Ishikawajma-Harima Heavy Industries Ltd Vs. Director of Income Tax, Mumbai [2007] Insc 8 (4 January 2007)
2007 Latest Caselaw 8 SC

Ishikawajma-Harima Heavy Industries Ltd V. Director of Income Tax, Mumbai [2007] Insc 8 (4 January 2007)

S.B. Sinha & Dalveer Bhandari [Arising out of SLP (Civil) No.5318 of 2005] S.B. SINHA, J :

Leave granted.

Appellant herein is a company incorporated in Japan. It is a resident of the said country. It pays its taxes in Japan. It is engaged, inter alia, in the business of construction of storage tanks as also engineering etc. It formed a consortium along with Ballast Nedam International BV, Itochu Corporation, Mitsui & Co. Ltd., Toyo Engineering Corporation and Toyo Engineering (India) Ltd. With the said consortium members, it entered into an agreement with Petronet LNG Limited (hereinafter referred to as "the Petronet") on 19.01.2001 for setting up a Liquefied Natural Gas (LNG) receiving storage and degasification facility at Dahej in the State of Gujarat.

A supplementary agreement was entered into by the parties on 19.03.2001.

The contract envisaged a turnkey project. Role and responsibility of each member of the consortium was specified separately. Each of the member of the consortium was also to receive separate payments. Appellant was to develop, design, engineer and procure equipment, materials and supplies, to erect and construct storage tanks of 5 MMTPA capacity, with potential expansion to 10 MMTPA capacity at the specified temperatures i.e. -200 degree Celsius. The arrangement also was to include marine facilities (jetty and island break water) for transmission and supply of the LNG to purchasers; to test and commission the facilities relating to receipt and unloading, storage and re-gasification of LNG and to send out of re-gasified LNG by means of a turnkey fixed lump-sum price time certain engineering procurement, construction and commission contract. The project was to be completed in 41 months. The contract indisputably involved :

offshore supply,

offshore services,

onshore supply,

onshore services and

construction and erection. The price was payable for offshore supply and offshore services in US dollars, whereas that of onshore supply as also onshore services and construction and erection partly in US dollars and partly in Indian rupees.

Liability to pay income tax in India by the appellant herein being doubtful, an application was filed by the same before the Authority for Advance Rulings (Income Tax) (hereinafter referred to as 'the Authority') in terms of Section 241(Q)(1) of the Income Tax Act, 1961 (hereinafter referred to as 'the Act'). The following questions were proposed by the appellant for determination:

 "On the facts and circumstances of the case, whether the amounts, received/receivable by the applicant from Petronet LNG for offshore supply of equipments, materials, etc. are liable to tax in India under the provisions of the Act and India- Japan tax treaty?

 If the answer to (1) is in the affirmative in view of Explanation (a) to section (1)(i) of the Act and/or Article (1) read together with the protocol of the India-Japan tax treaty, to what extent are the amounts reasonably attributable to the operations carried out in India and accordingly taxable in India?

On the facts and circumstances of the case, whether the amounts received/receivable by the applicant from Petronet LNG for offshore services are chargeable to tax in India under the Act and/or the India-Japan tax treaty?

If the answer to (3) above is in the affirmative, to what extent would be amounts received/receivable for such services be chargeable to tax in India under the Act and/or the India-Japan tax treaty?

If the answer to (3) above in the affirmative, would be applicant be entitled to claim deduction for expenses incurred in computing the income from offshore services under the Act and/or the India- Japan treaty? Before the Authority no issue was raised as regards the liability of the appellant to pay income tax on onshore supply and onshore services and on its activities relating to construction and erection. The dispute centered round its exigibility to pay tax in respect of 'offshore supply' and 'offshore services'.

It is also not in dispute that the Government of India and the Government of Japan entered into a by-lateral treaty in regard to the tax liabilities.

Contention of the appellant before the Authority was that the contract being a divisible one, it did not have any liability to pay any tax in regard to offshore services and offshore supply. Revenue, on the other hand, contended that the contract being a composite and integrated one, they were so liable.

