GVK Industries Ltd. & Anr. vs. The Income Tax Officer & Anr. Civil Appeal No. 7796 of 1997 dated February 18, 2015
The appellant, a company, was incorporated under the Companies Act, 1956 for the purpose of setting up a 235 MW Gas based power project at Jegurupadu, Rajahmundry, Andhra Pradesh at an estimated cost of Rs. 839 crore. The main object of the appellant company is to generate and sell electricity.
With the intention to utilie the expert services of qualified and experienced professionals who could prepare a scheme for raising the required finance and tie up the required loan, it sought the services of a consultant and eventually entered into an agreement with ABB – Projects & Trade Finance International Ltd., Zurich, Switzerland, (hereinafter referred to as “Non-Resident Company/NRC”).
The NRC, having regard to the requirements of the appellant-company offered its services as financial advisor to its project from 8th July, 1993. Those services included, inter alia, financial structure and security package to be offered to the lender, making an assessment of export credit agencies world-wide and obtaining commercial bank support on the most competitive terms, assisting the appellant in loan negotiations and documentation with lenders and structuring, negotiating and closing the financing for the project in a coordinated and expeditious manner. For its services the NRC was to be paid, what is termed as, “success fee” at the rate of 0.75% of the total debt financing. The said proposal was placed before the Board meeting of the company on 21st August, 1993 and the Board of Directors approved the appointment of the NRC and advised that it be involved in the proposed public issue of share by the company. The NRC rendered professional services from Zurich by correspondence as to how to execute the documents for sanction of loan by the financial institutions within and outside the country. With advice of NRC the appellant-company approached the Indian Financial Institutions with the Industrial Development Bank of India (IDBI) acting as the Lead Financier for its Rupee loan requirement and for a part of its foreign currency loan requirement it approached International Finance Corporation (IFC), Washington DC, USA. After successful rendering of services the NRC sent invoice to the appellant-company for payment of success fee amount i.e., $.17,15,476.16 (Rs. 5.4 Crore).
After the receipt of the said invoice the appellant-company approached the concerned income tax officer, the first respondent herein, for issuing a ‘No Objection Certificate’ to remit the said sum duly pointing out that the NRC had no place of business in India; that all the services rendered by it were from outside India; and that no part of success fee could be said to arise or accrue or deemed to arise or accrue in India attracting the liability under the Income-tax Act, 1961 (for brevity, ‘the Act’) by the NRC. It was also stated as the NRC had no business connection section 9(1)(i) is not attracted and further as NRC had rendered no technical services section 9(1)(vii) is also no attracted. The first respondent scanning the application filed by the company refused to issue ‘No Objection Certificate’ by his order dated 27th September, 1994.
Being dissatisfied with the said order passed by the first respondent the appellant-company preferred a revision petition before the Commissioner of Income-tax, Hyderabad, u/s. 264 of the Act. On 21st March, 1995 the Commissioner permitted the appellant-company to remit the said sum to the NRC by furnishing a bank guarantee for the amount of tax. The company took steps to comply with the said order but afterwards on 25th October,1995 the revisional authority revoked the earlier order and directed the company to deduct tax and pay the same to the credit of the Central Government as a condition precedent for issuance of the ‘No Objection Certificate’. Thus, the order passed by the first respondent was affirmed and resultantly the revision petition was dismissed.
The non-success in revision compelled the company to approach the High Court for issue of writ of certiorari for quashing of the orders passed by the Income-tax officer and that of by the revisional authority.
The High Court framed the following two issues for consideration:
“(1) Whether ‘success fee’ payable by the petitionercompany to the NRC or any portion thereof is chargeable under the provisions the Act; and
(2) Whether the petitioner-company is entitled to ‘No Objection Certificate’.”
