1. These two appeals are by the assessee, a non-resident company, against the order under Section 263 of the Income-tax Act, 1961 ('the Act'), by the Commissioner in respect of the assessment years 1975-76 and 1976-77. In these orders, the Commissioner had directed the ITO to ascertain whether any income arises to the assessee owing to business connection in India.
2. The assessee is a company, registered in USA (hereinafter referred to as 'US Co.'). They had filed returns in both the assessment years showing income from dividend from their Indian subsidiary company (hereinafter referred to as 'Indian Co.'). The assessments had been completed accepting the returns.
3. The reason why the Commissioner thought that there may be income arising to the assessee from business connection in India would be clear from the following facts: The US Co. had entered into an agreement with the Indian Co. as far back as 1-11-1931, which is still existent. That agreement describes the Indian Co. as 'dealer'. The US Co. would 'sell to the dealer for resale, goods and manufactures as covered by discount sheets' attached to the agreement 'to execute orders for the goods placed by Indian Co., and the US Co. would charge Indian Co. at net prices and list prices as per price list, less discounts'. The US Co, had reserved the right to increase or decrease the prices shown in the price list. On its part the Indian Co. agreed to make every effort to sell the goods and to pay the US Co. for all the goods shipped and the amount charged.
4. As a matter of practice, the discount allowed to the Indian Co. was 10 per cent. The modus operandi of the business would be clear from one illustrative deal, as given in the paper book furnished at the time of hearing.
5. On 8-12-1971, a purchase order was placed by Phillips Carbon Black Ltd. for spares for a compressor. The order is booked in terms of dollars and the price payable is $590.40-ffreight. Out of this, 10 per cent that is $ 59.04, is payable to Indian Co. in rupees. For the balance, the customer has to open a letter of credit in favour of Principals, Ingersoll Rand Co., USA,' against the import licence of the customer.
6. The Indian Co. then places a corresponding order on US Co. under reference 297-15112, on getting confirmation regarding letter of credit on 22-1-1973. Thereafter, the Indian Co. writes to the customer on 16-2-1973 that they had placed the corresponding order.
7. The US Co. then ships the goods direct to Calcutta as required by the customer. They then prepare an invoice dated 30-1-1973 which shows that goods were sold to Indian Co. This invoice also shows that $ 59.04 is payable to Indian Co. in rupee equivalent and the balance as per letter of credit in USA.8. Shipment is effected on 16-10-1973 direct to Calcutta. Final invoice is prepared by Indian Co. on 15-11-1973. In this invoice, although the rates are still given in terms of dollars, the amount payable is given in rupees--sale value is shown at Rs. 4,870.34.
9. In the books of the US Co., the net amount receivable by them is recorded, i.e., the amount paid through letter of credit. The 10 per cent payable in Indian currency does not figure in their books.
10. On these facts, as illustrated, the question is whether any income accrues or arises in India. Shri Dastur made the following submissions: (1) These are two independent transactions, one a sale by the Indian Co. to the Indian customer and two a sale by US Co. to Indian Co.
This is, therefore, a dealing at arm's length on principal to principal basis. (2) If this is not a sale, then it would mean that Indian Co. acts as an agent of the US Co. Even then, it does not represent a business connection. (3) Assuming there is business connection, there is no operation carried on in India and, therefore, no income accrues. (4) Assuming that there are operations in India, the expenditure in India is 10 per cent of the invoice price and the profit margin is considerably less. Consequently no profit arises.
11. Elaborating these submissions, he pointed out that except for 10 per cent of the invoice, the rest of the price is remitted direct to USA by the customer. The agreement of 1931 itself envisages a direct sale by the US Co. to Indian Co. It also provides for a direct sale by Indian Co. to the Indian customers. He further stated that there is a reason for remitting 90 per cent direct to US Co. The restrictions imposed by the Reserve Bank of India regarding the remittance and the import policy allowing import for direct consumers require the Indian Co. to adopt this method, so that the conditions for import could be satisfied. But, that does not, according to him, alter the nature of the transaction. There is no privity of contract between ,the Indian customer and the US Co. If there is a default, only remedy for the Indian customer is to sue the Indian Co. He relied on the Bombay High Court decision in CIT v. Gulf Oil (Great Britain) Ltd.  108 ITR 874 to show that the transactions under these circumstances have to be treated on principal to principal basis.
12. Regarding the second submission, he stated that even if the Indian Co. is to be treated as agent, it only gives information and such information would not amount to business connection. Reliance was placed on the decision of CIT v. R.D. Aggarwal & Co.  56 ITR 20(SC).
