Glimpses of Supreme Court Rulings

7.  Non-resident – Permanent Establishment – As
per Article 5 of the DTAA with UK, the PE has to be a fixed place of business
‘through’ which business of an enterprise is wholly or partly carried on. Some
examples of fixed place are given in Article 5(2), by way of an inclusion.
Article 5(3), on the other hand, excludes certain places which would not be
treated as PE, i.e. what is mentioned in Clauses (a) to (f) as the ‘negative
list’. A combined reading of sub-articles (1), (2) and (3) of Article 5 would
clearly show that only certain forms of establishment are excluded as mentioned
in Article 5(3), which would not be PEs. Otherwise, sub-article (2) uses the
word ‘include’ which means that not only the places specified therein are to be
treated as PEs, the list of such PEs is not exhaustive. In order to bring any
other establishment which is not specifically mentioned, the requirements laid
down in sub-article (1) are to be satisfied. Twin conditions which need to be
satisfied are: (i) existence of a fixed place of business; and (b) through that
place business of an enterprise is wholly or partly carried out.

Formula
One World Championship Ltd. vs. Commissioner of Income Tax, International
Taxation-3, Delhi and Ors. (2017) 394 ITR 80 (SC)

Brief background of the
factual matrix of this case is: Federation Internationale de l’ Automobile
[FIA], a non- profit association, was established to represent the interest of
motoring organisations and motor car users globally. It is a principal body for
Rules and Regulations for all major international four- wheel motorsports
events and accordingly, was a regulatory body which regulates FIA Formula- One
World Championship [F-1 Championship]. “Formula One” [F-1] is with reference to
set of rules that all participants’ cars must confirm to. This has been the
premier form of motor racing since its inception in 1950. The F-1 Championship
is an annual series of motor racing conducted in the name and style of Grand
Prix over three day duration at purpose-built circuits, etc., in
different countries around the world. The F-1 season consists of series of
races, known as Grand Prix, held across the world on specially designed and
built F-1 circuits. Formula-One World Championship Ltd [FOWC], a UK resident,
entered into an agreement with FIA and Formula-One Asset Management Ltd [FOAM]
under which the FOWC was licensed all commercial rights in the F-1 Championship
for 100 years term and accordingly, FOWC became Commercial Right Holder [CRH]
in respect of F-1 Championship events.

Furthermore, in F-1
Championship events, about 12 to 15 teams typically compete in any one annual
racing season. The teams assemble and construct their vehicle, which complies
with defined technical specifications and engage drivers who can successfully
manoeuvre the F-1 cars in the racing events. All teams are known as
“Constructors” and enter into a contract with FOWC and FIA, known as “Concorde
Agreement”. They also bind themselves in a covenant with FOWC that they would
not participate in any other similar motor racing event what-so-ever nor would
they promote in any name any other rival event. The F-1 racing teams
exclusively participate in about 19 to 21 F-1 annual racing events fixed by the
FIA. As such, on the one hand, participating teams have to enter into Concorde
Agreement with FOWC & FIA and on the other hand, promoters, like Jaypee,
also have to enter in to RPC with FOWC for hosting, promoting and staging F-1
racing events. This is, in effect, a closed circuit event, since no team other
than those bound by a contract with FOWC is permitted participation. Every F-1
racing event is hosted, promoted and staged by a promoter with whom FOWC enters
into contract and whose events is nominated by CRH (i.e. FOWC) to the FIA for
inclusion in the official F-1 racing events calendar. In other words, the FOWC
is the exclusive nominating body at whose instance the event promoter is
permitted participation. Grant of a right to host, stage and promote the F-1
racing event also carries with it a covenant or representation that F-1 racing
teams with their cars, drivers and other ancillary and support staff will
participate in the motor racing event hosted at the promoter’s motor-racing
circuit displaying the highest level of technical skill etc. These teams
and FOWC also represent that the highest level of skill in racing management
and maintenance of cars would be on display in the events. All these would
generally be revealed in the relevant Race Promotion Contract entered into by
promoter with FOWC.

FOWC had entered into a
‘Race Promotion Contract’ (RPC) dated September 13, 2011 with Jaypee Sports
International Ltd, Indian Resident, (Jaypee) granting Jaypee the right to host,
stage and promote the Formula One Grand Prix of India event for a consideration
of US$ 40 million. There was also a prior agreement [RPC] in 2007 between them
[prior RPC] which was replaced by this RPC. Some other agreements were also
entered into between FOWC and Jaypee as well as group companies of FOWC and
Jaypee.

As per the arrangement, the
promoter [Jaypee] was to construct the necessary circuit, as per the
specifications approved by FOWC and FIA, which will meet all the requirements
of the regulations and for which, the final inspection was to be completed by
FIA before the agreed time. In terms of the prior RPC, Buddh International Circuit
in Greater Noida [in National Capital Region (NCR)] was constructed [Buddh
Circuit] and current RPC replaced that RPC. Under the agreement, the promoter
is the owner of the motor racing circuit [in this case Buddh Circuit], which is
capable of hosting various motor racing events. The promoter who wishes to host
various motor racing events at such circuit is bound to include the hosting of
F-1 Grand Prix events. The Jaypee had secured the privilege to host such events
under the RPC. The rights and obligations of both the parties were elaborately
mentioned in the RPC, including the right of access to the circuit by FOWC, as
well as its group concerns, with which also the Jaypee had entered into
separate agreements. Pursuant to this RPC and these agreements, the races were
held in India in 2011, 2012 and 2013.

