Delhi High Court
M/S Nortel Networks India ... vs The Director Of Income Tax -I on 4 May, 2016
Author: Vibhu Bakhru
IN THE HIGH COURT OF DELHI AT NEW DELHI
% Judgment delivered on: 04.05.2016
+ ITA 666/2014
M/S NORTEL NETWORKS INDIA
INTERNATIONAL INC. ..... Appellant
Through: Mr. Deepak Chopra, Advocate with
Ms. Manasvini Bajpai, Advocate.
versus
THE DIRECTOR OF INCOME TAX -I ..... Respondent
Through: Mr. N.P. Sahni, Senior Standing
counsel with Mr. Nitin Gulati, Advocate.
WITH
+ ITA 667/2014
M/S NORTEL NETWORKS INDIA
INTERNATIONAL INC. ..... Appellant
Through: Mr. Deepak Chopra, Advocate with
Ms. Manasvini Bajpai, Advocate.
versus
THE DIRECTOR OF INCOME TAX-I ..... Respondent
Through: Mr. N.P. Sahni, Senior Standing
counsel with Mr. Nitin Gulati, Advocate.
WITH
+ ITA 689/2014
M/S NORTEL NETWORKS INDIA
INTERNATIONAL INC. ..... Appellant
Through: Mr. Deepak Chopra, Advocate with
Ms. Manasvini Bajpai, Advocate.
versus
ITA 666/2014 & Ors. Page 1 of 57
THE DIRECTOR OF INCOME TAX-I ..... Respondent
Through: Mr. N.P. Sahni, Senior Standing
counsel with Mr. Nitin Gulati, Advocate.
WITH
+ ITA 669/2014
M/S NORTEL NETWORKS INDIA
INTERNATIONAL INC. ..... Appellant
Through: Mr. Deepak Chopra, Advocate with
Ms. Manasvini Bajpai, Advocate.
versus
THE DIRECTOR OF INCOME TAX-I ..... Respondent
Through: Mr. N.P. Sahni, Senior Standing
counsel with Mr. Nitin Gulati, Advocate.
WITH
+ ITA 671/2014
M/S NORTEL NETWORKS INDIA
INTERNATIONAL INC. ..... Appellant
Through: Mr. Deepak Chopra, Advocate with
Ms. Manasvini Bajpai, Advocate.
versus
THE DIRECTOR OF INCOME TAX-I ..... Respondent
Through: Mr. N.P. Sahni, Senior Standing
counsel with Mr. Nitin Gulati, Advocate.
WITH
+ ITA 672/2014
M/S NORTEL NETWORKS INDIA
INTERNATIONAL INC. ..... Appellant
ITA 666/2014 & Ors. Page 2 of 57
Through: Mr. Deepak Chopra, Advocate with
Ms. Manasvini Bajpai, Advocate.
versus
THE DIRECTOR OF INCOME TAX-I ..... Respondent
Through: Mr. N.P. Sahni, Senior Standing
counsel with Mr. Nitin Gulati, Advocate.
AND
+ ITA 673/2014
M/S NORTEL NETWORKS INDIA
INTERNATIONAL INC. ..... Appellant
Through: Mr. Deepak Chopra, Advocate with
Ms. Manasvini Bajpai, Advocate.
versus
THE DIRECTOR OF INCOME TAX-I ..... Respondent
Through: Mr. N.P. Sahni, Senior Standing
counsel with Mr. Nitin Gulati, Advocate.
CORAM:
JUSTICE S.MURALIDHAR
JUSTICE VIBHU BAKHRU
JUDGMENT
VIBHU BAKHRU, J
1. Nortel Networks India International Inc. (hereafter ‗the Assessee')
has preferred the present appeals under Section 260A of the Income Tax
Act, 1961 (hereafter ‗the Act') against orders passed by the Income Tax
Appellate Tribunal (hereafter ‗ITAT'). ITA Nos. 669/2014, 671/2014
and 672/2014 are appeals preferred by the Assessee against a common
order dated 13th June, 2014 passed by the ITAT in ITA Nos. 1119, 1120
and 1121/Del/2010, which were appeals preferred by the Assessee against
a common order dated 22nd December, 2009 passed by the Commissioner
of Income Tax (Appeals) [hereafter 'CIT(A)'] in respect of Assessment
Years (AYs) 2003-04, 2004-05 and 2005-06. The common order dated
22nd December, 2009 passed by CIT(A) disposed of the appeals preferred
by the Assessee against two separate assessment orders both dated 18 th
December, 2006 passed by the Assessing Officer (hereafter 'AO') under
Section 147 read with Section 143(3) of the Act in respect of the AYs
2003-04 and 2004-05 as well as an assessment order dated 31st
December, 2007 passed by the AO in respect of assessment year 2005-06.
2. ITA Nos. 666/2014, 667/2014 and 673/2014 impugn a common
order dated 13th June, 2014 passed by the ITAT in ITA Nos. 2177, 2178
and 2179/Del/2011 which were appeals preferred by the Assessee against
a common order dated 20th January, 2011 passed by CIT(A) in appeals
no.78, 79 and 77/2009-10. These appeals were preferred by the Assessee
against separate orders dated 29th January, 2010 passed by the AO to give
effect to the common order dated 22nd December, 2009 passed by CIT(A)
for AYs 2003-04, 2004-05 and 2005-06.
3. ITA No. 689/2014 is directed against ITAT's order dated 13 th June,
2014 passed in an appeal preferred by the Assessee against final order
dated 17th August, 2011 passed by the AO under Section 144C of the Act
in respect of AY 2008-09.
4. By an order dated 24th February, 2015, ITA Nos. 666/2014,
667/2014 and 673/2014 were admitted and the following questions of law
were framed:-
"(i). Whether the Tribunal erred in concluding that the
Appellant had a Permanent Establishment (PE) within the
meaning of Article 5 of the Double Taxation Avoidance
Agreement (DTAA) between India and USA?
(iii). Whether the finding of the Tribunal that the Appellant had a
PE in India is perverse and contrary to the facts and material on
record?"
5. ITA Nos. 671/2014, 672/2014 and 669/2014 were admitted on 24 th
February, 2015 and the following questions of law were framed:-
―(i). Whether the Tribunal erred in concluding that the
Appellant had a Permanent Establishment (PE) within the
meaning of Article 5 of the Double Taxation Avoidance
Agreement (DTAA) between India and USA?
(ii). Whether the Tribunal erred in affirming that the Appellant
had a PE (fixed place PE and dependent agent PE) in India in
terms of the Liaison Office of Nortel Canada and also in terms
of the Nortel Networks (India) Private Ltd" (being installation
and service PE)?
(iii). Whether the finding of the Tribunal that the Appellant
had a PE in India is perverse and contrary to the facts and
material on record?
(iv). Whether, without prejudice, the Tribunal erred in
attributing 50% of the alleged profits to the alleged PE of the
Appellant in India and whether such approach and
quantification was inconsistent with Article 7 of the DTAA?‖
6. Similarly, ITA No. 689/2014 was also admitted on 24 th February,
2015 and the following questions of law were framed:-
―(i). Whether the Tribunal erred in concluding that the
Appellant had a Permanent Establishment (PE) within the
meaning of Article 5 of the Double Taxation Avoidance
Agreement (DTAA) between India and USA?
(ii). Whether the Tribunal erred in affirming that the Appellant
had a PE (fixed place PE and dependent agent PE) in India in
terms of the Liaison Office of Nortel Canada and also in terms
of the Nortel Networks (India) Private Ltd" (being installation
and service PE)?
(iii). Whether the finding of the Tribunal that the Appellant
had a PE in India is perverse and contrary to the facts and
material on record?
(iv). Whether, without prejudice, the Tribunal erred in
attributing 50% of the alleged profits to the alleged PE of the
Appellant in India and whether such approach and
quantification was inconsistent with Article 7 of the DTAA?
(v). Whether Tribunal erred in confirming the levy of interest
under section 234B of the Act?‖
7. The principal controversy involved in these appeals (ITA Nos.
669/2014, 671/2014, 672/2014 and 689/2014) is whether the Assessee, a
tax resident of United States of America (USA), has a Permanent
Establishment (hereafter 'PE') in India and consequently, is chargeable to
tax under the Act in respect of its business income attributable to its PE in
India.
