Ishikawajma-Harima Heavy Industries Ltd.

v.
Director of Income-tax*

Main issues: 1. Whether mere existence of business connection may result in income to
non-resident assessee from transaction with such a business connection accruing or arising
in India
2. Whether income arising out of turnkey project executed in India
would be assessable in India, only because a non-resident has a permanent
establishment

3. Whether for attracting taxing statute, there has to be some

activity through permanent establishment and

4. Whether for section 9(1)(vii) to be applicable, it is

necessary that services provided by a non-resident assessee under a contract should
not only be utilized within India, but should also be rendered in India or should have such
a live link with India that entire income from fees as envisaged in article 12 of DTAA
becomes taxable in India

facts: In this case, the assessee company provided services to person resident in
India. It is a non-resident company incorporated in Japan. It formed a consortium
along with five other enterprises. The consortium was awarded by Petronet, a
turnkey project for setting-up a liquefied natural gas (LNG) receiving, storage and re-
gasification facility in Gujarat.
The aforesaid company was to develop, design, engineer, procure equipment,
materials and supplies, to erect and construct storage tank
The contract involved: (i) off-shore supply, (ii) off-shore services, (iii) on-shore
supply, (iv) on-shore services and (v) construction and erection.
 

The issue was: Whether the amounts, received/ by the appellant from 'P' for offshore supply
and offshore services of equipments, materials, etc., are liable to tax in India under the
provisions of the Act and India-Japan Tax Treaty
The contention of the appellant before the Authority was that the contract being a divisible
one, it did not have any liability to pay any tax
The revenue, on the other hand, contended that the contract being a composite and integrated
one, it was so liable.
The authority held In the favour of the revenue. Hence the appeal..
The contract in the instant case is a complex arrangement. 'P' and the appellant are not the
only partieso, there are other members of the consortium who are required to carry out
different parts of the contract.
Obligations and Price for each of the components of the contract is separate. Similarly
offshore supply and offshore services have separately been dealt with
The contract indisputably was executed in India. By entering into a contract in India,
although parts would have to be carried out outside India, that would not make the entire
income derived by the contractor to be taxable in India.

Then the SC interpreted section 9(1)(i).

Section 9(1)(i) states that income accruing or arising whether directly or indirectly, through
or from any business connection in India shall be deemed to accrue or arise in India.
Section 9 raises a legal fiction but it should be interpreted keeping in mind the object it tries
to seek. It should be read with other sections also.

The provisions of section 42 of the Income-tax Act, 1922 provide that only such part of
income as is attributable to the operations carried out in India would be taxable in India
Territorial nexus doctrine, thus, plays an important part in assessment of tax. Tax is levied
on one transaction where the operations which may give rise to income may take place partly
in one territory and partly in another.
Income arising out of operation in more than one jurisdiction would have territorial nexus
with each of
the jurisdictions on actual basis. If that be so, it may not be correct to contend that the entire
income
'accrues or arises' in each of the jurisdictions.

The principle of apportionment is also recognized by c Explanation 1 to section 9(1)(i). Thus,

if submission of the revenue is accepted that the contract is a composite one, then offshore
supply would
be of equipment designed and manufactured in one territory (Japan), and then sold in
another tax
territory, leading to division of profits arising in two tax territories, which is not envisaged
under Indian
taxation law.

It would give rise to the question as to what would be the meaning of the phrase 'business
connection in
India'. Mere existence of business connection may not result in income, to the non-resident
assessee from
transaction with such a business connection, accruing or arising in India.

The term 'permanent establishment' has not been defined in the Act. Since the appellant
carries on
business in India through a permanent establishment, it clearly falls out of the applicability
of article
12(5) of the DTAA but within the ambit of article 7 of DTAA. All income arising out of the
turnkey project would not, therefore, be assessable in India, only because
the assessee has a permanent establishment.

The distinction between the existence of a business connection and the income accruing or
arising out of such business connection is clear and explicit. In the instant case, the
permanent establishment's non- involvement in transaction in question excludes it from being
a part of the cause of the income itself, and thus there is no business connection.
For attracting the taxing statute there has to be some activities through permanent
establishment. If
income arises without any activity of the permanent establishment, even under the DTAA the
taxation
liability in respect of overseas services would not arise in India.

In cases such as the instant one, where different severable parts of the composite contract
are performed
at different places, the principle of apportionment can be applied, to determine which fiscal
jurisdiction
can tax that particular part of the transaction. Applying it to composite
transactions which have some operations in one territory and some in others, is essential to
determine the
taxability of various operations.

Therefore, the concepts of profits of business connection and permanent establishment

should not be
mixed up. Whereas business connection is relevant for the purpose of application of section
9, the concept
of permanent establishment is relevant for assessing the income of a non-resident under the
DTAA.

SECTION 9 HAS TO BE READ WITH SECTION 5, which takes within its purview the
territorial nexus on the basis whereof tax is required to be levied, namely (a ) resident; and
(b) receipt or accrual of income
What is relevant is receipt or accrual of income
Having regard to the internationally accepted principle and DTAA, it may not be possible to
give an extended meaning to the words 'income deemed to accrue or arise in India' as
expressed in section 9
Whatever is payable by a resident to a non-resident by way of fees for technical services,
thus, would not always come within the purview of section 9(1)(vii). It must have sufficient
territorial nexus with India so as to furnish a basis for imposition of tax.
It must have a direct live link with the services rendered in India. When such a link is
established, the same may again be subjected to any relief under DTAA

the provisions
of Article 7 would be applicable, as services rendered outside India would have nothing to do
with
permanent establishment in India. Thus, if any services have been rendered by the head
office of
appellant outside India, only because they were connected with permanent establishment,
principle of
apportionment shall apply.

