In Re: Advance Ruling P. No. 13 of - Court Judgment

Excerpt:
appellants: in re: advance ruling p. no. 13 of 1995 vs.income tax act, 1961 - sections 2(17), 2(22a), 2(23a), 9, 28 to 44ac, 44c, 44d, 57 and 115a brooke bond and co. ltd. v. cit, [1986] 162 itr 373 (sc); snam progetti (s.p.a.) v. cit (addl.), [1981] 132 itr 70 (delhi); cit v. vr. s.r.m.firm, [1994] 208 itr 400; cit v. r.d. aggarwal and co., [1965] 56 itr 20; cit v. ahmedbhai umarbhai and co., [1950] 18 itr 472; tata iron and steel co. ltd, v. state of bihar, 1. abc company of france (referred to hereinafter as "abc") has, in this application filed under section 245q(1) of the income-tax act, 1961 ("the act"), posed as many as thirteen questions for the ruling of this authority. it is necessary to first outline the transactions which abc proposes to enter into in india out of which these.....

Judgment:
Appellants: In Re: Advance Ruling P. No. 13 of 1995 Vs.

Income Tax Act, 1961 - Sections 2(17), 2(22A), 2(23A), 9, 28 to 44AC, 44C, 44D, 57 and 115A Brooke Bond and Co. Ltd. v. CIT, [1986] 162 ITR 373 (SC); Snam Progetti (S.P.A.) v. CIT (Addl.), [1981] 132 ITR 70 (Delhi); CIT v. VR. S.R.M.Firm, [1994] 208 ITR 400; CIT v. R.D. Aggarwal and Co., [1965] 56 ITR 20; CIT v. Ahmedbhai Umarbhai and Co., [1950] 18 ITR 472; Tata Iron and Steel Co. Ltd, v. State of Bihar, 1. ABC Company of France (referred to hereinafter as "ABC") has, in this application filed under Section 245Q(1) of the Income-tax Act, 1961 ("the Act"), posed as many as thirteen questions for the ruling of this Authority. It is necessary to first outline the transactions which ABC proposes to enter into in India out of which these questions are said to arise.

2. A statement of relevant facts was enclosed as annexure "I" to ABC's application dated March 6, 1995. According to this, ABC expected to be awarded a contract by an Indian company, "X", in connection with X's plans to set up a manufacturing plant in India. Four questions in connection with this transaction were submitted for the Authority's ruling. A little later, the scope of the transaction seems to have got widened to include the setting up of another industrial complex at the same place for another Indian company "Y" which is a sister concern of X of India. ABC wrote to the Authority on June 10, 1995, stating that X and Y (hereinafter compendiously referred to as "XY") had not so far awarded any contract to ABC, but that the scope of the work and the terms and conditions of their execution had since been formalised.

Revised versions of annexure "I" (statement of relevant facts), annexure "II" (the applicant's interpretation of the facts and law) and annexure "III" (questions on which advance ruling is required) have been submitted in substitution of annexures "I", "II" and "III" submitted with the original application. These annexures are more elaborate and detailed and now 13 questions are posed for advance ruling in place of the original four questions. It is on the basis of these revised annexures that the Authority has to give its ruling.

3. ABC is a company incorporated under the laws of the France with affiliates in several countries. For the purposes of the Act, it is a nonresident "foreign company". It is in the business of engineering and construction management, providing project development services and construction of industrial plants. It is stated that the company is engaged in the execution of large infrastructure projects, particularly refineries, pipelines, chemical or petrochemical plants, roads, bridges, ports, etc. It is said to have carried out work from the conceptional engineering stage right down to the grass roots level project execution. It is claimed to have executed major projects in these sectors in several countries in Europe and elsewhere. The company's brochure says : " The company has demonstrated skills in the development, integration and management of complicated technologies across varying industries and terrain development of basic engineering designs, drawing up of detailed engineering plans, project construction, management services, sourcing through global procurement services and start up assistance at the time of handing over of the projects including training and technology transfer facilitation." 4. ABC provides services to its clients both on a turnkey basis and on specific assignment basis, the services provided being principally of the following nature : 5. Its negotiations with XY are "for providing complete project services on single point responsibility basis starting from technology transfer to the commissioning of the plant". However, it is stated, "it is possible that the final contract may exclude any one or more of the aforesaid services". ABC, for the purpose of providing these services, would be operating from its head office (HO) in France as well as a project head office (PHO) and a project site office (PSO) in India. It expects to employ about 200 to 400 employees in India and about 800 employees outside India.

6. The work to be done by ABC for XY is expected to be covered by the following seven agreements :(e) Buying Services Agreement (BSA) 8. Although ABC has requisite expertise, knowledge, capability, manpower and infrastructure to render effectively and properly all services, i.e., engineering, project management, procurement and site services and assistance, etc., time being the essence of the contract to erect and commission the plant, ABC may by way of sub-contract get part of the work relating to engineering and buying services done through their affiliate office/third parties while retaining the overall responsibility with them. As stated above the work to be done by ABC under all the agreements except USA and SA will involve activities in India as well as outside India. Such a bifurcation, however, is stated to be unnecessary for the USA and SA because no separate payment will be stipulated in these two agreements for the services to be rendered thereunder.

9. Against the background of this proposed transaction, the questions posed by ABC before the Authority for its ruling have been formulated as follows : Question No. 1 : Whether ABC will be treated as a person resident in France within the meaning of Article 4 of the DTAA Question No. 2 : Whether the project head office and project site office of ABC in India will constitute a permanent establishment within the meaning of Article 5 of the DTAA from the first day of commencement of its business in India Question No. 3 : Whether the payments under the agreements as enumerated in paragraph 1 of annexure II are in the nature of "royalty" and/or "fees for technical services" within the meaning of Articles 13.3 and 13.4 of the DTAA Question No. 4 : Whether the activities of ABC conducted outside India as enumerated in paragraphs 6 and 8 of annexure I are effectively connected with the activities conducted inside India by its permanent establishment in India Question No. 5 : Whether ABC will be considered as the "beneficial owner" in terms of Article 13.6 of the DTAA in respect of the licence technology and basic engineering procured from its worldwide affiliates and/or third parties Question No. 6 : Whether ABC will be considered as the beneficial owner in terms of Article 15.6 of the DTAA in respect of engineering services and buying services which it would sub-contract to its worldwide affiliates and/or third parties Question No. 7 : Whether the payments under the agreements are taxable under Article 13.2 of the DTAA or whether in terms of Article 13.6 of the DTAA the said amounts are liable to tax under Article 7 of the DTAA? Question No. 8. Whether in terms of Articles 7.1 and 7.2 read with paragraph 3 of the Protocol to DTAA, the profits attributable to activities inside India alone will be liable to tax in India Question No. 9 : Whether, while computing the profits of the permanent establishment in India, the restrictions imposed by Article 7.3(a) of the DTAA would extend to only Section 44C of the Act or to any other provision of the Act Question No. 10 : Whether, under Article 7.3(b) of the DTAA the payments made to the head office by the permanent establishment in India for procuring the licence technology and basic engineering will be considered as reimbursement and, therefore, will be deducted in computing the profits of the permanent establishment in India Question No. 11 : Whether under Article 7.3(b) of the DTAA the payments made to the head office by the permanent establishment in India in respect of engineering services and buying services which may be sub-contracted by the head office to its worldwide affiliates and third parties, will be considered as reimbursements and, therefore, will be deductible in computing the profits of the permanent establishment in India Question No. 12 : Whether the head office of ABC would be liable to withhold taxes under the Income-tax Act of India in respect of payments made to foreign suppliers (including ABC affiliates and sub-contractors) of goods, services and technologies Question No. 13 : Whether the profits of the permanent establishment in India will be computed under the head "Profits and gains of business or profession" as described in Chapter IV, Part D, of the Act and brought to tax at the rates applicable to a foreign company or the gross receipts will be subjected to tax at the rates prescribed under Section 115A of the Act 10. The "DTAA" mentioned in the above questions (and hereinafter so referred to) is the convention between India and France for the avoidance of double taxation with respect to taxes on income and capital. It came into force on August 1, 1994. A Protocol entered into between the signatories at the time of appending their signatures to the convention embodies certain further provisions as an integral part of the convention and has also been considerably relied upon at the time of the arguments. Some relevant provisions of the convention and the Protocol may now be referred to.