Factual background
8. The Assessee (formerly known as Nortel Networks RIHC Inc) was
incorporated as a company on 7th June, 2002 under the laws applicable in
the State of Delaware, USA and is a tax resident of USA. The Assessee
is a part of Nortel Group which is stated to be a leading supplier of
hardware and software for GSM Cellular Radio Telephone Systems. The
Assessee is a step-down subsidiary of Nortel Networks Limited (Canada),
a company incorporated in Canada (hereafter ‗Nortel Canada'); it is
wholly held by Nortel Networks Inc. which in turn is wholly owned
subsidiary of Nortel Canada. Nortel Canada also has an indirect
subsidiary in India, namely, Nortel Networks India Pvt. Ltd (hereafter
‗Nortel India'). Nortel Canada also owns 99.99% of share capital of
Nortel Networks (Luxemburg) SA which in turn holds the entire share
capital of Nortel Networks International Finance & Holdings BV (Nortel
BV). Nortel BV holds 99.99% shares of Nortel Networks Mauritius
Limited, a company incorporated in Mauritius, which in turn holds
99.99% of Nortel India. The above corporate structure of part of the
Nortel Group can be better understood by the following diagram :-
NORTEL NETWORKS LIMITED (CANADA)
100% 99.99%
Nortel Networks Inc Nortel Networks (Luxemburg) SA
100% 100%
Nortel Networks International Finance &
Holding BV
Nortel Networks India International Inc.
(Appellant)
99.82% 99.99%
Nortel Networks Singapore Pte. Nortel Networks Mauritius Ltd.
99.99%
Nortel Networks India Pvt. Ltd.
9. The Nortel Canada also has a Liaison Office in India (hereafter
called ‗Nortel LO').
10. Nortel India negotiated and entered into three contracts with
Reliance Infocom Limited (hereafter ‗Reliance'), namely, Optical
Equipment Contract (hereafter ‗the Equipment Contract'), Optical
Services Contract (hereafter ‗the Services Contract') and the Software
Contract (hereafter 'the Software Contract') on 8th June 2002. On the
same date, Nortel India entered into an agreement assigning all rights and
obligations to sell, supply and deliver equipment under the Equipment
Contract to the Assessee (hereafter referred to as the ‗Assignment
Contract'). Reliance and Nortel Canada were also parties to the
Assignment Contract and in terms thereof, Nortel Canada guaranteed the
performance of the Equipment Contract by the Assessee (Assignee). In
terms of the Assignment Contract, Reliance placed purchase orders
directly on the Assessee and also made all payments for the equipment
supplied directly to the Assessee.
11. The equipments supplied to Reliance were manufactured by Nortel
Canada and another Nortel group entity in Ireland (Nortel Ireland). The
same was invoiced by the Assessee directly to Reliance and consideration
for the same was also received directly by the Assessee. It is asserted by
the AO that the equipment supplied to Reliance was sourced from Nortel
Canada and Nortel Ireland at a much higher price than the price charged
to Reliance and this resulted in the Assessee suffering a loss during the
relevant period.
12. Since according to the Assessee, its income was not chargeable to
tax under the Act, it did not file any return for the AYs 2003-04 and
2004-05. The principal issues involved in the AYs 2002-03, 2003-04,
2004-05 and 2008-09 are common. The assessment orders passed by the
AO and the appellate orders passed by CIT(A) and the ITAT for AY
2002-03, 2003-04 and 2004-05 are also more or less similar in effect and,
therefore, for the sake of brevity only the facts as obtained for AY 2003-
04 (ITA 671/2014) are referred to herein.
13. On 27th March, 2006, the AO issued a notice under Section 148 of
the Act calling upon the Assessee to file its return of income for the AY
2003-04. In response to the aforesaid notice, the Assessee filed its return
of income on 16th May, 2006 disclosing its taxable income as ‗Nil'.
Thereafter, the AO issued notice under Section 143(2) of the Act. In
response to the aforesaid notices, the Assessee filed its statement of
accounts disclosing the loss stated to have been incurred by the Assessee.
The Assessee did not file its balance sheet or its audited accounts as
according to the Assessee, it was not required to have its accounts audited
in the tax jurisdiction where the Assessee is a resident, namely, Delaware,
USA. Thereafter, on 18th December, 2006, the AO passed an assessment
order under Section 143(3)/147 of the Act.
Assessment Order dated 18th December, 2006
14. The AO observed that the Assessee had not booked any
establishment cost, depreciation or any other indirect costs in its accounts.
Further, the Assessee had also not showed any source of funds. The AO
noted that the equipment stated to have been supplied by the Assessee to
Reliance was purchased from other group companies, namely, Nortel
Canada and Nortel Ireland and were supplied to Reliance at almost half
the price of the said goods. On the aforesaid basis, the AO concluded that
the Assessee did not have any financial or technical ability to perform the
Equipment Contract.
15. The AO further concluded that Nortel India and Nortel LO were
involved in pre-contract survey, pre-contract negotiation, finalization of
documents and carrying out of installation activities and at ground level,
there was no difference between the LO and Nortel India and both were
operating from the same premises and were providing services to the
group companies including the Assessee. The AO further held that the
contracts with Reliance constituted a single turnkey contract which had
been artificially divided into three separate contracts. The AO further
held that Nortel India also did not have the capacity to undertake the
contracts entered into with Reliance and consequently, the same was
transferred to other Nortel Group Companies including the Assessee.
16. The AO was of the view that the Assessee had been incorporated
solely with the sole motive to evade the taxes arising out of supply
contract in India and in substance, the contracts were performed by Nortel
Canada along with its LO and Nortel India, who acted in unison to
identify, negotiate, appraise, secure, execute, manufacture, supply, install,
commission and provide warranty and after sales service in respect of the
Optical Fibre project of Reliance. In addition, these companies also
provided sales service and training etc. The AO also held that the
activities performed by Nortel India were not within the scope of services
to be rendered under the Services Contract and the expatriate employees
of the Assessee had remained in India for a long period and had rendered
services for Nortel India for a period of more than 30 days in a fiscal year
and the Assessee had reimbursed large amount of expenses incurred by
Nortel India on these expatriate employees.
17. According to the AO, the Assessee was ―a shadow company of
Nortel Group.‖
18. On the basis of its findings, the Assessee concluded that Nortel
India and Nortel LO constituted the Assessee's PE in India (both Fixed
Place PE as well as Dependent Agent PE).
19. In view of the finding that the Assessee was inserted as an
intermediary and a shadow company of Nortel Canada solely for the
purpose of evading taxes, the AO rejected the accounts furnished by the
Assessee and further observed that the accounts provided by the Assessee
were not audited and had "no sanctity". He then proceeded to estimate the
taxable income of the Assessee based on the accounts of Nortel Group.
The AO noticed that the global accounts of the Nortel Group disclosed a
gross profit margin of 42.6%. He held that average selling, general and
marketing expenses of other similarly placed non-resident companies was
5% of the turnover and, therefore, made an allowance of 5% of such
expenses. He also made a further allowance for Head office expenses at
5% of the adjusted profits and estimated the total taxable income of the
Assessee at Rs.81,28,06,917/-.
CIT(A)'s Order dated 22nd December, 2009
20. The Assessee appealed against the aforesaid assessment order as
also against similar assessment orders passed for AY 2004-05 and 2005-
06. These appeals were heard together and disposed of by the CIT(A) by
an order dated 22nd December, 2009. The CIT(A) observed that: (a) that
the Assessee was assigned the contract for supply of hardware to
Reliance Infocom days after its incorporation; (b) this is the only business
that appellant had done during the relevant period under consideration;
(c) the Assessee did not have any financial or technical capability of its
own; (d) the equipment supplied was manufactured by Nortel Canada and
Nortel Ireland and shipped directly from Canada/Ireland; (e) that the
Assessee had supplied the equipment at approximately half its purchase
price, thus, incurring huge trading loss in the transaction. The CIT(A)
held that the transactions were to be viewed as a whole and not merely in
the form of the agreement. On the basis of the aforesaid findings, the
CIT(A) upheld the conclusion of the AO that the Assessee was a paper
company incorporated only with a motive to evade income tax liability on
the income arising out of the supply contract in India and, therefore,
Nortel Canada and the Assessee were to be considered as a single entity.