The applications were filed
by FOWC and Jaypee before the Authority for Advance Rulings (AAR), in which
advance ruling of AAR was solicited on two main questions/queries:

“ (i) whether the payment of consideration
receivable by FOWC in terms of the said RPC from Jaypee was or was not royalty
as defined in Article 13 of the ‘Double Taxation Avoidance Agreement’ (DTAA)
entered into between the Government of United Kingdom and the Republic of
India?; and

(ii)  whether FOWC was having any ‘Permanent Establishment’ (PE) in India
in terms of Article 5 of DTAA?

      Another
related question was also raised, viz.,

(iii)  whether any part of the consideration
received or receivable by FOWC from Jaypee outside India was subject to tax at
source Under section195 of the Indian Income Tax Act, 1961 (hereinafter after
referred to as the ‘Act’).”

AAR answered the first
question holding that the consideration paid or payable by Jaypee to FOWC
amounted to ‘Royalty’ under the DTAA. Second question was answered in favour of
FOWC holding that it did not have any PE in India. As far as the question of
subjecting the payments to deduction of tax at source u/s. 195 of the Act was
concerned, AAR ruled that since the amount received/receivable by FOWC was
income in the nature of Royalty and it was liable to pay tax thereon to the
Income-tax department in India, it was incumbent upon Jaypee to deduct the tax
at source on the payments made to FOWC.

FOWC and Jaypee challenged
the ruling on the first issue by filing writ petitions in the Delhi High Court
contending that the payment would not constitute Royalty Under Article 13 of
the India-UK Double Tax Avoidance Agreement (DTAA). Revenue also filed the writ
petition challenging the answer of the AAR on the second issue by taking the
stand that FOWC had ‘permanent establishment’ (PE) in India in terms of Article
5 of the DTAA and, therefore, tax was payable accordingly.

All these writ petitions
were decided by the High Court vide common judgement dated November 30, 2016
[390 ITR 199]. The High Court reversed the findings of the AAR on both the
issues. Whereas it held that the amount paid/payable under RPC by Jaypee to
FOWC would not be treated as Royalty, as per the High Court FOWC had the PE in
India and, therefore, it is taxable in India. The High Court also held, as the sequitur,
that Jaypee was bound to make appropriate deductions from the amount payable to
FOWC u/s.195 of the Act.

The Court also noted that
the bone of contention before this Court pertains to PE of FOWC in India and
the arguments advanced by both parties before this court was virtually the same
which were advanced before the High Court as well.

Therefore, their main
contentions before the High Court may be worth noting in brief. These are
summarised hereunder.

The broad contentions of
the assessees before the High Court, interalia, include that the FOWC
has only one place of business in its office in UK and did not have any fixed
place of office or business in India. By granting the right to host, stage and
promote the race to Jaypee, it did ‘business with a party that is resident of
India’, it did not undertake any business operations in India. Its business was
limited to a grant outside India of the right to Jaypee and after such grant of
the right, the Jaypee could host, stage and promote the F-1 events in
accordance with F-1 regulations. If limited access at the circuit granted to
FOWC by Jaypee accounted a fixed place, it would come into existence only at
the time when the race is held which is after the grant of right by FOWC: A
mere provision in the RPC for Jaypee to allow access to FOWC  for a very short duration and its affiliates
to the circuit for a very short duration prior to and during the F-1 event
could not make the Buddh Circuit [ which belongs to Jaypee] as a place at the
FOWC’s disposal. There was also uncertainty as to staging of event on a regular
basis which could not result in bringing into existence a fixed place PE of
FOWC. Merely because Jaypee had entered into agreement with FOWC’s affiliates,
which were conditions precedent to RPC, it did not extend the scope of its role
nor did it result in its possession or operating from a fixed place of business
in India. The circuit and other rights arose by virtue of the ownership of the
circuit which was that of Jaypee, those rights could be exploited only when
granted by it. The activities were undertaken by each of the affiliates
independently and on their own account and did not constitute its PE.