(a) Residence : Article 4 of the convention defines the concept of a "resident" for its purposes. This concept is important to regulate the mode of taxation of various categories of persons who have sources of income or income-earning activities in both the Contracting States (India and France). Clauses (1) and (3) of the definition are alone relevant and they read thus (see [1994] 209 ITR (St.) 130, 133) : " (1) For the purposes of this Convention, the term 'resident of a Contracting State' means any person who, under the laws of that Contracting State, is liable to tax therein by reason of his domicile, residence, place of management or any other criterion of a similar nature . . .

(3) Where by reason of the provisions of paragraph 1, a person, other than an individual is a resident of both Contracting States, then it shall be deemed to be a resident of the Contracting State in which its place of effective management is situated." (b) Permanent establishment : Another expression which has a vital significance for the purposes of the Convention is "permanent establishment". It is sufficient to extract certain portions of this definition which alone are relevant for our purposes (see [1994] 209 ITR (St.) 130, 133) : "Article 5. Permanent establishment. -- (1) For the purposes of this Convention, the term 'permanent establishment' means a fixed place of business through which the business of an enterprise is wholly or partly carried on.

(3) A building site or construction, installation or assembly project constitutes a permanent establishment only where such site or project continues for a period of more than six months ..." (c) Business profits. -- Article 7 deals with the mode of assessment of business profits. It is necessary to extract almost the whole of this article here (see [1994] 209 ITR (St.) 130, 136) : "Article 7. Business profits. -- (1) The profits of an enterprise of one of the Contracting States shall be taxable only in that Contracting State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other Contracting State but only so much of them as is attributable to that permanent establishment.

(2) Subject to the provisions of paragraph 3, where an enterprise of one of the Contracting States carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make, if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment. In any case where the correct amount of profits attributable to a permanent establishment is incapable of determination or the determination thereof presents exceptional difficulties, the profits attributable to the permanent establishment may be estimated on the basis of an apportionment of the total profits of the enterprise to its various parts, provided, however, that the result shall be in accordance with the principles contained in this Article.

(3) (a) In determining the profits of a permanent establishment, there shall be allowed as deduction expenses which are incurred for the purposes of the permanent establishment, including executive and general administrative expenses so incurred, whether in the Contracting State in which the permanent establishment is situated or elsewhere, in accordance with the provisions of and subject to the limitations of the taxation laws of that Contracting State : Provided that where the law of the Contracting State in which the permanent establishment is situated imposes a restriction on the amount of the executive and general administrative expenses which may be allowed, and that restriction is relaxed or overridden by any Convention, Agreement or Protocol signed after January 1, 1990, between that Contracting State and a third State which is a member of the OECD, the competent authority of that Contracting State shall notify the competent authority of the other Contracting State of the terms of the corresponding paragraph in the Convention, Agreement or Protocol with that third State immediately after the entry into force of that Convention, Agreement or Protocol and, if the competent authority of the other Contracting State so requests, the provisions of that paragraph shall apply under this Convention from that entry into force.

(b) However, no such deduction shall be allowed in respect of amounts, if any, paid (otherwise than towards reimbursement of actual expenses) by the permanent establishment to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for the use of patents or other rights, or by way of commission for specific services performed or for management, or, except in the case of a banking enterprise, by way of interest on moneys lent to the permanent establishment. Likewise, no account shall be taken, in the determination of the profits of a permanent establishment, for amounts charged (otherwise than towards reimbursement of actual expenses), by the permanent establishment to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for the use of patents or other rights, or by way of commission for specific services performed or for management, or, except in the case of a banking enterprise, by way of interest on moneys lent to the head office of the enterprise or any of its other offices . . .

(6) Where profits include items of income which are dealt with separately in other articles of this Convention, then the provisions of those articles shall not be affected by the provisions of this article." (d) Royalties and fees for technical services and payments for the use of equipment, -- Of particular relevance to this case is the mode of taxation of "royalties" and "fees for technical services".

This article also needs to be set out almost in full here (see [1994] 209 ITR (St.) 130, 143) : " Article 13. Royalties and fees for technical services and payments for the use of equipment. -- (1) Royalties, fees for technical services and payments for the use of equipment arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other Contracting State.

(2) However, such royalties, fees and payments may also be taxed in the Contracting State in which they arise and according to the laws of that Contracting State, but, if the recipient is the beneficial owner of these categories of income the tax so charged shall not exceed 20 per cent, of the gross amount of such royalties, fees and payments.

(3) The term "royalties" as used in this article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films, or films or tapes used for radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience.

(4) The term "fees for technical services" as used in this article means payments of any kind to any person, other than payments to an employee of the person making the payments and to any individual for independent personal services mentioned in Article 15, in consideration for services of a managerial, technical or consultancy nature.

(5) The term "payments for the use of equipment" as used in this article means payments of any kind received as a consideration for the use of, or the right to use, industrial, commercial or scientific equipment.

(6) The provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the royalties, fees for technical services or the payments for the use of equipment being a resident of a Contracting State, carries on business in the other Contracting State in which the royalties, fees for technical services or the payments for the use of equipment arises, through a permanent establishment situated therein, or performs in that other Contracting State independent personal services from a fixed base situated therein, and the royalties, fees for technical services or the payments for the use of equipment are effectively connected with such permanent establishment or fixed base. In such case the provisions of Article 7 or Article 15, as the case may be, shall apply.

(7) Royalties, fees for technical services or payments for the use of equipment shall be deemed to arise in a Contracting State when the payer is that Contracting State itself, a political sub-division, a local authority or a resident of that Contracting State. Where, however, the person paying the royalties, fees for technical services or the payments for the use of equipment, whether he is a resident of a Contracting State or not has in a Contracting State a permanent establishment or a fixed base in connection with which the contract under which the royalties, fees for technical services or the payments for the use of equipment, are paid was concluded and such royalties, fees for technical services or payments for the use of equipment are borne by such permanent establishment or fixed base, then such royalties, fees for technical services or payments for the use of equipment shall be deemed to arise in the Contracting State in which the permanent establishment or fixed base is situated . . ." (e) Protocol : Reference may now be made to paragraph (3) of the Protocol which, as already mentioned, is part of the Convention and has been considerably relied upon by counsel for ABC. It reads (see [1994] 209 ITR (St.) 130, 158) : " (3) In respect of paragraphs 1 and 2 of Article 7, where an enterprise of one of the Contracting States sells goods or merchandise or carries on business in the other Contracting State through a permanent establishment situated therein, the profits of that permanent establishment shall not be determined on the basis of the total amount received by the enterprise, but shall be determined only on the basis of the remuneration which is attributable to the actual activity of the permanent establishment for such sales or business. Especially, in the case of contracts for the survey, supply, installation or construction of industrial, commercial or scientific equipment or premises, or of public works, when the enterprise has a permanent establishment the profits of such permanent establishment shall not be determined on the basis of the total amount of the contract, but shall be determined only on the basis of that part of the contract which is effectively carried out by the permanent establishment in the Contracting State where the permanent establishment is situated. The profits related to that part of the contract which is carried out by the head office of the enterprise shall be taxable only in the Contracting State of which the enterprise is a resident." 11. Learned counsel for the applicant and the representative of the Commissioner of Income-tax have taken us through the relevant provisions of the agreements, the DTAA and the Act and have been of great assistance. The questions posed for the consideration of the Authority may be now dealt with.

