director of income tax v. samsung heavy industries co. ltd

SCV & Co.LLP Chartered Accountants SCV Case Laws

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Director of Income tax v. Samsung Heavy Industries Co. Ltd. Civil Appeal No. 12183 of 2016

Date of Pronouncement: July 22, 2020 Assessment Year: 2007-08

SUMMARY OF THE CASE

In a very recent decision in DIT v. Samsung Heavy Industries Co. Ltd., the Hon’ble Supreme Court

has held: “No Fixed Place PE exposure in the absence of carrying out of core business activities”.

The said decision is summarised below:


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Facts of the Case:

• Samsung Heavy Industries Co. Ltd. (SHCIL) is a South Korean Company and in the year 2006, ONGC awarded a “turnkey” contract to a consortium comprising of SHICL and Larsen & Toubro Limited for carrying out work of surveys, design, engineering, procurement, fabrication, installation and modification at existing facilities, and start-up and commissioning of entire facilities covered under the ‘Vasai East Development Project’.

• To facilitate this, SHICL set up a Project Office (PO) in Mumbai to act as "a communication channel" between itself and ONGC in respect of the Project

• Pre-engineering, survey, engineering, procurement and fabrication activities of the platform took place abroad in the year 2006. It was only starting November 2007 (i.e., after the close of the year under consideration) that these platforms started arriving in India to be installed at the project and hence, the installation activities commenced in the subsequent year (not in the year under consideration).

• The said project was to be completed by 26.07.2009

• Income tax Return was filed for Assessment Year 2007-08 by SHICL and loss of INR 23.5 lacs was claimed in the return.

• The AO treated the said Mumbai PO as a Fixed Place Permanent Establishment (PE) of SHICL which assertion was also confirmed by DRP and Hon’ble ITAT.

The AO further attributed 25% of the revenue to the said PO.

Issue for Consideration: Whether the Mumbai Project Office can be construed to be a Fixed Place Permanent Establishment

of SHICL in India? Arguments of SHICL: SHICL contented and argued the following:

• Mumbai PO was to merely act as a communication channel between SHICL and ONGC in respect of the Project and hence, the activities were preparatory & auxiliary in nature.

• The Pre-engineering, survey, engineering, procurement and fabrication activities took place abroad in the year 2006

• The PO consisted of only two employees, neither of whom had any technical qualification whatsoever.

• The accounts that were produced would show that the PO had not incurred any expenditure on execution of the project

• SHICL also argued that the burden of establishing that a foreign Assessee has a PE in India is on the tax authorities, which burden had not been discharged on the facts of the present case

• Reliance was placed on the decision of Hon’ble Supreme Court in CIT v. Hyundai Heavy Industries Co. Ltd. [2007] 7 SCC 422 to state that the facts in the aforesaid case were similar to the


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present case and hence, the said decision would apply to SHICL also. SHICL also sought to distinguish the judgement in the case of DIT v. Morgan Stanley & Co. [2007] 7 SCC 1and relied on ADIT v. E- Funds IT Solution Inc. [2018] 13 SCC 294

• SHICL, alternatively, also argued that even assuming that there is a PE in India through which the core business activity of the Assessee was carried out, no taxable income can be attributed to it, as audited accounts that were produced showed that the project did not yield any profit, but in fact resulted in only losses.

Arguments of Revenue Authorities: Not agreeing with the contention of SHICL, the Revenue Authorities contented the following:

• The project was a single indivisible “turnkey” project (which could not be split up), whereby ONGC was to take over a project that is completed only in India. Resultantly, profits arising from the successful commissioning of the Project would also arise only in India and attributed 25% revenue to the PO.

• The decision in Hyundai Heavy Industries (supra) was distinguished by the AO stating that, in that case, the project was in two separate parts, unlike the Project in the present case. PE was set up only at the stage of installation, i.e. long after the revenue had been earned from manufacture, design etc., and it was

for that reason that it could not be brought to tax.

• That the work relating to fabrication and procurement of material was very much a part of the contract for execution of work assigned by ONGC

• SHICL had not contested the existence of the PO in India but it had only contested that the project was used merely for preparatory and auxiliary activities. As per him, this submission of SHICL does not hold merit because if it wanted to perform only preparatory and auxiliary activities then it could have opened a liaison office.