The broad contentions of
the Revenue before the High Court, interalia, included: for deciding
fixed place of business in terms of Article 5, it is adequate if the place of
business is at the disposal of the enterprise to be used in business. Such
place need not be owned by the enterprise, it could be rented or otherwise
available at the disposal of the enterprise. The mere fact that an enterprise
has certain amount of space at its disposal, which is used for business
activities, is sufficient to constitute a place of business and no formal
/legal right to use the place is necessary. A place of business could
constitute a PE, even if it exists only for a very short period of time because
the nature of the business is such that it will be carried on for that short
period of time. FOWC’s business is to exploit commercial rights arising from
races and this business is carried on through exploitation of these commercial
rights, either by itself or through any one or more of its affiliates as
mentioned in ‘Concorde Agreement’. The fixed place is Buddh Circuit in Greater
Noida, which is owned by Jaypee and which was designed and constructed in terms
of prior RPC of 2007, which was replaced and continued by the current RPC of
2011. The said Buddh Circuit includes not only racing circuit but all the
attached buildings in the complex, including vending areas, hosting and
broadcasting facilities, media centres, etc., as widely defined in the
RPC itself and was available to FOWC and its affiliates (including their
employees and third party contractors appointed by them) for carrying on their
business operations. Under the RPC, Jaypee was obliged to allocate promotional
area in such a manner as FOWC shall specify and access to restricted area is
regulated by passes and tickets issued by FOWC. The FOWC and its affiliates
have complete access to the circuit in all its dimensions for a period
beginning 14 days prior to the event and 7 days after the event. Under the
terms of RPC, the fixed place was available to FOWC for carrying out its
business functions for a period of 5 years, extendable by another period of 5
years. In effect, FOWC had complete control over entire area during the event which
is apparent from the wholesome reading of the RPC and other agreements with
affiliates. Considering the overall arrangement under RPC and agreement with
the affiliates and the actual conduct the FOWC has fixed place of business at
its disposal through which it has carried out business operations and as such
it has a PE in India. For this purpose, the Revenue also relied on various
parts of the commentary of OECD on Article 5.

The judgement of the High
Court was challenged before the Supreme Court.

As per FOWC and Jaypee, no
tax was payable in India on the consideration paid under RPC as it was neither
Royalty nor FOWC had any PE in India. The Revenue did not challenge the
findings of the High Court that the amount paid under RPC does not constitute royalty.
Therefore, that aspect of the matter attained finality. The main question in
the appeals before the Supreme Court, therefore, pertained to PE.

The Supreme Court noted the
scheme of the Act as well as relevant provisions of DTAA on the subject. For
this the Court considered the basic scheme of taxation under sections 4 and 5.
The Court also considered the scope of taxation for non-resident under the Act
and noted that the income tax on non-resident is source based, i.e., source of
such income is India and, therefore, even a non-resident is liable to pay tax
on incomes earned in India. ‘Resident in India’ and ‘Not-ordinarily Resident in
India’ are covered by the provisions contained in section 6.

The Supreme Court further
noted that in the present case, it was concerned with the consideration
received by FOWC as a result of Agreement signed with Jaypee Sports. FOWC,
being a UK Company, was admittedly the non-resident in India. Since the
question was whether the aforesaid consideration/income earned by FOWC was
subject to tax in India or not, it had to be decided as to whether that income
accrued or arose in India. Section 9 contains varied situations where income is
deemed to accrue or arise in India.

The Supreme Court observed
that it was clear from the reading of Clause (i) of sub-section (1) of section
9 of the Act that it includes all those incomes, whether directly or
indirectly, which are accruing or arising through or from any business
connection in India is deemed to accrue in India. Therefore, an income which is
earned directly or indirectly, i.e. even indirectly, is to be deemed to accrue
or earned in India. Further, such an income should have some business
connection in India. Clause (a) of Explanation (1) stipulates that where all
the business operations are not carried in India and only some such operations
of business are carried in India, the income of the business deemed under this
clause to accrue or arise in India shall be only such part of the income as is
reasonably attributable to the operations carried in India. Explanation (2)
makes certain further provisions in respect of ‘business connection’. The
meaning of the expression ‘through’ is again clarified in Explanation (4).

If a non-resident has a PE in India, then
business connection in India stands established. Section 92F of the Act
contains definitions of certain terms, though those definitions have relevance
for the purposes of computation of arms length price, etc. Clause (3) thereof
defines ‘enterprise’ and such an enterprise includes a PE of a person. PE is
defined in Clause (iiia) in the following manner:

 (iiia)
“permanent establishment”, referred to in Clause (iii), includes a
fixed place of business through which the business of the enterprise is wholly
or partly carried on;

The Supreme Court also
noted Article 5 of DTAA between India and United Kingdom which lays down as to
what would constitute a PE. As per sub-article (1) of Article 5, a fixed place
of business through which the business of an enterprise is wholly or partly
carried on, is known as ‘permanent establishment’. It requires that there has
to be a fixed place of business. It also requires that from such a place
business of an enterprise (FOWC in the instant case) is carried on, whether
wholly or partly. Sub-Article (2) gives the illustrations of certain places
which will be treated as PEs. Sub-Article (3) excludes certain kinds of places
from the term PE. Sub-Article (4) enumerates the circumstances under which a
person is to be treated as acting on behalf of non-resident enterprise and
shall be deemed to have a PE under sub-article (4) of the enterprise.
Sub-Article (5) excludes certain kinds of agents of enterprise, namely, broker,
general commission agent or agent of an independent status, by clarifying that
if the business is carried on through these persons, the enterprise shall not
be deemed to be a PE. However, one exception thereto is carved out, namely, if
the activities of such an agent are carried out wholly or almost wholly for the
enterprise, or for the enterprise and other enterprises which are controlled by
it or have a controlling interest in it or are subject to same common control,
then, such an agent will not be treated as an agent of an independent status.
It means that if the business is carried out with such a kind of agent, the
enterprise will be deemed to have a PE in India.

