruity was
sought to be explained per curiam in Kwei Tek
Chao v. British Traders and Shippers Ltd. (1954) 2
K.B. 459. that if property passed when the
documents are transferred that property is subject
to the condition that the goods should re-vest in the
seller if on an examination by the buyer he finds
them not to be in accordance with the contract. It is
not necessary to consider this aspect because in
any case the ascertainment of the obligations under
the contract will determine to what extent the
transfer of property is subject to a condition or if
the property passes conditionally whether the
ownership left in the seller is the reversionary
interest in the property in the event of the
conditions subsequent operating to restore it to
him. In any case where the performance of some
condition is imposed upon the buyer but is not
made a condition of the transfer of the property,
the property once passed is not revested in the
seller by the buyer's subsequent default."
43. Thus, Overall Agreement does not result the income accruing in
India. The execution of an overall agreement is prompted by purely
commercial considerations as the India Cellular Operator would be
desirous of having a single entity that he could liaise with, a fact which
even the Board has noted in its Instruction No.1829 dated 21 st
September, 1989. Although Instruction number 1829 stands withdrawn
by virtue of Circular No.7/2008 dated 22nd October, 2009, such
withdrawal can have no retrospective effect and the principle laid down
in Instruction No. 1829 must continue to govern the assessment for the
relevant year.
44. The aforesaid analysis will bring forth the legal position that the
place of negotiation, the place of signing of agreement, or formal
acceptance thereof or overall responsibility of the assessee are irrelevant
circumstances. Since the transaction relates to the sale of goods, the
relevant factor and determinative factor would be as to where the
property in the goods passes. In the present case, the finding is that
property passed on the high seas. Concededly, in the present case, the
goods were manufactured outside India and even the sale has taken place
outside India. Once that fact is established, even in those cases where it
is one composite contract (though it is not found to be so in the present
case) supply has to be segregated from the installation and the only then
would question of apportionment arise having regard to the expressed
language of Section 9 (1) (i) of the Act, which makes the income taxable
in India to the extent it arises in India.
45. The judgment of the Supreme Court in Performing Rights Society
Ltd. Vs. CIT 106 ITR 11 has no relevance for determining where the
profits on the supply of equipment accrues when title to the goods
passes outside India. In the case before the Supreme Court the activity
which gave rise to the income, namely, the activity of broadcasting took
place in India, and it was in these circumstances the Court held that the
royalty earned by the assessee therein accrued in India even though the
agreement pursuant to which such royalty was earned was executed in
England. Merely because the activities, namely, the supply activity and
the installation activity are to be carried out by two separate Companies
who are part of the same Group cannot result in the transaction being
treated as one composite transaction. This is more so when both the
entities perform their own independent obligations, receive appropriate
separate remuneration and, as found by the Tribunal, are not financially
or technically dependent on each other.
46. Further, all of them are assessed in respect of the income that has
accrued to them and even the Revenue has, in the course of its
arguments, accepted that it is not their case that only one assessment has
to be made treating the transaction as one works contract.
47. Section 9 (1) (i) of the Act as it stood before the amendment to it
by the Finance Act, 2010 provides that income accruing or arising,
whether directly or indirectly, through or from any business connection
in India is deemed to accrue or arise in India. The Department has not
stated that the assessee has any business connection in India, inasmuch
as the cellular operators are independent contractee parties and action
cannot be held to be assessee‟s business connection. In such
circumstance, the case would be covered by Explanation-1 to Section 9
(1) (i) of the Act. Clause (a) of Explanation-1 lays down that in the case
of business if all the operations are not carried out India, the income of
business that is deemed to accrue or arise in India would be only such
part of the income as is reasonably attributable to operations carried out
in India. In view of the aforesaid discussion, it is clear that under the
Supply Contract, the assessee has not earned any income in India
through or from any business connection.
