The first three questions framed in the aforesaid appeals relate to the dispute whether the Assessee has a PE in India and the fourth question relates to the issue of attribution of income to the Assessee‘s alleged PE in India.
Q1. Appellant had a (PE) within the meaning of Article 5 of the DTAA between India and USA?
Ans: No as it doen’t includes the use of facilities solely for the purpose of storage, display, or occasional delivery of goods or merchandise belonging to the enterprise.
Q2. Tribunal that the Appellant had a PE in India is perverse and contrary to the facts and material on record?
Ans: No, as no material fact/ evidence out of the contract is available to prove so.
Q3 that the Appellant had a PE (fixed place PE and dependent agent PE) in India in terms of the Liaison Office of Nortel Canada and also in terms of the Nortel Networks (India) Private Ltd” (being installation and service PE)?
Q4 attributing 50% of the alleged profits to the alleged PE of the Appellant in India and whether such approach and quantification was inconsistent with Article 7 of the DTAA?
Ans: No, it is proved that Assessee is not an PE
The Assessee (formerly known as Nortel Networks RIHC Inc) was incorporated as a company on 7th June, 2002 under the laws applicable in the State of Delaware, USA and is a tax resident of USA. The Assessee is a part of Nortel Group which is stated to be a leading supplier of hardware and software for GSM Cellular Radio Telephone Systems. The above corporate structure of part of the Nortel Group can be better understood by the following diagram :-
The Nortel Canada also has a Liaison Office in India (hereafter called ‗Nortel LO‘).Nortel India negotiated and entered into three contracts with Reliance Infocom Limited (hereafter Reliance‘), namely, Optical Equipment Contract (hereafter the Equipment Contract‘), Optical Services Contract (hereafter the Services Contract‘) and the Software Contract (hereafter ‘the Software Contract’) on 8th June 2002. On the same date, Nortel India entered into an agreement assigning all rights and obligations to sell, supply and deliver equipment under the Equipment Contract to the Assessee (hereafter referred to as the Assignment Contract‘). Reliance and Nortel Canada were also parties to the Assignment Contract and in terms thereof, Nortel Canada guaranteed the performance of the Equipment Contract by the Assessee (Assignee). In terms of the Assignment Contract, Reliance placed purchase orders directly on the Assessee and also made all payments for the equipment supplied directly to the Assessee.
The equipments supplied to Reliance were manufactured by Nortel Canada and another Nortel group entity in Ireland (Nortel Ireland). The same was invoiced by the Assessee directly to Reliance and consideration for the same was also received directly by the Assessee. It is asserted by the AO that the equipment supplied to Reliance was sourced from Nortel Canada and Nortel Ireland at a much higher price than the price charged to Reliance and this resulted in the Assessee suffering a loss during the relevant period.
Since according to the Assessee, its income was not chargeable to tax under the Act, it did not file any return for the AYs 2003-04 and 2004-05. The principal issues involved in the AYs 2002-03, 2003-04, 2004-05 and 2008-09 are common. The assessment orders passed by the AO and the appellate orders passed by CIT(A) and the ITAT for AY 2002-03, 2003-04 and 2004-05 are also more or less similar in effect and, therefore, for the sake of brevity only the facts as obtained for AY 2003- 04 (ITA 671/2014) are referred to herein.
On 27th March, 2006, the AO issued a notice under Section 148 of the Act calling upon the Assessee to file its return of income for the AY 2003-04. In response to the aforesaid notice, the Assessee filed its return of income on 16th May, 2006 disclosing its taxable income as ‗Nil‘. Thereafter, the AO issued notice under Section 143(2) of the Act. In response to the aforesaid notices, the Assessee filed its statement of accounts disclosing the loss stated to have been incurred by the Assessee. The Assessee did not file its balance sheet or its audited accounts as according to the Assessee, it was not required to have its accounts audited in the tax jurisdiction where the Assessee is a resident, namely, Delaware, USA. Thereafter, on 18th December, 2006, the AO passed an assessment order under Section 143(3)/147 of the Act.
Contention of AO:
The AO was of the view that the Assessee had been incorporated solely with the sole motive to evade the taxes arising out of supply contract in India and in substance, the contracts were performed by Nortel Canada along with its LO and Nortel India, who acted in unison to identify, negotiate, appraise, secure, execute, manufacture, supply, install, commission and provide warranty and after sales service in respect of the Optical Fibre project of Reliance. In addition, these companies also provided sales service and training etc. The AO also held that the activities performed by Nortel India were not within the scope of services to be rendered under the Services Contract and the expatriate employees of the Assessee had remained in India for a long period and had rendered services for Nortel India for a period of more than 30 days in a fiscal year and the Assessee had reimbursed large amount of expenses incurred by
Nortel India on these expatriate employees. According to the AO, the Assessee was ―a Shadow Company of Nortel Group.‖
He held that Nortel India had not only acted as a service provider of the Assessee but also as a “sales outlet” providing after sales service and any other assistance as requested by the Assessee.
