Case Law Details
RELEVANT PARAGRAPH
All these appeals, filed by the assessee and the revenue, are directed against the common order dated 04.02.2005 passed by the Ld. CIT(A), pertaining to the assessment years 1997- 98, 1999- 2000, 2000- 01 and 2001- 02.
2. These appeals were heard along with ITA No. 4925/Del/2004 filed by the assessee for the A.Y. 1998- 99 in respect of which a separate order has already been passed.
3. In connection with the aforesaid appeals filed by the revenue, the assessee had also filed cross objections numbered as Co. Nos. 345 to 348/Del/2007, which have already been disposed of by a separate order passed by us by stating that the issue raised in the cross objections being same and identical to the issues raised by the assessee in the above referred appeals filed by the assessee, rendering the cross-objections as redundant.
ITA No. 1868/Del/2005 & 2289/Del/2005, A.Y. 1997- 98
4. We shall first take the appeals pertaining to the A.Y. 1997- 98.
5. In appeal filed by the assessee, ground no 1(a), 2, 3, 4 and 5 are directed against the CIT(A)’s order in holding that the AO has correctly and rightly initiated proceedings u/s. 147 of the Income Tax Act, 1961 (“the Act”)
6. In this year, the assessee filed its return of income on 05.12.1997 declaring total income at Rs. NIL. The return of income was processed u/s. 143(1) of the Act. Thereafter, the AO issued notice on 11.01.2002 u/s. 148 of the Act by initiating proceedings u/s. 147 of the Act. In response to notice issued u/s. 148 of the Act, Mr. Ajay Kumar Sood and Mr. K.K. Singh, Authorised Representative of the assessee attended and appeared before the AO and submitted various details. After hearing and considering all materials on record, the AO completed the assessment on 28.03.2003 determining the total income of the assessee at Rs. 9,26,70,000/ – u/s. 147/143(3) of the Act.
7. Being aggrieved with the AO’s order, the assessee preferred an appeal before the learned CIT(A).
8. Before the ld. CIT(A), the assessee had taken a ground that the initiation of reassessment proceedings u/s. 147 of the Act and issue of notice u/s. 148 of the Act was bad in law and without any jurisdiction as the assessment has been re-opened without any fresh material or information having come to light and specially when the assessee had disclosed fully and truly all material facts necessary for the assessment. The assessee submitted before the ld. CIT(A) that resorting to the provisions of the section 147/148 by the AO was bad in law and unwarranted. The assessee further contended before the ld. CIT(A) that the assessee specifically requested the AO to supply the reasons recorded by him for entertaining a belief that income had escaped assessment, in order to enable the assessee to file objections there against, but such reasons were never provided to the assessee during the course of the assessment proceedings. The assessee, therefore, contended that non-furnishing of the reasons by the AO to the assessee makes it clear that no reasons were actually recorded, and no reasons were existed at that material point of time. The assessee, therefore, contended that the assessee has been denied the opportunity to file objections against the reasons recorded by the AO. In this respect, the assessee relied upon the decision of the Hon’ble Supreme Court in the case of GKN Driveshafts (India) Ltd. vs. ITO (2003) 259 ITR 19 (SC) 9. Before the ld. CIT(A), the assessee also submitted that in the first year of assessment of the assessee i.e. the A.Y. 1993-94, the assessee case was selected for detailed scrutiny and assessee’s stand that the income from cultivating seeds was agricultural income, was accepted by the AO and this position continued to remain in subsequent assessment years until prior the assessment year 1998-99, when the AO had taken a different view than the view taken in the assessment year 1993- 94. It was, therefore, submitted that the reassessment proceedings initiated by the AO in the present assessment year 1997- 98 in the light of his view taken in A.Y. 1998- 99, is against the Rule of Consistency. He, therefore, submitted that the reassessment made by the AO is to be cancelled.
10. The ld. CIT(A) in Para 2.3 of his order has stated that on the specific request of the assessee, he perused the assessment records and the AO was asked to submit the copy of the reasons recorded u/s. 148 of the Act. From perusal of the record, it was found by the ld. CIT(A) that the AO has recorded the proper reasons before issuing the notice u/s. 148 of the Act and the copy of the reasons which were recorded by the AO was duly supplied to the assessee by the ld. CIT(A). The ld. CIT(A), therefore, stated that reasons were actually and duly recorded by the AO, which were supplied to the assessee by him.
11. Having received the copy of the reasons recorded by the AO, the assessee submitted a detailed reply stating that besides the arguments already made, the reasons recorded by the AO would indicate that there was no formation of belief that the income has escaped assessment as the reopening was made with a view to examine the issue as clear from the reasons given by the AO where the AO has mentioned that “the same issue needs to be examined this year”.
12. The assessee also submitted before the ld. CIT(A) that the reasons recorded has clearly established that no new facts came to the possession of the AO, and the AO had proceeded summarily and arbitrarily to issue notice u/s. 148 merely because her predecessor for another assessment year assess the income of the assessee from producing the seeds as business income as against agricultural income claimed by the assessee. He further argued before the ld. CIT(A) that there is no finding of the AO in the reasons that income of the assessee is business income and not agricultural income. He further submitted before the ld. CIT(A) that just because the AO had held that in A.Y. 1998-99 that income of the assessee is business income and not agricultural income, that by itself cannot be a sufficient and valid reason to believe that income had escaped assessment unless the reasons clearly states that facts during this year were identical to that of A.Y. 1998- 99 and the AO was also of the view on the facts of the case that the impugned income was not agricultural in nature. It was further submitted before the ld. CIT(A) that mechanically issuing of notice u/s. 148 of the Act by the AO for examining the issue and making enquiry is indication of bias, prejudice and complete non-application of mine of the AO. It was further submitted that reasons recorded by the AO also revealed that the AO has not given any reason as to how decision of A.Y. 1998-99 is applies to the facts of the assessee’s case for the A.Y. 1997- 98 and, why decision for A.Y. 1993-94 to 1996-97 on the same facts are distinguishable or are not to be considered. It was, therefore, argued by the assessee before the ld. CIT(A) that there was absence of a bonafide ground or material for reason to believe that income had escaped assessment, and there is also nothing in the reasons recorded by the AO to indicate that any reappraisal of the evidence or material are made which could justify the formation of belief that income had escaped assessment by way of wrongful claim of agricultural income being exempted u/s. 10(1) of the Act.
13. After considering the facts and circumstances of the case, reasons recorded by the AO and the submissions of the assessee, the ld. CIT(A) held that proceedings initiated by the AO u/s. 147 of the Act and issuing of notice u/s. 148 of the Act are valid by observing and holding as under:
“I have considered the detailed reply of the appellant and facts of the case carefully, I find that the AO has properly recorded reasons before issue of notice u/s. 148 which is a prime condition u/s. 148 for issue of notice. The order of GKN Driveshafts Ltd. of Honourable Supreme Court is dated November 25, 2002 while the AO has recorded the reasons on 8.1.2002 that is much before the judgement of Honourable Supreme Court. In spite of that as explained by Hon’ble Supreme Court in the case of GKN Driveshafts (India) Ltd. the reasons were duly supplied to the appellant at the appellate stage which clearly showed that reasons were recorded by AO before issuing of notice u/s. 148. The appellant’s assertion that the reasons were not recorded by the AO are baseless. The appellant has raised his objections mainly on the facts that in the A. Y. 1993-94 the appellant’s claim was allowed under scrutiny and thereafter till 1997- 98 the appellant’s view was accepted u/s. 143(1) of the IT Act and only when in A.Y. 1998- 99 the case was not empowered to issue notice for the A.Y. 1997- 98 and 1999- 2000 as it amounts to change of opinion and the Rule of Consistency is also violated. I do not find any merit in the contentions of the appellant. Only the assessment for A.Y: 1993-94 was completed in scrutiny and thereafter no assessment was completed under scrutiny and the returns were accepted u/s. 143(1) of the IT Act meaning thereby that the AO had not applied his mind in the A.Ys, 1994-95 to 1997-98 as only intimation was sent to the appellant. In sending the intimation u/s. 143(1) no opinion is formed by the AO. It cannot be said that the AO had made opinion and the same was changed later on while reopening the assessment. In A.Y. 1998- 99 the case was thoroughly examined by the AO and after analysing the judgement of the Honourable Delhi ITAT in the case of Proagro Seeds Co. Ltd. vs. JCIT (126 Taxman 37) AO reached to the conclusion that appellant’s income is not agricultural income and is a business income. The judgement of Honourable ITAT in the case of Pro Agro was not available while completing the case for A. Y. 1993-94. The principle of res-judicata is not applicable in the income tax proceedings. The AO on the basis of assessment order for A.Y. 1998- 99 was of he clear opinion that income of the appellant had escaped assessment and she has clearly written in the reasons that “I therefore have reasons to believe that income exceeding Rs. 1 lakh has escaped tax” which clearly shows that on the basis of assessment order for A.Y, 1998- 99 AO had made its clear opinion that appellant’s income was not agricultural income and therefore on that reason the income had escaped assessment. Therefore, the reasons recorded by the AO are perfectly justified to reopen the case. Neither there was any change of opinion nor any Rule of Consistency was violated by the AO.
It has been held in the case of Praful Chunilal Patel: Vasant Chunilal Patel Vs. Asst. CIT, (1999) 236 ITR 832, (Guj.) that the appellant cannot defend the initiation of action on the ground that the facts were already placed on record and the AO must have or ought to have considered them. Explanation 1 to section 147 has a bearing or disclosure aspect and it applied to the proviso to section 147 to the extent it allows initiation of of proceedings u/s. 147 on account of non-disclosure of material facts by the assessee. It was further held that on a proper interpretation of section 147, it would appear that the power to make assessment or reassessment, where the initiation has been made within four years of the end of the relevant assessment year, would be attracted even in cases where there has been a complete disclosure of all relevant facts upon which a correct assessment might have been based in the first instance, and whether it is an error of the or law that has been discovered or found out justifying the belief required to initiate the proceedings. Thus, the words ‘escaped assessment’ where the return is filed, are apt to cover the case or due to its non consideration, or, caused by a mistake of law applicable to such transfer or transaction even where there has been a complete disclosure of all relevant facts upon which is correct assessment could have been based.
Explanation 2 to section 147 also clarifies that where a return of income has been furnished by the assessee but no assessment has been made and it is notified by the AO that the assessee has understand the income or has claimed excessive loss, deduction, allowance or relief in the return, the same will be considered as a case of deemed escapement of income. From the perusal of Explanation 2 it is clear that it enacts certain deeming provisions where, in any of the circumstances stated above, income is deemed to have escaped assessment giving jurisdiction to the AO to act u/s. VXL India Ltd. vs. ACIT, (1997) 215 ITR 295, 27 (Guj.); Birla VXL Ltd. vs. ACIT (1996) 217 ITR 13 (Guj.)}
In other words, in the aforestated deemed cases of escapement of income, the AO can initiate the proceedings on finding or discovering such cases and no debate whether they constitute cases of escapement of income would be permissible.
The appellant had claimed the total income as exempt which was not agricultural income which means the appellant had understand the income and has claimed excessive, allowance or relief in the return.
2.5 Considering the above facts, arguments and legal position, it is clear that the AO had proper reason to believe that the income chargeable to tax had escaped assessment for both the assessment years and she has followed the proper procedure of recording the proper reasons for issuing the notice u/s. 148. In reopening the case neither, there was any change of opinion nor there was any violation of rule of consistency. The reasons were only communicated to the appellant at the appellate stage and appellant’s objections have been duly considered. Therefore, ground of the appellant on the issue of notice u/s. 148 for A.Ys. 1997- 98 & 1999- 2000 are not justified and the proceedings u/s. 148 are held to be valid for both the years. Accordingly these grounds are dismissed.”
14. Before us, the assessee has raised a ground by contending that initiation of re-assessment proceedings u/s. 147 of the Act and issuance of notice u/s. 148 of the Act are bad in law and without jurisdiction.