The CIT(A) further rejected the Assessee's contention that it did not have
a business connection in India.
21. On the issue of existence of a PE in India, the CIT(A) held that
there were two places in the business model which could be considered to
be Assessee's fixed place of business - (i) the location of Nortel India to
which employees of Nortel Group were sent on secondment basis to
assist in the execution of the project; and (ii) the place of installation of
equipment. Further, the CIT(A) also held that office of Nortel LO and
Nortel India would also constitute a fixed PE of the Assessee in India as
the Assessee and Nortel Canada were one and the same entity.
22. The CIT(A) held that Nortel India constituted a fixed place of
business of the Assessee as according to him, the Assessee had employed
the services of Nortel India for fulfilling his obligation of installation,
commissioning, and after sales service and warranty. In addition, Nortel
India had also undertaken all the pre-supply activities such as feasibility
survey, negotiation of terms and conditions of supply, finalization of
documents and signing of the contract, etc. He also concluded that since
the employees of Nortel Group companies visited India in connection
with the project, they had performed business of the Assessee through the
premises of Nortel India or the LO of Nortel Canada.
23. The CIT(A) referred to clause 6.1.2 of the Equipment Contract
which provided for rendering of certain services in relation to the
equipment supplied and held that the Equipment Contract did not end
with loading of equipment on vessels but also included a number of
activities to be carried out in India, the compensation of which was
included in the consideration for supply of equipment. The CIT(A) also
referred to clause 5.3.2 of the Equipment Contract and on the basis of the
said clause held that the consideration for supply of equipment in fact
represents the payment of works contract, where installation and
customization is carried out in India. He held that Nortel India had not
only acted as a service provider of the Assessee but also as a "sales
outlet" providing after sales service and any other assistance as requested
by the Assessee.
24. On the aforesaid basis, the CIT(A) held that Assessee had (a) a
fixed place of business in terms of Article 5(1) of the Indo-US Double
Taxation Avoidance Agreement (DTAA); (b) a fixed place of
management in India and thus, a PE in terms of Article 5(2)(a) of the
Indo-US DTAA; (c) a sales outlet and thus, a PE in terms of Article
5(2)(i) of the Indo-US DTAA; (d) an Installation PE in terms of Article
5(2)(k) of the Indo-US DTAA; (e) a Service PE in terms of Article 5(2)(l)
of the Indo-US DTAA; and (f) a Dependent Agent PE in terms of Article
5(4) of the Indo-US DTAA.
25. Insofar as the attribution of income is concerned, the CIT(A)
concurred with the AO that Rule 10 of the Income Tax Rules, 1962 was
applicable. He further held that the accounts provided by the Assessee
could not be accepted for computing the income as the transaction
between the Assessee and Nortel Canada was not on an Arm's Length
basis. However, the CIT(A) held that the expenses relatable to the PE
were liable to be allowed as a deduction while estimating the profits
attributable to the Assessee's PE in India and, accordingly, directed the
AO to do so. The CIT(A) further held that keeping in view the facts of
the case, 50% of the profits of the Assessee's estimated profits could be
attributed to the PE in India.
Proceedings before the ITAT
26. Both, the Assessee and the Revenue preferred appeals against the
order dated 22nd December, 2009. The Assessee was principally
aggrieved by the CIT(A)'s decision upholding that the Assessee had a PE
in India and attributing a part of its profits, computed on estimated basis,
to its PE and assessing the same as chargeable under the Act. On the
other hand, the Revenue was aggrieved to the extent that CIT(A) had
reduced the proportion of profits attributable to the Assessee's PE in
India. The ITAT concurred with the AO and the CIT(A) that the contracts
entered into between Nortel India and Reliance Infocom were a part of a
'turnkey contract' which had been artificially split up into three separate
contracts. The ITAT further upheld the conclusion that the Assessee was
only a shadow company of Nortel Group and was getting its work inter
alia executed through Nortel India. The contracts were pre-negotiated by
Nortel India and in view of the above, the ITAT concurred with the AO
and the CIT(A) that Nortel India constituted a fixed place of business and
a dependent agent PE of the Assessee in India. The ITAT also concurred
with the view that the LO of Nortel Canada was rendering all kinds of
service to Group companies including the Assessee and constituted a
fixed place PE of the Assessee.
27. The ITAT rejected the Assessee's contention that the sale of
equipment was completed overseas and the installation was done under a
separate contract. The ITAT held that "the assessee through Nortel India
and LO approached the customer, negotiated the contract, bagged the
contract, supplied equipment, installed the same, undertook acceptance
test after which the system was accepted. The equipment remained in the
virtual possession of Nortel Group till such time the equipment is set up
and acceptance test is done."
28. The ITAT also held that the employees of the group companies
visited India in connection with the project and this indicated that the
employees of the Nortel Group carried on the business of the Assessee
through the premises of Nortel India or the LO. As regards the
attribution of income to the Assessee's PE in India, the ITAT concurred
with the CIT(A)'s view that 50% of the estimated profits were attributable
to the Assessee's PE in India. Accordingly, the appeals filed by the
Revenue and the Assessee were dismissed.
Submissions
29. Mr Chopra, learned counsel appearing for the Assessee submitted
that the contract for supply of equipment was a separate contract and was
performed by the Assessee independently. He submitted that the said
contract could have been entered into directly but Reliance insisted on
having an Indian company as a single point of contact and, therefore, the
contract was initially entered into between Nortel India and Reliance and,
subsequently, assigned to the Assessee. He emphasized that Reliance is a
party to the assignment contract and such assignment was also
contemplated under the Equipment Contract. He submitted that the
purchase orders were placed directly by Reliance on the Assessee and the
payments for the supply were also made directly by Reliance to the
Assessee. Mr Chopra further referred to the definition of "price list"
under the Equipment Contract and submitted that the prices for
equipment as listed in Schedule A to the Equipment Contract were "FCA
relevant international airport basis INCOTERM 2000, including costs of
exportation procedures from the country/ies of export and insurance from
the Vendor's (i.e. Nortel India) warehouse up to Substantial Completion"
and this meant that the Vendor was liable to deliver the equipment to the
carrier at the port of shipment. He contended that in the circumstances,
the Equipment Contract only obliged the Assessee to deliver the
equipment overseas and no part of the Assessee's activities were to be
performed in India.
30. Next, Mr Chopra contended that Nortel India was an independent
Assessee and any income attributable to Nortel India was liable to be
assessed in its hands and not in the hands of the Assessee. He referred to
the decision of the Supreme Court in the case of DIT (International
Taxation), Mumbai v. Morgan Stanley and Co. Inc.: (2007) 292 ITR
416 (SC) and Director of Income Tax and Ors. etc v. M/s. E. Funds IT
Solution and Ors. etc: (2014) 364 ITR 256 (Delhi) in support of his
contention that a subsidiary of a foreign company could not be construed
as its PE. He further submitted that no expatriate employee of the
Assessee had visited India in connection with the Equipment Contract
since the equipment was manufactured and supplied from overseas and
there was no requirement to depute personnel to India.
31. Mr Chopra submitted that there was no material or evidence on
record which would suggest that any fixed place in India had been made
available to the Assessee for execution of its activities. Therefore, the
AO's conclusion that Assessee had a fixed place PE in India is palpably
erroneous. He further submitted that it was Nortel India who had
negotiated the contract on its behalf and, therefore, its activities prior to
assignment of contract could not be considered as the Assessee's
activities. He submitted that since Reliance had insisted that the contract
be secured with an Indian company, Nortel India had undertaken the
responsibility and secured the contracts which included the Services
Contract that was to be executed by Nortel India. In the circumstances,
the conclusion that Nortel India had acted on behalf of the Assessee was
erroneous.
