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CASE NO.: Appeal (civil)  9 of 2007

PETITIONER: Ishikawajma-Harima Heavy Industries Ltd

RESPONDENT: Director of Income Tax,  Mumbai

DATE OF JUDGMENT: 04/01/2007

BENCH: S.B. Sinha & Dalveer Bhandari

JUDGMENT: J U D G M E N T    [Arising out of SLP (Civil) No.5318 of 2005] S.B. SINHA, J :

       Leave granted.

       Appellant herein is a company incorporated in Japan.  It is a resident  of the said country.  It pays its taxes in Japan.  It is engaged, inter alia, in the  business of  construction of storage tanks as also engineering etc.  It  formed  a consortium along with Ballast Nedam International BV, Itochu  Corporation, Mitsui & Co. Ltd., Toyo Engineering Corporation and Toyo  Engineering (India) Ltd.  With the said  consortium members, it entered into  an agreement with Petronet LNG Limited (hereinafter referred to as "the  Petronet") on 19.01.2001 for setting up a Liquefied Natural Gas (LNG)  receiving storage and degasification facility at Dahej in the State of Gujarat.   A supplementary agreement was entered into by the parties on 19.03.2001.   The contract envisaged a turnkey project.  Role and responsibility of each  member of the consortium was specified separately.  Each of the member of  the consortium was also to receive separate payments.  Appellant was to  develop, design, engineer and procure equipment, materials and supplies, to  erect and construct storage tanks of 5 MMTPA capacity, with potential  expansion to 10 MMTPA capacity at the specified temperatures i.e. -200  degree Celsius. The arrangement also was to include marine  facilities (jetty  and island break water) for transmission and supply of the LNG to  purchasers; to test and commission the facilities relating to receipt and  unloading, storage and re-gasification of LNG and to send out of re-gasified  LNG by means of a turnkey fixed lump-sum price time certain engineering  procurement, construction and commission contract. The project was to be  completed in 41 months.  The contract indisputably involved : (i) offshore  supply, (ii) offshore services, (iii) onshore supply, (iv) onshore services  and  (v) construction and erection. The price was  payable  for offshore supply  and offshore services in US dollars, whereas that of onshore supply as also  onshore services and construction and erection partly in US dollars and  partly in Indian rupees.         Liability to pay income tax in India by the appellant herein being  doubtful, an application was filed by the same before the Authority for  Advance Rulings (Income Tax) (hereinafter referred to as ’the Authority’) in  terms of Section 241(Q)(1) of the Income Tax Act, 1961 (hereinafter  referred to as ’the Act’).  The following questions were proposed by the  appellant  for determination:

"1.     On the facts and circumstances of the case,  whether the amounts, received/receivable by the  applicant from Petronet LNG for offshore supply  of equipments, materials, etc. are liable to tax in  India under the provisions of the Act and India- Japan tax treaty?

2.      If the answer to (1) is in the affirmative in view of

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Explanation (a) to section (1)(i) of the Act and/or  Article (1) read together with the protocol of the  India-Japan tax treaty, to what extent are the  amounts reasonably attributable to the operations  carried out in India and accordingly taxable in  India?          3.      On the facts and circumstances of the case,  whether the amounts received/receivable by the  applicant from Petronet LNG for offshore services  are chargeable to tax in India under the Act and/or  the India-Japan tax treaty?

4.      If the answer to (3) above is in the affirmative, to  what extent would be amounts received/receivable  for such services be chargeable to tax in India  under the Act and/or the India-Japan tax treaty?

5.      If the answer to (3) above in the affirmative, would  be applicant be entitled to claim deduction for  expenses incurred in computing the income from  offshore services under the Act and/or the India- Japan treaty?                          Before the Authority no issue was raised as regards the liability of the   appellant to pay income tax on onshore supply and onshore services and on  its activities relating to construction and erection.  The dispute centered  round its exigibility to pay tax in respect of ’offshore supply’ and ’offshore  services’.   

       It is also not in dispute that the Government of India and the  Government of Japan entered into a by-lateral treaty in regard to the tax  liabilities.

       Contention of the appellant before the Authority was that the contract  being a divisible one, it did not have any liability to pay any tax in regard to  offshore services and offshore supply. Revenue, on the other hand,  contended that the contract being a composite and integrated one, they were  so liable.   

       The Authority referred to a large number of decisions governing the  field and opined that having regard to the provisions contained in Section 5  read with Section 9 of the Act, following propositions of law would emerge :

"(1)    In a case of sale of goods simpliciter by  a non- resident to a resident in India, if the consideration  for sale is received abroad and the property in the  goods also passes to the purchaser outside India,  no income accrues or arises or deemed to accrue or  arise to the seller in India.

(2)     In a case of transaction of  sale of goods by the  non-resident to an Indian resident which is a part  of a composite contract involving various  operations within and outside India, income from  such sale shall be deemed to accrue or arise in  India if it accrues or arises through or from any  business connection in India.

(3)     In the case of a business of which all operations  are not carried out in India, the deemed accrual or  arising of income shall be only such part of the  income as is reasonably attributable to the  operations carried out in India.

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(4)     Whether there is business connection in India  or/and whether all operations of the business are  not carried out in India are questions of fact which  have to be determined on the facts of each case."   

       Applying the said principles to the facts of the present case, the  Authority opined that the appellant was liable to pay direct tax even under  the Treaty having regard to Articles 5 and 7 thereof as also Clause 6 of the  Protocol.  It was held :

       "The substance of the protocol quoted above,  represents the consensus reached between the parties to  the treaty in regard to the meaning of the phrase "directly  or indirectly attributable to that permanent  establishment" employed in paragraph 1 of article 7.   Further, profits shall also be regarded as attributable to  the permanent establishment to the extent indicated in the  said protocol even when the contract or order relating to  the sale or provision of goods or services in question is  made or placed directly with the overseas head office of  the enterprise rather than with the permanent  establishment.

       It would be clear that having regard to provisions  of article 7(1) of the Treaty read with para 6 of the  protocol supply of equipment of machinery (sale of  which was completed abroad, having placed the order  directly overseas office of the enterprise) the same should  be within the meaning of the phrase directly or indirectly  attributable to that permanent establishment."                            

       As regards taxability of the amounts ’received’ and ’receivable’ by the  appellant from Petronet for offshore services, it was held :

       "In so far as the Treaty is concerned, both section  115A(1)(b)(B) and para 2 of Article 12 of the Treaty  clearly indicates that the whole technical fee without any  deduction is chargeable to tax, however, the tax so  charged shall not exceed 20% of the gross amount of the  royalty or fee for technical services."

Question Nos. 4 and 5 were held to be the consequential ones.  It was  opined :

"In the light of the above discussions we rule on :

(i)     Question No.1 that on the facts and in the  circumstances of the case, the amounts  received/receivable by the applicant from Petronet  LNG in respect of offshore supply of equipment  and materials is liable to be taxed in India under  the provisions of the Act and the India-Japan  Treaty.

(ii)    Question No.2 that in view of the Explanation (a)  to section  9(1)(i) of the Act and/or Article 7(1)  read with the Protocol of the India-Japan Treaty  the amounts that would be taxable in India is so  much of the profit as is reasonably attributable to  the operations carried out in India, we decline to  answer the other part of the question in regard to  quantification of the amount taxable in India as the  parties produced no evidence and did not address

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in this regard.

(iii)   Question No. 3 that the amount  received/receivable by the applicant from Petronet  LNG for offshore services is liable to be taxed in  India both under the provisions of the Act as well  as under Indo-Japan Treaty.

(iv)    Question No.4 that the entire amount received for  offshore services is chargeable to tax under the Act  and under the Treaty but at the rate not more than  20% of the gross amount.

(v)     Question No. 5 that the applicant would not be  able to claim any deduction in computing the  income from offshore service under the Act, and/or  under the Indo-Japan Treaty."   

       Before us, the following findings of the Authority are not disputed :

"(i)    the Petitioner has a business connection in India;

(ii)    if consideration accrues only for supply of goods  and the sale is completed outside India no profits  can accrue in India;

(iii)   however, if a contract envisages a composite  consideration for the various obligations to be  performed and if certain operations are to be  performed       by or through the business  connection, then, profits would be deemed to  accrue in India;  

(iv)    property in the goods, which were the subject  matter of the offshore supply, passed outside India;  and

(v)     the petitioner has a permanent establishment in  India within the meaning of the said term in  paragraph 3 of Article 5 of the Double Taxation  Avoidance Agreement entered into between the  Governments of India and Japan (hereinafter  referred to as "the DTAA")."     