15. The ld. sr. counsel for the assessee, Shri S.D. Kapitala, advocate has submitted that the first sentence in the reasons recorded by the AO to the effect that the assessee company is in the business of research and development of parent seeds which are supplied to other companies such as SPIC for development of hybrid seeds, which are then used by farmers, is factually incorrect and, is not borne out from the record. He submitted that R&D activity carried on by the assessee, if successful, may result in development of breeder seeds/ foundation seeds, which are then multiplied through ordinary agricultural operations to obtain sufficient quantity of parent seeds, which are supplied to PHI Seeds Ltd. (joint venture of the assessee company) in bulk quantity. The PHI Seeds Ltd., a joint venture company, produces commercial hybrid seeds by using parent seeds as input. He further submitted that the reasons recorded by the AO do not state that the present AO has agreed with the view taken by the AO in the assessment for A.Y. 1998-99 but the AO states that she need to examine the issue. The reasons so recorded by the AO do not even state that facts of the case in this year are same as for the A.Y. 1998- 99 and are not the same as to the facts for A.Y. 1993-94. Therefore, need to examine the issue was only the reasons stated by the AO in entertaining the belief that income had escaped assessment. He further submitted that since recording of reasons for issuance of notice u/s. 148 of the Act is not a mere formal ritual, the assessment proceedings initiated by the AO u/s. 147 of the Act, in the light of the reasons recorded by the AO, is not valid.
16. Ld. counsel for the assessee further submitted that the reasons recorded by the AO do not express any view or opinion on the assessee’s claim of exemption of agricultural income u/s. 10(1) of the Act as there is absolutely no allegation in the reasons that the assessee has not carried out basic agricultural operations and, therefore, the claim for exemption u/s. 10(1) was wrong. He, therefore, submit as the reasons do not contain such satisfaction, the reopening is invalid. He further submitted that assessment order u/s. 143(3) for the initial A.Y. 1993- 94, was made after detailed enquiry, which had become final and, therefore, it is clear that at the time of issuing the notice u/s. 148, the AO had two contradictory orders i.e. assessment order for A.Y. 1993-94 where assessee’s claim was accepted and the assessment order for the A.Y. 1998- 99 where assessee’s claim was rejected by taking a different view than that of A.Y. 1993-94, and that is why the AO felt the need to make the further enquiry for which purpose a notice u/s. 148 was issued.
17. It was further contended by the ld. counsel for the assessee that there was no application of mind by the AO while re-opening the assessment u/s. 147 of the Act, and the last sentence of the reasons recorded by the AO stating that she had reasons to believe that income had escaped assessment is merely an empty verbiage. He further submitted that need to examine the issue cannot said to be a valid reason to believe that income had escaped assessment. In the this connection, the ld. counsel for the assessee has relied upon number of decision including the decision of Honourable Supreme Court in the case of Asst. CIT Vs. Rajesh Jhavery Stock Brokers Pvt. Ltd. (2007) 291 ITR 500 (SC) and the recent decision of Jurisdictional Delhi High Court in the case of Jai Bharat Maruti Ltd. vs. CIT 223 CTR 269 (Delhi).
18. On the other hand, the ld. Standing Counsel for the department, Shri N.P. Sahni assisted by Jr. Standing Counsel Shri Prakash Chandra Yadav has submitted that the copy of reasons recorded by the AO have already been provided to the assessee by the ld. CIT(A), and the objections filed by the assessee against the reasons recorded by the AO has also been dealt with, considered and decided upon by the CIT(A). At the AO’s stage, the reasons were made known to the assessee’s authorised representative, who had appeared for and on behalf of the assessee in response to the notice issued u/s. 148 before by the AO and, thus, the copy of reasons recorded was not specifically given to the assessee by the AO, which has does not render the proceedings as void and invalid. However, the same has since been given to the assessee by the ld. CIT(A) and ld. CIT(A) has also considered the assessee’s objection. Therefore, for this reason, reopening of assessment u/s. 147 by the AO cannot be held to be invalid. He further submitted that having regard to the reasons recorded by the AO, it is clear that the reopening was done by the AO on the basis of assessment order for the A. Y. 1998-99, where assessee’s claim of parent seeds produced by the assessee as agricultural income has been rejected after giving elaborate reasons. He further submitted that in the light of the decision of Hon’ble Supreme Court in the case of Ess Ess Kay Engineering Pvt. Ltd. vs. CIT (2001) 247 ITR 818 (SC), it doesn’t precludes the AO to reopen the assessment of earlier year on the basis of fresh material found in the course of assessment of next assessment year. The order of the Honourable Supreme Court in this case runs as under:-
“This is a case of reopening. We have perused the documents. We find there was material on the basis of which the Income-tax Officer could proceeded to reopen the case, it is not a case of mere change of opinion. We are not inclined to interfere with the decision of the High Court merely because the case of the assessee was accepted as correct in the original assessment for this assessment year. It does not preclude the Income Tax Officer to reopen the assessment of an earlier year on the basis of his findings of fact made on the basis of fresh materials in the course of assessment of the next assessment year. This appeal is dismissed. No order as to costs.”
19. The ld. standing counsel for the department further drew our attention to the decision of Honourable Gujarat High Court in the case Bharat V. Patel Vs. Union of India 268 ITR 116 where it has been held that mere acceptance of return and adjustment of return against the earlier demand u/s. 143(1)(a) is not regular assessment and, in the liberalised and simplified tax collection regime, mere acceptance and acknowledgement of return and issuance of refund cannot be elevated to the status of regular assessment and formation of opinion about the incidence of tax on a particular income or item mentioned in the return of income, and, in view of deeming fiction provided in the Explanation 2 to section 147 of the Act impart, the AO had jurisdiction to reopen the assessment. According to the Explanation to clause (c) even where an assessment is made, but income chargeable to tax has not been correctly assessed, it is to be deemed that such income had escape assessment.
20. The ld. Standing Counsel for the revenue then heavily relied upon the decision of Honourable Supreme. Court in the case of Asst. CIT Vs. Rajesh Jhavery Stock Brokers Pvt. Ltd. (supra). He further submitted that in the light of the fact that there being no regular assessment completed u/s. 143(3) and the return of income filed by the assessee was merely processed u/s. 143(1)(a), and in the light of the fact that assessee’s claim of exemption of agricultural income has been rejected by the AO in the A.Y. 1998-99, it is clear that the AO had relevant and sufficient material before her to entertain a belief within the meaning of section 147 of the Act that income had escaped assessment with regard to the claim of the assessee that the income from producing and sale of hybrid parent seeds is exempted as agricultural income. He further submitted that the information that the assessee’s claim has been rejected in the A.Y 1998-99 is sufficient and relevant for any prudentment to form a reasonable belief that income had escaped assessment. He, therefore, submitted that the ld. CIT(A) was very much justified in holding that proceedings initiated by the AO u/s. 147 of the Act are valid and within jurisdiction.
21. We have heard both the parties and have carefully gone through the orders of the authorities below. We have deliberated upon the decisions cited by both the parties.
22. The reasons recorded by the AO on 08.01.2002 for issuance of notice u/s. 148 for the assessment year under consideration are as under:
“The ‘a’ Co. is in the business of research and development of parent seeds which are supplied to other Cos. Such as SPIC for devt. Of hybrid seeds which are then used by farmers. ‘A’ claims that its income is agricultural income. However, Assessing Officer held in A.Y. 98- 99 that A’ income is business income and not agricultural income. The case is in appeal.
The same issue needs to be examined this year also (turnover this year is Rs. 47,4,91,000 net profit Rs. 37,6,00,000).
I therefore have reason to belie that income of more than Rs. 1 lakh has escaped tax. Hence, the case is fit for reopening under section 147 of the I. T. Act 1961″.
23. It is not in dispute that there was no regular assessment made by the AO in pursuance to the return filed by the assessee before the notice u/s. 148 was issued. The return of income filed by the assessee was merely processed u/s. 143(1)(a) of the Act. From the reasons recorded by the AO, it is seen that the AO has recorded or had taken in the account the following facts for entertaining the belief that income has escaped assessment within the meaning of section 147 of the Act:-
(i) that assessee company is in the business of research and development of parent seeds, which are supplied and sold to SPIC (joint venture company) for development and production of hybrid seed, which are then sold to farmers by joint venture.
(ii) Assessee’s claim that its income is agricultural income.
(iii) However, the AO held in A.Y. 1998-99 that assessee’s said income is business income and not agricultural income, and hence not exempted from tax under the Act.
(iv) The assessment for assessment order 1998- 99, was under appeal.
(v) The same issue arise in A.Y. 1998- 99 needs to be examined in the year under consideration also.
(vi) The AO has also mentioned about the amount of turnover of Rs. 474,91,000/- and, the net profit of Rs. 3,76,00,000/- of the year under consideration.
(vii) The AO, therefore, stated that she had reason to believe that income of more than Rs. 1,00,000/- had escaped assessment.
(viii) The AO found the case fit for reopening u/s. 147 of the Act.
24. From reading as a whole the aforesaid facts narrated by the AO in the reasons recorded for issuing notice u/s. 148 of the Act, it is clear that the assessee’s claim that income from sale of hybrid parent seeds was agricultural income has been rejected by the AO in the regular assessment made for the A.Y. 1998- 99 by holding that assessee’s income is business income and not agricultural income. In other words, the finding arrived and recorded in the assessment order for A.Y. 1998- 99 has been looked into and perused by the AO, and he then found that the assessee’s claim has been rejected in A.Y. 1998- 99 treating the income shown by the assessee as business income chargeable to tax. In the assessment order for A.Y. 1998- 99, the AO has given a finding that the activity of doing research and production of parent seeds are same, and the assessee was engaged in the business of research and development of parent seeds. The observation noted by the AO in the reasons to the effect that the assessee company is in the business of research and development of parent seeds which are supplied to other companies such as SPIC for development of hybrid seeds is the inferences of law drawn by the AO from the facts found and discussed in the A.Y. 1998- 99. Therefore, this observation made by the AO in the reasons cannot said to be irrelevant for the purpose of forming an opinion or belief that income had escaped assessment within the meaning of section 147 of the Act, in as much as for the reasons given by the AO, the assessee’s claim of agricultural income has not been accepted by the AO in the A.Y. 1998- 99. Therefore, the contention of the ld. counsel for the assessee that the first statement of the reasons recorded is incorrect and irrelevant has no merit.
25. In the reasons, the AO has stated in brief the activity of the assessee of developing and producing parent seeds, which are supplies to SPIC for development of hybrid seeds, which are then used by fanners and this observation of the AO in the background of decisions taken in the assessment order for the A.Y. 1998-99 makes it very clear that over all activities of the assessee in producing and supplying parent seeds have been taken into account by the AO, while recording reasons for issuance of notice u/s. 148 of the Act.
26. Further, the AO had also taken not of the amount of turnover as well as the net profit shown by the assessee in the year under consideration, which goes to show that AO has looked into statement of account filed by the assessee alongwith the return of income. Having regard to the amount involved, which has been claimed by the assessee as exempted, the AO, therefore, stated that he had reasons to believe that income of more than Rs. 1,00,000/- had escaped assessment. This belief of the AO cannot said to be merely empty verbiage as contended by the ld. counsel for the assessee in as much as this belief has been recorded by the AO after considering the nature of the activity carried on by the assessee, the amount of the profit and turnover involved in the present assessment year. Therefore, it would be wrong to say that the reasons recorded by the AO stating that she had reason to believe that income of more than Rs. 1,00,000/- has escaped tax is merely empty verbiage. The AO also concluded in the reasons that this case was fit for reopening u/s. 147 of the Act.
27. Therefore, in the light of all the facts taken together as narrated by the AO in the reasons, it is to be considered as to whether the reasons recorded by the AO are sufficient for any prudentment to entertain a belief that income had escaped assessment within the meaning of section 147 of the Act. In this connection, various decisions have been relied upon by the ld. counsel for the assessee as well as by the ld. Standing Counsel for the department. It is important to note that both the parties have relied upon the decision of Honourable Supreme Court in the case of Asst. CIT vs. Rajesh Jhavery Stock Brokers Pvt. Ltd. (supra), which is the law of the land and has a binding effect and has to prevail over all other decisions of High Courts or Tribunal. We, therefore, consider it suffice to refer to the decision of Honourable Supreme Court in the above referred case of Asst. CIT Vs. Rajesh Jhavery Stock Brokers Pvt. Ltd. (supra) to decide whether the reopening of assessment u/s. 147 by the AO in the instant case is justified having regard to the ratio or principle -laid down by the Honourable Supreme Court in the above referred case.