32. Insofar as the existence of an installation PE is concerned, Mr
Chopra argued that in terms of the services agreement, Nortel India was
to carry out all activities relating to installation, erection and
commissioning. Since installation was not a part of scope of the works
contracted to the Assessee, there was no question of the Assessee having
any installation PE in India.
33. Mr N.P. Sahni, Senior Standing Counsel appearing on behalf of
the Revenue supported the decision of the ITAT.
Reasoning and Conclusion
34. The questions framed in ITA Nos.671/2014, 672/2014, 669/2014
and 689/2014 are similarly worded except in ITA No.689/2014 wherein
an additional question regarding levy of interest under Section 234B of
the Act is also framed. However, no contentions were advanced on either
side with regard to levy of interest under Section 234B of the Act and
consequently, the same is not being considered.
35. The first three questions framed in the aforesaid appeals relate to
the dispute whether the Assessee has a PE in India and the fourth
question relates to the issue of attribution of income to the Assessee's
alleged PE in India.
36. The controversy whether the Assessee has a PE in India is
interlinked to the finding that Nortel India had discharged some of the
obligations of the Assessee under the Equipment Contract. Whilst, the
Income Tax Authorities have held that the contracts entered into with
Reliance - the Equipment Contact, Software Contract and Services
Contract - are essentially a part of the singular turnkey contract, the
Assessee contends to the contrary. Further, the Income Tax Authorities
have held that a part of the Equipment Contract assigned to the Assessee
was, in fact, performed by Nortel India. This too, is stoutly disputed by
the Assessee. The question whether the Assessee has a PE in India is
clearly interlinked with the issue whether Nortel India or Nortel LO had
performed any of the functions or discharged any of the obligations
assumed by the Assessee.
37. It is not disputed - on the contrary it has been expressly admitted -
that the contracts entered into with Reliance were negotiated by Nortel
India and neither Nortel LO nor the Assessee were involved in
negotiations with Reliance. There is also no material on record which
would indicate that Nortel LO or the Assessee had participated in any
negotiation with Reliance. The facts on record indicate that Nortel India
had negotiated the contracts with Reliance, and Nortel Canada had
executed a deed of guarantee (referred to as a 'Parent Guarantee')
guaranteeing the performance of all the three contracts.
38. It has been argued on behalf of the Assessee that the agreement for
supply of hardware (Equipment Contract) could have been directly
executed between Reliance and the Assessee but Reliance had insisted on
an Indian company being responsible for the entire works. Therefore, at
the insistence of Reliance, in the first instance, the agreements were
executed between Nortel India and Reliance, with Nortel Canada as a
surety.
39. Thus, it is an admitted position that Nortel India had negotiated for
the contracts and had entered into agreements that were to be performed
not by Nortel India but by other entities of the Nortel group. According
to the Assessee, the only reason for Nortel India executing the contracts
was the insistence on the part of Reliance to have an entity in India
responsible for the contracts. In this view, the contention advanced on
behalf of the Assessee that Nortel India had acted for itself and not on
behalf of any other group entity cannot be accepted and the findings of
the Income Tax Authorities that Nortel India had negotiated the contract
on behalf of the Nortel group as a whole cannot be faulted.
40. The Income Tax Authorities concluded that the Assessee was a
shadow company of Nortel Canada and both the companies were
essentially a singular entity. In other words, the Income Tax Authorities
had disregarded the corporate structure of the Assessee and had
proceeded on the basis that its identity is the same as Nortel Canada. It is
now well settled that the corporate veil can be lifted only in exceptional
and limited circumstances. Indisputably, in cases where it is found that
the corporate structure has been devised only for evasion of taxes, the
courts have permitted piercing of the corporate veil and this is a well
accepted exception to the rule of a company being a juristic entity having
a separate identity (see : In Re: Sir Dinshaw Maneckjee Petit: AIR
1927, Bombay, 371). However, piercing a corporate veil can be justified
only in circumstances where it is found that a company has been
incorporated only to evade taxes; the company has no real substance; and
there is no commercial expediency for incorporating the company. In the
present case, the Income Tax Authorities found the Assessee to be a mere
paper company with no independent resources. Admittedly, the Assessee
has also not carried out any other activity except supplying equipment
pursuant to the contracts negotiated by Nortel India with Reliance and, in
a later year, with BSNL. The Assessee has neither produced any material
nor advanced any commercial reason for incorporation of the Assessee.
Significantly, the Assessee was incorporated a day prior to execution of
the agreements and, clearly, when the award of contract from Reliance
was a certainty. Admittedly, the equipment supplied to Reliance was
manufactured by Nortel Canada and Nortel Ireland and shipped directly
to Reliance. It is important to note that the performance of the Equipment
Contract was also guaranteed by Nortel Canada. In the circumstances, the
view of the authorities below that the Assessee is a mere shadow
company - in other words an alter ego of Nortel Canada - is certainly a
plausible view and cannot be held to be perverse.
41. In the aforesaid context, it would be appropriate to assume that the
Equipment Contract was performed by Nortel Canada - as has been held
by the AO and CIT(A) and concurred with by the ITAT - and on that
footing, it is to be examined whether any income from supply of
equipment could be taxed under the Act.
42. Section 4 of Act is a charging section and provides for levy of
income tax in respect of total income of the previous year of every
person. Section 5 of the Act outlines the scope of total income and
provides that the total income of a person who is a non-resident in any
previous year includes income from whatever source, which: (a) is
received or is deemed to be received in India in such year by or on behalf
of such person; or (b) accrues or arises or is deemed to accrue or arise to
him in India during such year. Section 9 of the Act specifies the income
that are deemed to accrue or arise in India. Section 9 (1) of the Act
specifies incomes which are deemed to accrue and arise in India. At this
stage, it is necessary to refer to Section 9(1)(i), clause (a) of Explanation
1, Explanation 2 and Explanation 3 to Section 9(1)(i) which are quoted
below:-
"Section 9 (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:
[Explanation 1] -For the purposes of this clause--(a)
in the case of a business of which all the operations are
not carried out in India, the income of the business
deemed under this clause to accrue or arise in India
shall be only such part of the income as is reasonably
attributable to the operations carried out in India;
[Explanation 2--For the removal of doubts, it is
hereby declared that ―business connection‖ shall
include any business activity carried out through a
person who, acting on behalf of the non-resident, -
(a) has and habitually exercises in India, an authority
to conclude contracts on behalf of the non-resident,
unless his activities are limited to the purchase of
goods or merchandise for the non-resident; or
(b)has no such authority, but habitually maintains in
India a stock of goods or merchandise from which he
regularly delivers goods or merchandise on behalf of
the non-resident; or
(c)habitually secures orders in India, mainly or wholly
for the non-resident or for that non-resident and other
non-residents controlling, controlled by, or subject to
the same common control, as that non-resident:
Explanation 3--Where a business is carried on in India
through a person referred to in clause (a) or clause (b)
or clause (c) of Explanation 2, only so much of income
as is attributable to the operations carried out in India
shall be deemed to accrue or arise in India."
43. It is apparent from the plain reading of Section 9(1) of the Act that
all income which accrues or arises through or from any business
connection in India would be deemed to accrue or arise in India. In CIT v.
R.D. Aggarwal & Co.: (1965) 56 ITR 20 (SC), the Supreme Court
observed that business connection would mean "a relation between a
business carried on by a non-resident and some activity in the taxable
territories which are attributable directly or indirectly to the earnings,
profits or gains of such business". However, by virtue of Explanation 1 to
Section 9(1) of the Act, only such part of the income which is reasonably
attributable to operations carried out in India would be taxable. Thus, if it
is accepted that the Assessee has received only the consideration for the
equipment manufactured and delivered overseas, it would be difficult to
uphold the view that any part of Assessee's income is chargeable to tax
under the Act as no portion of the said income could be attributed to
operations in India.
44. There is little material on record to hold that Nortel India habitually
exercises any authority on behalf of the Assessee or Nortel Canada to
conclude contracts on their behalf. There is also no material on record
which would indicate that Nortel India maintained any stocks of goods or
merchandise in India from which goods were regularly delivered on
behalf of the Assessee or Nortel Canada. Thus, by virtue of Explanation 2
read with Explanation 3 to Section 9(1)(i) of the Act, no part of
Assessee's income could be brought to tax under the Act. It is only when
a non-resident Assessee's income is taxable under the Act that the
question whether any benefit under the Double Taxation Avoidance
Treaty is required to be examined.