13. To show there are no operations carried on in India, he pointed out that the documents of title are handed over to the bank in USA against letter of credit. The goods are put on board F. A.S. Title to the goods passed in USA only. The Indian customer accepts the performance of the contract by US Co. as the agent of the Indian Co. He relied on the decision of the Supreme Court in Carborundum Co. v. CIT' 108 ITR 335 for the submission that there could be no business connection or operation in India; further reiterated in CIT v. Toshoku Ltd.  125 ITR 525, which according to him, showed a reverse facet.
14. Finally, he submitted that, in any case, if there are operations in India, the expenditure of the operations is 10 per cent payable to Indian Co., but the profits in these transactions factually were far less than 10 per cent.
15. Shri Bhargava, for the department, submitted that the dealings were not strictly according to the 1931 agreement; who accepts the Indian customer's order Indian Co. or the US Co., he submitted, is not at all clearly spelt out. There are sufficient indications that the US Co.
accepts the orders through the Indian Co. He submitted that the negotiations leading to sale are taking place only in India, and the Indian Co. merely acts as agents. He further submitted that the Indian Co. is never the owner of the goods at any stage so the theory of principal to principal deal has no application. There is complete control by the US Co. of the business of Indian Co. He then distinguished the cases relied on. In the case of CIT v. Tata Chemicals Ltd.  94 ITR 85 (Bom.), there were, as a fact, no transactions in India. The decision of the Supreme Court in Aggarwals case (supra) was on the facts of the case. That was a case under the old Act where the expressions used were different. The case of Carborandum case (supra) was decided on the facts found by the Tribunal that there were no operations in India. In Toshoku Ltd. case (supra) the question turned on the amount credited in the Indian principal's books. That is distinguishable.
16. As Shri Dastur had submitted, there are four issues arising from this appeal. The first issue is whether the dealing between the US Co.
and the Indian Co. is on principal to principal basis. If it is found to be so, nothing further need he looked into. While we decide the issue, we should apply and determine the true tests to determine whether the Indian Co. is an agent of the US Co. The facts, which emerge on going through the materials, are: 1. The agreement of 1931 describes the Indian Co. as a dealer. It should sell the goods at the listed prices only. It cannot sell at any price it likes.
2. The purchase order from the Indian customer lists the price in terms of dollars and not in rupees. It is only the final invoice after the shipment of the goods are effected that the price payable is given in terms of rupees.
3. In the material papers, the Indian Co. refers to the US Co. as principal.
4. The Indian Co. does not place an order with the US Co. unless it receives an order from the Indian buyer. On receipt of such an order, an identical order with pre-determined prices is placed with the US Co.
5. In all orders received by Indian Co., 10 per cent of the value predetermined as per listed price in dollars, is payable to Indian Co. in rupees. This 10 per cent does not figure at all in the books of US Co.
6. 90 per cent of the price is paid directly by the Indian consumer to US Co.
8. The property in the goods passes to the Indian consumer direct fro n US Co. The title passes to the buyer in USA.17. The prima facie impression created by the agreement of 1931 is that it resembles a selling agency, which is not normally considered as an agency under Section 182 of the Contract Act. In H. Prudhomme & Co. v.Hamel8c Hardly Ltd. AIR 1925 Cal. 161, the Privy Council observed: In many trades--particularly the motor trade--the so-called agent is merely a favoured and a favouring buyer, one who under an overriding contract, undertakes to do his best to find a market for the manufacturer's stock, who is given some special advantages, such as a special discount or preference in complying with his orders; but who in each particular contract acts as a buyer from the manufacturer, and sells at whatever price he can get, unless he is forbidden to sell too cheap.
If the Indian Co. is the only a favoured buyer, then it cannot be an agent. But, to be a favoured buyer, there are certain other points to be seen, which is brought out in the extract. The most favoured buyer should buy first; and then sell it at any price he likes. Both factors are absent in our case. The Indian Co. never buys on its own. It places an order only after it had received such an order from the Indian customer. It could be explained by pointing out that the Indian Co.
cannot stock them, since they do not have licences for import. That licence, as a matter of Government policy, is given only to the consumer. We have to give due weight to this aspect. But, then we find that the Indian consumer, having an import licence, although free to deal with the foreign company direct, does not do so. That company places the order only to the Indian Co. This has been the practice all these years. There has been no instance of any Indian consumer placing orders directly to the US Co. That being so, it is not possible to say, the first factor is found against the idea of a most favoured buyer.
