(i) On facts, turnkey contract found to be a composite contract.
(ii) On examination of documents, PO held to constitute PE.
(iii) PE under Article 5(3) can emerge even when it does not satisfy the requirement of Article 5(1) and (2).
(iv) On facts, activities of PO were not preparatory or auxiliary in nature as contemplated in Article 5(4).
Facts
The taxpayer, together with another Indian company, entered into turnkey contract with ONGC for survey, design, engineering, fabrication and installation of facility. In accordance with the contract, it opened a Project Office (‘PO’) in Mumbai after obtaining approval of RBI. The approval did not place any restriction on PO’s activities. The fabrication of equipment was given to an unrelated entity in Malaysia. The fabricated equipment was received in the subsequent tax year. The taxpayer filed the return of its income declaring loss in respect of its Indian operations. The loss was computed in accordance with Article 7 of India-Korea DTAA.
The taxpayer contended that:
As per Article 7(1) of DTAA, business profits could be taxed in India only if the business was carried on through PE in India. Hence, it was essential that a PE should be constituted. However, a fixed place of business carrying on only preparatory or auxiliary activities would not constitute a PE.
The PO was not involved in pre-contract meetings and it was set up after the contract was executed.
The PO had employed only non-technical personal and it only acted as interface between the taxpayer and ONGC.
Vis-à-vis the scope of overall project, the activities of the PO were merely preparatory or auxiliary and hence were covered within exemption scope of Article 5(4).
As per Article 5(3), installation PE comes into existence only if time threshold of nine months has elapsed. Since the taxpayer was involved in installation project, specific provisions of Article 5(3) should override the general provisions of Article 5(1) and (2). Also, an installation PE would be constituted only when installation activity is commenced.
Contract of taxpayer comprised two divisible components, namely, supply of fabricated equipment from Malaysia and installation of the same. The supply component cannot be attributed to installation PE which came into existence at a later point of time.
The onus of proving that the PO was carrying out revenue generation activity was on the tax authority.
The tax authority contended that:
The PO was fixed place of business in India of the taxpayer. The resolution of the Board of Directors of taxpayer stated that the PO was opened for carrying on and execution of contract. PO was coordinating with ONGC on an ongoing basis and without such coordination, contract would not be executed. Therefore, PO constituted PE of taxpayer in India.
The contract showed that it was not divisible and hence, the income was taxable in India to the extent of the profit attributable to the PE. The PO was actively involved in bidding, negotiations, tendering and award of contract. Therefore, it was involved in execution of core functions of the taxpayer. Title to the goods passed to ONGC after the project was completed. The consideration payable was for the full contract to be executed in India. Income earned by the taxpayer even in respect of activities carried on outside India should be taxable in India as being attributable to PE in India.
The fixed place PE is based on ‘permanence test’, irrespective of the nature of business carried on. To cover the situation where ‘permanence test’ is not likely to be met, Article 5(3) lays down ‘duration test’. However, Article 5(3) does not preclude application of base rule PE, Article 5(3) does not override Article 5(1).
The contract showed that it was not divisible right from the beginning and hence, the income was taxable in India to the extent of the profit attributable to the PE.
Held
The Tribunal observed and held as follows.
(i) The contract commenced with survey and ended with commissioning of the facility. Existence of PO was a condition precedent to commencement of the contract. The contract price was fixed without any provision for escalation. The progress payments were provisional and based on milestone formula, which did not indicate that the payment was related to any component. Hence, on facts, the contract was a composite contract.
(ii) Several documents such as board resolution, RBI application, RBI approval, etc. showed that PO was not restricted from carrying on any business activity. Rather, the board resolution clearly mentioned that PO was for coordination and execution of the project in India. The documents indicated that all project-related activities were to be routed through PO. Hence, PO constituted base rule PE in terms of Article 5(1).
(iii) Supreme Court decision in CIT v. Hyundai Heavy Industries Co. Ltd., (2007) 291 ITR 482 (SC), which was relied on by the taxpayer, was concerned with a contract, which was divisible in two parts, namely, fabrication and installation. In that case, taxpayer merely had a liaison office which was not authorised by RBI to carry on any business. Also, fabrication was completed outside India and that taxpayer did not have any other place of business in India till such date. As against that, the taxpayer had set up PO for coordination and execution of the project. Taxpayer also, wholly or partly, carried on business activity in India and hence PO constituted a PE.
(iv) Article 5(1) defines PE as a fixed place of business. Article 5(2) enlarges the meaning of PE to specifically include certain kinds of establishments. Article 5(3) mentions the expression ‘likewise encompasses’ and mentions construction, assembly or installation project, etc. Thus, Article 5(3) further enlarges the term PE. Therefore, Article 5(3) is not an exclusionary clause which restricts scope of Article 5(1) and 5(2).
(v) The terms of the contract and the manner of carrying out of the work clearly suggested that PO had a role in all the activities of the contract. The taxpayer had not proved that the activities of the PO were preparatory or auxiliary in nature as contemplated in Article 5(4).
(vi) In absence of necessary material on record, the AO was not justified in attributing 25% of the offshore income to the PE and hence, the matter was restored to the AO for proper determination.
