The profits from the offshore supply contract held to be not liable to tax in India on the ground that the transfer of title in the goods had passed outside India.
REPORTED
* IN THE HIGH COURT OF DELHI AT NEW DELHI
+ ITA No. 703/2009
DIRECTOR OF INCOME TAX, NEW DELHI Appellant
Through: Mr. Sanjeev Sabharwal, Advocate
versus
LG CABLE LTD. Respondent
Through: Mr. N. Venkatraman, Sr. Advocate with
Mr. Satish Kumar, Advocate
% Date of Decision: December 24, 2010
: REVA KHETRAPAL, J.
1. This is an appeal under Section 260-A of the Income-Tax Act, 1961 („the Act?) admitted on the following substantial questions of law:-
(1) Whether the Income Tax Appellate Tribunal is justified in not holding that the contract in question is not a composite one and, therefore, the assessee is not liable to pay tax in India in respect of offshore service?
(2) Whether the levy of interest under Section 234B for short deduction of TDS is mandatory and is leviable automatically?
2. Briefly the factual matrix giving rise to the present appeal is as follows. The respondent LG Cable Ltd. (“LGCL”) is a company incorporated under the laws of South Korea having its registered office at ASEM Tower (19-20F), 159 Samsung Dong, Gangnam-gu, Seol 135- 090 Korea. LGCL was awarded two contracts on February 26, 2001 by the Power Grid Corporation of India Limited (“PGCIL”). The first was for onshore execution of the Fibre Optic Cabling System Package Project under the System Coordination and Control Project for the Eastern Region involving onshore services, including erection/installation, testing and communicating, etc. of the fibre of the cabling system. The second contract was for offshore supply of equipment and offshore services. During the financial year 2001-02, LGCL had set up a “project office” in India after obtaining requisite approval from the Reserve Bank of India. The services under the onshore contract were rendered by LGCL through its project office in India for which separate books of account were maintained by the assessee. The income attributable to the activities carried out in India in connection with onshore contract was offered to tax on a net income basis in the return of income filed by the assessee in terms of Articles 5 and 7 of the Double Taxation Avoidance Agreement (“DTAA”) between India and Korea. As regards offshore supply contract, however, it was claimed by the assessee that this income was not liable to tax in India as the income wholly accrued or arose in Korea. It was also claimed that the entire contract was carried out in Korea and was subject to income-tax in Korea. The transfer of title along with the attendant risks had entirely passed on to PGCIL outside India.
3. Thus, the return filed by the assessee on October 31, 2002 showed a loss of ` 85,69,828/- for the assessment year 2002-03 and was only in respect of the onshore contract. The said return was processed under Section 143(1) of the Act and refund of tax deducted at source along with interest under Section 244A of the Act was granted. Subsequently, the return was taken up for assessment under Section 143(3) of the Act by the Deputy Director of Income Tax, Circle 1(1), International Taxation, New Delhi („AO?).
4. In the course of the assessment proceedings, the contention of the LGCL, as stated above, was that income from the offshore supply was not taxable in India. Several judicial precedents and circulars of the Central Board of Direct Taxes („CBDT?) in support of the said contention were cited. The AO, however, did not accept the claim of the assessee relating to offshore supply of equipment in the light of the decision of the Authority for Advance Ruling in the case of Ishikawajma-Harima Heavy Industries Co. Ltd., 271 ITR 193, wherein it was held that such offshore supply of material resulting from engineering procurement and construction contract is taxable in India. The AO according held the income accruing to LGCL from the offshore supply contract with PGCIL to be taxable in India. The AO found that the total revenue from the offshore supply contract in the relevant year was US $ 73,25,665. Since the assessee did not produce the profitability statement for the offshore supply as the assessee was not maintaining separate books of account for the same, the AO held that for deciding the profitability of the project, recourse could be taken to Section 44BBB of the Act, which examines the profits arising from contracts of more or less similar nature. Ten percent of the amount paid was deemed to be the gains of such business chargeable to tax. Hence, using this criterion, the AO held that it would reasonable to fix the profit element from the offshore supply contract at 10% of receipts, i.e., at US $ 7,32,567. The AO further held that since the bulk of activities, including manufacturing, were taking place outside India, it would be reasonable to attribute 30% of these profits to India. Hence, the income chargeable to tax in India was worked out at US $ 2,19,770, i.e., at ` 1,05,48,950/-. The above amount was added to the income of the assessee in the assessment order. The AO also levied interest under Section 234B and 234C of the Act.
