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The Commissioner Of Income Tax v. Energomach Exports
Structured Summary of the Opinion
Factual and Procedural Background
The assessee is a foreign company whose assessment for the year 1980–1981 was made through its agent, Karnataka Power Corporation Ltd (an Indian company). On 30 January 1974 the agent entered into an agreement with Energomach Exports (the foreign company) for the supply of equipment to be installed at the Linganamakki Hydro Electric Project. On the same day a supplementary agreement was entered into under which the foreign company agreed to deputise experienced engineers to supervise installation, provide technical advice and assistance for erection, adjustment and commissioning, and to train Karnataka Power Corporation engineers.
The equipment cost was Rs. 3,11,28,029/-. Technical personnel supplied by the foreign company supervised erection and performed duties under the contract. For the work of the technical personnel Karnataka Power Corporation paid the foreign company (the opinion records two differing figures in the text): the question referred quotes Rs. 2,04,095/-, while the narrative of facts records a payment of Rs. 2,40,095/- during the accounting period.
The Assessing Authority held that Section 9 of the Income-tax Act, 1961 applied and assessed the foreign company to tax. The assessee contested liability, arguing no "business connection." The Appellate Authority held that if any liability arose it would be under Section 9(1)(vii) but that the proviso to that clause excluded transactions under agreements made before 1 April 1976, and therefore held no tax liability. The Income Tax Appellate Tribunal agreed with the Appellate Authority. The Revenue challenged that outcome and two questions were referred to the Court under Section 256(1) of the Act for opinion.
Legal Issues Presented
- Whether, on the facts of the case, the sum of Rs. 2,04,095/- received by the assessee, a foreign company, from Karnataka Power Corporation is in the nature of fees for technical services, within the meaning of Explanation 2 below Section 9(1)(vii) of the Income-Tax Act?
- Whether the Income-Tax Appellate Tribunal is correct in law in holding that income by way of fees for technical services, whether arising out of business connection or not, was required to be dealt with only under clause (vii) and not under clause (i) of Section 9(1) of the Income Tax Act?
Arguments of the Parties
Assessee's Pleadings
- Before the Assessing Authority it was contended that Section 9 of the Act was not attracted and the assessee (foreign company) was not taxable because there was no "business connection" with India.
- Before the Appellate Authority it was pleaded that, at most, any tax liability would arise under Section 9(1)(vii) (fees for technical services), and that the proviso to Section 9(1)(vii) excluded liability because the agreement was entered into prior to 1 April 1976.
Revenue's Arguments
- The Assessing Authority held the assessee liable under Section 9 (i.e., disagreed with the assessee's "no business connection" contention).
- Learned counsel for the revenue relied upon the Andhra Pradesh High Court decision in Bharat Heavy Plate & Vessels Ltd. v. Addl. Commissioner of Income-Tax, A.P. (1979 119 ITR 986) and argued that rendering services by supplying technical knowhow for erecting plant and machinery will amount to expenditure arising from a business connection and thus make the foreign company taxable.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Commissioner Of Income-Tax v. Copes Vulcan Inc., (1987) 167 ITR 884 | When technical services are specially covered by Section 9(1)(vii) they will not fall under Section 9(1)(i); the specific provision displaces the general one. The proviso excluding transactions under agreements prior to 1.4.1976 removes tax liability for such agreements. | The Court relied on this authority to support the proposition that technical services fall under clause (vii) rather than clause (i), and that the proviso can exclude liability where the agreement predates 1.4.1976. |
| Commissioner Of Income-Tax, A.P v. Hindustan Shipyard Ltd., (1977) 109 ITR 158 (Andhra Pradesh High Court) | Definition and scope of "business connection": requires a "real and intimate connection" — a common thread of mutual interest that goes beyond mere principal-to-principal purchase and sale, such as management control, financial control, or profit-sharing. | The Court adopted this interpretation as applicable to the present case when analysing whether the foreign company's activities constituted a "business connection" with India. |