       Mr. Harish N. Salve, the learned Senior Counsel appearing on behalf  of Appellant, urged :

(i) The Authority misconstrued and misinterpreted the contract in  arriving at its aforementioned findings, as from a bare perusal thereof, it  would appear that the payments were made in US dollars in respect of  ’offshore supply’ and ’offshore services’ and furthermore title to the goods  passed on to Petronate outside the territories of India and services had also  been rendered outside India;  (ii) The fact that the contract signed in India was of consequences as  converse could not have made the appellant not liable to pay the tax;  (iii) The Authority committed a manifest error in arriving at its  findings insofar as it failed to properly construe  Explanation-2 appended to  Section 9(1)(vii) of the Act as it was nobody’s case that the consideration  related to a construction, assembly, mining or like project so as to fall  outside the scope thereof;  (iv)  Although fee received by  Appellant is effectively connected to  the contract but it is not attributable to the permanent establishment and,  therefore, Article 12(5) of the Double Taxation Avoidance Agreement  (DTAA)  is not attracted;  (v)  Appellant being a non-resident in terms of Section 5(2) of the Act,

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it would be chargeable to tax in India only in the event income accrues or  arises in India or is deemed to accrue or arise in India or income is received  or is deemed to be received in India and not otherwise;  (vi)  As no part of the income for the ’offshore supply’ or ’offshore  services’ is received in India, the Authority misdirected itself in passing the  impugned judgment;  (vii)  A legal fiction raised under the Act cannot be pushed too far.  Also, as all operations in connection with the offshore supply are carried out  outside India, the question of any portion of the consideration to be regarded  as deemed to accrue or arise in India would not arise;   (viii) The requirement of the appellant to perform certain services in  India, such as unloading, port clearance, transportation of the equipments   supplied would not render the appellant eligible to tax as the  consideration  thereof is embedded in the consideration for the offshore supply; (ix) Although the appellant was required to carry out certain activities  in India, the consideration for offshore services had separately been provided  for.  (x) Assuming that the income from the offshore supply is chargeable  to tax in India on the premise that Section 9(1)(i) applies, it was required to  be examined by the Authority as to whether it would also be chargeable in  accordance with the provisions of the Double Taxation Avoidance  Agreement (DTAA) in terms whereof no charge to tax in India was leviable  in respect of the consideration for offshore supply.         Mr. Mohan Parasaran, the learned Additional Solicitor General  appearing on behalf of  the respondent, on the other hand,  submitted :

(i) The question as to whether terms of the contract constitute a  composite contract or not is essentially a question of fact and the findings of  the Authority being final, therefore, should not ordinarily be interfered with;  (ii) The Authority having found  in favour of the Revenue two  primary tests to determine as to whether the contract in question was a  composite one for execution of a turnkey project viz :  (a) whether the ’offshore’ and ’onshore’ elements of the contract are  so inextricably linked that the breach of the ’offshore’ element would  result in the breach of the whole contract;  (b) whether the dominant object of the contract is the execution of a  turnkey project and the question whether the title to the goods  supplied passes offshore or within India is secondary to the execution  of the contract,  the impugned judgment should not be interfered with;                 (iii) Each component of the contract was directly relatable to the  performance of the integrated contract as violation and/or breach on the  part  of the parties thereto would affect the entire contract; (iv) The contract itself providing for milestone dates, the breach of  any of the terms thereof  would result in the breach of the entire contract and  not just the particular obligation;   (v) The turnkey project contemplated a permanent establishment and  in that view of the matter Explanation appended to Section 9(1)(i) of the Act  is directly applicable.   (vi)  The appellant has business connection in India and in that view  of the matter the causal connection between the offshore supply and offshore  services being interlinked with the entire project, the opinion of the  Authority cannot be faulted;

(vii) By reason of  DTAA, the parties thereto can always allocate the  jurisdiction to tax the entire income  attributable to such permanent  establishment to the country in which it is established;

(viii) Supply of goods whether offshore or onshore as well as  rendition of service whether offshore or onshore are attributable to the  turnkey project and, thus, it would be wrong to contend that in terms of  Article 7 of DTAA,  no tax could be levied upon the appellant.

Contract : The Material Part :

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       Petronat LNG Limited, on the one hand,  and five members of the  consortium, on the other, are parties to the contract.  The contract contained  broad items.  It has its own interpretation clauses.  Clause 2.1 provides for   scope of the work in the following terms :

       "2.1    The Work

Except as otherwise expressly provided in this  Contract,  Contractor shall provide, furnish and perform, or cause to  be provided, furnished and performed, on a turnkey basis  all necessary design, engineering, procurement, supplies,  installation, erection, construction, testing,  commissioning, operation and turning over services,  activities and work (including all rectification and  remedial services, activities and work relating to defects  and deficiencies) for the Equipment and Materials and  the Facilities in accordance with the Scope of Work  (Exhibit A) and the other terms, provisions and  requirements of this Contract, including the Contract  Schedule, and shall provide all necessary and sufficient  Contractor’s Equipment and experienced personnel  having the requisite expertise for such purposes.

After Mechanical Completion of the Facilities,  Contractor shall carry out Commissioning, start-up and  testing of the Facilities and, if requested by Owner, shall  provide advisory assistance in connection with the  operation and maintenance of the Facilities and shall  provide all necessary and sufficient experienced  personnel having the requisite expertise for the prompt  performance of any rectification and remedial work  required until Final Acceptance of the Facilities, in  accordance with this Contract.

The Parties acknowledge and agree that this Contract is a  lump-sum firm fixed price time certain turnkey contract  and Contractor’s obligation to provide, furnish and  perform its services, activities and work under this  Contract  includes Contractor providing Owner with the  operating and completed Facilities, complete in every  detail within the time and for the purposes specified in  this Contract and to do and furnish Owner everything  necessary in connection herewith.

The foregoing obligations, work, services, activities and  responsibilities of Contractor are more fully set forth in  this Contract, including the Scope of Work (Exhibit A).   The Technical Documents  and the obligations under  Clause 2.2. are herein collectively referred to as the  "Work".

Except as otherwise expressly provided in this Contract,  Contractor agrees and acknowledges that Contractor shall  perform all of its obligations and responsibilities under  this Contract at its own risk, cost and expense."

       Clause 2.2. provides for additional responsibilities of the appellant,  which reads as under :.  

   "2.2        Additional Responsibilities          Except as otherwise expressly provided in this Contract,  Contractor shall be responsible for providing, or causing  the provision of, design, engineering, procurement,

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erection, construction and commissioning and testing  services, activities and work, and personnel and labour,  and all Equipment and Materials (and components  thereof) and Contractor’s Equipment, and any other items  not specifically described in the Scope of Work (Exhibit- A) and/or the Technical Documents if (a) it reasonably  may be inferred in accordance with Good Industry  Practice that the providing, or causing the provision, of  such additional items  was contemplated as part of the  Work (including the Technical Documents) or (b) the  providing, or causing the provision, of such additional  items is necessary in order for Contractor to satisfy the  Completion and Performance Guarantees and the  warranties set forth, in this Contract and to make the  Facilities operable and capable of performing  as  specified in the Technical Documents or as otherwise  necessary in order to comply with the requirements of  this Contract.  Without limitation to the foregoing,  wherever this Contract describes any portion of the Work  in general terms, but not complete in detail, Contractor  agrees that the Work shall include any incidental work,  activities and services which may be reasonably inferred  as required or necessary to complete and render operable  the Facilities in accordance with the terms and conditions  of the Contract, and owner shall have no obligation or  responsibility whatsoever (except as specifically set forth  in this Contract) with respect to the completion of the  Facilities.

Contractor shall ensure that the Facilities shall be fit and  suitable for its intended purpose (including  attaining the  Completion and Performance Guarantees) as evidenced  by, or reasonably to be inferred from, this Contract, and  shall fully comply with the Contract.