5. The assessee impugned the above assessment in appeal before the CIT(A), reiterating its submission that the transfer of title in the equipment supplied by it had taken place in favor of PGCIL outside India and hence income of offshore supply equipment could not be said to accrue or arise in India. After comparing and contrasting both the agreements and in particular Article 6 thereof, the CIT(A) held as under:-
“4 1 From the combined reading of Article 6 of both the agreements, the following facts emerge:
(1) Notwithstanding the award of work under two separate agreements, the contractor (the appellant) has the overall responsibility for the execution of all the work right from the beginning till the end.
(2) Notwithstanding the award of work under two separate agreements, in case of default or breach under one contract the same shall automatically be deemed to be a default or breach under both the contracts. This means that if there is a default in any part of one contract by the appellant, both the contracts are liable to be cancelled.
(3) Notwithstanding the award of work under two separate agreements, it was agreed by the appellant that the equipment/material supplied by it to PGCIL under the first contract, when erected and commissioned by the appellant under the second contract shall give satisfactory performance in accordance with the provisions of the contract. This condition has been specified in Article 6 of the Onshore erection contract. This clearly shows that even in the Onshore erection contract it is the responsibility of the appellant that the materials/equipment supplied by it under the offshore equipment supply contract shall give satisfactory performance. The same responsibility has been cast on the appellant in Article 6 of the Offshore supply of equipment also.
(4) Notwithstanding the award of contract under two separate agreements, the contractor (appellant) shall achieve successful completion of the project under both contracts and successful taking over the project by PGCIL.”
6. The CIT(A) held that it was clear from the foregoing that the two contracts were not independent of each other as claimed by the assessee, that there was inter-relation and inter-dependence between the two agreements and that one could not exist without the other. Thus, the CIT(A) concluded that though there were two agreements, in fact, it was a composite contract for supply of equipment as well as execution, erection and installation of equipment in India. He further observed that a colourable device had been adopted by the assessee to conceal its real tax liability. The supply of offshore equipment was inextricably linked with the operations to be carried in India. He, therefore, held that the decision of the Authority for Advance Ruling in the case of Ishikawajima-Harima Heavy Industries Co. Ltd. (supra) was applicable to the facts of the case. Applying Article 7 of the DTAA, the CIT(A) held that the income from the offshore sale of goods could be deemed to be accrued to assessee in India and was taxable in India in terms of Section 9(1)(i) of the Act. The computation of income of the assessee at ` 1,05,48,950/- made by the Assessing Officer as well as the levy of interest under Section 234B and 234C by the Assessing Officer was also upheld. Resultantly, the appeal filed by the assessee was dismissed.
7. Aggrieved by the aforesaid dismissal of its appeal, the assessee preferred a second appeal before the Appellate Tribunal. The Tribunal after a detailed consideration of the matter held that the income from the offshore contract taken at ` 1,05,48,950/- was not taxable in the hands of the assessee and directed the deletion thereof. The Tribunal further ruled that the assessee was not liable to pay any tax under Section 234B of the Act. It was now the turn of the Department to feel aggrieved and hence the present appeal under Section 260A of the Act has been filed by the Department to challenge the order of the Tribunal dated 8th August, 2008.
8. The focal point of controversy between the parties is whether the income from the offshore contract between the parties would be taxable in India under the provisions of Section 9 of the Act, the relevant portion whereof reads as under:-
“Income deemed to accrue or arise in India.
9. (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 purposes 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.”
9. It was submitted by Mr. Venkatraman, the learned counsel for the assessee that the supply of equipment in this case was made on principal to principal basis and, therefore, the income from supply of equipment was not taxable in India. In this regard, reliance was placed on the circular of CBDT Circular No. 23 dated 23.07.2009. Reliance was also placed on the decisions of the Supreme Court rendered in Income tax Officer and Ors. vs. Sri Ram Bearings Ltd. and Ors., (1997) 224 ITR 724 (SC) and Mahabir Commercial Co. Ltd. vs. Commissioner of Income-Tax West Bengal, (1972) 86 ITR 417 (SC) to submit that income from the offshore supply of equipment was not covered under Section 5(2) of the Act.
10. At the outset Mr. Sajeev Sabharwal, the learned counsel for the Revenue contended that a plain reading of the two contracts would show that they were integrated contracts. Relying heavily upon Article 6 of both the contracts, the contention of Mr. Sabharwal was that any default or breach in one contract was not to relieve the respondent- assessee of its obligation under the other contract. Mr. Sabharwal emphasized that a reading of Clause 6 of both the agreements was by itself sufficient to bear out his contention that in terms thereof, the equipment/material supplied by the assessee in the first contract when erected and commissioned by the assessee under the second contract was required to give satisfactory performance in accordance with the terms of the agreements. Any default in supply or in erection would be taken as a default in the other agreement so that one agreement could not work without the other. It is expedient at this juncture to reproduce clause 6 of both the onshore and offshore agreements in juxtaposition with each other, which read as under: –