The Authority referred to a large number of decisions governing the field and opined that having regard to the provisions contained in Section 5 read with Section 9 of the Act, following propositions of law would emerge :

"In a case of sale of goods simpliciter by a non- resident to a resident in India, if the consideration for sale is received abroad and the property in the goods also passes to the purchaser outside India, no income accrues or arises or deemed to accrue or arise to the seller in India.

In a case of transaction of sale of goods by the non-resident to an Indian resident which is a part of a composite contract involving various operations within and outside India, income from such sale shall be deemed to accrue or arise in India if it accrues or arises through or from any business connection in India.

In the case of a business of which all operations are not carried out in India, the deemed accrual or arising of income shall be only such part of the income as is reasonably attributable to the operations carried out in India.

Whether there is business connection in India or/and whether all operations of the business are not carried out in India are questions of fact which have to be determined on the facts of each case." Applying the said principles to the facts of the present case, the Authority opined that the appellant was liable to pay direct tax even under the Treaty having regard to Articles 5 and 7 thereof as also Clause 6 of the Protocol. It was held :

"The substance of the protocol quoted above, represents the consensus reached between the parties to the treaty in regard to the meaning of the phrase "directly or indirectly attributable to that permanent establishment" employed in paragraph 1 of article 7.

Further, profits shall also be regarded as attributable to the permanent establishment to the extent indicated in the said protocol even when the contract or order relating to the sale or provision of goods or services in question is made or placed directly with the overseas head office of the enterprise rather than with the permanent establishment.

It would be clear that having regard to provisions of article 7(1) of the Treaty read with para 6 of the protocol supply of equipment of machinery (sale of which was completed abroad, having placed the order directly overseas office of the enterprise) the same should be within the meaning of the phrase directly or indirectly attributable to that permanent establishment." As regards taxability of the amounts 'received' and 'receivable' by the appellant from Petronet for offshore services, it was held :

"In so far as the Treaty is concerned, both section 115A(1)(b)(B) and para 2 of Article 12 of the Treaty clearly indicates that the whole technical fee without any deduction is chargeable to tax, however, the tax so charged shall not exceed 20% of the gross amount of the royalty or fee for technical services." Question Nos. 4 and 5 were held to be the consequential ones. It was opined :

"In the light of the above discussions we rule on :

Question No.1 that on the facts and in the circumstances of the case, the amounts received/receivable by the applicant from Petronet LNG in respect of offshore supply of equipment and materials is liable to be taxed in India under the provisions of the Act and the India-Japan Treaty.

Question No.2 that in view of the Explanation (a) to section 9(1)(i) of the Act and/or Article 7(1) read with the Protocol of the India-Japan Treaty the amounts that would be taxable in India is so much of the profit as is reasonably attributable to the operations carried out in India, we decline to answer the other part of the question in regard to quantification of the amount taxable in India as the parties produced no evidence and did not address in this regard.

Question No. 3 that the amount received/receivable by the applicant from Petronet LNG for offshore services is liable to be taxed in India both under the provisions of the Act as well as under Indo-Japan Treaty.

Question No.4 that the entire amount received for offshore services is chargeable to tax under the Act and under the Treaty but at the rate not more than 20% of the gross amount.

Question No. 5 that the applicant would not be able to claim any deduction in computing the income from offshore service under the Act, and/or under the Indo-Japan Treaty." Before us, the following findings of the Authority are not disputed :

 the Petitioner has a business connection in India;

 if consideration accrues only for supply of goods and the sale is completed outside India no profits can accrue in India;

however, if a contract envisages a composite consideration for the various obligations to be performed and if certain operations are to be performed by or through the business connection, then, profits would be deemed to accrue in India;

property in the goods, which were the subject matter of the offshore supply, passed outside India; and

the petitioner has a permanent establishment in India within the meaning of the said term in paragraph 3 of Article 5 of the Double Taxation Avoidance Agreement entered into between the Governments of India and Japan (hereinafter referred to as "the DTAA")." Mr. Harish N. Salve, the learned Senior Counsel appearing on behalf of Appellant, urged :