Work undertaken, Equipment and Materials (including  components thereof), Contractor’s Equipment, labour and  personnel, and additional items provided pursuant to this  Clause 2.2 shall not give rise to any adjustment in this  Contract Price, the Contract Schedule or any other terms  of this Contract, and shall be included in and comprise  the Work for all purposes of this Contract.

Clause 7.1 provides for shipment in the following terms :

       "7.1    Notice of Shipment  

Contractor shall comply with and follow the procedures  for shipment set forth in Section E of Exhibit H (General  Project Requirements and Procedures).  In particular, at  least prior to arrival of each shipment in India, Owner  and Owner’s insurance company providing insurance  will receive from the Contractor, the notice of shipment,  such notice shall set forth the following information  concerning such shipment : (a) a reference to the date,  parties and subject matter of this Contract; (b) a  description of, or that part of, the Equipment and  Materials contained in such shipment; (c) the date of  embarkation and departure, (d) the port of origin, (e) the  means of shipment (air or sea); (f) the estimated date of  arrival in India; (g) the port of entry in India; (h) the  value of the shipment; (i) the approximate weight and  volume (gross and net); (j) the name, flag and owner of  the vessel if shipment by sea or the designation of aircraft

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if ship is by air; and (k) the number and value of bill of  lading or airfreight bill.   Contractor  shall ensure that a  provision similar to this Clause 7.1 is included in all  agreements with Suppliers.

Contractor shall be responsible for packing, loading,  transporting, receiving, unloading, storing and protecting  all Equipment and Materials and/or Contractor’s  Equipment and other things required for the Works."

       Price is specified under Clause 13.1 in the following terms :

       "13.1   Contract Price

The total price to be paid by or on  behalf of Owner to  Contractor in full consideration for the performance by  Contractor of its obligations and responsibilities under  this Contract, including the Work, shall be a fixed and  firm lump sum price of US$ 151,044.192 (One hundred  fifty one million forty four thousand one hundred ninety  two US Dollars) (the "US Dollar Portion) and  Rs.7,602,796,324 (Seven billion six hundred two million  seven hundred ninety six thousand three hundred twenty  four Indian Rupees) (the "Indian Rupee Portion"), which  shall be subject to adjustment only as provided under  Clause 13.4 (the US Dollar Portion and the Indian Rupee  Portion, as the same may be so adjusted, together, the  "Contract Price")."

       The contract envisages that the appellant may do the job itself or get  the same done by sub-contracting.   It may only do a part of  the job itself.  

       The contract splits in  dollar and rupee components separately.  Clause  14.8 provides for general terms of payment, effect of payment and   methodology of payment.  Pursuant to or in furtherance whereof separate  payment in US dollars and Indian rupees is to be made depending upon the  nature of supply viz. offshore supply and offshore services and onshore  supply and onshore services.          

       Clause 22.1 deals with passing of title to the goods supplied in the  following terms : 22.1  Title to Equipment and Materials and Contractor’s  Equipment   Contractor agrees that title to all Equipment and  Materials shall pass to Owner from the Supplier or  Subcontractor pursuant to Section E of Exhibit H  (General Project Requirements and Procedures).   Contractor shall, however, retain care, custody, and  control of such Equipment and Materials and exercise  due care thereof until (a) Provisional Acceptance of the  Work or (b) termination of this Contract, whichever shall  first occur.  Such transfer of title shall in no way affect  Owner’s rights under any other provision of this  Contract."

The interpretation of different components of contract has been dealt within  Annexure-A appended thereto.  So far as ’offshore services work items’ are  concerned, the same  has been defined to mean the items of work set forth as  item numbers D-2.2.1, 2.2.2 and 2.2.3 of the Contract Price Schedule; details  whereof have been mentioned in the said Annexure, which, inter alia,  provides :

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                                        Notes General 1.    xxx                xxx            xxx

2.  Offshore supply (Exhibit D-2.1) is the price  of Equipment & Material (including cost of  engineering, if any, involved in the  manufacture of such Equipment & Material)  supplied from outside India on CFR basis, and  the property therein shall pass on to the Owner  on high seas for permanent incorporation in the  Works, in accordance with the provisions of  the Contract.

3. Offshore Services (Exhibit D-2.2) is the  price of design and engineering including  detail engineering in relation to supplies,  services and construction & erection and cost  of any other services to be rendered from  outside India.   

4.  Onshore Supply (Exhibit D-2.3 is the price  of Equipment & Material supplied from within  India for direct delivery at Site and permanent  incorporation in the Works.

5. Onshore services (Exhibit D-2.4) is the price  of design engineering, detail engineering,  customs clearance, inland transportation,  procurement services, supervision services,  project management, testing and  commissioning and any such service in relation  to the Works rendered in India."                         

The break down of contract price is as under :     

Exhibit No./Sl. No. Description of  Scope In Indian Rupees In US Dollars Name and  address of  Contracting  entity D-2.1 Offshore Supply  (Total of 2.1.1.,  2.1.2 and 2.1.3 Nil 81,711,877 IHI, BNI &  TEIL D-2.2 Offshore Services (Total of 2.2.2 to  2.2.3)

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Nil 19,756,225 IHI, BNI &  TEIL D-2.3 Onshore Supply (Total of 2.3.1 to  2.3.3) 1,869,978,658 Nil IHI, BNI &  TEIL D-2.4 Onshore Services (Total of 2.4.1 to  2.4.3)  1,774,353,282 12,780,467 IHI, BNI &  TEIL D-2.5 Construction and  Erection  (Total of 2.5.1. to  2.5.3) 3,958,464,384 36,795,623 IHI, BNI &  TEIL D-2.0 Total (D-2.1 to D- 2.5) (See Note 9 7,602,796,324 151,044,192

Treaty :  Double Taxation Avoidance Agreement (DTAA) :         Article 5 of the Double Taxation Avoidance Agreement (DTAA)  between India and Japan, inter alia, provides as under :

"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 other sales outlet; and (j) an installation or structure used for the exploration of  natural resources, but only if so used for a period of more  than six months.

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\005\005\005\005\005\005\005\005\005\005\005\005\005\005\005\005\005\005\005\005\005\005"  

       Clause 1 of  Article 7 of the said agreement  reads as under :

       "1.     The profits of an enterprise of a Contacting  State shall be taxable only in that Contracting State  unless the enterprise carries on business in the other  contracting State through a permanent establishment  situated therein.  If the enterprise carries on business as  aforesaid, the profits of the  enterprise may be taxed in  that other Contracting State but only so much of them as  is directly or indirectly attributable to that permanent  establishment."

       Clauses 1, 2 and 5 of Article 12 which are relevant for the purpose of   this case, read as under :

       "1.     Royalties and fees for technical services  arising in a Contracting State and paid to a resident of the  other Contracting State may be taxed in that other  Contracting State.

       2.      However, such royalties and fees for  technical services may also be taxed in the Contracting  State in which they arise and according to the laws of that  Contracting State, but if the recipient is the beneficial  owner of the royalties or fees for technical services, the  tax so charged shall not exceed 20 per cent of the gross  amount of the royalties or fee for technical services.

       5.      The provisions of paragraphs 1 and 2 shall  not apply if the beneficial owner of the royalties or fees  for technical services, being a resident of a Contracting  State, carries on business in the other Contracting State in  which the royalties or fees for technical services arise,  through a permanent establishment situated therein, or  performs in that other Contracting State independent  personal services from a fixed base situated therein, and  the right, property or contract in respect of which the  royalties or fees for technical services are paid is  effectively connected with such permanent establishment  or fixed base.  In such case, the provisions of article 7 or  article 14, as the case may be, shall apply."

       The Treaty contains the Japanese notes,  clause 6 whereof reads as  under :         "6.     With reference to paragraph 1 of article 7 of  the Convention, it is understood that by using the term  "directly or indirectly attributable to the permanent  establishment", profits arising from transactions in which  the permanent establishment has been involved shall be  regarded as attributable to the permanent establishment to  the extent appropriate to the part played by the permanent  establishment in those transactions.  It is also understood  that profits shall be regarded as attributable to the  permanent establishment to the above-mentioned extent,  even when the contract or order relating to the sale or  provision of goods or services in question is made or  placed directly with the overseas head office of the  enterprise rather than with the permanent establishment."                           