28. The Honourable Supreme Court in the case of Asst. CIT Vs. Rajesh Jhavery Stock Brokers Pvt. Ltd. (supra) has observed and held as under:-
“Section 147 authorizes and permits the Assessing Officer to assess or reassess income chargeable to tax if he has reason to believe that income for assessment year has escaped assessment. The word “reason” in the phrase “reason to believe” would mean cause or justification. If the Assessing Officer has cause or justification to know or suppose that income has escaped assessment, it can be said to have reason to believe that an income had escaped assessment. The expression cannot be read to mean that the Assessing Officer should have finally ascertained the fact by legal evidence or conclusion. The function of the Assessing Officer is to administer the statute with solicitude for the public exchequer with an inbuilt idea of-fairness to taxpayers. As observed by the Supreme Court in Central Provinces Manganese Ore Co. Ltd. Vs. ITO [1991] 191 ITR 662, for initiation of action u/s. 147 (a) (as the provision stood at the relevant time) fulfilment of the two requisite conditions in that regard is essential. At that stage, the final outcome of the proceedings is not relevant. In other words, at the initiation stage, what is required is “reason to believe”, but not the established fact of escapement of income. At the stage of issue of notice, the only issue whether there was relevant material on which a reasonable person could have formed a requisite belief. Whether the material would conclusively prove the escapement is not the concern at that stage. This is so because the formation of belief by the Assessing Officer is within the realm of subjective satisfaction (see ITO vs. Selected Dalurband Coal Co. P. Ltd. [1996] 217 ITR 597 (SC); Raymond Woollen Mills Ltd. vs. ITO [1999] 236 ITR 34 (SC).
The scope and effect of section 147 as substituted with effect from April 1, 1989, as also sections 148 to 152 are substantially different from the provisions as they stood prior to such substitution. Under the old provisions of section 147, separate clauses (a) and (b) laid down the circumstances under which income escaping assessment for the past assessment for the past assessment years could be assessed or reassessed. To confer jurisdiction under section 147(a) two conditions were required to be satisfied: firstly the Assessing Officer must have reason to believe that income, profits or gains chargeable to income tax have escaped assessment, and secondly he must also have to income tax have escaped assessment, and secondly he must also gave reason to believe that such escapement has occurred by reason of either omission or failure on the part of the assessee to disclose fully or truly all material facts necessary for his assessment of that year. Both these conditions were conditions precedent to be satisfied before the Assessing Officer could have jurisdiction to issue notice under section 148 read with section 147(a). But under the substituted section 147 existence of only the first condition suffices. In other words, if the Assessing Officer for whatever reason has reason to believe that income has escaped assessment it confers jurisdiction to reopen the assessment. It is, however, to be noted that both the conditions must be fulfilled if the case falls within the ambit of the proviso to section 147. The case at hand is covered by the main provision and not proviso.
So long as the ingredient of section 147 are fulfilled, the Assessing Officer is free to initiate proceedings under section 147 and failure to take steps under section 143(3) will not render the Assessing Officer powerless to initiate re-assessment proceedings even when the intimation under section 143(1) had been issued”
29. From the said decision of Honourable Supreme Court, it becomes clear to us that if the A.O. has cause or justification to know or suppose that income has escaped assessment, it can be said to have reason to believe that an income had escaped assessment. At the time of recording reasons for initiating proceedings u/s. 147 of the Act, it is not necessary that the Assessing Officer should have finally ascertained the fact by legal evidence or conclusion. At that initial stage, what is required is “reason to believe” but no established fact of escapement of income. At the stage of issue of notice, the only question is whether there was relevant material on which a reasonable person could have formed a requisite belief. Whether the materials would conclusively prove the escapement is not the concern at that stage. This is so because the formation of belief by the Assessing Officer is within the realm of subjective satisfaction.
30. In the light of the aforesaid position of law laid down by the Honourable Supreme Court with regard to the scope and effect of section 147 and with regard to the meaning of expression “reason to believe” used in section 147 of the Act, we have to examine and analyse the fact of the present case to decide as to whether the Assessing Officer had any relevant material on which a reasonable person could have formed a requisite belief i.e. reason to believe that income has escaped assessment within the meaning of section 147 of the Act.
31. From the said decision, it is clear that at the stage of issuing notice u/s. 148 of the Act, the only question that arises for consideration is whether there was relevant material on which a reasonable person could have formed the requisite belief, and materials would concussively prove the escapement of income is not the concern at that stage. This is so because the formation of belief by the Assessing Officer is within the realm of subjective satisfaction, and it is not necessary that at the time of recording reason u/s. 148 of the Act, the AO should have finally ascertained the fact by legal evidence or conclusion. At the initial stage what is required is “reason to believe” and not established fact of escapement of income. Therefore, in the light of this decision, we do not find any merit in the contention of the learned counsel for the assessee that AO should have finally given a finding that the assessee’s income is not agricultural income but is a business income, and the assessment order of A.Y. 1993- 94 must have been taken into account by the AO while entertaining a belief that income had escaped assessment at the time when the notice u/s. 148 was issued. It is further clear from the aforesaid decision that intimation issued u/s. 143(1) is not an assessment and at the stage of issuing the intimation u/s. 143(1), it could not be said that AO had formed any opinion about the incidence of tax on a particular claim or item mentioned in the return of income. Therefore, the contention of the ld. counsel for the assessee that this is a case of change of opinion on the part of the AO, is also not tenable, and we reject the said contention same is thus rejected.
32. Since the copy of reasons recorded by the AO were provided by the CIT(A) to the assessee and, the assessee had availed the opportunity to file objections against the reasons so recorded, and the assessee’s objection’s has been considered by the CIT(A), we do not find any merit in contention of the assessee that proceedings initiated u/s. 147 of the Act are to be held as invalid merely because copy of reasons were not specifically provided by the AO to the assessee at the assessment stage though the reasons were duly made known to the assessee’s authorized representative by the AO.
33. In the aforesaid case of Rajesh Jhavery Stock Brokers Pvt. Ltd., the Honourable Supreme Court has categorically stated that only issue is to be considered is to see whether there was relevant material on which a reasonable person could have formed a requisite belief that income has escaped assessment within the meaning of section 147 of the Act. The fact that the assessee’s claim that its income is agricultural income has not been accepted in the regular assessment made u/s. 143(3) for the A.Y. 1998- 99, where the matter was thoroughly analysed and discussed and the AO held that the assessee’s claim of agricultural income is incorrect, is undoubtedly a relevant material on which reasonable person could have formed a requisite belief required u/s. 147 of the Act. The Honourable Supreme Court in the case of Ess Ess Kay Engineering Pvt. Ltd. Vs. CIT (supra) has categorically held that reopening of the assessment u/s. 147 on the basis of finding of facts made on the fresh material obtained in the course of assessment for the next assessment year is justified. In the present case, the AO has taken into consideration the finding of facts on the basis of the material obtained in the course of assessment for the A.Y. 1998- 99 that income from parent seeds is not an agricultural income but a business income. In this view of the matter, we, therefore, hold where there were relevant material stated in reasons recorded by the AO to entertain a belief that income had escaped assessment u/s. 147 of the Act in as much as assessee’s claim that its income is agricultural income is not justified in the light of the view taken in the assessment for A.Y. 1998- 99. Further, the words used by the AO in the reasons recorded “the same issue needs to be examined this year also” cannot be read in isolation but have to be read together with all the facts narrated by the AO in the reasons recorded for issuing the notice u/s. 148 of the Act. The observation categorically made by the AO are that assessee’s turnover is Rs 4,74,91,000/- and net profit shown is Rs. 3,76,00,000/- and assessee is in the business of research and development of parent seeds, and assessee’s claim that its agricultural income has not been accepted in the assessment year 1998-99 taken together would lead to the conclusion that the ad-hoc reason to believe that income of more than Rs. 1,00,000/- had escaped assessment, and the case was fit for reopening u/s. 148. These facts noted by the AO are very much sufficient and relevant to entertain a belief that income had escape assessment within the meaning of section 147 of the Act.
34. The view we have taken above is fully supported by the propositions laid down by the Honourable Supreme Court in the case of Rajesh Jhavery Stock Brokers Pvt. Ltd. and by the decision of Honourable Supreme Court in the case of Ess Ess Kay Engineering Co. Pvt. Ltd. Vs. CIT having regard to the facts of the present case and the light of the reasons recorded by the AO. Therefore, we do find any further necessity to refer to the various other decisions of High Courts relied upon by the ld. counsel for the assessee. In the said decision of Honourable Supreme Court in the case of Rajesh Jhavery stock brokers Pvt. Ltd. (supra) rendered in the context of new provisions of section of 147 inserted w.e.f. 01.04.1989 the principle laid down by the Honourable Supreme Court in earlier cases has been thoroughly analysed and deliberated upon by the Honourable Supreme Court.
35. For the reasons given above, we, therefore, uphold the decision of CIT(A) in holding that the reopening of the assessment u/s. 147 and issuance of notice u/s. 148 by the AO in year under consideration is justified and are valid. Thus, the ground no. 1 (a), 2 to 5 raised by the assessee are rejected, and the issue involved therein is decided in favour of the revenue and against the assessee.
36. Now we shall come to the ground nos. 1(b) and 7 to 15 revolving around the issue as to whether the assessee’s income from sale of alleged parent seeds is agricultural income or business income.
37. This issue has been decided by the CIT(A) against the assessee in the light of his order dated 08.09.2004 for the A.Y. 1998-99, where the issue has been elaborately discussed and decided upon. The CIT(A) has rejected these grounds raised by the assessee by observing as under:
“3. As per various ground the appellant for all the four years has mentioned that the AO has erred in law in bringing to tax the agricultural income of the appellant as business income by wrongly disallowing the appellant’s claim for exemption u/s. 10(1) read with section 2(1A) of the IT Act. The AO has erred in wrongly interpreting and applying the provisions of section 10(1) read with section 2(1A) of the IT Act. The appellant has given detailed arguments which are same arguments as were given in A. Y. 1998- 99.
3.1 This issue has been elaborately discussed in my order for the A.Y. 1998- 99 date 8.9.2004 in Appeal No. 60/01-02 in the appellant’s own case. After considering all the submissions of the appellant and facts of the case, I have held in the aforesaid order that the appellant was not carrying on agricultural activities within the meaning of section 2(1A) and, therefore, AO was justified in treating the income of the appellant as business income. As during these four years, the facts are entirely similar, following the same order, I hold that, the AO was justified in treating the income of the appellant from sale of seeds as business income and not an agricultural income. Therefore, grounds of the appellant relating to this income are hereby dismissed.
38. We have heard both the parties and have carefully gone through the orders of the authorities below.
39. In the course of hearing of this appeal, it was submitted by both the parties that this issue is also involved in A.Y. 1998-99, and the leading order on the identical issue confirming the AO’s order, has been passed by the ld. CIT(A) in the A.Y. 1998- 99. The appeal filed by the assessee in the A.Y, 1998- 99 involving the identical issue was heard along with all these present appeals, and an order pertaining to the A.Y. 1998-99 has been separately passed by us where we have uphold the order of the CIT(A) in part in confirming the AO’s action in treating the income from sale of parent seeds as business income. In the assessment year 1998- 99, we have taken a view that ten percent of total income from producing and sale of parent hybrid seeds is to be considered or recorded as agricultural income and the balance is to be assessed as business income liable to be taxed under the Act. Therefore, in the light of our decision dated 30.11.2009 for the A.Y. 1998- 99, which would be applicable to the present assessment years also, the ground no. 7 to 15 raised by the assessee stand decided accordingly.