The Supreme Court further
stated that as per Article 5 of the DTAA, the PE has to be a fixed place of
business ‘through’ which business of an enterprise is wholly or partly carried
on. Some examples of fixed place are given in Article 5(2), by way of an
inclusion. Article 5(3), on the other hand, excludes certain places which would
not be treated as PE, i.e. what is mentioned in Clauses (a) to (f) is the
‘negative list’. A combined reading of sub-articles (1), (2) and (3) of Article
5 would clearly show that only certain forms of establishment are excluded as
mentioned in Article 5(3), which would not be PEs. Otherwise, sub-article (2)
uses the word ‘include’ which means that not only the places specified therein
are to be treated as PEs, the list of such PEs is not exhaustive. In order to
bring any other establishment which is not specifically mentioned, the
requirements laid down in sub-article (1) are to be satisfied. Twin conditions
which need to be satisfied are: (i) existence of a fixed place of business; and
(b) through that place business of an enterprise is wholly or partly carried
out.

The Supreme Court was of
the firm opinion that it could not be denied that Buddh Circuit is a fixed
place. From this circuit different races, including the Grand Prix is
conducted, which is undoubtedly an economic/business activity. The core
question was as to whether this was put at the disposal of FOWC? Whether this
was a fixed place of business of FOWC was the next question. For this, the
Court first discussed on a crucial parameter, viz., the manner in which
commercial rights which are held by FOWC and its affiliates, have been
exploited in the instance case. In this context, according to the Court, the
entire arrangement between the FOWC and its affiliates on the one hand and
Jaypee on the other hand is to be kept in mind. Various agreements cannot be
looked into by isolating them from each other. Their wholesome reading would
bring out the real transaction between the parties. Such an approach is
essentially required to find out as to who is having the real and dominant
control over the event to determine as to whether Buddh Circuit was at the
disposal of FOWC and whether it carried out any business therefrom or not.
There is a inalienable relevance of witnessing the wholesome arrangement in
order to have a complete picture of the relationship between FOWC and Jaypee.
That would reveal the real essence of the FOWC’s role. Effectively, according
to the Court, in a case like this, what is to be seen is the substance of the
arrangement and not merely the form.

The Apex Court then
observed that a mere running of the eye over the flowchart of these commercial
rights, produced by the Revenue, bring about the following material factors
evidently discernible:

”(i) 
FIA had assigned commercial rights in favour of FOAM vide agreement
dated April 24, 2001 and on the same day another agreement was signed between
FOAM and FOWC vide which these rights were transferred to FOWC. Vide another
agreement of 2011, these rights stand transferred in favour of FOWC for a
period of 100 years. Vide Concorde Agreement of 2009, FOWC is authorised to
exploit the commercial rights directly or through its affiliates only.
Significantly, this agreement defines “F-1 Business” to mean exploitation of
various rights, including media rights, hospitality rights, title sponsorship, etc.

(ii)  Armed
with the aforesaid rights, FOWC signed first agreement with Jaypee on October
25, 2007 whereby it granted right to promote the event to Jaypee. This is
replaced by race promotion contract dated September, 13, 2011. Under this
agreement, right to host, stage and promote the event are given by FOWC to
Jaypee for a consideration of US $ 40 million. On the same day, another
agreement is signed between Jaypee and three affiliates of FOWC whereby Jaypee
gives back circuit rights, mainly media and title sponsorship, to Beta Prema 2
and paddock rights to Allsports. FOAM is engaged to generate TV Feed. All the
revenues from the aforesaid activities are to go to the said companies, namely,
Beta Prema2, Allsports and FOAM respectively. 
These three companies are admittedly affiliates to FOWC.

Though Beta Prema 2 is
given media rights, etc., on September 13, 2011, it had entered in to
title sponsorship agreement dated August 16, 2011 with Bharti Airtel(i.e., more
than a month before getting these rights from Jaypee) whereby it transferred
those rights to Bharti Airtel for a consideration of US$ 8 million.

Service agreement is signed
between FOWC and FOAM on October, 28, 2011 (i.e., on the date of the race)
whereby FOAM engaged FOWC to provide various services like licensing and
supervision of other parties at the event, travel and transport and data
support services. The aforesaid arrangement clearly demonstrates that the
entire event is taken over and controlled by FOWC and its affiliates. There
cannot be any race without participating/competing teams, a circuit and a
paddock. All these are controlled by FOWC and its affiliates. Event has taken
place by conduct of race physically in India. Entire income is generated from
the conduct of this event in India. Thus, commercial rights are with FOWC which
are exploited with actual conduct of race in India.

