1. In this reference under s. 256(1) of the I.T. Act, 1961, at the instance of the commissioner of Income-tax, the following question has been referred :
'Whether, on the facts and in the circumstances of the case, there was business connection between the Indian company and the non-resident foreign company within the meaning of section 9 of the Income-tax Act, 1961 ?'
2. The Lakshmi Machine Works Ltd. is a company incorporated in India. It wanted to install a grey iron foundry for manufacturing spinning casting. It entered into an agreement on 1st February, 1966, with Fried Krupp Industries of West Germany for the supply of the necessary equipments and for furnishing technical data regarding the foundry and also for the purpose of getting technicians so as to supervise the construction of the plant. The machinery was to be supplied from Europe on f.o.b. terms, North Sea Port, suitably and securely packed for ocean shipment and subsequent movement by rail and on road in India and for tropical conditions. The foreign company was also to supply drawings and also to supervise the erection of the grey iron foundry. 100% of the contract price for the technical co-ordination in the supply of drawings was to be made in Germany and on receipt of the contract price, the foreign company undertook to deliver the drawings to the Indian company. The entire work connected with the technical co-ordination and supplies of drawings with reference to the materials to be procured in India was to be carried out by the contractor in West Germany. The obligation of the foreign company was to be discharged if the drawings were delivered to the Indian company's representative for onward dispatch to it. The payments were to be arranged by letters of credit being opened. The erection of the machinery and equipment was to be done by the Indian company under its responsibility. The foreign company had only to depute the specialists to advise, guide and supervise the erection work. Any damage to the plants, equipments, etc., caused by gross errors in drawings and documents supplied was to be made good by the foreign company. The liability of the foreign company for damages was restricted, however, to 50% of the amount actually paid to it for technical collaboration and supply of drawings. In accordance with the terms of the agreement, the foreign company deputed its engineers to supervise the erection of the machinery, which was manufactured in Germany and shipped therefrom. The salary and other emoluments of the engineers were paid in India.
3. The ITO treated the Indian company, Lakshmi Machine Works Ltd., as the agent of the foreign company. The ITO was of the view that a portion of the receipts of the non-resident pertained to technical know-how and supervision charges and that they were taxable in India. The ITO took 10% of the sale price of the machinery as assessable profit in India. The amount referable to supply of drawings and supervision charges was brought to tax in its entirety. As the figures, as such, are not in dispute, it is not necessary for us to reproduce those figures.
4. After the assessment for 1967-68 to 1970-71 were completed on Lakshmi Machine Works Ltd. as the agent of the foreign company, M/s. Fried Krupp Industries, appeals were filed before the AAC in respect of all these years. By a common order, except for 1970-71, dated February 22, 1973, the AAC held that there was a single indivisible contract under which the foreign company undertook to supply some part of the equipment and the know-how necessary for erecting and running a grey iron foundry in India and that the said transaction could not be dissected into a series of transactions, merely because the performance of the contract was spread over a period of years. He held that no part of the amount paid to the non-resident was chargeable to tax in India, that there was no business connection between the Indian company and the foreign company and that no income could be arrived at for the taxable territories. The appeal for 1970-71 was also disposed of on the same lines.
5. The ITO appealed against the order of the AAC to the Tribunal. The Tribunal disposed of the appeals by its common order dated September 6, 1975, for all these years. In substance the Tribunal has held that there was no business connection as contemplated by s. 9 and that the order of the ITO was rightly cancelled by the AAC. The question as extracted above has been referred, at the instance of the Commissioner, who feel aggrieved by the order of the Tribunal.
6. A perusal of the Tribunal's order would show that there is some confusion in its mind as to who the assessee is. In the case of a foreign or a non-resident company, there are two courses open to the ITO. He can proceed against the non-resident company itself if he is able to get at it. This course would not be available when the non-resident company has no office in India. In such a case, he has got to make an assessment on the non-resident only through an agent. It is for this purpose that the I.T. Act has provided for the appointment of an agent for the non-resident company and for the assessment being made in a representative capacity, on such agent. The agent is described in the Act itself as a 'representative assessee'. Thus, the assessee would be the foreign company, and the agent, though he is technically proceeded against, is really acting in a vicarious capacity. Therefore, it would be more proper to describe the foreign company as the assessee and the Indian company as the agent, though ultimately on the basis that the Indian company is liable to pay tax, it is treated as an assessee. But the capacity in which the Indian company is assessed, viz., only as a representative of the foreign company, is not to be lost sight of.