18. The second factor is the independence to sell at any price it likes provided it is not too cheap. This is also not satisfied. We have seen that the Indian Co. has to sell at the listed price only. So, we cannot hold that the Indian Co. is not an agent by applying the ratio of the Privy Council's ruling, We have to decide the issue independently.
19. The main test to be applied, Shri Dastur stated, is to see if there is a privity of contract between the U.S. Co. and the Indian consumer.
According to him, there is none and so, there is no agency. This is certainly one important test; but it is not conclusive. That is what the Court of Appeal observed in Weiss Bihellor & Brooks Ltd. 8 TC 381.
The Court of Appeal was dealing with similar facts. "There are two very important matters which are favourable to the appellant. One is this, that I do not think there is anything to show here that any privity whatever was created between the ultimate purchaser and the Ramie Union, and that any contract binding the Ramie Union was made by the appellants. This is an important matter but not conclusive ...." 20. Another test to be applied was the passing of the title to the goods. It had been urged that the deal between the Indian Co. and US Co. on the one hand, and the Indian Co. and the Indian consumer, on the other, are independent; the title to the property passed from US Co. to Indian Co. and to Indian consumer and the US Co. gave the title to the property to Indian consumer only as a part of the performance of the contract between Indian and US Co. Passing of the title to the goods is certainly an important test. But this, again, is not conclusive; and for this proposition also, the authority is the same, decision of Court of Appeal, ibid.
21. Some further tests may now be considered. A study of the Bombay High Court decision in Supdt. of Stamps v. Breul & Co.  46 Bom.
LR 686 bring them out. Their Lordships have pointed out that whether two parties act as principal to principal or as agent to a principal has to be decided on the facts of the case and the law governing the contract. In that case, their Lordships were considering a question whether a member of East India Cotton Association making a sale note to a non-member was acting as an agent or as a principal. The Chief Justice found expressions in the contract note which are in conformity with principal to principal relation.
We accept your offer,' and not 'we will execute your order.' I agree with the learned Chief Presidency Magistrate that, as stated in his judgment annexed to the reference, by-law 81A must govern this contract, and that it must be construed as between principal and principal. In my judgment, the document referred to us is not a note or memoradum sent by a broker or agent to his principal intimating the purchase or sale on account of such principal. It is an agreement for the sale of fifty bales of cotton for Rs. 500 by Mr.
Murty to Messrs Breul & Co. The relationship between the parties is that of vendor and purchaser, and not that of principal and agent.
Messrs Breul & Co. neither promise nor impose upon themselves any of the duties or obligations of an agent. The whole tenor of the agreement, read in conjunction with by-laws which govern it, is a contract between principal and principal.
22. We will note one more authority before we apply the law to the facts. The Calcutta High Court in Modi Vanaspati Mfg. Co. v. Katihar Jute Mills AIR 1969 Cal. 496 was faced with a similar problem. Katihar Jute Mills ('KJM'for short) entered into agreement for purchase of generators with Bhaduri ('B' for short). The generators were properties of Modi's ('M' for short). There was break of contract and the case of KJM was that B was agent of M and so they could sue M for damages. The High Court had to decide whether B were agents. Para 14 of the judgment is reproduced below: 14. The correspendence between the plaintiff and the Bhaduris would indicate that the transaction between the plaintiff and the Bhaduris came into existence in the month of October 1952. The letter dated 6 October, 1952 was rightly relied on by the counsel for the appellant as constituting the definite bargain between the parties, namely, the plaintiff and the Bhaduns, To my mind it appears that if the Bhaduns acted as the agents of the Modis there would not be subsequent contracts between the Bhaduris on the one hand and the Modis on the other hand. The most noticeable feature of the case is that the contract between the plaintiff and the Bhaduris was for the purchase of two sets at the total price of Rs. 1,40,000. The very fact that there were subsequent contracts between the Bhaduris and the Modis with the additional feature of a different price would indicate that the transactions were independent and separate. One of the tests of finding out agency is as to who was to pay the price.
The Supreme Court in the recent decision of Gordon Woodroffe & Co.
