Per Pramod Kumar, Accountant Member. - The neatly identified legal issue that we are required to adjudicate in this revenue’s appeal is whether or not the profits on sale of equipments supplied by the assessee-company for a consideration of Rs. 25,61,29,696 on the facts of this case, are liable to be taxed in India.

2. This grievance has been raised by the revenue by way of following grounds of appeal:

"Ground of appeal as set out in the memorandum of appeal :

On the facts and in the circumstances of the case and in law, the learned CIT(A) failed to appreciate that the receipt of Rs. 25,61,29,696 by the assessee formed part of execution of turnkey project with Nava Sheva Port Trust and that being one integrated contract, it could not be split up as constituting separate activities and thereby erred in holding that profits arising to the assessee from such activities performed outside India are not chargeable to tax in India.

Additional grounds of appeal vide letter dated 9th November, 1991

1.On the facts and in the circumstances of the case and in law, the learned CIT(A) erred in allowing the assessee’s claim in respect of receipts of Rs. 25,61,29,696 attributable to the activities performed outside India as not chargeable to tax in India, and simultaneously directing the Assessing Officer to look into article 7 of the DTAA between India and Finland, both the decisions being self- contradictory.

2.On the facts and in the circumstances of the case and in law, the learned CIT(A) erred in interpreting the provisions of article 7 of DTAA between India and Finland which is very wide in scope and is not restricted to profits attributable to the permanent establishment for taxation of a company of Finland in India.

3.Without prejudice to the above, on the facts and in the circumstances of the case and in law, the learned CIT(A) erred in treating the receipts of Rs. 25,61,29,696 by the assessee from supplies outside India as distinct and separate activities and therefore not taxable in India, without appreciating the fact that supply of equipment is totally interlinked with installation, commissioning, testing of the project for which the assessee-company is entirely responsible and without completing anyone of these activities, the assessee-company cannot be said to have discharged its responsibilities under the agreement."

3. These elaborate grounds of appeal highlight the factual matrix in which the revenue’s grievance is set out and the arguments in support of the revenue’s grievance. The main grievance of the revenue, as is clearly discernible from the above grounds of appeal is that the CIT(A) ought to have held that the profit attributable to the equipment supplied by the assessee-company to Nava Sheva Port Trust, for a consideration of Rs. 25,61,29,696, formed part of the turnkey project executed by the assessee-company and was liable to be taxed in India.

4. The factual matrix giving rise to this appeal is like this. The assessee, i.e. Roxon OY, is a non-resident company incorporated under the laws of Finland. By an assignment agreement dated 12th January, 1987, it joined a consortium of companies which was assigned the contract to design, manufacture, deliver, erect, test and commission certain bulk handling facility at the Nava Sheva Port Trust (NSPT), and to impart training to the NSPT. This consortium originally consisted of Klochner Industries Anlagen GmbH, Kone Corporation and Hyundai Corporation, but, as a result of the assignment deed dated 12th January, 1987 (supra), the assessee-company was substituted for Kone Corporation. It was pursuant to these arrangements that the assessee-company was engaged in executing a contract with Nava Sheva Port Trust. Under this contract, the assessee-company supplied the required equipments and also sent its employees for erection, commissioning and training purposes. The assessee-company filed its income-tax return showing the profits attributable to the permanent establishment in India at a negative figure i.e. loss of Rs. 2,49,55,710. In the course of the scrutiny assessment proceedings, the Assessing Officer, amongst other things, noted that the assessee had not taken into account the ‘remittance of gross receipts in respect of income earned outside India’ aggregating to Rs. 25,61,29,696. The Assessing Officer noted that ‘as per the terms of the contract, the assessee is required to supply certain equipments to Nava Sheva Port Trust authorities but the assessee has not included the gross profit pertaining to supplies effected outside India, in the profit and loss account filed along with the return of income. It was in this background that the Assessing Officer made an addition of Rs. 5,12,25,939 by observing as follows:

"As per terms of contract, the assessee was required to execute turnkey scope of work, i.e. supply of certain equipments and its installation in India. The supply is essentially linked to erection of the installation activities in India. This is also a fact that without the supply of equipment, there cannot be any installation work carried out in India. The supply of equipment is invariably linked to the work performed inside India.

The CBDT has, in the case of oil and gas exploration companies operating in India executing turnkey contracts, which also earn certain amount on account of work to be performed outside India, recognized that a certain portion of supply of equipment and other work performed outside India should also be liable to tax in India. This means that in turnkey contract there would be certain work performed outside India of which a certain percentage is liable to tax in India. The CBDT, for oil and gas companies in India, has held that 1% of the work done outside India should be liable to tax in India. It is also noteworthy that oil and gas companies are highly specialized industry. The above principles outlined in Instruction No. 1767 dated 1st July, 1987 also constitute guidelines for working out the percentage of profits, pertaining to work outside India, in the instant case. In view of the facts and circumstances of the case, as discussed above, 20% of the gross receipt received for the work done outside India is taken as liable to tax in India. The 20% of gross receipts works out to Rs. 5,12,25,939 and the same is being treated as income of the assessee from undisclosed source and is being added to the total income of the assessee."