The ITAT held that “the assessee through Nortel India and LO approached the customer, negotiated the contract, bagged the contract, supplied equipment, installed the same, undertook acceptance test after which the system was accepted. The equipment remained in the virtual possession of Nortel Group till such time the equipment is set up and acceptance test is done.“
Judgement of Reputed High Court:
As noticed earlier, there seems to be no dispute that the title to the equipment passed in favour of Reliance overseas. However, the AO, CIT (A) and ITAT did not consider the same to be relevant as according to them, the equipment continued to be in the possession of the ―Nortel Group‖ till its final acceptance by Reliance. In our view, even if it is accepted that the equipment supplied overseas continued to be in possession of Nortel India till the final acceptance by Reliance, the same would not imply that the Assessee‘s income from supply of equipment could be taxed under the Act.
Clause (a) of Explanation 1 to Section 9(1)(i) of the Act postulates the principle of apportionment and only such income that can be reasonably attributed to operations in India would be chargeable to tax under the Act.
The position in Ishikawajima-Harima Heavy Industries was also similar. There too, the equipments were supplied overseas and the contractor continued to retain control of equipment and material till the provisional acceptance of the work or the termination of the contract. The relevant clause which was considered by the Supreme Court in that case is as under:-
A bare perusal of the Services Contract clearly indicates that the task of installation, commissioning and testing was contracted to Nortel India and thus, the operations pertaining to installation and commissioning were not performed by Nortel India on behalf of the Assessee or Nortel Canada but on its own behalf. Thus, neither the Assessee nor Nortel Canada can be stated to have performed any installation or commissioning activity in India.
Next, it will be important to consider whether the consideration received by the Assessee for supply of equipment also subsumed consideration for other activities that were performed in India. The CIT(A) has held that “the supply contract does not end with loading of equipment on the ship but includes a number of activities which are carried on in Indian territories and compensation/remuneration for that is also included in the consideration“. This dispute, as observed earlier, is at the heart of the controversy in this matter.
However, there is no material to indicate that any of the obligations other than supply of equipment was performed by the Assessee or on its behalf in consideration of the amounts received by the Assessee. According to the Assessee, it had supplied the subject equipment and received the consideration for the same.
Article 5 of the Equipment Contract contains provisions for Pricing and Invoicing. Sub Article 5.1 is captioned ―Price List and paragraph 5.1.1 of the Equipment Contract reads as under ―5.1.1 The prices as set forth in the Price List shall be applicable to all purchases by Reliance of Equipment, including without limitation spare and replacement parts.‖
The Assessee has consistently asserted that ―FCA, relevant international airport basis, INCOTERM 2000, from the country/ies of export and insurance from Vendor’s warehouse to Substantial Completion” meant that the supplier was liable to deliver the equipment to the carrier at the port of shipment/airport of departure which in the present case would be outside India. The said interpretation has not been disputed on behalf of the Revenue.
In terms of the Assignment Contract, the Assessee assumed all rights and obligations of Nortel India under the Equipment Contract “to sell, supply and deliver the Equipment to the Purchaser under the Equipment Contract”. It is apparent from the contract that the Assessee only assumed the obligation to sell, supply and deliver equipment in terms of the Equipment Contract and was paid in terms of the pricing mechanism as agreed to under the Equipment Contract. It is also material to note that Nortel India continued to be responsible for performance of the Equipment Contract except for performance of Purchase Orders and Exchange Orders for supply of equipment which were placed directly by Reliance on the Assessee.
Although, the Assessee had repeatedly asserted that all other obligations for testing, installation and commissioning was done by Nortel India, for which Nortel India had been paid separately, no material or evidence was gathered by the AO to contradict the same.
There is no material to indicate that equipment for Test Bed Laboratory, which was to be supplied at no additional cost to Reliance had been procured by Nortel India at additional cost or that Nortel India was not remunerated for all the services rendered by it to Reliance. In terms of the Equipment Contract, adequate stock of spares was required to be maintained in India, however, there is no material to indicate that such stock was maintained in India by the Assessee or that such stock was maintained by Nortel India, not on its own behalf but on behalf of the Assessee, without being sufficiently remunerated.
Thus, in absence of any such evidence or material, it is difficult for us to concur with the view that certain activities were performed in India for which the consideration was received by the Assessee.