40. Now, we come to the next issue which has been raised by the assessee in ground nos. 1(c) and 19 to 19 reading as under:-
“That the action of the Commissioner of Income Tax (Appeals) XXIX contravenes the Rule of Consistency and the provisions of Article 7 of the Convention for Avoidance of Double Taxation (DTA) entered into between India and the United States of America.
That, the Commissioner of Income Tax (Appeals) XXIX erred in arbitrarily confirming 50% of addition of Rs. 8,41,96,000/- made by the learned Assessing Officer by attributing, on an estimated, arbitrary and ad-hoc basis, business income of the Head Office to the India Branch Office by reason of the probable/alleged use of the research information and data placed in a common pool by the Head Office/ Branch Offices of the appellant.
That, on the facts of the case, the Commissioner of Income Tax (Appeals) XXIX erred in not correctly applying the provisions of Article 7 of the Convention for Avoidance of Double Taxation (DTA) entered into between India and the United States of America.
That, the Commissioner of Income Tax (Appeals) XXIX erred in arbitrarily disregarding categorical information and evidence regarding income of the head office of the appellant filed by the appellant in response to specific query/ directions of the Commissioner of Income Tax Appeals XXIX and holding that:
a. “the appellant has simply mentioned that it has not earned any income of any nature from sale of research activities per se carried in India. But the use of research activities carried out in India at other BO or HO and to produce seeds at other places by use of this research is not ruled out which has also not been denied by the appellant.”
b. “the actual utilisation of the research carried in India and income generated out of production/ sale of seeds of various crops by use of this research was not submitted by the appellant.”
c. “The basis of estimation of income adopted by the AO is justified in absence of any other details provided by the appellant.”
41. Connecting to the ground nos. 16 to 19 raised by the assessee, the department has also raised one solitary ground in the appeal filed by the revenue, which reads as under:
“On the facts & in the circumstances of the case, the learned CIT(A) has erred in directing the AO to take only 50% of the total income from utilisation of research data/ findings to be attributable to India without giving any basis for such attribution and without referring to any material on record.”
42. In the course of assessment proceedings the assessee was asked by the AO vide order-sheet entry dated 26.03.2003 to give details regarding utilisation of research data/ findings developed in Indian branch office, by the H.O. in the other part of the world. Further, the assessee was asked to give details of the amounts earned by the HO by utilising research data/ information or results provided by branch office and to explanation as to why in the absence of these details, the consideration or amount for such utilisation be not estimated on reasonable basis by treating such income as attributable to operations carried out in India. The AO had mentioned in his assessment order that the assessee vide letter dated 24.03.2003 had stated that the expenses were incurred for scientific agricultural research and, in the event, the assessee’s income from research activity is to be taxed as business income, the entire scientific agricultural research expenses may be allowed u/s. 35 of the Act. However, later on, the assessee vide its reply dated 28.03.2003 had withdrawn this claim of deduction of research expenses u/s. 35 of the Act. The assessee’s reply dated 28.03.03 in response to the query raised by the AO vide order sheet entry dated 26.03.03 reads as under as reproduced by the CIT(A) in his order:
“Pool of information collected from research units of all branches at the head office is shared amongst all branches. This information includes current and archived information. It may be noted that the HO has a library of research information going back to 1926 and all information is freely available for referencing at al time to the Indian Research Unit. This information is catalogued and may be referenced for further research and development. In such a work environment, no specific information is available regarding the utilisation of the research data by the Head Office in other parts of the world of regarding any amount earned by the HO by utilising the research/ seeds in other parts of the world. It is therefore not. possible to quantify or assign any value in any manner to the information exchanged between the HO and the RU.”
43. The assessee further stated before the AO that Article 7(3) of the Indo-US DTAA provides that no estimate of attributable profits shall be made in respect of the information that is share bilaterally between the H.O. and the PE, and because of the fact that the research expenses incurred by the Indian Branch has been fully reimbursed by the HO, the assessee would not claim the same as deduction from the income of the Indian Branch, and, accordingly the assessee has already withdrawn such claim.
44. Further, the AO has observed in his assessment order as under: –
From above it is clear that the assessee has not furnished the detail of utilisation of research information obtained by head office from its branch office and is utilised world over, nor it has furnished how much income has been earned by the head office there from. As narrated in detail in the preceding paragraphs, these activities are carried out in Indian branch office but the benefits are reaped out side India. No income from utilisation of these information has been shown or attributated to the account of Indian branch office. In fact, the company earned huge profit from these activities carried out through its branch all over the world. Therefore, the payments have been received by the lead, head office from, its various branches abroad. In case of a multinational company they have the benefits that they receive payments some where, whereas the actual activity is carried out some where else. In the instant case, all the research work is carried out in India, the research information is made available to the head office for simultaneous utilisation by the HO and its branch offices all over the world.
45. Thereafter, the AO referred to article 7 of Indo- US DTAA and decided this issue as under: –
“From the above, it is clear that the assessee argument based on the last sentence of Article 7(3) of the DTAA regarding profit determination in such situation in the hand of PE is not applicable in this case. It is because this sentence mention about charges of income of the nature of “Royalty, Fees or other similar payments in return for the use of patent know-how or other rights, or by way of commission or other charges for specific services perform or for management”. On the contrary, the income being referred to here is not any of these income mentioned in Article 7(2) of DTAA it permits attributation of profit to the PE assuming it to be distinct and independent enterprises vis-a-vis the HO and other enterprises of HO. Further, since the assessee has failed to proved the details of the research information utilised by HO and other branches abroad and no quantification of income earned therefrom is made. Article 7(2) has been relied upon once again for estimation of profit attributable to PE.
In order to estimate the deemed income attributable to PE, it is assumed that the income from utilisation of research information would be in the same ratio w.r.t. research expenses, as gross sale to gross expenses relating to the production of seeds in India. Accordingly, the income attributable to the branch office in this A.Y. is estimated as under:-
Income from Utilisation of Research Data which is attributed to Branch Office:=(Sale/ Net production expenses)*(Research expenses) = Rs.(47,491,000/13,402,000)*(21,651,000)=Rs. 7,67,21,000
However, from the estimated income attributable to PE as arrived above, the expense relating to research expenses which has been reimbursed by the HO is allowed for deduction to arrive at the net profit from such attribution, despite the claim by the assessee to the contrary.”
46. Being aggrieved, the assessee preferred an appeal before the CIT(A).
47. The assessee’s submissions and arguments made before the CIT(A) on this issue has been reproduced by the CIT(A) in para 4.2 of his order. The assessee objected to the additions made by the AO for three reasons: –
I. The Research Unit in India is not a permanent establishment (PE) falling under the exclusionary clause of Article 5(3)(e) of the Indo-US Double Tax Avoidance Treaty.
II. Without prejudice, the Assessing Officer has wrongly applied the provisions of Article 7(2) reads with Article 7(3) by attributing profits to the Head Office on pro-rata basis.
III. Without prejudice, the Assessing Officer has wrongly rejected the claim that any income attributable for services rendered by the PE to the Head Office is exempt under Art. 7(3) of the treaty.
48. The first contention of the assessee that research unit of the assessee in India is separate and independent to the parent seeds production unit, and, therefore, it doesn’t constitute a PE in terms of article 5 of the Indo-US Treaty has not been accepted by the CIT(A).
49. The other contentions of the assessee were also rejected by the CIT(A) by holding as under:-
I have considered the submissions of the appellant and facts of the case carefully. This is a fact that the appellant had its BO in India which is carrying on the research activities as well as sale of seeds. Both the activities of the appellant are interlinked and interdependent. Therefore the appellant is carrying on its business in India through its BO which is PE of the appellant in India. It has also been accepted by the appellant that its research activities are being pooled at HO and they are accessible to all other branches as well as HO of the appellant company. The appellant’s activities are too fold that is conducting the research and utilisation of research in preparation of parent/hybrid seeds of high quality of various crops and sale thereof. Therefore, the research is interwoven with the activities of the sale of hybrid seeds for commercial exploitation. Research activity is not the sole activity of the PE in India. The appellant is carrying the commercial research which fructifies in preparation & sale of parent hybrid seeds. The research conducted by the appellant is main core activity which is commercially exploited by the appellant by selling of hybrid/parent seeds. This activity by no stretch of imagination can be treated as auxiliary or preparatory activities in the appellant’s case. The research activity carried on by the appellant at the branch office (PE) in India itself forms an essential and significant part of the activity of the enterprise as a whole. The research activities are interrelated, coordinated, interdependent and interwoven with the preparation and sale of hybrid-seeds. In any case, a fixed place of business whose general purpose is one which is identical to the general purpose of the whole enterprise does not exercise a preparatory or auxiliary activity. Accordingly the appellant’s case is not covered in articles 5(3)(e) of the DTAA. The appellant is investing lot of money in India for conducting these research which are being utilised not only in India but at other places also. The AO has also mentioned in his submission that contention of the assessee that the appellant is not earning any income from the research carried out in India is totally incorrect. The appellant’s arguments that it had two PE is totally misleading and beyond any legal comprehension. The appellant has its branch office in India which is carrying on two activities namely research activities and production and sell of parent and hybrid seeds. The appellant itself in his reply to AO vide submission dt. 28.03.03 stated that the appellant had one PE which is carrying on two activities. Therefore it is undisputed fact that the appellant had PE in India in the form of branch office which is carrying on research activities and is also involved in preparation and sale of parent seeds.
As per report of AO, from the website of the appellant it is also clear that the appellant was the first to commercialise rice hybrids in India, with the 1993 release of PHB 31. The major hybrid, Pioneer sell today is PHB71, released in 1995. The company also markets and sells hybrid of improved varieties of sorghum, sunflower, soybean, alfalfa, canola and wheat as well as forage and grain additives. It has been mentioned by the appellant on the website that worldwide, Pioneer sells products through a variety of organisations, including wholly owned subsidiaries, joint ventures, sales representatives, and independent dealers. Therefore the income of the PE is to be taxed in India as per provisions of Article 7 of the DTAA. All over the world the appellant’s business comprises of conducting the research and utilisation of the same in preparation of seeds and sales thereof. The same business model is in Indian PE. The HO has reimbursed only the cost of expenses incurred in India. No mark up price was paid by HO. The appellant’s arguments that appellant’s income from-research activities is not liable to be taxed in view of the provision of article 7(3) is also not justified as the article 7(3) specifies only the payment like FTS or royalty or services of similar nature while in the appellant’s case the research is commercial business activity of the appellant. Therefore appellant’s arguments on this basis is not justified. The appellant has also mentioned that in A. Y. 1993-94 and earlier years no income was attributed to the PE on account of research and. therefore in these years which are under appeal no income is liable to be added. This argument is also unsustainable as in earlier years this issue has not been discussed by the AO and the principle of res-judicata is not applicable.
The appellant has simply mentioned that it has not earned of any nature from sale of research activities per se carried in India. But the use of research activities carried out in India, at other BO or HO and to produce seeds at other places by the use of this research is not ruled out which has also not been denied by the appellant. The appellant has admitted that research carried out is accessible to any BO or HO. The appellant has also admitted that there is pool of research at HO which is used by all BO. The various crops by use of this research was not submitted by the appellant. Therefore, keeping reliance on the provisions of article 7(2) of DTAA the income has to be estimated on the reasonable basis as there are exceptional difficulties in determination of the profits attributable to PE on account of utilisation of expenditure on research activities and expenditure on production on total sales. The basis of estimation of income adopted by the AO is justified in absence of any other details provided by the appellant. However, as per the provisions of Article 7(5) of DTAA only that much profit can be attributed to the PE as derived from the assets and activities of the PE in India. In the appellant’s case the income is generated only when the seeds prepared on the basis of research are sold. The income from sale of seed in India has been taxed separately. When the income is generated outside India or HO by use of research carried out in India, then all the activities are not taking place in India. The preparation of seeds and its sale has taken place outside India. Therefore, only the profit which is attributable to activities i.e. research will be taxable in India. Considering these facts and circumstances and legal position only 50% of incomer estimated by AO can be confirmed. Therefore, these grounds are partly allowed.