48. Insofar as Installation Contract is concerned, that is between the
installation contractee and the cellular operators. There is no contract
between the assessee and the installation contractor and no profit arises
therefrom insofar as assessee is concerned. We are in agreement with
the submissions of Mr. Dastur that merely because the installation
contractor is a subsidiary of the assessee holding company would not,
by itself, give rise to a business connection. In Gulf Oil (supra) this very
issue was dealt with, referring to CBDT Circular No.23 of 1969 in the
following manner:-
"Under item (ii) above, the Board has clarified that
where a non-resident parent company sells goods to
its Indian subsidiary, the income from the transaction
will not be deemed to accrue or arise in India under
section 9, provided three conditions are satisfied :
(i) the contract to sell are made outside India which
on the finding of the Tribunal has been found in the
instant case in favour of the non-resident company;
(ii) the sales are made on a principal-to-principal
basis and at arm's length - an aspect on which Mr.
Joshi wanted us to consider the matter in the light of
the facts and circumstances of the case; and
(iii) the subsidiary does not act as an agent of the
parent - again an aspect which will have to be
considered in view of the facts and circumstances
obtained in the instant case. There is no doubt that the
Indian subsidiary is a hundred per cent. subsidiary of
the non-resident, but the Tribunal has found as a fact
that all the contracts regarding the have been made in
U.K. principally on the basis that the indents which
were placed by the India subsidiary with the non-
resident company were accepted by the non-resident
company in U.K."
PERMANENT ESTABLISHMENT (PE):
49. We, therefore, hold that the assessee did not have any business
connection in India. In view of this, it is not necessary to go into the
issue whether the assessee had any Permanent Establishment in India or
not during the relevant period in India or not.
WHETHER THE INCOME FROM THE SUPPLY CONTRACT
CAN BE TREATED AS 'ROYALTY' UNDER SECTION 9(1)(vi)
OF THE ACT:
50. Section 9 (1) (i) of the Act which deals with the taxability of
„royalty income‟ reads as under:-
"Section 9 .INCOME DEEMED TO ACCRUE
OR ARISE IN INDIA.
(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"
51. The submission of Mr. Prasaran, learned ASG was that software
part of the equipment supply would attract royalty as copy right of the
said software programme still vests with the assessee. Therefore,
payments made for the licence to use the software programme give rise
to „royalty‟ for the purposes of both the Income-Tax Act as well as
DTAA entered into between Sweden and India. Referring to
Explanation-II (v) to Section ( (1) (vi) of the Act as well as Article 13,
para-3 of DTAA, it was argued that for the purposes of Income-Tax
law, royalty is essentially a payment received as consideration for the
use or right to use a particular integral property right, whether
partially or entirely.
52. We find that the Tribunal has held that there was no payment
towards any royalty and this conclusion is based on the following
reasoning:-
(i) Payment made by the cellular operator cannot be
characterized as royalty either under the Income
Tax Act or under the DTAA.
(ii) The operator has not been given any of the seven
rights under S.14 (a) (i) to (vii) of the Copyright
Act, 1957 and, therefore what is transferred is not
a copyright but actually a copyrighted article
(iii) The cellular operator cannot commercially exploit
the software and therefore a copyright is not
transferred.
(iv) Further, the parties to the agreement have not
agreed upon a separate price for the software and
therefore it is not open for the income tax
authorities to split the same and consider part of
the payment for software to be royalty
(v) The bill of entry for importing of goods shows that
the price has been separately mentioned for
software and that this was only for the purposes of
customs. There is no evidence to show that the
assessee was a party to the fixation of value for the
customs duty purposes
(vi) The software provided under the contract is goods
and therefore no royalty can be said to be paid for
it.