It is also necessary to observe that even if the AO was of the view that Nortel India was not adequately remunerated for the Assignment Contract, the AO was required to make an appropriate transfer pricing adjustment in the hands of Nortel India. Thus, in our view, the question whether the Assessee has a PE in India is not material as it is not possible to hold that any part of the income of the Assessee could be apportioned to operations carried on in India.
if the Assessee did not have any PE in India then its business income would not be taxable under the Act even though a part of the same can be attributed to activities in India.
Article 5 of the Indo-US DTAA defines PE werein 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.
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.
The fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State, or which carries 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.
The AO, CIT(A) and ITAT have held that the office of Nortel India and Nortel LO constituted a fixed place of business of the Assessee. As pointed out earlier, we find no material on record that would even remotely suggest that Nortel LO had acted on behalf of the Assessee or Nortel Canada in negotiating and concluding agreements on their behalf. Thus, it is not possible to accept that the offices of Nortel LO could be considered as a fixed place of business of the Assessee. In so far as Nortel India is concerned, there is also no evidence that the offices of Nortel India were at the disposal of the Assessee or Nortel Canada. Even if it is accepted that Nortel India had acted on behalf of the Assessee or Nortel Canada, it does not necessarily follow that the offices of Nortel India constituted a fixed place business PE of the Assessee or Nortel Canada. Nortel India is an independent company and a separate taxable entity under the Act. There is no material on record which would indicate that its office was used as an office by the Assessee or Nortel Canada. Even if it is accepted that certain activities were carried on by Nortel India on behalf of the Assessee or Nortel Canada, unless the conditions of paragraph 5 of Article 7 of the Indo-US DTAA is satisfied, it cannot be held that Nortel India constituted a fixed place of business of the Assessee or Nortel Canada.
The AO has further alleged that the offices of Nortel LO and Nortel India were used as a sales outlet. In our view, this finding is also unmerited as there is no material which would support this view. The facts on record only indicate that Nortel India negotiated contracts with Reliance. Even assuming that the contracts form a part of the single turnkey contract, which include supply of equipment – as held by the authorities below – the same cannot lead to the conclusion that Nortel India was acting as a sales outlet.
The AO‘s conclusion that there is an installation PE in India, is also without any merit. A bare perusal of the Services Contract clearly indicates that the tasks of installation, commissioning and testing was contracted to Nortel India and Nortel India performed such tasks on its own behalf and not on behalf of the Assessee or Nortel Canada. Undisputedly, Nortel India was also received the agreed consideration for performance of the Services Contract directly by Reliance.
The finding that Nortel India is a services PE of the Assessee is also erroneous. There is no material to hold that Nortel India performed services on behalf of the Assessee.
In the present case, there is no material on record which would indicate that Nortel India habitually exercises authority to conclude contracts for the Assessee or Nortel Canada. In order to conclude that Nortel India constitutes a Dependent Agent PE, it would be necessary for the AO to notice at least a few instances where contracts had been concluded by Nortel India in India on behalf of other group entities. In absence of any such evidence, this view could not be sustained.
The CIT(A) as well as the ITAT has proceeded on the basis that the Assessee had employed the services of Nortel India for fulfilling its obligations of installation, commissioning, after sales service and warranty services. In this regard, it is relevant to observe that a subsidiary company is an independent tax entity and its income is chargeable to tax in the state where it is resident. In the present case, the tax payable on activities carried out by Nortel India would have to be captured in the hands of Nortel India
Thus, the income from installation, commissioning and testing activities as well as any function performed by expatriate employees of the group companies seconded to Nortel India would be subject to tax in the hands of Nortel India and the same cannot be considered as income of the Assessee.
Thus, the first three questions framed in ITA 671/2014, 672/2014, 669/2014 and 689/2014 are answered in the affirmative, that is, in favour of the Assessee and against the Revenue.
In view of our conclusion that the Assessee’s income from supply of equipment was not chargeable to tax in India, the question relating to attribution of any part of such income to activities in India does not arise. In view of our conclusion that the Assessee does not have a PE in India, the question of attribution of any income to the alleged PE also does not arise. 77. The controversy involved in ITA 666/2014, 667/2014 and 673/2014 does not relate to the issue whether the Assessee has a PE in India but concerns the question whether research and development expenses were liable to be taken into account while estimating the profits under Rule 10 of the Income Tax Rules, 1962. This issue also no longer survives in view of our conclusion that no part of the Assessee’s income from supply of equipment is chargeable to tax under the Act.
The appeals are, accordingly, allowed and the impugned orders are set aside. However, the parties are left to bear their own costs.