50. Still aggrieved, the assessee is in appeal before us.
51. The ld. counsel for the assessee at the very outset has submitted that this item about apportionment of HO income to Indian operations cannot be considered in the present assessment in as much as while reopening the present assessment u/s. 147 of the Act, the AO has not recorded any reason to entertain a belief that income earned by the HO is attributable to operations carried out in India and is asses sable in India. He, therefore, contended that in so far a this addition of alleged attribution of profits to the PE in India is concerned, the issuance of notice u/s. 148 and the assessment made consequently is illegal and invalid. In this connection, the ld. counsel for the assessee has relied upon the decision of Honourable Delhi High Court in the case of Jai Bharat Maruti Ltd. Vs. CIT (supra). He further submitted that there is no dispute to the fact that there is not even a whisper or mention of any escapement of income on account of attribution of profits to the Indian PE in the reasons recorded for the issuance of notice u/s. 148 of the Act and, hence, in the light of the decision of the Honourable Delhi High Court in the case of Jai Bharat Maruti Ltd. Vs. CIT (supra), this income cannot be added in the impugned assessment even it is held that some attribution of income can be made under the article 7(3) of DTAA between India and USA.
52. In so far as this preliminary contention raised by the ld. counsel for the assesses is concerned, the ld. Standing Counsel for the department has submitted that the issue with regard to the attribution of HO profit to PE in India is closely or directly connected or related to the item whether the income from production of parent seeds is agricultural income or not, which was made the reasons for initiating proceedings u/s. 147 of the Act by the AO. The issue whether the research activity of the assessee is independent and distinct from the activity of producing parent seeds is a vital issue while deciding the basic issue as to whether income from parent seeds is agricultural income or not. Therefore, the research undertaken by the assessee to develop or producing breeder or hybrid seeds is undoubtedly closely connected to the very basic issue about the tax ability of income from sale of parent seeds, and, thus, the issue about the apportionment of profit to PE in India because of use of research activity carried out in India by HO is closely connected or related to the issue in respect of which the AO has recorded the reasons for issuing notice u/s. 148 of the Act. He, therefore, submitted that even in the light of the decision of Honourable Delhi High Court in the case of Jai Bharat Maruti Ltd. Vs. CIT (supra), the AO’s action in considering the issue in the present reassessment is valid.
53. We have heard both the parties on this preliminary objection raised by the assessee against the validity of AO’s action whether the addition on account of apportionment of profit attributable to PE in India for use of research activity carried out in India by HO can be made in the present reassessment notwithstanding the fact that no specific reason relating to this issue were recorded by the AO while reopening the assessment u/s. 147 of the Act or at the time of issuance of notice u/s. 148 of the Act. Without going to deliberate upon the various contention raised by both the parties on this issue, this issue is no more debatable in the light of the insertion of Explanation 3 below section 147 by the Finance No 2 (Act), 2009 with retrospective effect from 01.04.1989, where it has been provided that for the purpose of assessment or reassessment u/s. 147, the AO may assess or reassess the income in respect of any issue, which has escaped assessment and such issue comes to his notice subsequently in the course of the proceedings u/s. 147, notwithstanding that the reasons for such issue have not been included in the reasons recorded under subsection 148 of the Act. Therefore, in the light of the provisions contained in Explanation 3 to section 147 of the Act inserted by the Finance No. 2 (Act) w.e.f. 01.04.2009, this very preliminary objection of the assessee is rejected.
54. Now, we shall proceed to decide the issue on merit as to whether the CIT(A) was justified in confirming the AO’s order in making addition on account of attribution of profits of H.O. to PE in India.
55. The Sr. Counsel for the assessee has submitted that the assessee’s liaison office was converted into Branch Office vide RBI approval dated 18.10.1992 to carry out, inter-alia, to conduct agri-genetic research for development of new products and to make available parent seeds to Joint Venture company under a parent seeds charges arrangement provided the results of the research work are made available to Indian companies, and in that view of the matter the Indian Branch of the assessee company has been carrying out two distinct activities:-
(i) conducting agri-genetic research, the results of which to be made available to Indian Companies; and
(ii) production of parent seeds and its sales to Joint Venture company under an arrangement
56. It was further submitted by the ld. Sr. Counsel for the assessee that agricultural research conducted by the Research Unit results in development of parent breeder/ foundation seeds in small quantities, and these breeder/ foundation seeds are used as inputs as seed for multiplication and sale of parent seed. He further pointed out that research activity is in-house and exclusive, and the research material and know-how are neither sold nor licensed or otherwise transferred to any third party including Production unit of the Indian branch. Research unit is vertically integrated to the Research unit of the Head office in USA, and the expenditure of research are separately recorded in the books of accounts and are fully reimbursed by the Head Office. He further submitted that the assessee is not in the business of selling, licensing, or otherwise transferring research material/know-how to any outside party nor does it carry out research for third party on job basis. He, therefore, submitted that the research activity is nothing but preparatory and auxiliary activity to the main business of assessee company, which is production and sale of hybrid parent seeds. In India, the assessee’s Branch office is engaged in the production and sale of hybrid parent seeds to Joint Venture group company. He, therefore, submitted that the research activity are preparatory and auxiliary to the main business of assessee, and are thus, covered by exclusionary clause of Article 5(3)(e) of the treaty between India and USA.
57. The ld. Sr. counsel for the assessee further submitted that in the light of the provisions contained in Article 5(3)(e) of the DTAA between India and USA, it is clear that scientific activities are auxiliary activities, and as such, doing agri-genetic research by Indian branch of assessee company cannot be considered to be a permanent establishment as contemplated under Article 5(3)(e) of the Treaty between India and USA. In support of this contention, the assessee relied upon the following decisions:-
I. In Morgan Stanley and Co. 292 ITR 416
II. U.A.E. Exchange Centre Ltd. vs. Union of India (2009) 223 CTR (Del) 250
58. In this connection, the ld. counsel for the assessee further submitted that research unit is an independent and distinct unit of which entire cost was borne by the Head Office in USA, and it is solely engaged in scientific research. He, therefore, submitted that the research activity of the Indian Branch do not constitute permanent establishment as contemplated under the provisions contained in the Treaty entered into between India and USA.
59. He farther contended that no attribution of profit can be made for specific research activities performed by the Indian branch for the Head Office because last sentence used in Article 7(3) of the treaty between India and USA. At this stage, the ld. counsel for the assessee drew our attention to the provisions contained in Article 7 of Indo-US DTAA dealing with computation of business profit of PE in India. He submitted that as per provisions contained in Article 7(1)(a), only profits attributable to the P.E. are taxable in India, and 7(1)(a) and 7(1)(c) incorporate limited force of attraction rule but, on the fact, these clauses are not applicable to the present case as no activity is carried on by the assessee in India except P.E. He further submitted that Article 7(1) must be read and interpreted in conjunction with paragraph 2, 3, 5 and 6 of this Article i.e. Article 7, and in that sense of the term, the Indian branch must be treated as a distinct entity and profit center, and attribution under Article 7(1), (2) and (5) can be made only on the basis as to what an outsider would charge the Head Office for rendering such services at arms length. In support of this contention, the ld. counsel for the assessee drew our attention to the Circular no. 5 dated 28.09.2004 issued by the CBDT and the decision of Honourable Supreme Court in the case of CIT Vs. Hyundai Heavy Industries Co. Ltd. (291 ITR 482 and in the case of Morgan Stanley & Co. (292 ITR 416) and the decision of Honourable Bombay High Court in the case of Set Satellite (Singapore) Pvt. Ltd. (218 CTR 452).
60. He, therefore, submitted that the formula adopted by the AO and by the CIT(A) for determining the deemed income in India “through research activities is arbitrary, whimsical and contrary to the facts of the case and as well as contrary to the Explanation 1 to section 9(1)(i) of the Act. It was further submitted by the ld. counsel for the assessee what can be at best be taxed as income arising from operation in India, which by applying arm’s length principle can only be a certain percentage of the cost of research activities as mark-up, as has been done by the AO in the later year starting from A.Y. 2002-03 on wards on the basis of transfer pricing adjustment u/s. 92 CA (3) of the Act. It is important to note that functions performed, assets employed and risk borne by the PE in India have remained static for all these years. He further pointed out that for all the years starting from A.Y. 1993- 94 up to date, the Head Office has been reimbursing the entire expenditure on research, and no attribution was made by the revenue on account of business connection or PE right up to and including A.Y. 1998-99. He further contended that the present action of the AO in this assessment year is contrary to the stand taken by the AO in earlier years.
61. With regard to the fact that assessee has made an application under MAP, the ld. counsel for the assessee has submitted that mere because the assessee has made an application under MAP cannot be a ground to assume that there is an admission on the part of the assessee that income of Head Office is also taxable in India being attributable to the activities carried out by it at branch office in India. He further submitted that business profit of assessee company can only be taxed in India only if there is a PE in India, and there is no admission by the assessee that there exist a PE in India so as to attract provisions of Article 7 of DTAA between India and USA. In this respect, the ld. counsel for the assessee has relied upon the decision in the case of Motorola Inc. vs. Dy. CIT 96 TTJ 1 (Del)(SB).
62. He further submitted that the assessee was not engaged in the business of sale of germ-plasm seeds (hybrid breeder seeds), which were developed and produced by doing research activities, and thus, there was no commercial exploitation of the research of developing and producing germ plasm seeds by the assessee.
63. The ld. Special Counsel for the revenue, on the other hand, has submitted that in the light of the approval granted by the RBI for conversion of liaison office to branch office to carry out certain activities as provided in the letter of approval, it is clear that the assessee has been engaged in the agri-genetic research for development of new products and to make available parent seeds to its Joint Venture company. He further submitted that the contention of the assessee that research activities and the activity of producing of parent seeds, which are supplied to joint venture company, are independent and distinct, is contrary to the facts in as much as, in the present case, the books of research unit as well as production unit are common, funds are common, management are common, and whatever hybrid breeder seeds has been produced by the assessee has been utilised as seed for multiplication of parent seeds, which are in turn supplied to the joint venture company. He, therefore, submitted that the development and production of hybrid breeder-seed is a necessary input to produce hybrid parent seeds, and therefore, both the activities cannot be said to be distinct and independent to each other. He, therefore, submitted that the assessee’s activities of making agri-genetic research to develop and produce hybrid breeder seeds and then producing parent seeds, which are supplied to the joint venture company, are the core business activities of the assessee and not a mere preparatory or auxiliary activities as contemplated under article 5(3)(e) of the Indo-US Treaty. In this respect, the ld. Special Counsel for the department relied upon the findings and observations made by the CIT(A) in para 4.6 of his order.
64. He further submitted that seeds produced in any one crop are mostly discarded and then sold in the market, and the sales proceeds of discarded seeds has been adjusted against the expenses incurred towards the research operation activities of developing and producing hybrid breeder seeds, and only the net expenses are being reimbursed by the Head Office. This makes it clear that the products produced by the assessee are being sold in India. He, therefore, submitted that the assessee company’s activities of developing and producing hybrid breeder seeds, which are used as input for producing parent seeds, are core activity of assessee’s business. He further pointed out a fact that determination of the price of seeds sold by the assessee to the joint venture company is also made by the HO. He, therefore, submitted that the decision of Honourable Delhi High Court in the case of UAE Exchange Industry, Morgan Stanley etc. are not applicable to the present case, in as much as the present case is a case where primary and core business activity are being carried out by the branch office of the assessee company.
65. With regard to the interpretation of Article 7, he further submitted that the manner in which the profit has been attributed to the operations carried out in India, by the AO is proper and justified and, thus, the addition made by the AO is to be restored.
66. We have considered the rival contentions of both the parties and have carefully gone through the orders of the authorities below. Various documents and papers placed before us have been looked into. We have deliberated upon the provisions of law viz-a-viz., provisions contained in DTAA between India and USA, and have deliberated upon the various decisions cited at the bar.
67. In order to resolve the controversy, it is necessary for us to decide first as to whether there exist a PE in India in the nature of Branch office, in respect of which approval has been granted by the RBI to carry out certain activities mentioned in the letter of approval issued by the RBI.