(iii) Even
the physical control of the circuit was with FOWC and its affiliates from the
inception, i.e. inclusion of event in a circuit till the conclusion of the
event. Omnipresence of FOWC and its stamp over the event is loud, clear and
firm. Mr. Rohatgi is right in his submission that the undisputed facts were
that race was physically conducted in India and from this race income was
generated in India. Therefore, a commonsense and plain thinking of the entire
situation would lead to the conclusion that FOWC had made their earning in
India through the said track over which they had complete control during the
period of race. The appellants are trying to trivialise the issue by harping on
the fact that duration of the event was three days and, therefore, control, if
at all, would be for that period only. His reply was that the duration of the
agreement was five years, which was extendable to another five years. The
question of the permanent establishment has to be examined, keeping in mind
that the aforesaid  race was to be
conducted only for three days in a year and for the entire period of race the
control was with FOWC.

(iv) Even
when we examine the matter by examining the race promotion contract agreement
itself, it points towards the same conclusion. The High Court in its judgement
has reproduced relevant clauses of the agreement which we have already
reproduced above. “

The RPC is analysed by the
High Court which brings out the real position and after referring to High
Court’s analysis of various clauses of RPC, the Court stated that it is an
agreement with the same which correctly captures the substance of the relevant
clauses of the RPC. From this, it appears that this seems to be in line with
the above referred material factors brought out by the Court from the flowchart
of commercial rights, produced by the Revenue.

The Supreme Court, after
considering various agreements and nature of business activity involved in this
case, also held that the High Court had rightly concluded that having regard to
the duration of the event, which was for limited days, and for the entire
duration FOWC had full access through its personnel, number of days for which
the access was there would not make any difference. In this context, after
referring to the discussion of the High Court on this aspect, the Court noted
that a stand at a trade fair, occupied regularly for three weeks a year,
through which an enterprise obtained contracts for a significant part of its
annual sales, was held to constitute a PE (Joseph Fowler vs. MNR (1990) 2
CTC 2351 (Tax Court of Canada). Likewise, a temporary restaurant operated
in a mirror tent at a Dutch flower show for a period of seven months was held
to constitute a PE (Antwerp Court of Appeal, 2001 WTD 106-11).

The Supreme Court also
noted the following two judgements referred to by High Court:

(i)  In Universal Furniture Ind. AB vs.
Government of Norway, a Swedish company sold furniture abroad that was
assembled in Sweden. It hired an individual tax resident of Norway to look
after its sales in Norway, including sales to a Swedish company, which used to
compensate him for use of a phone and other facilities. Later, the company
discontinued such payments and increased his salary. The Norwegian tax
authorities said that the Swedish company had its place of business in Norway.
The Norwegian court agreed, holding that the salesman’s house amounted to a
place of business: it was sufficient that the Swedish Company had a place at
its disposal, i.e. the Norwegian individual’s home, which could be regarded as
‘fixed’.

(ii)  In Joseph Fowler vs. Her Majesty
the Queen 1990 (2) CTC 2351, the issue was whether a United States tax
resident individual who used to visit and sell his wares in a camper trailer,
in fairs, for a number of years had a fixed place of business in Canada. The
fairs used to be once a year, approximately for three weeks each. The court
observed that the nature of the individual’s business was such that he held
sales in similar fares, for duration of two or three weeks, in two other
locales in the United States. The court held that conceptually, the place was
one of business, notwithstanding the short duration, because it amounted to a
place of management or a branch having regard to peculiarities of the business.

Coming to the second aspect
of the issue, namely, whether FOWC carried on any business and commercial
activity in India or not, the Supreme Court held that FOWC is the Commercial
Right Holder (CRH). These rights could be exploited with the conduct of F-1
Championship, which is organised in various countries. It was decided to have
this championship in India as well. In order to undertake conducting of such
races, the first requirement was to have a track for this purpose. Then, teams
would be needed who would participate in the competition. Another requirement
was to have the public/viewers who would be interested in witnessing such races
from the places built around the track. Again, for augmenting the earnings in
these events, there would be advertisements, media rights, etc. as well.
It was FOWC and its affiliates which have been responsible for all the
aforesaid activities. The Concorde Agreement is signed between FIA, FOA and
FOWC whereby not only FOWC became Commercial Rights Holder for 100 years, this
agreement further enabled participation of the teams who agreed for such
participation in the FIA Championship each year for every event and undertook
to participate in each event with two cars. FIA undertook to ensure that events
were held and FOWC, as CRH, undertook to enter into contracts with event
promoters and host such events. All possible commercial rights, including
advertisement, media rights, etc. and even right to sell paddock seats,
were assumed by FOWC and its associates. Thus, as a part of its business, FOWC
(as well as its affiliates) undertook the aforesaid commercial activities in
India.

According to the Supreme
Court, it was difficult to accept the arguments of the Appellants that it was
Jaypee who was responsible for conducting races and had complete control over
the event in question. Mere construction of the track by Jaypee at its expense
would be of no consequence. Its ownership or organising other events by Jaypee
was also immaterial. The examination in the present case was limited to the
conduct of the F-1 Championship and control over the track during that period.