7. Why we were obliged to bring out the above features in the assessment of a non-resident will be clear from the following extract from the Tribunal's order. In para. 13 of its order the Tribunal states thus :
'Turning to the facts of the present case it is clear that what the assessee-company has done was only to purchase certain sophisticated machinery from a German company on a principal to principal basis.'
8. We have underlined the word 'assessee-company'. Apparently the Tribunal takes the view that the Indian company is the assessee-company. It is only on that basis that it referred to purchase of sophisticated machinery from the German company on a principal to principal basis. Having regard to the context in which the assessment came to be made, the Tribunal was clearly in error in proceedings as if the Indian company was the assessee-company. The Indian company does not pay any tax on its purchase. Its purchase is not thus relevant. It was really acting only in a representative capacity in so far as the present assessment on the profits from sale, etc., is concerned.
9. It is not as if the above sentence is an isolated piece of some error in describing the assessee. In the same paragraph, after 2 or 3 sentences, the Tribunal has added :
'The assessee was merely the recipient of an article for which he made payment. The assessee did not even carry on any commercial activity with respect to this machinery but only made use of them for his own production. It cannot, therefore, be stated that there was any business connection between the assessee and the non-resident company.'
10. Here also the mixing up of the idea as to who the assessee is, is evident. In the present reference, or in the appeal before the Tribunal, it was not necessary to see what the Indian company did. It is necessary to concentrate attention only on how far the foreigner had acted in India.
11. Again towards the close of the paragraph the Tribunal has stated thus :
'But in the present case the assessee has purchased from the non-resident company only goods for his own use as a consumer and customer.'
12. Even in the above passage it is clear that the Tribunal had in its mind the Indian company as the purchaser. The Indian company is certainly not taxed on the purchase of goods. The question is, what is the extent of activity of the foreigner and what are the operations of the foreigner in India, which will establish any business connection or bring about any liability to tax on the basis of income being deemed to accrue or arise in India. It is not necessary to labour on this point further. It is enough to point out that the assessee is a foreign company and that the Indian company is acting only in its representative capacity as the agent of the foreign company and consequently falls within the concept of the word 'assessee' as understood by the Act for the limited purpose of discharging the liability of the foreign company.
13. Section 9 is the appropriate provision which is to be considered in connection with the assessments under consideration. Income is deemed to accrue or arise in India in certain cases, one of them being where it accrues or arises through or from any business connection in India. The term 'business connection' has not been defined in the Act. It is referred to in decided cases as having a wide, though uncertain, meaning. It admits of no precise definition and the solution to the problem as to whether there is any business connection in a particular case would depend upon the facts of each case.
14. In CIT v. R. D. Aggarwal and Co. : 56ITR20(SC) , Shah J., speaking for the Supreme Court, observed at page 24 follows :
'A business connection...... involves a relation between a business carried on by a non-resident which yields profits or gains and some activity in the taxable territories which contributes directly or indirectly to the earning of those profits or gains. It predicates an element of continuity between the business of the non-resident and the activity in the taxable territories : a stray or isolated transaction is normally no to be regarded as a business connection. Business connection may take several forms : it may include carrying on a part of the main business or activity incidental to the main business of the non-resident through an agent, or it may merely be a relation between the business of the non-resident and the activity in the taxable territories, which facilitates or assists the carrying on of that business. In each case the question whether there is a business connection from or through which income, profits or gains arise or accrue to a non-resident must be determined upon the facts and circumstances of the case.'
15. Again at page 28 it was stated :
'The expression 'business connection' postulates a real and intimate relation between trading activity carried on outside the taxable territories and trading activity within the territories, the relation between the two contributing to the earning of income by the non-resident in his trading activity.'