The Authority misconstrued and misinterpreted the contract in arriving at its aforementioned findings, as from a bare perusal thereof, it would appear that the payments were made in US dollars in respect of 'offshore supply' and 'offshore services' and furthermore title to the goods passed on to Petronate outside the territories of India and services had also been rendered outside India;

The fact that the contract signed in India was of consequences as converse could not have made the appellant not liable to pay the tax;

The Authority committed a manifest error in arriving at its findings insofar as it failed to properly construe Explanation-2 appended to Section 9(1)(vii) of the Act as it was nobody's case that the consideration related to a construction, assembly, mining or like project so as to fall outside the scope thereof;

Although fee received by Appellant is effectively connected to the contract but it is not attributable to the permanent establishment and, therefore, Article 12(5) of the Double Taxation Avoidance Agreement (DTAA) is not attracted;

Appellant being a non-resident in terms of Section 5(2) of the Act, it would be chargeable to tax in India only in the event income accrues or arises in India or is deemed to accrue or arise in India or income is received or is deemed to be received in India and not otherwise;

As no part of the income for the 'offshore supply' or 'offshore services' is received in India, the Authority misdirected itself in passing the impugned judgment;

A legal fiction raised under the Act cannot be pushed too far. Also, as all operations in connection with the offshore supply are carried out outside India, the question of any portion of the consideration to be regarded as deemed to accrue or arise in India would not arise;

The requirement of the appellant to perform certain services in India, such as unloading, port clearance, transportation of the equipments supplied would not render the appellant eligible to tax as the consideration thereof is embedded in the consideration for the offshore supply;

Although the appellant was required to carry out certain activities in India, the consideration for offshore services had separately been provided for.

 Assuming that the income from the offshore supply is chargeable to tax in India on the premise that Section 9(1)(i) applies, it was required to be examined by the Authority as to whether it would also be chargeable in accordance with the provisions of the Double Taxation Avoidance Agreement (DTAA) in terms whereof no charge to tax in India was leviable in respect of the consideration for offshore supply.

Mr. Mohan Parasaran, the learned Additional Solicitor General appearing on behalf of the respondent, on the other hand, submitted :

The question as to whether terms of the contract constitute a composite contract or not is essentially a question of fact and the findings of the Authority being final, therefore, should not ordinarily be interfered with;

The Authority having found in favour of the Revenue two primary tests to determine as to whether the contract in question was a composite one for execution of a turnkey project viz :

 whether the 'offshore' and 'onshore' elements of the contract are so inextricably linked that the breach of the 'offshore' element would result in the breach of the whole contract;

whether the dominant object of the contract is the execution of a turnkey project and the question whether the title to the goods supplied passes offshore or within India is secondary to the execution of the contract, the impugned judgment should not be interfered with;

Each component of the contract was directly relatable to the performance of the integrated contract as violation and/or breach on the part of the parties thereto would affect the entire contract;

The contract itself providing for milestone dates, the breach of any of the terms thereof would result in the breach of the entire contract and not just the particular obligation;

The turnkey project contemplated a permanent establishment and in that view of the matter Explanation appended to Section 9(1)(i) of the Act is directly applicable.

The appellant has business connection in India and in that view of the matter the causal connection between the offshore supply and offshore services being interlinked with the entire project, the opinion of the Authority cannot be faulted;

By reason of DTAA, the parties thereto can always allocate the jurisdiction to tax the entire income attributable to such permanent establishment to the country in which it is established;

Supply of goods whether offshore or onshore as well as rendition of service whether offshore or onshore are attributable to the turnkey project and, thus, it would be wrong to contend that in terms of Article 7 of DTAA, no tax could be levied upon the appellant.