The Supreme Court observed
that, no doubt, FOWC, as CRH of these events, was in the business of exploiting
these rights, including intellectual property rights. However, these became
possible, in the instant case, only with the actual conduct of these races and
active participation of FOWC in the said races, with access and control over
the circuit.

According to the Supreme
Court, the test laid down by the Andhra Pradesh High Court in Visakhapatnam
Port Trust case (1993) 144 ITR 146 (AP) was fully satisfied. Not only the Buddh
Circuit was a fixed place where the commercial/economic activity of conducting
F-1 Championship was carried out, one could clearly discern that it was a
virtual projection of the foreign enterprise, namely, Formula-1 (i.e. FOWC) on
the soil of this country. As per Philip Baker, a PE must have three
characteristics: stability, productivity and dependence. All characteristics
were present in this case. Fixed place of business in the form of physical
location, i.e. Buddh Circuit, was at the disposal of FOWC through which it
conducted business. The taxable event had taken place in India and non-resident
FOWC was liable to pay tax in India on the income it has earned on this soil.

The Supreme Court also
dealt with incidental issues raised by the assessees during the hearing. First
was on the interpretation of section 195 of the Act. It could not be disputed
that a person who makes the payment to a non-resident is under an obligation to
deduct tax u/s.195 of the Act on such payments. The Supreme Court held that the
High Court rightly relying on the judgement in the case of GE India Technology
Centre Private Limited (2010) 327 ITR 456 (SC), held that payments made by
Jaypee to FOWC under the RPC were business income of the FOWC through PE at the
Buddh Circuit, and, therefore, chargeable to tax and Jaypee was bound to make
appropriate deductions from the amounts paid u/s.195 of the Act.

The Supreme Court, however,
accepted the submission of assessee that only that portion of the income of
FOWC, which was attributable to the said PE, would be treated as business
income of FOWC and only from that part of income deduction was required to be
made u/s.195 of the Act. The Supreme Court observed that in GE India Technology
Centre Private Limited, it has been clarified that though there is an
obligation to deduct tax, the obligation is limited to the appropriate portion
of income which is chargeable to tax in India and in respect of other payments
where no tax is payable, recourse is to be made u/s. 195(2) of the Act. It
would be for the Assessing Officer to adjudicate upon the aforesaid aspects
while passing the Assessment Order, namely, how much business income of FOWC
was attributable to PE in India, which was chargeable to tax. At that stage,
Jaypee could also press its argument that penalty etc. be not charged as the
move on the part of Jaypee in not deducting tax at source was bona fide. The
Supreme Court however, made it clear that it had not expressed any opinion on
this either way.

The Court also clarified
that so far as appeal filed by the Revenue is concerned, it was submitted by
the learned counsel appearing for the Revenue that the issue of dependent agent
PE had now become academic. This was in view of the fact that the Court had
already held that the FOWC had a fixed place PE through which it was carrying
on business in India. As such, the Court did not examine that issue and
disposed of the appeal of the Revenue accordingly.

Notes:

i)   
In the above case, the Apex Court has accepted the basic principle that
determination of existence of a PE of an enterprise should be based on actual
facts of the relevant case. The above judgements are primarily based on complex
arrangements and factual matrix of the case from which the Court ascertained
the real position relevant for determination of PE etc. [and rendered
its judgement running into more than 50 printed pages of ITR] which has been
briefly digested. In the process, the Court has made various observations
confirming certain internationally accepted principles and tests (such as test
of fixed place of business, disposal test, duration test, virtual projection of
foreign enterprise test, etc.) relating to determination of fixed place
PE under Article 5 of the relevant DTAA. These principles and tests have been
applied to the real facts emerging in this case to come to the conclusion that
the FOWC has PE in India through which it was carrying on business in India.
Effectively, the Court has gone by the substance of the arrangement rather than
merely its form. The Court, in the process, has also referred to relevant
commentaries on this Article given by OECD as well as by learned authors Philip
Baker and Klaus Vogel and also referred to various judicial precedents
including the celebrated judgements of the Apex Court in the cases of Azadi
Bachao Andolan [(2003) 263 ITR 706], Transmission Corporation [(1999) 239 ITR
587] and GE Technology Center [(2010) 327 ITR 456]. All these three judgments
were analysed by us in the column ‘Closements’ (in the months of December,
2003/ January, 2004, October, 1999 and December, 2010 respectively) of this
journal.

ii)    The
assessees should become wiser from the approach of the Court in applying those
principles and tests to such complex arrangements and should be cautious in
arranging their factual affairs in such cases. This judgement should be mainly
viewed from this perspective and now, more so with the GAAR provisions becoming
effective from 01.04.2017. In future, in this respect, global developments in
the area of BEPS should also be borne in mind, more particularly, in this
context, Anti-abuse Rules for PEs situated in third Jurisdiction contained in
Article 10 of MLI [Multilateral Convention to Implement Tax Treaty Related
Measures to Prevent Base Erosion and Profit Sharing (BEPS)], which is expected
to become effective for certain Indian covered tax agreement [DTAAs] within
about the next two years.