53. Mr. Prasaran, countered the aforesaid reasoning arguing that
Clause 20 of the Supply Contract uses the term „licence‟ and the same
term is used in the context of software throughout the three Agreements,
indicating that it is not an outright sale of goods, or a full transfer of
rights from the assessee to the Indian company. He also submitted that
the software is a computer programme, which is treated differently from
a book, not only in the Copyright Act, 1957 but also the Income Tax Act
itself. His submission was that Section 52(1) (aa) of the Copyright Act
only deems that certain acts will not to amount to infringement in the
light of various concerns, where otherwise such acts would amount to
infringement under Section 51 of the Copyright Act. The provision
cannot by itself be used to hold that no right exists in the first place,
since the scope of the right has to be understood only from the
provisions of Section 14 of the Copyright Act, 1957. He also argued
that the ITAT has misinterpreted the provisions of the DTAA,
specifically Article 13, para 3 of the DTAA (Article 12, para 3 of the
Model Convention) which defines royalties to mean "payments of any
kind received as a consideration for the use of, or the right to use, any
copyright of literary, artistic or scientific work". The ITAT, it was
submitted, has not appreciated that the royalty is for the use or right to
use any copyright. According to him, since title of the software
continued to vest with the assessee as provided in clause 20.2 of the
Supply Agreement and the assessee was free to grant non-exclusive
licenses to other parties, it follow that there was no full time transfer of
copyright but it was only a case of right to use the software, and thus
payment for use of software is to be treated as royalty. He further
argued that reference to OECD Commentary was not apposite as it could
not be used to interpret the scope of the relevant provisions of DTAA.
54. It is difficult to accept the aforesaid submissions in the facts of the
present case. We have already held above that the assessee did not have
any business connection in India. We have also held that the supply of
equipment in question was in the nature of supply of goods. Therefore,
this issue is to be examined keeping in view these findings. Moreover,
another finding of fact is recorded by the Tribunal that the Cellular
Operator did not acquire any of the copyrights referred to in Section 14
(b) of the Copyright Act,1957.
55. Once we proceed on the basis of aforesaid factual findings, it is
difficult to hold that payment made to the assessee was in the nature of
royalty either under the Income-Tax Act or under the DTAA. We have
to keep in mind what was sold by the assessee to the Indian customers
was a GSM which consisted both of the hardware as well as the
software, therefore, the Tribunal is right in holding that it was not
permissible for the Revenue to assess the same under two different
articles. The software that was loaded on the hardware did not have any
independent existence. The software supply is an integral part of the
GSM mobile telephone system and is used by the cellular operator for
providing the cellular services to its customers. There could not be any
independent use of such software. The software is embodied in the
system and the revenue accepts that it could not be used independently.
This software merely facilitates the functioning of the equipment and is
an integral part thereof. On these facts, it would be useful to refer to the
judgment of the Supreme Court in TATA Consultancy Services Vs.
State of Andhra Pradesh, 271 ITR 401, wherein the Apex Court held
that software which is incorporated on a media would be goods and,
therefore, liable to sales tax. Following discussion in this behalf is
required to be noted:-
"In our view, the term "goods" as used in Article
366(12) of the Constitution of India and as defined
under the said Act are very wide and include all
types of movable properties, whether those
properties be tangible or intangible. We are in
complete agreement with the observations made by
this Court in Associated Cement Companies Ltd.
(supra). A software programme may consist of
various commands which enable the computer to
perform a designated task. The copyright in that
programme may remain with the originator of the
programme. But the moment copies are made and
marketed, it becomes goods, which are susceptible
to sales tax. Even intellectual property, once it is
put on to a media, whether it be in the form of
books or canvas (In case of painting) or computer
discs or cassettes, and marketed would become
"goods". We see no difference between a sale of a
software programme on a CD/floppy disc from a
sale of music on a cassette/CD or a sale of a film
on a video cassette/CD. In all such cases, the
intellectual property has been incorporated on a
media for purposes of transfer. Sale is not just of
the media which by itself has very little value. The
software and the media cannot be split up. What
the buyer purchases and pays for is not the disc or
the CD. As in the case of paintings or books or
music or films the buyer is purchasing the
intellectual property and not the media i.e. the
paper or cassette or disc or CD. Thus a transaction
sale of computer software is clearly a sale of
"goods" within the meaning of the term as defined
in the said Act. The term "all materials, articles
and commodities" includes both tangible and
intangible/incorporeal property which is capable of
abstraction, consumption and use and which can be
transmitted, transferred, delivered, stored,
possessed etc. The software programmes have all
these attributes."