45. In Ishikawajima-Harima Heavy Industries v. Dir. Of Income
Tax: (2007) 288 ITR 408 (SC), the Supreme Court considered a case
where Petronet LNG Limited and five members of a consortium had
entered into an agreement for setting up a Liquefied Natural Gas (LNG)
receiving, storage and de-gasification facility at Dahej in the State of
Gujarat. The contract was a turnkey project and the role of each
member/consortium of contractors was separately specified. The contract
involved offshore supply, offshore services, onshore supply, onshore
services and construction and erection of the facility. The contract price
included consideration for offshore supplies and offshore services which
was specified separately. The disputes arose as to liability to pay tax
relating to consideration for offshore supplies and offshore services.
Whereas the appellant (a member of the consortium of contractors)
contended that the contract was a divisible one and it did not have any
liability to pay tax in respect of consideration for offshore services and
offshore supplies, the Revenue contended to the contrary. According to
the Revenue, the contract in question was a composite one and could not
be split up for the purposes of considering whether the income arising
therefrom was taxable under the Act. The relevant extracts from the said
judgment are reproduced below:-
―30. The contract is a complex arrangement. Petronet and
the Appellant are not the only parties thereto, there are other
members of the consortium who are required to carry out
different parts of the contract. The consortium included an
Indian company. The fact that it has been fashioned as a
turnkey contract by itself may not be of much significance.
The project is a turnkey project. The contract may also be a
turnkey contract, but the same by itself would not mean that
even for the purpose of taxability the entire contract must be
considered to be an integrated one so as to make the
appellant to pay tax in India. The taxable events in execution
of a contract may arise at several stages in several years. The
liability of the parties may also arise at several stages.
Obligations under the contract are distinct ones. Supply
obligation is distinct and separate from service obligation.
Price for each of the component of the contract is separate.
Similarly, offshore supply and offshore services have
separately been dealt with. Prices in each of the segment are
also different.
31. The very fact that in the contract, the supply segment and
service segment have been specified in different parts of the
contract is a pointer to show that the liability of the appellant
thereunder would also be different.
32. The contract indisputably was executed in India. By
entering into a contract in India, although parts thereof will
have to be carried out outside India would not make the
entire income derived by the contractor to be taxable in
India. We would, however, deal with this aspect of the
matter a little later.
xxxx xxxx xxxx xxxx xxxx
39. The territorial nexus doctrine, thus, plays an important
part in assessment of tax. Tax is levied on one transaction
where the operations which may give rise to income may
take place partly in one territory and partly in another. The
question which would fall for our consideration is as to
whether the income that arises out of the said transaction
would be required to be proportioned to each of the
territories or not.
40. Income arising out of operations in more than one
jurisdiction would have territorial nexus with each of the
jurisdictions on actual basis. If that be so, it may not be
correct to contend that the entire income ―accrues or arises‖
in each of the jurisdiction. ......
xxxx xxxx xxxx xxxx xxxx
76. In construing a contract, the terms and conditions thereof
are to be read as a whole. A contract must be construed
keeping in view the intention of the parties. No doubt, the
applicability of the tax laws would depend upon the nature
of the contract, but the same should not be construed keeping
in view the taxing provisions.
xxxx xxxx xxxx xxxx xxxx
98. We, therefore, hold as under:
(A) Re: Offshore supply
(1) That only such part of the income, as is attributable to
the operations carried out in India can be taxed in India.
(2) Since all parts of the transaction in question i.e. the
transfer of property in goods as well as the payment, were
carried on outside the Indian soil, the transaction could not
have been taxed in India.
(3) The principle of apportionment, wherein the territorial
jurisdiction of a particular State determines its capacity to
tax an event, has to be followed.
(4) The fact that the contract was signed in India is of no
material consequence, since all activities in connection with
the offshore supply were outside India, and therefore cannot
be deemed to accrue or arise in the country.
(5) There exists a distinction between a business
connection and a permanent establishment. As the
permanent establishment cannot be said to be involved in the
transaction, the aforementioned provision will have no
application. The permanent establishment cannot be equated
to a business connection, since the former is for the purpose
of assessment of income of a non-resident under a Double
Taxation Avoidance Agreement, and the latter is for the
application of Section 9 of the Income Tax Act.
(6) Clause (a) of Explanation 1 to Section 9(1)(i) states
that only such part of the income as is attributable to the
operations carried out in India, are taxable in India.
(7) The existence of a permanent establishment would not
constitute sufficient ―business connection‖, and the
permanent establishment would be the taxable entity. The
fiscal jurisdiction of a country would not extend to the taxing
of entire income attributable to the permanent establishment.
(8) There exists a difference between the existence of a
business connection and the income accruing or arising out
of such business connection.
(9) Para 6 of the Protocol to the DTAA is not applicable,
because, for the profits to be 'attributable directly or
indirectly', the permanent establishment must be involved in
the activity giving rise to the profits.
(B) Re: Offshore services:
(1) Sufficient territorial nexus between the rendition of
services and territorial limits of India is necessary to make
the income taxable.
(2) The entire contract would not be attributable to the
operations in India viz. the place of execution of the
contract, assuming the offshore elements form an integral
part of the contract.
(3) Section 9(1)(vii) of the Act read with Memo cannot be
given a wide meaning so as to hold that the amendment was
only to include the income of non-resident taxpayers
received by them outside India from Indian concerns for
services rendered outside India.
(4) The test of residence, as applied in international law
also, is that of the taxpayer and not that of the recipient of
such services.
(5) For 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 India.
(6) The terms 'effectively connected' and 'attributable to'
are to be construed differently even if the offshore services
and the permanent establishment were connected.
(7) Section 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 India.
(8) Article 7 of 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 India.
(9) Applying 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 operations.
(10) The location of the source of income within India
would not render sufficient nexus to tax the income from
that source.
(11) If 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
accordingly.
(12) The services are inextricably linked to the supply of
goods, and it must be considered in the same manner.‖
46. It is clear from the above that even in cases of a turnkey contract, it
is not necessary that for the purposes of taxability, the entire contract be
considered as an integrated one. And, it does not follow that the amount
payable for supply of goods overseas would be chargeable to tax under
the Act.
47. As noticed earlier, there seems to be no dispute that the title to the
equipment passed in favour of Reliance overseas. However, the AO, CIT
(A) and ITAT did not consider the same to be relevant as according to
them, the equipment continued to be in the possession of the ―Nortel
Group‖ till its final acceptance by Reliance. In our view, even if it is
accepted that the equipment supplied overseas continued to be in
possession of Nortel India till the final acceptance by Reliance, the same
would not imply that the Assessee's income from supply of equipment
could be taxed under the Act. Clause (a) of Explanation 1 to Section
9(1)(i) of the Act postulates the principle of apportionment and only such
income that can be reasonably attributed to operations in India would be
chargeable to tax under the Act. The position in Ishikawajima-Harima
Heavy Industries (supra) was also similar. There too, the equipments
were supplied overseas and the contractor continued to retain control of
equipment and material till the provisional acceptance of the work or the
termination of the contract. The relevant clause which was considered by
the Supreme Court in that case is as under:-
―22.1 Title to equipment and materials and contractor's
equipment:
Contractor agrees that title to all equipment and materials
shall pass to the owner from the supplier or subcontractor
pursuant to section E of exhibit H (General Project
Requirements and Procedures). Contractor shall,
however, retain case, custody, and control of such
equipment and materials and exercise due care thereof
until (a) provisional acceptance of the work, or (b)
termination of this contract, whichever shall first occur.
Such transfer of title shall in no way affect the owner's
rights under any other provision of this contract.‖
48. In the present case, the CIT(A) had concluded that Assessee's
obligations were not limited to supply of the equipment overseas but also
included other obligations that were to be performed in India. He further
held that the amounts received by the Assessee also included
consideration for performance of certain activities in India. This is stoutly
disputed by the Assessee. This dispute is pivotal for determining whether
any part of the Assessee's income is chargeable to tax in India.
