The Indian Income Tax Appellate Tribunal (ITAT) delivered a ruling dated 18 August 2006 in the case of Deputy Commissioner of Income Tax v. Roxon OY (103 TTJ 891) on whether profits from the supply of equipments under a turnkey project executed in India were taxable in India under the India-Finland tax treaty (the tax treaty).
(a) Facts. The taxpayer (i.e. Roxon OY) was a non-resident company incorporated in Finland. It was part of a consortium of companies, which were awarded a turnkey contract to design, manufacture, deliver, erect, test and commission certain bulk handling facility and to impart training to Nava Sheva Port Trust (NSPT). Under the contract, the taxpayer supplied the required equipment which came from outside India and also sent its employees to India for the purposes of erecting, commissioning and training. The taxpayer filed its tax return in India showing profits attributable to its permanent establishment (PE) in India, at a loss.
The tax authorities noted that the supply of equipment from overseas was essentially linked to the work (erection, etc.) performed in India and without such supply, the taxpayer could not have carried out such work in India. Accordingly, the tax authorities took the view that there would be certain work, which would have been performed outside India (value estimated at 20% of gross receipts), which was liable to tax in India. On appeal by the taxpayer, the Commissioner of Income Tax (Appeals) allowed the appeal on the grounds that revenue arising to the taxpayer from the activities performed outside India was not chargeable to tax in India. The tax authorities then appealed to the ITAT for its ruling.
(b) Issue. The key issue before the ITAT was whether the taxpayer was liable to tax in India in respect of profits from supply of equipments by its head office to NSPT in India.
(c) Decision. The ITAT ruled that, under the tax treaty, the taxpayer was not liable for those profits from supply of equipments by its head office under a turnkey contract.
The ITAT observed that the scope of Art. 7 of the tax treaty extends only to "same or similar activities" of the resident of a contracting state as are carried out through the PE in the other contracting state. The ITAT held that just because the taxpayer had procured equipment locally to be used in the installation and commissioning works, one cannot come to the conclusion that the taxpayer was engaged in selling "same or similar goods or merchandise" through its PE (i.e. equating the supply of locally procured equipment with the supply of equipment by its head office to NSTP).
The ITAT also observed that profits attributable to the supply of equipment cannot be brought to tax in India under Art. 7(1)(a) of the tax treaty unless there was a PE and in this case, the PE came into existence only after the transaction giving rise to supply of equipment had materialized. The ITAT went on to hold that in the case of a turnkey contract, the taxability is restricted to profits, which are attributable to work effectively carried out by the PE. Under Art. 7(1)(b) of the tax treaty, direct sales by a foreign enterprise would be covered by the "force of attraction" principle only where the PE is engaged in "selling goods or merchandise of the same or similar kind". Because, in the taxpayer's case, there was no evidence to suggest that the equipment directly sold by the taxpayer's head office to NSPT were same or similar to the equipment sold through the PE, Art. 7(1)(b) of the tax treaty was not applicable.
The ITAT observed that as per Art. 7(2) of the tax treaty, profits attributable to a PE are the profits, which are derived by independent enterprises (under arm's length situation) engaged in the "same or similar activities" under "same or similar conditions". Therefore, in this case, no part of the profits on the supply of equipment could be treated as attributable to the PE unless it is shown that the supplies were not at an arm's length price to the PE. Further, the ITAT observed that in the taxpayer's case, the equipment supply price did not include any price towards the service element and therefore, no further profits could be attributed to the PE.Accordingly, the ITAT concluded that the profits from supply of equipments by the taxpayer under the turnkey contract were not taxable in India under the tax treaty as the profits were not attributable to PE in India.