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    Statutory provisions :         Sections 5(2), Section 9(1)(i), Section 9(1)(vii) of the Act, which are  relevant  for our  purpose, read as under :

"5(2) Subject to the provisions of this Act, the total  income of any previous year of a person who is a non- resident includes all income from whatever source  derived which \026

(a)     is received or is deemed to be received in India in  such year by or on behalf of such person; or   

(b)     accrues or arises or is deemed to accrue or arise to  him in India during such year."

"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.                                 \005            \005            \005            \005

(vii) income by way of fees for technical services payable  by \026

(a)     the Government; or

(b)     a person who is a resident, except where the fees  are payable in respect of services utilized in a  business or profession carried on by such person  outside India or for the purposes of making or  earning any income from any source outside India;  or

(c)     a person who is a non-resident, where the fees are  payable in respect of services utilized in a business  or profession carried on by such person in India or  for the purposes of making or earning any income  from any source in India :

       Provided that nothing contained in this clause shall  apply in relation to any income by way of fees for  technical services payable in pursuance of an agreement  made before the 1st day of April, 1976, and approved by  the Central Government."

Analysis :          For the purpose of taxation, the authority had proceeded on the basis  that the element of tax consisted of  : (i) onshore supply and onshore  services; and (ii) construction of offshore supply and offshore services.  It is  not denied or disputed, as indicated hereinbefore,  that in respect of the first  element of onshore  supply and onshore service, and construction tax would  be payable in India.   

       Two basic issues which, thus, arise  for our consideration are :  (a) the  taxation of the price of goods supplied,  by way of offshore supply price of  which is specified in Ex. D, Clause 2.1; and (b) the taxation of consideration  paid for rendition of services  described in the contract as offshore services

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at Ex. D.  

       The contract is a complex arrangement.  Petronat and Appellant are  not the only parties thereto, there are other members of the consortium who  are required to carry out different parts of the contract.  The consortium  included an Indian company.  The fact that it has been fashioned as a  turnkey contract by itself may not be of much significance.  The project is a  turnkey project.  The contract may also be a turnkey contract, but the same  by itself would not mean that even for the purpose of taxability the entire  contract must be considered to be an integrated one so as to make the  appellant to pay tax in India.  The taxable events in execution of a contract  may arise at several stages in several years.  The liability of the parties may  also arise at several stages.  Obligations under the contract are distinct ones.   Supply obligation is distinct and separate from service obligation.  Price for  each of the component of the contract is separate.  Similarly offshore supply  and offshore services have separately been dealt with.  Prices in each of the  segment are also different.        

       The very fact that in the contract, the supply segment and service  segment have been specified in different parts of the contract is a pointer to  show that the liability of the appellant thereunder would also be different.

       The contract indisputably was executed in India.  By entering into a  contact in India, although parts thereof will have to be carried out outside  India would not make the entire income derived by the contractor to be  taxable in India.  We would, however, deal with this aspect of the matter  a  little later.

       Scope of work is contained in clause 2.1 of Ex. A appended to the  contract which includes supply of equipment, materials and facilities.  The  said exhibit spells out different systems to be set in place. It imposes an  obligation on the contractor to supply equipments required therefor.  It was  to arrange for the engineering services in relation thereto.  It was also  required to render various other services within India.  Ex. D, however,  provides for the prices to be paid in respect of offshore supplies and offshore  services, onshore supply and onshore services, construction and erection.   Payment schedule has also been separately specified in respect of each of the  components separately.   

       It is not in dispute that title in the equipments supplied was to stand  transferred upon delivery thereof outside India on high-sea basis as provided  for in Article 22.1.  Similarly, Article 13.1. provides for a lump sum contract  price, whereas Article 13.3.2. specifically refers to the cost of offshore  supplies.  The provisions with regard to offshore supplies and offshore  services were to be read with the provisions contained in Ex. D which  formed the basis of customs duty.  Clause 13.4 refers to Ex. D as the basis  for price escalation.   

       The question of imposition of tax on income arising from a business  connection may, thus, have to be considered keeping in view the  aforementioned factual backdrop.   

       Section 9(1)(i) of the Act states that income accruing or arising  whether directly or indirectly, through or from any business connection in  India shall be deemed to accrue or arise in India.  Appellant is a non-resident  assessee.

       Section 9 raises a legal fiction; but having regard to the contextual  interpretation and furthermore in view of the fact that we are dealing with a  taxation statute the legal fiction must be construed having regard to the  object it seeks to achieve.  The legal fiction created under Section 9 of the  Act must also be read having regard to the other provisions thereof. [See  Maruti Udyog Ltd. v. Ram Lal and Others, (2005) 2 SCC 638]

       For our benefit we may notice the provisions of Section 42 of the

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Income Tax Act, 1922.  It provided that only such part of income as was  attributable to the operations carried out in India would be taxable in India.

       Territorial nexus doctrine, thus,  plays an important part in assessment  of tax.  Tax is levied on one transaction where the operations which may  give rise to income may take place partly in one territory and partly in  another.  The question which would fall for our consideration is as to  whether the income that arises out of the said transaction would be required  to be proportioned to each of the territories or not.

       Income arising out of operation in more than one jurisdiction would  have territorial nexus with each of the jurisdiction on actual basis.  If that be  so, it may not be correct to contend that the entire income ’accrues or arises’  in each of the jurisdiction.  The Authority has proceeded on the basis that  supplies in question had taken place offshore.  It, however, has rendered, its  opinion on the premise that offshore supplies or offshore services were  intimately connected with the turnkey project.   

       The learned Additional Solicitor General in support of his contention  that the contract is a composite one, has relied upon the following decisions : N. Khadervali Sahib (Dead) by L.Rs. and Another v. N. Gudu Sahib (Dead)  and Others [(2003) 3 SCC 229]; Hindustan Shipyard Ltd. v. State of A.P.  [(2000) 6 SCC 579];  State of Rajasthan v. M/s Man Industrial Corporation  Ltd. [(1969) 1 SCC 567],  K.S. Subbiah Pillai  v. Commissioner of Income  Tax [(1999) 3 SCC 170]; M/s Patnaik and Co. Ltd. v. Commissioner of  Income Tax, Orissa  [(1986) 4 SCC 16]; BSES Ltd. (Now Reliance Energy  Ltd.) v. Fenner India Ltd. and Another [(2006) 2 SCC 728].  The said  decisions, in our considered view, are not applicable herein.

       In Khadervali Sahib (supra), the question which arose for  consideration was whether an award amounted to creation of or  transfer of  any fresh rights  in respect of  movable or immovable properties so as to  require registration under Section 17 of the Registration Act, when the same  related to the properties of a partnership firm.  Therein by reason of an  award, the residue upon settlement of accounts on dissolution of the  partnership firm was allocated to the partners.  It was held that the award did  not require any registration.   

       In Hindustan Shipyard (supra), the question which arose for  consideration was whether a contract constituted a sale or works contract.   Laying down the tests therefor, having regard to the terms and conditions  contained therein, it was  opined that a contract of sale of goods was separate  from a contract for works and labour.  In regard to the categories of contract,  it was stated :                          "(i) the contract may be for work to be done for  remuneration and for supply of materials used in the  execution of the work for a price;

(ii) it may be a contract for work in which the use of the  materials is accessory or incidental to the execution of the  work; and

(iii) it may be a contract for supply of goods where  some work is required to be done as incidental to the sale."

Whereas the first contract was held to be a composite contract, the  second was held to be a contract for work and labour not involving the sale  of goods; and the third was held to be a contract of sale where the goods  were sold as chattels and the work done was merely incidental thereto.

The view taken in State of Madras v. Gannon Dunkerley & Co.  (Madras) Ltd.  [1959 SCR 379] is sought to be applied.  The contract in such  a case must stipulate that the equipment would be supplied on CRF basis. It

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spells out the price for supply of goods, in which event, for the purpose of  sales tax, the contract would involve sale of goods.  The principle of Gannon  Dunkerly (supra), does not appear to be of much relevance in the instant  case.

Decisions of this court under the Sales Tax Laws referred to by the  learned counsel, moreover,  may have to be considered on a different  footing.

In this case,  we are faced with a different situation.  It is only for the  purpose of taxability that the terms of the contract are required to be  construed.  A turnkey contract may involve supply of materials used in the  execution of the contract for  price as also for use of the materials by works  and labour; but the same may not have any relation with the taxability part  of it.   