49. Section 3 of the Services Contract which provide for the scope of
work and services to be performed under the Service Contract and the
relevant extracts from the said section are reproduced below:-
―3.1.1 The Vendor has to provide to Reliance the Services set
forth in the relevant Purchase Order pursuant to and in
accordance with this Optical Services Contract. All Services
shall comply with the Specifications and the Standards. The
Vendor shall coordinate its efforts hereunder with all
Subcontractors, Third Party providers and the Other
Contractors, to ensure compliance with any and all supply and
transportation requirements and all Governmental Entities. All
Services, requiring certification shall be certified by
independent and appropriate professionals licensed or
properly qualified to perform such certification in an
appropriate jurisdictions, reasonably acceptable and at no cost
to Reliance, if such certification is required by Applicable
Law or the Specifications. Vendor shall provide to Reliance,
necessary installation Certificates, as per EPCG regulations
for which the Parties will mutually agree on a format and
procedure and for which Reliance shall reimburse Vendor for
reasonable actual fees paid to any chartered engineers
providing such certification.
xxxx xxxx xxxx xxxx xxxx
3.2.1 Vendor shall provide all Services purchased under a
Purchase Order and in accordance with the relevant
Specifications on an end-to-end basis to ensure successful
completion of the Work (provided, however, that installation
and commissioning Services shall be limited to the Services
requested ordered in the applicable Purchase Order), which
Services include but are not limited to:
(a) Product installation and commissioning (including
commissioning testing) Services including, but not limited
to, ready for installation inspection and validation and as-
built documentation (redline versions); and
xxxx xxxx xxxx xxxx xxxx
3.2.2 At Reliance's request Vendor shall mobilize and commit
sufficient resources necessary to successfully implement the
Initial Optical ,Reliance Network Which will include up to
two hundred (200) expatriates, with the approval of Reliance,
as required, including subject matter experts (Subject to the
experience requirements set forth in Section 3.10 below).‖
50. A bare perusal of the Services Contract clearly indicates that the
task of installation, commissioning and testing was contracted to Nortel
India and thus, the operations pertaining to installation and
commissioning were not performed by Nortel India on behalf of the
Assessee or Nortel Canada but on its own behalf. Thus, neither the
Assessee nor Nortel Canada can be stated to have performed any
installation or commissioning activity in India.
51. Next, it will be important to consider whether the consideration
received by the Assessee for supply of equipment also subsumed
consideration for other activities that were performed in India. The
CIT(A) has held that "the supply contract does not end with loading of
equipment on the ship but includes a number of activities which are
carried on in Indian territories and compensation/remuneration for that
is also included in the consideration". This dispute, as observed earlier, is
at the heart of the controversy in this matter.
52. The equipment supplied by the Assessee is indisputably as per the
terms of the obligations under the Equipment Contract. The recitals of the
said contract reads as under:-
―A. Reliance desires to purchase from the Vendor
certain Equipment appropriate for the efficient and
effective installation, operation, management and
maintenance of the Optical Reliance Network including
the Initial Optical Reliance Network; and
B. The Vendor, desires to provide to Reliance such
Equipment and shall including, without limitation
manufacture, supply and deliver such Equipment, in
accordance with the terms and conditions set forth herein.‖
53. Paragraph 1.2 of the Equipment Contract indicates the objectives
of the said contract and reads as under:-
―Reliance requires equipment that fully supports: (a)
the Initial Optical Reliance Network and the Optical
Reliance Network, including all cost, performance and
functional requirements set forth in the relevant
Documents; (b) Interoperability; and (c) Reliance's
business requirements described in the Documents
(collectively, the ―objectives‖) The Vendor represents
warrants and covenants that the Equipment shall be fully
compatible with and fully supports ,the Objectives as shall
be demonstrated to Reliance, in part, in the Acceptance
Tests.‖
54. Article 3 of the Equipment Contract provides for the scope of
work, responsibilities and milestones. A bare reading of the Equipment
Contract also indicates that the vendor had other obligations such as
coordinating its efforts with the sub-contractors; maintaining a fully
equipped centre and depot with the requisite tools, spares and test
equipment to ensure spares replacement within a period of 48 hours for
critical spares and 15 working days for normal spares; warranty services;
and a toll free access to vendor's technical assistance centres. The vendor
was also obliged to provide equipment for a Test Bed Laboratory at no
extra cost to Reliance. However, there is no material to indicate that any
of the obligations other than supply of equipment was performed by the
Assessee or on its behalf in consideration of the amounts received by the
Assessee. According to the Assessee, it had supplied the subject
equipment and received the consideration for the same.
55. Article 5 of the Equipment Contract contains provisions for Pricing
and Invoicing. Sub Article 5.1 is captioned ―Price List‖ and paragraph
5.1.1 of the Equipment Contract reads as under:-
―5.1.1 The prices as set forth in the Price List shall be
applicable to all purchases by Reliance of Equipment,
including without limitation spare and replacement
parts.‖
56. The expression ―Price List‖ is defined under the contract to read as
under:-
―Price List
means a table of list prices (FCA, "relevant international
airport basis, INCOTERM 2000, including costs for
exportation procedures from the country/ies of export and
insurance from the Vendor's warehouse up to Substantial
Completion) applicable to Equipment supplied by Vendor
to Reliance as amended from time to time as set forth
herein. The Price List as of the Effective Date is set forth
in Exhibit A.‖
57. The Assessee has consistently asserted that ―FCA, relevant
international airport basis, INCOTERM 2000, from the country/ies of
export and insurance from Vendor's warehouse to Substantial
Completion" meant that the supplier was liable to deliver the equipment
to the carrier at the port of shipment/airport of departure which in the
present case would be outside India. The said interpretation has not been
disputed on behalf of the Revenue.
58. In terms of the Assignment Contract, the Assessee assumed all
rights and obligations of Nortel India under the Equipment Contract "to
sell, supply and deliver the Equipment to the Purchaser under the
Equipment Contract".
Section 1 of the Assignment Contract is quoted below for ready
reference:-
―Section 1. Assignment and Assumption. Assignor
hereby assigns to the Assignee all the rights, entitlements,
covenants and obligations of the Assignor under the
Equipment Contract to sell, supply and deliver the
Equipment to the Purchaser under the Equipment Contract
and the Assignee hereby assumes, and agrees with all of the
parties hereto, to perform, observe and be bound by each
and all of the foregoing obligations and covenants of
Assignor. Notwithstanding the foregoing assignment and
assumption, except as set forth in the next sentence, as
between Assignor and Purchaser, the parties agree that
Assignor shall continue to be bound by all of the terms and
conditions of the Equipment Contract and shall remain fully
liable to Purchaser under the Equipment contract to the
same extent as if the foregoing assignment and assumption
had not occurred. Purchaser agrees that from and after the
Effective Date of this Assignment, Purchaser shall place all
Purchase Orders and Change Orders for the supply of
Equipment directly with Assignee and Assignor shall have
no liability or obligations under this Assignment with
respect to such Purchase Orders and Change Orders (the
"Liability Exception").‖
59. It is apparent from the above that the Assessee only assumed the
obligation to sell, supply and deliver equipment in terms of the
Equipment Contract and was paid in terms of the pricing mechanism as
agreed to under the Equipment Contract. It is also material to note that
Nortel India continued to be responsible for performance of the
Equipment Contract except for performance of Purchase Orders and
Exchange Orders for supply of equipment which were placed directly by
Reliance on the Assessee. Although, the Assessee had repeatedly asserted
that all other obligations for testing, installation and commissioning was
done by Nortel India, for which Nortel India had been paid separately, no
material or evidence was gathered by the AO to contradict the same.