Contract : The Material Part :

Petronat LNG Limited, on the one hand, and five members of the consortium, on the other, are parties to the contract. The contract contained broad items. It has its own interpretation clauses. Clause 2.1 provides for scope of the work in the following terms :

"2.1 The Work Except as otherwise expressly provided in this Contract, Contractor shall provide, furnish and perform, or cause to be provided, furnished and performed, on a turnkey basis all necessary design, engineering, procurement, supplies, installation, erection, construction, testing, commissioning, operation and turning over services, activities and work (including all rectification and remedial services, activities and work relating to defects and deficiencies) for the Equipment and Materials and the Facilities in accordance with the Scope of Work (Exhibit A) and the other terms, provisions and requirements of this Contract, including the Contract Schedule, and shall provide all necessary and sufficient Contractor's Equipment and experienced personnel having the requisite expertise for such purposes.

After Mechanical Completion of the Facilities, Contractor shall carry out Commissioning, start-up and testing of the Facilities and, if requested by Owner, shall provide advisory assistance in connection with the operation and maintenance of the Facilities and shall provide all necessary and sufficient experienced personnel having the requisite expertise for the prompt performance of any rectification and remedial work required until Final Acceptance of the Facilities, in accordance with this Contract.

The Parties acknowledge and agree that this Contract is a lump-sum firm fixed price time certain turnkey contract and Contractor's obligation to provide, furnish and perform its services, activities and work under this Contract includes Contractor providing Owner with the operating and completed Facilities, complete in every detail within the time and for the purposes specified in this Contract and to do and furnish Owner everything necessary in connection herewith.

The foregoing obligations, work, services, activities and responsibilities of Contractor are more fully set forth in this Contract, including the Scope of Work (Exhibit A).

The Technical Documents and the obligations under Clause 2.2. are herein collectively referred to as the "Work".

Except as otherwise expressly provided in this Contract, Contractor agrees and acknowledges that Contractor shall perform all of its obligations and responsibilities under this Contract at its own risk, cost and expense." Clause 2.2. provides for additional responsibilities of the appellant, which reads as under :.

"2.2 Additional Responsibilities Except as otherwise expressly provided in this Contract, Contractor shall be responsible for providing, or causing the provision of, design, engineering, procurement, erection, construction and commissioning and testing services, activities and work, and personnel and labour, and all Equipment and Materials (and components thereof) and Contractor's Equipment, and any other items not specifically described in the Scope of Work (Exhibit- A) and/or the Technical Documents if (a) it reasonably may be inferred in accordance with Good Industry Practice that the providing, or causing the provision, of such additional items was contemplated as part of the Work (including the Technical Documents) or (b) the providing, or causing the provision, of such additional items is necessary in order for Contractor to satisfy the Completion and Performance Guarantees and the warranties set forth, in this Contract and to make the Facilities operable and capable of performing as specified in the Technical Documents or as otherwise necessary in order to comply with the requirements of this Contract. Without limitation to the foregoing, wherever this Contract describes any portion of the Work in general terms, but not complete in detail, Contractor agrees that the Work shall include any incidental work, activities and services which may be reasonably inferred as required or necessary to complete and render operable the Facilities in accordance with the terms and conditions of the Contract, and owner shall have no obligation or responsibility whatsoever (except as specifically set forth in this Contract) with respect to the completion of the Facilities.

Contractor shall ensure that the Facilities shall be fit and suitable for its intended purpose (including attaining the Completion and Performance Guarantees) as evidenced by, or reasonably to be inferred from, this Contract, and shall fully comply with the Contract.

Work undertaken, Equipment and Materials (including components thereof), Contractor's Equipment, labour and personnel, and additional items provided pursuant to this Clause 2.2 shall not give rise to any adjustment in this Contract Price, the Contract Schedule or any other terms of this Contract, and shall be included in and comprise the Work for all purposes of this Contract.

