2014 (3) TMI 291 - AT - Income Tax

Taxability of Technical fees DTAA between India and Japan - Whether the fees for technical services received by the assessee was taxable under Article 12 (2) or Article 12(5) read with Article 7 (3) of Double Taxation Avoidance Agreement between India and Japan Held that - The supervision fee in dispute is related to the fee received for installation of equipments supplied to MUL - Article 12 (5) of DTAA between India and Japan is on the line of OECD Model Convention wherein the clause allows the state where the PE is located to tax only those profits which are economically attributable to the PE - The income should arise as a result of activities of PE - The state where the PE is located can tax the income only, if a connection exists, between the income and the PE - Thus, Article 12(5) of Indo Japan DTAA adopts No Force of Attraction principle - the term effectively connected used in the language of Article 12 (5) of DTAA between Indo Japan is not to be construed as the opposite of legally connected but in the sense of something really connected . Producing activities should be closely connected in terms of relationship besides being connected economically also with the PE - LO was only facilitating the communication of the Head Office with MUL and was nowhere involved in the supervisory activities - Simply existence of the LO cannot be merely a basis that assessee was having supervisory PE in India - LO was not permitted to carry out any trading, commercial or industrial activity - There is no evidence whether the LO has violated the conditions laid down by RBI in this regard - The assessee has established a project office with the approval of RBI for each separate project. Equipments supplied under one purchase order were not complemented to the equipment supplied in another purchase order - The installation of equipments was to be carried out by MUL. The technicians were deputed for supervisions of work from Japan. Separate tenders were floated for each of the purchase orders and the assessee was not the only bidder and there were other enterprises which were awarded purchase orders also. There are finding of ITAT that the period of supervision under each contract was less than the period of 180 days as contemplated in Article 5(4) of the DTAA. There is no dispute remains about the payment received by the assessee the same is fee for technical services - The LO was only facilitating the communication of the Head Office with MUL - There is no evidence on record to establish that LO was involved in the supervisory activities - The LO was not allowed to do any trading, commercial or industrial activity as per RBI guidelines - There is no evidence on record that the LO has violated any of the conditions laid down by Reserve Bank of India in this regard - The personnel of LO present in the meetings with MUL were only accompanying the persons deputed from Japan and they were not having any role in the meeting thus, the income is taxable as fee for technical services as per Article 12(2) of the DTAA between India and Japan - the FTS received by the assessee for Assessment Years 1992-93, 1993-94, 1994- 95 and 1996-97 are covered under Article 12 (2) of the Indo Japan DTAA and liable for the tax @ 20% - Decided against Assessee. For Assessment Year 1995-96 since the details of contract No.19 to 25 were not available there for question of taxability of F.T.S. thus, the matter remitted back to the AO Decided in favour of Assessee.

Issues Involved:
1. Taxability of supervision fees as 'fees for technical services' (FTS).
2. Applicability of Article 12(2) or Article 12(5) read with Article 7(3) of the Double Taxation Avoidance Agreement (DTAA) between India and Japan.
3. Existence and role of Permanent Establishment (PE) in India.
4. Effective connection of supervision fees with PE.
5. Aggregation of supervision periods for determining PE.

Detailed Analysis:

1. Taxability of Supervision Fees as 'Fees for Technical Services' (FTS):
The primary issue is whether the supervision fees earned by the assessee from the supply of equipment should be taxed as 'fees for technical services' under Article 12(2) or Article 12(5) read with Article 7(3) of the DTAA between India and Japan. The Hon'ble High Court reframed the question, focusing on the taxability of FTS received by the assessee from M/s Maruti Udyog Ltd. The ITAT initially held that the supervision fees were taxable under Article 12(2) of the DTAA.

2. Applicability of Article 12(2) or Article 12(5) read with Article 7(3) of the DTAA:
The ITAT had to determine whether the FTS received by the assessee was taxable under Article 12(2) or Article 12(5) read with Article 7(3) of the DTAA. The revenue argued that the payment received by the assessee was in the nature of technical services and the only question was whether it was taxable under the specified articles of the DTAA. The ITAT concluded that the supervision fees were not effectively connected with any PE in India and thus were taxable under Article 12(2) at the rate of 20%.

3. Existence and Role of Permanent Establishment (PE) in India:
The ITAT examined whether the Local Office (LO) in India constituted a PE. The revenue argued that the LO performed functions akin to a PE, but the ITAT found that the LO's activities were preparatory and auxiliary in nature and did not constitute a PE. The ITAT also considered whether there was a supervision PE under Article 5(4) of the DTAA, concluding that the supervision activities were not effectively connected with any PE in India.

4. Effective Connection of Supervision Fees with PE:
For Article 12(5) to apply, the FTS must be effectively connected with a PE in India. The ITAT found no evidence that the supervision fees were connected with any PE. The LO facilitated communication but did not engage in supervisory activities. The ITAT emphasized that the connection must be real and substantial, not merely formal or legal.

5. Aggregation of Supervision Periods for Determining PE:
The ITAT considered whether the periods of supervision under different contracts should be aggregated to determine the existence of a PE. The ITAT held that each project should be considered separately, and the supervision periods for individual contracts did not exceed 180 days, thus not constituting a PE under Article 5(4) of the DTAA.

Conclusion:
The ITAT concluded that the supervision fees received by the assessee were taxable under Article 12(2) of the DTAA between India and Japan at the rate of 20%. The appeals for Assessment Years 1992-93, 1993-94, 1994-95, and 1996-97 were allowed, while the appeal for Assessment Year 1995-96 was remanded to the Assessing Officer for further examination based on the ITAT's guidelines. The ITAT emphasized that the supervision fees were not effectively connected with any PE in India, and the LO's activities were preparatory and auxiliary, not constituting a PE.

Order Pronounced:
The decision was pronounced in open court on February 27, 2014.

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