12. ABC is a "company" as defined in Section 2(17)(ii) of the Act. The definitions contained in Section 2(22A) and (23A) of the Act make it a "foreign company". Also, by reason of Section 6(3) of the Act, since it is not an Indian company and the control and management of its affairs is not wholly situated in India, it is a "non-resident" company entitled to make the present application. Article 4(1) of the DTAA makes a person "resident of a Contracting State" who, "under the laws of that Contracting State, is liable to tax therein by reason of domicile, residence, place of management or any other criterion of a like nature". ABC is clearly a resident of France because it is liable to tax in France on account of its residence and place of management being in France. But, though ABC is admittedly liable to tax in India on its income, it is arguable that its liability cannot be attributed to its residence or place of management being in India or any other criterion of a similar nature. It is, however, unnecessary to consider this in greater depth for, even assuming that it can be said to be resident also in India within the meaning of Article 4(1) of the DTAA, its residence for the purposes of the DTAA has to be attributed to France in view of the clarification contained in paragraph 3 of Article 4. There can, therefore, be no doubt that, for the purposes of the DTAA, ABC has to be treated as a person resident in France. There is no controversy between the parties on this. This is the answer to question No. 1.

13. The answer to question No. 2 is equally clear and simple. Under the contract, ABC is to maintain not one, but two offices in India which will also be places from which the execution of the contract will be looked after, managed and overseen. It is, therefore, clear that ABC will be having a "permanent establishment" in India once these offices are set up and the activities of ABC in India are commenced. The wording of the question, however, which lays stress on whether ABC can be said to have a permanent establishment in India "from the first day of commencement of its business in India" seems to have derived inspiration from the language of paragraph 3 of Article 5 of the DTAA.This question, however, proceeds on an erroneous approach to the concept of permanent establishment under the DTAA. Its relevance arises in that, under Article 7, the business profits of a resident of France having a permanent establishment in India will be taxed in India in so far as they are attributable to such permanent establishment and under Article 13, even royalties and fees for technical services realised in the course of such business and effectively connected with such permanent establishment would be taxable as business profits. In other words, the concept of permanent establishment has impact not because of the time element of its existence but because of the causal connection of the profits sought to be taxed with the permanent establishment. It is doubtful whether the time restriction imposed by paragraph 3 will also apply to the office, factory and other units referred to in paragraph 2, but even if it is taken as covering the other establishments in paragraph 2 as well, it would appear that the only practical way of approaching the issue is to consider the duration of the profit-earning activities as a whole and then verify whether the permanent establishment has been in existence for more than six months during this period. So far as the present case is concerned, however, this aspect would be academic because once ABC gets the contracts from XY they will immediately establish their Indian offices and the profit-earning activities will start only thereafter. It has indeed been so stated in paragraph 6 of annexure I to the application (as originally filed) and there is no reason to believe that this will not be so under the finalised contract as well. Having regard to this and the long duration of the contract (expected to last for 28 to 30 months from the date of the award), it can easily be asserted that ABC will be carrying on business through a permanent establishment in India. This position is also not controverted on behalf of the Department. This is the answer to question No. 2 posed by ABC in the application.

14. The contract, as mentioned earlier, is reduced to seven agreements, for five of which consideration is to be stipulated hereinafter. Except the SA which only relates to supply of equipment by ABC and the USA which stipulates for no separate consideration at all, all the other contracts provide for payments to ABC as a consideration for the use of "patenting trademarks, designs, models, plans, secret formula or processes" which belong to ABC or are acquired by it from others or "for information concerning industrial, commercial or scientific experience" or "in consideration for services of a managerial, technical or consultancy nature". Hence, there can be no manner of doubt that the payments received by ABC under the agreements answer the description of "royalties" or "technical fees" as defined in paragraphs 3 and 4 of Article 13 of the DTAA. On behalf of the Department, it is contended that ABC's receipts under the contract are in the nature of the profits of a business of setting up a plant and an industrial complex in India and are assessable under Article 7 of the DTAA. But the question whether the receipts are in the nature of royalties and technical services has to be answered with reference to the terms of the agreement under which they arise. There is no incompatibility between recognising the receipts as royalties and fees for technical services -- which they are under the agreements -- and looking upon them also as the profits of a business assessable under Article 7.

Judicial decisions have recognised this principle in regard to other types of receipts such as dividends and interest : vide, Brooke Bond and Co. Ltd. v. CIT [1986] 162 ITR 373 (SC), Snam Progetti (S. P. A.) v. CIT (Addl.) [1981] 132 ITR 70 (Delhi). This position is indeed envisaged also by Article 13(6) of the DTAA which will be referred to later. Question No. 3 posed by the applicant has, therefore, to be answered in the affirmative.

15. At the outset, it must be pointed out that the wording of question No. 4 as posed by the applicant needs to be modified to bring out the real question at issue. The Authority is of the opinion that the question should read as follows : " Whether the royalties and technical fees received by ABC under the contract in respect of its activities outside India are effectively connected with the permanent establishment in India ?" 16. As will be pointed out later, the contention of the applicant's counsel in regard to questions Nos. 7 and 8 is that they are so connected. All the outside activities are directed towards the installation of the manufacturing plant and industrial complex in India. Though carried out elsewhere, they are integrally connected with the project in India. The designs, basic engineering services and other services are based on information collected in India and the use of the process and technologies have to be adapted to the needs of, and prove workable in, Indian conditions. The permanent establishment in India has an undoubted voice over the outside activities as well and the royalties and fees in question cannot but be described as effectively connected with it. We, therefore, answer the question in the affirmative.

17. It will be next convenient to deal with questions Nos. 5 and 6 together. Their purport is the same involving an interpretation of paragraph G of Article 13 of the DTAA. Only, they relate to different agreements to be entered into between the parties : question No. 5 arises out of the LBEA and question No. 6 arises out of the ESA and BSA. Under the LBEA, ABC will be using, in the execution of the contract, not merely the process technologies belonging to it ; it can also procure suitable process technologies from others and utilise them for the purposes of the contract with such modifications as may be necessary. In like manner, ABC may find it necessary to acquire expertise from others to enable it to perform efficiently the services expected of it under the ESA and BSA though the abstract of these agreements supplied by the applicant makes no specific reference to this aspect. Naturally, for acquiring or utilising the process technologies or expertise of others, ABC will have to make payments to the affiliates or other suppliers who make such technologies or expertise available to it. Naturally, ABC would have taken into account the cost of acquisition or hire of such technologies and special knowledge in arriving at the consideration it should receive from XY under each of the several agreements. The position, thus, will be that a good part of the payments received by ABC from XY under these agreements may either go in reimbursement of the payments made by ABC to its suppliers for the acquisition or utilisation of their processes or expertise or will be utilised by ABC to make such payments. The question raised, apparently, is whether this feature of the payments by XY to ABC will disentitle ABC from claiming to be the beneficial owner of the royalties and technical fees received by it from XY to the extent they get passed on, in turn, to its own suppliers. The questions, as framed, do not bring out their real purport. The insertion of the words "of the royalties and fees for technical services which it receives from XY after the word "DTAA" in each of the questions would bring out the meaning more clearly. The questions, as thus modified, have to be answered in the affirmative. The agreements require ABC to utilise all the expertise at its disposal--whether its own or acquired from others- in the execution of the contract and for these services it receives payments which are in the nature of royalties or fees for technical services. The circumstance that, for discharging its functions under the contracts, ABC in turn may have to seek similar help from others and pay for it cannot detract from the beneficial ownership of ABC over the royalties and technical fees it receives from XY. On the other hand, it is because ABC has such beneficial ownership that it is able to utilise the payments received from XY for making payments to its suppliers if not already made. In fact, ABC may or may not be passing on to its suppliers the same amounts which it receives from XY. Nor may it be passing on the expertise acquired by it from the various suppliers in the same form to XY as it has to modify, synthesise and integrate them so as to suit the needs of the manufacturing plant and industrial complex and supply the technologies to XY as a single source. Hence, unless the processes and expertise referred to are supplied directly to XY by the affiliates and third parties - which is not envisaged under the agreements -- the royalties and technical fees paid by XY to ABC will belong to the latter and be in its beneficial ownership. Questions Nos. 5 and 6 modified as indicated above are answered accordingly.