16. This question has now to be considered in the light of the agreement between the parties, that is the Indian company and the German Company. As pointed out by the Supreme Court in the case cited already, the question is one of drawing the proper inference of the existence of business connection on the facts of each case. We may refer to a few cases to see what is relevant in such agreements.
17. In Carborandum Co. v. CIT : 108ITR335(SC) , the Supreme Court dealt with a case where the Indian company (assessee), a manufacturer of abrasive products, entered into an agreement with a foreign company for getting the benefit of technical know-how in the manufacture. The assistance was in the shape of furnishing of technical information relating (i) the manufacture of bonded abrasive and coated abrasive products; (ii) providing technical management including factory design and layout, etc ; (iii) furnishing comprehensive technical information in the manufacture of the special products; (iv) providing the Indian company with a resident-factory manager for starting the plant and superintending its operation during its initial production stages ; and (v) training Indian personnel to replace the foreign technical personnel as quickly as possible. With reference to these services, 3% on the net sale proceeds of the products manufactured by the Indian company was payable to the foreign company. The ITO held that 5% of the technical fee paid by the Indian company to the foreign company was earned by the foreign company in India and, therefore, was taxable. The Commissioner was of the view that at least 75% of the fee had accrued or arisen in India, as the information was applied in India and the fee was payable mainly on account of the use of technical know-how, or services rendered by the foreign personnel in India. The Appellate Tribunal restored the assessment and the order of the Commissioner on the ground that the service rendered had not been proved to have been rendered in India. On a reference, the High Court held that the fee received must be taken to be fee that has accrued or arisen in India from its business connection and was wholly taxable. However, in so far as the Commissioner had brought to tax only 75%, the High Court pointed out that only 75% of the profits could be taxed. On further appeal, the Supreme Court held that the service in that case were rendered outside India and that even assuming there was any business connection, no part of the activity or operation could be said to have been carried on by the foreign company in India. It was held that no part of the fee paid to the foreign company accrued or arose in India. However, as the ITO had brought to tax 5% of the fees paid by the Indian company, the assessment to that extent, not having been objected to by the assessee, the foreign company, was allowed to stand. While not agreeing with the conclusion of this court, the Supreme Court approved the decision of the Bombay High Court in CIT v. Tata Chemicals Ltd. : 94ITR85(Bom) , wherein it had been held that in order to rope in the income of a non-resident, under the deeming provision, it must be shown by the department that some of the operations were carried out in India in respect of which the income was sought to be assessed.
18. There are certain other decisions which applied the principle that in respect of principal to principal transaction there is no question of any business connection. Where a person purchased goods from a foreigner without anything more, and the purchased goods are utilised in commercial operations in India by the Indian, then the Indian merchant or company is earning his own or its own income. The foreigner in such a case has nothing to do with the Indian-assessee's transaction in India, as by selling his machinery abroad, he had no further interest in the business in India. The term 'business connection' postulates a continuity of business relationship between the foreigner and the Indian. There is no question of continuing business relation when a person purchases machinery or other goods abroad and uses them in India and earns profit. The part of the foreigner has been played wholly abroad, so that there is no connection as such with any business in India. It is this aspect which has been brought out in CIT v. Gulf Oil (Great Britain) Ltd. : 108ITR874(Bom) . In that case, the assessee who was a dealer of petroleum products and incorporated in U.K., had a wholly-owned subsidiary in India. The non-resident received indents from time to time for the supply of the products from the Indian subsidiary and those orders were honoured by shipment. The prices charged were in c.i.f. terms. Once the goods were put on ship, there was no reservation of the right of disposal in the goods by the non-resident. On the question whether these transactions amounted to business connection and whether any income was derived in India by the foreign company, it was held that the transaction between the non-resident company and the Indian subsidiary were on a principal to principal basis and that the Indian subsidiary could not be regarded as the agent of the non-resident company.