The High Court referring to the contents of the correspondence, the nature and extent of services which the NRC had undertaken under the agreement, the resolution passed by the Board of Directors which had perused the letter dated 8th July, 1993 addressed by the NRC stipulating the scope of services to be undertaken by NRC; the decisions of the Board to pay a fee to NRC and came to hold thus:
“On a careful reading of the letter of proposal of the NRC and the extract of resolution of the Board of Directors of the petitioner-company, it is clear to us that it was no part of the services to be provided by the NRC to manage public issue in India to correspond with various agencies to secure loan for the petitionercompany, to negotiate the terms on which loan should be obtained or to draft document for it. The NRC has only to develop a comprehensive financial model, tie up the rupee/foreign currency loan requirements of the project, assess export credit agencies worldwide and obtain commercial bank support, assist the petitionercompany in loan negotiations and documentation with the lender. It appears to us that the service to be rendered by the NRC is analogous to draw up a plan for the petitioner-company to reach the required destination indicating roads and highways, the curves and the turns; it does not contemplate taking the petitioner-company to the destination by the NRC. Once the NRC has prepared the scheme and given necessary advice and assistance to the petitionercompany for obtaining loan, the responsibility of the NRC is over. It is for the petitioner-company to proceed on the suggested lines and obtain loan from Indian or foreign agencies. On the petitionercompany obtaining loan, the NRC becomes entitled to ‘success fees’.”
The High Court scanned the letters with due consideration and opined that the business connection between the petitioner company and the NRC had not been established. Thereafter, the writ court adverted to the proposition whether success fee could fall within clause (vii) (b) of section 9(1) of the Act. Interpreting the said provision, the High Court opined that:
“Thus from a combined reading of clause (vii) (b) Explanation (2) it becomes clear that any consideration, whether lump sum or otherwise, paid by a person who is a resident in India to a non-resident for running any managerial or technical or consultancy service, would be the income by way of fees for technical service and would, therefore, be within the ambit of “income deemed to accrue or arise in India”. If this be the net of taxation under Section 9 (1) (vii) (b), then ‘success fee’, which is payable by the petitioner company to the NRC as fee for technical service would be chargeable to income tax thereunder. The Income-tax officer, in the impugned order, held that the services offered by the NRC fell within the ambit of both managerial and consultancy services. That order of Income-tax officer found favour by the Commissioner in revision. In the view we have expressed above, we are inclined to confirm the impugned order.”
A contention was advanced before the high Court by the assessee that the nrC did not render any technical or consultancy service to the company but only rendered advise in connection with payment of loan by it and hence, it would not amount to technical or consultancy service within the meaning of section 9(1)(vii)(b) of the act. While not accepting the said submission, the high Court observed that for the purposes of attracting the said provision, the business of the company cannot be divided into water-tight compartments like fire, generation of power, plant and machinery, management, etc. and to hold that managerial and technical and consultancy service relate to management, generation of power and plant and machinery, but not to finance. Elaborating further, the high Court observed that advice given to procure loan to strengthen finances may come within the compartment of technical or consultancy service and “success fee” would thereby come within the scope of technical service within the ambit of section 9(1)(vii)(b) of the act. Being of this view, the high Court opined the assessee was not entitled to the “No Objection Certificate”.
Being aggrieved, the appellant approached the Supreme Court. according to the Supreme Court, the crux of the matter was whether, in the obtaining factual matrix, the High Court was justified in concurring with the view expressed by the revisional authority that the assessee- company was not entitled to “No Objection Certificate” under the act as it was under the obligation to deduct the tax at source pertaining to payment to the nrC as the character of success fee was substantiated by the revenue to put in the ambit and sweep of section 9(1)(vii)
(b)of the act.
The Supreme Court observed that NRC was a non- resident Company and it did not have a place of business in india. The revenue has not advanced a case that the income had actually arisen or received by the NRC in india. The high Court has recorded the payment or receipt paid by the appellant to the NRC as success fee would not be taxable u/s. 9(1)(i) of the act as the transaction/ activity did not have any business connection. that being the position, the singular question that remained to be answered was whether the payment or receipt paid by the appellant to NRC as success fee would be deemed to be taxable in india u/s. 9(1)(vii) of the act. As the factual matrix would show, the appellant had not invoked double taxation avoidance agreement between india and Switzerland. that being not there, the Supreme Court was only concerned with as to whether the “success fee” as termed by the appellant was “fee for technical service” as enjoined u/s. 9(1)(vii) of the act.
