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CBDT Challenges another AAR Ruling in SC
August, 20th 2007

The Income Tax Department has challenged another ruling  AIT-2007-78-AAR passed by the Authority for Advance Rulings (Income Tax) in Supreme Court by filing SLP on which notice has been issued by the Apex Court.

The Authority for Advance Ruling in its ruling had ruled that the receipt arising to the applicant from the proposed assignment of the Turbocharger Development and Supply Agreement dated 6.8.2004 in accordance with the assignment deeds would not be taxable in India having regard to the provisions of the Act.

The applicant was a company incorporated in Switzerland and was a tax resident of that country.  It is a part of the D Group of companies.  E Ltd. is a one of the D Group of companies.  It was incorporated in U.K. and it is a tax resident of U.K.  The said company was engaged in the business of manufacturing of turbochargers and providing engineering services.  XYZ Ltd issued a letter of intent (LOI) duly specifying the key terms and conditions for the supply of turbochargers in favour of E. Ltd. for the purchase of turbochargers for L litres diesel engines in September, 2003.  The D Group took up a restructuring exercise with the objective of centralizing key functions in Switzerland whereunder E. Ltd. transferred its business of manufacturing turbochargers on a going concern basis to the applicant w.e.f. 1st January, 2004.  Thereafter the applicant is engaged in the business of manufacture of turbochargers for passenger and commercial vehicles.  Under the arrangement the LOI issued by XYZ Ltd to E Ltd. for the purchase of turbochargers was transferred by it (E Ltd.) to the applicant as a successor.  The applicant entered into a turbocharger development and supply (TDS) agreement with XYZ Ltd for manufacturing and supply of turbochargers for vehicles manufactured by XYZ Ltd using L litres diesel engines.  The applicant proposes to establish an Indian subsidiary named J Pvt. Ltd. to be incorporated under the Indian Companies Act, which would be engaged in the business of supplying of turbochargers to customers including XYZ Ltd as per the TDS agreement. J Pvt. Ltd. would manufacture locally and supply turbochargers to XYZ Ltd.  For that purpose the applicant would assign its rights, interests and obligations in the TDS agreement to J Pvt. Ltd. on agreed consideration to be paid to the applicant in installments.  As part of the agreement the applicant proposes to provide a volume guarantee to J Pvt. Ltd. to the effect, should the volumes under the TDS agreement fail to materialize from XYZ Ltd. at the prices indicated thereunder, the applicant would source additional turbochargers from J Pvt.Ltd. to make good such deficiency. 

In this backdrop the applicant set forth the following questions to seek advance rulings of the Authority:-

1.     On the facts and in the circumstances of the case, whether the receipt arising to the Applicant, from the proposed assignment of the Turbocharger Development and Supply Agreements in accordance with the assignment deeds be taxable in India having regard to the provisions of the Income-tax Act, 1961 (the Act) and the Double Taxation Avoidance Agreement between India and Switzerland (the DTAA) ?

2.     If the answer to (1) above is in affirmative, then, to what extent and in which year/s would the receipt be taxable in India having regard to the provisions of the Act and the DTAA?

3.     If in the facts and circumstances of the case, the receipt is not taxable in India, then, whether the assignee of the Turbocharger Development and Supply Agreement is required to withhold any tax under section 195 of the Act while making remittance to the Applicant?

The rival contentions of the parties gave rise to the following points for determination:-

(i)    Whether amounts payable under the assignment agreement, either in the nature of business receipts or royalty, are taxable under the Act.
(ii)   If the answer of the first point is that they are taxable as business receipts, whether the applicant has a PE in India?
(iii)  Whether the amounts payable under the TDS Agreement attract section 195 of the Act?
(i)    To comprehend the real nature of payments to be made by the J Pvt. Ltd. to the applicant under the assignment agreement, it is necessary to read both the TDS agreement dated 6.8.2004 (Exhibit-2) as well as draft assignment agreement (Exhibit-4) because the subject matter of Exhibit-4 is the same as the subject matter of Exhibit-2.  Exhibit-2 is between the XYZ Ltd and the applicant. 

Authority Ruled as Under:

The usual formal clause expressing the offer and acceptance is contained in para (E) and which runs thus:-

The Assignor is desirous of assigning its rights and obligations under the TDS Agreement in favour of the Assignee and the Assignee is desirous of acquiring all the rights and obligations of the Assignor under the TDS Agreement on and subject to the terms and conditions hereinafter appearing. 

The essential features of business connection may be summed up as follows:-

(a)   a real and intimate relation must exist between the trading activities carried on outside India by a non-resident and the activities within India;
(b)   such relation, shall contribute, directly or indirectly, to the earning of income by the non-resident in his business;
(c)   a course of dealing or continuity of relationship and not a mere isolated or stray nexus between the business of the non-resident outside India and the activity in India, would furnish a strong indication of business connection in India.