Clause 7.1 provides for shipment in the following terms :

"7.1 Notice of Shipment Contractor shall comply with and follow the procedures for shipment set forth in Section E of Exhibit H (General Project Requirements and Procedures). In particular, at least prior to arrival of each shipment in India, Owner and Owner's insurance company providing insurance will receive from the Contractor, the notice of shipment, such notice shall set forth the following information concerning such shipment : (a) a reference to the date, parties and subject matter of this Contract; (b) a description of, or that part of, the Equipment and Materials contained in such shipment; (c) the date of embarkation and departure, (d) the port of origin, (e) the means of shipment (air or sea); (f) the estimated date of arrival in India; (g) the port of entry in India; (h) the value of the shipment; (i) the approximate weight and volume (gross and net); (j) the name, flag and owner of the vessel if shipment by sea or the designation of aircraft if ship is by air; and (k) the number and value of bill of lading or airfreight bill. Contractor shall ensure that a provision similar to this Clause 7.1 is included in all agreements with Suppliers.

Contractor shall be responsible for packing, loading, transporting, receiving, unloading, storing and protecting all Equipment and Materials and/or Contractor's Equipment and other things required for the Works." Price is specified under Clause 13.1 in the following terms :

"13.1 Contract Price The total price to be paid by or on behalf of Owner to Contractor in full consideration for the performance by Contractor of its obligations and responsibilities under this Contract, including the Work, shall be a fixed and firm lump sum price of US$ 151,044.192 (One hundred fifty one million forty four thousand one hundred ninety two US Dollars) (the "US Dollar Portion) and Rs.7,602,796,324 (Seven billion six hundred two million seven hundred ninety six thousand three hundred twenty four Indian Rupees) (the "Indian Rupee Portion"), which shall be subject to adjustment only as provided under Clause 13.4 (the US Dollar Portion and the Indian Rupee Portion, as the same may be so adjusted, together, the "Contract Price")." The contract envisages that the appellant may do the job itself or get the same done by sub-contracting. It may only do a part of the job itself.

The contract splits in dollar and rupee components separately. Clause

14.8 provides for general terms of payment, effect of payment and methodology of payment. Pursuant to or in furtherance whereof separate payment in US dollars and Indian rupees is to be made depending upon the nature of supply viz. offshore supply and offshore services and onshore supply and onshore services.

Clause 22.1 deals with passing of title to the goods supplied in the following terms :

22.1 Title to Equipment and Materials and Contractor's Equipment Contractor agrees that title to all Equipment and Materials shall pass to Owner from the Supplier or Subcontractor pursuant to Section E of Exhibit H (General Project Requirements and Procedures).

Contractor shall, however, retain care, custody, and control of such Equipment and Materials and exercise due care thereof until (a) Provisional Acceptance of the Work or (b) termination of this Contract, whichever shall first occur. Such transfer of title shall in no way affect Owner's rights under any other provision of this Contract." The interpretation of different components of contract has been dealt within Annexure-A appended thereto. So far as 'offshore services work items' are concerned, the same has been defined to mean the items of work set forth as item numbers D-2.2.1, 2.2.2 and 2.2.3 of the Contract Price Schedule; details whereof have been mentioned in the said Annexure, which, inter alia, provides :

Notes General

xxx xxx xxx

Offshore supply (Exhibit D-2.1) is the price of Equipment & Material (including cost of engineering, if any, involved in the manufacture of such Equipment & Material) supplied from outside India on CFR basis, and the property therein shall pass on to the Owner on high seas for permanent incorporation in the Works, in accordance with the provisions of the Contract.

Offshore Services (Exhibit D-2.2) is the price of design and engineering including detail engineering in relation to supplies, services and construction & erection and cost of any other services to be rendered from outside India.

Onshore Supply (Exhibit D-2.3 is the price of Equipment & Material supplied from within India for direct delivery at Site and permanent incorporation in the Works.

Onshore services (Exhibit D-2.4) is the price of design engineering, detail engineering, customs clearance, inland transportation, procurement services, supervision services, project management, testing and commissioning and any such service in relation to the Works rendered in India." The break down of contract price is as under :

Exhibit No./Sl.

No.