(Madras) Ltd. v. Shaik M.A. Majid & Co. AIR 1967 SC 181 considered as to whether the defendant in that case was acting as agent of the plaintiff or whether the defendant was the outright purchaser of the goods. The respondent in that case was a trader at Madras in hides and skins. The appellant Gordon Woodroffe & Company (Madras) Ltd. was doing business as exporters of hides and skins, For several months commencing January 1, 1949 there were many contracts. The case of the respondent was that he entered into an agreement with the appellant to act as agents. In that case, the express terms of the contract were decisive of that question. But there are certain observations of the Supreme Court which may be referred to. The first observation is that if the defendants in that case were intended to be constituted as the agents for sale, the terms of the contract in that case would have been entirely different. The terms in that case were inter alia as follows: 'We confirm buying from you for resale the following subject to UK Import licence." The second important feature there was that a definite price was fixed in the contract for the plaintiff's goods. According to the plaintiff in that case the rates fixed in the contract were the ones at which the goods were sold to London purchaser and not a different rate and the defendants were agents who were obtaining for him only the price at which the goods were sold at London'. In that context the Supreme Court observed 'the important point is that if the contract; was one of agency there was no need to mention the price at all as between the plaintiff and the defendants'. The reason why I referred to this decision is to show that the differences in price as also the difference in the terms and parties in the present case would indicate the transaction between the Bhaduris and the plaintiff on the one hand and the transaction between the Bhaduris and the Modis on the other hand to be absolutely independent of each other. In order to establish agency it is true that surrounding circumstances in the present case establish that the contracts between the parties are totally distinct and different and came into existence at different points or time on different terms at different prices. It will not, therefore, be correct to conclude that the contracts, though they are separate and independent, should still be regarded as one composite contract between the agents.
23. We will now turn to the facts. The illustrative deal with Phillips Carbon Black referred to earlier shows that the transaction started with the quotations given by the Indian Co. on 1-12-1972 (foot note of purchase order). The purchase order gives the rates in dollars.
Delivery is 4 to 6 weeks Ex-Works USA after receipt of order and covering letter of credit. Terms of payment are by letter of credit, open in favour of "your principal". Clearly, as far as Phillips Carbon is concerned, they were treating the Indian Co. as agents of the US Co.
Otherwise, the rate in dollars, reference to shipment, reference to 'your principal' are inexplicable.
24. The respondence from Indian Co. is given in the letter to Phillips Carbon dated 16-2-1973 which reads: We have already released our corresponding order on our Painted Post Plant in USA under reference 297-15112.
With regard to shipment schedule, we will write to you as soon as we hear from them.
This does not read as a letter of a trader dealing at arm's length. To recall, unlike Brvel & Co.'s case (supra), the Indian Co. does not say in substance. We accept your offer. They say 'We will execute your order'. They go on to say that 'With regard to shipment schedules, we will write to you as soon as we hear from them', i.e., the principal, according to the understanding of Phillips Carbon. In the letter of 22-1-1973, Phillips Carbon again refers to US Co. as principals at two places. The extract from Calcutta High Court decision quoted above had laid emphasis on the two independent rate of contracts. Such is the case before us also but, unlike the Calcutta High Court case, there is no feature of two different prices. There is one and only one price, part to be paid in rupees in India and part in USA by opening a letter of credit. The other test suggested by the Supreme Court in Gordon Woodroffe case (supra) quoted by Calcutta High Court is who was to pay the price. That also indicates the Indian buyer only.
25. Shri Dastur had also submitted that if there is breach of contract between Phillips Carbon and the Indian Co., the remedy is to file a suit only against Indian company; the US Co. would not be in the picture and not liable. This submission is correct as far as it goes.
But, suit could be as the agent of the principal. That is what happened in Mahammedally v. Schillar quoted in The Law of Contract in India of V.G. Ramachandran .
The defendants were merchants and commission agents trading in Bombay, being a branch of a French Firm of the same name, trading in Paris. Plaintiff, a Bombay merchant, ordered through the defendant 48 casks of zinc sheets by an indent which read: 'I hereby request you to instruct your agents to purchase for me the under-mentioned goods on my account and risk upon the terms stated below.' The terms limited the price and the time by which the shipments were to be made. The plaintiff later consented to increase the limit of the price on receiving defendant's letter to the effect: We have the pleasure to inform you that our home firm has reported by wire concerning your esteemed order as follows: 'Placed at your increased limit'. Later the defendents informed the plaintiffs that the manufacturers being full with orders, the zinc sheets could not be ready in time and so suggested that defendants may extend the time or cancel the indent. Thereupon the plaintiff wrote that the contract time had been exceeded and that he would buy similar goods in Bombay in defendant's account. This he did and brought a suit to recover from the defendant the difference in price as damages 'on account of the defendant's having failed to perform their contract for the delivery of 48 casks of zinc sheets'. The court held that the defendant was accountable to plaintiff only as an agent and not as a vendor.
