Holding

Only the portion of income that is reasonably attributable to operations carried out in India is taxable; offshore supply and services performed wholly outside India are not taxable in India, and the principle of apportionment must be applied.

Summary

Ishika Wajma‑Harima Heavy Industries Ltd., a Japanese company, entered into a turnkey LNG project contract with Petronet LNG Ltd. that involved offshore supply of equipment, offshore services, onshore supply, onshore services and construction. The company sought an advance ruling on whether the amounts received for offshore supply and offshore services were taxable in India under the Income Tax Act, 1961 and the India‑Japan Double Taxation Avoidance Agreement (DTAA). The Authority for Advance Rulings held that the offshore portions were taxable, but the Supreme Court examined the contractual segregation, the concept of business connection versus permanent establishment, and the principle of apportionment. The Court held that only the portion of income attributable to operations actually carried out in India could be taxed, and that offshore supply and services performed wholly outside India did not create a taxable nexus. Consequently, the appeal was partly allowed, limiting tax liability to the Indian‑connected portion of income and rejecting the Authority’s broader view.

Issues considered

Whether amounts received for offshore supply of equipment and materials are taxable in India under the Income Tax Act and the India‑Japan DTAA.
If taxable, to what extent are such amounts attributable to operations carried out in India.
Whether amounts received for offshore services are taxable in India under the Act and the DTAA.
If taxable, the extent of taxability of offshore services income.
Whether the appellant is entitled to claim deductions for expenses incurred in computing income from offshore services.

Legislation cited

Income Tax Act, 1961s. 24I(q)(J), s. 42, s. 5(2), s. 9(1)(i), s. 9(1)(vii)(c)

Subjects

income taxoffshore supplyoffshore servicesbusiness connectionpermanent establishmentdouble taxation avoidance agreementapportionmentterritorial nexuscomposite contractturn‑key project

Judgment

A ISHIKA WAJMA-HARIMA HEAVY INDUSTRIES LTD.
V.
DIRECTOR OF INCOME TAX, MUMBAI

JANUARY 4, 2007

B [S.B. SINHA AND DAL VEER BHANDARI, JJ.]

income TaxAct, 1961; ss. 5, 9, 42 and 24I(q)(J) of Double Taxation
Avoidance Agreement, Clauses 5 and 7, Article I 2: income tax liability-
A foreign company entering into a contract with an Indian company for
C offshore supply of equipments and providing services-Tax liability--
Extent of-Held: Contract executed in India-Since part thereof has to be
carried out outside India, entire income derived by Contractor would not
be taxable in India-Income arising from a business connection could be
assessed keeping into consideration terms of the agreement and s.9 of the
Act-Income arising out of operation in more than one jurisdiction would
D have territorial nexus with eachjurisdiction on actual basis-Tax liability
on income of assessee would depend upon the facts of each case-income
earned by assessee from offshore and onshore supply of goods and services
clearly demarcated-Therefore, principle ofapportionment could be applied
to determine fiscal jurisdiction to assess tax liability-Merely because
E assessee is a non resident having business connection in India, his income
may not be treated as accruing in India-In terms of provisions in DTAA,
income arising out of turnkey project as in the instant case would not be
assessable in India only because the assessee had a permanent establishment
in India-In terms of s.9(J)(vii)(c) of the Act, a non-resident could be taxed
F on income for services rendered in India-In the facts and circumstances
of the case, in te1ws of Double Taxation Avoidance Agreement and
provision of the Act, only such part of income as attributable to the
operation carried out in India could be taxed in India.
)--

Existence of business connection and income accruing or arising out
G of such business-Distinction between-Discussed.

Doctrines:

Doctrine of territorial nexus-Applicability of in the context of
H assessment of tax liability.
112
)r_

ISHIKAWAJMA-HARlMAHEA VY INDUSTRIES LTD. 1·. DIRECTOR OF INC<:JME TAX, MUMBAI 113

Appellant, a company incorporated in Japan, is engaged in the business A
·- ,,, ?'
of construction of storage tanks as also engineering equipments etc. It
formed a consortium along with other companies and entered into an
agreement with an Indian company for setting up a Liquefied Natural Gas
(LNG), a project, receiving storage and degasification facility in the State
of Gujarat. The contract envisaged a turnkey project. Role and responsibility
of each member of the consortium was specified separately. Each of the
B
member of the consortium was to receive separate payments. The project
was to be completed in 41 months. The contract mainly involved: (i) offshore
supply, (ii) offshore services, (iii) onshore supply, (iv) onshore services and
(v) construction and erection. The price payable for offshore supply and
offshore services was in US dollars, whereas that of onshore supply as also c
onshore services and construction and erection partly in US dollars and
partly in lndian rupees.

Liability to pay income tax in India by the appellant being doubtful, an
application was filed by the appellant before the Authority for Advance
Rulings (Income Tax) in terms of Section 241 (Q)(l) of the Income Tax Act, D
1961. The following questions were proposed by the appellant for
) determination by the Authority:

"l. On the facts and circumstances of the case, whether the amounts,
received/receivable by the applicant from the Indian company for offshore E
supply of equipments, materials, etc. are liable to tax in India under the
provisions of the Act and India-Japan tax treaty;

2. lfthe answer to (1) is in the affirmative in view of Explanation (a)
to section (l)(i) of the Act and/or Article (1) read together with the protocol
of the India-Japan tax treaty, to what extent are the amounts reasonably F
attributable to the operations carried out in India and accordingly taxable
in India;

3. On the facts and circumstances of the case, as to whether the
amounts received/receivable by the applicant from the Indian company for G
offshore services are chargeable to tax in India under the Act and/or the
India-Japan tax treaty;

) 4. lfthe answer to (3) above is in the affirmative, to what extent would
be amounts received/receivable for such services be chargeable to tax in
India under the Act and/or the India-Japan tax treaty; H
114 SUPREME COURT REPORTS [2007] 1 S.C.R.

A S. If the answer to (3) above in the affirmative, would be applicant be
entitled to claim deduction for expenses incurred in computing the income
from offshore services under the Act and/or the India-Japan treaty."
\
The dispute centered round its exigibility to pay tax in respect of
'offshore supply' and 'offshore services'. The Government oflndia and the
B Government of Japan entered into a by-lateral treaty on "Double Taxation
Avoidance Agreement" (DTAA) in regard to the tax liabilities. The Authority
opined that having regard to the provisions contained in Section S read with
Section 9 of the Income Tax Act, following propositions of law would ,
emerge:
c "(1) In a case of sale of goods simpliciter by a non-resident to a
resident in India, if the consideration for sale is received abroad and the
property in the goods a lso passes to the purchaser outside India, no income
1

accrues or arises or deemed to accrue or arise to the seller in India.

D (2) In a case of transaction of sale of goods by the non-resident to an
Indian resident which is a part of a composite contract involving various
operations within and outside India, income from such sale shall be deemed
to accrue or arise in India if it accrues or arises through or from any
business connection in India.

E (3) In the case of a business of which all operations are not carried
out in India, the deemed accrual or arising of income shall be only such
part of the income as is reasonably attributable to the operations carried
out in India.

F (4) As to whether there is business connection in India or/and as to
whether all operations of the business are not carried out in India are
questions of fact which have to be determined on the facts of each case."

Applying these principles to the facts of the present case, the Authority
opined that the appellant-assessee was liable to pay direct tax even under
G the Treaty having regard to Articles S and 7 thereof as also Clause 6 of
the Protocol. As regards taxability of the amounts 'received' and 'receivable'
by the assessee from other company for offshore services, it was held that
the whole technical fee without any deduction is chargeable to tax, however,
the tax so charged shall not exceed 20% of the gross amount of the royalty
H or fee for technical services.
ISHIKAWAJMA-HARIMAl-IEA \'Y INDUSTRIES LTD 1: DIRECTOR OF INCO~IETAX. MUMBAI 115

Question Nos. 4 and 5 were held to be the consequential ones. A
~ • _.. Assessee challenged the findings of the authority by filing the appeal
before this Court.

Appellant-assessee contended that the Authority misconstrued and
misinterpreted the contract in arriving at its findings, as from a bare
perusal thereof, it would appear that the payments were made in US dollars B
in respect of 'offshore supply' and 'offshore services' and furthermore title
to the goods passed on to the Indian company outside the territories of India
and services had also been rendered outside India; that the fact that the
contract signed in India was of consequences as converse could not have
made the assessee not liable to pay the tax; that the Authority committed C
a manifest errur in arriving at its findings insofar as it failed to properly
construe Explanation-2 appended to Section 9(l)(vii) of the Act related to
a construction, assembly, mining or like project so as to fall outside the
scope thereof; that although fee received by the assessee is effectively
connected to the contract but it is not attributable to the permanent D
establishment and, therefore, Article 12(5) of the Double Taxation Avoidance
Agreement (DT AA) is not attracted; that assessee being a non-resident in
terms of Section 5(2) of the Act, it would be chargeable to tax in India only
in the event income accrues or arises in India or is deemed to accrue or
arise in India or income is received or is deemed to be received in India
and not otherwise; that as no part of the income for the 'offshore supply' E
or 'offshore services' is received in India, the Authority misdirected itself
in passing the impugned judgment; that a legal fiction raised under the Act
cannot be pushed too far. Also, as all operations in connection with the
offshore supply are carried out outside India, the question of any portion
of the consideration to be regarded as deemed to accrue or arise in India F
would not arise; that the requirement of the assessee to perform certain
services in India, such as unloading, port clearance, transportation of the
equipments supplied would not render him eligible to tax as the consideration
thereof is embedded in the consideration for the offshore supply; that
although he was required to carry out certain activities in India, the
consideration for offshore services had separately been provided for; and G
that assuming that the income from the offshore supply is chargeable to
tax in India on the premise that Section 9(1)(i) applies, it was required to
be examined by the Authority as to whether it would also be chargeable in
)
accordance with the provisions of the Double Taxation Avoidance Agreement
H
116 SUPREME COURT REPORTS [2007) I S.C.R.

A (DTAA) in terms whereof no charge to tax in India was leviable in·respect
of the consideration·for offshore supply. " .-
Respondent submitted that the question as to whether terms of the
contract constitute a composite contract or not is essentially a question of
fact and the findings of the Authority being final, therefore, should not
B ordinarily be interfered with; that each component of the contract·was
directly relatable to the performance of the integrated contract as violation
and/or breach on the part of the parties thereto would affect the entire
contract; that the contract itself providing for milestone dates, the breach
of any of the terms thereof would result in the breach ofthe·entire contract
c and not just the particular obligation; that the turnkey project contemplated
a permanent establishment and in that view of the matter Explanation
appended to Section 9(1)(i) of the· Act is directly applicable; that the
appellant has business connection in India and in that view of the matter
the causal connection between ·the·offshore supply and offshore services
being interlinked with the entire project, the opinion of the Authority
D
cannot be faulted; that by reason ofDTAA, the parties thereto can always
allocate the jurisdiction to tax the entire income attributable to such
permanent establishment to the country in which it is established; and that -'.
supply of goods whether offshore or onshore as well as rendition of service
whether offshore or onshore are attributable to the turnkey project and,
E thus, it would be wrong to contend that in terms of Article 7 of DTAA, no
tax could be levied upon the assessee.