18. It will be convenient next to deal with question No. 9. It is dealt with on the assumption that ABC's profits from the contract will be assessable as business profits under Article 7 of the DTAA and will be subject to the Authority's determination on the other questions regarding the mode of their assessability. It is clear from the language of sub-paragraph (a) of paragraph 3 of Article 7 of the DTAA which has been extracted earlier that in determining the profits of a permanent establishment, expenses which are incurred for the purposes of the permanent establishment in India or elsewhere -- including executive and general administrative expenses so incurred -- will be allowed as deduction but in accordance with the provisions of and subject to the limitations of the taxation laws of India. The underlined phrase governs not merely executive and administrative expenses (limitation on the deductibility of which is dealt with by Section 44C of the Act) but also all other expenses in respect of which deduction is sought in the computation of the profits of the establishment. Having said this, the proviso seeks to grant a relaxation in respect of the deductibility of executive and administrative expenses where such relaxation is permitted by subsequent DTAA agreements entered into by either of the two countries.

This proviso does not cut down the generality of the rule enunciated in the first sentence of the sub-paragraph that the deductibility of all expenses (and not merely the head office administrative expenses referred to in Section 44C) shall be in accordance with and subject to the limitations laid down in the Act. Question No. 9 has to be answered accordingly.

19. Questions Nos. 10 and 11 relate to the interpretation of sub-paragraph (b) of paragraph 3 of Article 7 of the DTAA and they are now dealt with, as in respect of question No. 9, on the assumption that ABC's profits from the contract will be assessable under Article 7. The purport of both the questions is the same : Question No. 10 refers to the payments made under the LBEA, while question No. 11 pertains to the payments made under the ESA and BSA. The questions arise this way.

Sub-paragraph (b) of paragraph 3 of Article 7 prohibits ABC from claiming, as deductions in the computation of the profits of the permanent establishment, payments made by the permanent establishment to the head office or other offices by way of royalties, fees, commission and interest, except when paid by way of reimbursement of expenses incurred by the head office or other office on its behalf. It also correspondingly excludes, from the profits of the permanent establishment, royalty, fees, commission, interest received from the head office and other offices otherwise than by way of reimbursement of actual expenses incurred by it. The applicant has explained, in the revised annexure II filed by it, that, according to it, the computation of the profits of the permanent establishment should not include any receipts for the work done outside India and that, therefore, the question of claiming as expenses any payments made by the permanent establishment to the head office will not at all arise and that it may not be necessary to answer these questions if this interpretation is accepted. The applicant's assumption may not be strictly correct as payments made by the permanent establishment to the head office and other offices may even relate to work done inside India and the question of the deductibility of such payments against the relevant receipts will have to be determined in terms of Article 7(3)(b). The principle behind this sub-paragraph is that payments by the permanent establishment to head office and other offices or receipts from such offices by the permanent establishment are only in the nature of mutual adjustments between several branches of activities of the same person and are of no relevance in computing the overall profits attributable to the permanent establishment as a separate and distinct enterprise.

However, where the payment is made by the permanent establishment to the head office by way of reimbursement of actual expenses, it has to be deducted because it really goes out of the enterprise. The question raised, however, is whether the payments made by the permanent establishment of ABC to the head office : (b) in respect of engineering services and buying services which may be sub-contracted by the head office to its world-wide associates and third parties will be considered as such reimbursements and, therefore, become deductible in computing the profits of the permanent establishment in India. This issue has been basically answered while dealing with questions Nos. 5 and 6. It has been pointed out there that the beneficial ownership of the royalties and technical fees received by the ABC under these agreements vests in ABC and is not affected by the fact that ABC, in its turn, may have to pay other parties for the expertise acquired by it. By the same token, the payments made by the permanent establishment to the head office or other offices for the technology supplied by it or the services rendered by it cannot be said to be by way of reimbursement of the expenses incurred by the head office or other offices for acquiring such technology or services. In fact, the two sets of activities are not causally interconnected, ABC's head office may be acquiring various kinds of technologies and expertise from time to time. It may modify, refine or update such technology or expertise or create new technology and expertise on its own. That is all part of the activities of ABC in general. XY does not concern itself therewith : all it is interested in is that its contract should be executed by the use of the most up-to-date and appropriate technology and expertise. If the permanent establishment pays the head office for the services rendered by the latter, that is not intended to be by way of reimbursement of the expenses that may be or may have been incurred by the head office in this direction. Questions Nos. 10 and 11 are, therefore, answered in the negative.

20. This is a very interesting question and the answer to it requires careful consideration. The question is whether ABC's head office would be liable to deduct taxes under the Act in respect of the payments which it may have to make to its suppliers abroad (including its affiliates, subcontractors and third parties) in payment of goods, services and technologies acquired from them. The applicant's counsel suggests that since ABC is a non-resident foreign company for the purposes of the Act, the provisions regarding tax deduction at source in the Act will not be applicable to it. This is not correct. It is generally true that tax deductions at source envisaged in respect of certain types of payments made by residents to other residents and particularly non-residents as a convenient mode of collection when the moneys pass hands rather than await an assessment on, and recovery from, the payee in due course. But the language of the relevant provisions comprehensively covers "any person" responsible for paying any sums chargeable to income-tax. Foreign or non-resident companies and persons cannot, therefore, be considered outside the scope of these provisions of the Act, though it is true that there may be some practical difficulties in enforcing these obligations on such persons, unless they have a representative or agent who can be made vicariously liable in this regard. The more important and relevant point is whether the payments in question are payments from which deduction of tax at source is obligatory under the Act. We shall assume for the purposes of this question (a) that the persons to whom the payments are made are non-residents under the Act ; (b) that the payments are made outside India ; and (c) that the payments are in the nature of royalties or fees for technical services. Ex facie, such payments accrue or arise outside India and will not be chargeable under the Act in the hands of the nonresident recipients and since Section 195 enforces the obligation of tax deduction only from payments which will constitute income chargeable to income-tax in the hands of the recipient, there will be no requirement on the part of ABC to withhold the Indian income-tax appropriate to the payments while making the same. However, an answer to question No. 12 cannot be furnished without considering two relevant provisions, one of the Act and one contained in the DTAA.21. The Act contains a very far-reaching provision which seems to impose an obligation on the head office of ABC for tax deduction even in respect of such payments. The relevant provision of the Act is Section 9(1) [Clauses (vi) and (vii)] which may be extracted here as they are relevant for our present purposes : "Section 9. (1) The following income shall be deemed to accrue or arise in India-. . .

(b) a person who is a resident, except where the royalty is payable in respect of any right, property or information used or services utilised for the purposes of a business or profession carried on by such person outside India or for the purposes of making or earning any income from any source outside India ; or (c) a person who is a non-resident, where the royalty is payable in respect of any right, property or information used or services utilised for the purposes of a business or profession carried on by such person in India or for the purposes of making or earning any income from any source in India : Provided that nothing contained in this clause shall apply in relation to so much of the income by way of royalty as consists of lump sum consideration for the transfer outside India of, or the imparting of information outside India in respect of, any data, documentation, drawing or specification relating to any patent, invention, model, design, secret formula or process or trade mark or similar property, if such income is payable in pursuance of an agreement made before the 1st day of April, 1976, and the agreement is approved by the Central Government . . .