5. Aggrieved by the stand so taken by the Assessing Officer, the assessee carried the matter in appeal before the CIT(A). Learned CIT(A), after elaborately reproducing the contentions of the assessee, set out his conclusions as follows :

"There appears to be sufficient force in the contentions of the appellant with respect to the provisions of section 9(1)(i) read with Explanation 9 of the Instruction No. 1767 of the Board. The revenue arising to the assessee from the activities performed outside India are not chargeable to tax in India. It is also brought to my notice that the Department has accepted similar treatment in the cases of Nippon Kokan KK for the assessment year 1989-90 and Zonon Verstoep NV for the assessment year 1989-90.

In view of the above, the claim of the appellant is allowable and the Assessing Officer would look into Article 7 of the Double Taxation Avoidance Agreement, which overrides the other IT provisions and decide the matter afresh. I find that the provisions of the DTAA have not been discussed at all, and, from the relevant details, I would hold that profits outside India, under the circumstances are not chargeable to tax."

6. Revenue is aggrieved of the order so passed by the Commissioner (Appeals) and is in appeal before us.

7. The contention of the revenue is that as per the terms of contract, the assessee-company was required to execute turnkey work i.e. supply certain equipments and install the same in India. The supply is essentially linked to its installation in India. Thus, there is a business connection and the supplies are linked to the project in India. For this reason, according to the revenue appellant, the consideration received by the assessee for supplies from outside India are taxable in India in terms of the provisions of section 9(1)(i) of the Income-tax Act. It is also contended that the scope of Article 7 in India Finland Double Taxation Avoidance Agreement is much larger than many other tax treaties. It is submitted that under article 7 of the India Finland DTAA, not only the profits attributable to the permanent establishment (PE, in short) are taxable in the source country but this article also extends to the profits attributable to (a) sales in the other State of goods or merchandise of the same or similar kind as those sold through that PE; and (b) other business activities carried on in that other State of the same or similar kind as those effected through that PE. It is contended that article 7 of the India Finland treaty is based on the ‘force of attraction’ rule, and that under the force of attraction rule once an enterprise of one of the Contracting States has PE in the other Contracting State, all profits out of the transactions with the PE State, whether routed through PE or not, are taxable in the source country. Our attention is invited to the fact that as per the contract with NSPT, part of activities are carried out in India and other part is to be carried out outside India. As evident from the payments received from NSPT, according to revenue, ‘the work in India relates to goods and services including supply of equipment’ and the similar activity of supply of goods and services is being carried out from outside India. On this basis, according to the revenue, rule of force of attraction is attracted and the entire income from supply of goods and services, whether from within or outside India, becomes liable to tax in India. It is also contended that the contract was assigned to a consortium of three persons, i.e. the assessee, Klockner INA and Hyundai, and there was no specification regarding payment for services rendered outside India and inside India. The basis for bifurcation of consideration is far from clear, and, therefore, entire work is to be treated as a composite project and the receipts for entire work are liable to be taxed in India. We were thus urged to vacate the order of the CIT(A). Learned counsel, on the other hand, contends that the CIT(A) had merely restored the matter to the file of the Assessing Officer and the Assessing Officer himself has accepted the contentions of the assessee vide appeal effect order dated 31st October, 1991. A copy of the said appeal effect order was also filed before us. Learned counsel contended that once the revenue itself accepts the contentions of the assessee, it is not open to the revenue to challenge the same in these appellate proceedings. Learned counsel also took us through the order of the CIT(A), vehemently supported and justified the same, and reiterated the elaborate contentions raised therein. We were thus urged to confirm the order of the CIT(A) and decline to interfere in the matter. The case was subsequently refixed and both the parties were heard at length on the scope article 7 of the India Finland DTAA and on the impact of applicability of force of attraction rule in the present case. The rival contentions are conscientiously heard, material on record is carefully perused and factual matrix of the case as also the applicable legal position duly considered.

8. We find that in the course of assessment proceedings, the only objection raised by the Assessing Officer was that as per the terms of the contract, the assessee is required to supply certain equipments to Nava Sheva Port Trust authorities but the assessee has not included the gross profit pertaining to supplies effected outside India. It was for this reason that the impugned addition of Rs. 5,12,25,939 was made. We must, therefore, confine ourselves to the core question whether or not, on the facts of this case, the assessee was liable to tax in India in respect of income attributable to supply of the equipments in question.

9. Learned counsel’s preliminary objection is that it was not open to revenue to challenge the restoration of matter to the file of the Assessing Officer when the Assessing Officer himself has given relief as a result of the matter being restored to his file. We are not impressed with this plea. Even on a cursory reading of the terms of the matter being set aside to the file of the Assessing Officer, it is difficult to miss the fact that, in his brief or rather cryptic order, the Commissioner (Appeals) has, on one hand, categorically held that "the claim of the appellant is allowable", that "from the relevant details, I would hold that profits outside India, under the circumstances, are not chargeable to tax", and yet remitted the matter to the file of the Assessing Officer for looking into "Article 7 of the Double Taxation Avoidance Agreement, which overrides the other IT provisions, and decide the matter afresh". It is on account of these contradictions that the Assessing Officer perhaps had no choice but to give relief in terms of CIT(A)’s rather ambiguous directions, but, in exercise of his right to raise grievance against the said order, appeal to the Tribunal as well. We see no impropriety or infirmity in the stand of the Assessing Officer.