Partly allowing the appeal, the Court

p HELD:• 1.1. The very fact that in the contract; the supply segment
and service segment have been specified in different parts of the contract
is a pointer to show that the liability of the assessee thereunder would also
be different. The contract was executed in India. By entering into a contact
in India, although parts thereof will have to be carried out outside India
would not make the entire income derived by the contractor to be taxable
G in India. [Paras 22 and 231 [140-H, 141-A)

1.2. The provisions with regard to offshore supplies and offshore
services wereto be read with the provisions contained in the agreement'Ex.
D which formed the basis of customs,duty; Clause 13.4 of the agreement "-
H refers to Ex.Das the basis for price escalation. The question of imposition
):

ISHIKAWAJMA-HARJMAHEAVY INDUSTRIES LTD. v. DIRECTOR OF INCOME TAX, MUMBAI 117

of tax on income arising from a business connection may, thus, have to be A
considered keeping in view the terms of the agreement.
[Paras 25 and 26] [141-E-FJ

1.3. Section 9 of the Income Tax Act raises a legal fiction; but having
regard to the contextual interpretation and furthermore in view of the fact
that in dealing with a taxation statute the legal fiction must be construed B
having regard to the object it seeks to achieve. The legal fiction created
under Section 9 of the Act must also be read having regard to the other
provisions thereof. [Para 28) (141-H, 142-A)

Maruti U.iyog Ltd. v. Ram Lal and Others, (2005) 2 SCC 638, relied
on. c
1.4. Section 42 of the Income Tax Act, 1922 provided that only such
part of income as was 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
D
the operations which may give rise to income may take place partly in one
territory and partly in another. (Paras 29 and 30] (142-B, CJ

1.5. Income arising out of operation in more than one jurisdiction
would have territorial nexus with each of the jurisdiction on actual basis.
If that be so, it may not be correct to contend that the entire income E
'accrues or arises' in each of the jurisdiction. The Authority has proceeded
on the basis that supplies in question had taken place offshore. It, however,
has rendered, its opinion on the premise that offshore supplies or offshore
services were intimately connected with the turnkey project.
[Para 31) [142-D)
F
N. Khadervali Sahib (Dead) by L.Rs. and Another v. N. Gudu Sahib
(Dead) and Others, [2003} 3 SCC 229 and Hindustan Shipyard Ltd. v. State
of A.P., [2000} 6 SCC 579, referred to.

1.6. It is only for the purpose of taxability that the terms of the
contract are required to be construed. A turnkey contract may involve
G
supply of materials used in the execution of the contract for price as also
for use of the materials by works and labour; but the same may not have
)
any relation with the taxability part of it. [Para 38] [143-H, 144-A]

State of Madras v. Gannon Dunkerley & Co. (Madras) Ltd., (1959] H
118 SUPREME COURT REPORTS [2007] 1 S.C.R.

A SCR 379; State of Rajasthan v. Mis Man Industrial Corporation Ltd.,
[1969) 1 SCC 567; Mis Patnaik and Co. Ltd v. Commissioner of Income
Tax, Orissa, [1986] 4 SCC 16 and BSES Ltd. (Now Reliance Energy Ltd.)
v. Fenner India Ltd. and Another, [2006) 2 SCC 728, held not applicable.

1.7. Tax under the Act has to be assessed under different heads.
B Income under one head may be subject to exemption; under same head,
ded~ctions may be claimed; yet under another, no tax may be payable at all.
Whether a part of the income of the assessee would be taxable or not
depends upon the fact of each case. [Para 42] [145-H, 146-A)

Union of India and Another v. Azadi Bachao Ando/an and Another,
c (2004) 10 SCC 1; Commissioner of Income Tax, Bombay v. Ahmedbhai
Umarbhai & Co., Bombay, [1950] SCR 335; Commissioner of Taxation v.
Kirk, (1900] AC 588; Carborandum Co. v. Commissioner of Income-Tax,
Madras, [1977] 108 ITR 335: [19771 2 SCC 862 and Commissioner of
Income Tax, Punjab v. R.D. Aggarwal and Co.& Another, [1965) 56 ITR
20, relied on.
D
Anglo-French Textile Co. Ltd. v. Commissioner ofIncome Tax, Madras,
[1954] SCR 523, referred to.

1.8. In the instant case, since the payment for the offshore and
onshore supply of goods and services was in itself clearly demarcated and
E therefore it cannot be held to be a complete contract that has to be read as
a whole and not in parts. [Para 52] [150-B]

CIT v. Mitsui Engineering and Ship Building Co. Ltd., 259 ITR 248,
distinguished.
F 1.9. Principle of apportionment is recognized by Clause (a)
·of Explanation I. Thus, if submission of the Additional Solicitor General
is accepted that the contract is a composite ooe, th-en 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
G arising in two tax territories, which is not envisaged under taxation law in
India. [Para 53] [150-D] -

1.10. Mere existence of business connection may not result in income
of the non-resident assessee from transaction with such a business
connection accruing or arising in India. [Para 54] [150-E]
H
ISHIKAWAJMA-HARIMA HEAVY INDUSTRIES LTD. v. DIRECTOR OF INCOME TAX. MUMBAI 119

Mazagaon Dock Ltd. v. CIT and Excess Profits Tax, 34 ITR 368; A
Anglo French Textile Co. Ltd. v. CIT Madras, 23 ITR 101 and Barendra
Prasad Ray v. ITO 129 ITR 295, held in applicable.

Commissioner of Income-Tax v. Atlas Steel Co. Ltd., [1987J 164 ITR
401; Income-Tax Officer and Others v. Shriram Bearings Ltd., [1987) 164
ITR 419 and Income-Tax Officer and Others v. Shriram Bearings Ltd.,
B
; [1997) 224 ITR 724 : [1997) 10 SCC 332, referred to.
'

. 2.1. In construing a contract, the terms and conditions thereof are to
·' be read as a whole. A contract must be construed keeping in view the
intention of the parties. No doubt, the applicability of the tax laws would c
\.
depend upon the nature of the contract, but the same should not be
construed keeping in view the ta:i::ing provisions. (Para 65) (153-G)

Commissioner ofIncome-Tax, Tamil Nadu-Vv. Fried Krupp Industries,
(1981) 128 ITR 27
D
2.2. Since the appellant carries on business in India through a
Permanent Establishment, they clearly fall out of the applicability of Article
12(5) of the Double Taxation Avoidance Agreement (DTAA) and into the
ambit of Article 7. The permanent establishment here h_itsJiad no role to
play in the transaction.that is sought to be taxed, since the transaction took E
place abroad. [P~ra 68f (154-G, H, 155-A)
""'!!"""

2.3. Clause 1 of Article 7 of DT AA provides that if an income ar!ses
in Japan (Contracting State), it shall be taxable in that country unless the
enterprise carries on business in the other Contracting State (India)
F
through a permanent establishment situated therein. What is to be
taxed is profit of the enterprise in India, but only so much of them as is
directly or indirectly attributable to that permanent establishment.
All income arising out of the turnkey project would not, therefore,
be assessable in India, only because the assessee has a permanent
establishment. (Para 69) (155-B] G

2.4. 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 present case, the permanent estabJishment'g non-
involvement in the business transaction excludes it from being a part of the H
120 SUPREME COURT REPORTS [2007] I S.C.R.

A cause of the income itself, and thus there is no business connection.
[Para 72] [156-G, Hl
\...

2.5. For attracting the taxing statute there has to be some activities
through permanent establishment. If incorrie arises without any activity of
the permanent establishment, even under the DT AA the taxation liability
B in respect of oversea services would not arise in India. Section 9 spells out
the extent to which the income of non-resident would be liable to tax in
India. Section 9 has a direct territorial nexus. Relief under a Double
Taxation Treaty having regard to the provisions contained in Section 90(2)
of the Income Tax Act would arise only in the event a taxable income of the
C assessee arises in one Contracting State on the basis of accrual of income
in another Contracting State on the basis of residence. Thus, if assessee
had income that accrued in India and is liable to tax because in its
State all residents it was entitled to relief from such double taxation
payable in terms of Double Taxation Treaty. However, so far as accrual of
income in India is concerned, taxability must be read in terms of Section
D
4(2) read with Section 9 of the Act, whereupon the question of seeking
assessment of such income in India on the basis of Double Taxation Treaty
would arise. (Para 74) [157-D, E, F)

2.6. In cases such as this, where differe!lt severable parts of the
E composite contract is performed in different places, the principle of
apportionment can be applied, to determine which fiscal jurisdiction can tax
that particular part of the transaction. (Para 75) (157-F)

2.7: The concepts 'profits of business connection' and 'permanent
F 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 DT AA. [Para 76) (158-A]

2.8. The entire transaction having been completed on the high seas,
G the profits on sale did not arise in India, as has been contended by the
assessee. Thus, having been excluded from the scope of taxation under the
Act, the application of the double taxation treaty would not arise. Double Tax
.....
Treaty, however, was taken recourse to by assessee only by way of an
alternate submission on income from services and not in relation to the tax
H of offshore supply of goods. [Para 76) [158-B, CJ
ISHIKAWAJMA-HARIMA HEAVY INDUSTRIES LTD. v. DIRECTOR OF INCOME TAX, MUMBAI 121

3.1. Parties were ad idem that there existed a distinction between A
onshore supply and offshore supply. The intention of the parties, thus, must
be judged from different types of services, different types of prices, as also
different currencies in which the prices are to be paid. (Para 77) [158-B)

3.2. Reading the provision of Section 9(1)(vii)(c) of the Act in its
plain sense, it can be seen that it requires two conditions to be met - the B
services which are the source of the income that is sought to be taxed, has
to be rendered in India, as well as utilized in India, to be taxable in India.
/ In the present case, both tl}ese conditions have not been satisfied
simultaneously, therefore. excluding this income from the ambit of
taxation in India. Thus, for a non-resident to be taxed on income for c
services, such a service needs to be rendered within India, and has to be
a part of a business or profession carried on by such person in India. The
Petitioners in the present case have provided services to persons resident
in India, and though the same have been used here, it has not been rendered
in India. [Para 78] [158-G]
D
3.3. Global income of a resident although is subjected to tax,
global income of a non-resident may not be. The answer to the question
would depend upon the nature of the contract and the provisions ofDTAA.
[Para 80] [159-BJ
E
3.4. Territorial nexus for the purpose of determining the tax liability
is an internationally accepted principle. An endeavour should, thus, be
made to construe the taxability of a non-resident in respect of income
derived by it. Having regard to the internationally accepted principle and
DT AA, it may not be possible to give an extended meaning to the words F
'income deemed to accrue or arise in India' as expressed in Section 9 of
the Act. Section 9 incorporated various heads of income on which tax is
sought to be levied by the Republic of India. 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(l)(vii) of the Act. It must
have sufficient territorial nexus with India so as to furnish a basis for G
imposition of tax. Whereas a resident would come within the purview of
.... Section 9(l)(vii) of the Act, a non-resident would not, as services of a non-
resident to a resident utilize in India may not have much relevance in
)
determining whether the income of the non-resident accrues or arises in
India. It must have a direct live link between the services rendered in India, H
122 SUPREME COURT REPORTS [2007] 1 S.C.R

A when such a link is established, the same may again be subjected to any
relief under DTAA. [Para 81) [159-C, D, E, F)

3.5. The provisions of Section 9(1)(vii) of the Act are plain and capable
of being given a meaning. There, therefore, may not be any reason not to
give full effect thereto. However, even in relation to such income, the
B provisions of Article 7 of the DTAA 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 assessee outside India, only because they were connected with
permanent establishment Even in relation thereto, principle of apportionment
C shall apply. [Para 83) [160-B, CJ

4. The Authority has committed an error as 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.
D
It would be contrary to the intent and purport of the Double Taxation
Convention which is a part of the scheme under the Income Tax Act. Hence
with regard to offshore supply only such part of the income, as is attributable
to the operations carried out in India can be taxed in India in terms of
detailed directions in the Judgment and with regard to Offshore Services
E sufficient territorial nexus between the rendition of services and territorial
limits of India is necessary to make the income taxable.
[Paras 84, 85, 86 and 87) [160-D, F, 161-G]

CIVIL APPELLATE JURISDICTION: Civil Appeal No. 9 of2007.
F
From the final Ruling dated 1i.I0.2004 of the Authority for Advance
Rulings (Income Tax), New Delhi in A.A.R. No. 618/2003.

