Introduction

The case of Deputy Commissioner of Income-tax, Special Range-26, Mumbai v. Roxon OY revolves around the taxation of profits arising from a turnkey project executed by Roxon OY, a non-resident company incorporated in Finland. The core issue pertains to whether the profits from the sale of equipment supplied by Roxon OY for a substantial consideration are taxable in India, considering the activities span both within and outside Indian territory. The taxpayer challenged the Revenue's stance, invoking provisions of the India-Finland Double Taxation Avoidance Agreement (DTAA) and contesting the interpretation of Indian Income-tax Act sections.

Summary of the Judgment

The Income Tax Appellate Tribunal (ITAT) examined whether Roxon OY's profits from selling equipment, as part of a turnkey project with Nava Sheva Port Trust (NSPT), were subject to taxation in India. The Assessing Officer had added Rs. 5,12,25,939 to the taxable income based on the premise that a portion of profits from activities outside India, linked to the turnkey project, were taxable in India under Instruction No. 1767. Roxon OY appealed, arguing that under the India-Finland DTAA, particularly Article 7, such profits should not be taxable in India. The CIT(A) initially sided with the assessee, but the Revenue appealed. The ITAT upheld the CIT(A)'s decision, concluding that the profits from the sale of equipment were not taxable in India, primarily due to the restricted application of the force of attraction rule under the relevant DTAA.

Analysis

Precedents Cited

The Tribunal referenced several precedents and model conventions to interpret the DTAA provisions:

• The UN Model Convention (1979 draft), which outlines the "restricted force of attraction" rule in Article 7, limiting taxation to profits attributable to the permanent establishment (PE) or related activities.
• The case of Hindalco Industries Ltd. v. Asstt. CIT, where similar tax treaty interpretations were discussed.
• Specific India tax treaties, such as those with Germany, France, and the Netherlands, which include protocol clauses clarifying profit attribution to PEs in turnkey projects.

These precedents influenced the Tribunal's interpretation by emphasizing the modern, restricted application of the force of attraction principle, diverging from the broader application seen in older treaties like the UK-USA Convention.

Legal Reasoning

The Tribunal dissected Article 7 of the India-Finland DTAA, which incorporates a limited version of the force of attraction rule. This rule allows the source country (India) to tax profits not only attributable to the PE but also from sales of similar goods or services conducted by the head office. However, the Tribunal found that:

• The profits from equipment sales were concluded before the establishment of the PE in India, making them non-attributable to the PE.
• The sales by the head office were at arm's length, eliminating any additional profit element attributable to the PE.
• Protocol clauses in similar treaties restrict profit attribution to activities directly linked to the PE, such as installation or commissioning.

Consequently, the Tribunal determined that the supply of equipment did not fall within the scope of taxable profits under Article 7(1)(a) or (b) of the DTAA. Additionally, Article 7(1)(c) was deemed inapplicable as the issue did not pertain to other business activities in the source state.

Impact

This judgment clarifies the application of the restricted force of attraction principle in modern tax treaties, particularly under the UN Model Convention-based articles. It underscores that:

• Profits from turnkey projects, specifically from equipment sales concluded before PE establishment, are not taxable in the source country.
• The arm's length principle is pivotal in determining taxability, ensuring that only genuine economic activities linked to the PE are taxed.
• Tax authorities must meticulously differentiate between profits attributable to PEs and those arising from independent head office activities.

For future cases, this judgment provides a benchmark for interpreting similar DTAA provisions, promoting clarity and consistency in international tax disputes.

Complex Concepts Simplified

Turnkey Project

A turnkey project is a type of contract where a single entity is responsible for designing, engineering, procuring, constructing, and commissioning a project to a functioning state, which is then handed over to the client.

Permanent Establishment (PE)

A PE refers to a fixed place of business through which the business of an enterprise is wholly or partly carried out. In taxation, it's crucial because it determines the jurisdiction under which taxes are imposed.

Force of Attraction Rule

This rule allows a country to tax profits of a foreign enterprise beyond the profits attributable to its PEs within that country. The "restricted" version limits this taxation to profits from similar goods or services engaged by both the PE and the head office.

Double Taxation Avoidance Agreement (DTAA)

DTAA is a treaty between two countries to avoid taxing the same income twice. It provides rules to determine the taxing rights of each country and relief measures to prevent double taxation.

Arm's Length Principle

This principle ensures that transactions between related entities are conducted as if they were between unrelated parties, each acting in their own best interest, to determine fair transfer prices and prevent tax evasion.

Conclusion

The Deputy Commissioner of Income-tax v. Roxon OY judgment serves as a pivotal reference in the realm of international taxation, particularly concerning turnkey projects and the application of modern tax treaty provisions. By elucidating the restricted nature of the force of attraction rule under the India-Finland DTAA, the Tribunal affirmed that only profits with a direct economic nexus to India's PE are taxable within its jurisdiction. This reinforces the importance of clear contractual arrangements and the adherence to international tax principles such as the arm's length standard. Consequently, the judgment not only resolves the immediate dispute but also provides a structured framework for future tax assessments involving similar international business configurations.