According to the Supreme Court, the principal provision is Clause (b) of section 9(1)(vii) of the act. the said provision carves out an exception. the exception carved out in the latter part of clause (b) applies to a situation when fee is payable in respect of services utilised for business or profession carried out by an indian payer outside india or for the purpose of making or earning of income by the indian assessee i.e. the payer, for the purpose of making or earning any income from a source outside india.
The Supreme Court held that on a studied scrutiny of the said Clause, it becomes clear that it lays down the principle what is basically known as the “source rule”, that is, income of the recipient to be charged or chargeable in the country where the source of payment is located, to clarify, where the payer is located. the Clause further mandates and requires that the services should be utilised in india.
The two principles, namely, “Situs of residence” and “Situs of source of income” have witnessed divergence and difference in the field of international taxation. The principle “residence State taxation” gives primacy to the country of the residency of the assessee. This principle postulates taxation of world-wide income and world-wide capital in the country of residence of the natural or juridical person. The “Source State taxation” rule confers primacy to right to tax to a particular income or transaction to the State/nation where the source of the said income is located. The second rule, as is understood, is transaction specific. To elaborate, the source State seeks to tax the transaction or capital within its territory even when the income benefits belongs to a non residence person, that is, a person resident in another country. The aforesaid principle sometimes is given a different name, that is, the territorial principle. It is apt to state here that the residence based taxation is perceived as benefiting the developed or capital exporting countries whereas the source based taxation protects and is regarded as more beneficial to capital importing countries, that is, developing nations. Here comes the principle of nexus, for the nexus of the right to tax is in the source rule. It is founded on the right of a country to tax the income earned from a source located in the said State, irrespective of the country of the residence of the recipient. It is well settled that the source based taxation is accepted and applied in international taxation law.
The two principles that have been mentioned hereinabove, are also applied in domestic law in various countries. the source rule is in consonance with the nexus theory and does not fall foul of the said doctrine on the ground of extra-territorial operation. The doctrine of source rule has been explained as a country where the income or wealth is physically or economically produced.
Appreciating the aforesaid principle, it would apply where business activity is wholly or partly performed in a source State, as a logical corollary, the State concept would also justifiably include the country where the commercial need for the product originated, that is, for example, where the consultancy is utilised. From the aforesaid, it is quite vivid that the concept of income source is multifaceted and has the potentiality to take different forms. The said rule has been justified on the ground that profits of business enterprise are mainly the yield of an activity, for capital is profitable to the extent that it is actively utilised in a profitable manner. To this extent, neither the activity of business enterprise nor the capital made, depends on residence.
The purpose of adverting to these aspects is only to highlight that the source rule has been accepted in the un Commentaries and the organisation of economic Corporation and development (OECD) Commentaries. It is well known that what is prohibited by international taxation law is imposition of sovereign act of a State on a sovereign territory. This principle of formal territoriality applies in particular, to acts intended to enforce internal legal provisions abroad. Therefore, deduction of tax at source when made applicable, it has to be ensured that this principle is not violated.
The Supreme Court adverting to the instant case, held that, it was evident that fee which had been named as “success fee” by the appellant had been paid to the NRC. It had to be seen whether the payment made to the non- resident would be covered under the expression “fee for technical service” as contained in explanation (2) to section 9(1)(vii) of the act. The said expression means any consideration, whether lumpsum or periodical in rendering managerial, technical or consultancy services. It excludes consideration paid for any construction, assembling, mining or like projects undertaken by the non-resident that is the recipient or consideration which would be taxable in the hands of the non- recipient or non-resident under the head “salaries”. In the case at hand, the said exceptions were not attracted. What was required to be scrutinised was that the appellant had intended and desired to utilise expert services of qualified and experience professional who could prepare a scheme for raising requisite finances and tie-up loans for the power projects. As the company did not find any professional in India, it had approached the consultant NRC located in Switzerland, who offered their services. Their services rendered included, inter alia, financial structure and security package to be offered to the lender, study of various lending alternatives for the local and foreign borrowings, making assessment of expert credit agencies world-wide and obtaining commercial bank support on the most competitive terms, assisting the appellant company in loan negotiations and documentations with the lenders, structuring, negotiating and closing financing for the project in a coordinated and expeditious manner.