• The authorities extracted data from Capitaline software and picked up 4 similar projects executed by companies outside India, and found the average profit margin to be 24.7%, which, according to the DRP, would justify the figure of 25% arrived at in the Draft Order.

Decision of Hon’ble ITAT: SHICL filed appeal before Hon’ble ITAT against the order of the ld. AO, however, ITAT dismissed the appeal and remitted the matter back to the AO. The observations of the Hon’ble ITAT were as under:

• ITAT went into the establishment of the PO in much more detail than had been gone into either in the Draft Order or the DRP’s decision

• The Application dated 24.4.2006 filed by SHICL to RBI was referred and Board


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Resolution dated 3.4.2006 for opening of PO was also referred.

• ITAT observed that Mr. Sangsoon Park, the General Manager of SHICL, had been appointed as a representative to sign documents for opening of the PO and a bank account in India and to look after operations of the PO

• ITAT also noted that the scope of the Mumbai PO was neither restricted by SHICL itself nor was it restricted by RBI in any terms, while in the case of Hyundai Heavy Industries (supra), the PO was to act only as a Liaison Office and this is a vital difference between that case and the present case.

• ITAT further noted that as per the Board Resolution dated 3.4.2006, it was clear that PO was opened for coordination and execution of impugned project

• In the absence of any restriction put by SHICL in the application moved by it to RBI, in the BR passed by SHICL for the opening of PO and the permission given by RBI, it cannot be said that PO was not a fixed place of business

• In the absence of any restriction put by SHICL in the application moved by it to RBI, in the Board Resolution passed by SHICL for the opening of PO and the permission given by RBI, ITAT held that it cannot be said that the PO was not a fixed place of business

• ITAT also rejected the argument of SHICL that ‘as per the accounts of the PO, no expenditure of execution was debited, hence, it cannot be said that PO carried out core activities’. It held that ‘the maintenance of account is in the

hands of assessee and mere the mode of maintaining the accounts alone cannot determine the character of PE as the role of PE only will be relevant to determine what kind of activities it has carried on’

• ITAT also held that ‘the way the terms of the contract are described and the way the work on contract has to proceed, clearly describes that in all the activities of contract there will be the role of Mumbai project office as the same has to work as a channel between assessee company and ONGC’

• Further, as per ITAT, no material was brought on record by SHICL to prove that the activities of PO are preparatory & auxiliary and hence, it was held that the Mumbai PO constituted a fixed place PE

• Having so held, ITAT found that there was lack of material to ascertain as to what extent activities of the business were carried through PO and therefore, remitted back to the AO to ascertain the profits attributable to the Mumbai PO.

Decision of Hon’ble Uttarakhand High Court: SHICL preferred an appeal against the ITAT order before the Hon’ble Uttarakhand High Court. The Hon’ble Court framed 5 substantial questions of law: i) Whether ITAT erred in holding that

SHICL had a Fixed Place PE as per Article 5(1)/ 5(2) of the DTAA between India & Korea?

ii) Whether the finding of ITAT, that the PO was opened for coordination and


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execution of the project and all activities to be carried out in relation to the said project were routed through the PO only, is perverse?

iii) Without prejudice, whether the ITAT has erred in not holding that even if no fixed place PE existed, no income on account of offshore activities was attributable to the said PE?

iv) Without prejudice, whether the ITAT has erred in not holding that no income could be brought to tax in India since SHICL had overall losses?

v) Whether the contract was divisible and if so, whether activities of designing & fabrication took place in any part of India?

The aforesaid mentioned 5 substantial Questions of law were framed by the Hon’ble Court, however, the Court concerned itself with only one question: ‘can it be said that the Agreement permitted the India Taxing Authority to arbitrarily fix a part of the revenue to the permanent establishment of the appellant in India?’ The Hon’ble High Court held as under:

• There was no finding that 25% of the gross revenue of SHICL outside India was attributable to the business carried out by the PO. Neither the AO nor ITAT made any effort to bring on record any evidence to justify this figure.

• The appeal was, accordingly, allowed by holding that the tax liability could not be fastened without establishing that the

same is attributable to the tax identity or PE of the enterprise situated in India.