68. We, therefore, find it necessary to refer to the meaning of “permanent establishment” as defined under Article 5 of Indo-US Treaty, which is setout as under:-
“PERMANENT ESTABLISHMENT
1. “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.
2. The term “permanent establishment” includes especially :-
(a) a place of management;
(b) a branch;
(c) an office;
(d) a factory;
(e) a workshop;
(f) a mine, an oil or gas well, a quarry, or any other place of extraction of natural resources;
(g) a warehouse, in relation to a person providing storage facilities for others;
(h) a farm, plantation or other place where agriculture, forestry, plantation or related activities are carried on;
(i) a store or premises used as sales outlet;
(j) an installation or structure used for exploration or exploitation of natural resources, but only if so used for period of more than 120 days in any twelve-months period;
(k) a building side or construction, installation or assembly project or supervisory activities in connection therewith, where such site, project or activities (together with other such sites, projects or activities, if any) continue for a period of more than 120 days in any twelve-month period;
(l) the furnishing of services, other than included services as defined in Article 12 (royalties and fees for included services), within a Contracting State by an enterprise through employees or other personnel, but only if:
(i) activities of that nature continue within that State for a period or periods aggregating to more than 90 days within any twelve-months period; or
(ii) the services are performed within that Slate for related enterprise (within the meaning of paragraph of article 9 (associated enterprises)
3. Notwithstanding the preceding provisions of this article, the term “permanent establishment” shall be deemed not to include any one or more of the following:-
(a) the use of facilities solely for the purpose of storage, display, or occasional delivery of goods or merchandise belonging to the enterprise;
(b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display, or occasional delivery;
(c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;
(d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or of collecting information, for the enterprise;
(e) the maintenance of a fixed place of business solely for the purpose of advertising, for the supply of information, for scientific research or for other activities which have a preparatory or auxiliary character, for the enterprise.
4. Notwithstanding the provisions of paragraphs 1 and 2, where a person – other than an agent of an independent status to whom paragraph 5 applies – is acting in a Contracting State, that shall be deemed to have a permanent establishment in the first-mentioned State, if;
(a) he has and habitually exercises in the first-mentioned State ah authority to conclude contracts on behalf of the enterprise, unless his activities are limited to those mentioned in paragraph 3 which, is exercised through a fixed place of business, would not make that fixed place of business a permanent establishment under the provisions of that paragraph.
(b) he has no such authority but habitually maintains in the first-mentioned State a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the enterprise, and some additional activities conducted in that State on behalf of the enterprise have contributed to the sale of the goods or merchandise; or
5. An enterprise of a Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because it carries on business in that other State through a broker, general commission agent, or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business. However, when the activities of such an agent are devoted wholly or almost wholly on behalf of that enterprise and the transactions between the agent and the enterprise are not made under arm’s length conditions, he shall not be considered an agent of independent status within the meaning of this paragraph.
6. The fact that a company which is a resident of a Contracting State controls or is controlled by a company which is resident of the other Contracting State, or which carried on business in that other State (whether through a permanent establishment or otherwise), shall not of itself constitute either company a permanent establishment of the other.”
69. Item “e” of para (3) of Article 5 of Indo-US Treaty provides that the term “permanent establishment” shall not include the maintenance of a fixed place of business solely for the purpose of advertising, for the supply of information for scientific research or for other activities which has a preparatory or auxiliary character, for the enterprise. The ld. counsel for the assessee has submitted that the Branch office of the assessee company exist solely for scientific research and for other activities, which have preparatory or auxiliary character. The ld. Standing counsel for the department, on the other hand, submitted that the branch office of the assessee company in India does not exist solely for scientific research or for other activities, which have preparatory or auxiliary character for the enterprise. Having regard to the nature of the activities carried out by the branch office of the assessee company in India, we, therefore, have to see whether the assessee is maintaining Branch office for India solely for scientific research or for other activities which have a preparatory and auxiliary character for the assessee company. The clause (e) of Article 5(3) can be expanded item-wise as under:-
(i) The maintenance of a fixed place of business solely for the purpose of advertising, for the enterprise;
(ii) The maintenance of a fixed place of business solely for supply of information, for the enterprise;
(iii) The maintenance of a fixed place of business solely for scientific research, for the enterprise;
(iv) The maintenance of a fixed place of business solely for other activities, which have a preparatory or auxiliary character, for the enterprise;
70. The assessee’s claim is that the assessee company is maintaining Branch office in India solely for scientific research for the assessee company or for other activities, which have preparatory or auxiliary character for the assessee company.
71. There is no dispute as to the fact that Reserve Bank of India vide approval dated 18.10.1992 has allowed the assessee company to convert its liaison office into a Branch office in India for the purpose of undertaking following activities:-
i. “to represent the parent company (PCC) on commercial and business matters in India;
ii. to conduct agri- genetic research for the development of new products and to make available parent seed to Joint Venture Company under a parent seed charge arrangement provided the results of these research work are made available to Indian companies;
iii. to undertaken export and import of PCC’s products;
iv. to supervise and promote Pioneer’s technical and financial collaboration with Indian Companies.”
From the nature of activities and the purpose of which the assessee was allowed permissions to convert its liaison office into Branch office,’ it is seen that the assessee was allowed to represent parent company on commercial and business matter in India, and to conduct agri-genetic research for the development of new product and to make available parent seed to joint venture company under a parent seed charge arrangement provided the results of these research works are made available to Indian companies, and to undertake export and import of parent companies product, and to supervise and promote parent company’s financial and technical collaboration with Indian companies. From the overall activities of the assessee earned out by its Branch office in India, as so explained by the assessee before the authorities below, it is seen that the assessee company in India is engaged in the business of production and sale of various variety of parent seeds, which are sold to its joint venture company. For production of parent seeds in large quantities, the first requirement is the availability of ‘hybrid breeder seeds’ or ‘hybrid germ plasm’, which would be sown for raising crops of parent seeds. It is the claim of the assessee that the hybrid breeder seeds are developed or produced by the assessee as an ongoing research and development programme taking about 8-10 years for developing the successful hybrid breeder seeds of desired quality. These hybrid breeder seeds are developed and produced by the assessee as an ongoing research and development programme, and are used as input or as seeds for the purpose of producing and multiplying parent seeds, which are then sold to the joint venture company. In the light of the very activities of developing and producing hybrid breeder seeds by the assessee and then using them as input or as seeds for producing parent seeds, it is clear to us that all the aforesaid activities undertaken by the assessee are nothing but one composite integrated activity intended to be carried out by the assessee for the purpose of producing parent seeds, which are being supplied to the joint venture company as per the approval granted by the RBI. It was the dominant object and purpose of the assessee company to make available parent seeds to joint venture company. It is also clear that the assessee would not be in a position to make available parent seeds to joint venture company unless and until the assessee develops and produces hybrid breeder seeds, which are used as input and are being multiplied to obtain parent seeds in large quantities, which are in turn supplied to joint venture company. Thus, the dominant purpose of object of the assessee company to seek approval from RBI for conversion of its liaison office into branch office in India for the purpose of undertaking various activities mentioned in the approval letter was to conduct agri-genetic research for the development of new products and to make available parent seeds to joint venture company. The sole object of the assessee company to open a Branch office in India was not to do solely any scientific research or agri-genetic research but at the same time the object of the assessee was to produce parent seeds for making them available to its joint venture company. Therefore, conducting agri-genetic research for the development of new products and making available parent seeds to joint venture company are inter-dependent, inter-connected and inter lacing. This view has already been taken by us while deciding the issue about the assessee’s claim as to whether the income from producing and supply of parent seeds to joint venture company is agricultural income or not, in ITA no. 4925/Del/2004 pertaining to the A.Y. 1998-99 filed by the assessee, where vide order dated 30.11.2009. We have observed and held as under:
“47. At this juncture, we consider it appropriate to see whether the assessee’s activity of developing hybrid parent seed, i.e. breeder seed, and activity of multiplication of parent seed by sowing breeder seed, are totally distinct and separate to each other as so claimed by the assessee. It is the case of the assessee that research unit developing breeder seed is a self-contained unit and its object is to develop elite germplasm seeds or hybrid parent seeds know as breeder seeds, which are capable of producing commercial hybrid seeds. The assessee has explained before the authorities below the various components and stages of its activity of developing hybrid parent seeds, which has been reproduced by the CIT(A) in pare 3.3 to 3.7 of his order. The relevant portion of CIT(A) ‘s order has already been reproduced above herein by us.
48. From the nature of activity carried out by the assessee, it is clear that the breeder seeds developed or produced by the assessee are sown to obtain large quantities of parent seeds, which are being supplied to joint venture company for a price. The assessee undertakes the production of parent seed through multiplication of breeder seed, which are developed by the assessee after a long drawn process of combining two or more traits of different seeds into one seed. The assessee was allowed permission under section 29(1)(a) of the Foreign Exchange Regulation Act, 1973 for opening a branch office in India by the Reserve Bank of India vide letter dated 18 November, 1992. It is important to note that this permission was granted to the assessee in pursuance to assessee’s application dated 22nd October, 1992. The assessee was granted permission for conversion of its liaison office at New Delhi into a branch office for the purpose of undertaking the following activities:-
v. “to represent the parent company (PCC) on commercial and business matters in India;
vi. to conduct agri-genetic research for the development of new products and to make available parent seed to Joint Venture Company under a parent seed charge arrangement provided the results of these research work are made available to Indian companies;
vii. to undertaken export and import of PCC’s products;
viii. to supervise and promote Pioneer’s technical and financial collaboration with Indian Companies.”
49. From the nature of activities for the purpose of which the assessee was allowed a permission for conversion of its liaison office into a branch officer, it is evident that the assessee was allowed to conduct agri- genetic research for the development of new products and to make available parent seed to joint venture company under a parent seed charge arrangement provided the results of these research work are made available to Indian companies. Therefore, conducting agri- genetic research for the development of new products and making available parent seed to Joint Venture company under a parent seed charge arrangement is one and composite activity intended to be carried out by the assessee while seeking a permission from RBI. Both the activities of conducting agri- genetic research for the development of new products and making available parent seed to Joint Venture Company are inter-dependent, inter connected and inter-lacing. The assessee would not be in a position to make available parent seed to Joint Venture company for enabling it to produce commercial hybrid seed unless and until the assessee develops breeder seeds which are multiplied to obtain parent seeds in large quantity and then supplying the parent seeds in large quantity to joint venture company. If we look to the dominant and primary object and intention of the assessee company in obtaining permission from RBI to undertake the certain activities, it is more than clear that the assessee’s activity of developing breeder seeds by research and producing parent seeds in large quantity for the purpose of supplying the same to joint venture company cannot, by any stretch of imagination, be said to be to totally distinct, separate and independent to each other so as to consider the activity of producing parent seeds being dissociated from activity of developing breeder seeds. This sort of contention advanced the assessee is totally misconceived and baseless. The activity of developing breeder seed is nothing but apart of one and composite integrated activity of producing parent seeds of desired results for the purpose of supplying it to the Joint Venture company. The assessee’s contention that breeder seeds are developed in different field or plot of land than that of producing parent seed is not material and relevant, and it does not change the very dominant and primary object and intention of the assessee to conduct agri- genetic research for the development of new products and to make available parent seed to joint venture company under a parent seed charge arrangement. It is very common and usual in any industry that various activities necessary to manufacture or produce any article or thing or goods are carried out by that industry at different places or factories or workshop or sites and mere because various stages or steps necessary to manufacture any item or things or goods or articles are performed or carried out at different places, sites, workshops, factory it would not mean that all such activities carried out to manufacture a final product are independent and distinct to each other. It is well settled that in order to determine the true and correct nature of any activity, the treatment or label or name given by the assessee in its books or documents or papers is not conclusive and what is conclusive and relevant is the true nature and substance of the activity having regard to the intention of the party coupled with all relevant surrounding circumstances of a given case. Therefore, the treatment given by the assessee in . its accounts or other documents cannot be a sole determinative factor to determine the true and correct nature of any transaction or activity but all other surrounding and relevant facts and circumstances of the case are to be taken note of and be considered. It is also equally true that purchase or acquisition of raw material in one particular year and manufacturing or producing final goods from those raw material in any later year would not make the activity of purchasing or acquiring raw material in one year and activity of manufacturing final goods using said, raw materials in later year a totally distinct and independent activity to each other when both activities are undertaken by the same person in the course of business of manufacturing goods etc. In order to treat various activities or stages or steps necessary to manufacture any item as one and composite activity, it is not necessary that all such various activities or stages or steps should be carried out in one year. Therefore, the assessee’s contention that because of time gap of several years between the activity of developing breeder seeds and producing parent seeds after sowing breeder seeds, both these activities should be considered to be totally distinct and independent to each other is not acceptable. From the various components and stages of producing or developing hybrid parent seeds known as breeder seeds and then producing parent seeds in large quantity after sowing breeder seeds as narrated or stated by the assessee, it is noticed by us that the breeder seeds are developed through fixation of desired traits by raising successive generations of crops to arrive at pure in bred lines (elite germ plasma or breeder seeds or hybrid parent seeds, by whatever name it may be called) which are then hybrid-ed with in bred lines or elite germ plasma of another set of desired traits and so on and so forth taking about 7-10 years to develop a successful hybrid parent seed, and only then it can be used for commercial production of parent seed for supply to assessee’s joint venture company. The assessee has incurred huge expenditures in developing a successful hybrid parent seed or elite hybrid germ plasma. The different breeder seeds of distinct traits are produced by sowing and planting a vast variety of seeds individually and each plant is harvested individually and thereafter two seeds of different traits are hybrid-ed by way of process where two plants or seeds are crossed over number of generations of crops until the two traits of desired result are fixed in one hybrid seed, and hybrid parent seed are then multiplied to obtain a large quantity of hybrid parent seeds for the purpose of supplying it to joint venture company. The whole process of sowing and planting a vast variety of seeds individually, and raising crops year after year, producing hybrid parent seeds of desired result, multiplication of hybrid parent seeds and then supplying the same to Joint venture company is nothing but one single integrated activity where all operations are undertaken or carried out by the same assessee with a view to supply multiplied parent seeds to its joint venture company as per object and intention of the assessee specified in the approval granted by RBI.