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"In Advent Systems Ltd. v. Unisys Corpn, 925 F. 2d 670
(3rd Cir. 1991), relied on by Mr. Sorabjee, the court was
concerned with interpretation of uniform civil code which
"applied to transactions in goods". The goods therein were
defined as "all things (including specially manufactured
goods) which are moveable at the time of the identification
for sale". It was held :
"Computer programs are the product of an
intellectual process, but once implanted in a
medium are widely distributed to computer
owners. An analogy can be drawn to a compact
disc recording of an orchestral rendition. The
music is produced by the artistry of musicians and
in itself is not a "good," but when transferred to a
laser-readable disc becomes a readily merchantable
commodity. Similarly, when a professor delivers a
lecture, it is not a good, but, when transcribed as a
book, it becomes a good.
That a computer program may be copyrightable as
intellectual property does not alter the fact that
once in the form of a floppy disc or other medium,
the program is tangible, moveable and available in
the marketplace. The fact that some programs may
be tailored for specific purposes need not alter their
status as "goods" because the Code definition
includes "specially manufactured goods."
56. A fortiorari when the assessee supplies the software which is
incorporated on a CD, it has supplied tangible property and the payment
made by the cellular operator for acquiring such property cannot be
regarded as a payment by way of royalty.
57. It is also to be borne in mind that the supply contract cannot be
separated into two viz. hardware and software. We would like to refer
the judgment of Supreme Court in CIT Vs. Sundwiger EMFG Co., 266
ITR 110 wherein it was held:
"A plain and cumulative reading of the terms and
conditions of the contract entered into between the
principal to principal i.e., foreign company and
Midhani i.e., preamble of the contract, Part-I and II
of the contract and also the separate agreement, as
referred to above, would clearly show that it was
one and the same transaction. One cannot be read
in isolation of the other. The services rendered by
the experts and the payments made towards the
same was part and parcel of the sale consideration
and the same cannot be severed and treated as a
business income of the non-resident company for
the services rendered by them in erection of the
machinery in Midhani unit at Hyderabad.
Therefore, the contention of the Revenue that as
the amounts reimbursed by Midhani under a
separate contract for the technical services
rendered by a non-resident company, it must be
deemed that there was a "business connection",
and it attracts the provisions of Section 9(1)(vii) of
the Income Tax Act cannot be accepted and the
judgments relied upon by the Revenue are the
cases where there was a separate agreement for the
purpose of technical services to be rendered by a
foreign company, which is not connected for the
fulfillment of the main contract entered into
principal to principal. This is not one such case and
thus the contention of the Revenue cannot be
accepted in the circumstances and nature of the
terms of the contract of this case."
58. No doubt, in an annexure to the Supply Contract the lump sum
price is bifurcated in two components, viz., the consideration for the
supply of the equipment and for the supply of the software. However, it
was argued by the learned counsel for the assessee that this separate
specification of the hardware/software supply was necessary because of
the differential customs duty payable.
59. Be as it may, in order to qualify as royalty payment, within the
meaning of Section 9(1) (vi) and particularly clause (v) of Explanation-
II thereto, it is necessary to establish that there is transfer of all or any
rights (including the granting of any license) in respect of copy right of
a literary, artistic or scientific work. Section 2 (o) of the Copyright Act
makes it clear that a computer programme is to be regarded as a
„literary work‟. Thus, in order to treat the consideration paid by the
cellular operator as royalty, it is to be established that the cellular
operator, by making such payment, obtains all or any of the copyright
rights of such literary work. In the presence case, this has not been
established. It is not even the case of the Revenue that any right
contemplated under Section 14 of the Copyright Act,1957 stood vested
in this cellular operator as a consequence of Article 20 of the Supply
Contract. Distinction has to be made between the acquisition of a
"copyright right" and a "copyrighted article".