Appeal before Hon’ble Supreme Court by the Revenue

Aggrieved by the order of Hon’ble High Court, the Revenue preferred an appeal before the Hon’ble Supreme Court. The following judicial pronouncements were referred in the present case:

• CIT v. Hyundai Heavy Industries Co. Ltd. [2007] 7 SCC 422 – the facts in this case made it clear that the turnkey contract entered into between Hyundai Heavy Industries Co. Ltd. and ONGC and the Court held as under:

o Profits earned by the Korean GE on

supplies of fabricated platforms cannot be made attributable to its Indian PE as the installation PE came into existence only on conclusion of the transaction giving rise to the supplies of the fabricated platforms.

o The installation PE emerged only after the contract with ONGC stood concluded. It emerged only after the fabricated platform was delivered in Korea to the agents of ONGC.

o Therefore, the profits on such supplies of fabricated platforms cannot be said to be attributable to the PE.


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• DIT v. Morgan Stanley & Co. [2007] 7 SCC 1 – In this case no Fixed Place PE was constituted as regards Stewardship activities being in the nature of back office support and which were merely to protect the interest of the US Company.

• ADIT v. E- Funds IT Solution Inc. [2018] 13 SCC 294 – In this case, it was held that the burden of proving the fact that a foreign assessee has a PE in India and must therefore suffer tax from the business generated from such PE, is initially on the Revenue.

• Ishikawajma-Harima Heavy Industries Ltd v. DIT [2007] 3 SCC 481 – In the said case, the Hon’ble Court held as under:

o The distinction between the existence

of a business connection and the income accruing or arising out of such business connection is clear and explicit. PE’s non-involvement in the transaction excludes it from being a part of the cause of the income itself, and thus there is no business connection.

o For attracting the taxing statute there has to be some activities through PE. If income arises without any activity of PE then even under DTAA the taxation liability in respect of overseas services would not arise in India.’

Decision of Hon’ble Supreme Court: The Hon’ble Supreme Court noted the above facts and took into consideration the arguments put forth by SHCIL as well as Revenue. On the general principles governing a fixed place PE, the Hon’ble Court held as under: • The condition precedent for applicability

of Article 5(1) of the DTAA and the ascertainment of a “PE” is that it should be an establishment “through which the business of an enterprise” is wholly or partly carried on

• Profits of a foreign enterprise are taxable only where the said enterprise carries on its core business through a PE

• Maintenance of a fixed place of business which is of a preparatory or auxiliary character in the trade or business of the enterprise would not be considered to be a PE under Article 5 of the treaty

• Only so much of the profits of the enterprise, as is attributable to the PE, may be taxed in the other State

After noting down the general principles, the Hon’ble Court applied the same to the facts of the present case and held as under: • As per Board Resolution, the Mumbai PO

was established to coordinate & execute “delivery documents in connection with construction of offshore platform modification of existing facilities for ONGC”. ITAT relied upon only the 1st paragraph of the Board Resolution, and


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then jumped to the conclusion that the PO was for coordination & execution without going through the 2nd paragraph of the Board Resolution. The finding, therefore, that the PO was not a mere liaison office, but was involved in the core activity of execution of the project itself is therefore clearly perverse.

• Hon’ble Supreme Court also rejected the arguments of Revenue Authorities related to accounts of the PO that mere mode of maintaining accounts alone cannot determine the character of PE, holding it as perverse.

• The finding that the onus is on the Assessee and not on the Tax Authorities to first show that the project office at Mumbai is a permanent establishment is against the decision of Hon’ble Supreme

Court in E-Funds IT Solution Inc (supra). An interesting phrase was used by Hon’ble Supreme Court in this context of not considering its earlier decision: ‘in the teeth of our judgment’

• Hon’ble Supreme Court also held that ITAT ignored the fact that there were only 2 persons working in the Mumbai office, neither of whom was qualified to perform any core activity of the Assessee

• Accordingly, it was held that no fixed place PE was established because the activities would fall within Article 5(4)(e) of DTAA between India and Korea i.e., preparatory and auxiliary activities.

The principle related to carrying on of ‘Core Business Activity’ is of Prime Importance for establishing Fixed Place PE and this judgement has upheld that. The

present Landmark judgment of the Hon'ble Supreme Court will give clarity to PE issues which will help MNCs in doing business in India and will go a long way to

promote the ease of doing business in India. Further, this is another extremely important decision, after E-Funds IT Solutions Inc. (supra), on the issue that ‘burden of proving that a Foreign Assessee has a PE, is first on the Revenue’.

Our Remarks


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director of income tax v. samsung heavy industries co. ltd

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