Harish N. Salve, Sr. Adv. Percy Pardiwalla, Kamaldeep Dayal,
Ms. Ruby Singh Ahuja, Debmalya Banerjee, Mrs. Manik Karanjawala Advs.
G for the Appellant.

Mohan Parasaran, A.S.G., Shilpa Singh, Pritish Kapur,
O.P. Srivastava, Gaurav Dhingra and B.V. Balaram Das Advs. for the
Respondent.
H
ISHIKAWAJMA-HARIMA HEAVY INDUSTRIES Lill. v. DIRECTOR OF INCOME TAX, MUMBAI [SINHA, J.] 123

The Judgment of the Court delivered by A
S.B. SINHA, J. : Leave granted.

I. Appellant herein is a company incorporated in Japan. It is a resident
of the said country. It pays its taxes in Japan. It is engaged, inter alia,
in the business of construction of storage tanks as also engineering etc.
B
It formed a consortium along with Ballast Nedam International BV, Itochu
Corporation, Mitsui & Co. Ltd., Toyo Engineering Corporation and Toyo
Engineering (India) Ltd. With the said consortium members, it entered into
an agreement with Petronet LNG Limited (hereinafter referred to as "the,
Petronet") on 19.01.2001 for setting up a Liquefied Natural Gas (LNG) c
receiving storage and degasification facility at Dahej in the State of Gujarat.
A supplementary agreement was entered into by the parties on 19.03.2001.
The contract envisaged a turnkey project. Role and responsibility of each
member of the consortium was specified separately. Each of the member of
the consortium was also to receive separate payments. Appellant was to
D
develop, design, engineer and procure equipment, materials and supplies, to
erect and construct storage tanks of 5 MMTPA capacity, with potential
expansion to IO MMTPA capacity at the specified temperatures i.e. -200
degree Celsius. The arrangement also was to include marine facilities Getty
and island break water) for transmission and supply of the LNG to purchasers;
to test and commission the facilities relating to receipt and unloading, E
storage and re-gasification of LNG and to send out of re-gasified LNG by
means of a turnkey fixed lump-sum price time certain engineering procurement,
construction and commission contract. The project was to be completed in
41 months. The contract indisputably involved : (i) offshore supply, (ii)
offshore services, (iii) onshore supply, (iv) onshore services and (v) F
construction and erection. The price was payable for offshore supply and
offshore services in US dollars, whereas that of onshore supply as also
onshore services and construction and erection partly in US dollars and
partly in Indian rupees.

2. Liability to pay income tax in India by the appellant herein being G
doubtful, an application was filed by the same before the Authority for
Advance Rulings (Income Tax) (hereinafter referred to as 'the Authority') in
terms of Section 24l(Q)(l) of the Income Tax Act, 1961 (hereinafter referred
to as 'the Act'). The following questions were proposed by the appellant
for determination: H
•--k
124 SUPREME COURT REPORTS (2007] 1 S.C.R.

A "l. On the facts and circumstances of the case, whether the
..........
amounts, received/receivable by the applicant from Petronet
LNG for offshore supply of equipments, materials, etc. are
liable to tax in India under the provisions of the Act and India-
Japan tax treaty?

B 2. If the answer to (1) is in the affirmative in view of Explanation
(a) to section (l)(i) of the Act and/or Article (1) read together
with the protocol of the India-Japan tax treaty, to what extent
are the amounts reasonably attributable to the operations
carried out in India and accordingly taxable in India?
c ,,
.). On the facts and circumstances of the case, whether the
amounts received/receivable by the applicant from Petronet
LNG for offshore services are chargeable to tax in India under
the Act and/or the India-Japan tax treaty?

D 4. If the answer to (3) above is in the affirmative, to what extent
would be amounts received/receivable for such services be
ch_argeable to tax in India under the Act and/or the India-
Japan tax treaty?

E 5. If the answer to (3) above in the affirmative, would be
applicant be entitled to claim deduction for expenses incurred
in computing the income from offshore services under the Act
and/or the India-Japan treaty?"

F 3. Before the Authority no issue was raised as regards the liability of
the appellant to pay income tax on onshore supply and onshore services
and on its activities relating to construction and erection. The dispute
centered round its exigibility to pay tax in respect of 'offshore supply' and
'offshore services'.

G 4. it is also not in dispute that the Government of India and the
Governme11t of Japan entered into a by-lateral treaty in regard to the tax
liabilities.

5. Contention of the appellant before the Authority was that the
H contract being a divisible one, it did not have any liability to pay any tax
ISHIKAWAJMA-HARIMAHEAVY INDUSTRIES LTD. v. DIRECTOR OF INCOME TAX, MUMBAI [SINHA, J J 125

in regard to offshore services and offshore supply. Revenue, on the other A
hand, contended that the contract being a composite and integrated one,
they were so liable.

6. The Authority referred to a large number of decisions governing
the field and opined that having regard to the provisions contained in
Section 5 read with Section 9 of the Act, following propositions oflaw would B
emerge:

"(I) In a case of sale of goods simpliciter by a non-resident to
a resident in India, if the consideration for sale is received
abroad and the property in the goods also passes to the C
purchaser outside India, no income accrues or arises or
deemed to accrue or arise to the seller in India.

(2) In a case of transaction of sale of goods by the non-resident
to an Indian resident which is a part of a composite contract
involving various operations within and outside India, income D
from such sale shall be deemed to accrue or arise in India if
it accrues or arises through or from any business connection
' in India.

(3) In the case of a business of which all operations are not
carried out in India, the deemed accrual or arising of income E
shall be only such part of the income as is reasonably
attributable to the operations carriP-d out in India.

(4) Whether there is business connection in India or/and whether
all operations of the business are not carried out in India are F .
questions of fact which have to be determined on the facts
of each case."

- 7. Applying the said principles to the facts of the present case, the
Authority opined that the appellant was liable to pay direct tax even under
the Treaty having regard to Articles 5 and 7 thereof as also Clause 6 of the
Protocol. It was held :
G

,..
"The substance of the protocol quoted above, represents the
consensus reached between the parties to the treaty in regard to
the meaning of the phrase "directly or indirectly attributable to that H
126 SUPREME COURT REPORTS [2007] I S.C.R.

A pennanent establishment" employed in paragraph I of article 7.
Further, profits shall also be regarded as attributable to the pennanent
establishment to the extent indicated in the said protocol even
when the contract or order relating to the sale or provision of
goods or services in question is made or placed directly with the
overseas head office of the enterprise rather than with the pennanent
B establishment.

It would be clear. t}_lat having regard to provisions of article
7(1) of the Treaty read with para 6 of the protocol supply of
equipment of machinery (sale of which was completed abroad,
c having placed the order directly overseas office of the enterprise)
the same should be within the meaning of the phrase directly or
indirectly attributable to that pennanent establishment."

8. As regards taxability of the amounts 'received' and 'receivable' by
D the appellant from Petronet for offshore services, it was held :

"In so far as the Treaty is concerned, both section l 15A(l)(b)(B)
and para 2 of Article 12 of the Treaty clearly indicates that the
whole technical fee without any deduction is chargeable to tax,
however, the tax so charged shall not exceed 20% of the gross
E
amount of the royalty or fee for technical services."

9. Question Nos. 4 and 5 were held to be the consequential ones. It
was opined:

F "In the light of the above discussions we rule on :

(i) Question No. I that on the facts and in the circumstances of
the case, the amounts received/receivable by the applicant
from Petronet LNG in respect of offshore supply of equipment ,.
and materials is liable to be taxed in India under the provisions
G of the Act and the India-Japan Treaty.

(ii) Question No.2 that in view of the Explanation (a) to section
9(1 )(i) of the Act and/or Article 7(1) read with the Protocol of
the India-Japan Treaty the amounts that would be taxable in
India is so much of the profit as is reasonably attributable to
H
~.

ISHIKAWAJMA-HARJMAHEAVY INDUSTRIES LID. v. DIRECTOR OF INCOME TAX, MUMBAI [SINHA, J.J 127

,,. the operations carried out in India, we decline to answer the A
other part· of the question in regard to quantification of the
amount taxable in India as the parties produced no evidence
and did not address in this regard.

(iii) Question No. 3 that the amom1t received/receivable by the
applicant from Petronet LNG for offshore services is liable to B
be taxed in India both under the provisions of the Act as well
as under Indo-Japan Treaty.

(iv) Question No.4 that the entire amount received for offshore
. services is chargeable to tax under the Act and under the
T~eaty but at the rate not more than 20% of the gross amount.
c
(v) Question No. 5 that the applicant would not be able to claim
·any deduction in computing the income from offshore service
under the Act, and/or under the Indo-Japan Treaty."
D
Before us, the following findings of the Authority are not disputed :
~
"(i) the Petitioner has a business connection in India;

(ii) if consideration accrues only for supply of goods and the sale
is completed outside India no profits can accrue in India; E
(iii) howeyer, if a contract envisages a composite consideration
for the various obligations to be perfonned and if certain
operations are to be performed by or through the business
connection, then, profits would be deemed to accrue in India;
F
(iv) property in the goods, which were the subject matter of the
offshore supply, passed outside India; and
1:

(v) the petitioner has a permanent establishment in India within
the meaning of the said term in paragraph 3 of Article 5 of the
Double Taxation Avoidance Agreement entered into between G
the Governments of India and Japan (hereinafter referred to as
"the DTAA")."
)

10. Mr. Harish N. Salve, the learned Senior Counsel appearing on
behalf of Appellant, urged :
H
128 SUPREME COURT REPORTS [2007] 1 S.C.R.

A (i) The Authority misconstrued and misinterpreted the contract in -..
arriving at its aforementioned findings, as from a bare perusal thereof, it
would appear that the payments were made in US dollars in respect of
'offshore supply' and 'offshore services' and furthermore title to the goods
passed on to Petronate outside the territories of India and services had also
been rendered outside India;
B
(ii) The fact that the contract signed in India was of consequences as
converse could not have made the appellant not liable to pay the tax;

(iii) The Authority committed a manifest error in arriving at its findings
c insofar as it failed to properly construe Explanation-2 appended to Section
9(l)(vii) of the Act as it was nobody's case that the consideration related
to a construction, assembly, mining or like project so as to fall outside the
scope thereof;

(iv) Although fee received by Appellant is effectively connected to
D the contract but it is not attributable to the permanent establishment and,
therefore, Article 12(5) of the Double Taxation Avoidance Agreement (DTAA)
is not attracted;

(v) Appellant being a non-resident in terms of Section 5(2) of the Act,
E it would be chargeable to tax in India only in 'the event income accrues or
arises in India or is deemed to accrue or arise in India or income is received
or is deemed to be received in India and not otherwise;

(vi) As no part of the income for the 'offshore supply' or 'offshore
services' is received in India, the Authority misdirected itself in passing the
F
impugned judgment;

(vii) A legal fiction raised under the Act cannot be pushed too far.
Also, as all operations in connection with the offshore supply are carried
out outside India, the question of any portion of the consideration to be
G regarded as deemed to accrue or arise in India would not arise;

(viii) The requirement of the appellant to perform certain services in
India, such as unloading, port clearance, transportation of the equipments (
supplied would not render the appellant eligible to tax as the consideration
H thereof is embedded in the consideration for the offshore supply;
ISHIKAWAJMA·HARIMA HEAVY INDUSTRIES LTD. v. DIRECTOR OF INCOME TAX, MUMBAI [SINHA, J] 129

(ix) Although the appellant was required to carry out certain activities A
,; in India, the consideration for offshore services had separately been provided
for.