50. In this view of the matter, we are in agreement with the CIT(A) ‘s finding that the two activities are completely interlinked, interlaced and dependent on each other, and cannot be divorced or dissociated from each other. The production of parent seeds is undoubtedly in continuation of the development and production of elite hybrid germplasms or hybrid parent seeds known as breeder seeds. These two activities of the assessee have got to be understood as connoting one integrated activity of making available parent seeds to its joint venture company.
72. In the light of the discussions made above we are, therefore, in agreement with conclusion arrived at by the ld. CIT(A) in holding that the research activity and the sale of parent seeds by the assessee company are inter-linked, inter-lacing and inter-dependent.
73. Having said so, we have to decide whether the aforesaid activities of doing agri-genetic research for producing new products and making available and sale of parent seeds to joint venture company can be considered to be the activity in the nature of preparatory or auxiliary character.
74. There is no quarrel as to the proposition that preparatory and auxiliary business activities do not constitute a PE even if they are performed through a fixed place of business. Any activity of a preparatory and/or auxiliary nature is exempted from PE status. The essential and significant activities within the framework of the business purpose of the enterprise would constitute core business activities, and in that event, the business operations in the nature of core business activities would invariably constitute a PE. The core business activities would include management, exploitation of natural resources, manufacturing transportation and sales. Sales activities includes pre-sales activities, such as solicitation and negotiation of sales. In the case on hand, there is a combination of developing and producing breeder seeds and sales of parent seeds to assessee’s joint venture company, which would undoubtedly lead the branch office to PE status. It is not the case where mere and/or sole scientific research is being carried on by the branch office but it is the case where the assessee carries on agri-genetic research to develop and produce breeder seeds, which are used as input and/ or seeds for producing parent seeds, which are in turn sold to joint venture company. Even the discarded seeds produced during the course of developing and producing breeder seeds are being sold in India, and the proceeds realised therefrom are adjusted against the research expenses in the books instead of showing the same separately as income in the books. The information or results or datas collected during the course of developing and producing hybrid breeder seeds are being supplied to the HO and in turn o various group companies over the world. Having regard to the various stages of developing and producing breeder seeds and then producing parent seeds from breeder seeds, it is clear beyond any doubt that the activity of developing and producing breeder seeds by doing extensive research is an “essential” and “significant” part of the activity of the branch office in supplying parent seeds to its joint venture company. In this view of the matter, we find ourselves in full agreement with the learned CIT(A) in observing and holding that the assessee ‘s two fold activities of conducting the research and utilisation of the research in preparation or production of parent/hybrid seeds of high quality of various crops and sales thereof are interwoven, inter-related, coordinated, inter-linked and inter-dependent, and the research activity of the assessee is not the sole activity of its branch office in India but the research conducted by the assessee is the main core activity, which is commercially exploited by the assessee by way of selling of hybrid/parent seeds.
75. In the light of the facts of the present case, the decision of Hon’ble Delhi High Court in the case of U.A.E. Exchange Centre Ltd. Vs. Union of India (2009) 223 CTR (Del) 250: (2009) 22 DTR (Del) 33: on which heavy reliance has been placed by the ld. senior counsel for the assessee, is not applicable to the present case as discussed below:-
The Honourable- Delhi High Court in the case of U.A.E. Exchange Centre Ltd. vs. Union of India (2009) 223 CTR (Del) 250: (2009) 22 DTR (Del) 33: had an occasion to consider as to whether the income of the non-resident is taxable in India in view of having a LO at five places in India. The exclusionary clause found in that case was similar to art. 5(4)(e) of the agreement between India and South Korea. The Honourable High Court observed that the plain meaning of the word ‘auxiliary’ is found in Black Law Dictionary, 7th Edition at p. 130 which reads as “aiding or supporting, subsidiary”. In that case, the only activity of the LO in India was simply downloaded information, which was contained in the main servers located in UAE based on which cheques were drawn on banks in India whereupon the said cheques were couriered or dispatched to the beneficiaries in India keeping in mind he instructions of the NRI remitter. Such an activity was held as an activity in aid or support of the main activity. The Honourable Delhi High Court further observed that the activity carried on by the LO in India did not in any manner, whatsoever contribute directly or indirectly to the earning of profits or gains by the petitioner in UAE. Commission for the services of remittance offered by the petitioner was also earned in UAE. Now from the above it is clear that if the activity carried out in India contributes directly or indirectly to the earning of profits or gains by the non-resident then extent of contribution is to be taxed in India. In the instant case before us, it is not in dispute that the assessee has engaged in the activity of developing and producing breeder seeds by doing extensive research over a number of generations of crops from year to year and the information or data or results found during the course of such activities of developing and producing breeder seeds are transferred to the Head Office, which is accessible to other branches all over the world, and the breeder seeds so developed and produced by the assessee is used as raw material or input or as seed for the purpose of producing hybrid parent seeds which are in turn sold and supplied to the joint venture company by the assessee. The information or data or result collected by the assessee during the course of developing and producing breeder seeds are used or applied by the Head Office and other branches of the assessee company all over the world for the purpose of producing hybrid seeds. We further find that all the information or data or results obtained by the assessee in the course of developing and producing hybrid breeder seeds or hybrid germplasms are accessible to any other branch office or Head Office of the assessee company. There exist a pool of research available at Head Office which is used by other branch offices all over the world. Hence, the research activity carried out by the branch office in India in the course of developing and producing hybrid breeder seeds is to be considered for the purpose of determining income accruing to the assessee company in India, and the quantum is to be ascertained on the basis of the profit of the Head Office attributable to the branch office in India. It, thus, makes it clear that activity carried out in India contributes directly or indirectly to the earning of profits or gains by the Head Office from developing and producing hybrid seeds and, therefore, the income to the extent of the contribution made by the branch office in India to the Head Office is to be taxed in India.
76. In the present case, the income of the Head Office or other branch offices all over the world is generated outside India by use of the data or information or results provided by the branch office to Head Office, and all the activity of producing hybrid seeds by the Head Office or other branch offices all over the world are not taking place in India. Since the preparation or production of hybrid seeds and its sale by the Head Office or other branch offices all over the world is taken place outside India, only the profit which is attributable to the activities earned out in India i.e. use of the result of the research provided by the branch office in India to H.O., will only be taxable in India. In this view of the matter we, therefore, hold that the decision of Honourable Delhi High Court in the case of U.A.E. Exchange Centre Ltd. vs. Union of India (supra) does not advance the assessee’s case any further.
77. The ld. counsel for the assessee has also placed reliance upon the decision of the Honourable Supreme Court in the case of Morgan Stanley and Co. 292 ITR 416 where the Honourable Supreme Court had observed and held with reference to the Article 5(3)(e) of the Treaty as under:-
“”In our view, the second requirement of article 5(1) of the DTAA is not satisfied as regards back office functions. We have examined the terms of the agreement along with the advance ruling application made by MS Co. inviting the AAR to give its ruling. It is clear from a reading of the above agreement/ application that MSAS in India would be engaged in supporting the front office functions of MS Co in fixed income and equity research and in providing IT enabled services such as data processing support centre and technical services as also reconciliation of accounts. In order to decide wither a P.E. stood constituted one has to undertake what is called a functional and factual analysis of each of the activities to be undertaken by an establishment. It is from that point of view, we are in agreement with the ruling of the AAR that in the present case article 5(1) is not applicable as the said MSAS would be performing in India only back office operations. Therefore to the extent of the above back office functions the second part of article 5(1) is not attracted.”
The Supreme Court further observed (P. 177/PB/IV)
“There is one more aspect which needs to be discussed namely, exclusion of P.E. under article 5(3). Under article 5(3)(e) activities which are preparatory or auxiliary in character which are carried out at a fixed place of business will not constitute a P.E. Article 5(3) commences with a non obstante clause. It states that notwithstanding what is a fixed place of business solely for advertisement, scientific research or for activities which are preparatory or auxiliary in character. In the present case we are of the view that the above mentioned back office functions proposed to be performed by MSAS in India fall under article 5(3)(e) of the DTAA. Therefore, in our view in the present case MSAS would constitute a fixed place P.E. under article 5(1) of the DTAA as regards its back office operations. “
78. However, in the light of the view we have taken above holding that research activities carried out by the branch office in India are not an independent and distinct activity to the activity of producing and sale of parent seeds sold to joint venture company, and the said research activities are core business activities, the decision of Honourable Supreme Court in the case of Morgan Stanley and Co. 292 ITR 416 (SC) is not applicable to the facts of the present assessee’s case in as much as the research activities of developing and producing hybrid breeder seeds, which are used as input or seed for producing parent seeds, cannot be held to held to be the functions of back office supporting the business of the branch carrying on business of production and sale of parent seed. If one has to make functional and factual analysis of each of the activities undertaken by branch office in India, it is more than clear that the activity of doing extensive research to develop and produce breeder seeds, which are used as seed for producing hybrid parent seeds are core business activity of producing hybrid parent seeds sold to the joint venture company. Thus, the said decision mentioned just above gives no assistance to the assessee’s case being based on different facts.
79. In the light of discussions made above, we, therefore, hold that the assessee’s case is not covered by exclusionary provisions contained in Article 5(3)(e) of the Treaty between India and USA. Consequently, we hold that the assessee’s branch office in India do constitute a PE within the meaning of article 5 of DTAA between India and USA, and the income of the PE is, thus, to be taxed in India as per provisions of Article 7 of DTAA.
80. Article 7(1) of the DTAA between India and USA provides that the profits of an enterprise of a Contacting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein and if the enterprise carries on business in other Contracting State through a permanent establishment situated there in, the profits of an enterprise may be taxed in the other State but only so much of them as is attributable to that permanent establishment; or sales in the other State of goods or merchandise of the same or similar kind as those sold through that permanent establishment; or other business activities carried on in the other State of the same or similar kind as those effected through that permanent establishment.
