TaxTMI 
TaxTMI 
1993 (9) TMI 160
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....ntered into different Agreements with the assessee-company for the development and manufacture of electronic digital telephone switching equipment of E-10 type inIndia. In all four Agreements were concluded on the very same day by the Government of India with the assessee-company. The first Agreement entered into between the Indian Telephone Industries Ltd., a Government of India Undertaking and the Government of France through the Department of Tele-Communication was for the provision of technical collaboration and grant of licence and transfer technology by the assessee-company to the Indian Telephone Industries. This Agreement dated 28th July, 1982 provided that the Government of India and the Government of France entered into a Financial Protocol on 28th May, 1982 providing for the necessary financing for a global tele-communication project, comprising-- - A technical collaboration agreement for licence and transfer of technology ; - An agreement for the supply of machinery, equipment, sub-assemblies, components and raw materials for local manufacture ; - An agreement for the supply of electronic digital telephone exchanges and performance of related services ; - An....
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....between the Government of India and the Government of France. 8. For the assessment year 1984-85, the assessee filed a return showing an income of Rs. 4.61 crores which consisted of receipts of royalties of Rs. 5,00,30,296 and Rs. 22,02,473 as fees received for technical services. Against these receipts, a sum of Rs. 61,02,120 was claimed as expenditure ; so that the net income was Rs. 4,61,30,650. Besides the assessee showed receipts of certain amounts as sale consideration of documentation and instrument but treated the same as not taxable by virtue of the provisions of Article III of the Double Taxation Avoidance Agreement betweenFranceandIndia. The assessment was completed by the ITO on29-3-1985accepting the income as returned. This assessment was cancelled by the CIT by invoking the provisions of section 263 and the ITO was directed to make a fresh assessment taking into consideration an aspect namely whether any profit arose on the supply of the equipment by the assessee-company to the Government of India in India and whether for that purpose it could be said that the assessee was having a permanent establishment in India. These are in main the aspects on which enquiry was....
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.... be applied and a higher rate of tax be levied as against the rate of 20 per cent provided for royalties ; and lastly why not the payments made to Mekaster Consultancy (P.) Ltd. which was fixed at Rs. 60 lacs a year to be considered excessive. The attempt of the IAC (Asst.) was to treat the Mekaster Consultancy (P.) Ltd. as an office maintained by the assessee-company inIndiaamounting to having a permanent establishment inIndiaand treating the sales of equipment made to the Government of India, though delivered inFranceFOBFrenchPortas sales made inIndiaand bring the profits accrued therefrom to tax inIndia. His attempt was also to disallow a portion of the expenditure paid to Mekaster Consultancy (P.) Ltd. 11. In response to these queries the assessee-company replied that it employed Mekaster Consultancy (P.) Ltd. only to arrange and provide the necessary support facilities for their technicians so that the work could be started immediately on arrival of their technicians at a minimum cost and that Mekaster Consultancy (P.) Ltd. and the assessee-company entered into a principal to principal agreement for that limited purpose and that did not amount to maintaining an office inInd....
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....m sales made outsideIndiawere not taxable inIndia. Rejecting this contention, the IAC (Asst.) proceeded to estimate the income of the assessee attributable to transactions inIndiaon ad hoc basis at Rs. one crore and brought that sum to tax. 13. Turning his attention then to the payments made to the Mekaster Consultancy (P.) Ltd. and also to the application of the provisions of section 44D, the Inspecting Asstt. Commissioner (Asst.) held that although the assessee had shown income from royalty and technical fee as income from two separate and distinct sources and debited expenses only against the fees receivable for technical services, as per section 44D neither any expenditure could be allowed against receipts from royalty nor did the assessee claim any expenditure against royalty. However, the assessee's expenses in respect of technical services far exceeded the fees received resulting in a loss and that loss was sought to be set off against receipts from royalty, thus indirectly deducting expenses from royalty income, which was opposed to the provisions of section 44D of the Income-tax Act. From the fact that the expenses claimed against fees for technical services far exceede....