(x) Assuming that the income from the offshore supply is chargeable
to tax in India on the premise that Section 9(1 )(i) applies, it was required to
be examined by the Authority as to whether it would also be chargeable in
B
accordance with the provisions of the Double Taxation Avoidance Agreement
(DTAA) in terms whereof no charge to tax in India was leviable in respect
of the consideration for offshore supply.

11. Mr. Mohan Parasaran, the learned Additional Solicitor Gener£1.l C
appearing on behalf of the respondent, on the other hand, submitted :

(i) The question as to whether terms of the contract constitute a
composite contract or not is essentially a question of fact and the findings
of the Authority being final, therefore, should not ordinarily be interfered
with;
D

-
(ii) The Authority having found in favour of the Revenue two primary
tests to determine as to whether the contract in question was a composite
one for execution of a turnkey project viz :
E
(a) whether the 'offshore' and 'onshore' elements of the contract
are so inextricably linked that the breach of the 'offshore' element
would result in the breach of the wholP- contract;

(b) whether the dominant object of the contract is the execution
F
of a turnkey project and the question whether the title to the
goods supplied passes offshore or within India is secondary to
the execution of the contract,

the impugned judgment should not be interfered with;
G
(iii) Each component of the contract was directly relatable to the
performance of the integrated contract as violation and/or breach on the
part of the parties thereto would affect the entire contract;

(iv) The contract itself providing for milestone dates, the breach of any H
130 SUPREME COURT REPORTS [2007] 1 S.C.R.

A of the terms thereof would result in the breach of the entire contract and
not just the particular obligation;

(v) The turnkey project contemplated a permanent establishment and
in that view of the matter Explanation appended to Section 9(l)(i) of the Act
is directly applicable.
B
(vi) The appellant has business connection in India and in that view
of the matter the causal connection between the offshore supply and
offshore services being interlinked with the entire project, the opinion of the
Authority cannot be faulted;
c
(vii) By reason of DTAA, the parties thereto can always allocate the
jurisdiction to tax the entire income attributable to such permanent
establishment to the country in which it is established;

(viii) Supply of goods whether offshore or onshore as well as rendition
D of service whether offshore or onshore are attributable to the turnkey project
and, thus, it would be wrong to contend that in terms of Article 7 of DTAA,
no tax could be levied upon the appellant.

Contract : The Material Part :
E
12. Petronat LNG Limited, on the one hand, and fivt; members of the
consortium, on the other, are parties to the contract. The contract contained
broad items. It has its own interpretation clauses. Clause 2.1 provides for
scope of the work in the following terms :
F
"2.1. The Work

Except as otherwise expressly provided in this Contract,
Contractor shall provide, furnish and perform, or cause to be;
provided, furnished and performed, on a turnkey basis all
G necessary design, engineering, procurement, supplies,
installation, erection, construction, testing, commissioning,
operation and turning over services, activities arid work
(including all rectification and remedial services, activities and
work relating to defects and deficiencies) for the Equipment
H and Materials and the Facilities in accordance with the Scope
ISHIKAWAJMA-HARIMA HEAVY INDUSTRIES LTD. v. DIRECTOR OF INCOME TAX, MUMBAI [SINHA, J.J 13}

of Work (Exhibit A) and the other terms, provisions and A
-... ·
.I
requirements of this Contract, including the Contract Schedule,
and shall provide all necessary and sufficient Contractor's
Equipment and experienced personnel having the requisite
expertise for such purposes.

After Mechanical Completion of the Facilities, Contractor B
shall carry out Commissioning, start-up and testing of the
Facilities and, if requested by Owner, shall provide advisory
assistance in connection with the operation and maintenance
of the Facilities and shall provide all necessary and sufficient
experienced personnel having the requisite expertise for the c
prompt performance of any rectification and remedial work
requit~d until Final Acceptance of the Facilities, in accordance
with this Contract.

The Parties acknowledge and agree that this Contract is a
lump-sum firm fixed price time certain turnkey contract and
D
Contractor's obligation to provide, furnish and perform its
services, activities and work under this Contract includes
Contractor providing Owner with the operating and completed
Facilities, complete in every detail within the time and for the
purposes specified in this Contract and to do and furnish E
Owner everything necessary in connection herewith.

The foregoing obligations, .work, services, activities and
responsibilities of Contractor are more fully set forth in this
Contract, including the Scope of Work (Exhibit A). The
F
Technical Documents and the obligations under Clause 2.2.
are herein collectively referred to as the "Work".

Except as otherwise expressly provided in this Contract,
Contractor agrees and acknowledges that Contractor shall
perform all of its obligations and responsibilities under this G
Contract at its own risk, cost and expense."

J Clause 2.2. provides for additional responsibilities of the appellant,
which reads as under :
H
132 SUPREME COURT REPORTS [2007] l S.C.R.

A "2.2. Additional Responsibilities

Except as otherwise expressly provided in this Contract,
Contractor shall be responsible for providing, or causing the
provision of, design, engineering, procurement, erection,
construction and commissioning and testing services, activities
B and work, and personnel and labour, and all Equipment and
Materials (and components thereof) and Contractor's
Equipment, and any other items not specifically described in
the Scope of Work (Exhibit-A) and/or the Technical Documents
if (a) it reasonably may be inferred.in accordance with Good
c Industry Practice that the providing, or causing the provision,
of such additional items was contemplated as part of the
Work (including the Technical Documents) or (b) the
providing, or causing the provision, of such additional items
is necessary in order for Contractor to satisfy the Completion
and Performance Guarantees and the warranties set forth, in
D
this Contract and to make the Facilities operable and capable
of performing as specified in the Technical Documents or as
otherwise necessary in order to comply with the requirements
of this Contract. Without limitation to the foregoing, wherever
this Contract describes any portion of the Work in general
E tenns, but not complete in detail, Contractor agrees that the
Work shaHinclude any incidental work, activities and services
which may be reasonably inferred as required or necessary to
complete and render operable the Facilities in accordance with
the terms and conditions of the Contract, and owner shall
F have no obligation or responsibility whatsoever (except as
specifically set forth in this Contract) with respect to the
completion of the Facilities.

Contractor shall ensure that the Facilities shall be fit and
suitable for its intended purpose (including attaining the
G Completion and Performance Guarantees) as evidenced by, or
reasonably to be inferred from, this Contract, and shall fully
comply with the Contract.

Work undertaken, Equipment and Materials (including
H components thereof), Contractor's Equipment, labour and
ISHIKAWAJMA-HARIMA HEAVY INDUSTRIES LTD. v. DIRECTOR OF INCOME TAX, MUMBAI [SINHA, J.J 133

personnel, and additional items provided pursuant to this A
Clause 2.2 shall not give rise to any adjustment in this
Contract Price, the Contract Schedule or any other terms of
this Contract, and shall be included in and comprise the Work
for an· purposes of this Contract.

Clause 7 .1 provides for shipment in the following terms : B

"7.l. Notice of Shipment

Contractor shall comply with and follow the procedures for
shipment set forth in Section E of Exhibit H (General Project
Requirements and Procedures). In particular, at least prior to
c
arrival of each shipment in India, Owner and Owner's insurance
company providing insurance will receive from the Contractor,
the notice of shipment, such notice shall set forth the followiJig
information concerning such shipment : (a) a reference to the
date, parties and subject matter of this Contract; (b) a D
description of, or that part of, the Equipment and Materials
contained in such shipment; (c) the date of embarkation and
departure, (d) the port of origin, (e) the means of shipment (air
t
or sea); (f) the estimated date of arrival in India; (g) the port
of entry in India; (h) the value of the shipment; (i) the
E
approximate weight and volume (gross and net); (j) the name,
flag and owner of the vessel if shipment by sea or the
designation of aircraft if ship is by air; and (k) the number and
value of bill of lading or airfreight bill. Contractor shall
ensure that a provision similar to this Clause 7. l is included
in all agreements with Suppliers. F
Contractor shall be responsible for packing, loading,
transporting, receiving, unloading, storing and protecting all
Equipment and Materials and/or Contractor's Equipment and
other things required for the Works." G
Price is specified under Clause 13.1 in the following terms :

"13.1. Contract Price
J
The total p:rice to be paid by or on behalf of Owner to H
f
134 SUPREME COURT REPORTS [2007] I S.C.R.

A Contractor in full consideration for the performance by
Contractor of its obligations and responsibilities under this
Contract, including the Work, shall be a fixed and firm lump
sum price of US$ 151,044.192 (One hundred fifty one million
forty four thousand one hundred ninety two US Dollars) (the
"US Dollar Portion") and Rs.7;602,796,324 (Seven billion six
B hundred two million seven hundred ninety six thousand three
hundred twenty four Indian Rupees) (the "Indian Rupee
Portion"), which shall be subject" to adjustment only as
provided under Clause 13.4 (the US Dollar Portion and the
Indian Rupee Portion, as the same may be so adjusted,
c together, the "Contract Price")."

13. The contract envisages that the appellant may do the job itself or .
get the same done by sub-contracting. It may only do a part of the job
itself.
D 14. The contract splits in dollar and rupee components separately.
Clause 14.8 provides for general terms of payment, effect of payment and
methodology of payment. Pursuant to or in furtherance whereof separate
payment in US dollars and Indian rupees is to be made depending upon the
nature .of supply viz. offshore supply and offshore· services and onshore
E supply and onshore services.

Clause 22.1 deals with passing of title to the goods supplied in the
following terms :

22. l Title to Equipment and Materials and Contractor's Equipment
F
,-
Contractor agrees that title to all Equipment. and Materials
·shall pass to Owner from. the Supplier or Subcontractor
pursuant to Section E of Exhibit H (General Project
Requirements and Procedures). Contractor shall, however,
G retain care, custody, and control of such Equipment and
Materials and exercise due care thereof until (a) Provisional
Acceptance of the Work or (b) termination of this Contract,
whichever shall first occur. Such transfer of title shall in no
way affect Owner's rights under any other provision of this
H Contract."
ISHIKAWAJMA-HARIMA HEAVY INDUSTRIES LTD. v. DIRECTOR OF INCOME TAX. MUMBAJ [SINHA. J.] 135

15. The interpretation of different components of contract has been A
.,/
dealt within Annexure-A appended thereto. So far as 'offshore services
work items' are concerned, the same has been defined to mean the items
of work set forth as item numbers D-2.2.1, 2.2.2 and 2.2.3 of the Contract
Price Schedule; details whereof have been mentioned in the said Annexure,
which, inter alia, provides :
B
Notes

General 1. xxx xxx xxx

2. Offshore supply (Exhibit D-2.1) is the price of
Equipment & Material (including cost of
c
engineering, if any, involved in the manufacture of
such Equipment & Material) supplied from outside
India on CFR basis, and the property therein shall
pass on to the Owner on high seas for permanent
incorporation in the Works, in accordance with the D
provisions of the Contract.

3. Offshore Services (Exhibit D-2.2) is the price of
design and engineering including detail engineering
in relation to supplies, services and construction & E
erection and cost of any other services to be
rendered from outside India.

4. Onshore Supply (Exhibit D-2.3 is the price of
Equipment & Material supplied from within India
for direct delivery at Site and permanent F
incorporation in the Works.

'
5. Onshore services (Exhibit D-2.4) is the price of
design engineering, detail engineering, customs
clearance, inland transportation, procurement G
services, supervision services, project management,
testing and commissioning and any such service in
relation to the Works rendered in India."