The Authority has committed an error in this behalf. If services rendered by the head office
are
considered to be the services rendered by the permanent establishment, the distinction
between Indian
and foreign operations and the apportionment of the income of the operations shall stand
obliterated.

finally the court held with regard to offshore supply: Only such part of income, as is
attributable to the operations carried out in India can be taxed in India as contemplated
in Explanation 1(a) of section 9(1)(i ) Since all parts of the transaction in question, i.e. the
transfer of property in goods as well as the payment, were carried out outside the Indian soil,
the transaction could not have been taxed in India;
The principle of apportionment, wherein the territorial jurisdiction of a particular State
determines its capacity to tax an event, has to be followed
The fact that the contract was signed in India is of no material consequence, since all
activities in connection with the offshore supply are carried outside India, and therefore
cannot be deemed to accrue or arise in India
There exists a distinction between a business connection and a permanent establishment. As
the permanent establishment cannot be said to be involved in the transaction, the provision
of section 9 will have no application. The permanent establishment cannot be equated to a
business connection, since the former is for the purpose of assessment of income of a non-
resident under a Double Taxation Avoidance Agreement, and the latter is for the application
of section 9; (6) The existence of a permanent establishment would not constitute sufficient
'business connection',

Regarding offshore services:

Sufficient territorial nexus between the rendition of services and territorial limits of India is
necessary to make the income taxable; (2) The entire contract would not be attributable to
the operations in India
  For section 9(1)(vii) to be applicable, it is necessary that the services should not only be
utilized within India, but should also be rendered in India or should have such a "live link"
with India that the entire income from fees as envisaged in article 12 of DTAA becomes
taxable in India
Section 9(1)(vii)(c) in the instant case would have no application as there is nothing to show
that the income derived by a non-resident company irrespective of where rendered, was
utilized in India; (8) Article 7 is applicable in instant case, and it limits the tax on business
profits to that arising from the operations of the permanent establishment. In the instant case,
the entire services have been rendered outside India, and have nothing to do with the
permanent establishment, and can thus not be attributable to the permanent establishment
and, therefore, not taxable in India; (9) Applying the principle of apportionment to composite
transactions which have some operations in one territory and some in others, is essential to
determine the taxability of various operations
The location of the source of income within India would not render sufficient nexus to tax the
income from that source; (11) If the test applied by the Authority for Advance Rulings is to be
adopted, in the instant case too, then it would eliminate the difference between the
connection between Indian and foreign operations, and the apportionment of income
accordingly; (12)

The Supreme Court, in the case of Ishikawajma Harima Heavy Industries Ltd. v. Director of
Income-tax [2007] 288 ITR 408/158 Taxman 259, was dealing with the DTAA entered into
between India and Japan. What was in issue was the provisions of section 9(1)(vii)( b) and
section 9(1)(vii )(c) and whether the income receivable thereunder could be taxed in India.
Considering the law, the Supreme Court observed that for attracting the taxing statute,
there has to be some activity through the PE. If income arises without any activity of the PE,
even under the DTAA the taxing liability in respect of overseas services would not arise in
India.
The Parliament took note of that judicial pronouncement and inserted the Explanation in
section 9 by the Finance Act, 2007 with effect from 1-6-1976. According to
the Explanation, even if any non-resident has no PE, the income from royalty accrued or
paid by a resident would be deemed to be taxable in India. 
By this amendment the concept of having residence or place of business connection in India
has been done away with. 
The initial insertion of the Explanation under Section 9 removed the territorial nexus
requirements of business connection in India

By the Explanation it appears that the ratio of the judgment in Ishikawajma Harima Heavy
Industries Ltd.'s case (supra) is sought to be overcome by providing that even if any non-
resident has no PE the income from royalty accrued or paid by a resident would deemed to be
taxable in India.

In linklaters llp v. ITO, after the amendment, done away with the requirement of rendition
of the services in Inida. The Tribunal in this ruling applied the amendment and held that, the
rule laid down in Ishikawajma were now bad in law and that mere utilization of the services
in India was now sufficient to attract taxability in India.
CIT V SIEMENS 2009 BOMBAY HIGH COURT
It is evident that S.9(1)(vii), read in its plain sense, envisages the fulfilment of two
conditions: services which are source of income sought to be taxed in India must be
(i) utilized in India, and (ii) rendered in India. In the present case, both these
conditions have not been satisfied simultaneously.
So far, the normally accepted view in this regard has been that if the technical or
consultancy services in the context of S.9(1)(vii) of the Act, are utilized in India, then
the fees payable for the same are liable to tax in India, irrespective of the place
where such services are rendered.
The Apex Court has totally reversed the aforesaid view and has clearly held
that in the context of S.9(1)(vii), fulfilment of two conditions is envisaged. The
services which are source of income sought to be taxed in India, must be
utilized in India and also rendered in India. Both the aforesaid conditions must
be satisfied simultaneously. Therefore, if the technical or consultancy
services, though utilized in India, are rendered outside India, the fees for the
same will not be liable to tax in India within the provisions of S.9(1)(vii) of the
Act.

Hence, it is imperative that services provided to non-resident must have been both
provided in India and utilised in India if the fees are to be taxed.
After this decision, Finance Act, 2007 instilled an amendment by adding an explanation
–

Explanation- "For the removal of doubts, it is hereby declared that for the purposes
of this section, where income is deemed to accrue or arise in India under clauses (v),
(vi) and (vii) of sub-section (1), such income shall be included in the total income of
the non-resident, whether or not the non-resident has a residence or place of
business or business connection in India."
The initial insertion of the Explanation under Section 9 removed the territorial nexus
requirements of business connection in India.
Revenue loss na ho

Source of revenue.. good for growth of india..