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.... Indian Telephone Industries. (c) The title and risk to the goods supplied passed on to the Indian Telephone Industries inFranceFOBFrenchPort(Articles 7.4 and 6. 1 of the agreement with Indian Telephone Industries). (d) Indian Telephone Industries arranged for the insurance cover of the goods commencing from the FOB delivery point inFrance. The insurance charges are directly paid by the Indian Telephone Industries and settlement and recovery of insurance claim is also the responsibility of the Indian Telephone Industries. (e) All payments to the assessee-company for supply of goods were made in French Frank to the bank account of the assessee-company maintained in France Banque Nationale de Paris. The payments were made against French Treasury Loans and the Bank Export Credit as provided for in the Financial Protocol signed on28th May, 1982between the Govt. of India and Govt. of France. " Besides the Commissioner (A) also found that there were certain other services to be rendered in France by the assessee-company, which included preparation and supply of technical documentation, information and training to the personel of the Indian Telephone Industries in France again....
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....lly the assessee-company had no office. The Commissioner (A) did not also agree with the view of the Inspecting Asstt. Commissioner that merely because the payment for support services were more than the technical services fee received, it could be inferred that a part of the payment to Mekaster Consultancy (P) Ltd. was attributable to the FOB supplies made in France for the reason that the FOB supplies were anterior in point of time to the supervision of the installation carried out by the French Engineers in India. 18. Turning his attention to Article II(1)(bb) of the Double Taxation Avoidance Agreement and the protocol dated 26th March, 1969 entered into between the Govt. of India and the Govt. of France, the Commissioner (A) held that merely because supervision charges were paid in India, it did not amount to having a permanent establishment in India within the meaning of that Article or the protocol. The Commissioner (A) had pointed out, in our opinion very rightly, that both under the Article II(1)(bb) and the Protocol, there must be a construction, installation and assembly project in one of the contracting States, so that it could be said that it has maintained a fixed p....
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.... to the operations and therefore no profit could be said to arise inIndia. He thus found that neither there was any permanent establishment inIndiamaintained by the assessee-company nor there were any activities carried on by only permanent establishment inIndiaeven if there was one, so that any profit could be attributed to those operations. He then referred to section 9(1)(i) of the Income-tax Act to find out whether there was any business connection. Here again he held that even in the case of a business of which all operations are not carried out in India, the income that can be said to accrue or arise in India could only be that which could reasonably be attributed to the operations carried out in India. Since no operations were carried out inIndiaat all, no profits could be attributed even assuming that there was a business connection. In this context he placed reliance upon two Supreme Court judgments, one in the case of Carborandum Co. v. CIT [1977] 108 ITR 335 and again in CIT v. Toshoku Ltd. [1980] 125 ITR 525. Since all the steps relating to the completion of the FOB supplies were concluded in France, the goods were delivered to the Indian Telephone Industries Forwarding....
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....he provisions in the Income-tax Act. In view of the above, the disallowances of the expenses claimed were not justified and the IAC (Asst.) is directed to allow Rs. 60,97,120 in asst. year 1984-85 and Rs. 92,97,267 in asst. year 1985-86. " 21. Dealing with the question that when as a result of the allowance of full expenses from technical service fees, such loss could be set off against income from royalty, the Commissioner (A) held that as per section 70(1) of the Income-tax Act, if the net result in any source falling under any head of income is a loss, such loss can be set off against the income from any other source under the same head and therefore the loss from the technical service fees in the assessment year 1984-85 could be set off against the income from the source royalty and only the balance of royalty could be subjected to tax. In this connection, he compared the Double Taxation Avoidance Agreement and found no suggestion to the contrary in it. Thus the Commissioner (Appeals) held on almost all the important points against the view held by the Inspecting Asstt. Commissioner (Assessment), aggrieved by which the department has filed the further appeals before us. 2....