H
136 SUPREME COURT REPORTS [2007] 1 S.C.R

A 16. The break down of contract price is as under :

Exhibit Description In Indian In US Name and
No.ISi. of Scope Rupees Dollars address of
No. Contracting
entity
B
D-2.1 Offshore Supply Nil 81,711,877 IHI,BNI&
(Total of2. l. l., TEIL •
2.1.2 and 2.1.3)

D-2.2 Offshore Services Nil 19,756,225 IHI, BNI &
c (Total of 2.2.2 to TEIL
22.3)

D-2.3 Onshore Supply 1,869,978,658 Nil IHI, BNI&
(Total of2.3. l TEIL
to 2.3.3)
D
D-2.4 Onshore Services 1,774,353,282 12,780,467 IHI, BNI &
(Total of2.4. l TEIL
to 2.4.3)

D-25 Construction and 3,958,464,384 36,795,623 IHI, BNI &
E Erection (Total of TEIL
2.5. l. to 2.5.3)

D-2.0 Total (D-2. l to 7,602,796,324 151,044,192
D-2.5) (See Note 9
F
17. Treaty : Double Taxation Avoidance Agreement (DTAA) :

Article 5 of the Double Taxation Avoidance Agreement
(DTAA) between India and Japan, inter alia, provides as
G under:

"l. 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.
H
ISHIKAWAJMA-HARIMAHEAVY INDUSTRIES LTD. v. DIRECTOR OF INCOME TAX, MUMBAI [SINHA, J.J 137

2. The tenn "pennanent establishment" includes especially : A
(a) a place of management;

(b) a branch;

(c) an office; B
(d) a factory;

(e) a workshop;

(f) a mine, an oil or gas well, a quarry or any other place C
of extraction of natural resources;

(g) a warehouse in relation to a person providing storage
facilities for others;

(h) a fann, plantation or other place where agriculture, D
forestry, plantation or related activities are carried on;

(i) a store or other sales outlet; and

G) an installation or structure used for the exploration of
natural resources, but only if so used for a period of E
more than six months.

Clause 1 of Article 7 of the said agreement reads as under : F

"1. The profits of an enterprise of a Contacting State 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
G

..
on business as aforesaid, the profits of the enterprise may be taxed
in that other Contracting State but only so much of them as is
directly or indirectly attributable to that permanent establishment."

Clauses 1, 2 and 5 of Article 12 which are relevant for the purpose of
this case, read as under : H
138 SUPREME COURT REPORTS [2007] 1 S.C.R

A "1. Royalties and fees for technical services 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 and fees for technical services
may also be taxed in the Contracting State in which they arise and
B according to the laws of that Contracting State, but if the recipient
is the beneficial owner of the royalties or fees for technical services,
the tax so charged shall not exceed 20 per cent of the gross amount
of the royalties or fee for technical services.

c 5. The provisions of paragraphs 1 and 2 shall not apply
ifthe beneficial owner of the royalties or fees for technical services,
being a resident of a Contracting State, carries on business in the
other Contracting State in which the royalties or fees for technical
services arise, through a permanent establishment situated therein,
or performs in that other Contracting State independent personal
D
services from a fixe.d base situated therein, and the right, property
or contract in respect of which the royalties or fees for technical
services are paid is effectively connected with such permanent
establishment or fixed base. In such case, the provisions of article
7 or article 14, as the case may be, shall apply."
E
The Treaty contains the Japanese notes, clause 6 whereof reads as
under:

"6. With reference to paragraph I of article 7 of the
Convention, it is understood that by using the term "directly or
F
indirectly attributable to the permanent establishment", profits
arising from transactions in which the permanent establishment has
been involved shall be regarded as attributable to the permanent
establishment to the extent appropriate to the part played by the
permanent establishment in those transactions. It is also understood
G that profits shall be regarded as attributable to the permanent
establishment to the above-mentioned extent, even when the
contract or order relating to the sale or provision of goods or
services in question is made or placed directly with the overseas
head office of the enterprise rather than with the permanent
H establishment."
ISHIKAWAJMA-HARIMA HEAVY INDUSTRIES LTD. v. DIRECTOR OF INCOME TAX, MUMBAI [SINHA, J.) 139

Statutory provisions : A
18. Sections 5(2), Section 9(l)(i), Section 9(1 )(vii) of the Act, which are
relevant for our purpose, read as under :

"5(2) Subject to the provisions of this Act, the total income of any
previous year of a person who is a non-resident includes all income B
from whatever source derived which -

(a) is received or is deemed to be received in India in such year
by or on behalf of such person; or

(b) accrues or arises or is deemed to accrue or arise to him in
c
India during such year,''

"9(1). The following incomes shall be deemed to accrue or arise in
India:

(i) all income accruing or arising, whether directly or indirectly,
through or from any business connection in India, or through
t or from any property in India, or through or from any as.set
or source of income in India or through the transfer of a ;
capital asset situate in India.
E

(vii) income by way of fees for technical services payable by -

(a) the Government; or F
(b) a person who is a resident, except where the fees are payable
in respect of services utilized 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 G

(c) a person who is a non-resident, where the fees are payable

-- ,)
in respect of services utilized 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 : H
140 SUPREME COURT REPORTS [2007] 1 S.C.R.

A 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 hy the Central Government."

Analysis :
B
19. For the purpose of taxation, the authority had proceeded on the
basis that the element of tax consisted of : (i) onshore supply and onshore
services; and (ii) construction of offshore supply and offshore services. It
is not denied or disputed, as indicated hereinbefore, that in respect of the
c first element of onshore supply and onshore service, and construction tax
would be payable in India.

20. Two basic issues which, thus, arise for our consideration are : (a)
the taxation of the price of goods supplied, by way of offshore supply price
of which is specified in Ex. D, Clause 2.1; and (b) the taxation of consideration
D paid for rendition of services described in the contract as offshore services
at Ex. D.

21. The contract is a complex arrangement. Petronat and Appellant are
- not the only parties thereto, there are other members of the com:ortium who
E are required to carry out different parts of the contract. The consortium
included an Indian company. The fact that it has been fashioned as a
turnkey contract by itself may not be of much significance. The project is
a turnkey project. The contract may also be a turnkey contract, but the same
by itself would not mean that even for the purpose of taxability the entire
contract must be considered to be an integrated one so as to make the
F
aprellant to pay tax in India. The taxable events in execution of a contract
may arise at several stages in several years. The liability of the parties may
also arise at several stages. Obligations under the contract are distinct ones.
Supply obligation is distinct and separate from service obligation. Price for
each of the component of the contract is separate. Similarly offshore supply
G and offshore services have separately been dealt with. Prices in each of the
segrnent are also different.

22. The very fact that in the contract, the supply segrnent and service •
segrnent have been specified in different parts of the contract is a pointer
H to show that the liability of the appellant thereunder would also be different.
ISH!KAWAJMA-HARJMAHEAVY INDUSTRIES LTD."· DIRECTOR OF INCOME TAX. MUMBAI [SINHA, J.J 141

23. The contract indisputably was executed in lndia. By entering into A
a contact in India, although parts thereof will have to be carried out outside
India would not make the entire income derived by the contractor to be
taxable in India. We would, however, deal with this aspect of the matter a
little later.

24. Scope of work is cont_ained in clause 2.1 of Ex. A appended to the
B
contract which includes supply of equipment, materials and facilities. The
said exhibit spells out different systems to be set in place. It imposes an
obligation on the contractor to supply equipments required therefor. It was
to arrange for the engineering services in relation thereto. It was also
required to render various other services within India. Ex. D, however, c
provides for the prices to be paid in respect of offshore supplies ahd
offshore services, onshore supply and onshore services, construction and
erection. Payment schedule has also been separately specified in respect
of each of the components separately.

D
25. It is not in dispute that title in the equipments supplied was to
stand transferred upon delivery thereof outside India on high-sea basis as
provided for in Article 22.1. Similarly, Article 13 .1. provides for a lump sum
contract price, whereas Article 13.3.2. specifically refers to the cost of
offshore supplies. The provisions with regard to offshore supplies and
offshore services were to be read with the provisions contained in Ex. D E
which formed the basis of customs duty. Clause 13.4 refers to Ex. Das the
basis for price escalation.

26. The question of imposition of tax on income arising from a business
connection may, thus, have to be considered keeping in view the F
aforementioned factual backdrop.

27. Section 9(1)(i) of the Act 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. Appellant is a non-resident
assessee. G

.... 28. Section 9 raises a legal fiction; but having regard to the contextual
interpretation and furthennore in view of the fact that we are dealing with
a taxation statute the legal fiction must be construed having regard to the
object it seeks to achieve. The legal fiction created under Section 9 of the H
f-

142 SUPREME COURT REPORTS [2007] 1 S.C.R.

A Act must also be read having regard to the other provisions thereof. [See
Maruti Udyog Ltd v. Ram Lal and Others, [2005] 2 SCC 638.

29. For our benefit we may notice the provisions of Section 42 of the
Income Tax Act, 1922. It provided that only such part of income as was
attributable to the operations carried out in India would be taxable in India.
B
30. 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.
The question which would fall for our consideration is as to whether the
C income that arises out of the said transaction would be required to be
proportioned to each of the territories or not.

31. Income arising out of operation in more than one jurisdiction would
have territorial nexus with each of the jurisdiction on actual basis. If that
be so, it may not be correct to contend that the entire income 'accrues or
-D arises' in each of the jurisdiction. The Authority has proceeded on the basis
that supplies in question had taken place offshore. It, however, has
rendered, its opinion on the premise that offshore supplies or offshore
services were intimately connected with the turnkey project.

E 32. The learned Additional Solicitor General in support of his contention
that the contract is a composite one, has relied upon the following decisions:
N. Khadervali Sahib (Dead) by L.Rs. and Another v. N. Gudu Sahib (Dead)
and Others, {2003] 3 SCC 229; Hindustan Shipyard Ltd v. State of A.P.,
[2000] 6 SCC 579; State of Rajasthan v. Mis Man Industrial Corporation
Ltd, [1969] 1SCC567, K.S. Subbiah Pillai v. Commissioner ofIncome Tax,
F
[1999] 3 SCC 170; Mis Patnaik and Co. Ltd v. Commissioner ofIncome Tax,
Orissa, [1986] 4 SCC 16; BSES Ltd (Now Reliance Energy Ltd) v. Fenner
India Ltd and Another, [2006] 2 SCC 728. The said decisions, in our
considered view, are not applicable herein.

G

..
33. In Khadervali Sahib (supra), the question which arose for
consideration was whether an award amounted to creation of or transfer of
any fresh rights in respect of movable or immovable properties so as to
require registrafrm under Section 17 ofth~·Registration Act, when the same
related to the properties of a partnership firm. Therein by reason of an /
H award, the residue upon settlement of accounts on dissolution of the
~·
I

ISHIKAWAJMA-HARIMA HEAVY INDUSTRIES LTD.'" DIRECTOR OF INCOME TAX, MUMBAI [SINHA, J.] )43

partnership firm was allocated to the partners. It was held that the award A
did not require any registration.

34. In Hindustan Shipyard (supra), the question which arose for
consideration was whether a contract constituted a sale or works contract.
Laying down the tests therefor, having regard to the tenns and conditions
contained therein, it was opined that a contract of sale of goods was B
separate from a contract for works and labour. In regard to the categories
of contract, it was stated :

"(i) the contract may be for work to be done for remuneration
and for supply of materials used in the execution of the work for
a price;
c
(ii) it may be a contract for work in which the use of the
materials is accessory or incidental to the execution of the work;
and
D
(iii) it may be a contract for supply of goods where some work
is required to be done as incidental to the sale."
;

35. Whereas the first contract was held to be a composite contract, the
second was held to be a contract for work and labour not involving the sale
of goods; and the third was held to be a contract of sale where the goods E
were sold as chattels and the work done was merely incidental thereto.