There is no material to indicate that equipment for Test Bed Laboratory,
which was to be supplied at no additional cost to Reliance had been
procured by Nortel India at additional cost or that Nortel India was not
remunerated for all the services rendered by it to Reliance. In terms of the
Equipment Contract, adequate stock of spares was required to be
maintained in India, however, there is no material to indicate that such
stock was maintained in India by the Assessee or that such stock was
maintained by Nortel India, not on its own behalf but on behalf of the
Assessee, without being sufficiently remunerated. Thus, in absence of any
such evidence or material, it is difficult for us to concur with the view
that certain activities were performed in India for which the consideration
was received by the Assessee.
60. It is also necessary to observe that even if the AO was of the view
that Nortel India was not adequately remunerated for the Assignment
Contract, the AO was required to make an appropriate transfer pricing
adjustment in the hands of Nortel India.
61. Thus, in our view, the question whether the Assessee has a PE in
India is not material as it is not possible to hold that any part of the
income of the Assessee could be apportioned to operations carried on in
India.
62. Having stated the above, for the sake of completeness, we may also
examine the controversy whether the Assessee has a PE in India and
whether any part of the Assessee's income could be attributed to such PE.
63. Undisputedly, even if it is accepted that some portion of the
obligations undertaken by the Assessee were performed in India, the
Assessee's income arising from the performance of the Equipment
Contract could be brought to tax only to the extent as permissible under
the relevant DTAA - DTAA between India and USA or DTAA between
India and Canada.
64. Both the OECD and US Model Conventions specify that only such
portion of business profits that is attributable to the PE of a foreign
enterprise would be taxable in the other contracting state. The UN Model
Convention also provides for additionally bringing such business profits
that could be attributed to the PE by force of attraction to a PE; that is,
income from sale of goods and merchandise or through business activities
carried on in a State which are similar to goods and merchandise sold
through the PE or activities carried on through a PE would also be subject
to tax in the contracting state in which the PE is situated. Paragraphs 1 of
Article 7 of the Model Conventions are relevant and are re-produced
below:
"OECD MC
Article 7
Business Profits
1. Profits of an enterprise of a Contracting State shall be
taxable only in that State unless the enterprise carries on
business in the other Contracting State through a
permanent establishment situated therein. If the enterprise
carries on business as aforesaid, the profits that are
attributable to the permanent establishment in accordance
with the provisions of paragraph 2 may be taxed in that
other State.
UN MC
Article 7
Business Profits
1. The profits of an enterprise of a Contracting State shall
be taxable only in that State unless the enterprise carries on
business in the other Contracting State through a
permanent establishment situated therein. If the enterprise
carries on business as aforesaid, the profits of the
enterprise may be taxed in the other State but only so much
of them as is attributable to (a) that permanent
establishment; (b) sales in that other State of goods or
merchandise of the same or similar kind as those sold
through that permanent establishment; or (c) other business
activities carried on in that other State of the same or
similar kind as those effected through that permanent
establishment.
US MC
Article 7
Business Profits
"1. The profits of an enterprise of a Contracting State shall
be taxable only in that State unless the enterprise carries on
business in the other Contracting State through a
permanent establishment situated therein. If the enterprise
carries on business as aforesaid, the business profits of the
enterprise may be taxed in the other State but only so much
of them as is attributable to that permanent
establishment."
65. Article 7 of the Indo-USA DTAA reads as under:
―1. The profits of an enterprise of a Contracting State
shall be taxable only in that State unless the enterprise
carries on business in the other Contracting State
through a permanent establishment situated therein. If
the enterprise carries on business as aforesaid, the profits
of the enterprise may be taxed in the other State but only
so much of them as is attributable to (a) that permanent
establishment; (b) sales in the other State of goods or
merchandise of the same or similar kind as those sold
through that permanent establishment; or (c) other
business activities carried on in the other State of the
same or similar kind as those effected through that
permanent establishment.
2. Subject to the provisions of paragraph 3, where an
enterprise of a Contracting State carries on business in
the other Contracting State through a permanent
establishment situated therein, there shall in each
Contracting State be attributed to that permanent
establishment the profits which it might be expected to
make if it were a distinct and independent enterprise
engaged in the same or similar activities under the same
or similar conditions and dealing wholly at arm's length
with the enterprise of which it is a permanent
establishment and other enterprises controlling,
controlled by or subject to the same common control as
that enterprise. In any case where the correct amount of
profits attributable to a permanent establishment is
incapable of determination or the determination thereof
presents exceptional difficulties, the profits attributable
to the permanent establishment may be estimated on a
reasonable basis. The estimate adopted shall, however,
be such that the result shall be in accordance with the
principles contained in this Article.
3. In the determination of the profits of a permanent
establishment, there shall be allowed as deductions
expenses which are incurred for the purposes of the
business of the permanent establishment, including a
reasonable allocation of executive and general
administrative expenses, research and development
expenses, interest, and other expenses incurred for the
purposes of the enterprise as a whole (or the part thereof
which includes the permanent establishment), whether
incurred in the State in which the permanent
establishment is situated or elsewhere, in accordance
with the provisions of and subject to the limitations of
the taxation laws of that State. However, no such
deduction shall be allowed in respect of amounts, if any,
paid (otherwise than towards reimbursement of actual
expenses) by the permanent establishment to the head
office of the enterprise or any of its other offices, by
way of royalties, fees or other similar payments in return
for the use of patents, know-how or other rights, or by
way of commission or other charges for specific services
performed or for management, or, except in the case of a
banking enterprises, by way of interest on moneys lent
to the permanent establishment. Likewise, no account
shall be taken, in the determination of the profits of a
permanent establishment, for amounts charged
(otherwise than toward reimbursement of actual
expenses), by the permanent establishment to the head
office of the enterprise or any of its other offices, by
way of royalties, fees or other similar payments in return
for the use of patents, know-how or other rights, or by
way of commission or other charges for specific services
performed or for management, or, except in the case of a
banking enterprise, by way of interest on moneys lent to
the head office of the enterprise or any of its other
offices.
4. No profits shall be attributed to a permanent
establishment by reason of the mere purchase by that
permanent establishment of goods or merchandise for
the enterprise.
5. For the purposes of this Convention, the profits to be
attributed to the permanent establishment as provided in
paragraph 1(a) of this Article shall include only the
profits derived from the assets and activities of the
permanent establishment and shall be determined by the
same method year by year unless there is good and
sufficient reason to the contrary.
6. Where profits include items of income which are dealt
with separately in other Articles of the Convention, then
the provisions of those Articles shall not be affected by
the provisions of this Article.
7. For the purposes of the Convention, the term
"business profits" means income derived from any trade
or business including income from the furnishing of
services other than included services as defined in
Article 12 (Royalties and Fees for Included Services)
and including income from the rental of tangible
personal property other than property described in
paragraph 3(b) of Article 12 (Royalties and Fees for
Included Services).‖
66. India and Canada have also entered into a DTAA. Paragraph 1 of
Article 7 of the Indo-Canada DTAA is slightly different from paragraph 1
of Article 7 of the Indo-US DTAA - which is similar to paragraph 1 of
Article 7 of the UN model convention - in as much as other business
activities carried on in the other State of the same or similar kind as those
effected through the permanent establishment are not subject to tax in the
state where the PE is situated.
67. Thus, if we proceed on the assumption that a part of the Assessee's
income is attributable to activities carried out in India through a business
connection, the question whether the Assessee had a PE in India during
the relevant AYs would become relevant. This is so because, if the
Assessee did not have any PE in India then its business income would not
be taxable under the Act even though a part of the same can be attributed
to activities in India.
68. Article 5 of the Indo-US DTAA defines PE as under:-
"Article 5
PERMANENT ESTABLISHMENT
1. For the purposes of this Convention, the term
"permanent establishment" means a fixed place of business
through which the business of an enterprise is wholly or
partly carried on.