Description of Scope In Indian Rupees In US Dollars Name and address of Contracting entity D-2.1 Offshore Supply (Total of 2.1.1., 2.1.2 and 2.1.3 Nil 81,711,877 IHI, BNI & TEIL D-2.2 Offshore Services (Total of 2.2.2 to 2.2.3) Nil 19,756,225 IHI, BNI & TEIL D-2.3 Onshore Supply (Total of 2.3.1 to 2.3.3) 1,869,978,658 Nil IHI, BNI & TEIL D-2.4 Onshore Services (Total of 2.4.1 to 2.4.3) 1,774,353,282 12,780,467 IHI, BNI & TEIL D-2.5 Construction and Erection (Total of 2.5.1. to 2.5.3) 3,958,464,384 36,795,623 IHI, BNI & TEIL D-2.0 Total (D-2.1 to D- 2.5) (See Note 9 7,602,796,324 151,044,192 Treaty : Double Taxation Avoidance Agreement (DTAA) :

Article 5 of the Double Taxation Avoidance Agreement (DTAA) between India and Japan, inter alia, provides as under :

" 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.

The term "permanent establishment" includes especially :

a place of management;

a branch;

an office;

a factory;

a workshop;

a mine, an oil or gas well, a quarry or any other place of extraction of natural resources;

a warehouse in relation to a person providing storage facilities for others;

a farm, plantation or other place where agriculture, forestry, plantation or related activities are carried on;

a store or other sales outlet; and (j) an installation or structure used for the exploration of natural resources, but only if so used for a period of more than six months.

" Clause 1 of Article 7 of the said agreement reads as under :

"The profits of an enterprise of a Contacting State shall be taxable only in that Contracting 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 that other Contracting State but only so much of them as is directly or indirectly attributable to that permanent establishment." Clauses 1, 2 and 5 of Article 12 which are relevant for the purpose of this case, read as under :

"Royalties and fees for technical services arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other Contracting State.

However, such royalties and fees for technical services may also be taxed in the Contracting State in which they arise and according to the laws of that Contracting State, but if the recipient is the beneficial owner of the royalties or fees for technical services, the tax so charged shall not exceed 20 per cent of the gross amount of the royalties or fee for technical services.

The provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the royalties or fees for technical services, being a resident of a Contracting State, carries on business in the other Contracting State in which the royalties or fees for technical services arise, through a permanent establishment situated therein, or performs in that other Contracting State independent personal services from a fixed base situated therein, and the right, property or contract in respect of which the royalties or fees for technical services are paid is effectively connected with such permanent establishment or fixed base. In such case, the provisions of article 7 or article 14, as the case may be, shall apply." The Treaty contains the Japanese notes, clause 6 whereof reads as under :

"With reference to paragraph 1 of article 7 of the Convention, it is understood that by using the term "directly or indirectly attributable to the permanent establishment", profits arising from transactions in which the permanent establishment has been involved shall be regarded as attributable to the permanent establishment to the extent appropriate to the part played by the permanent establishment in those transactions. It is also understood that profits shall be regarded as attributable to the permanent establishment to the above-mentioned extent, even when the contract or order relating to the sale or provision of goods or services in question is made or placed directly with the overseas head office of the enterprise rather than with the permanent establishment." Statutory provisions :

Sections 5(2), Section 9(1)(i), Section 9(1)(vii) of the Act, which are relevant for our purpose, read as under :

"5(2) Subject to the provisions of this Act, the total income of any previous year of a person who is a non- resident includes all income from whatever source derived 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." "9(1). The following incomes shall be deemed to accrue or arise in India :

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.

income by way of fees for technical services payable by (a) the Government; or (b) a person who is a resident, except where the fees are payable in respect of services utilized in a business or profession carried on by such person outside India or for the purposes of making or earning any income from any source outside India;

or (c) a person who is a non-resident, where the fees are payable in respect of services utilized in a business or profession carried on by such person in India or for the purposes of making or earning any income from any source in India :

Provided that nothing contained in this clause shall apply in relation to any income by way of fees for technical services payable in pursuance of an agreement made before the 1st day of April, 1976, and approved by the Central Government." Analysis :

For the purpose of taxation, the authority had proceeded on the basis that the element of tax consisted of :

onshore supply and onshore services; and