2007 (5) TMI 196 - SC - Income Tax

Computation of the profits of the Indian (PE) of the Korean company - held that profits, if any, from the Korean operations (designing and fabrication) arose outside India, they are not taxable - As regards the quantum of profits embedded in the Indian operations attributable to the Indian PE, we hold that the CIT was right in attributing the profits to the Indian PE at 10 % of the gross receipts in respect of its activities of installation, commissioning etc. performed in India

Summary

Issues Involved:
1. Existence of Permanent Establishment (PE) in India.
2. Taxability of profits from Korean operations in India.
3. Quantum of profits attributable to the Indian PE.
4. Applicability of Section 44BB and Instruction No. 1767 for computing taxable profits.
5. Method of accounting for computing profits.

Detailed Analysis:

1. Existence of Permanent Establishment (PE) in India:
The primary issue was whether the Korean company, M/s. Hyundai Heavy Industries Co. Ltd. (HHI), had a permanent establishment (PE) in India. The Assessing Officer (AO) concluded that the project duration extended beyond nine months, constituting a PE under Article 5(3) of the Convention for Avoidance of Double Taxation (CADT). Additionally, the office in Bombay was considered a PE under Article 5(2)(c). The Tribunal and the Commissioner of Income-tax (Appeals) (CIT(A)) upheld this view, confirming the existence of a PE in India.

2. Taxability of Profits from Korean Operations in India:
The Department argued that the contract with ONGC was a turnkey project and indivisible, thus profits from designing and fabrication in Korea were taxable in India. However, the Tribunal held that the contract was divisible, and the profits from Korean operations were not attributable to the Indian PE. The Supreme Court agreed, stating that the installation PE came into existence only after the fabrication was completed and delivered in Korea. Therefore, profits from Korean operations were not taxable in India.

3. Quantum of Profits Attributable to the Indian PE:
The CIT(A) and the AO attributed a portion of the profits from designing and fabrication to the Indian PE, considering them linked to the installation and commissioning activities. The Tribunal, however, held that only profits from Indian operations were taxable. The Supreme Court upheld the Tribunal's view, emphasizing that profits from Korean operations were not attributable to the Indian PE.

4. Applicability of Section 44BB and Instruction No. 1767:
The AO rejected the completed contract method and computed income on a receipt basis, while the CIT(A) applied Section 44BB and Instruction No. 1767, taxing profits at 10% for Indian operations. The Tribunal reduced this rate to 3%, but the Supreme Court reinstated the 10% rate, agreeing with the CIT(A). The Court noted that under presumptive taxation, if the assessee claims lower income, they must produce books of account, which the assessee failed to do.

5. Method of Accounting for Computing Profits:
The AO rejected the completed contract method due to the assessee's failure to produce relevant books of account. The CIT(A) and the Supreme Court endorsed the percentage of completion method, which aligns with the concept of contract accounts. The Supreme Court emphasized that without proper details from the assessee, the CIT(A)'s estimation of profits at 10% of gross receipts for Indian operations was justified.

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 should be taxed at 10% of gross receipts for activities of installation, commissioning, etc., performed in India.

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