(b) a person who is a resident, except where the fees are payable in respect of services utilised in a business or profession carried on by such person outside India or for the purposes of making or earning any income from any source outside India ; or (c) a person who is a non-resident, where the fees are payable in respect of services utilised in a business or profession carried on by such person in India or for the purposes of making or earning any income from any source in India : Provided that nothing contained in this clause, shall apply in relation to any income by way of fees for technical services payable in pursuance of an agreement made before the 1st day of April, 1976, and approved by the Central Government." 22. The effect of the above provisions is that though ABC is a non-resident and it may be making payments by way of royalty or technical fees to another non-resident person, such royalty or technical fees would be income deemed to accrue or arise in India and, consequently, chargeable to income-tax in the hands of the payee in the circumstances set out above. Counsel for the applicant says that there are several difficulties in imposing an Indian tax liability on a foreigner in respect of a transaction entered into by him outside India with another foreigner merely because the right, property, information or service in respect of which the payment is made happens to be used at some point of time for the purpose of carrying on a business, or for earning income from a source, in India. The acquisition of the right, property, information or services may have been made in different kinds of situations. The transaction may have been effected and the full payments also made long before the utilisation in India takes place ; the payee -- supplier of the technology or expertise or services may not have intended or anticipated or even known that such expertise, technology or services would be used in India ; the payment may have been made in respect of technology or services which are considerably added to, improved upon, updated or even changed beyond recognition by the payer before using it in his Indian business or source of income ; the utilisation may not be confined to India but may also extend to other countries which are in need of like technology or expertise and in which the person making the payment has business or source of income. It appears to us that whatever may be the difficulties of a person who is in receipt of amount of royalty, or fees for technical services which attract the provisions of Clause (c) of Section 9(1)(vi) and (vii) of the Act, the task before ABC which is the person making the payment is fairly simple. At the time when any amount of royalty or fees becomes payable (whether as a lump sum or as a periodically recurring amount). ABC cannot but be aware whether the payment is being made in respect of right, property, information or services used or utilised for the purpose of a business carried on by it in India or for the purposes of making or earning any income from any source in India.

There can be no difficulty, therefore, for ABC in identifying the payments made which will be chargeable to income-tax in India and withholding appropriate tax therefrom. If ABC is of the opinion that the whole of the payments made to any person may not be income chargeable to tax in the hands of that person either because the right, property, information or services are used or utilised not only in India but also elsewhere or for any other reason, it will be open to ABC to make an appropriate application under Section 195(2) of the Act and seek an authoritative determination, by the officer, of the rate of tax deduction. There is no difficulty or hardship to ABC in complying with the terms of the Act. Hence, if this provision of the Act alone were to be kept in view, it would appear that the head office will be under an obligation to deduct tax at source from the payments made to foreign suppliers of the kind discussed above.

23. However, the DTAA also deals with the same situation and while doing so, restricts the scope of applicability of Section 9(1)(vi) and (vii) to a certain extent. The terms of this article have been set out earlier. For the present discussion, reference may be made to para 7 of Article 13 of the DTAA. While the first sentence of the above para of Article 13 locates in India the situs of accrual of payments made to ABC by XY by way of royalties or technical services, the second sentence of the para squarely deals with situation presently under consideration. Here, ABC is the person paying the royalties and fees for technical services in question. Though ABC is not a resident of India, it has a permanent establishment in India in connection with which it proposes or expects to enter into the contracts under which it will have to pay the royalties and fees for technical services. This circumstance that the royalties or fees for technical service are paid in respect of information or services put to use in India is sufficient, under Section 9(1)(vi) and (vii) of the Act, to consider them as accruing or arising in India. But para 7 of Article 13 of the DTA requires the fulfilment of a further condition before such royalties and fees for technical services can be deemed to arise in India where it has a permanent establishment, viz., that the royalties or fees for technical services are borne by such permanent establishment. It is this condition that is not fulfilled in the present case. As has been discussed while dealing with earlier questions, the burden of payment of the royalties and fees for technical services in question is borne by the head office of ABC : such royalties or fees as ABC may receive from XY under the various agreements between them are received by it in its own right as beneficial owner thereof and cannot be treated as being in the nature of reimbursement to the head office of the royalties and technical fees paid by it, in its turn, for rights, property, information or services acquired by it from various other parties to enable it to fulfil and discharge its obligation to XY under the contract.

24. It is well established that where a matter is governed by the provisions of the Act and also by a DTAA, the provisions of the DTAA should prevail unless the statutory provision is more beneficial to the assessee. Reference may be made in this context to Section 90(2) of the Act, Circular No. 333, dated April 2, 1982, issued by the Central Board of Direct Taxes ([1982] 137 ITR (St.) 1) and the decision of the Madras High Court in CIT v. VR. S. R. M. Firm [1994] 208 ITR 400. It is clear from the above discussion that the payments made by the head office of ABC and referred to in the question cannot be deemed to accrue or arise in India and ABC is under no obligation to withhold Indian income-tax from those payments. Question No. 12 is answered accordingly.

25. This question has also to be dealt with on the basis that the receipts of ABC under the contract will be assessable under Article 7 and not Article 13 of the DTAA. This is, indeed, common ground between the applicant and the Commissioner's representative, though they are at variance as to the extent to which the receipts will be so assessable in India. Article 7.2 provides that the profits will be assessed on the same basis as if the permanent establishment is carrying on a separate and distinct enterprise and Article 7.3 is specific that the computation of the profits of the permanent establishment will be made after allowing the deduction of all expenses incurred for the permanent establishment, but only in accordance with and subject to the limitations of the Indian law. In other words, the computation has to be in accordance with the provisions of the Act which include not merely Sections 28 to 44C but Section 44D as well, which prohibits the deduction of any expenses against income in the nature of royalties and fees for technical services, the agreements we are concerned with being ones entered into after March 31, 1976. If, however, the agreements between ABC and XY can be brought within the purview of Section 115A of the Act, Sub-section (3) of that section precludes the application of Sections 28 to 44C and Section 57 of the Act and renders certain types of income taxable at a specified rate, but subject to certain conditions.

26. It will be appropriate, therefore, to consider the provisions of Section 115A first. Section 115A(1) consists of two clauses. Clause (a) applies to foreign companies as well as other categories of non-resident assessees and it covers a case where such assessee derives income by way of dividends or interest on monies lent in a foreign currency to the Government or to an Indian concern or income from units of certain mutual funds purchased in foreign currency. The present case does not fall in this category. Clause (b) deals with foreign companies whose income includes income by way of royalties and fees for technical services received from the Government or an Indian concern under an agreement entered into after March 31, 1976, as in the present case.

However, before Section 115A could apply to such agreement, where it is with an Indian concern, it should either be one approved by the Central Government or where the agreement relates to a matter included in the industrial policy of the Government of India for the time being in force, it should be one in accordance with that policy. If these conditions are fulfilled, the royalties and fees for technical services received by the applicant and included in its total income will be chargeable to tax at the rate of 30 per cent. There is, however, a disadvantage resulting from the applicability of the section which is that the rate of 30 per cent, will be applied to the entire gross receipts by way of royalties and fees for technical services without any deduction whatever for expenses which might have been available if they had been processed in the normal course as profits of business, under Sections 28 to 44C or as income from other sources, under Section 57. In the present case, the agreements have not yet been finalised and it is not possible to say whether they will receive the approval of the Central Government finally. As to the agreement being in relation to and in accordance with the Government's industrial policy no material was placed before the authority at the time of the hearing. However, the attention of the authority has subsequently been invited to a Statement on Industrial Policy tabled by the Government in both Houses of Parliament on 24th July, 1991. The relevant portion of the statement dealing with Foreign Technology Agreements is as follows : "39C. Foreign Technology Agreements.--(i) Automatic permission will be given to foreign technology agreements in high priority industries (annexure III) up to a lump sum payment of Rs. 1 crore, 5 per cent, royalty for domestic sales and 8 per cent, for exports, subject to total payments of 8 per cent, of sales over a ten year period from the date of agreement or 7 years from commencement of production. The prescribed royalty rates are net of taxes and will be calculated according to standard procedures.