19. Similarly, in CIT v. Hindustan Shipyard Ltd. : 109ITR158(AP) , the Andhra Pradesh High Court dealt with a case where the Hindustan Shipyard Ltd. entered into an agreement for the purchase of diesel engines with accessories from a Polish company. The property in the goods was to pass to the purchaser immediately on board the vessel named by the forwarding agents of the purchaser. The engines were agreed to be erected by the staff of the purchaser under the supervision of a supervision engineer placed at the disposal of the purchaser by the Polish company. The foreign company agreed also to supply an erector and an erecting supervising engineer for a period of 12 months for every ship free of charge and to provide free of cost one guarantee engineer for a period of six months. There was also a provision of further guarantee given by the Polish company including training of technical employees in Poland in batches. The expenses including travelling expenses were to be borne by the Polish company. It was held that though the Polish company had agreed to render certain limited services, the services were connected with the effective fulfilment of the contract of sale and were merely incidental to the contract. It was held on the facts that there was no business connection and in the course of the judgment at page 171 it was pointed out that the transaction between the Indian company and the Polish company was one between principal and principal.
20. In VDO Tachometer Werke, West Germany v. CIT : 117ITR804(KAR) , the contract between the Indian company and the foreign company was arrived at in Germany. The services of the foreign company were rendered outside India. The drawings, plans, inspection of goods, raw materials, etc., were delivered abroad. The Indian personnel were also trained abroad. The technical personnel deputed by the foreign company entered into contracts of service with the Indian company as approved by the Government of India and became the employees of the Indian company solely subject to its control and authority. Under the agreement with the foreign company the Indian company had to pay 3% of the total turnover of the licensed articles to the German company. A further 1% was payable to the foreign company for being passed on to any company from which the foreign company itself had taken a licence. The learned judges of the Karnataka High Court held that no part of the licence fees payable under the agreement in question could be treated as income which was deemed to have accrued or arisen in India to the not-resident. The payments were found to be outside the scope of s. 9 of the I.T. Act, 1961.
21. Thus, these cases uniformly lay down that there must be some activity in India with reference to which the foreigner is concerned. The profits contributed by that activity would come in for taxation under s. 9 of the Act. It is in this context that we have to examine the agreement in the present case.
22. The Tribunal had not annexed the entire agreement between the foreign company and the Indian company. Mr. Swaminathan, the learned counsel for the respondent, placed before us a full copy of the agreement, which is referred to in all the orders of the income-tax authorities. We think it necessary to refer to those parts of the agreement, which bear on the point now before us.
23. Clause 1 of the agreement indicates that it is regarding the supply from Europe of equipment for a grey iron foundry, technical co-ordination and supply of drawings for Indian supplies and supervision of erection at Coimbatore. Clause 3 states :
'In consideration of the price to be paid to him (foreign company) as stated hereunder the contractor (foreign company) shall supply the equipment from Europe, the technical co-ordination and supply of drawing for Indian supplies and supervise the erection of the grey iron foundry for spinning machine castings as per annex. I to this agreement.'
24. Clause 5 provides :
'The total contract price in foreign exchange, namely, Deutsche Marks of the Deutsche Bundesbank, Frankfurt Main, for European supplies of equipment for a grey iron foundry for spinning machine castings and technical co-ordination and supply of drawings for Indian supplies as detailed in annexure 1 which forms an integral part of this agreement, shall be DM. 2,556,200 (Deutsche Marks two million five hundred fifty-six thousand two hundred) under the terms and conditions set out hereunder.
The above amount is exclusive of a sum of DM 2,30,000-(Deutsche Marks two hundred and thirty thousand) for spare parts......
(ii) The estimated amounts in foreign exchange for supervision of erection will be approximately DM 2,10,000-(Deutsche Marks two hundred and ten thousand) and approximately DM 55,000-(Deutsche Marks fifty-five thousand) for the delegation of two planning engineers in connection with the Indian supplies. For details please refer to articles 12 and 13 of this agreement.....
(iv) In respect of drawings and equipment to be supplied by the contractor from Europe, the prices are for delivery f.o.b. North-Sea Port, suitably and securely packed for ocean shipment and subsequent movement by rail and/or road in India and for tropical conditions including one coat of primer, wherever necessary and/or customary.....