36. The view taken in Stat~ of Madras v. Gannon Dunkerley & Co.
(Madras) Ltd., [1959] SCR379 is sought to be applied. The contract in such
a case must stipulate that the equipment would be supplied on CRF basis.
F
It spells out the price for supply of goods, in which event, for the purpose
of sales tax, the contract would involve sale of goods. The principle of
Gannon Dunkerly (supra), does not appear to be of much relevance in the •
instant case.

37. Decisions of this court under the Sales Tax Laws referred to by the G
learned counsel, moreover, may have to be considered on a different
footing.
-)
38. In this case, we are faced with a different situation. It is only for
the purpose of taxability that the terms of the contract are required to be
H
144 SUPREME COURT REPORTS [2007] 1 S.C.R.

A construed. A turnkey contract may involv~ supply of materials used in the ·'-..
execution of the contract for price as also for use of the materials by works
and labour; but the same may not have any relation with the taxability part
of it.

39. It is interesting to note that Instruction No.1829 issued by the
B Central Board of Direct Taxes on 21.09.1989 provides for certain guidelines
having regard to the possibility of undertaking of Hydro Electric Power
Project by a consortium of a foreign company, stating :

"The concept of turnkey execution of the project involves
c total and complete responsibilities of the persons undertaking the
contracts for commissioning the project and they are accordingly
required to furnish performance guarantees for timely completion."

It was further stated :

D "Apart from the separate contracts for the jobs mentioned in
Para 4 above, there would be an overall co-ordination agreement
\·
between the public sector company on ~e one hand and the
foreign contracting parties referred to in Paragraph 4 on the other
hand· to ensure guaranteed performance of all the contracts in a
E coordinated manner, and within an agreed time frame and for
undertaking to meet necessary liabilities and responsibilities
including payments of liquidated damages for delays etc. One of
the companies would, for this purpose, act as leader to ensure
supervision and coordination of inter-relatf'd tasks."
F
In Mis Man. Industrial Corporation Ltd. (supra), this Court held :

"16. Our attention was invited to a judgment of the Court of Appeal
in Love v. Norman Wright (Builders) Ltd., [ 1944] I K.B. 484. In that
case the respondents contracted with the Secretary of State for
G War to do the work and supply the material mentioned in the
Schedules to the contract, including the supply of black-out curtains,
curtain rails and battens arid their erection at a number of police
stations. It was held by the Court of Appeal that the respondents
were liable to pay purchase-tax. Reliance was placed upon the
observations made by Godiard, L.J. at p. 482:
H
JSHJKAWAJMA-HARIMA HEAVY INDUSTRJES LID. v. DIRECTOR OF INCOME TAX. MUMBAI [SINHA, J] 145

"If one orders another to make and fix curtains at his A
house the contract is one of sale though work and labour are
involved in the making and fixing, nor does it matter that
ultimately the property was to pass to the War Office under

- the head contract. As between the plaintiff and the defendants
the former passed the property in the goods to the defendants
B
who passed it on to the War Office."

. We do not think that these observations furnish a universal test
that whenever there is a contract to "fix" certain articles made by
a manufacturer the contract must be deemed one for sale and not
of service. The test in each case is whether the object of the party C
sought to be taxed is that the chattel as chattel passes to the other
party and the services rendered in connection with the installation
are under a separate contract or are incidental to the execution of
the contract of sale."

40. In Mis Patnaik and Co. (supra), whereupon reliance has been D
placed by the learned Additional Solicitor General, the question which arose
for consideration was as to whether the investment in the loan by the
assessee out of the advance payment made by the Government departments
was a capital asset and the loan was a capital loan or not. We are not herein
concerned with such a situation. The said decision, therefore, cannot be E
said to have any application at all.

41. In BSES Ltd (supra), this Court was concerned with the construction
of bank guarantees. The question which arose for consideration therein was
as to whether in the fact situation of the case, customer faced irretrievable
injuries so as to obtain an order of injunction. In view of the terms and F
conditions of the contract, it was opined, although for the sake of convenience,
the same had been split up into four sub-contracts, it constituted a
composite contract executable on a turnkey basis. The question which
arose for consideration, thus, was whether in terms of the contract having
been reduced into writing by the "wrap around agreement", Appellant G
therein had a right to negotiate any or all the guarantees for any breach of
any of the four contracts. The said decision again has no application in the
facts of the present case.

42. Tax under the Act has to be assessed under different heads.
Income under one head may be subject to exemption; under same head, H
146 SUPREME COURT REPORTS (2007] 1 S.C.R.

A deductions may be· claimed; yet under another, no tax may be payable at
all. Whether a part of the income of the assessee would be taxable or not
depends upon the fact of each case. Even there is nothing to prevent the
income accruing or arising at the sources.

43. In Union of India and Another v. Azadi Bachao Ando/an and
B Another, (2004] 10 SCC 1, this Court was dealing with a double taxation
treaty. It was held :

"6. The Agreement provides for allocation of taxing jurisdiction
to different contracting parties in respect of different heads of
c income. Detailed rules are stipulated with regard to taxing of
dividends under Article 10, interest under Article 11, royalties
under Article 12, capital gains under Article B, income derived from
independent personal services in Article 14, income from dependent
personal services in Article I 5, directors' fees in Article 16, income
of artists and athletes in Article 17, governmental functions in
D Article 18, income of students and apprentices in Article 20, income
of professors, teachers and research sc.holars in Article 21 and
other income in Article 22.

44. In Commissioner of Income Tax, Bombay v. Ahmedbhai Umarbhai
E & Co., Bombay, [1950] SCR 335, this Court, having regard to the provisions
contained in Section 42 of the Income Tax Act, 1922, held that profits
accrued to the assessee of a part of the business in an Indian State having
accrued out of such business carried on in such State are exempted under
the third proviso to Section 5 of the Excess Profit Tax Act. ~

F 45. Opining that the source of income can never be the place where
the income accrues or arises, Kania, CJ, stated :

" ..... .In my opinion there is nothing to prevent income accruing or
arising at the place of the source. The question where the income
G accrued has to be determined on the facts of each case. The income
may accrue or arise at the place of the source or may accrue or arise
elsewhere, but it does not follow that the income cannot accrue or -·.,,
arise at the place where the source exists. Therefore it is necessary
to ascertain whether that part of the business which is capable of
being treated as one separate unit in the Hyderabad State has given
H
ISHIKAWAJMA-HARIMA HEAVY INDUSTRIES LTD. v. DIRECTOR OF INCOME TAX, MUMBAI [SINHA, J J 147

rise to the income or profit sought by the assessee to be exempted A
from taxation in the present case .... "

46. Patanjali Sastri, J. approved the application of the principle
underlying the decision in Commissioner of Taxation v. Kirk, [1900] AC 588,
namely, the principle of apportioning profits as between different processes
employed in producing those profits and the different places where they B
were employed.

Mahajan, J. held :

" .... For instance, where a person carries on manufacture, sale,
export and import, it is not possible to say that the place where the c
profits accrue to him is the place of sale. The profits received relate
firstly to his businrss as a manufacturer, secondly to his trading
., operations, and thirdly to his business of import and export. Profit
or loss has to be apportioned between these businesses in a
businesslike manner and according to well-established principles of D
accountancy. In such cases it will be doing no violence to the
meaning of the words "accrue" or "arise" if the profits attributable
-t to the manufacturing business are said to arise or accrue at the
place where the manufacture is being done and the profits which
arise by reason of the sale are said to arise at the place where the
sales are made and the profits in respect of the import and export E
business are said to arise at the place where the business is
conducted. This apportionment of profits between a number of
businesses which are carried on by the same person at different
places determines also the place of the accrual of profits. To hold
that though a businessman has invested millions in establishing a F
business of manufacture, whether in the nature of a textile mill or
in the nature of steel works, yet no profits are attributable to this
business or can accrue or arise to the business of manufacture
because the produce of his mills is sold at a different place and that
" it is only the act of sale by which profits accrue and they arise only
at that place is to confuse the idea of receipt of income and G
realization of profits with the idea of the accrual of profits. The act
of sale is the mode of realizing the profits. If the goods are sold to
-} a third person at the mill premises no one could have said that.
these profits arose merely by reasori of the sale. Profits would only
be ascribed to the business of manufactUre and would arise at the H
148 SUPREME COURT REPORTS [2007] I S.C.R.

A mill premises. Merely because the mill owner has started another
business organization in the nature of a sales depot or a shop, that
cannot wholly deprive the business of manufacture of its profits,
though there may have to be· apportionment in such a case between
the business of manufacture and business of shop keeping. Jn a
number of cases such apportionment is made and is also suggested
B by the provisions of Section 42 of the Indian Income Tax Act,
reference to which has also been made in Proviso (2) of Section 5
of the Excess Profits Tax Act."

47. In Anglo-French Textile Co. Ltd v. Commissioner of Income Tax,
Madras, [1954] SCR 523, the question which arose for consideration, inter
c alia, was :

"(2) Can the income received in India be said to arise in India within
the meaning of Section 4-A(c)(b) of the Act? If not, should only \.
those profits determined under Section 42(3) as attributable to the
operations carried out in India be taken into account for applying
D
the test laid down in Section 4-A(c)(b), and remanded the case to
the High Court with the direction that it should give its opinion on ~
these two questions."

48. In regard to the first question, it was opined that Section 42(3) had
E nothing to do with the determination of the income arising in the taxable
territories as distinguished from the income arising without taxable territories
as understood in Section 4A(c)(b) of the Act, it was held

"The phraseology of Section 42(3) of the Act also repels the
contention insofar as the profits and gains of the business which
F are referred to therein and which are capable of apportionment as
therein mentioned are deemed to accrue or arise in the taxable
territories thus using the words "accrue" and "arise" as synonymous
with each other.
~

The above passage is also sufficient in our opinion to establish
G that the apportionment of income, profits or gains between those
arising from business operations carried on in taxable territories and
those arising from business operations carried on without the
taxable territories is based not on the applicability of Section 42(3) ,_
of the Act but on general principles of apportionment of income,
H profits or gains ... "

t
J
ISHIKAWAJMA-HARIMA HEAVY INDUSTRIES LTD. v. DIRECTOR OF INCOME TAX. MUMBAI (SINHA. J] 149

49. While the first question was answered in negative, question no.2 A
was answered in the following tenns :

"Question 2-The income received in British India cannot be said
to wholly arise in India within the meaning of Section 4-A(c)(b)
of the Act and that there should be allocation of the income
between the various business operations of the assessee
B
company demarcating the income arising in the taxable territories
in the particular year from the income arising without the
taxable territories in that year for the purposes of Section 4-A(c)(b)
of the Act."
c
50. In Carborandum Co. v. Commissioner of Income-Tax, Madras,
[1977] 108 ITR 335 : [1977] 2 SCC 862, this Court referring to its earlier
decision in Commissioner of Income Tax, Punjab v. R.D. Aggarwal and
Co.& Another, (1965) 56 ITR 20, opined:
D
"15. On a plain reading of sub-sections (I) and (3) of Section
42 it would appear that income accruing or arising from any
business connection in the taxable territories - even though the
income may accrue or arise outside the taxable territories - will be
deemed to be income accruing or arising in such territory provided
operations in connection with such business, either all or a part, are E
carried out in the taxable territories. If all such operations are carried
out in the taxable territories, sub-section (I) would apply and the
entire income accruing or arising outside the taxable territories
but as a result of the operations in connection with the business
giving rise to the income would be deemed to accrue or arise in the F
taxable territories. If, however, all the operations are not carried
out in the taxable territories the profits and gains of the
business deemed to accrue or arise in the taxable territories shall
be only such profits and gains as are reasonably attributable to that
part of the operations carried out in the taxable territories. Thus

- comes in the question of apportionment under sub-section (3) of G
I
Section 42."

