Background
This decision ((2020) 7 SCC 347) of the Honourable Supreme Court deals with the question as to the taxability of income attributable to a “permanent establishment” set up in a fixed place in India under the India – Republic of Korea (“DTAA”).
On 28.02.2006, the Oil and Natural Gas Company (“ONGC”) awarded a “turnkey” contract to a consortium comprising of the Assessee and Larsen & Toubro Limited. The turnkey contract was for carrying out the “Work”, inter alia, of surveys, design, engineering, procurement, fabrication, installation and modification at existing facilities, and start-up and commissioning of entire facilities covered under the ‘Vasai East Development Project’ (“Project”).
As per Board Resolution dated 03.04.2006, the Assessee was to establish a project office for coordinating and executing delivery of documents in connection with construction of offshore platform modification of existing facilities for ONGC. On 24.05.2006, the Assessee set up a Project Office (“PO”) in Mumbai, India. The PO had 2 non-technical employees. The Financial statements of PO showed that no expenditure relating to the execution of the contract was incurred by PO.
Assessment Proceedings
For AY 2007-08, the Assessee filed a loss return. The Return was picked up for scrutiny. The Assessee contended that PO was to act as “a communication channel” between the Assessee and ONGC in respect of the Project and therefore qualify for ‘preparatory or auxiliary activity’ exemption. The AO held that Project in question is a single indivisible “turnkey” project and profits arising from the successful commissioning of the Project would also arise only in India. The AO attributed 25% of the revenues allegedly earned outside India as liable to tax in India. The DRP upheld the findings of the AO.
ITAT and HC Decision
The ITAT upheld the existence of PE but set aside the attribution of profits at 25% for the following reasons:
- The scope of Mumbai Project Office was neither restricted by the Assessee itself nor it was restricted by RBI in any terms.
- As per BOD Resolution, the PO has been opened for coordination and execution of Project.
- Under contract with ONGC, the Assessee had to obtain insurance for the entire project.
- The argument of auxiliary office and non-core functions was rejected by ITAT on the ground that maintenance of account is in the hands of Assessee and mere the mode of maintaining the accounts alone cannot determine the character of PE.
The ITAT however set aside the attribution of profits at 25% of offshore revenue on the ground of lack of material to ascertain the extent of business activities carried on by the PO. The matter was remanded back for fresh ascertainment of profits attributable to the PO.
The Uttarakhand High Court allowed the appeal of the Assessee on the ground that there was no finding that 25% of offshore revenue was attributable to the business carried out by the PO in India.
SC Decision
The Supreme Court referred to its previous decisions on PE[1] and held that to constitute “fixed place PE” under DTAA, the condition precedent is that it should be an establishment “through which the business of an enterprise” is wholly or partly carried on. The SC observed that 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 PE under Article 5.
The SC held that no PE is triggered in the instant case on the following reasons:
- The BOD Resolution shows that the PO was established for coordinating and executing delivery of documents in connection with construction of offshore platform modification of existing facilities for ONGC. The SC held that ITAT looked at only first paragraph of BOD Resolution and jumped to the conclusion. The SC held that finding of ITAT is perverse.
- The SC held that the finding of the ITAT that mode of maintaining accounts alone cannot determine the character of PE is a perverse finding.
- The onus is on the Revenue to demonstrate that the Assessee has PE.
- There were only two persons working in the PO and neither of them were qualified to perform any core activity of the Assessee.
- PO is solely an auxiliary office and falls within Article 5(4)(e) of DTAA.
Key Learnings
The key learnings from this decision are as follows:
- The determination of PE is a factual exercise. Therefore, it is important that the facts are properly captured in primary documents like BOD Resolution, minutes, financial statements, contracts etc.
- Clear description of facts in the BOD Resolution would go a long way to defend the case. The Supreme Court relied on the BOD Resolution to understand the business activities of the PO.
- It is necessary to analyse the technical competency of employees. In this case, an important aspect that went in favour of the Assessee was that there were only 2 non-technical employees.
- Analysis of financial statement should be made to support an argument. In the instant case, the Supreme Court relied on the details of expenses incurred as per the financial statement to drive home the point that the PO was not engaged in any core activity.
- The Supreme Court held that the burden of proof to demonstrate the existence of PE is on the Revenue.
- This case also highlights how perversity in the ITAT findings can be demonstrated before the higher forums.
[1] DIT v. M/s Morgan Stanley & Co. Inc., (2007) 7 SCC 1, CIT v Hyundai Heavy Industries Co. Ltd., (2007) 7 SCC 422, Ishikawajma-Harima Heavy Industries Ltd. v. DIT (2007) 3 SCC 481 and ADIT v. E-Funds IT Solution Inc. (2018) 13 SCC 294
Good read.