(vi) Not included in the prices are : any costs arising subsequent to f.o.b. delivery such as ocean freight, transit insurance, customs duty, clearing and port charges and inland transport charges in India and all taxes dues and fees if any leviable in India.'
25. Clause 9 relates to the terms of payment. 100% of the contract price for the technical co-ordination and supply of drawings for Indian supplies was to be payable as soon as the foreign company advised that the drawings were ready for delivery. For technical co-ordination 100% of the price was payable, against submission of invoice and postal receipt and/or bill of lading out of an irrevocable letter of credit without recourse to drawers. 10% of the contract price for European supplies was payable within two months from the date of receipt of the import licence, and the balance of 90% out of an irrevocable letter of credit without recourse to drawers. As far as spare parts are concerned, 100% of the contract amount must be paid against submission of shipping documents proving that the goods were delivered as f.o.b. Supervision and erection is dealt with in clause 12. The erection is to be done by the Indian company under its own responsibility. The foreign company has only to depute some specialists like one chief engineer, one specialised engineer and five chief erectors or fitters. The period during which these persons were to serve is also specified in the agreement. However, the actual period for which they would work would depend on the progress of the erection work at the site. The deputed personnel were to be paid at a specified rate per day. There are certain other allowances which are also payable to them. Clause 12(xi) provides :
'The contractor cannot be held responsible for any damages including subsequent and/or consequential damages caused by the contractor's personnel, irrespective of the cause and nature of such damage. Contractor is only liable for the careful selection of the erection specialists ; in this respect he shall apply the same care as in the conduct of his own affairs.'
26. Clause 13 contemplates delegation to the Indian company of two engineers for the purpose of assisting in the procurement of the Indian component parts. There is a guarantee clause which envisages liability of the maximum of 50% of the amount actually paid to the foreign company for the technical co-ordination and supply of drawings. It is unnecessary to refer to the rest of the terms of the agreement.
27. From the terms of the agreement, it would be clear that it deals with 3 types of activities of the foreign company. The first type of activity is the sale of machinery. The machinery was to be delivered on f.o.b. terms, and thereafter the entire responsibility is made over to the Indian company. On the terms of the agreement, it is clear that the part played by the foreign company with reference to the shipment of machinery ends with putting the machinery on board. The result is that there is no operation of the foreign company in India so as to envisage and business connection.
28. The second activity of the foreign company is in respect of supply of spare parts. The spare parts are also to be shipped from Germany on f.o.b. terms. Whatever we have said with reference to the machinery would equally apply to the spare parts. The result is that there is no part of the activity referable to the supply of spare parts in India so as to give rise to any business connection and any liability to tax. The same applies to the delivery of the plans, etc.
29. We are left only with the deputation of the foreign personnel for purchasing spare parts in India and for the erection of the machinery. As for as the personnel deputed for the erection of the machinery is concerned, the terms of the agreement go to show that they became employees of the Indian company. The foreign company has nothing to do with the erection of the machinery as such. It may be that if there is any defect in the machinery as such, or any gross negligence on the part of the personnel so deputed, the foreign company is liable to pay damages to the Indian company. This liability is not attributable to any operation of the foreign company in India. It is merely a contractual term for the purpose of ensuring the proper supply of goods and the deputation of the proper technical personnel. If the foreign company is to be taken as operating in India, then it would be necessary to show that it is the foreign company which erect the machinery. 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. 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 Indian 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 is not the same as the foreign company performing any operation in pursuance of this contract in India. Whatever we have said 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 better picked up by these personnel, who have experience in running the machinery. It is merely an assistance provided to the Indian company, the foreign personnel being treated as the employees of the Indian company. Having gone through the terms of the agreement in full, we are satisfied that there are no operations 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. The assessment for the years under consideration were rightly set aside by the AAC and by the Tribunal. The question referred is accordingly answered in the negative and in favour of the assessee. The assessee will be entitled to its costs. Counsel's fee Rs. 500. One set.