60. Mr. Dastur is right in this submission which is based on the
commentary on the OECD Model Convention. Such a distinction has
been accepted in a recent ruling of the Authority for Advance Ruling
(AAR) in Dassault Systems KK 229 CTR 125. We also find force in the
submission of Mr. Dastur that even assuming the payment made by the
cellular operator is regarded as a payment by way of royalty as defined
in Explanation 2 below Section 9 (1) (vi), nevertheless, it can never be
regarded as royalty within the meaning of the said term in article 13,
para 3 of the DTAA. This is so because the definition in the DTAA is
narrower than the definition in the Act. Article 13(3) brings within the
ambit of the definition of royalty a payment made for the use of or the
right to use a copyright of a literary work. Therefore, what is
contemplated is a payment that is dependent upon user of the copyright
and not a lump sum payment as is the position in the present case.
61. We thus hold that payment received by the assessee was towards
the title and GSM system of which software was an inseparable parts
incapable of independent use and it was a contract for supply of goods.
Therefore, no part of the payment therefore can be classified as payment
towards royalty.
EFFECT OF AMENDMENT TO SECTION 9 OF THE FINANCE
ACT, 2010:
61. We have to determine as to whether amendment made to Section 9
of the Finance Act, 2010 whereby Explanation to sub-Section (2) has
been inserted has the effect of turning around the result. Vide Finance
Act, 2010 the following amendment was made to sub-Section (2) of
Section 9:-
"Explanation- For the removal of doubts, it is hereby
declared that for the purposes of this section, income
of a non-resident shall be deemed to accrue or arise
in India under clause (v) or clause (vi) or clause (vii)
of sub section (1) and shall be included in the total
income of the non-resident, whether or not,-
(i) the non- resident has a residence or place of
business or business connection in India; or
(ii) the non-resident has rendered services in
India."
62. We may place on record that initially the Finance Act, 2007
inserted an Explanation at the end of Section 9 to provide that "for the
removal of doubts, it is hereby declared that for the purposes of this
section, where income is deemed to accrue to arise in India under clauses
(v), (vi), and (vii) of sub-Section (1) ,such income shall be included in
the total income of the non-resident, whether or not the non-resident has
a residence or place of business or business connection in India." This
Explanation was inserted ostensibly to get over that part of the judgment
of the Supreme court in the case of Ishikawajima (supra) where the
Supreme court had observed that for Section 9(1) (vii) to be applicable it
is necessary that the services should not only be utilized in India but
should also be rendered In India. As this Explanation did not achieve
the purpose it was intended to serve, as was pointed out by the
Karnataka High Court in its judgment titled Jindal Thermal Power
Company Limited Vs. Deputy Commissioner of Income-Tax (ITA
3021/2005 and other connected matters decided on 16.3.2009) the
Legislature once again amended the Explanation below Section 9 by the
Finance Act, 2010 with retrospective effect from 1st June, 1976.
63. Based on the aforesaid amendment, the submission of the
Revenue is that this amendment has been introduced by the Legislature
to undo the effect of Ishikawajima (supra) and makes the Legislative
intendment clear by providing "source rule" that is, income which has
arisen in India as taxable under Section 9 of the Act. It was argued that
even the plain wording of Section 9 was clear, namely, if the income
has its source in India, it would be taxable in India. However, since
Ishikawajima (supra) had not interpreted the provision as containing the
"source rule" in order to rectify this situation created by the aforesaid
judgment, the Parliament introduced the aforesaid Explanation to clarify
that irrespective of where the services were actually rendered, so long as
they were utilized in India, income obtained from such services by a
non-resident would be treated as income accruing or arising in India.