It may be pointed out that the requirements of business connection for the purpose of Section 9(1)(i) of the Act have to be examined with reference to the income in question.  There must be nexus between the income in question and the business connection, which is responsible for accruing or arising of the deemed income.  General business operations, which have no nexus to the income under consideration, would not satisfy the requirements of section 9(1)(i) of the Act.  From that point of view factor (i), noted above, is wholly irrelevant.  Factors (ii) to (iv) are the obligations arising under TDS agreement (exhibit-2) and we are not concerned here with the income that might have accrued or arisen to the applicant on working out the rights and obligations thereunder.  Even assuming that what all is stated in the above para establishes business connection it could only be for the purpose of TDS agreement and has no relevance to the income accruing or arising under the assignment agreement to J Pvt. Ltd.  Therefore, these factors would not, in our view, establish any business connection of the applicant within the meaning of section 9(1)(i) of the Act for the purpose of assignment agreement.

In our view to determine the business activities of a limited company it is not necessary to wait and watch the commencement of actual business activities.  They can be ascertained from the articles of association and the attending circumstances.  On the facts stated by the applicant, on the basis of the articles of association of J Pvt. Ltd. and the deed of assignment it is not possible to conclude that J Pvt. Ltd. is carrying out business for and on behalf of the applicant.  Indeed what appears to us is that it would be carrying on business in its own rights and that it has also acquired business under the deed of assignment.  It cannot be lost sight of that in view of section 245S of the Act, the advance ruling pronounced by the Authority shall be binding in respect of the transaction in relation to which the ruling has been sought and if there is really a change in law or facts on the basis of which the ruling has been pronounced, the ruling will lose the efficacy of its binding nature on the revenue.  On the facts stated above and from the discussion of the above contentions, it is clear that neither the requirements of business connection culled out from the decision of the courts nor the ingredients of the expression within the meaning of explanation-2, are satisfied.

The real question centres round the situs of the assignment.  We have noted above the specific averment in the application that the deed of the assignment would be executed in Switzerland and the consideration for the assignment would be payable in F Bank

A plain reading of TDS agreement shows that a particular volume of the products was to be supplied by the applicant to XYZ Ltd.  It is that volume of products which is a subject matter of assignment.  Parties have provided the eventuality in the case of increase in the supply of volume of products as well as decrease in the volume of products.  In neither case it can be accepted that the business connection is established.  The rights and obligations under the agreement cannot be taken as proof of existence of business connection.  The business connection must exist between a non-resident and an Indian resident, who is responsible for giving rise to the activities which yield income or profit to the non-resident.  No such connection is shown to exist here.

In applicant was a non-resident company incorporated in Japan.  The applicant formed a consortium, which was awarded by Petronet a turnkey project for setting up a liquefied natural gas (LNG) receiving, storage and regasification facility in Gujarat.  Among other things supplying of materials and equipment was the responsibility of the applicant.  The price of offshore supply and offshore services was paid in US dollars and for onshore supply of services, construction and erection partly in US dollars and partly in Indian rupees.  The consideration for offshore supply of equipment and materials supplied from outside India was received by the applicant by credit to a bank account in Tokyo and the property in the goods passed to petronet on high seas outside India.  On these facts the Authority has ruled, inter alia, the consideration represents only the price of the goods and the transaction of sale is completed outside India and not by or through a business connection in India, so on the sale of goods profits cannot be deemed to accrue or arise in India.

It follows that the applicant has no business connection in India, therefore, Section 9(1)(i) of the Act is not attracted.  In as much as the preconditions of deemed income under section 9(1)(i) read with explanation-2 of the Act are not satisfied, it is superfluous to refer to articles-7 and 5 of the treaty because it is well settled that if no obligation exists under the Act the treaty does not create any additional charge for taxation of the income in question.  In a case of an enterprise of a contracting state with which India has treaty, the provisions of the treaty will determine the rights and obligations provided the enterprise is entitled to invoke the provisions of the treaty and the provisions of the Act will apply to non-resident only when they are more beneficial to it than the terms of the treaty.  For this reason no Discussion is warranted as to whether the applicant has a permanent establishment in India and whether a corporate body can be a permanent establishment of an enterprise of a non resident.

It was ruled by the Authority on questions as under:

(1)   That on the facts and in the circumstances of the case, the receipt arising to the applicant from the proposed assignment of the Turbocharger Development and Supply Agreement dated 6.8.2004 in accordance with the assignment deeds would not be taxable in India having regard to the provisions of the Act.  In view of this position, it is unnecessary to examine the position under the Treaty between India and Switzerland.
(2)   That in view of our ruling on question no.(1), this question does not survive, as it is consequential to question no. (1)
(3)   On the facts and in the circumstances of the case and in view of ruling on question no. (1) the assignee of the TDS agreement is not required to withhold any tax u/s 195 of the Act while making remittance to the applicant.

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