| Carborandum Co. v. Commissioner of Income-Tax, Madras, (1977) 108 ITR 335 (Supreme Court) | Supply of foreign technical personnel and technical knowhow to an Indian company for erection of plant and machinery does not, by that fact alone, amount to a "business connection". | The Court relied upon this Supreme Court authority to support the conclusion that making technical personnel available for erection and related services does not automatically create a business connection. |
| Bharat Heavy Plate & Vessels Ltd. v. Addl. Commissioner of Income-Tax, A.P., (1979) 119 ITR 986 (Andhra Pradesh High Court) | The Division Bench held that rendering services by supplying technical knowhow for erecting plant and machinery may amount to expenditure arising in a business connection, in circumstances where there is continuity of activities and other connecting factors (e.g., shareholding or interest in management). | The Court noted that Revenue relied on this authority but distinguished it on the facts: that case involved a foreign company with a share/interest in the Indian company and broader continuing connections, whereas in the present case the foreign company had no share or management interest and supplied services only to complete the installation under the sale contract. |
Court's Reasoning and Analysis
The Court framed the primary question as whether the services rendered by the foreign company in erecting and commissioning the machinery and deputing technical personnel amount to a "business connection" under Section 9(1)(i) of the Income-tax Act, or whether any income falls to be considered under Section 9(1)(vii) as fees for technical services.
The Court proceeded by reference to relevant precedents and principles:
- The Court cited Copes Vulcan to state the principle that where a special provision (Section 9(1)(vii)) specifically covers technical services, such income should be dealt with under that special provision rather than under the general provision (Section 9(1)(i)). The proviso to clause (vii) excluding agreements prior to 1.4.1976 may therefore remove tax liability where applicable.
- The Court relied on the Andhra Pradesh High Court's exposition in Hindustan Shipyard to explain the required content of a "business connection": there must be a "real and intimate connection" — something over and above mere transactions of purchase and sale, such as management control, financial control, profit-sharing or comparable continuing ties.
- The Supreme Court decision in Carborandum Co. was invoked for the proposition that merely making foreign technical personnel and knowhow available for erection and installation does not of itself create a business connection.
- The Court examined the decision in Bharat Heavy Plate & Vessels, which suggested that supplying technical knowhow could amount to a business connection, but carefully distinguished that case on its facts: there the foreign company held a share or interest in the Indian company and there were continuing rights and interests (management/production rights) that linked the two companies beyond the discrete supply-and-installation transaction.
Applying these principles to the present facts, the Court observed that the foreign company in this case had no shareholding or management interest in Karnataka Power Corporation. Its role was limited to selling machinery and supplying technical personnel/services to complete installation and commissioning; the technical services ceased once the machinery began functioning. There was no continuing interest or control by the foreign company in the Indian company beyond fulfilment of the contract.
On that basis the Court concluded that the circumstances did not establish the "real and intimate" connection required for a business connection under Section 9(1)(i), and that the decision in Bharat Heavy Plate & Vessels was distinguishable on factual grounds.
Holding and Implications
The Court answered both referred questions against the Revenue and in favour of the Assessee.
Direct effect on the parties: the Court concluded that, on the facts before it, the payment(s) to the foreign company for technical personnel and services connected solely to the installation and commissioning of machinery do not amount to income arising from a "business connection" under Section 9(1)(i). The Court accepted that technical services fall to be considered under the special provision (Section 9(1)(vii)) and noted the relevance of the proviso excluding agreements prior to 1 April 1976 as applied by the Appellate Authority and Tribunal. Consequently, the outcome is favourable to the assessee on the question of liability to tax in respect of the payment(s) in dispute.
The opinion confines itself to the direct legal questions referred and the factual matrix of this case; it distinguishes prior authority on factual grounds where necessary. The opinion does not purport to announce a broader, novel rule beyond the application and distinction of the cited authorities to the facts before the Court.