64. To buttress this submission, the learned counsel for the Revenue
relied upon the Memorandum explaining the following provisions in the
Finance Bill, 2010:-
"Vide Finance Act, 1976, a source rule was provided
in Section 9 through insertion of clauses (v), (vi) and
(vii) in sub-section (1) for income by way of interest,
royalty or fees for technical services respectively. It
was provided, inter alia, that in case of payments as
mentioned under these clauses, income would be
deemed to accrue or arise in India to the non-resident
under the circumstances specified therein. The
intention of introducing the source rule was to bring
to tax interest, royalty and fees for technical services,
by creating a legal fiction in section 9, even in cases
where services are provided outside India as long as
they are utilized in India. The source rule, therefore,
means that the situs of the rendering of services is not
relevant. It is the situs of the prayer and the situs of
the utilization of services which will determine the
taxability of such services in India.
This was the settled position of law till 2007.
However, the Supreme Court in the case of
Ishikawajima-Harima Heavy Industries Ltd. Vs. DIT
(2007) [288 ITR 408], held that despite the deeming
fiction in section 9, for any such income to be
taxable in India, there must be sufficient territorial
nexus between such income and the territory of India.
It further held that for establishing such territorial
nexus, the services have to be rendered in India as
well as utilized in India.
This interpretation was not in accordance with the
legislative intent that the situs of rendering service in
India is not relevant as long as the services are
utilized in India. Therefore, to remove doubts
regarding the source rule, an Explanation was
inserted below sub-Section (2) of Section 9 with
retrospective effect from 1st June, 1976 vide Finance
Act, 2007. The Explanation sought to clarify that
where income is deemed to accrue or arise in India
under clauses (v), (vi) and (vii) of sub-section (1) of
Section 9, such income shall be included in the total
income of the non-resident, regardless of whether the
non-resident has a residence or place of business or
business connection in India. However, the
Karnataka High Court, in a recent judgment in the
case of Jindal Thermal Power Company Ltd. Vs.
DCIT (TDS), has held that the Explanation, in its
present form, does not do away with the requirement
of rendering of services in India for any income to be
deemed to accrue or arise to a non-resident under
Section 9. It has been held that on a plain reading
of the Explanation, the criteria of rendering services
in India and the utilization of the service in India laid
down by the Supreme court in its judgment in the
case of Ishikawajima Harima Heavy Industries Ltd.
(supra) remains untouched and unaffected by the
Explanation.
In order to remove any doubt about the legislative
intent of the aforesaid source rule, it is proposed to
substitute the existing Explanation with a new
Explanation to specifically state that the income of a
non-resident shall be deemed to accrue or arise in
India under clause (v) or clause (vi) or clause (vii) of
sub section (1) of Section 9 and shall be included his
total income, whether or not, (a) the non-resident has
a residence or place of business or business
connection in India; or
(b) the non-resident has rendered services in India.
This amendment is proposed to take effect
retrospectively from 1st June, 1976 and will,
accordingly, apply in relation to the assessment year
1977-78 and subsequent years."
65. It was argued that a plain construction of the Explanation shows
that income received by a non-resident from interest, royalty, or fees for
technical services will be deemed to accrue or arise in India in
accordance with Section 9 (1) (i) irrespective of the place of business,
residence or presence of business connection in India. Moreover, in the
specific context of royalty and fee for technical service, the second half
of the Explanation makes it clear that services for which royalty or fee is
being paid need not be rendered within the territory of India in order to
be deemed as income accruing or arising in India. As per the learned
counsel for the Revenue the scope of the said provisions is made clear
when one examines the relevant Notes on Clauses that accompanied the
Bill in its passage in Parliament:
"Clause 4 of the Bill seeks to amend section 9 of the
Income-Tax Act relating to income deemed to accrue
or arise in India.
The existing provisions contained in the Explanation
occurring after sub-section (2) of the aforesaid section
provide that, for the removal of doubts, for the
purposes of the said section, where income is deemed
to accrue or arise in India under clauses (v), (vi) and
(vii) of sub-section (1), such income shall be included
in the total income of the non-resident, whether or not,
the non-resident has a residence or place of business or
business connection in India.