(ii) In respect of industries other than those in annexure IV, automatic permission will be given subject to the same guidelines as above if no free foreign exchange is required for any payment ; (iii) All other proposals will need specific approval under the general procedures in force." 27. A copy of a Press Note (No. 10), dated August 14, 1991, issued by the Government of India, extracting the above paragraph from the Statement of Industrial Policy and setting out the detailed procedure for seeking approval of foreign technology agreements has been forwarded to ABC by X together with the remark that the present case will be governed by sub-para (iii) of para 39C and that "for our agreements to fall within the Industrial Policy of the Government of India, we require specific approval under the general procedures in force" and that, on receipt of the necessary approvals, the said agreements will meet the conditions required under Section 115A of the Act.

28. The above communication places the authority in an unenviable position. The agreements do not fulfill the requirements of Section 115A as on date and so the applicability of that section is out of question at present. But it is to be borne in mind that the formal agreements are yet to be executed and it is possible that the parties may seek to obtain, and succeed in obtaining, the approval of the Government and thus bringing the case within the scope of Section 115A of the Act. Question 13 has, therefore, to be answered in the alternative as to what the position would be in either event.

29. In case Section 115A does not apply, the answer to the question is simple and straightforward. The royalties and technical fees will be assessable in accordance with Part D of Chapter IV of the Act as business profits and in doing so, the provisions of Sections 28 to 44D will become applicable. The result, as pointed out earlier, will be that the gross amount of the profits assessable under Article 7 of the DTAA read with Sections 28 to 44D--this aspect is dealt with while dealing with questions Nos. 7 and 8 below--will be taxed at the rate appropriate to the profits of a business which in the case of the applicant--a foreign company--will be 55 per cent.

30. If, however, the agreement is got approved by the Government of India--and the option so to do rests with the parties and may be exercised, perhaps, in the light of the rulings given by the Authority--the terms of Section 115A will become squarely applicable to the case. It has already been pointed out that the terms of Article 13(6) of the DTAA invite the application of Article 7 and require the computation of the profits in accordance with the provisions of Sections 28 to 44D, of which Section 44C is a special provision applicable to foreign companies and Section 44D a special provision applicable to foreign companies having income by way of royalties and fees for technical services. Equally, Section 115A is a special provision applicable to foreign companies and purporting, apparently, to give them a concessional tax rate of 30 per cent, in respect of their income by way of royalties and technical fees, but to be computed on the gross receipts of this nature. There is no real conflict between these two sets of provisions, for while Chapter IV of Part D of the Act deals with the computation of the profits and gains of a business, Section 115A deals with the topic of the rate of tax applicable in certain cases. In the present case, the profits of ABC assessable to tax have to be ascertained and computed in the manner indicated, and to the total income so determined, the rates set out in Section 115A will apply. However, when we come to Section 115A, the rate of tax will be applicable differently to different sections of the income of the company. In the present case, the income of the company will consist mostly, if not wholly, of income of the nature of royalties and fees for technical services. At this stage, the fact that they have been assessed as part of the profits of a business would not affect the applicability of the standard rate set out in Section 115A(1)(b), for these receipts do not lose the character of being royalties or fees for technical services as defined in that section. They will, therefore, have to be charged, on the gross amount, at 30 per cent, thereof. In other words, the gross amount of royalties and fees for technical services would be charged to tax at 30 per cent.

31. Pausing here, it will be noticed that the above conclusion results in a somewhat anomalous situation. If the applicant's receipts had been assessed as royalties and fees for technical services simpliciter under Article 13 of the DTAA, the applicant could have insisted that they cannot be charged at a rate exceeding 20 per cent. However, the applicant will not be able to avail itself of this privilege or concession because the royalties and technical fees, having been derived in the course of a business carried on through a permanent establishment, have specifically been taken out of the purview of Article 13(1) and (2). The anomaly is one which arises, unfortunately, from the terms of the DTAA and cannot be helped. The net result of the discussion is that-- (a) if the provisions of Section 115A are not applicable to the present case, the profits attributable to the permanent establishment will be liable to be computed in accordance with Article 7 of the DTAA read with Sections 28 to 44D and the gross amount taxed at the rate appropriate to the amount thereof ; and (b) if the provisions of Section 115A are applicable to the present case, the profits attributable to the permanent establishment will be computed in accordance with Article 7 of the DTAA read with Sections 28 to 44D but the gross amount of the royalties and fees for technical services included therein will be charged to tax at the rate of 30 per cent, and the balance of the profits, if any, at the tax rate appropriate to the quantum thereof.

32. The above answer, however, is subject to a very important qualification. The answer given above turns on the definition of "royalties" and "fees for technical services" contained in Article 13(2) of the DTAA. But there is also a definition of these expressions in Explanation 2 to Section 9{l){vi) and (vii) of the Act. These definitions read as under : "Clause (vi)--Explanation 2.--For the purposes of this clause, 'royalty' means consideration (including any lump sum consideration but excluding any consideration which would be the income of the recipient chargeable under the head 'Capital gains') for- (i) the transfer of all or any rights (including the granting of a licence) in respect of a patent, invention, model, design, secret formula or process or trade mark or similar property ; (ii) the imparting of any information concerning the working of, or the use of, a patent, invention, model, design, secret formula or process or trade mark or similar property ; (iii) the use of any patent, invention, model, design, secret formula or process or trade mark or similar property ; (iv) the imparting of any information concerning technical, industrial, commercial or scientific knowledge, experience or skill ; (v) the transfer of all or any rights (including the granting of a licence) in respect of any copyright, literary, artistic or scientific work including films or video tapes for use in connection with television or tapes for use in connection with radio broadcasting, but not including consideration for the sale, distribution or exhibition of cinematographic films ; or (vi) the rendering of any services in connection with the activities referred to in Sub-clauses (i) to (v).

Clause (vii).--Explanation 2.--For the purposes of this clause, 'fees for technical services' means any consideration (including any lump sum consideration) for the rendering of any managerial, technical or consultancy services (including the provision of services of technical or other personnel) but does not include consideration for any construction, assembly, mining or like project undertaken by the recipient or consideration which would be income of the recipient chargeable under the head 'Salaries'." 33. While the definitions of the expression "royalty" under the Act as well as the DTAA are not materially different in their application to the facts of the present case, there is a variation between the definitions of "fees for technical services" contained in the Act and the DTAA which has some significance for the present case. If these definitions are compared, it will be seen that though the statutory definition of "fees for technical services" takes in consideration of any kind for the rendering of any managerial, technical or consultancy services, it does not include consideration for any construction, assembly, mining or like project undertaken by the recipient, a limitation which is not to be found in the definition embodied in the DTAA. The consequence is that, while for purposes of the DTAA, all payments made under the various agreements for services will qualify as "fees for technical services", such portions of the payments made under those agreements, if any, in consideration of construction, assembly or like project will not be treated as "fees for technical services" in the contexts where the application of the Act conies up for consideration. There are at least two such contexts--one is in regard to the applicability of Section 115A and the other is in regard to the applicability of Section 44D. Assuming that Section 115A applies to the present case and para (b) of the answer given in para 27 (at page 516) above becomes applicable, care has to be taken to see that the rate of 30 per cent, is applied only in respect of "royalties" and "fees for technical services" in their statutory meaning. Fees received in consideration of construction, assembly and the like included in ABC's profits determined as assessable under Article 7 will, however, be assessed--not at the rate of 30 per cent, but at the rate applicable to business profits. The second consequence of the distinction is that irrespective of whichever of the two alternatives set out in paras 27(a) and (b) (at page 516) is applicable, when the portion of the applicant's income which represents "fees for technical services" within the meaning of the DTAA is being processed under Article 7 read with the provisions of the Act, the embargo of Section 44D will not apply as this part of these receipts will not be "fees for technical services" within the meaning of that section. In other words, in determining the assessable profits of ABC in relation to such receipts, the applicant will be entitled to exclude the application of Section 44D and claim the deduction of expenses attributable to the earning of such income, if any. In other words, so far as this element included in the applicant's assessable profits is concerned two consequences follow : (i) that the rate of tax applicable thereto will not be 30 per cent, but will be the rate of tax appropriate to the total income of the company ; and (ii) that the amount of income of this description that will be taxable will be not the gross amount, but the net amount arrived at after deduction of expenses incurred for the earning of such income.