CASES REFERRED AT PARAS 1. (1987) 167 ITR 884 - Commissioner Of Income-Tax v. Copes Vulcan Inc.) 5 2. (1977) 109 ITR 158 - Commissioner Of Income-Tax, A.P v. Hindustan Shipyard Ltd. (do) 6 3. (1977) 108 ITR 335 - Carborandum Co. v. Commissioner of Income-Tax Madras (do) 7 4. (1979) 119 ITR 986 - Bharat Heavy Plate & Vessels Ltd. v. Addl. Commissioner of Income-Tax, A.P (Dist) 8
Sri E.R Indrakumar, Advocate for Petitioner
Sri V.R Gupta and Sri S. Parthasarathy, Advocates
Y. Bhaskar Rao, J.:—
The following 2 question are referred under Section 256(1) of the Income Tax Act, 1961 (hereinafter referred to as the Act) for our opinion:
“1. Whether on the facts of the case, the sum of Rs. 2,04,095/- received by the assessee, a foreign company, from Karnataka Power Corporation is in the nature of fees for technical services, within the meaning of Explanation 2 below Section 9(1)(vii) of the Income-Tax Act?
2. Whether the Income-Tax Appellate Tribunal is correct in law in holding that income by way of fees for technical services, whether arising out of business connection or not was required to be dealt with only, under clause (vii) and not under cluase (i) of Section 9(1) of the Income Tax Act?
2. The facts of the case are: The assessee is a foreign company and assessment is made through its Agent, Karnataka Power Corporation Ltd, for the assessment year 1980-1981. The Agent of the assessee/Company, i.e, Karnataka Power Corporation Limited (Indian Company) entered into an agreement on 30.1.1974 with Energomach Exports of Russia (hereinafter called the foreign company) for supply of equipment for being installed at Linganamakki Hydro Electric Project and on the same day a supplementary agreement was also entered into with the foreign company to depute its experienced engineers to supervise the installation of the equipment at the dam site. As per the supplementary agreement, the foreign company has agreed to provide technical advice and assistance to the purchaser in the erection, adjustment and commissioning of the equipment as well as for training the engineers of the Karnataka Power Corporation. Relevant clauses were provided in the agreement. The cost of the equipment supplied by the foreign company came to Rs. 3,11,28,029/-. The technical personnel supervised the actual erection of the equipment supplied by the foreign company at the dam site and did other jobs laid down under the contract. For the word done by the technical personnel, the Karnataka Power Corporation paid a sum of Rs. 2,40,095/- to the foreign company during the accounting period. The question that arises for our consideration is whether in respect of this payment there is any liability to tax on the foreign company under Section 9 of the Act Before the Assessing Authority it is contended that Section 9 of the Act is not attracted and the assessee/company is not taxable, as there was no business connection. The said contention was negatived by the Assessing Authority and it was held that the assessee is liable to pay tax. Assailing the order of the Assessing Authority an appeal was filed. Before the Appellate Authority it was pleaded that the tax liability at the most would arise under Section 9(1)(vii) of the Act. But, by virtue of the proviso thereto, the assessee is not liable to pay tax, as the proviso provides that all transactions which are covered by an agreement prior to 1.4.1976 are not governed by Section 9(1)(vii) of the Act. The Appellate Authority accepted the contention and held that there is no tax liability. The Revenue preferred an appeal before the Income Tax Appellate Tribunal. The Tribunal also agreed with the view of the Appellate Authority and as the revenue sought the reference, the reference is made to this Court regarding the two questions referred supra.
3. The question for our consideration is whether rendering the services for erection of the machinery sold by the assessee/company to the Karnataka Power Corporation and making the machinery function by deputing engineers and offering technical services amount to transaction involved in business connection.
4. The question what constitutes ‘business connection’ has been considered by a number of High Courts earlier. Therefore, it is just and proper to refer to the relevant case laws on the subject.