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.... sale of material involved and when the end result was installation of the licensed system, the question of conveying the title in the goods inFrancewhen FOB sales were made to a Port inFrance, did not arise. The entire contract is turnkey contract but cleverly shown as if they are four different contracts. Since the entire thing is only one contract, the title in the goods passed on to the Government or its agency only when the installation was complete and when an acceptance certificate as provided for in the agreement was issued by the concerned authority in India, namely, the Secretary, Ministry of Communications. Till the certificate of acceptance was issued by the concerned authority, the title in the equipment remained with the assessee-company and did not pass on to the Indian Telephone Industries as was wrongly assumed by the Commissioner (Appeals). These machines are such that they cannot run on their own. They do not have any independent existence. They come into a working condition into an integrated whole only when they are properly erected, installed and assembled and put on trials. That was the reason why there was insistence for the issue of an acceptance certificat....
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....e agreements and the activities that were carried on by the assessee-company inIndiathrough Mekaster Consultancy (P.) Ltd., the learned Departmental Representative Shri Tandon submitted that there was a business connection inIndiaand therefore profits must be deemed to accrue inIndiaand that profit, which accrued inIndia, had to be estimated because the assessee had failed to cooperate with the Department by furnishing the necessary details called for. Once it was established that there was a business connection inIndia, there was no option left to the Income-tax Department except to estimate the profits attributable to those operations. The Act itself gave the authority to the Income-tax Officer to estimate the profit. The only thing that could be said was whether the estimate was excessive or not but the factum of arisal of income and its quantification by estimate could not be questioned. 25. Dealing with the agreement entered into with Mekaster, he pointed out that that amounted to having a permanent establishment inIndiabecause the engineers who came toIndiastayed for more than three months. The inferences drawn by the Commissioner (A) in this behalf are, according to him, ....
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....ght to be placed defeats the very object sought by the Legislature, that construction must be avoided. For this rule of interpretation and proposition, he placed reliance upon the decision of the Supreme Court in the case of CIT v. S. Teja Singh [1959] 35 ITR 408 and supported it by referring to another decision of the Supreme Court in the case of CIT v. Godavari Sugar Mitts Ltd. [1967] 63 ITR 310 and also in the case of S. A. L. Narayan Row v. Ishwarlal Bhagwandas [1965] 57 ITR 149 and AIR SC 395 (sic). In sum his argument was that the expenditure incurred should not have been allowed against technical service fees and in any case setting it off against the income from royalty was against the specific law. The plea of the department that a part of the expenditure was incurred in a bid to support the entire activity relating to the installation, supply and supervision of the entire project inIndiashould have been upheld. 27. Reacting to these arguments the learned senior Advocate Shri N. A. Palkhivala submitted that the attempt of the revenue appears to be to rewrite the agreements in a bid to support its contention, which was not only impermissible in Law but also was based upo....
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....-company, under the agreement will have to be paid by the Government of India, Ministry of Communications. If the agreement is to be interpreted in the manner in which the Department wants it to be done, the loser is certainly the Government of India because the Revenue goes from one pocket of the department to another pocket of the same Government. There could not have been therefore any contemplation of tax avoidance because under the agreement convenience, facility, economy and early execution and imparting of training to our personnel, which is so important in the interest of the Nation were the basic motives, and none else. This aspect should not have been given a go-bye by the department in putting upon this agreement a queer interpretation of a turnkey project, which was never intended by the parties. 29. He then referred to the written arguments filed before the Commissioner (A), which were at pages 179 to 290 in the paper book and submitted that every aspect was very properly explained and was understood by the Commissioner (A) and the Commissioner (A) has given a very cogent, sustained and correct reasons and conclusions and those are unassailable and unexceptionable a....
