2007 (5) TMI 73 - SC - Income Tax

Tax liability - Department contended that the work of designing and fabrication under the Turkey Project was totally inter linked with installation and commissioning and therefore there was no merit in the assessee s claim in respect of receipts attributable to the activities - HC allow department appeal partly

Summary

Issues Involved:
1. Existence of Permanent Establishment (PE) in India.
2. Taxability of profits from Korean operations.
3. Quantum of profits attributable to Indian PE.
4. Method of accounting for profits.

Detailed Analysis:

1. Existence of Permanent Establishment (PE) in India:
The primary issue was whether the Korean company had a PE in India. The assessee argued that it did not have a PE in India as its operations in India were less than nine months. However, the Assessing Officer (A.O.) and CIT (A) found that the project duration extended beyond nine months, thereby constituting a PE under Article 5(3) of the Convention for Avoidance of Double Taxation (CADT). The Tribunal also held that the PE did exist in India in terms of Article 5(3) of CADT.

2. Taxability of Profits from Korean Operations:
The Department argued that the contract was an integrated Turnkey Project and that the profits from designing and fabrication in Korea were linked to the installation and commissioning in India, making them taxable in India. However, the Tribunal and Supreme Court held that the profits from Korean operations were not attributable to the Indian PE as the installation PE came into existence only after the fabrication work was completed and delivered in Korea. The Court emphasized that profits from Korean operations were not taxable in India under Article 7 of CADT unless it was shown that the transactions were not at arm's length, which the Department failed to establish.

3. Quantum of Profits Attributable to Indian PE:
The CIT (A) and Tribunal had differing views on the quantum of profits attributable to the Indian PE. The CIT (A) attributed 10% of the gross receipts from Indian operations to the Indian PE, while the Tribunal reduced this to 3%. The Supreme Court upheld the CIT (A)'s decision, stating that the accounts submitted by the assessee were rejected, and the A.O. had to resort to best judgment assessment. The Court also noted that the assessee had itself suggested the application of Section 44BB or CBDT Instruction No. 1767, which prescribes a 10% tax rate on gross receipts for such operations.

4. Method of Accounting for Profits:
The assessee used the Completed Contract Method for accounting, which was rejected by the A.O. and not challenged by the assessee. The Supreme Court noted that under the Percentage of Completion Method, profits are estimated based on the value of work certified. Since the assessee did not provide these details, the CIT (A)'s estimation of 10% of gross receipts for installation and commissioning activities was deemed appropriate.

Conclusion:
(a) Profits from Korean operations (designing and fabrication) arose outside India and are not taxable.
(b) Profits from Indian operations attributable to the Indian PE are taxable at 10% of the gross receipts for installation and commissioning activities.

The civil appeals by the Department were partly allowed with no order as to costs.