We have laid considerable emphasis on the fact that the price quoted between the Indian buyer and Indian Co. is in terms-of dollars and that only in the final invoice, after the shipment has reached India, that price is quoted in rupees. Now, suppose, there was a devaluation or revaluation of Indian currency vis-a-vis dollars. If the transaction between the Indian buyer and Indian Co. were independent, devaluation would not affect it at all. But, since the prices are quoted in dollars, it would affect, as if the transaction is entirely with US Co.
26. After considering all these facts and circumstances, we have come to the finding, with some hesitation, that the Indian Co. is the agent of the US Co.
27. We take up the next issue. The manufacture of the goods is, undoubtedly, in America. Sale also is effected there. So, it is difficult to say that any income accrues or arises under Section 5 of the Act. So, we necessarily have to turn to Section 9 of the Act. Under Section 9, the first point we should consider is whether there is any business connection in India. It has been urged that there is none and strong reliance has been placed on Aggarwal & Co.'s case (supra). The concept of business connection has been explained in that case and if we see the facts in the light of the ratio of that decision, it will be difficult to say that there is no business connection. As the Supreme Court pointed out, business connection may take many forms; it may be merely a relation between the business of the non-resident and the activity in the taxable territory. But if that facilitates or assists in carrying on of that business, the inference of business connection is not out of order. The Indian Co. books the order from the Indian customer on the basis of the price list of the US Co. They arrange with the Indian consumer that 90 per cent of the invoice price be sent to USA by opening letter of credit. These activities are regular and had been done throughout over the years. They are not stray or isolated instances. Unlike Aggarwal & Co.'s case (supra), where the agent merely forwards offers, here the Indian Co. books the orders and holds that the US Co. is their principal. In Aggarwal & Co.'s case (supra), the non-resident principal is not obliged to accept any orders, since the agent was merely forwarding offers. That is not the case here.
28. Since there is a business connection, we must next see if there is any business operation in India. Only then and to that extent only, could income be deemed to accrue or arise. On the finding that the Indian Co. is an agent of the US Co. we have to give a finding that there are some operations carried on in India. No doubt, the goods are manufactured in USA. The documents of title are handed over to the bankers in USA with whom letter of credit is opened. But, the order is secured in India. Negotiations for the purchase with the Indian buyer is in India. Such an activity has been considered as business operation in Annamalais Timber Trust & Co. v. CIT  41 ITR 781. Much emphasis has been laid on Supreme Court decision in Carborandum & Co.'s case (supra). On the point of business connection, the Tribunal gave a finding. The Supreme Court did not found it necessary to review this finding as the question did not at all arise. The High Court did go into it and the Supreme Court pointed out that the High Court should not have gone into it. The facts on which the Tribunal gave a finding are so dissimilar, we need not consider that case. The case of Toshoku Ltd. (supra) also has no bearing. Therein, the commission due to the non-resident was debited in the Indian books of the principal and the question was whether the commission accrued in India. The non-resident was an agent of an Indian principal and his entire operations were admittedly outside India. This case would not help us in resolving the issue.
29. Since we give a finding that some operations are in India, there is question of apportionment of the income under Explanation to Section 9(1)(i). It is not necessary for us to go into full details, because we find that the point is fully covered by a circular of the CBDT. The circular has been set out fully in Sundaram's Law of Income-tax, 1978 edition [Taxmanris Direct Taxes Circular, Vol. I, 1980 edition, p. 29].
The points arising in the case of a non-resident operating through a subsidiary is set out below: (c) Where a non-resident's sales to Indian customers are secured through the services of an agent in India, the assessment in India of the income arising but of the transaction will be limited to the amount of profit which is attributable to the agent's services, provided that: (a) the non-resident principal's business activities in India are wholly channelled through his agent; (b) the contracts to sell are made outside India; and (c) the sales are made on a principal-to-principal basis. In the assessment of the amount of profit, allowance will be made for the expenses incurred, including the agent's commission, in making the sales. If the agent's Commission fully represents the value of the profit attributable to his service, it should prima facie extinguish the assessment.
30. On the facts of the case, we cannot say, considering that only procurement of orders and negotiations thereof are the only operations in India, that the profit attributable would be more than 10 per cent.
Since the Indian Company gets a commission of 10 per cent, as per the circular, there is no liability for Indian taxation. We have ourselves gone into the details of expenditure.