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....e income from technical services. Section 70 provided for the set off of loss from one source to another source under the same head. There was therefore, no disharmony except a misunderstanding of the provisions. The Commissioner (A) has rightly understood this provision and gave the appropriate relief. Anything other than what the Commissioner (A) had done would contravene and violate the specific provision of the Income-tax Act. The department does not deny or dispute that royalty was not a separate source of income as is the fees received from technical services and so section 70 was automatically attracted if there is a loss in one source and income from another source, both of them falling under the same head. The set off was therefore inevitable and was rightly done by the Commissioner (A). 32. Shri Palkhivala went to the extent of saying that he would even concede that there was a permanent establishment inIndiaas well as a business connection. But even then he submitted that only a reasonable profit can be estimated attributable to the operations carried on inIndiaprovided there are operations inIndiaattributable to the FOB sales. The operations carried on inIndiawere on....
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.... was eminently justified in deleting the entire addition made on ad hoc basis as baseless and uncalled for. To recapitulate the entire case of the department was that some transactions in respect of these agreements relatable to the sale of goods had taken place inIndiaand in respect of those transactions some profit has to be estimated. For this purpose they went into the question of the assessee-company having to maintain a permanent establishment inIndia. Since no permanent establishment was maintained by the assessee-company directly or indirectly, the agreement entered into with Mekaster Consultancy (P.) Ltd. was construed as amounting to maintaining a permanent establishment inIndiaall because the Mekaster Consultancy (P.) Ltd. have been entrusted with the task of receiving the foreign technicians as and when they arrive, look after their accommodation, transport and other facilities. Having thus interpreted the agreement with Mekaster Consultancy (P.) Ltd. as amounting to maintaining a permanent establishment inIndia, it ignored the fact that the equipment handed over to the Indian party inFranceFOBFrancePortdid not complete the conveyance of title in full. It then proceeded....
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.... the entire money. If any damage had taken place during transit, the seller i.e. the assessee-company was completely exonerated from the risk of paying the damages. The seller did not even retain the lien because under the agreement it received the entire payment in French Francs in a named French Bank. Thus the goods under the contract were appropriated to the buyer in France, delivered to the buyer in France, the risk from then on was taken over by the Indian Telephone Industries, the title in the goods having passed on to the Indian Telephone Industries. The payment was also made inFrance. Nothing therefore remained to be done to complete the conveyance in the title of the goods from the assessee-company to the buyer i.e. the Indian Telephone Industries. Nothing therefore remained by way of conducting any operation inIndiain order to complete the sale so as to convey the title. The title in the goods had already been conveyed to the Indian party inFranceand the assessee-company ceased to be the owner of the goods in any sense of the term. 35. The agreements that were entered into with the assessee-company were executed by the Government of India through the Ministry of Commun....
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....ationally independent in order that after erection the system continue to work efficiently without having to depend upon the foreign technicians either for repairs or for training or for the use of that information or erection of similar equipment elsewhere in the country. 36. The second agreement which is in a way the most crucial agreement for our present purpose, deals with the supply of machinery, equipment, sub-assemblies, the components and the raw materials for the manufacture of Digital Time Division Electronic Switching System in India. The scope of this agreement was laid down in Article 2 and it says that it was for the supply of the components, pieces, parts including semi-knocked down/completely knocked down materials, proprietary items and the raw materials under the conditions mentioned in Annexure 3 and to supply the knowledge and expertise, advice concerning the installation and the operation of the machinery and also to supply the integrated lay out of all sections of the factory including the machinery, production and service shop. Under this agreement by Article 6 shipment and deliveries were provided. It stated that the machinery shall be deliveredFOBFrenchP....