81. Article 7(2) of the Treaty provides that subject to the provisions of article 7(3), where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and independent enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly at arm’s length with the enterprise of which it is a permanent establishment and other enterprises controlling, controlled by or subject to the same common control as that enterprise. In any case where the correct amount of profits attributable to a permanent establishment is incapable of determination or the determination thereof presents exceptional difficulties, the profits attributable to the permanent establishment may be estimated on a reasonable basis. The estimate adopted shall, however, be such that the result shall be in accordance with the principles contained in Article 7.
82. In the light of the Article 7(1) & (2) of Indo-US Treaty, the Indian permanent establishment should be treated as separate profit centre and profits to be attributed to it should be worked out by following arm’s length principle as so held by the Honourable Supreme Court in the case of CIT vs. Hyundai Heavy Industries Companies Ltd. 291 ITR 482 in the case of Morgan Stanley 292 ITR 416) in the case of Ishikawajama Harima Heavy Industries Ltd. 288 ITR 408 and the decision of Honourable Bombay High Court in the case of Set Satellite (Singapore) Pvt. Ltd. reported in 218 CTR 45. From the said decisions it is clear that it is the arm’s length price, which should be constitute the basis for computing the profit of the permanent establishment in India for providing services to the Head Office. However, if the correct amount of attribution is incapable of determination or poses exceptional difficulties, the attribution may be estimated on a reasonable basis, and the result of such estimation should be in accordance with the principles contained in Article 7.
83. At this stage, it is deemed necessary by us to consider the impact of DTAA on the provisions of local enactment i.e. Income Tax Act. It is well settled that where liability to tax arises under the local enactment, the provisions of section 4 and 5 of the Act provide for taxation of global income of an assessee chargeable to tax there under, then it is subject to the provisions of an agreement entered into between the Central Government and the Government of a foreign country for avoidance of double taxation as envisaged under section 90 to the contrary, if any, and such an agreement will act as an exception to or modification of section 4 and 5 of the Income Tax Act. The provisions of such agreement cannot fasten a tax liability where liability is not imposed by a Local Act. Where tax liability is imposed by the Act, the agreement may be resorted to either reducing the tax liability or altogether avoiding the tax liability. In case of any conflict between the provisions of the agreement and the Act, the provisions of the agreement would prevail over the provisions of the Act as is clear from the provisions of s. 90(2) of the Act. Hence, we have to see first as to whether any tax liability is imposed on the present assessee (a non-resident company) under the Act.
84. As per s. 5(2) of the IT Act, the total income of a non-resident also includes income which accrues or arises or is deemed to accrue or arise to him in India during the previous year. Sec. 9 specifies the incomes which are deemed to accrue, or arise in India. The relevant section is s. 9(1)(i) is reproduced as under:
“9. Income deemed to accrue or arise in India.
(1) The following incomes shall be deemed to accrue or arise in India:-
(i) 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;
Explanation 1: For the purpose of this clause-
(a) in the case of a business of which all the operations are not carried out in India, the income of the business deemed under this clause to accrue or arise in India shall be only such part of the income as is reasonably attributable to the operations carried out in India;
(b) in the case of a non-resident, no income shall be deemed to accrue or arise in India to him through or from operations which are confined to the purchase of goods in India for the purpose of export;
(c) in the case of a non-resident, being a person engaged in the business of running of a news agency or of publishing newspapers, magazines or journals, no income shall be deemed to accrue or arise in India to him through or from activities which are confined to the collection of new and view in India for transmission out of India;
(d) in the case of a non-resident, being-
(1) an individual who is not a citizen of India; or
(2) a firm which does not have any partner who is a citizen of India or who is resident in India; or
(3) a company which does not have any shareholder who is a citizen of India or who is resident in India, no income shall be deemed to accrue or arise in India to such individual, firm or company through or from operations which are confined to the shooting of any cinematography film in India;
Explanation 2: xxx xxx xxx”
85. Therefore, we have to see whether there is any business connection of assessee non-resident company in India, and whether through such business connection, any income is accruing or arising to the assessee company. As already discussed in detail herein above, the assessee has a branch office in India to undertake various activities a per permission granted by the RBI, and the result of the agri-genetic research conducted in the course of developing and producing hybrid breeder seeds are provided to the HO in USA. There exists a relation between a business of producing hybrid breeder seeds in USA by the assessee non-resident company which yield profits or gains and the activity of providing result of research conducted by Branch office in India which contributes directly or indirectly to the earning of those profits or gains. There exists a PE in India, and the assessee company has a business connection in India. Thus, such part of profits or gains earned in USA as is reasonably attributable to the operations or activities carried out in India, shall be taxable in India.
86. As already discussed above, in the light of the Article 7(1) and (2) of Indo-US Treaty, the Indian permanent establishment is to be treated as a separated profit centre, and profits to be attributed to it should be worked out by following arm’s length principle. In this connection as to the method of determining profit attributable to PE in India, the ld. counsel for the assessee has submitted that the revenue authorities below have not made out any case for any exceptional difficulty or has not established that the present case is an unusual one. but, on the other hand, after the insertion of Transfer Pricing Provisions in the Income Tax Act effective from A.Y. 2002-03, the AO has determined the arm’s length price of the services rendered by Indian branch office i.e. Indian P.E. to the US Head Office, at a percentage ranging from 12.5% to 18% of the cost of the services. We are in agreement with this contention advanced by the ld. counsel for the assessee, and in the light of the provisions contained in Article 7(2), we hold that the arm’s length principle would be applied for attribution of profit of the US Head Office to the PE in India in respect of the services rendered by the Indian PE to the HO, and the manner of computation of profit attributable to the operations carried out in India adopted by the AO, as partially confirmed by the Ld. CIT(A), is not in order. In the present case, the Indian branch office must be treated as a distinct and independent entity and profit center, and the attribution of profit under Article 7(1) and (2) can be made only on the basis as to what an outsider would charge the Head Office for providing the result of research at arm’s length. In other words, profits to be attributed to branch office in India are those that branch office in India would have made if instead of dealing with its Head Office, it had been dealing with an entirely separate enterprise under the same conditions and at prices prevailing in the ordinary market. This method corresponds to the “arm’s length principle”. Hence, in determining the profits attributable to branch office in India, which constitutes a permanent establishment, it is necessary to determine the price of the services rendered by the branch office in India to the Head Office on the basis of arm’s length principle. In the present case, it is not in dispute that the research expenses incurred by the branch office, as reduced by the amount realized by the assessee by way of sale of discarded seeds, has been reimbursed by the H.O., and the net research expenses incurred by the branch office has not been claimed as deduction against its income realized from producing and sale of parent seeds in India. The amount realised by the branch office from the HO has not been separately included nor the research expenses has been claimed as deduction in the profit and loss account. But, the fact remains that the research result has been provided by the branch office to the HO, and the branch office has already realized net research expenses from HO. This fact is to be taken into account while determining the arm’s length price and the mark-up on the cost incurred by the branch office. Since the AO as well as Ld. CIT(A) has not determined the profit attributable to the branch office in India in the manner provided under Article 7(2) subject to the provisions of Article 7(3), and since in subsequent assessment years from the A.Y. 2002-03, the AO did not find any difficulty at all in determining the arm’s length price of the services rendered by the Indian branch office to the US Head Office, we restore this part of the issue about the determination of the price of the services rendered by the Indian branch office to the Head Office at arm’s length price to the file of the AO after providing reasonable opportunities of being heard to the assessee. The assessee shall produce and furnish all the details and particulars before the AO in order to determine the profit attributable to the research activity carried out in India, and used by the HO for its business carried on there. The AO shall decide the issue as per law, in the light of the facts and circumstances of the present case, and after considering the assessee’s submissions by passing a speaking and reasoned order. We order accordingly.
ITA No. 1869/Del/2005 & 2290/Del/2005, A.Y. 1999- 2000
87. Now, we shall come to the appeal filed by the assessee as well as by the revenue pertaining to the A.Y. 1999- 2000.
88. In the assessee’s appeal, the first issue raised in ground no. 1 to 5 is against the initiation of re-assessment proceedings u/s. 147 of the Act by the AO.
89. In this assessment year the assessee filed original return of income on 29.12.1999 declaring total income at Rs. 4,99,000/-. The AO thereafter initiated re-assessment proceedings u/s. 147 of the Act and issued notice u/s. 148 on 11.01.2002. On an appeal, the CIT(A) confirmed the AO’s action in initiating proceedings u/s. 147 and in issuing notice u/s. 148 of the Act for the reasons similar to the reasons given by him in the A.Y. 1997-98, this position that issue with regard to the validity of reassessment proceedings u/s. 147 is identical in both the assessment years i.e. A.Y. 1997- 98 and A.Y. 1999- 2000 is not in dispute. Therefore, in the light of our decision given above on this issue in the A.Y. 1997- 98, we upheld the order of the CIT(A) in confirming the AO’s action in initiating proceedings u/s. 147 of the Act and in issuing notice u/s. 148 of the Act. Therefore, the grounds of the assessee on the issue of validity of notice u/s. 148 of the Act for the A.Y. 1999- 2000, are rejected, and the proceeding initiated u/s. 147 by the AO are held to be valid.
90. Further, in the assessee’s appeal, the assessee has raised grounds about the nature of income earned from producing and sale of parent seeds. This issue has been raised in the ground nos. 6 to 15.
91. In the light of our decision on the identical issue in the A.Y. 1998-1999, which have been followed in the A.Y. 1997-98, we decide the issue raised in these ground nos. 6 to 15 in the terms of our order passed in the A.Y. 1998-99, and direct the AO to modify the assessment order accordingly.
92. Now, we come to the next issue raised by the assessee in ground nos. 16 to 19, which are identical and similar to the ground nos. 16 to 19 raised in the A.Y. 1997-98. Therefore, in the light of our order on these grounds in the A.Y. 1997-98, these grounds stand decided accordingly. This will also take care of a solitary ground raised by the revenue in the A.Y. 1999-2000, which is identical to the solitary ground raised by the revenue in the A.Y. 1997-98.
ITA No. 1870/Del/2005 & 2291/Del/2005, A.Y. 2000 -01
93. In this A.Y.2000- 04, the assessee has raised only two issues as under:-
(i) Whether income derived from producing parent seeds is agricultural income or not,
(ii) Whether assessment of 50% of ad-hoc amount being income attributable to the Indian branch office in the hands of the assessee is justified.
94. The revenue has also taken a ground that the CIT (A) has reduced the allocation of income to the Indian branch by 50% of the amount determined by the AO as similarly raised in the A.Y. 1997- 98 and 1999- 2000.
95. We have heard both the parties and have perused the material on record.
96. The issue no. 1 has already been decided in the A.Y. 1998-99, which has been followed in the A.Y. 1997-98 and 1999-2000. Therefore, in the light of our order passed in the A.Y. 1998- 99, this issue stand decide accordingly.
97. The issue no. 2 about allocation of income to the Indian branch is identical to the issue raised by the assessee as well as by the revenue in the A.Y. 1997-98 and 1999-2000. The issues has been decided by us in the A.Y. 1997-98, which has been followed by us in the A.Y. 1998-99, vide this common order. Therefore, this issue no. 2 stand decided accordingly.
ITA No. 1871/Del/2005 & 2292/Del/2005, A.Y. 2001- 02
98. In this A.Y. 2001-02, the assessee has raised identical two issues as raised in the A.Y. 2000-01. The department has also raised one issue about extent of allocation of income to the branch office, which is identical to the ground raised by the revenue in the A.Y. 1997- 98, 1999- 2000 and 2000- 01. The issues raised in this assessment years are identical to the issues raised by the assessee as well as by the revenue in the A.Y. 1997- 98, 1999- 2000 and 2000- 01, and these issues has been decided by us in the A.Y. 1997-98, which has been followed in the A.Y. 1999- 2000 and 2000-01, vide this common order. Therefore, the issues raised in A.Y. 2001- 02 stand decided accordingly in the terms of our order for the A.Y. 1997-98.
In the result, all the assessee ‘s appeal as well as the revenue’s appeal for all these assessment years i.e. A.Y. 1997-98, 1999- 2000, 2000- 01 and 2001- 02 are partly allowed in the manner as indicated above.