The Supreme Court held that from the letter dated 8.7.1993 addressed by the NRC and resolution passed by the Board on 21st august, 1993, it was clear as crystal that the obligation of the NRC was to:
“(i) Develop comprehensive financial model to tie-up the rupee and foreign currency loan requirements of the project.
(ii) assist expert credit agencies world-wide and obtain commercial bank support on the most competitive terms.
(iii) assist the appellant company in loan negotiations and documentation with the lenders.”
Pursuant to the aforesaid exercises carried out by the NRC, the company was successful in availing loan/financial assistance in India from the Industrial development Bank of india (IDBI) which acted as a lead financier for the rupee loan requirement. For foreign currency loan requirement, the appellant approached international finance Corporation, Washington D.C., USA and was successful. in this backdrop, “success fee” of Rs. 5.4 crore was paid to the NRC.
According to the Supreme Court, it was in this factual score, that the expression, managerial, technical or consultancy service, were to be appreciated. The said expressions have not been defined in the Act, and, therefore, it was obligatory on the part of the Supreme Court to examine how the said expressions are used and understood by the persons engaged in business. The general and common usage of the said words has to be understood at common parlance.
The Supreme Court held that in the case at hand, it was concerned with the expression “consultancy services” and in this regard, a reference to the decision by the authority for advance ruling In Re.P.No. 28 of 1999 (1999) 242 itr 280, would be applicable. The observations therein read as follows:
“By technical services, we mean in this context services requiring expertise in technology. By consultancy services, we mean in this context advisory services. The category of technical and consultancy services are to some extent overlapping because a consultancy service could also be technical service. However, the category of consultancy services also includes an advisory service, whether or not expertise in technology is required to perform it.”
In this context, according to the Supreme Court, a reference to the decision in C.I.T. vs. Bharti Cellular Limited and others (2009) 319 ITR 139, was also apposite. In the said case, while dealing with the concept of “consultancy services”, the high Court of delhi has observed thus:
“Similarly, the word “consultancy” has been defined in the said Dictionary as “the work or position of a consultant; a department of consultants.” “Consultant” itself has been defined, inter alia, as “a person who gives professional advice or services in a specialized field.” It is obvious that the word “consultant” is a derivative of the word “consult” which entails deliberations, consideration, conferring with someone, conferring about or upon a matter. Consult has also been defined in the said Dictionary as “ask advice for, seek counsel or a professional opinion from; refer to (a source of information); seek permission or approval from for a proposed action”. It is obvious that the service of consultancy also necessarily entails human intervention. The consultant, who provides the consultancy service, has to be a human being. A machine cannot be regarded as a consultant.”
The Supreme Court, in this context, referred to the dictionary meaning of ‘consultation’ in Black’s law dictionary, eighth edition. The word ‘consultation’ has been defined as an act of asking the advice or opinion of someone (such as a lawyer). It means a meeting in which a party consults or confers and eventually it results in human interaction that leads to rendering of advice.
The Supreme Court held that as the factual matrix in the case at hand, would exposit the nrC had acted as a consultant. It had the skill, acumen and knowledge in the specialised field i.e. preparation of a scheme for required finances and to tie-up required loans. The nature of service referred by the nrC, can be said with certainty would come within the ambit and sweep of the term ‘consultancy service’ and, therefore, it had been rightly held that the tax at source should have been deducted as the amount paid as fee could be taxable as ‘fees for technical service’. once the tax is payable the grant of ‘no Objection Certificate’ was not legally permissible. Ergo, the judgment and order passed by the high Court was absolutely impregnable.
The Supreme Court dismissed the appeal, being devoid of merit.