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....ll issue a certificate regarding the machinery which shall not constitute an acceptance as in Article 9 (which shall occur only after delivery and acceptance test of the machinery at Site). The inspectors shall have the right to reject the machinery if the standards are not met. " The learned Departmental Representative's argument was that the inspection provided is subject to the issuance of an acceptance certificate in Article 9 and therefore, the provisional inspection certificate issued by the Inspectors does not amount to conveying the title, inasmuch as, under Article 9, which we shall presently show, the power is given to the Indian Telephone Industries to reject even the Inspector's certificate of acceptance. In Article 9 it was provided that the inspection and test by the Inspectors have to take place within 90 days after arrival of the machinery at site or at the latest within 120 days after arrival of the machinery inIndia. Then it says further down that : " Where ITI is satisfied that the results of such inspection and tests for acceptance indicate that the standards are met, ITI shall Issue an acceptance certificate which shall constitute an acceptance. ITI shall....
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.... the equipment after installation shall work smoothly and for any defect found in the running of the machinery, no extra expense was to be incurred by the Indian Telephone Industries. That was the reason why in Article 9.5 it was provided that upon issuance of the acceptance certificate, the assessee-company is released from its obligations related to the machinery. Now what are those obligations related to the machinery ? They are all provided in Articles 2, 6, 7, 8 and 9, which provided for scope of the agreement, inspection, shipment and installation. When we go to the installation of machinery in Article 8, it clearly provides that : "Article 8 - Installation of Machinery 8.1 The Installation of Machinery shall be carried out by qualified employees of ITI. 8.2 CIT-Alcatel may have one representative present at each Site during the Installation of the Machinery as per programme and planning to be mutually agreed. 8.3 CIT-Alcatel shall supply ITI with general installation specifications (assembling instructions and drawings) issued by CIT-Alcatel or the relevant manufacturers. 8.4 A general plan for installation at the Site and a particular plan for the installatio....
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....ive, that shall have full authority to act in the name and on behalf of the ITI concerning installation and testing under the agreement. Under the agreement the obligations cast upon the assessee-company was only in the event of the defective installation by the employees of the ITI as a consequence of any incorrect instruction. The responsibility for the import of necessary tools was cast upon the ITI. We do not think that this installation in India under this agreement can amount to any sale of services because the entire price to be paid is provided for in Article 4 of the agreement, which is by drawing on the French Treasury Loans as provided for in the Financial Protocol signed between the Government of India and the Government of France. All the payments are to be made in French Francs to its bank account maintained with Banque Nationale de Paris,France. Therefore a provision for supervision of installation is not installation. We therefore agree with the view expressed by the learned Commissioner (A) that supervision is something different from installation work and as we have seen the specific provision in the Articles was that the installation shall be carried out only by ....
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....ue is perfectly justified. 38. In conclusion we would like to mention that under the agreement for the supply of Electronic Digital Telephone Exchanges and performance of related services, Article 5.3.2 provides : " Any Indian duty, tax or charge on prices will be paid by the Purchaser or if amounts are withheld from such prices by any Indian Governmental Authority or sub-division thereof, they will be immediately reimbursed by the Purchaser to the Supplier. " Similarly in the next Article 5.3.3 it was provided that : "Any tax or duty imposed by the French Governmental Authority up to the point of FOB delivery shall be borne by the Supplier." The above clause would show that whatever be the tax that is levied by the Government of India in respect of these transactions will have to be paid by the purchaser, i.e., Government of India in another Department, provided the interpretation of this clause is that the expression any tax would mean tax on income and not tax on purchases. If so, and assuming the claims of the Revenue are correct, then the tax levied by the Income-tax Department will have to be paid by another Department of Government ofIndia. In view of this Art....
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....1. Before we conclude this issue, we would like to mention in sum our answers to the positive questions raised by the learned Departmental Representative during the course of arguments : " (a) The first question was whether the property in the goods passed to the Indian Telephone Industries inFranceor inIndia. According to the documents and according to the facts present in this case, the property in the goods passed in its entirety inFranceand therefore it was the responsibility of the Indian party to bring them toIndiaunder their care and responsibility. (b) The second question was whether there was a business connection within the meaning of section 9(1) of the Income-tax Act. Our answer to this also is in the negative because according to our understanding, tendering of advice for the installation of the machinery does not establish any business connection nor can it be said that the performance of services to receive the engineers deputed for the purpose of supervision work had lent any credence to the view that there was a business connection. With or without the services of Mekaster Consultancy (P.) Ltd. the personnel sent fromFrancehave to be received by some one inIn....