2. The term "permanent establishment" includes
especially:
(a) a place of management;
(b) a branch;
(c) an office;
(d) a factory;
(e) a workshop;
(f) a mine, an oil or gas well, a quarry, or any other
place of extraction of natural resources;
(g) a warehouse, in relation to a person providing
storage facilities for others;
(h) a farm, plantation or other place where
agriculture, forestry, plantation or related
activities are carried on;
(i) a store or premises used as a sales outlet;
(j) an installation or structure used for the
exploration or exploitation of natural resources,
but only if so used for a period of more than 120
days in any twelve-month period;
(k) a building site or construction, installation or
assembly project or supervisory activities in
connection therewith, where such site, project or
activities (together with other such sites, projects
or activities, if any) continue for a period of
more than 120 days in any twelve-month period;
(l) the furnishing of services, other than included
services as defined in Article 12 (Royalties and
Fees for Included Services), within a
Contracting State by an enterprise through
employees or other personnel, but only if:
(i) activities of that nature continue within that
State for a period or periods aggregating more
than 90 days within any twelve-month period; or
(ii) the services are performed within that State for a
related enterprise [within the meaning of
paragraph 1 of Article 9 (Associated
Enterprises)].
3. Notwithstanding the preceding provisions of this
Article, the term "permanent establishment" shall be deemed
not to include any one or more of the following:
(a) the use of facilities solely for the purpose of
storage, display, or occasional delivery of goods
or merchandise belonging to the enterprise;
(b) the maintenance of a stock of goods or
merchandise belonging to the enterprise solely
for the purpose of storage, display or occasional
delivery;
(c) the maintenance of a stock of goods or
merchandise belonging to the enterprise solely
for the purpose of processing by another
enterprise;
(d) the maintenance of a fixed place of business
solely for the purpose of purchasing goods or
merchandise, or of collecting information, for
the enterprise;
(e) the maintenance of a fixed place of business
solely for the purpose of advertising, for the
supply of information, for scientific research or
for other activities which have a preparatory or
auxiliary character, for the enterprise.
4. Notwithstanding the provisions of paragraphs 1 and 2,
where a person--other than an agent of an independent status
to whom paragraph 5 applies--is acting in a Contracting State
on behalf of an enterprise of the other Contracting State, that
enterprise shall be deemed to have a permanent establishment
in the first-mentioned State, if:
(a) he has and habitually exercises in the first-
mentioned State an authority to conclude
contracts on behalf of the enterprise, unless his
activities are limited to those mentioned in
paragraph 3 which, if exercised through a fixed
place of business, would not make that fixed
place of business a permanent establishment
under the provisions of that paragraph;
(b) he has no such authority but habitually
maintains in the first-mentioned State a stock of
goods or merchandise from which he regularly
delivers goods or merchandise on behalf of the
enterprise, and some additional activities
conducted in that State on behalf of the
enterprise have contributed to the sale of the
goods or merchandise; or
(c) he habitually secures orders in the first-
mentioned State, wholly or almost wholly for
the enterprise.
5. An enterprise of a Contracting State shall not be
deemed to have a permanent establishment in the other
Contracting State merely because it carries on business in
that other State through a broker, general commission agent,
or any other agent of an independent status, provided that
such persons are acting in the ordinary course of their
business. However, when the activities of such an agent are
devoted wholly or almost wholly on behalf of that enterprise
and the transactions between the agent and the enterprise are
not made under arm's-length conditions, he shall not be
considered an agent of independent status within the meaning
of this paragraph.
6. The fact that a company which is a resident of a
Contracting State controls or is controlled by a company
which is a resident of the other Contracting State, or which
carries on business in that other State (whether through a
permanent establishment or otherwise), shall not of itself
constitute either company a permanent establishment of the
other.‖
The Definition of PE under Article 5 of the DTAA between India and
Canada is also similar.
69. The AO, CIT(A) and ITAT have held that the office of Nortel India
and Nortel LO constituted a fixed place of business of the Assessee. As
pointed out earlier, we find no material on record that would even
remotely suggest that Nortel LO had acted on behalf of the Assessee or
Nortel Canada in negotiating and concluding agreements on their behalf.
Thus, it is not possible to accept that the offices of Nortel LO could be
considered as a fixed place of business of the Assessee. In so far as Nortel
India is concerned, there is also no evidence that the offices of Nortel
India were at the disposal of the Assessee or Nortel Canada. Even if it is
accepted that Nortel India had acted on behalf of the Assessee or Nortel
Canada, it does not necessarily follow that the offices of Nortel India
constituted a fixed place business PE of the Assessee or Nortel Canada.
Nortel India is an independent company and a separate taxable entity
under the Act. There is no material on record which would indicate that
its office was used as an office by the Assessee or Nortel Canada. Even if
it is accepted that certain activities were carried on by Nortel India on
behalf of the Assessee or Nortel Canada, unless the conditions of
paragraph 5 of Article 7 of the Indo-US DTAA is satisfied, it cannot be
held that Nortel India constituted a fixed place of business of the
Assessee or Nortel Canada.
70. The AO has further alleged that the offices of Nortel LO and
Nortel India were used as a sales outlet. In our view, this finding is also
unmerited as there is no material which would support this view. The
facts on record only indicate that Nortel India negotiated contracts with
Reliance. Even assuming that the contracts form a part of the single
turnkey contract, which include supply of equipment - as held by the
authorities below - the same cannot lead to the conclusion that Nortel
India was acting as a sales outlet.
71. The AO's conclusion that there is an installation PE in India, is
also without any merit. A bare perusal of the Services Contract clearly
indicates that the tasks of installation, commissioning and testing was
contracted to Nortel India and Nortel India performed such tasks on its
own behalf and not on behalf of the Assessee or Nortel Canada.
Undisputedly, Nortel India was also received the agreed consideration for
performance of the Services Contract directly by Reliance.
72. The finding that Nortel India is a services PE of the Assessee is
also erroneous. There is no material to hold that Nortel India performed
services on behalf of the Assessee.
73. The AO has also held that Nortel India constituted Dependent
Agent PE of the Assessee in India. The aforesaid conclusion was
premised on the finding that Nortel India habitually concludes contracts
on behalf of the Assessee and other Nortel Group Companies. In the
present case, there is no material on record which would indicate that
Nortel India habitually exercises authority to conclude contracts for the
Assessee or Nortel Canada. In order to conclude that Nortel India
constitutes a Dependent Agent PE, it would be necessary for the AO to
notice at least a few instances where contracts had been concluded by
Nortel India in India on behalf of other group entities. In absence of any
such evidence, this view could not be sustained.
74. The CIT(A) as well as the ITAT has proceeded on the basis that the
Assessee had employed the services of Nortel India for fulfilling its
obligations of installation, commissioning, after sales service and
warranty services. The ITAT also concurred with the view that since
employees of group companies had visited India in connection with the
project, the business of the Assessee was carried out by those employees
from the business premises of Nortel India and Nortel LO. In this regard,
it is relevant to observe that a subsidiary company is an independent tax
entity and its income is chargeable to tax in the state where it is resident.
In the present case, the tax payable on activities carried out by Nortel
India would have to be captured in the hands of Nortel India. Chapter X
of the Act provides an exhaustive mechanism for determining the Arm's
Length Price in case of related party transactions for ensuring that real
income of an Indian Assessee is charged to tax under the Act. Thus, the
income from installation, commissioning and testing activities as well as
any function performed by expatriate employees of the group companies
seconded to Nortel India would be subject to tax in the hands of Nortel
India and the same cannot be considered as income of the Assessee.
75. Thus, the first three questions framed in ITA 671/2014, 672/2014,
669/2014 and 689/2014 are answered in the affirmative, that is, in favour
of the Assessee and against the Revenue.
76. In view of our conclusion that the Assessee's income from supply
of equipment was not chargeable to tax in India, the question relating to
attribution of any part of such income to activities in India does not arise.
In view of our conclusion that the Assessee does not have a PE in India,
the question of attribution of any income to the alleged PE also does not
arise.
77. The controversy involved in ITA 666/2014, 667/2014 and
673/2014 does not relate to the issue whether the Assessee has a PE in
India but concerns the question whether research and development
expenses were liable to be taken into account while estimating the profits
under Rule 10 of the Income Tax Rules, 1962. This issue also no longer
survives in view of our conclusion that no part of the Assessee's income
from supply of equipment is chargeable to tax under the Act.
78. The appeals are, accordingly, allowed and the impugned orders are
set aside. However, the parties are left to bear their own costs.
VIBHU BAKHRU, J
S.MURALIDHAR, J
MAY 04, 2016
RK/MK/pkv