It is proposed to substitute the said Explanation so as
to provide that the income of a non-resident shall be
deemed to accrue or arise in India under clause (v) or
clause (vi) or clause (vii) of subsection (1) and shall be
included in the total income of the non-resident,
whether or not,-
the non-resident has a residence or place of business or
business connection in India; or
the non-resident has rendered services in India.
This amendment will take effect, retrospectively, from
1st June, 1976 and will, accordingly, apply in relation
to the assessment year 1977-78 and subsequent years."
66. On the other hand, argument of the learned counsel for the
assessee is that this amendment does not impact the present case. It was
argued that the Explanation as initially inserted in the year 2007 sought
to clarify as to when income received by way of interest, royalty or fees
for technical services, can be regarded as deemed to accrue or arise in
India. The subsequent amendment made in the Explanation by the
Finance Act, 2010 enacts a further clarification (by effectively adding
clause (ii) in the Explanation) in so far as the taxability of fees for
technical services are concerned. The Supreme Court in Ishikawajima
(supra) has held that if the transfer of property in goods as well as the
payment were both made outside India, the transaction of supply was
not chargeable to tax in India inspite of the fact that the contract was
signed in India. The Court has further held that under the DTAA even if
the non-resident has a permanent establishment in India, the income
accruing from the supply would not be chargeable to tax in India if the
permanent establishment is not involved in that activity. In the present
case the finding of the Tribunal is that both the transfer of the property
in goods as well as risk has passed outside India and, therefore, having
regard to the provisions of the Act, the consideration receivable for the
supply of such equipment is not chargeable to tax in India. According
to the assessee, the judgment of the Supreme Court in the case of
Ishikawajima insofar as it deals with the taxability of the offshore
supplies is in no manner affected by the amendment made to section 9
by the Finance Act, 2010 as it only impacts the issue as to when income
by way of fee for technical services can be deemed to accrue or arise in
India. As it is nobody‟s case that the respondent has rendered technical
services which are deemed to accrue or arise in India when it supplies
the equipment or the software, the insertion of the Explanation below
section 9 and the addition of clause (ii) in the said Explanation by the
Finance Act, 2010 has no relevance insofar as the appeals before this
Court are concerned.
67. In our opinion on the facts of this case, it may not even be
necessary to go into this issue for the reason that in respect of clauses
(v),(vi), and (vii) of sub Section (1) of Section 9, once it is held that
payment in question is not royalty which would come within the
mischief of clause of clause (vi), the Explanation will have no
application.
68. Therefore, it is not necessary to go into the question as to whether
the purpose of this amendment was to undo the effect of Ishikwajima
(supra) by providing "source rule" as taxable under Section 9 of the Act.
In the present case, once it relates to supply of goods and further in any
case, where both the transfer of the property in goods or risk passed
outside India, the conclusion is that no taxable event took place in
India. The question of applicability of the Explanation would arise
only when payment is to be treated as "royalty" within the meaning of
clause (vi) or "fee for technical services" as provided in clause (vii) of
the Act.
69. The result of the aforesaid discussion would lead to the answer
to questions framed in favour of the assessee and against the revenue
and would result in the dismissal of the appeals of the Revenue.
ITA No. 397/2007
70. This appeal was admitted on the following questions of law:-
"1. Whether Ld. ITAT in the facts and
circumstances of the case erred in holding that
such software supplies were „sale‟ and hence
business income and not Royalty in terms of Indo-
UK Treaty?
2. Whether Ld. ITAT was correct in law in
confirming decision of the Ld. CIT (A) by limiting
income from hardware sales at 8%?
3. Whether Ld. ITAT erred in holding that
Assessee is not liable for interest under Section
234A and 234B of the Income Tax Act, 1961?"
71. It was agreed that the result of the aforesaid questions would
depend upon the outcome of the ITA 504/2007 and other connected
matters.
72. In view of our decision in ITA 504/2007, whereby appeals of the
revenue have been dismissed, the questions of law stand answered
against the revenue in this appeal. This appeal is also dismissed.
ACTING CHIEF JUSTICE
(REVA KHETRAPAL)
JUDGE
DECEMBER 23,2011
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