34. This aspect has become important since we find, on a perusal of the abstract of contents of the various agreements as stated by the applicant, that the "site services and assistance agreement" as well as the "project management services agreement" relate to the assembly and construction of the manufacturing plant and the industrial complex to be set up by ABC for XY. The consideration stipulated for these agreements will, therefore, fall outside the purview of the definition of "fees for technical services" under Explanation 2 to Section 9(1)(vii). In view of this, the answer given to question No. 13 in para 28 (at page 517) above will need to be modified by the addition of the following paragraph thereto : "(c) However, in either of the above events, the provisions of Sections 44D and 115A shall not be applicable in respect of that part of the receipts of ABC which represent payments in consideration of services under the agreements referred to at (f) and (g) of para 5 (at page 495) supra which relate to construction, assembly or like project with the result that only the net amount of such part of the receipts (after deduction of expenses permissible against them under Sections 28 to 44C or Section 57 of the Act) will be assessable to tax and that such net amount will be assessable not at the rate of 30 per cent, but at the rate of income-tax applicable to such income in the hands of a foreign company." 35. The above discussion leaves us free to tackle what are, perhaps, the really important questions raised by the applicant. The case of the applicant in regard to these questions has been set out in the revised annexure II. After pointing out that though the payments received by ABC from XY will be in the nature of royalties and fees for technical services, they will be assessable not under Article 13 but under Article 7 of the DTAA, the applicant states : "9. As per the provisions of Articles 7.1 and 7.2 the position of law as it emerges is that only the profits attributable to the permanent establishment of ABC are liable to be taxed in India and such profits are to be worked out as if the permanent establishment is an independent enterprise irrespective of the fact that it is a part of the company incorporated in France. The word 'profits attributable to the permanent establishment' as used in Article 7.1 and elaborated in Article 7.2 of the DTAA, have been explained in para 3 of the Protocol signed between Government of India and Republic of France which Protocol is an integral part of the DTAA. Para 3 of the said Protocol provides that if an enterprise of one Contracting States carries on business in another Contracting State through a permanent establishment constituted therein, the profits of that permanent establishment shall not be determined on the basis of the total amount received by the permanent establishment but shall be determined only on the basis of the remuneration which is attributable to the actual activities of the permanent establishment and for such business. In other words, if the permanent establishment of ABC in India carries on business in India, its income relating to the activities carried on in India alone will be liable to be taxed in India. Activities which are effectively connected with the business of the permanent establishment in India which are carried out by the applicant outside India will not be liable to be taxed in India." 36. As already briefly mentioned, the applicant had stated in annexure I that the USA and SA involve no consideration at all, while all the activities of the applicant under the LBEA will be only outside India.

In regard to the SSA, all the activities will admittedly be in India while the services under the other three agreements will be rendered partly in India and partly outside India. It is, therefore, contended that the profits attributable to the activities carried out outside India under the ESA, BSA and MSA alone can be brought to tax in the hands of ABC.37. The applicant's counsel, representing ABC, virtually reiterates this argument but with a slight legal refinement based on Article 7 read with Article 13 of the agreement. He points out that Article 13(6) lifts out of the purview of Article 13 and transposes to Article 7 all payments received as royalties or technical fees which are effectively connected with the permanent establishment in India. He says that all the royalties, etc., that may be received by ABC under the agreements, either for services, etc., in India or outside India, are effectively connected with the permanent establishment and are to be considered for assessment under Article 7. Article 7, however, provides for a bifurcation of the profits thus emerging into profits attributable to the operations in India and others and restricts the assessability to the former alone. Clause 3 of the Protocol then steps in to make it clear that profits attributable to the permanent establishment can only mean those attributable to the "activities in India" and none others.

The charge of tax on ABC, he says, should be so restricted.

38. On the other hand, the case of the Department is that this is a simple case of a French company carrying on business in India through a permanent establishment here. The business is that of a simple turnkey project of establishing a manufacturing plant and an industrial complex. XY is not really concerned with the details of the know-how, expertise or services made use of by ABC for setting up the plant and complex. ABC has agreed to set up the plant and complex in India and the work involves no structures or pipelines or other installations outside India. The transaction is something analogous to a sale in India of a fully equipped plant and complex. There is no specific provision in the agreements for transfer of any know-how or patents or other rights to XY. There is a single, indivisible contract performed and executed in India for which payment is to be made by XY. The control of the permanent establishment over the execution of the entire contract is dominant, effective, universal and all-pervasive. The entire profits from the contract accrue in India where the plant and complex are set up and the entire discussion about "outside" and "inside" activities involving various kinds of services, elaborately dissected and particularised in separate agreements, is totally artificial and irrelevant. The entire profits of the contract, computed under Sections 28 to 44D of the Act, and not merely a proportion thereof, will be assessable in the hands of ABC at the normal rate of tax applicable to foreign companies, viz., 55 per cent.

39. To make a proper approach to the questions posed, it is first necessary to analyse the principles enunciated in the Act and the DTAA for the determination of the income or profits of a non-resident which are taxable in India.

(a) To take up the Act first, the basic principle underlying it, is that a non-resident will be chargeable to tax on the income that accrues or arises to, or is received by him in India or that is deemed to so accrue, arise or be received. Two provisions in this regard need to be noticed : Section 9(1)(i) of the Act brings into the Indian tax net, all income of a non-resident which has some nexus in India which gives rise to the income such as a business connection, a property, an asset or source of income or a capital asset. Taking up the question of a business, a business connection is postulated where the non-resident does not carry on all the operations that give rise to the accrual or arisal of profits in India itself (i.e., where the entire business is in India) but carries on some systematic operations in India which, in a tangible and reasonable sense, can be treated as contributing to the accrual or arisal of the ultimate profits of the business. This concept has been fully explained by the Supreme Court in CIT v. R. D. Aggarwal and Co. [1965] 56 ITR 20. The question as to the place or places of accrual of the profits of such a business had been one of some controversy in the past but the principles are fairly well established now. The earlier concept that profits of a business arise only at the place where the sales take place was too simplistic and can no longer hold good, particularly in conditions of modern business which involve the exercise of skill and expertise at various stages, each of which adds to the value of the goods or services ultimately supplied. The decisions of the Supreme Court in the case of CIT v. Ahmedbhai Umarbhai and Co. [1950] 18 ITR 472 and Tata Iron and Steel Co. Ltd, v. State of Bihar [1963] 48 ITR (SC) 123 and other cases establish this general principle of distributive accrual. Section 9 has given statutory recognition to this principle. Section 9(1)(i) read with Explanation 1 thereto enacts that, where a non-resident earns income from a business the entirety of operations of which is not carried on in India, he/it will be taxable in India not on the totality of the profits of the business as a whole, but only on such part of the profits as is reasonably attributable to the operations carried out in India. This can be done in two ways. The profits attributable to the business operations in India can be separately ascertained and assessed, if that is possible. Or, alternatively, the entire profits of the business can be ascertained and a proportion thereof ascertained on some logical basis, such as turnover or relative importance of the several operations involved or the like attributed to the Indian operations. The profits so determined will be computed under Sections 28 to 44D of the Act and then brought to tax at the rate appropriate to such income or at special rates specified in the Act.

(b) Section 9(1)(vi) and (vii) of the Act enact a special rule in respect of the accrual of the income of a non-resident in the nature of royalty or fees for technical services and deems such income to accrue or arise in India in the circumstances set out in Clauses (a) to (c) thereof.

