Ishikawajima-Harima survives the retrospective amendment in section 9 (1) (vii) – Income from Offshore Services not taxable despite PE in India:

The decision of the Tribunal, according to me, should serve sufficient notice to crafty law makers that domestic laws should not be amended to usurp jurisdictions which are internationally forbidden. The sanctity of taxing according to one’s own territorial jurisdiction is well protected in the international law contained in tax treaties

The decision of the Mumbai Tribunal in the case of IHI Corporation vs. Addl. Director of Income Tax (International Taxation} [2013] 32 taxmann.com 132 {Mumbai –Trib} presents an interesting study regarding the impact of the retrospective amendment in section 9 (1)(vii) retaliating the decision of the Supreme Court in Ishikawajima-Harima Heavy Industries Ltd. vs. DIT (2007) 288 ITR 408 (SC).

The Supreme Court, in this case, on the subject of taxation of income from offshore services in context of section 9 (vii) of the Income Tax Act 1961 [ i.e. fees for technical services] and the provisions of the Indo-Japan DTAA had settled the following principles –

(a) In order that section 9 (1)(vii) be applicable, it is not just necessary that the technical services must utilized within India. It is also essential that the services must be rendered in India.

(b) Merely because the source of income exists in India, the same is not sufficient to subject the said income to tax entirely in India. Mere location of the source of income within India does confer sufficient nexus to tax the income from that source. The existence of territorial nexus is also essential.
If any operations deriving the income are not rendered in India, then the income relating to such operations cannot also be taxed in India. The income having territorial nexus with India must be determined on basis of apportionment and then taxed.

(c) Merely because offshore services of the assessee are effectively connected with a permanent establishment in India, it cannot render the assessee’s income entirely taxable in India. What can be taxed is only that portion of income which is attributable to the activities of the permanent establishment in India.

To counter this Supreme Court decision, the Legislature had introduced a new Explanation in section 9, that income of a non resident shall be deemed to accrue or arise in India in terms of clause (vii) of section 9 (1), whether or not the non resident has rendered services in India or not.

The decision of the Mumbai Tribunal in the IHI Corporation comes in the aftermath of this amendment. The decision of the Supreme Court in the case of Ishikawajima-Harima Heavy Industries Ltd. vs. DIT (2007) 288 ITR 408 (SC) is stated to be the assessee’s own case in the Tribunal decision.

Thus, following the Supreme Court decision, as passed in its own case, the Tribunal has held that the income from offshore services was not taxable. The reasoning, on which the decision has been rendered, is summarized as under :-

(a) Since the offshore services are admittedly in the nature of fees for technical services as understood in section 9 (1)(vii), the same will be taxable despite the fact that the same are not rendered in India in view of the retrospective amendment.

(b) Article 12 (5) of Indo-Japan DTAA provides that if the beneficial owner of the fees for technical services carries on business in India through a permanent establishment and the contract, in respect of which the fees for technical services is paid, is effectively connected with such permanent establishment, then the provisions of Article 7 {Business Profits} and not Article 12 {Fees for Technical Services}shall apply.

In the assessee’s case, the Tribunal found that the offshore services payments to the non resident assessee were in respect of a contract which was effectively connected with permanent establishment. Hence, it held that the question of taxation of the same must be considered under the provision of Article 5 {Business Profits}.

{d} If the provisions of Article 5 {Business Profits} are applied, then the income from offshore services cannot be taxed in India even though the assessee carried on business in India through a permanent establishment and the contract in respect of which the offshore services payments is effectively connected with this permanent establishment. This is because what can be taxed in India is only the income attributable to the permanent establishment. The activities relating to the offshore activities are not rendered in India and therefore, its income cannot be attributed to the permanent establishment by apportionment

The Tribunal thus found that since the provisions of the Indo-Japan DTAA were more beneficial to the assessee than the provisions of section 9 (1) (vii) of the Income Tax Act 1961, the assessee had the right u/s 90 to be assessed as per the DTAA. Based on this reasoning, the income from the offshore services was held not taxable in India.

The decision of the Tribunal, according to me, should serve sufficient notice to crafty law makers that domestic laws should not be amended to usurp jurisdictions which are internationally forbidden. The sanctity of taxing according to one’s own territorial jurisdiction is well protected in the international law contained in tax treaties.