2009 (1) TMI 81 - HC - Income Tax

Foreign supplier found to have business connection; offshore composite contract partly taxable, profits fixed and remitted for reassessment.

The HC upheld that the foreign supplier had a business connection in India and that the offshore supplies formed a composite contract with ongoing on-site ... Taxability of income from offshore supply of equipment - non-resident Company - scope of word 'business connection' - composite contract - Applicability of the Supreme Court's decision in Ishikawajima-Harima Heavy Industries Ltd. (IHHI) case [2007 (1) TMI 91 - SUPREME COURT] - Estimation of profits attributable to activities conducted outside India - The assessee controlled and managed ASPL for quality ensuring, maintenance of time schedule, quality control, progress of work etc. It is Mr. Zara; Project Manager of assessee who signed all the periodical reports. On the basis of materials available the Commissioner of Income-tax (Appeals) and the Tribunal concluded that the entire profits of the offshore supply can not be excluded from taxation. HELD THAT:- The word 'business connection' is too wide to admit any precise definition. From the various judgments of the Supreme Court some of which will be cited infra we find that, it includes close, real, intimate relationship and commonness of interest between the non-resident and the Indian person and where there is control of management or finances or substantial holding of equity shares or sharing of profits by the non-resident of the Indian person, the requirement of principle (iii), i.e., the existence of close, real and intimate relationship and commonness between the non-resident and Indian person, is fulfilled. In this case, the part played by the foreign company did not end with putting the machinery on board. Even the supplies under Contract I was an ongoing process, unlike Hyundai where with the supply of the fabricated platform in Korea, the offshore supply stood concluded. The assessee continued its operations in India. Its Manager Mr. Zara was very much on site, the offshore supply continued for several months and the machinery so supplied was modulated to suit the need on site in India and as regards the foreign personnel they did not become the employees of ASPL. They continued to be the employees of the assessee and the assessee was solely responsible for the erection of the machinery and its responsibility continued till the entire project was set up and actually run. Taking into account all these cumulative factors, the Tribunal agreed with the view of the CIT that only 25% of the activity could have been done outside India particularly in view of the various clauses of contract indicating that many plant and equipment were fabricated in India. The Tribunal concluded on the basis of Ishikawajima-Harima Heavy Industries Ltd.[2007 (1) TMI 91 - SUPREME COURT], case that activities which were not conducted in India cannot be taxed in India and on the basis of profit margins of similar companies directed the Assessing Officer to tax the profit at 7% in the context of Contract II to IV and with regard to Contract I 7%, profit shall be taken in relation to 75% of the receipts only. Thus, we do not think that the Tribunal has ignored the decision in Ishikawajima-Harima Heavy Industries Ltd... On the other hand, it has applied the ratio in that case, but, has held, for reasons given in its order that the entire profits of Contract I cannot be segregated and dealt with as if they arose outside India. We confirm the findings that, the foreign company and the activities rendered by it under contract I and the other three contracts are inextricably linked and it was a composite contract - all responsibility from the beginning to the end rested on the assessee, - there is an intimate, real and continuous relationship with the subsidiary company and that the price of the other contract was loaded on to Contract I. The Tribunal then confirmed the conclusion of Commissioner of Income-tax (Appeals) that 75% of the profits of Contract I is taxable. No reason has been given for fixing the percentage. So we are remitting the matter to the Tribunal to assess the percentage of taxable profit properly, bearing in mind the findings we have confirmed. Both the parties may be heard and documents received for the limited purpose of enabling the Tribunal to work out the percentage. The Tribunal after hearing the submissions shall fix the percentage and give reasons therefor. The tax case (appeal) is partly allowed to that extent. Issues: (i) Whether the Tribunal erred in not applying the ratio of Ishikawajima-Harima (2007) and thereby in holding that offshore supply receipts under Contract I are taxable in India despite passing of title and payment offshore; (ii) Whether the Tribunal was correct in holding that 75% of the offshore supply activities/profits arose in India.Issue (i): Whether the ratio in Ishikawajima-Harima (2007) applies to exclude taxation of offshore supply receipts where title and payment passed outside India.Analysis: The contract and factual matrix were examined for (a) whether the contractual parts were truly severable, (b) involvement of an Indian presence/permanent establishment in the offshore supply transaction, and (c) whether the onshore subsidiary was an independent counterparty or effectively controlled by the foreign enterprise. The court compared the present contract terms and factual findings with Ishikawajima-Harima and Hyundai, noting differences including price-loading allegations, continuous on-site involvement, control over the subsidiary, shared site offices and supervisory functions. The tribunal and CIT(A) findings that the four contracts were interlaced, that the subsidiary functioned as an alter ego for the project, and that the foreign enterprise retained control and responsibility were treated as concurrent factual findings supported by material on record. The court held that Ishikawajima-Harima does not operate as an absolute rule that passing of title/payment offshore alone excludes taxation where the contract is in substance composite and the onshore connection is real.Conclusion: Against the assessee.Issue (ii): Whether 75% of the offshore supply activities/profits can be held to have arisen in India.Analysis: The Tribunal had affirmed that only 25% of Contract I profits arose offshore and directed taxation of 75% as attributable to India, relying on factual findings about interlacing of contracts, price loading, and on-site supervisory and managerial involvement. However, the Tribunal did not provide reasons or adequate basis for fixing the specific percentage; further quantification evidence was incomplete in the record. The court therefore accepted the factual premise that a substantial portion of profits is attributable to Indian operations but found the precise percentage determination lacking in reasoned analysis and remitted the matter to the Tribunal for re-assessment of the taxable percentage after hearing parties and receiving documents.Conclusion: Against the assessee.Final Conclusion: The Court confirmed the substantive findings that the four contracts formed a composite arrangement with an intimate and continuous connection between the foreign enterprise and the Indian operations, that the foreign enterprise retained overall responsibility, and that profits attributable to operations in India are taxable; but the Court remitted determination of the correct percentage of Contract I profits taxable in India to the Tribunal for fresh reasoned quantification.Ratio Decidendi: Where contractual parts are in substance interlaced and a real, continuous connection exists between the foreign enterprise and onshore operations (including control over a local affiliate and ongoing supervisory activity), passing of title/payment offshore is not alone decisive to exclude taxation; the principle of apportionment must be applied and profits attributable to operations carried out in India are taxable and must be determined by reasoned quantification.