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.... thing must be seen as one contract and that contract was a turnkey contract like a works contract and that was completed on the issuance of an acceptance certificate. Even this was not found acceptable for the reasons given above, namely, that all these four contracts were different and distinct contracts and cannot be integrated into one transaction, which would amount to re-writing the contracts nor can we read into this any tax planning or tax avoidance, which would mean certain amount of attributing collusory part on the Government of India. 42. For these reasons we hold that the addition of Rs. 1 crore made by the Assessing Officer for the assessment year 1984-85 and Rs. 25 lacs for the assessment year 1985-86 was totally unwarranted and we delete them. 43. The next question that we have to consider is whether the Commissioner (A) was justified in allowing the expenses claimed by the assessee against fees for technical services although the expenses were incurred all along to support the entire activity relating to the installation, supply and supervision of the entire project inIndia. The answer to this question is related to and consequent to our conclusion with regar....
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....l services were more than the payments made for support services. The technical service fee paid was received by the assessee-company directly and it was not routed through Mekaster Consultancy (P.) Ltd. Therefore we are not able to find any connection or nexus between the payments by the assessee-company to Mekaster Consultancy (P.) Ltd. for support services it rendered to it for its engineers and the technical service fee received by the assessee-company from Indian Telephone Industries was directly for services rendered under the agreement. They are therefore distinct and separate and one is not connected with the other, though there may be dependence in the sense that Mekaster Consultancy (P.) Ltd. has to provide reception to the engineers that were deputed by the assessee to go over toIndia. 44. The other question that is related to this is about the expenses. As we have pointed out earlier the Inspecting Asstt. Commissioner (Asst.) has allowed only 50 per cent of the fees received for technical services as expenses as against the claim of the assessee for the allowance of Rs. 60,97,120 in the assessment year 1984-85 and Rs. 92,97,267 in the assessment year 1985-86. The rea....
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....d in the grounds of appeal also, that the Commissioner (A) should not have directed the Inspecting Asstt. Commissioner (Asst.) to set off the loss computed under the head " Fee for technical against income from royalty ", which was prohibited under the express provisions of section 44D of the Income-tax Act. 46. We have already mentioned above the answer of Shri Palkhivala for this objection. Section 44D provides for special provisions for computing income by way of royalties in the case of a foreign company. It says that : " 44D. Notwithstanding anything to the contrary contained in sections 28 to 44C, in the case of an assessee, being a foreign company,-- (b) no deduction in respect of any expenditure or allowance shall be allowed under any of the said sections in computing the income by way of royalty or fees for technical services received from Government or an Indian concern in pursuance of an agreement made by the foreign company with Government or with the Indian concern after the 1st day of March, 1976 ; " Shri Tandon's argument was that when there is a specific prohibition on the deduction in respect of any expenditure or allowance under any of the provisions o....
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....ad except as otherwise provided in the Act. There is no provision to the contrary in the Income-tax Act insofar as the set off of loss from one source against the income from another source under the same head is concerned. The income from royalty as well as income from fees for technical services is to be assessed either under the head business or under the head other sources. We shall not go into that controversy because the department appeared to have treated these two incomes as income from business i.e. if royalty and fees for technical services are assessed under the head business, these two become too distinct sources of income under the same head. When royalty is one source of income and the fees for technical services is another source of income, then if there is loss from fees for technical services, then by operation of the provision of section 70, that loss from that source is to be set off against the income from another source i.e. royalty. Once the expenditure incurred for rendering technical services in India is determined, that expenditure having to be allowed as a deduction under the overriding provisions of the Double Taxation Avoidance Agreement and as a result,....