2007 (1) TMI 91 - SC - Income Tax

Accrual of income u/s 9 offshore supply & onshore services business connection must be established if no operation is carried out in India not taxable in India provision of DTAA limited to tax from the operation of PE advance ruling is modified

Summary

Issues Involved:
1. Taxability of amounts received for offshore supply of equipment and materials.
2. Taxability of amounts received for offshore services.
3. Entitlement to deductions for expenses incurred in computing income from offshore services.

Issue-wise Analysis:

1. Taxability of Amounts Received for Offshore Supply of Equipment and Materials:

The appellant, a Japanese company, entered into a consortium agreement to set up an LNG facility in India. The contract included offshore supply and services, onshore supply and services, and construction and erection. The appellant argued that the contract was divisible, and thus, it had no tax liability for offshore supply and services. The Revenue contended that the contract was composite and integrated, making the appellant liable for tax in India.

The court noted that the contract specified separate prices for each component, including offshore supply and services. The title to the goods supplied passed outside India on a high-sea basis. The court emphasized the principle of apportionment, stating that only the part of the income attributable to operations carried out in India could be taxed in India. Since the transfer of property and payment occurred outside India, the transaction could not be taxed in India. The court also distinguished between a business connection and a permanent establishment, stating that the latter could not be equated to the former for tax purposes.

Key Judgments:
1. No Taxation for Offshore Supply: "Since all parts of the transaction in question, i.e., the transfer of property in goods as well as the payment, were carried on outside the Indian soil, the transaction could not have been taxed in India."
2. Principle of Apportionment: "The principle of apportionment, wherein the territorial jurisdiction of a particular state determines its capacity to tax an event, has to be followed."

2. Taxability of Amounts Received for Offshore Services:

The appellant argued that the services were rendered outside India and thus should not be taxed in India. The Revenue contended that the services were part of a composite contract and should be taxed in India.

The court held that for Section 9(1)(vii) of the Income Tax Act to apply, services must be both rendered and utilized in India. In this case, the services were rendered outside India, and thus, the income could not be taxed in India. The court also noted that the Double Taxation Avoidance Agreement (DTAA) between India and Japan limits the tax on business profits to those arising from the operations of the permanent establishment. Since the services had no connection with the permanent establishment in India, they could not be taxed in India.

Key Judgments:
1. Territorial Nexus Required: "Sufficient territorial nexus between the rendition of services and territorial limits of India is necessary to make the income taxable."
2. Application of DTAA: "Article 7 of the DTAA is applicable in this case, and it limits the tax on business profits to that arising from the operations of the permanent establishment."

3. Entitlement to Deductions for Expenses Incurred in Computing Income from Offshore Services:

The court held that the appellant would not be entitled to claim any deduction for expenses incurred in computing the income from offshore services under the Act or the Indo-Japan Treaty. This was a consequential ruling based on the determination that the income from offshore services was not taxable in India.

Key Judgments:
1. No Deductions Allowed: "The applicant would not be able to claim any deduction in computing the income from offshore service under the Act, and/or under the Indo-Japan Treaty."

Conclusion:

The Supreme Court allowed the appeal in part, ruling that the income from offshore supply and services was not taxable in India. The court emphasized the principles of apportionment and territorial nexus, distinguishing between business connection and permanent establishment for tax purposes. The appellant was not entitled to deductions for expenses incurred in computing income from offshore services.