It is interesting to note that Instruction No.1829 issued by the Central  Board of Direct Taxes on 21.09.1989 provides for certain guidelines having  regard to the possibility of undertaking of Hydro Electric Power Project by a  consortium of a foreign company, stating :

       "The concept  of turnkey execution of the project  involves total and complete responsibilities of the  persons undertaking the contracts for commissioning the  project and they are accordingly required to furnish  performance guarantees for timely completion."  

       It was further stated :

       "Apart from the separate contracts for the jobs  mentioned in Para 4 above, there would be an overall co- ordination agreement between the public sector company  on the one hand and the foreign contracting parties  referred to in Paragraph 4 on the other hand to ensure  guaranteed performance of all the contracts in a  coordinated manner, and within an agreed time frame and  for undertaking to meet necessary liabilities and  responsibilities including payments of liquidated  damages for delays etc.  One of the companies would, for  this purpose, act as leader to ensure supervision and  coordination of inter-related tasks."            In M/s Man. Industrial Corporation Ltd. (supra), this Court held :  "16. Our attention was invited to a judgment of the Court  of Appeal in Love v. Norman Wright (Builders) Ltd.  [1944] 1 K.B. 484 In that case the respondents contracted  with the Secretary of State for War to do the work and  supply the material mentioned in the Schedules to the  contract, including the supply of black-out curtains,  curtain rails and battens and their erection at a number of  police stations. It was held by the Court of Appeal that  the respondents were liable to pay purchase-tax. Reliance  was placed upon the observations made by Godiard, L.J.  at p. 482:         "If one orders another to make and fix  curtains at his house the contract is one of sale  though work and labour are involved in the making  and fixing, nor does it matter that ultimately the  property was to pass to the War Office under the  head contract. As between the plaintiff and the  defendants the former passed the property in the  goods to the defendants who passed it on to the  War Office." We do not think that these observations furnish a  universal test that whenever there is a contract to "fix"  certain articles made by a manufacturer the contract must

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be deemed one for sale and not of service. The test in  each case is whether the object of the party sought to be  taxed is that the chattel as chattel passes to the other party  and the services rendered in connection with the  installation are under a separate contract or are incidental  to the execution of the contract of sale."

In M/s Patnaik and Co. (supra), whereupon reliance has been placed  by the learned Additional Solicitor General, the question which arose for  consideration was as to whether the investment in the loan by the assessee  out of the advance payment made by the Government departments was a  capital asset and the loan was a capital loan or not.   We are not herein  concerned with such a  situation.  The said decision, therefore, cannot be  said to have any application at all.

In BSES Ltd. (supra), this Court was concerned with the construction  of bank guarantees.  The question which arose for consideration therein was  as to whether in the fact situation of the case, customer faced irretrievable  injuries so as to obtain an order of injunction.  In view of the terms and  conditions of the contract, it was opined, although for the sake of  convenience, the same had been split up into four sub-contracts, it  constituted a composite contract executable on a turnkey basis.  The  question which arose for consideration, thus, was whether in terms of the  contract having been reduced into writing by the "wrap around agreement",   Appellant therein had a right to negotiate any or all the guarantees for any  breach of any of the four contracts.  The said decision again has no  application in the facts of the present case.   

Tax under the Act has to be assessed under different heads.  Income  under one head  may be subject to exemption; under same head, deductions  may be claimed;  yet under another, no tax may be payable at all.  Whether a  part of the income of the assessee would be taxable or not depends upon the  fact of each case.  Even there is nothing to prevent the income accruing or  arising at the sources.     

In Union of India and Another v. Azadi Bachao Andolan and Another   (2004) 10 SCC 1], this Court was dealing with a double taxation treaty.  It  was held :

"6. The Agreement provides for allocation of taxing  jurisdiction to different contracting parties in respect of  different heads of income. Detailed rules are stipulated  with regard to taxing of dividends under Article 10,  interest under Article 11, royalties under Article 12,  capital gains under Article 13, income derived from  independent personal services in Article 14, income  from dependent personal services in Article 15,  directors’ fees in Article 16, income of artists and  athletes in Article 17, governmental functions in Article  18, income of students and apprentices in Article 20,  income of professors, teachers and research scholars in  Article 21 and other income in Article 22.

       In Commissioner of Income Tax, Bombay v. Ahmedbhai Umarbhai &  Co., Bombay [(1950) SCR 335], this Court,  having regard to the provisions  contained in Section 42 of the Income Tax Act, 1922, held that profits  accrued to the assessee of a part of the business in an Indian State having  accrued out of such business carried on in such State are exempted under the  third proviso to Section 5 of the Excess Profit Tax Act.         Opining that the source of income can never be  the place  where the  income accrues or arises, Kania, CJ, stated :

"\005In my opinion there is nothing to prevent income  accruing or arising at the place of the source. The  question where the income accrued has to be determined

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on the facts of each case. The income may accrue or arise  at the place of the source or may accrue or arise  elsewhere, but it does not follow that the income cannot  accrue or arise at the place where the source exists.  Therefore it is necessary to ascertain whether that part of  the business which is capable of being treated as one  separate unit in the Hyderabad State has given rise to the  income or profit sought by the assessee to be exempted  from taxation in the present case\005"

       Patanjali Sastri, J. approved the application of the principle underlying  the decision in Commissioner of Taxation v. Kirk  [(1900 AC 588], namely,  the principle of apportioning profits as between different processes  employed in producing those profits and the different places where they  were employed.

       Mahajan, J. held :

 "\005For instance, where a person carries on manufacture,  sale, export and import, it is not possible to say that the  place where the profits accrue to him is the place of sale.  The profits received relate firstly to his business as a  manufacturer, secondly to his trading operations, and  thirdly to his business of import and export. Profit or loss  has to be apportioned between these businesses in a  businesslike manner and according to well-established  principles of accountancy. In such cases it will be doing  no violence to the meaning of the words "accrue" or  "arise" if the profits attributable to the manufacturing  business are said to arise or accrue at the place where the  manufacture is being done and the profits which arise by  reason of the sale are said to arise at the place where the  sales are made and the profits in respect of the import and  export business are said to arise at the place where the  business is conducted. This apportionment of profits  between a number of businesses which are carried on by  the same person at different places determines also the  place of the accrual of profits. To hold that though a  businessman has invested millions in establishing a  business of manufacture, whether in the nature of a  textile mill or in the nature of steel works, yet no profits  are attributable to this business or can accrue or arise to  the business of manufacture because the produce of his  mills is sold at a different place and that it is only the act  of sale by which profits accrue and they arise only at that  place is to confuse the idea of receipt of income and  realization of profits with the idea of the accrual of  profits. The act of sale is the mode of realizing the  profits. If the goods are sold to a third person at the mill  premises no one could have said that these profits arose  merely by reason of the sale. Profits would only be  ascribed to the business of manufacture and would arise  at the mill premises. Merely because the mill owner has  started another business organization in the nature of a  sales depot or a shop, that cannot wholly deprive the  business of manufacture of its profits, though there may  have to be apportionment in such a case between the  business of manufacture and business of shop keeping. In  a number of cases such apportionment is made and is  also suggested by the provisions of Section 42 of the  Indian Income Tax Act, reference to which has also been  made in Proviso (2) of Section 5 of the Excess Profits  Tax Act."

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In Anglo-French Textile Co. Ltd. v. Commissioner of Income Tax,  Madras (1954) SCR 523], the question which arose for consideration, inter  alia, was :           " (2) Can the income received in India be said to arise in  India within the meaning of Section 4-A(c)(b) of the Act?  If not, should only those profits determined under Section  42(3) as attributable to the operations carried out in India  be taken into account for applying the test laid down in  Section 4-A(c)(b), and remanded the case to the High  Court with the direction that it should give its opinion on  these two questions."

In regard to the first question, it was opined that Section 42(3) had  nothing to do with the determination of the income arising in the taxable  territories as distinguished from the income arising without taxable  territories  as understood in Section 4A(c)(b) of the Act, it was held  

"The phraseology of Section 42(3) of the Act also  repels the contention insofar as the profits and gains of  the business which are referred to therein and which are  capable of apportionment as therein mentioned are  deemed to accrue or arise in the taxable territories thus  using the words "accrue" and "arise" as synonymous  with each other.