iii)   In this column, generally, as a policy
(decided for various justifiable reasons in the past), the judgements reported
in ITRs are digested. Currently, for this column, we are considering 394/395
ITRs. Whenever it is felt that a particular judgement of the Apex Court lays
down some important relevant principles relating to tax matter, which is of a
general interest for larger readership of the journal, the same is picked up
(on a case to case basis) for analysis in greater detail in our another column
‘Closements’ (which now does not feature every month) even before it is so
reported, like the one relating to ‘deemed dividend’ analysed in that column in
this issue of the journal and Part II thereof will appear in the next issue.

iv)   Recently,
another judgement of the Apex Court has also been delivered in the case of
E-funds IT Solution Inc. [which is decided, based on its facts, in favour of
the assessee]. In this also, principles and tests for determination of
existence of PE, in the context of India-USA DTAA, have been considered. In
this, the above judgement has also been considered. The same will be digested
in this column in due course.

 8.  Closing
Stock-Valuation-With dissolution of the firm, if the business comes to an end,
the cost method of valuing closing stock is not permissible and has to be
valued at the market rate but where the dissolution is by operation of law and
the business does not come to an end, it is not necessary to value the stock in
trade at market prices and could be valued at cost method of valuation.

Revision-Erroneous
and prejudicial to revenue- If the view taken by the Assessing Officer is
plausible view, the CIT cannot exercise his power u/s. 263.

Commissioner
of Income Tax-Gujarat-II vs. Kwality Steel Suppliers Complex (2017) 395 ITR 1
(SC)

The Respondent-Assessee was
a registered firm engaged in the business of sale of scrap of ship materials.
The firm was constituted with two partners, i.e., mother and son. During the
period under consideration, the firm was dissolved on 01.02.1993 on account of
the death of one of the partners. At the time of dissolution, the firm had
valued the closing stock at cost price.

The Respondent-Assessee
filed return of income showing total income of Rs. 16,41,760/- for assessment
year 1993-1994. The relevant previous year is financial year 1992-1993. On this
return, the assessment order was passed by the Assessing Officer on 24.02.1995
u/s. 143(3) of the Act accepting the method of valuation adopted by the
Respondent-Assessee.

Subsequently, the
Commissioner of Income Tax (CIT) in exercise of his revisional jurisdiction
u/s. 263 of the Act issued show cause notice dated 27.02.1997 and directed the
Assessing Officer to value the closing stock at the time of dissolution at the
market price. He further observed in his order that the Assessing Officer had
erred while passing the assessment order for the year 1993-1994. According to
him, during the accounting year under consideration, the firm was dissolved,
and therefore, the closing stock was to be valued at market rate in view of the
decision of the Supreme Court in the case of A.L.A. Firm vs. Commissioner of
Income Tax [(1991) 189 ITR 285]. So, he added the average gross profit of
15 per cent to the disclosed value of the closing of Rs. 12 crore and the same
resulted in addition of Rs. 1.82 crore.

The Respondent-Assessee
questioned the validity of the order passed u/s. 263 of the Act taking the plea
that revisional jurisdiction could not be exercised in this manner. However,
the CIT by his order dated 20.03.1997 rejected the contention of the Assessee
and set aside the assessment order with a direction to the Assessing Officer to
pass fresh order in accordance with the direction given in the order passed by
CIT.

The  Assessee 
challenged  the said order dated
20.03.1997 by filing appeal before the Income Tax Appellate Tribunal (ITAT),
ITAT dismissed the appeal on 28.04.2000.

This order of ITAT was
challenged before the High Court in the form of statutory appeal u/s. 260A of
the Act. The High Court has accepted the contention of the Assessee and,
thereby, set aside the revisional order dated 20.03.1997 passed by CIT. For
this, the High Court referred to various judgments of the Apex Court dealing
with cases of dissolution of the firm including the judgement in the case of
Shakhti Trading Co. [(2001) 250 ITR 871] in which it was effectively held that
if post dissolution the business is continued, the closing stock could be
valued at cost.

The Revenue challenged the
order of the High Court before the Supreme Court.

According to the Supreme
Court, the moot question was as to whether the view taken by the Assessing
officer in accepting the valuation of the closing stock at cost price was a
plausible view in the circumstances of this case. If it was so, then CIT could
not have exercised his revisionary jurisdiction u/s. 263 of the Act.

The Supreme Court observed
that the judgement in ALA Firm’s case proceeded on the basis that with the
dissolution of the firm, the business of the firm comes to an end and in that
situation, the cost method of valuing the stock was not permissible.

The Supreme Court wondered
as to whether this situation would apply in the instant case where the
partnership firm stood dissolved by the operation of law in view of the death
of one of the partners, i.e., the mother, but the business did not come to an
end as the other partner, viz., son, who inherited the share of the mother,
continued with the business. According to the Supreme Court, in a situation
like this, there was no question of selling the assets of the firm including
stock-in-trade and, therefore, it was not necessary to value stock-in-trade at
market price.

