2011 (6) TMI 153 - AT - Income Tax

DTAA - Reopening - Income escaping assessment - Advance ruling - assessee had not filed the return of income under the provisions of section 139(1) of the Act - AO was of the view that Income arising on account of software maintenance, anomaly resolution and modification of the software pertaining to MATSBD systems escaped assessment - Since the assessee has not filed the return u/s 139(1) and no assessment has been made prior to this assessment, the provision contained in first proviso to this section is also not applicable - the assessee was a regular assessee and similar facts had been disclosed in the returns over a period of time - In this case, no return of income had been filed by the assessee prior to recording of reasons and issuance of notice u/s 148 - Held that recitals to agreement dated 4.2.2003 will lead any man of common prudence to come to a conclusion that the assessee had earned income from anomaly resolution and modification of systems in this year - Decided against the assessee Two agreements - Separate contract or one - It is another matter that two separate contracts were executed for the sake of some convenience of both the parties. However, the essential purpose was to set up the ATS at Delhi and Bombay, for which hardware and software was supplied by the assessee, installation was carried out leading to site acceptance test. The training for the personnel of the AAI as well as Indian industry was also to be carried out for preparing them to handle the ATS. Accordingly, we are of the view that the two contracts constitute one contract. Regarding PE in India - In this case, the essence of the contract is to completely renovate the existing ATS, which constitutes the PE of the assessee - It is the case of the assessee that the work of system specification review, PDR and CDR required occasional visits of the personnel of the assessee, but all the work in relation thereto, after initial inspection, was conducted outside India - There is no evidence on record that apart from inspection, the ATS were made freely available to the assessee to be occupied by its personnel for system specification review, PDR or CDR - it also emerges clearly that after clearance of goods in India, the possession was handed over to the assessee and it became responsible for any damage to the goods - Accordingly it was held that assessee had PE in India Regarding bifurcating the revenues - the contract does not contain any stipulation regarding separate prices of the equipment and the software - The supply of equipment and software constitutes one milestone as both were supplied together and property therein passed to the AAI at the port of shipment as per common intention of the parties - The assessee was also not able to produce any order from customs authorities passed at the time of clearance of the equipment and the software at the customs port in India from which we could have an idea whether that authority had segregated the consideration in terms of equipment and software due to differential rate of duty - the composition of hardware and software in the two contracts may be different, nonetheless the figures mentioned above show that the values placed by the ld. CIT(Appeals) are not arbitrary or highly excessive Regarding turn-key contract - The assessee has not maintained separate India specific accounts - The policy for recognizing revenue is stated to be on the basis of the milestone achieved and, thus, the revenue is recognized in respect of a milestone when right to receive the consideration has accrued - It is not in dispute that the title in the equipment stands transferred upon delivery outside India - Since the activities are distinct and consideration for supply of equipment and the software has been separately mentioned, the ratio of the aforesaid decision will be applicable to the facts of this case - it is held that the profits will become taxable on completion of a milestone when the right to receive the consideration accrues to the assessee -whether, various rulings of the AAR could have been relied upon by the ld. CIT(Appeals) - the consideration received for repair of software answer the description of fees for included services within the meaning of article 12(4)(a) and, therefore, it will be taxable in India - The exclusion should be given due meaning and effect otherwise the provision will be practically redundant - When the infringement is ruled out, it would be difficult to reach the conclusion that the buyer/licensee of product has acquired a copyright therein - Appeal is partly allowed

Summary

Issues Involved:
1. Validity of reopening under section 147.
2. Treating separate supply and service contracts as a single indivisible contract.
3. Bifurcation of revenue between supply of equipment and royalty.
4. Permanent Establishment (PE) in India.
5. Taxability based on completed contract.
6. Estimation and working of profit.
7. Disallowance of R&D expenses.
8. Levy of interest under sections 234B, 234C, and 220(2).

Detailed Analysis:

1. Validity of Reopening under Section 147:
The assessee challenged the reopening of the assessment under section 147, arguing that the reasons recorded by the AO did not have an intelligible nexus with the belief that income had escaped assessment. The Tribunal upheld the reopening, stating that the AO had reasonable grounds to believe that income had escaped assessment based on the contract dated 04.02.2003 for software maintenance and anomaly resolution. The Tribunal referenced various case laws, including Ganga Saran and Sons (P) Ltd. vs. ITO and ACIT vs. Rajesh Jhaveri Stock Brokers P. Ltd., to support the validity of the reopening.

2. Treating Separate Supply and Service Contracts as a Single Indivisible Contract:
The Tribunal examined the two contracts dated 19.03.1993 between the assessee and AAI, one for supply of equipment and the other for installation and training. It concluded that both contracts were interlinked and constituted a single indivisible turn-key contract for modernizing the ATS at Delhi and Mumbai airports. The Tribunal noted that the payments under the supply contract were tied to milestones related to installation and testing, reinforcing the view that the contracts were not standalone but part of a comprehensive project.

3. Bifurcation of Revenue Between Supply of Equipment and Royalty:
The Tribunal upheld the bifurcation of revenue into 30% for equipment and 70% for software/royalty, as determined by the AO. It referenced the ruling in Mitsubishi Corporation and noted that the assessee failed to provide any objective evidence for a different allocation. The Tribunal also considered the AAR rulings, which supported the bifurcation and taxation of software as royalty.

4. Permanent Establishment (PE) in India:
The Tribunal examined whether the assessee had a PE in India under Article 5 of the DTAA. It concluded that the assessee had a PE in India from the date the equipment was handed over by AAI for installation. The Tribunal noted that the presence of the assessee's personnel in India for installation, testing, and training activities exceeded the thresholds stipulated in the DTAA, thereby constituting a PE.

5. Taxability Based on Completed Contract:
The Tribunal held that profits from the supply contract should be recognized and taxed based on the completion of each milestone rather than waiting until the final acceptance test. It referenced the decision in Ishikawajima Harima Heavy Industries Ltd. and concluded that the property in goods passed to AAI at the port of shipment, and thus, profits from supply were taxable outside India. However, the installation and service contract profits were taxable upon completion of the installation and testing in India.

6. Estimation and Working of Profit:
The Tribunal directed the AO to recompute the profits attributable to the PE in India based on the installation and service activities carried out during the relevant financial year. It noted that the assessee did not maintain separate accounts for Indian operations and emphasized the need for a reasonable estimation of profits based on global accounts.

7. Disallowance of R&D Expenses:
The Tribunal upheld the disallowance of R&D expenses while computing the global profit margins for attributing business income to the PE in India. It noted that the assessee failed to provide adequate evidence to support the claim for R&D expenses.

8. Levy of Interest under Sections 234B, 234C, and 220(2):
The Tribunal did not make a final decision on the levy of interest under sections 234B, 234C, and 220(2), as the matter was remanded to the AO for recomputation of income. The AO was directed to decide on the interest levies afresh while computing the income, after giving the assessee an opportunity to be heard.

Conclusion:
The Tribunal's judgment addressed multiple complex issues involving the reopening of assessment, bifurcation of revenue, existence of PE, and taxability based on the completion of contracts. It provided a detailed analysis of each issue, referencing relevant case laws and AAR rulings to support its conclusions. The appeal was partly allowed, with directions for the AO to recompute the income and decide on the levy of interest afresh.