The above passage is also sufficient in our opinion to  establish that the apportionment of income, profits or  gains between those arising from business operations  carried on in taxable territories and those arising from  business operations carried on without the taxable  territories is based not on the applicability of Section  42(3) of the Act but on general principles of  apportionment of income, profits or gains\005"  

While the first question was answered in negative, question no.2 was  answered in the following terms :

"Question 2\027The income received in British India  cannot be said to wholly arise in India within the  meaning of Section 4-A(c)(b) of the Act and that there  should be allocation of the income between the various  business operations of the assessee company demarcating  the income arising in the taxable territories in the  particular year from the income arising without the  taxable territories in that year for the purposes of Section  4-A(c)(b) of the Act."

In  Carborandum Co. v. Commissioner of Income-Tax, Madras    [(1977) 108 ITR 335 : (1977) 2 SCC 862], this Court referring to its earlier  decision in Commissioner of Income Tax, Punjab   v. R..D. Aggarwal and  Co.& Another   [(1965) 56 ITR 20], opined :

"15. On a plain reading of sub-sections (1) and (3) of  Section 42 it would appear that income accruing or  arising from any business connection in the taxable  territories \027 even though the income may accrue or arise  outside the taxable territories \027 will be deemed to be  income accruing or arising in such territory provided  operations in connection with such business, either all or  a part, are carried out in the taxable territories. If all such  operations are carried out in the taxable territories, sub-

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section (1) would apply and the entire income accruing or  arising outside the taxable territories but as a result of the  operations in connection with the business giving rise to  the income would be deemed to accrue or arise in the  taxable territories. If, however, all the operations are not  carried out in the taxable territories the profits and gains  of the business deemed to accrue or arise in the taxable  territories shall be only such profits and gains as are  reasonably attributable to that part of the operations  carried out in the taxable territories. Thus comes in the  question of apportionment under sub-section (3) of  Section 42."

       In CIT v. Mitsui Engineering and Ship Building Co. Ltd.  [259 ITR  248], on which reliance was placed;  the contention was that the finding that  the contract for designing, engineering, manufacturing, shop testing and  packing up to f.o.b port of embarkation could not  be split up since the entire  contract was to be read together and was for one complete transaction.  It  was in the said fact situation held that it was not possible to apportion the  consideration for design on one part and the other activities on the other part.  The price paid to the assessee was the total contract price which covered all  the stages involved in the supply of machinery.  

       This case is clearly distinguishable from the facts of the present case,  since the payment for the offshore and onshore supply of goods and services  was in itself clearly demarcated and cannot be held to be a complete contract  that has to be read as a whole and not in parts.  

The principle of apportionment is also recognized by Clause (a) of   Explanation I. Thus, if submission of the learned Additional Solicitor  General is accepted that the contract is a composite one, then offshore  supply would be of equipment designed and manufactured in one territory  (Japan), and then sold in another tax territory,  leading to division of profits  arising in two tax territories, which is not envisaged under our taxation law.  

It gives rise to the question as to what would be the meaning of the  phrase ’business connection in India’.  Mere existence of business  connection may not result in income of the non-resident assessee from  transaction with such a business connection accruing or arising in India.            

       In Mazagaon Dock Ltd. v. CIT and Excess Profits Tax  [34 ITR 368],  whereupon again reliance placed is distinguishable.  In that case a non- resident carried on business with a resident, and the issue adjudicated upon  by the Court was that whether there was a clear and close connection  between them that produced profits or not, and whether any such income  generated by the non-resident company sending its ships for repairs to the  resident company is taxable, if it amounted to business. The Court answered  both questions affirmatively.

       The principle laid down therein has no application to the current fact  situation because there was an extremely close connection between the  appellant company and non residents in that the two non-resident (British)  companies beneficially owned the entire share capital of the appellant  company. In the present situation there is no such connection, which can be  said to give rise to a business connection between the permanent  establishment in India and the transaction that is sought to be taxed.  

       Yet again in Anglo French Textile Co. Ltd. v. CIT Madras  [23 ITR  101], in the fact situation obtaining therein, it was held that when there was a  continuity of business relationship between the person in India who helps  make the profits and the person outside who receives or realizes this profit, a  business connection exists.  

       In that case, the Assessee company incorporated in the UK, owned a

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textile company in French Pondichery and had appointed another limited  company in Madras to act as its constituted agents. The same was held to be  a business connection within British India. Such a close connection cannot  be envisaged in the present case since it does not involve any such principle- agent relationship between the PE and the non residents.

       Barendra Prasad Ray v. ITO  [129 ITR 295] whereupon reliance has  been placed, is not apposite.  Therein, the Court held that the professional  relationship of a solicitor, who was a non-resident, with an Indian firm will  be a business connection. There was a connection between the Indian firm  and the British solicitor which was real and intimate and not just a casual  one and the fees earned by the solicitor was only through this connection,  and could not have done so without associating himself with the firm. Thus,  the income earned by the solicitor was subject to tax in India, and payable by  the firm as agents of the solicitor.  

       The principle of this case, is again not applicable in the present  scenario since the nature of the relationship between the permanent  establishment, the foreign firms and the Indian firms are evidently  contractual and not professional. And the transaction of sale and supply of  goods offshore have not taken place with the involvement of the permanent  establishment, therefore excluding this transaction from the scope of  taxation in India.  

In Commissioner of Income-Tax, A.P. v. Toshoku Ltd. [(1980) 125  ITR 525 : (1980) Supp. SCC 614], this Court interpreted Section 9(1)(i) and  the Explanation thereto on the factual matrix obtaining therein that the  statutory agent exported his goods to Japan and  France where they were  sold through the assessee and the entire sales price was received in India by  the said agent who made credit entries in his accounts books regarding the  commission amounts payable to the assessees and remitted the commission  amounts to them subsequently.  Having regard to the fact that the Japanese  company was a non-resident company, distinguishing the case Raghava  Reddi & Another   v. Commissioner of Income Tax, A.P.  [(1962) 44 ITR  720] , it was held :                  "\005It is not possible to hold that the non-resident  assessees in this case either received or can be deemed to  have received the sums in question when their accounts  with the statutory agent were credited, since a credit  balance without more only represents a debt and a mere  book entry in the debtor’s own books does not constitute  payment which will secure discharge from the debt. They  cannot, therefore, be charged to tax on the basis of  receipt of income actual or constructive in the taxable  territories during the relevant accounting period."

                                A Division Bench of the Karnataka High Court presided over by  Venkataramiah, J., in VDO Tachometer Werke, West Germany etc. v.  Commissioner of Income-Tax, Karnataka-I etc.  [(1979) 117 ITR 804]  following  Carborandum Co. (supra), held that notwithstanding the  amendment of Section 9 of the Act by the addition of Clauses (vi) and (vii),  the cases continued to be governed by the provisions of Section 9 of the Act.   

       In Commissioner of Income-Tax  v. Atlas Steel Co. Ltd. [(1987) 164  ITR 401], a Division Bench of the Calcutta High Court following  Carborandum (supra) and other decisions held : "35. The expression "business connection" in the  context of the Income-tax Act has come to acquire a  special meaning as laid down by the Supreme Court in R.  D. Aggarwal & Co.’s case.  A business connection  contemplated under Section 42 of the Indian Income-tax  Act, 1922 (corresponding to Section 9 of the Income-tax  Act, 1961, involved "a relation between a business

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carried on by a non-resident and some activity in the  taxable territories which are attributable directly or  indirectly to the earnings, profits or gains of such  business". It was laid down by the Supreme Court that  there must be trading activity both outside and within the  taxable territory. In the facts of this case, for the supply  of inventions, patents, application for patents, secret  knowledge and know-how, no trading activity had been  or was required to be carried on by the assessee within  the taxable territory. Further, on a consideration of the  agreement, it cannot be said that the trading activity  which was intended to be carried on by the assessee as  production adviser of Hindustan Steel Ltd., in future was  relatable to or connected with the past supply of the said  know-how and other items.

