1. By Sushil Lakhani RECENT CASE LAWS 9 TH JUNE, 2007 INTERNATIONAL FISCAL ASSOCIATION – WESTERN REGIONAL CHAPTER

2. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 2 ISHIKAWAJIMA-HARIMA HEAVY INDUSTRIES CO. LTD. (288 ITR 408 (SC)) SET SATELLITE (SINGAPORE) PTE. LTD. (MUMBAI, ITAT) CONTENTS

3. ISHIKAWAJIMA-HARIMA HEAVY INDUSTRIES CO.LTD. (288 ITR 408 (SC))

4. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 4 Assessee a member of a Consortium of six parties. Consortium entered into a contract with Petronet LNG Limited (‘PLL’) in 2001 for setting up LNG Terminal. Contract was signed in India. Role/responsibility and consideration of each consortium member provided separately. FACTS

5. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 5 Scope of work for IHI was categorized into the following categories: o Onshore supply o Onshore services o Construction and erection o Offshore supply o Offshore services FACTS (Cont…) IHI established a Project Office in India for execution of project

6. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 6 IHI has a Permanent Establishment (‘PE’) under Article 5(3) of the India-Japan tax Treaty. The property in goods which were the subject matter of offshore supply passed on high seas outside India. The offshore services were also rendered outside India. FACTS (Cont…)

7. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 7 ISSUE BEFORE ITAT Whether the AAR’s Ruling in 271 ITR 193 was correct ? That is: Whether any part of consideration for off- shore supplies taxable in India ? And Whether consideration for off-shore services are taxable in India?

8. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 8 AAR’s view on offshore supplies Taxability under the Income-tax Act, 1961 (‘Act’)  Sale takes place outside India – property in goods passes outside India  However, certain operations – signing of contract, receiving, unloading, storing and transporting, paying demurrage charges, etc. performed in India. AAR Ruling (271 ITR 193)

9. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 9  As such, income deemed to accrue or arise in India to the extent attributable to operations in India. Taxability under the India-Japan tax treaty  Supply of equipment directly or indirectly attributable to PE in India. Profits from offshore supplies thus, taxable in India AAR Ruling (271 ITR 193) (Cont…)

10. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 10 AAR’s view on offshore services – Taxability under the Act & the India- Japan tax treaty oOffshore services – Fees for technical services (‘FTS’) under the Act as well as under the India-Japan tax treaty oOffshore services were not effectively connected to PE AAR Ruling (271 ITR 193) (Cont…)

11. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 11 AAR’s view on offshore services (Cont…) oOffshore services, thus, taxable at the rate of 20 percent on a gross basis as per Article 12 of the India-Japan tax treaty AAR Ruling (271 ITR 193) (Cont…)

12. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 12 The title to goods passed outside India - payment made outside India – income from offshore supply not taxable in India Signing of contract in India not relevant as the converse would not have made an assessee not taxable IHI’S CONTENTIONS BEFORE SC Re: Off-shore Supply:

13. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 13 Performing of certain activities in India (loading, unloading, inland transportation) would not render any part of off-shore supplies liable to tax in India. The position same under the India-Japan Treaty. Re: Off-shore Supply: IHI’S CONTENTIONS BEFORE SC

14. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 14 Re: Off-shore Services: Not taxable under the Treaty as though effectively connected to PE not attributable to PE IHI’S CONTENTIONS BEFORE SC

15. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 15 Each component of the contract was directly relatable to the overall performance Contract was indivisible; breach of any of the terms would impact the entire contract The turnkey project constituted a PE under the India-Japan tax treaty & as such Explanation I to Section 9(1)(i) applicable. Turnkey project was executed in India in its entirety DEPARTMENT’S CONTENTIONS BEFORE SC

16. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 16 Offshore supply and offshore services were interlinked with the entire project Entire income attributable to the project and deemed to arise in India by virtue of section 9(1)(i) of the Act Income from offshore supply and services taxable in India DEPARTMENT’S CONTENTIONS BEFORE SC

17. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 17 Far-reaching observations made by the Supreme Court: Regarding Turnkey contract:  The mere fact that contract is a turnkey contract would not itself mean that for the purpose of taxability the entire contract must be considered to be an integrated one; SUPREME COURT RULING

18. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 18  The very fact that supply and service segments were specified separately indicates that the liability of the assessee would also be different;  The payment for offshore supply and services was clearly demarcated – cannot be held to be a complete contract that has to read as a whole. SUPREME COURT RULING (Cont…)

19. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 19 -Regarding Income arising from business connection:  Although section 9 of the Act raises a legal fiction, it must be construed having regard to the object it seeks to achieve (Maruti Udyog Vs. Ramlal (2 SCC 638 followed)  There is a distinction between existence of a business connection and income accruing or arising from such business connection SUPREME COURT RULING (Cont…)

20. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 20  Mere existence of a business connection may not result in income accruing or arising in India;  Existence of a Permanent Establishment does not necessarily mean existence of business connection  Where severable parts of a composite contract are performed in different jurisdictions, the principle of apportionment should be applied to determine profits taxable in each Jurisdiction. SUPREME COURT RULING (Cont…)

21. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 21 Regarding situs of the source of income: The source of income need not be the place where income accrues or arises (CIT Vs. Ahmedbhai Umerbhai (18 ITR 472 (SC)) & CIT Vs. Kirk (1900) AC 588 (HL), Anglo- French Textile Co. Ltd. Vs. CIT (25 ITR 27 (SC)), Carborandum Co. Vs. CIT (108 ITR 335 (SC), ITO Vs. Sriram Bearings Ltd. (224 ITR 724 (SC)). SUPREME COURT RULING (Cont…)

22. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 22 Supreme Court’s view on offshore supplies: Taxability under the Act  Only such part of the income as is attributable to the operations carried out in India can be taxed in India. The territorial nexus doctrine plays an important part in assessment of tax.  The mere fact that contract is a turnkey contract would not itself mean that for the purpose of taxability the entire contract must be considered to be an integrated one SUPREME COURT RULING (Cont…)

23. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 23  Sale takes place outside India – property in goods passes outside India and payment outside India  The fact that the contract was signed in India is of no material consequence  PE doesot constitute Business Connection as PE not a cause of the income. SUPREME COURT RULING (Cont…)

24. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 24  Income from offshore supply not taxable in India Taxability under the India-Japan tax treaty  Paragraph 6 of the Protocol to the India-Japan tax treaty not fulfilled as PE did not play any part in off-shore supplies. SUPREME COURT RULING (Cont…)

25. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 25  Supply of equipment not directly/ indirectly attributable to PE in India – PE not involved in operations in connection with offshore supply  Income from offshore supplies not taxable in India SUPREME COURT RULING (Cont…)

26. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 26 Supreme Court’s view on offshore services Taxability under the Act  For being covered U/s. 9(1)(vii) two conditions to be fulfilled:  Services should be rendered in India; and  Services should be utilised in India. (“Section 9(1)(vii) must be read with Section 5 which takes within its purview the territorial nexus”) SUPREME COURT RULING (Cont…)

27. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 27  Sufficient nexus between the rendering of services and territorial limits of India necessary to make the income from offshore services taxable  Even after insertion of (vi) & (vii) in Section 9, the provisions of 9(1)(i) continue to given such cases (VDO Tachometer Werke Vs. CIT (117 ITR 804 (Kar)). SUPREME COURT RULING (Cont…)

28. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 28  Location of source of income in India would not render sufficient nexus to tax the income from that source  To be covered in Sec. 9(1)(vii) the services should have a “live link” with India.  Entire contract would not be attributable to the operations in India assuming the offshore elements form an integral part of the contract SUPREME COURT RULING (Cont…)

29. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 29 (Query: Whether the position of taxability under the Act of off-shore services would change after insertion of the new Explanation added to Section 9 w.e.f. 1.6.76 ?)  Entire services rendered outside India – not deemed to accrue or arise in India SUPREME COURT RULING (Cont…)

30. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 30 Taxability under the Japan Tax Treaty  Comments on Page 409 of Klaus Vogel approved by SC – only profits which are economically attributable to the PE i.e. those which arise from PE’s activities taxable in source country.  Art 12(5) would apply as offshore services “effectively connected” to the PE. SUPREME COURT RULING (Cont…)

31. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 31  Article 7(2) r.w. Para 6 of the protocol of the India-Japan tax treaty applicable – only profits directly or indirectly attributable to its PE taxable in India  Offshore services were rendered outside India – PE did not have any role to play in such services – therefore not attributable and hence not taxable in India SUPREME COURT RULING (Cont…)

32. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 32  The term “effectively connected” & “attributable to” are to be construed differently – even if offshore services & the PE are “connected”  Offshore services inextricably linked to the offshore supply – must be considered in the same manner SUPREME COURT RULING (Cont…)

33. SET SATELLITE (SINGAPORE) PTE. LTD. (MUMBAI, ITAT)

34. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 34 FACTS Assessee is a Singapore resident engaged in business of broadcasting television channels. It has a subsidiary in India viz. SET India Pvt. Ltd. which is assessees’ “dependent agent” (“DA”) for sale of airtime. Assessee pays the DA arms’ length commission for its services.

35. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 35 The AO applied Circular No. 742 & taxed 10% of gross receipts. The Commissioner (Appeals) held that payment of arms’ length commission to DA extinguishes the tax liability of the DA’s PE (DAPE) as well FACTS (Cont…)

36. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 36 Once the DA is paid “arms’ length price”, can any further income, other than remuneration paid to DA, be attributed to PE & be taxed in India? (Note: Examination of taxability under the Act & exact quantification of amount taxable in India have been remitted back to AO) ISSUE BEFORE ITAT

37. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 37 1. Taxability of a foreign principal cannot exceed beyond arms’ length profits earned by a DA as: PE is nothing but the DA-both are one entity & not two separate entities. Art. 7(2) attributes to the PE only those profits which the PE would make if it were a distinct & separate enterprise ASSESSEES’ ARGUMENT

38. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 38 2.Payment of arms’ length compensation to DA extinguishes tax liability of foreign principal relying on: Commentaries of Philip Baker, Prof. Roy Rohatgi & Prof. David Davies. AAR ruling in Morgan Stanley & Co. (284 ITR 260) ITAT Ruling in DCIT Vs. Roxon (103 TTJ 891) Circular No. 23 of 1969 Circular No. 5 of 2004 for BPO companies. ASSESSEES’ ARGUMENT (Cont…)

39. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 39 3.SC Ruling in UOI Vs. Azadi Bachao Andolan (263 ITR 743) relied to advance the proposition that the purpose of treaties is to allocate taxing Jurisdictions. ASSESSEES’ ARGUMENT (Cont…)

40. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 40 1.“Single taxpayer approach” doesnot result in fair division of taxing rights between the two Jurisdictions as it ignores assets & risks that relate to the activity in source Jurisdiction. ITAT’S VIEW 2.DA & DAPE are two separate enterprises.

41. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 41 3.DAPE is distinct from DA as: Treaty provides that “the enterprise shall be deemed to have a PE” if it has a DA in the other state. Treaty doesnot state that the DA shall be deemed to be the PE of the enterprise. ITAT’S VIEW (Cont…)

42. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 42 4.Rationale for a DAPE is simple: DA, being “economically” & “financially” dependent on the foreign principal, is integrated into the principal’s business to a large extent. Would be too easy to circumvent PE taxation if tax position is to vary based only on whether or not the business activities are carried out directly or through an agent. ITAT’S VIEW (Cont…)

43. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 43 5.Treaty, thus, provides that profit attributable continue to remain same whether the F.E. carries on business directly or through a DA. 6.Further, Art. 7(2) provides that part of profits of the foreign enterprise shall be taxable in source country & DA’s profits are not the same as FE’s profits. ITAT’S VIEW (Cont…)

44. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 44 7. Circular No. 5 of 2004 & Circular No. 23 of 1969 not relevant as these circulars do not deal with taxability of a dependent agent. 8.AAR’s decision in Morgan Stanley (284 ITR 260) not binding on ITAT. ITAT’S VIEW (Cont…)

45. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 45 Australian Tax Office Guidelines titled “Attribution of profits to a Dep. Agent PE”. OECD’s Final Report in “Attribution on Profits to a PE” 9.Approved the views of: ITAT’S VIEW (Cont…)

46. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 46 10.Two steps process to compute profits attributable to a DAPE. Hypothesise the PE as a distinct & separate enterprise i.e. allocate assets & liabilities to PE on the basis of FAR analysis. ITAT’S VIEW (Cont…)

47. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 47 Determine the hypothetical revenues of the DAPE on the basis of functional analysis after deducting arms’ length compensation to DA & other expenses incurred. (Over-simplistic example (with some arithmetical errors) given by ITAT on page 18 of its Order with a caveat that FE can claim further adjustment for activities outside India) ITAT’S VIEW (Cont…)

48. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 48 Held that part of profits of FE taxable in India as it has a DAPE in India. Upheld action of AO in taxing 10% of gross receipts as no further details provided. ITAT’S CONCLUSION

49. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 49 Issue regarding taxability under the Act & regarding applicability of Circular No. 23 of 1969 remitted back to CIT(A) for adjudication. (Passing comment that the Circular No. 23 of 1969 & Circular No. 5 of 2004 donot deal with dep. Agent.) ITAT’S CONCLUSION (Cont…)

50. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 50 Art. 5(4) & Art. 7(2) refer to “activities” (of agent) & thus the profits attributable should be only those that relate to “activity” (of an agent) CONTENTIONS NOT RAISED BY ASSESSEE BEFORE ITAT

51. IFA - WRC9TH JUNE, 2007RECENT CASE LAWS BY SUSHIL LAKHANI 51 IMPACT OF SC DECISION IN HYUNDAI CASE? SC has on Page 19 of its order in Hyundai’s case reiterated that hypothetical profits can be attributed to PE only if the transactions between FE & PE were not at arms’ length.

52. THANK YOU sushillakhani@gmail.com