51. In CIT v. Mitsui Engineering and Ship Building Co. Ltd., [259 ITR
248], on which reliance was placed; the contention was that the finding that
the contract for designing, engineering, manufacturing, shop testing and H
'~
I

150 SUPREME COURT REPORTS [2007] 1 S.C.R.

A packing up to f.o.b port of embarkation could not be split up since the entire
contract was to be read together and was for one complete transaction. It
was in the said fact situation held that it was not possible to apportion the
consideration for design on one part and the other activities on the other
part. The price paid to the assessee was the total contract price which
B covered all the stages involved in the supply of machinery.

52. This case is clearly distinguishable from the facts of the present
case, since the payment for the offshore and onshore supply of goods and
services was in itself clearly demarcated and cannot be held to be a complete

c contract that has to be read as a whole and not in parts.

53. The principle of apportionment is also recognii;ed by Clause (a) of
Explanation I. Thus, if submission of the learned Additional Solicitor General
is accepted that the contract is a composite one, then offshore supply would
be of equipment designed and manufactured in one territory (Japan), and
D then sold in another tax territory, leading to division of profits arising in
two tax territories, which is not envisaged under our taxation law.

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

55. In Mazagaon Dock Ltd v. CIT and Excess Profits Tax, [34 ITR 368],
whereupon again reliance placed is distinguishable. In that case a non-
resident carrie<!_on business with a resident, and the issue adjudicated upon
F by the Court was. that whether there was a clear and close connection
between them that produced profits or not, and whether any such income
generated by the non-resident company sending its ships for repairs to the
resident company is taxable, if it amounted to business. The Court answered
both questions affimmtively.
G
56. The principle laid down therein has no application to the current
fact situation because there was an extremely close connection between the
appellant company
.
~
and non residents in that the two non-resident (British)
companies beneficially owned the entire share capital of the appellant I- .

company. In the present situation there is no such connection, which can
H
y
/

ISHIKAWAJMA-HARIMA HEAVY INDUSTRIES LTD. v. DIRECTOR OF INCOME TAX. MUMBAI [SINHA, J.J 151

be said to give rise·. to a business connection between the permanent A
.,., establishment in India and the transaction that is sought to be taxed_
-:"f
57. Yet again in Anglo French Textile Co. Ltd v. CIT Madras, [23 ITR
101], in the fact situation obtaining therein, it was held that when there was
a continuity of business relationship between the person in India who helps
make the profits and the person outside who receives or realizes this profit, B
a J?usiness connection exists.

i
58. Jn that case, the Assessee company incorporated in the UK, owned
a textile company in French Pondichery and had appointed another limited
company in Madras to act as its constituted agents. The same was held to c
be a business connection within British India. Such a close connection
cannot be envisaged in the present case since it does not involve any such
principle-agent relationship between the PE and the non residents .
..._
59. Barendra Prasad Ray v. ITO, [129 ITR 295] whereupon reliance has
been placed, is not apposite. Therein, the Court held that the professional
D
relationship of a solicitor, who was a non-resident, with an Indian firm will
i be a business connection. There was a connection between the Indian firm
and the British solicitor which was real and intimate and not just a casual
one and the fees earned by the solicitor was only through this connection,
and could not have done so without associating himself with the firm. Thus, E
the income earned by the solicitor was subject to tax in India, and payable
by the firm as agents of the solicitor.

· 60. The principle of this case, is again not applicable in the present
scenario since the nature of the relationship between the permanent
F
..,, establishment, the foreign firms and the Indian firms are evidently contractual
and not professional. And the transaction of sale and supply of goods
offshore have not taken place with the involvement of the permanent
establishment, therefore excluding this transaction from the scope of taxation
in India.
G
61. In Commissioner of Income-Tax, A.P. v. Tosho_k,u J;,tc!.., [1980] 125
ITR 525: [1980] Supp. SCC 614, this Court interpreted Section 9(1)(i) anp,t~,~,.
Explanation thereto on the factual matrix obtaining therein that the statutory
_)
agent exported his goods to Japan and France where they were rnld
through the assessee and the entire sales price was received in India by the H
152 SUPREME COURT REPORTS [2007] l S.C.R.

A said agent who made credit entries in his accounts books regarding the
commission amounts payable to the assessees and remitted the commission
amounts to them subsequently. Having regard to the fact that the Japanese
company was a non-resident company, distinguishing the case Raghava
Reddi & Another v. Commissioner of Income Tax, A.P., [1962] 44 ITR 720,
it was held:
B
" .. .It is not possible to hold that the non-resident assessees in this
case either received or can be deemed to have received the sums
in question when their accounts with the statutory agent were ·-
credited, since a credit balance without more only represents a debt
c and a mere book entry in the debtor's own books does not
constitute payment which will secure discharge from the debt. They
cannot, therefore, be charged to tax on the basis of receipt of
income actual or constructive in the taxable territories during the
relevant accounting period."

D 62. A Division Bench of the Karnataka High Court presided over by
Venkataramiah, J., in VDO Tachometer Werke, West Germany etc. v.
Commissioner ofIncome-Tax, Karnataka-1 Etc., [ 1979] 117 ITR 804 following
Carborandum Co. (supra), held that notwithstanding the amendment of
Section 9 of the Act by the addition of Clauses (vi) and (vii), the cases
E continued to be governed by the provisions of Section 9 of the Act.

63. In Commissioner ofIncome-Tax v. Atlas Steel Co. Ltd., (1987] 164
ITR 401, a Division Bench of the Calcutta High Court following Carborandum
(supra) and other decisions held :
F
"35. The expression "business connection" in the context of
the Income-tcix Act has come to acquire a special meaning as laid
down by the Supreme Court in R. D. Aggarwal & Co. 's case. A
business connection contemplated under Section 42 of the Indian
Income-tax Act, 1922 (corresponding to Section 9 of the Income-tax
G Act, 1961, involved "a relation between a business carried on by
a non-resident and some activity in the taxable territories which are
attributable directly or indirectly to the earnings, profits or gains of
such business". It was laid down by the Supreme Court that there
•.-
must be trading activity both outside and within the taxable
H territory. In the facts of this case, for the supply of inventions,
ISHIKAWAJMA-HARIMA HEAVY INDUSTRIES LTD.''· DIRECTOR OF INCOME TAX, MUMBAI [SINHA, J.J 153

patents, application for patents, secret knowledge and know-how, A
no trading activity had been or was required to be carried on by
the assessee within the taxable territory. Further, on a consideration
of the agreement, it cannot be said that the trading activity which
was intended to be carried on by the assessee as production
adviser of Hindustan Steel Ltd., in future was relatable to or
connected with the past supply of the said know-how and other
B
items.

[See also Income-Tax Officer and Others v. Shriram Bearings Ltd.,
[1987] l64ITR419.
c
64. A similar view was taken, when the matter came before this Court
in Income-Tax Officer and Others v. Shriram Bearings Ltd., [1997] 224 ITR
724 : (1997] IO SCC 332, wherein B.P. Jeevan Reddy, J. speaking for the
Division Bench, opined :

D
"We are not prepared to agree that the High Court has not
correctly understood the purport of the agreement between the
respondent and Mis Nippon Seike Kabushiki Kaisha (NSK). The
agreement is in two parts. It is true that the two parts are
interdependent but yet the consideration for the sale of trade
secrets and consideration of technical assistance is separately E
provided for and mentioned under separate sections. So far as the
consideration for the technical assistance is concerned, its taxability
is not in doubt. The only controversy is with respect to the
taxability of 1,65,000 US Dollars which is stipulated as the
consideration for sale of trade secrets. The agreement specifically F
says that the said sale is effected in Japan. We are unable to see
on what basis it can be said that any part of the said amount has
been earned in India."

65. In construing a contract, the terms and conditions thereof are to
be read as a whole. A contract must be construed keeping in view the G
intention of the parties. No doubt, the applicability of the tax laws would
depend upon the nature of the contract, but the same should not be
. ..J construed keeping in view the taxing provisions.

66. In Commissioner of Income-Tax, Tamil Nadu-V v. Fried Krupp H
154 SUPREME COURT REPORTS (2007] 1 S.C.R

A Industries, [1981] 128 ITR 27, a Division Bench of the Madras High Court
opined:

" ... Nowadays we have what are called turnkey projects, and in such
projects until the machinery is actually run and proves its
performance, the responsibility of the foreigner would continue.
B But in the present case the contract cannot be equated to a turnkey
contract. The operations in India for the erection of the machinery
are only the responsibility of the Indi~ company. It is only any
defect in the machinery or any negligence in the performance of the
foreign engineer, that may give rise to a claim for damages. But that
c is not the same as the foreign company performing any operation
in pursuance of this contract in India. Whatever we have said
:i-•'. above would apply also to deputation of foreign personnel for
procuring Indian spare parts. It was obviously considered necessary
to get foreign personnel from abroad for this purpose only because
the type of spare parts required for the foreign machinery could be
D
better picked up by these personnel, who have experience in
running the machinery. It is merely an assistance provided to the
f
Indian company, the foreign personnel being treated as the
employees ofthe Indian company. Having gone through the terms
of the agreement in full, we are satisfied that there are no operations
E in India attributable to the foreign company whiCh can give rise to
any profits being earned in India. The agreement itself says that the
terms of the payments were in Germany. Thus, there is absolutely
no operation in India which would give rise to tax liability in India
as far as the foreign company is concerned ... "
F
67. The term 'permanent establishment' has not been defined in the
Income Tax Act.

68. Since the appellant carries on business in India through a Permanent
Establishment, they clearly fall out of the applicability of Article 12(5) of the
G OTAA and into the ambit of Article 7. The Protocol to the OTAA, in
paragraph 6, discusses the involvement of the permanent establishment in
transactions, in order to determine the extent of income that can be taxed.
It is stated that the term 'directly or indirectly attributable' indicates the
income that shall be regarded on the basis of the extent appropriate to the
H part played by tl1e - permanent establishment in those transactions. The
1
ISHIKAWAJMA-HARIMA HEAVY INDUSTRIES LTD. v. DIRECTOR OF INCOME TAX, MUMBAI [SINHA, J] 155

permanent establishment here has had no role to play in the transaction that A
-,I
,,,. is sought to be taxed, since the transaction took place abroad.

69. Clause l of Article 7, thus, provides that if an income arises in
Japan (Contracting State), it shall be taxable in that country unless the
enterprise carries on business in the other Contracting State (India) through
a permanent establishment situated therein. What is to be taxed is profit of
B
the enterprise in India, but only so much of them as is directly or indirectly
attributable to that permanent establishment. All income arising out of the
)" turnkey project would not, therefore, be assessable in India, only because
the assessee has a permanent establishment.
c
70. It is relevant to note that the tax treaty between India and Japan
is essentially based on OECD model, providing :

"(a) the income of a resident, including of the kind
that would fall under would be table under Section 9, would D
be taxed in the State ofresidence, save and except the income
attributable to a Permanent Establishment, and
i
(b) even in the case of a permanent establishment,
income from business would be taxable in the State of
residence." E

71. In Klaus Vogel on Double Taxation Conventions, it is stated :

"(g) No force of attraction principle : The second
sentence of Art. 7 (I) allows the State of the permanent F
--,; establishment to tax business profits, 'but only so much of
them as is attributable to that pennanent establishment'. The
MC has thus decided against adopting the so-called 'force of

- attraction of the pennanent establishment', i.e. against the
principle that, where there is a pennanent establishment, the
State of the permanent establishment should be allowed to tax
G
all income derived by the enterprise from sources in that State
irrespective of whether or not such income is economically
..J connected with the pennanent establishment. In line with the
domestic Jaw then prevailing in the USA, such a 'force of
H
156 SUPREME COURT REPORTS [2007] 1 S.C.R.