The Supreme Court on
consideration of the judgement in Chainrup Sampatram vs. CIT (1953) 24 ITR
481 (SC) observed that the position which emerges from the said judgement
is that when a business continues, it may not be necessary to follow the market
rate to value the closing stock as the reasons, because of which the same is to
be done are not available.

According to the Supreme
Court when this position becomes clear, it follows that in the instant case the
view taken by the Assessing Officer in accepting the book value of the
stock-in-trade was a plausible and permissible view. In this scenario, the CIT
could not have exercised his powers u/s. 263 of the Act.

The Supreme Court dismissed
the appeal of the Revenue with costs.

Note:

The judgements of the Apex
Court in the cases of A.L.A Firm and Shakhti Trading Co. (in which the
judgement of the Apex Court in Chainrup Sampatram was also relied) have been analysed
by us in the column ‘Closements’ (in the months of July, 1991 and September,
2001 respectively) of this journal. It may also be noted that para 24 of ICDS
II (Valuation of Inventories) now specifically provides that in the event of
dissolution of a firm, the inventory on the date of dissolution shall be valued
at Net Realizable Value, notwithstanding the fact whether the business is
discontinued or not. It is also worth noting that recently, the Delhi High
Court in the case of the Chamber of Tax Consultants (vide order dated
11.11.2017) has struck down some of the provisions of certain ICDSs as ultra
vires the Act and this includes the said para 24 of ICDS II.

9.  Export markets development allowance –
Weighted deduction – Agreement stated that Mr. Jack Barouk had agreed to work
as an agent of the assessee on payment of the commission and RBI had approved
the same as ‘Selling Agency Agreement’ – Entitled to weighted deduction u/s.
35(1)(b)(iv)

Velvet
Carpet and Co. Ltd. vs. Commissioner of Income Tax (2017) 395 ITR 515 (SC)

In the return filed by the
Assessee for the assessment year 1983-84, it had stated that a sum of Rs.
4,60,433 was paid by the Assessee to one Mr. Jack Barouk of Brussels who was
appointed by the Assessee as its commercial agent in the said country for the
sale of the Assessee’s goods. Section 35B(1)(b)(iv), provides for weighted
deduction that is in addition to the actual amount spent, one-third thereof as
an additional expenditure in case the expenditure is incurred wholly and exclusively
on maintenance outside India of a branch, office or agent for the promotion of
the sale outside India of such goods, services or facilities.

The Appellant had filed
appeal against the order of the Assessing Officer refusing to give benefit of the
aforesaid provision, with the Commissioner of Income-tax (Appeals), which was
dismissed. However, in further appeal preferred before the Income-tax Appellate
Tribunal [ITAT], the Appellant succeeded. The ITAT, looking into the agreement
that was entered into between the Assessee and the aforesaid Mr. Jack Barouk,
found that the agreement was an agency agreement. The ITAT also took into
consideration another supporting fact that as per the legal requirement, the
said agreement was approved by the Reserve Bank of India and the Reserve Bank
of India in its approval had treated this agreement to be an agency agreement.

The High Court while
allowing the appeal of the Department and rejecting the claim of the Assessee,
observed that at no stage, the Assessee had put up a case that it had maintained
branch or agency outside the country.

The Supreme Court observed
that what was not in dispute was that the expenditure was in fact incurred. It
was also incurred wholly and exclusively outside India as the payment was made
to Mr. Jack Barouk a resident of Brussels. It was also not in dispute that this
payment was made against some sales of carpets belonging to the Assessee, made
by the said Mr. Jack Barouk. The only dispute was as to whether he could be
treated as “agent” of the Assessee.

The Supreme Court went
through the agreement that was entered into between the Assessee and Mr. Jack
Barouk. It was in the form of communication dated October 24, 1977 addressed by
Mr. Jack Barouk to the Assessee, stating therein the terms and conditions on
which two parties agreed to work together. In this communication, Mr. Jack
Barouk agreed to keep the goods of the Assessee in his godown, show the said
products to the visiting customers personally and secure orders from the territories
mentioned therein namely, Benelux and France.

This communication further
stated that he will be given 5 % 
commission on all goods shipped by the Assessee to the aforesaid
territories on the orders procured by the said Mr. Jack Barouk. The Assessee
had accepted and agreed on the aforesaid terms contained in the said
communication and there was a specific endorsement to this effect by the
Assessee that the said communication, on acceptance by the Assessee, became a
valid and enforceable agreement between the parties.

The aforesaid terms clearly
stated that Mr. Jack Barouk had agreed to work as an agent of the Assessee and
on the orders procured he was to get 5 % commission. The Supreme Court held
that this aspect that the agreement was in fact an agency agreement which stood
conclusively established by the registration given by the Reserve Bank of India
vide its letter dated October 29, 1977. Captioned communication of the Reserve
Bank of India reads as “Registration of Selling Agency Arrangement”.