IMPORTANT POINT
Whatever is payable by a resident to a non-resident by way of fees for technical services would not always come within the purview of Section 9(1)(vii) of the Income Tax Act as it must have sufficient territorial nexus with India so as to furnish a basis for imposition of tax.

Headnote:Income Tax Act, 1961—Sections 5(2), 9(1)(i), 9(1)(vii)—Exigibility to pay tax in respect of ‘offshore supply’ and ‘offshore services’—Liability of a company incorporated in Japan and resident of that country—Appellant assessee company formed a consortium and entered into an agreement with Petronet LNG Ltd. for setting up a Liquefied Natural Gas receiving storage and degasification facility in State of Gujarat—Contract envisaged a turnkey project—Each of the members of the consortium was also to receive separate payments—Appellant, resident of Japan was to develop, design, engineer and procure equipments, materials and supplies to erect and construct storage tanks—Contract was to be completed in 41 months—It involved (i) offshore supply, (ii) offshore services, (iii) onshore supply, (iv) onshore services and (v) construction and erection—Price was payable for offshore supply and offshore services in US dollars—For that of onshore supply as also onshore services and construction and erection partly in US dollars and partly in Indian rupees—Dispute regarding exigibility to pay tax in respect of ‘offshore supply’ and ‘offshore services’—Appellant company disputed its liability to pay tax in India in regard to offshore services and offshore supply—Revenue contended that the contract being a composite and integrated one, they were so liable—All activities in connection with the offshore supply were outside India—Whether transaction of offshore supply could be taxed in India—(No)—Location of source of income within India would not render sufficient nexus to tax the income from that source.
       Held : 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 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.(Para 78)
       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.(Para 79)
       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 – 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.(Para 82)
       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.(Para 85)
       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.
       (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 provisionwill 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 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.(Para 90)

JUDGMENT

S.B. Sinha, J.—Leave granted.

2. 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.

3. 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 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?

4. 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’.

5. It is also not in dispute that the

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2007 Supreme(SC) 5

IMPORTANT POINTWhatever is payable by a resident to a non-resident by way of fees for technical services would not always come within the purview of Section 9(1)(vii) of the Income Tax Act as it must have sufficient territorial nexus with India so as to furnish a basis for imposition of tax.

Cases Referred (16)

IMPORTANT POINT
Whatever is payable by a resident to a non-resident by way of fees for technical services would not always come within the purview of Section 9(1)(vii) of the Income Tax Act as it must have sufficient territorial nexus with India so as to furnish a basis for imposition of tax.