[See also Income-Tax Officer and  Others v. Shriram Bearings Ltd. \026 (1987)  164 ITR 419]  

       A similar view was taken, when the matter came before this Court  in  Income-Tax Officer and Others v. Shriram Bearings Ltd. [(1997) 224 ITR  724 : (1997) 10 SCC 332], wherein B.P. Jeevan Reddy, J. speaking for the  Division Bench, opined  :

"We are not prepared to agree that the High Court  has not correctly understood the purport of the agreement  between the respondent and M/s Nippon Seike Kabushiki  Kaisha (NSK). The agreement is in two parts. It is true  that the two parts are interdependent but yet the  consideration for the sale of trade secrets and  consideration of technical assistance is separately  provided for and mentioned under separate sections. So  far as the consideration for the technical assistance is  concerned, its taxability is not in doubt. The only  controversy is with respect to the taxability of 1,65,000  US Dollars which is stipulated as the consideration for  sale of trade secrets. The agreement specifically says that  the said sale is effected in Japan. We are unable to see on  what basis it can be said that any part of the said amount  has been earned in India."

       In construing a contract, the terms and conditions thereof are to be  read as a whole.  A contract must be construed keeping in  view the intention  of the parties.  No doubt, the applicability of the tax laws would depend  upon the nature of the contract, but the same should not be construed  keeping in view the taxing provisions.                  In Commissioner of Income-Tax, Tamil Nadu-V  v. Fried Krupp  Industries  [(1981) 128 ITR 27], a Division Bench of the Madras High Court  opined : "\005Nowadays we have what are called turnkey projects,  and in such projects until the machinery is actually run  and proves its performance, the responsibility of the  foreigner would continue. But in the present case the  contract cannot be equated to a turnkey contract. The  operations in India for the erection of the machinery are  only the responsibility of the Indian company. It is only  any defect in the machinery or any negligence in the  performance of the foreign engineer, that may give rise to  a claim for damages. But that is not the same as the  foreign company performing any operation in pursuance  of this contract in India. Whatever we have said above  would apply also to deputation of foreign personnel for  procuring Indian spare parts. It was obviously considered

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necessary to get foreign personnel from abroad for this  purpose only because the type of spare parts required for  the foreign machinery could be better picked up by these  personnel, who have experience in running the  machinery. It is merely an assistance provided to the  Indian company, the foreign personnel being treated as  the employees of the Indian company. Having gone  through the terms of the agreement in full, we are  satisfied that there are no operations in India attributable  to the foreign company which can give rise to any profits  being earned in India. The agreement itself says that the  terms of the payments were in Germany. Thus, there is  absolutely no operation in India which would give rise to  tax liability in India as far as the foreign company is  concerned\005"  

The term ’permanent establishment’ has not been defined in the  Income Tax Act.   

       Since the appellant carries on business in India through a Permanent  Establishment, they clearly fall out of the applicability of Article 12(5) of the  DTAA and into the ambit of Article 7. The Protocol to the DTAA, in  paragraph 6, discusses the involvement of the permanent establishment in  transactions, in order to determine the extent of income that can be taxed. It  is stated that the term ’directly or indirectly attributable’ indicates the  income that shall be regarded on the basis of the extent appropriate to the  part played by the permanent establishment in those transactions. The  permanent establishment  here has had no role to play in the transaction that  is sought to be taxed, since the transaction took place abroad.

Clause 1 of Article 7, thus, provides that if an income arises in Japan  (Contracting State), it shall be taxable in that country unless the enterprise  carries on business in the other Contracting State (India) through a  permanent establishment situated therein.  What is to be taxed is profit of the  enterprise in India, but only so much of them as is directly or indirectly  attributable to that permanent establishment.  All income arising out of the  turnkey project would not, therefore, be assessable in India, only because the  assessee has a permanent establishment.

It is relevant to note that the tax treaty between India and Japan is  essentially  based on OECD model, providing :

       "a)     the income of a resident, including of the  kind that would fall under would be table under Section  9, would be taxed in the State of residence, save and  except the income attributable to a Permanent  Establishment, and

       b)      even in the case of a permanent  establishment, income from business would be taxable in  the State of residence."

       In Klaus Vogel on Double Taxation Conventions, it is stated :

       "g)     No force of attraction principle : The second  sentence of Art. 7 (1) allows the State of the permanent  establishment to tax business profits, ’but only so much  of them as is attributable to that permanent  establishment’.  The MC has thus decided against  adopting the so-called ’force of attraction of the  permanent establishment’, i.e. against the principle that,  where there is a permanent establishment, the State of the

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permanent establishment should be allowed to tax all  income derived by the enterprise from sources in that  State irrespective of whether or not such income is  economically connected with the permanent  establishment.  In line with the domestic law then  prevailing in the USA, such a ’force of attraction’ was,  for instance, incorporated in Germany’s 1954 DTC with  USA (second sentence of Art. III (I).  In contrast, the  second sentence of Art. 7(1) MC allows the State of the  permanent establishment to tax only those profits which  are economically attributable to the permanent  establishment, i.e. those which result from the permanent  establishment’s activities, which arise economically from  the business carried on by the permanent establishment  (cf. also para 5 MC Comm. Art. 7, supra m. no. 10).  As  regards the profits made by the enterprise in the State of   the permanent establishment, a distinction must always  be made between those profits which result from the  permanent establishment’s activities and those made,  without any interposition of the permanent establishment,  by the head office or any other part of the enterprise (also  for mere assembly permanent establishment :BFH 37  RIW 258 (1991).  It is only when there is a connection  with the permanent establishment that the State of the  permanent establishment is entitled to impose tax.   Conversely, losses incurred in connection with direct  transactions may not be set off against a permanent  establishment’s profits.   Since a DTC may not increase  tax liability, the USA, it is true, imposes tax at the lower  amount that would ensue if the permanent  establishment’s business and direct transactions were  combined and treated as if no DTC existed (of course, the  taxpayer may, in such event, not only set off the result of  individual direct transactions, which amounted to a loss  against the permanent establishment’s positive operating  result :I.R.S. Rev. Rul. 84-17, 1984-I Cum. Bull. 308).   According to that ruling, the taxpayer is in such cases  entitled to elect taxation which discounts the DTC. (see  surpa Art. I, at m. no.44)."

       We generally agree with the said statement law.

       The distinction between the existence of a business connection and  the income accruing or arising out of such business connection is clear  and explicit. In the present case, the permanent establishment’s non- involvement in this transaction excludes it from being a part of the cause of  the income itself, and thus there is no business connection.  

Article 5.3 provides that a person  is regarded as having a permanent  establishment if he  carries on construction and installation activities in a  Contracting State only if the said activities are carried out for more than six  months.  Paragraph 6 of the Protocol to India Japan Tax Treaty also provides  that only income arising from activities wherein the permanent  establishment has been involved can be said to be attributable to the  permanent establishment. It gives rise to two questions, firstly offshore  services are rendered outside India;  the permanent establishment would  have no role to play in respect thereto in the earning of the said income.   Secondly, entire services having been rendered outside India, the income  arising therefrom cannot be attributable to the permanent establishment so as  to bring within the charge of tax.             For attracting the taxing statute there has to be some activities through  permanent establishment.  If income arises without any activity of the  permanent establishment, even under the DTAA the taxation liability in

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respect of oversea services would not arise in India.  Section 9 spells out the  extent to which the income of non-resident would be liable to tax in India.   Section 9 has a direct territorial nexus.  Relief under a Double Taxation  Treaty having regard to the provisions contained in Section 90(2) of the  Income Tax Act would arise only in the event a taxable income of the  assessee arises in one Contracting State on the basis of  accrual of income  in  another Contracting State on the basis of residence.  Thus, if  Appellant had  income that accrued in India and is liable to tax because in its State all  residents it was entitled to relief from such double taxation payable in terms  of Double Taxation Treaty.  However, so far as accrual of income in India is  concerned,  taxability must be read in terms of Section 4(2) read with  Section 9, whereupon the question of seeking assessment of such income in  India on the basis of Double Taxation Treaty would arise.

       In cases such as this, where different severable parts of the composite  contract is performed in different places, the principle of apportionment can  be applied, to determine which fiscal jurisdiction can tax that particular part  of the transaction. This principle helps determine, where the territorial  jurisdiction of a particular state lies, to determine its capacity to tax an event.  Applying it to composite transactions which have some operations in one  territory and some in others, is essential to determine the taxability of  various operations.  