5. In the case of Commissioner Of Income-Tax v. Copes Vulcan Inc. . 1987 167 ITR, 884. the question referred was whether the assessee is liable for payment of tax under Section 9(1)(i) or 9(1)(vii) of the Act, when there are technical services rendered and the Madras High Court held therein that, when technical services are specially covered under Section 9(1)(vii) of the Act, they will not fall under Section 9(1)(i) of the Act. It is further stated that, when there is a special provision dealing with a special type of income, the general provision will not apply and held that the tax liability comes under Section 9(1)(vii) of the Act. As the proviso to Section 9(1)(vii) of the Act excludes the transactions which were held under the agreement earlier to April, 1976, there is no tax-liability to the assessee. When there is any technical service rendered arising out of business connection,’ it will not fall under Section 9(1)(i) of the Act even if it does not come under Section 9(1)(vii), because of the agreement providing technical services or technical know how, as the agreement entered into is prior to April, 1976, and the proviso to Section 9(1)(vii) of the Act excludes the tax liability of the assessee.
6. The Division Bench of Andhra Pradesh High Court in Commissioner Of Income-Tax, A.P v. Hindustan Shipyard Ltd. . 1977 109 I.T.R 158. considered the scope and meaning of “business connection” and after considering earlier cases on the subject held thus:
“To conform with the requirements of the expression “business connection” which have been fairly settled by judicial decisions, it is necessary that the common thread of mutual interest must run through the fabric of the trading activities carried on outside and inside the taxable territory and the same has been described as “real and intimate connection”. The commonness of interest may be by way of management control or financial control or by way of sharing of profits. It may come into existence in some other manner but there must be something more than mere transaction of purchase and sale between principal and principal in order to bring the transaction within the purview of the expression ‘business connection’ within the meaning of Section 9(1)(i) and 163(1)(b) of the Income-tax Act.”
The interpretation given by the Andhra Pradesh High Court regarding business connection squarely applies to the present, case.
7. In Carborandum Co. v. Commissioner of Income-Tax, Madras . 1977 108 I.T.R 335. THE Hon'ble Supreme Court considered whether making services of foreign, technical personnel available to the Indian company amounts to ‘business connection’ or not and held that it will not. The Hon'ble Supreme Court elaborately referred to all the relevant cases and held that supply, of technical personnel and technical knowhow by foreign company to Indian company, for erection of plant and machinery and expenses incurred thereto will not amount to arising out of business connection.
8. Learned Counsel for the revenue relied upon a judgment of the Andhra Pradesh High Court in Bharat Heavy Plate & Vessels Ltd. v. Addl. Commissioner of Income-Tax, A.P . 1979 119 I.T.R 986. and contended that the Division Bench of the Andhra Pradesh High Court has clearly laid down that rendering service by supply of technical knowhow for erecting plant and machinery will amount to expenditure arising in business connection and, therefore, that has to be accepted.
9. It is to be noticed that the Division Bench has referred to the earlier case wherein it was found that merely agreeing to supply technical personnel and technical know how for erection of machinery will not amount to the expenditure arising out of business connection unless there is continuity of activities. The fact in that case is that the foreign company has a share in the Indian company and the right to assign to the Indian Company the production rights. Both the foreign and the Indian companies had the right to change the personnel and to assign to the assessee the production rights. The agreement therein provided for supply of machinery and technical know how and technical personnel for installation of the machinery and the foreign company had a share in the Indian company. Therefore, it was held that there is business connection between the foreign company and the Indian Company and the foreign company has got interest in the ownership of the Indian company by way of share or any other mode and as such supply of technical services and technical knowhow definitely has to be held in the business connection, because there have got interest in the management of the Indian company itself as its shareholder. Therefore, the judgment is quite different from the present one.
10. In the present case the foreign company has no share or interest in the management, of the Indian Company. The foreign company has sold the machinery to the Indian Company and for installation of the said machinery and plant supplied technical personnel and technical services until the machinery starts functioning and production. Thereafter, the services of the technical personnel in the Indian company will cease and the Indian company is hot responsible on the foreign company. Except to complete the terms of the agreement entered for the purchase of machinery there is no other interest of the foreign company in the Indian company. Therefore, it cannot be said that there is any business connection or the salary, and other expenses paid to the technical personnel will amount to the expenses incurred in business connection.
Therefore, we answer both the questions against the revenue and in favour of the assessee.
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