(a) The DTAA also proceeds on a like basis though the language used is somewhat different. It provides that a resident of France will be taxable in India on business profits, only where he carries on business through a permanent establishment in India and, further that he shall be taxed, not on the profits of the entire business but only on such part of the profits as are attributable to the permanent establishment. This, however, is somewhat wider than the scope of Clause (a) of Explanation (1) to Section 9(1)(i), because, it is just possible that the permanent establishment may be carrying out operations both in India and outside India, in which event the profits attributable to the permanent establishment will be not only the profits attributable to its operations in India but also the profits which are effectively connected with the permanent establishment, though such operations of the permanent establishment may be carried on outside India. It is, at this juncture, that the Protocol which is part of the DTAA between India and France assumes great significance. Clause (3) of the Protocol restricts the taxability of the business profits to that part thereof as is attributable only to the operations carried out by the permanent establishment in India. The net effect will practically be the same as of the application of Section 9(1)(i) read with its Explanation.

(b) The DTAA also proceeds to lay down separate rules for the assessability of payments in the nature of royalties and technical fees. The definitions of those expressions are analogous to, though not identical with, those contained in the Explanation to Section 9(1)(vi) and (vii) but for the purposes of the present case these definitions are not materially different. Both the definitions encompass the payments received by ABC from XY as consideration for various services. Article 13 provides : (a) that these types of receipts should be deemed to arise in India when the payer is a resident of India as in the present case (sub-paragraph 7) and (b) that they should not be charged to tax at a rate exceeding 20 per cent, on their gross amount (sub-paragraph 2). This, no doubt, is the general rule. But this "concessional rate", if one can call it so, will not apply and the payments will cease to be assessable in terms of Article 13 and become assessable in terms of Article 7 if :-- (i) the beneficial owner of these kinds of payments carries on a business in India through a permanent establishment ; (ii) the payments in question arise in the course of such business ; and (iii) the payments are effectively connected with such permanent establishment.

40. These three conditions are satisfied in the present case. But because of the restrictions imposed by Section 9 of the Act as well as paragraph 3 of the Protocol, the assessment should be restricted only to such part of the business profits as are attributable to the actual operations conducted by ABC in India.

41. The position will be no different even if one views the profits of ABC as arising from a contract entered into by it in the course of its business which, as mentioned at the outset, is that of execution of large infrastructure projects. With modern advances in scientific technologies, a single point accrual to the execution of such projects cannot be attributed as is suggested by the Department. It is too ingenuous to think, as was suggested by the Department, that what is essentially a simple transaction of "sale" of a "factory" in India has been artificially dissected and the various steps in the setting up of the "factory" magnified into a large number of separate agreements. It is not really so. The execution of a project of this magnitude involves the acquisition and development of various kinds of technologies, modern designs for fabrication of plants of varied categories, up-to-date engineering technology and expertise, installation techniques appropriate to the nature and situs of the factory, provision of start-up assistance and furnishing of periodical supplements from time to time. The setting up of such a plant is a formidable and complicated task requiring co-ordinated effort of specialists in varied fields of knowledge, information, experience and expertise. As has been mentioned in annexure I to the application, all these services, expertise and knowledge may be available with one person or may be acquired from different persons and it is not necessary, though perhaps very likely, that should XY's contract to ABC fructify, it should involve the rendering of all the services envisaged under the different agreements. The segmentation of the contract into agreements providing for various kinds of services is not artificial.

As urged on behalf of the applicant, in the context of the globalisation of trade and restrictions imposed under the GATT, all international agreements are sectionalised so as to define and segregate the part to be played by different areas of speciality involved in the execution of a project. It is difficult to accept the plea of the Department that this contract should be viewed as the simple one of putting up a project in India and that the analysis of the various kinds of operations involved therein and their location is artificial or meaningless. Even viewed as a business contract for the putting up of a plant in India, its execution involves operations involving rendering of services at various places in different areas of specialisation and, on a proper understanding of the provisions of the Act and the DTAA, only that part of the profits referable to the operations carried out in India can be brought to tax in India. The applicant has used the expressions "inside" and "outside" activities but it is advisable to adhere to the language of the statute and the DTAA.42. In the light of the discussion above, the answer to question No. 7 is that the payments under the agreements are taxable in terms of Article 7 read with Article 13(6) of the DTAA and the answer to question No. 8 is that in terms of Articles 7(1) and 7(2) of the DTAA read with paragraph 3 of the Protocol, the profits of ABC attributable to the operations carried out by its permanent establishment in India will alone be liable to tax in India.

43. To summarise, on the questions raised by the applicant, the Authority pronounces the following ruling : ABC is a person resident in France within the meaning of Article 4 of the DTAA.The PHO and PSO will together constituteABC's permanent establishment for the purposes of taxation of the income from the contract.

The payments made to ABC by XY under thevarious agreements proposed to be entered intobetween them will be in the nature of "royal-ties" and/or "fees for technical services" withinthe meaning of Article 13(3) and (4) of theDTAA.The royalties and fees for technical services inrelation to the "outside" activities of ABC areeffectively connected with the permanentestablishment of ABC in India.

ABC will be considered as the "beneficialowner" in terms of Article 13(6) of the DTAAof the royalties and technical fees received byit from XY in respect of the licence, technologyand basic engineering procured from its world-wide affiliates and/or third parties.

ABC will be considered as the "beneficialowner" in terms of Article 13(6) of the DTAAof the royalties and technical fees received byit from XY in respect of engineering servicesand buying services which it would sub-con-tract to its world-wide affiliates and/or thirdparties.

The payments under the agreements will hetaxable under Article 7 read with Article 13(6)of the DTAA.In view of Articles 7.1 and 7.2 of the DTAAread with paragraph 3 of the Protocol, onlythe profits of ABC attributable to the opera-tions carried out by its permanent establish-ment in India will be liable to tax.

The words "in accordance with the provisionsof and subject to the limitations of the taxa-tion laws of the Contracting State" used inArticle 7.3(a) of the DTAA, would attract, in thecomputation of the profits under Article 7, thelimitations and restrictions not merely of sec-tion 44C of the Act but of all other provisionscontained in the Act as well.

In view of Article 7(3)(b) of the DTAA, the pay-ments made by the permanent establishmentto the head office for procuring licence tech-nology and basic engineering services cannotbe considered as reimbursement and will,therefore, not be deductible in computing theprofits of the permanent establishment inIndia.

In view of Article 7(3)(b) of the DTAA, the pay-ments made by the permanent establishmentto the head office in respect of engineeringservices and buying services which may be sub-contracted by the head office to its world-wideaffiliates and third parties will not be consi-dered as reimbursement and will, therefore,be not deductible in computing the profits ofthe permanent establishment in India.

: The head office of ABC will not be liable towithhold taxes under the Income-tax Act ofIndia in respect of payments made by it toforeign suppliers (including ABC affiliates andsub-contractors) of goods, services and techno-logies.

(a) If the contract and agreements between ABCand XY do not receive the approval of theGovernment of India under section 115Aof the Act, the profits of the permanentestablishment in India will have to be com-puted as "profits and gains of business"under Part D of Chapter IV of the Act andbrought to tax at the rates applicable tothe total income of a foreign company.

(b) If, however, the contract and agreementsare approved by the Government of India,generally or with reference to the terms ofsection 115A of the Act, such profits willbe computed as mentioned above but willbe charged to tax at 30 per cent. on theamount of royalties and fees for technicalservices included therein and, at the rateapplicable to a foreign company, on thebalance thereof, if any.

(c) However, in either of the above events, theprovisions of sections 44D and 115A shallnot be applicable in respect of that part ofthe receipts of ABC which represent pay-ments in consideration of services underthe agreements referred to at (f) and (g) ofparagraph 5 (page 495) supra which relateto construction, assembly or like projectwith the result that only the net amountof such part of the receipts (after deduc-tion of expenses permissible against themunder sections 28 to 44C or section 57 ofthe Act) will be assessable to tax and thatsuch net amount will be assessable not atthe rate of 30 per cent, but at the rate ofincome-tax applicable to such income inthe hands of a foreign company.