A attraction' was, for instance, incorporated in Germany's 1954
DTC with USA (second sentence of Art. III (I). In contrast,
the second sentence of Art. 7(1) MC allows the State of the
permanent establishment to tax only those profits which are
economically attributable to the permanent establishment, i.e.
those which result from the permanent establishment's
B activities, which arise economically from the business carried
on by the permanent establishment (cf. also para 5 MC Comm.
Art. 7, supra m. no. 10). As regards the profits made by the
enterprise in the State of the permanent establishment, a
distinction must always be made between those profits which
c result from the permanent establishment's activities and those
made, without any interposition of the permanent
establishment, by the head office or any other part of the
enterprise (also for mere assembly permanent establishment
:BFH 37 RIW 258 (1991). It is only when there is a connection
with the permanent establishment that the State of the
D
permanent establishment is entitled to impose tax. Conversely,
losses incurred in connection with direct transactions may not
be set off against a permanent establishment's profits. Since
a DTC may not increase tax liability, the USA, it is true,
imposes tax at the lower amount that would ensue if the
E permanent establishment's business and direct transactions
were combined and treated as if no DTC- existed (of course,
the taxpayer may, in such event, not only set off the result of
individual direct transactions, which amounted to a loss
against the permanent establishment's positive operating result
F :l.R.S. Rev. Ru!. 84-17, 1984-I Cum. Bull. 308). According to
that ruling, the taxpayer is in such cases entitled to elect
taxation which discounts the DTC. (see surpa Art. I, at m.
no.44)."

We generally agree with the said statement law.
G
72. 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 present case, the permanent establishment's non-
involvement in this transaction excludes it from being a part of the cause
H of the income itself, and thus there is no business connection.
···---
ISHIKAWAJMA-HARIMA HEA\'Y INDUSTRIES LTD. v. DIRECTOR OF INCOME TAX, MUMBAI [SINHA, J) )57

73. Article 5.3 provides that a person is regarded as having a A
permanent establishment if he carries on construction and installation
activities in a Contracting State only if the said activities are carried out for
more than six months. Paragraph 6 of the Protocol to India Japan Tax Treaty
also provides that only income arising from activities wherein the permanent
establishment has been involved can be said to be attributable to the
permanent establishment. It gives rise to two questions, firstly offshore
B
services are rendered outside India; the permanent establishment would
have no role to play in respect thereto in the earning of the said income.
Secondly, entire services having been rendered outside India, the income
arising therefrom cannot be attributable to the permanent establishment so
as to bring within the charge of tax. c
74. For attracting the taxing statute there has to be some a_ctivities
through permanent establishment. If income arises without any activity of
the permanent establishment, even under the DTAA the taxation liability in
respect of oversea services would not arise in India. Section 9 spells out D
the extent to which the income ofnon-resident would be liable to tax in India.
Section 9 has a direct territorial nexus. Relief under a Double Taxation
Treaty having regard to the provisions contained in Section 90(2) of the
Income Tax Act would arise only in the event a taxable income of the
assessee arises in one Contracting State on the basis of accrual of income
in another Contracting State on the basis of residence. Thus, if Appellant E
had income that accrued in India and is liable to tax because in its State all
residents it was entitled to relief from such double taxation payable in terms
_I of Double Taxation Treaty. However, so far as accrual of income in India
is concerned, taxability must be read in terms of Section 4(2) read with
Section 9, whereupon the question of seeking assessment of such income F
in India on the basis of Double Taxation Treaty would arise.

75. In cases such as this, where different severable parts of the
composite contract is performed in different places, the principle of
__; apportionment can be applied, to determine which fiscal jurisdiction can tax
!
that particular part of the transaction. This principle helps determine, where G
the territorial jurisdiction of a particular state lies, to determine its capacity
to tax an event. 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.
H
158 SUPREME COURT REPORTS [2007] 1 S.C.R.

A 76. It is, therefore, in our opinion, the concepts 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. There, however, may be a case where
there can be over-lapping of income; but we are not concerned with such
B a situation. The entire transaction having been completed on the high seas,
the profits on sale did not arise in India, as has been contended by the
appellant. Thus, having been excluded from the scope of taxation under
the Act, the application of the double taxation treaty would not arise. Double
tax Treaty, however, was taken recourse to by Appellant only by way of
c an alternate submission on income from services and not in relation to the
tax of offshore supply of goods.

77. We would in the aforementioned context consider the question of
division of taxable income of offshore services. Parties were ad idem that
there existed a distinction between onshore supply and offshore supply.
D
The intention of the parties, thus, must be judged from different types of
services, different types of prices, as also different currencies in which the
prices are to be paid.

78. Section 9{l)(vii)(c} of the Act states that "a person who is a non-
E resident, where the fees are payable in respect of services utilized 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".
Reading the provision in its plain sense, it can be seen that it requires two
conditions have to be met - the services which are the source of the income
F that is sought to be taxed, has to be rendered in India, as well as utilized
in India, to be taxable in India. In the present case, both these conditions
have not been satisfied simultaneously, therefore excluding this income from
the ambit of taxation in India. Thus, for a non-resident to be taxed on income
for services, such a service needs to be rendered within India, and has to
be a part of a business or profession carried on by such person in India.
G The Petitioners in the present case have provided services to persons
resident in India, and though the same have been used here, it has not been
rendered in India.

79. Section 9(1)(vii) of the Act whereupon reliance has been placed by
H the learned Additional Solicitor General, must be read with Section 5 thereof,
ISHIKAWAJMA-HARIMA HEAVY INDUSTRIES LTD. v. DIRECTOR OF INCOME TAX, MUMBAI [SINHA. JJ 159

which takes within itp purview the territorial nexus on the basis whereof tax A
.- is required to be levied, namely, : (a) resident; and (b) receipt or accrual of
income.

80. Global income of a resident although is subjected to tax, global
income of a non-resident may not be. The answer to the question would
depend upon the nature of the contract and the provisions of DTAA. B

81. What is relevant is receipt or accrual of income, as would be
evident from a plain reading of Section 5(2) of the Act. The legal fiction
created although in a given case may be held to be of wide import, but it
is trite that the terms of a contract are required to be construed having c
regard to the international covenants and conventions. In a case of this
nature, interpretation with reference to the nexus to tax territories will also
assume significance. Territorial nexus for the purpose of determining the
tax liability is .an internationally accepted principle. An endeavour should,
thus, be made to construe the taxability of a non-resident in respect of D
income derived by it. 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 of the
Act. Section 9 incorporated various heads of income on which tax is sought
to be levied by the Republic of India. Whatever is payable by a resident
to a non-resident by way of fees for technical services, thus, would not E
always come within the purview of Section 9(1 )(vii) of the Act. It must
have sufficient territorial nexus with India so as to furnish a basis for
imposition of tax. Whereas a resident would come within the purview of
Section 9( 1)(vii) of the Act, a non resident would not, as services of a non-
resident to a resident utilize in India may not have much relevance in F
determining whether the income of the non-resident accrues or arises in
India. It must have a direct live link between the services rendered in India,
when such a link is established, the same may again be subjected to any
relief under DTAA. A distinction may also be made between rendition of
services and utilization thereof.
G
82. Section 9(1)(vii)(c) clearly states " .... where the fees are payable in
respect of services utilized in a business or profession carried on by such
person in India" It is evident that Section 9(l)(vii), read in its plain, same
envisages the fulfillment of two conditions : services, which are source of
income sought to be taxed in India must be (i) utilized in India and (ii) H .~,
160 SUPREME COURT REPORTS [2007] 1 S.C.R.

A rendered in India. In the present case, both these conditions have not been
satisfied simultaneously.

83. The provisions of Section 9(l)(vii) of the Act are plain and capable
of being given a meaning. There, therefore, may not be any reason not to
give full effect thereto. However, even in relation to such income, the
B provisior.s of Article 7 of the DT AA 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. Even in relation thereto, principle of apportionment
c shall apply.

84. The Authority, in our opinion, has committed an error in this behalf,
as if ser".ices 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
D shall stand obliterated.

85. It would be contrary to the intent and purport of the Double
Taxation Convention which is a part of the scheme under the Income Tax
Act.
E
86. We, therefore, hold as under :

Re : Offshore Supply :

F (1) That only such part of the income, as is attributable to the operations
carried out in India can be taxed in India.

(2) Since all parts of the transaction in question, i.e. the transfer of
property in goods as well as the payment, were carried on outside the
Indian soil, the transaction could not have been taxed in India.
G
(3) The principle of apportionment, wherein the territorial jurisdiction of a
particular state determines its capacity to tax an event, has to be
followed.

H (4) The fact that the contract was signed in India is of no material
JSHIKAWAJMA-HARJMA HEAVY INDUSTRIES LID. v. DIRECTOR OF INCOME TAX. MUMBAI [SINHA, J] 161

consequence, since aII activities in connection with the offshore A
supply were outside India, and therefore cannot be deemed to accrue
or arise in the country.

(5) 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 aforementioned provision
B
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 of the Income Tax Act. c
(6) Clause (a) of Explanation 1 to S. 9(1)(i) states that only such part of
the income as is attributable to the operations carried out in India, are
taxable in India.
D
(7) The existence of a permanent establishment would not constitute
sufficient 'business connection', and the permanent establishment
would be the taxable entity. The fiscal jurisdiction of a country would
not extend to the taxing entire income attributable to the permanent
establishment.
E
(8) There exists a difference between the existence of a business connection
and the income accruing or arising out of such business connection.

(9) Paragraph 6 of the Protocol to the DTAA is not applicable, because,
for the profits to be 'attributable directly or indirectly', the permanent F
establishment must be involved in the activity giving rise to the
profits.

87. Re: Offshore Services:

(1) Sufficient territorial nexus between the rendition of services and G
territorial limits of India is necessary to make the income taxable.

(2) The entire contr:-ct would not be attributable to the operations in India
viz. the place of execution of the contract, assuming the offshore
elements form an integral part of the contract. H
''f--

162 SUPREME COURT REPORTS [2007) l S.C.R.

A (3) Section.9(l)(vii) of the Act read with Memo cannot be give.n a wide
meaning so as to hold that the amendment was only to include the
. ~-

income of non-resident taxpayers received by them outside India from
Indian concerns for services rendered outside India.

(4) The test of residence, as applied in international law also, is that of the
B taxpayer and not that of the recipient of such services.

(5) For Section 9(l)(vii) to be applicable, it is necessary that the services r-
not only be utilized within India, but also be rendered in India or have ""
such a "live link" with India that the entire income from fees as
c envisaged in Article 12 of DTAA becomes taxable in India.

(6) The terms 'effectively connected' and 'attributable to' are to be
construed differently even if the offshore services and the permanent
establishment were connected.

D (7) Section 9(l)(vii)(c) of the Act in this 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 of the DTAA is applicable in this case, and it limits the tax
E on business profits to that arising from the operationsofthe permanent
establishment. In this case, the entire services have been rendered
outside India, and have nothing to do with the permanent establishmei;it,
~nd can thus not be attributable to the permanent establishment and
therefore not taxable in India.
F
(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.

(10) The location of the source of income within India would not render
G sufficient nexus to tax the income from that source.

(11) If the test applied by -the_ Authority for Advanced Rulings is to be
adopted here too, then it would eliminate the difference between the L.

connection between. Indian and foreign operations, and the
H apportionment of income accordingly.
ISHIKAWAJMA-HARIMA HEAVY INDUSTRIES LTD. v. DIRECTOR OF INCOME TAX, MlThffiAI [SINHA, J.J 163

(12) The services are inextricably linked to the supply of goods, and it must A
be considered in the same manner.

88, For the reasons aforementioned, the appeal is allowed in part and
to the extent mentioned hereinbefore. No costs.

S.K.S. Appeal partly allowed. B