Facts

In 2006, The Oil and Natural Gas Company (ONGC) awarded a turnkey contract    to a consortium comprising of Larsen & Toubro Limited (L&T) and Samsung Heavy Industries Co. Ltd (Samsung), a company incorporated in South Korea, for carrying out complete work for Vasai East Development Project (VEDP). Samsung, the assessee, then set up a project office in Mumbai for coordinationand execution of work for the turnkey project via a Board Resolution. Subsequently,    in AY 2007-08, Samsung filed a NIL return in accordance with India-South Korea DTAA. Disagreeing with the return, the Income Tax Department issued a show cause notice to the assessee, post which a draft assessment order that was passed which went into the terms of the agreement in great detail, and concluded that    the Project in question was a single indivisible “turnkey” project, whereby ONGC was to take over a project that was completed only in India. Resultantly, profits arising from the successful commissioning of the Project would also arise only       in India. The AO held that the work relating to fabrication and procurement of material was very much a  part of  the contract for execution of  work assigned  by  ONGC. The work was wholly executed by  a  Permanent Establishment (PE)  in India and it would be absurd to suggest that PE in India was not associated    with the designing or fabrication of materials. The Assessing officer went on to attribute 25% of the revenues allegedly earned outside India as being the income   of the assessee eligible to tax.

The application to Dispute Resolution Panel (DRP) was dismissed as the DRP concurred with the AO and held that the nature of activities undertaken by Samsung in India showed that it had a PE in India.

The matter then moved to ITAT where after referring to Samsung’s Board resolution and its application to RBI for opening the Project office, the ITAT concluded that the Project office was Samsung’s fixed place PE in India, to

 

 

carry out the contract wholly or partly, as under article 5(1), DTAA.  Assessee  had argued before the ITAT that the project office was not involved in any core business activity and that the Project office was just an auxiliary office. Books        of Accounts that were maintained by the Samsung which did not show any expenditure related to the ONGC turnkey project were also produced before the ITAT. The ITAT rejecting these arguments observed that the terms in the contract, and the way in which the work was executed,  showed that the project office had    a vital role to be played in the execution of the entire contract by acting has a channel between ONGC and Samsung Heavy Industries Co. Ltd Korea. The ITAT also held that onus was on the Assessee to prove that the activities undertaken     by its Indian PE are auxiliary or preparatory in nature. Since the onus was not discharged, the Project office fell under article 5(4), of the Tax Treaty. ITAT further held that the mode of maintaining accounts alone cannot determine the character of the PE.

The assessee then challenged the ITAT  order before the High Court which ruled    in the favour of  the  assessee. The  High court noted that there was  no  finding on record that the  revenue had been earned or  said to  have been on  account  of India activity of the Project office. It also observed that the DTAA did not permit the Tax Authorities to arbitrarily fix a part of  the  revenue to  the  PE  of the assessee in India. Lastly, the High court also noted that neither the AO nor     the ITAT established or had made any effort to bring on record any evidence to justify that the business was actually carried out by the project office and that       25 percent of the gross revenue is attributable to such Project office. The revenue then challenged the decision of the High Court before the Supreme Court.

 

Issue

The issue before the Supreme court was with regard to taxability of income attributable to a “permanent establishment” set up in a fixed place in India, arising from the India-Korea DTAA.

 

Views

In DIT (International Taxation), Mumbai v. M/s Morgan Stanley & Co. Inc., [2007] 7 SCC 1, went on to hold that activities performed by  stewards who were deployed by the American Company to work in India as employees of the Indian company were so employed merely to protect the American companies’ interests in a competitive world, by ensuring quality and confidentiality of services performed in India. It was therefore found that so far as stewardship was concerned, this activity would fall within Article 5(2)(l) of the US-India treaty, and therefore would be outside the term “permanent establishment” as defined. On the deputation of certain employees of the American Company to work as employees  of the Indian Company, it was found, however, that the American Company was rendering services through its employees to the Indian Company, as a result of which a “service” permanentestablishment would stand established on this count.

 

 

In ADIT v. E-Funds IT Solution Inc. [2018] 13 SCC 294, the Court while dealing with ‘support services’ rendered by an Indian Company to American Companies, held that the outsourcing of such services to India would not amount to a fixed place permanent establishment under Article 5 of the aforesaid treaty.

 

Held

Supreme Court held that when it comes to “fixed place” permanent establishments under double taxation avoidance treaties, the condition precedent for applicability of Article 5(1) of the double taxation treaty and the ascertainment of a “permanent establishment” is that it should be an establishment “through which the business  of an enterprise” is wholly or partly carried on. Further, the profits of the foreign enterprise are taxable only where the said enterprise carries on its core business through a permanent establishment. What is equally clear is that the maintenance of a fixed place of business which is of a preparatory or auxiliary character in the trade or business of the enterprise would not be considered to be a permanent establishment under Article 5. Also, it is only so much of the profits of the enterprise that may be taxed in the other State as is attributable to that permanent establishment.

The Supreme Court upheld the High Courts’ decision and ruled that the project office of Samsung Korea  did not constitute a PE in India in terms of Article 5 of   the Tax Treaty given the nature of the activities carried out by such Project Office.

To  determine the nature of activities and auxiliary nature of the Project office,   the Supreme court delved deeper into the documents relied upon by ITAT and looked at various other factors which the ITAT  had either ignored or dismissed.     It observed that the Board Resolution submitted to RBI for registration of the Project office showed that it was established to co-ordinate and execute “delivery  of documents in connection with construction of offshore platform modification    of existing facilities for ONGC”. The Court held that ITAT  wrongly jumped to  the conclusion that the Mumbai office was for coordination and execution of the project itself and the finding, therefore, that the Mumbai office was not a mere liaison office, but was involved in the core activity of execution of the project itself is therefore clearly perverse. Further when the Assessee pointed out  that the accounts of the Mumbai office showed that no expenditure relating to the execution of the contract was incurred, the ITAT  rejected the argument, stating  that as accounts are in the hands of the Assessee, the mere mode of maintaining accounts alone cannot determine the character of permanent establishment. This  as per the Court was another perverse finding.

The Court relied on the fact that the accounts of the Project office showed no expenditure incurred in relation to execution of the contract, and that the only   two people employed in the Project office were not qualified to carry out any core activity of the Assessee. The Court thus dismissed the department appeal.   (AY. 2007-08) (CA No. 12183 of 2016 dt. 24-07-2020).

 

Editorial: This Supreme Court decision has spelled a wave of relief  for  the Tax  payers (especially MNC’s) and iterates an important principle that instead   of general perceptions and sweeping assumptions (that a project office would generally execute a project), a deep, factual enquiry into the determination of existence of the PE is required and tax liability to be imposed based on actual activities carried out by a taxpayer. Also, the supreme court has clearly underlined the fact that the initial burden lies on the Indian Revenue, and not the assessee,     to prove that there is a PE of the foreign enterprise in India, before moving further    to determine the Indian tax liability of that enterprise.

Samsung Heavy Industries Co. Ltd. v. DIT (IT) & Anr. (2014) 221 Taxman 315/265 CTR 109/98 DTR 89 (Uttarakhand)(HC), affirmed

Reference can also be drawn to the following judgements; Ishikawajma-Harima Heavy Industries Ltd. [2007] 288 ITR 408 (SC), LG Cable Ltd. (2011) 237 CTR

438 (Delhi) HC)

 

 

 

“Look at the sparrows; they do not know what they will do in the next moment. Let us literally live from moment to moment.”

– Mahatma Gandhi