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Issues: (i) Whether the reopening under section 147 for the earlier assessment years was valid; (ii) whether the assessee's income from India was taxable on accrual basis and not on cash basis; (iii) whether the assessee had a business connection or permanent establishment in India in relation to supply of spares; and (iv) what portion of the profits from supply of spares was attributable to the permanent establishment in India.
Issue (i): Whether the reopening under section 147 for the earlier assessment years was valid.
Analysis: The recorded reasons were based on material emerging from the assessment for a later year, including the nature of receipts, the method of accounting adopted for Indian income, and the failure to show the relevant income in the earlier years. At the stage of reopening, the Assessing Officer was required only to have reason to believe that income had escaped assessment, not to establish escapement conclusively.
Conclusion: The reopening was valid and was upheld against the assessee.
Issue (ii): Whether the assessee's income from India was taxable on accrual basis and not on cash basis.
Analysis: The assessee was a foreign company maintaining its accounts at the head office on mercantile basis. For a non-resident, income chargeable in India must be computed consistently with the system of accounting regularly employed by the assessee. A mixed method, one for global accounts and another only for Indian receipts, was not accepted. The direction that income already assessed on accrual basis should not be taxed again on receipt basis protected against double taxation.
Conclusion: The assessee's income from India was held taxable on accrual basis and not on cash basis.
Issue (iii): Whether the assessee had a business connection or permanent establishment in India in relation to supply of spares.
Analysis: The supply contracts and service contracts were examined separately, but the agreement with the Indian agent showed that the agent rendered liaison, promotion, customer-development and order-solicitation functions under close control of the assessee. The agent acted almost wholly for the assessee, was subject to detailed instructions, and the remuneration structure did not establish arm's length independence. On these facts, the agent was not an independent agent, and the statutory and treaty tests for a dependent agent permanent establishment and business connection were satisfied.
Conclusion: The assessee was held to have a business connection and a permanent establishment in India.
Issue (iv): What portion of the profits from supply of spares was attributable to the permanent establishment in India.
Analysis: The permanent establishment's role was confined mainly to promotion, liaison and order solicitation. Core supply activities were performed outside India. In these circumstances, only a limited portion of the trading profit could be attributed to Indian operations, and the rate of 10 per cent of the profit from supply of spares was found appropriate for all years. The higher attribution adopted for some years was not supported by a rational basis.
Conclusion: Only 10 per cent of the profit from supply of spares was attributable to the permanent establishment in India.
Final Conclusion: The assessee succeeded only in part. The reopening and the findings on accrual basis, business connection and permanent establishment were sustained, but the attribution of profits was restricted to 10 per cent and the Revenue's challenge to the reduced attribution failed.
Ratio Decidendi: A non-resident that maintains its accounts on mercantile basis cannot claim a separate cash basis only for Indian receipts, and a dependent agent permanent establishment arises where the Indian agent acts almost wholly for the enterprise under close control and is not functionally independent; only the profit attributable to the limited Indian functions may then be taxed.
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