       It is, therefore, in our opinion, the concepts profits of business  connection and permanent establishment should not be mixed up.  Whereas  business connection is relevant for the purpose of application of Section 9;  the concept of permanent establishment is relevant for assessing the income  of a non-resident under the DTAA.  There, however, may be a case where  there can be over-lapping of income; but we are not concerned with such a  situation.  The entire transaction having been completed on the high seas, the  profits on sale did not arise in India, as has been contended by the appellant.   Thus, having been excluded from the scope of  taxation under the Act, the  application of the double taxation treaty would not arise. Double Tax Treaty,  however, was taken recourse to by Appellant only by way of an alternate  submission on income from services and not in relation to the tax of offshore  supply of goods.   

       We would in the aforementioned context consider the question of  division of taxable income of offshore services.  Parties were ad idem that  there existed a distinction between onshore supply and offshore supply.  The  intention of the parties, thus, must be judged from different types of services,  different types of prices, as also different currencies in which the prices are  to be paid.   

        Section 9(1)(vii)(c) of the Act states that "a person who is a non- resident, where the fees are payable in respect of services utilized in a  business or profession, carried on by such person in India, or for the  purposes of making or earning any income from any source in India".  Reading the provision in its plain sense, it can be seen that it requires two  conditions have to be met \026 the services which are the source of the income  that is sought to be taxed, has to be rendered in India, as well as utilized in  India, to be taxable in India. In the present case, both these conditions have  not been satisfied simultaneously, therefore excluding this income from the  ambit of taxation in India. Thus, for a non-resident to be taxed on income for  services, such a service needs to be rendered within India, and has to be a  part of a business or profession carried on by such person in India. The  Petitioners in the present case have provided services to persons resident in  India, and though the same have been used here, it has not been rendered in  India.  

Section 9(1)(vii) of the Act whereupon reliance has been placed by  the learned Additional Solicitor General, must be read with Section 5  thereof, which takes within its purview the territorial nexus on the basis  whereof tax is required to be levied, namely,  : (a) resident; and (b) receipt or  accrual of income.  

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       Global income of a resident although is subjected to tax, global  income of a non-resident may not be.  The answer to the question would  depend upon the nature of the contract and the provisions of DTAA.  

What  is  relevant is receipt or accrual of income, as would be evident  from a plain reading of Section 5(2) of the Act..  The legal fiction created  although in a given case may be held to be of wide import, but it is trite that  the terms of a contract  are required to be construed having regard to the  international covenants and conventions.  In a case of this nature,    interpretation with reference to the nexus to tax territories will also assume  significance.  Territorial nexus  for the purpose of determining the tax  liability is an internationally accepted principle.  An endeavour should, thus,   be made to construe the taxability of a non-resident in respect of income  derived by it.   Having regard to the internationally accepted principle and  DTAA, it may not be possible to give an extended meaning to the words  ’income deemed to accrue or arise in India’ as expressed in Section 9 of the  Act.  Section 9 incorporated various heads of income on which tax is sought  to be levied by the Republic of India.  Whatever is payable by a resident to a  non-resident by way of fees for technical services, thus, would not always  come  within the purview of Section 9(1)(vii) of the Act.   It must have  sufficient territorial nexus with India so as to furnish a basis for imposition  of tax.  Whereas a resident would come within the purview of Section  9(1)(vii) of the Act, a non resident would not,  as services of a non-resident  to a resident utilize in India may not have much relevance in determining  whether the income of the non-resident accrues or arises in India.  It must  have a direct live link between the services rendered in India, when such a  link is established, the same may again be subjected to any relief under  DTAA.  A distinction may also be made between rendition of services and  utilization thereof.    

Section 9(1)(vii)(c) clearly states "\005where the fees are payable in  respect of services utilized in a business or profession carried on by such  person in India\005"  It is evident that Section 9(1)(vii), read in its plain, same  envisages the fulfillment of two conditions : services, which are source of  income sought to be taxed in India must be  (i) utilized in India and (ii)  rendered in India.  In the present case, both these conditions have not been  satisfied simultaneously.      

The provisions of Section 9(1)(vii) of the Act are plain and  capable of   being given a meaning.  There, therefore, may not be any reason not to give  full effect thereto.  However, even in relation to such income, the provisions  of  Article 7 of the DTAA would be applicable, as services rendered outside  India would have nothing to do with permanent establishment in India. Thus,  if any services have been rendered by the head office of  Appellant outside  India, only because they were connected with permanent establishment.   Even in relation thereto, principle of apportionment shall apply.   

The Authority, in our opinion, has committed an error in this behalf,  as if services rendered by the head office are considered to be the services  rendered by the permanent establishment, the distinction between Indian and  foreign operations and the apportionment of the income of the operations  shall stand obliterated.   

It would be contrary to the intent and purport of the Double Taxation  Convention which is a part of the scheme under the Income Tax Act.

We, therefore, hold as under :

Re : Offshore Supply :

(1)     That only such part of the income, as is attributable to the operations          carried out in India can be taxed in India.

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(2)     Since all parts of the transaction in question, i.e. the transfer of          property in goods as well as the payment, were carried on outside the          Indian soil, the transaction could not have been taxed in India.  (3)     The principle of apportionment, wherein the territorial jurisdiction of          a particular state determines its capacity to tax an event, has to be          followed. (4)     The fact that the contract was signed in India is of no material          consequence, since all activities in connection with the offshore          supply were outside India, and therefore cannot be deemed to accrue          or arise in the country.  (5)     There exists a distinction between a business connection and a          permanent establishment.  As the permanent establishment cannot be          said to be involved in the transaction, the aforementioned provision          will have no application.  The permanent establishment cannot be          equated to a business connection, since the former is for the purpose          of assessment of income of a non-resident under a Double Taxation          Avoidance Agreement, and the latter is for the application of Section          9 of the Income Tax Act. (6)     Clause (a) of Explanation 1 to S. 9(1)(i) states that only such part of          the income as is attributable to the operations carried out in India, are          taxable in India.  (7)     The existence of a permanent establishment would not constitute          sufficient ’business connection’, and the permanent establishment          would be the taxable  entity. The fiscal jurisdiction of a country would          not  extend to the      taxing entire income attributable to the permanent          establishment. (8)     There exists a difference between the existence of a business          connection      and the income accruing or arising out of such business          connection. (9)     Paragraph 6 of the Protocol to the DTAA is not applicable, because,          for the profits to be ’attributable directly or indirectly’, the permanent          establishment  must be  involved in the activity giving rise to the          profits.

Re: Offshore Services : (1)     Sufficient territorial nexus between the rendition of services and          territorial limits of India is necessary to make the income taxable. (2)     The entire contract would not be attributable to the operations in India  viz. the place of execution of the contract, assuming the offshore  elements form an integral part of the contract. (3)     Section.9(1)(vii) of the Act read with Memo cannot be given a wide          meaning so as to hold that the amendment was only to include the          income of non-resident taxpayers received by them outside India from          Indian concerns for services rendered outside India. (4)     The test of residence, as applied in international law also, is that of the          taxpayer and not that of the recipient of such services.  (5)     For Section 9(1)(vii) to be applicable, it is necessary that the services          not only be utilized within India, but also be rendered in India or have          such a "live link" with India that the entire income from fees as          envisaged in Article 12 of DTAA becomes taxable in India.  (6)     The terms ’effectively connected’ and ’attributable to’ are to be  construed differently even if the offshore services and the permanent  establishment were connected. (7)     Section 9(1)(vii)(c) of the Act in this case would have no application  as there is nothing to show that the income derived by a non-resident  company irrespective of where rendered, was utilized in India.  (8)     Article 7 of the DTAA is applicable in this case, and it limits the tax  on business profits to that arising from the operations of the  permanent establishment. In this case, the entire services have been  rendered outside India, and have nothing to do with the permanent  establishment, and can thus not be attributable to the permanent  establishment and therefore not taxable in India. (9)     Applying the principle of apportionment to composite transactions  which have some operations in one territory and some in others, is

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essential to determine the taxability of various operations. (10)    The location of the source of income within India would not render          sufficient nexus to tax the income from that source.  (11)    If the test applied by the Authority for Advanced Rulings is to be  adopted here too, then it would eliminate the difference between the  connection between Indian and foreign operations, and the  apportionment of income accordingly. (12)    The services are inextricably linked to the supply of goods, and it          must be considered in the same manner.

For the reasons aforementioned, the appeal is allowed in part and to  the extent mentioned hereinbefore.  No costs.