10. Revenue has laid a lot of emphasis on the application of ‘force of attraction’ principle in this case, and it is, therefore, necessary to deal with this aspect of the matter first. The basic philosophy underlying the force of attraction rule is that when an enterprise sets up a permanent establishment in another country, it brings itself within the fiscal jurisdiction of that another country to such a degree that such another country can properly tax all profits that the enterprise derives from that country - whether through the PE or not. Therefore, under the force of attraction rule, mere existence of PE in another country, leads all profits, which can be said to be derived from that another country, being treated, as taxable of that another country. This principle, in its pure form, probably has no takers so far as the current tax treaties are concerned but, only to give an example of a typical treaty on the basis of ‘force of attraction rule’, we may refer to Article III of United Kingdom - United States of America Income Tax Convention, 1945 which was as follows :

"Article III

(1) A United Kingdom enterprise shall not be subject to United States tax in respect of its industrial or commercial profits unless it is engaged in trade or business in the United States through a permanent establishment situated therein. If it is so engaged, United States tax may be imposed upon the entire income of such enterprise from sources within the United States.

(2) A United States enterprise shall not be subject to United Kingdom tax in respect of its industrial or commercial profits unless it is engaged in trade or business in the United Kingdom through a permanent establishment situated therein. If it is so engaged, United Kingdom tax may be imposed upon the entire income of such enterprise from sources within the United Kingdom : Provided that nothing in this paragraph shall affect any provisions of the law of the United Kingdom regarding the imposition of United Kingdom excess profits tax and national defence contribution in the case of inter-connected companies.

(3) Where an enterprise of one of the contracting Parties is engaged in trade or business in the territory of the other contracting Party through a permanent establishment situated therein, there shall be attributed to such permanent establishment the industrial or commercial profits which it might be expected to derive if it were an independent enterprise engaged in the same or similar activities under the same or similar conditions and dealing at arm’s length with the enterprise of which it is a permanent establishment, and the profits so attributed shall, subject to the law of such other contracting Party, be deemed to be income from sources within the territory of such other contracting Party.

(4) In determining the industrial or commercial profits from sources within the territory of one of the contracting Parties of an enterprise of the other contracting Party, no profits shall be deemed to arise from the mere purchase of goods or merchandise within the territory of the former contracting Party by such enterprise (6 UNTS 189, 93 TNI251-115; DOC 94-30292)." [Emphasis supplied]

A plain reading of the above provision would indicate that in the early stages of development and usage of the tax treaties, when an enterprise of a contracting country had a PE in the other country, its taxability in that other country was not only of the profits attributable to such PE, or even to the profits which could be directly or indirectly attributed to that PE, but of entire profits sourced from that other country. In such a situation, say, if X Ltd. of UK had a business branch in the USA and X Ltd. had also earned some other business profits from USA, even if those other business profits were not even remotely connected with activities of its USA business branch, all these profits would have been taxable in the USA. This paradigm, as we have stated earlier, has no takers so far as modern tax treaties are concerned.

11. It does not, however, mean that ‘force of attraction rule’ is now completely abandoned in the tax treaties. It is alive but in a somewhat sub-dued and different form altogether. The rule, underlying the modern treaties is an improvised and highly restricted ‘force of attraction rule’. This "restricted force of attraction" rule, in essence, additionally expands source State taxation by permitting States where non-residents maintain traditional PEs to tax other income that is attracted to the PE, even though that income is not directly related to the PE. In UN Model Convention (1979 draft), this newer version of the force of attraction rule, finds place. It is implicit in the following provision in Article 7(1) of the UN Model Convention :

"The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to (a) that permanent establishment; (b) sales in that other State of goods or merchandise of the same or similar kind as those sold through that permanent establishment; or (c) other business activities carried on in that other State of the same or similar kind as those effected through that permanent establishment."

12. Explaining the background in which the above model article was drafted, the Commentary on UN Model Convention observes as follows:

"This paragraph reproduces article 7, paragraph 1, of the OECD Model Convention, with the addition of the provisions contained in clauses (b) and (c). In the discussion preceding the adoption by the Group of Experts of this paragraph, several members from developing countries expressed support for the "force of attraction" rule, although they would limit the application of that rule to business profits covered by article 7 of the OECD Model Convention and not extend it to income from capital (dividends, interest and royalties) covered by other treaty provisions. The members supporting the application of the "force of attraction" rule also indicated that neither sales through independent commission agents nor purchase activities would become taxable to the principal under that rule. Some members from developed countries pointed out that the "force of attraction" rule had been found unsatisfactory and abandoned in recent tax treaties concluded by them because of the undesirability of taxing income from an activity that was totally unrelated to the establishment and that was in itself not extensive enough to constitute a permanent establishment. They also stressed the uncertainty that such an approach would create for taxpayers. Members from developing countries pointed out that the proposed "force of attraction" approach did remove some administrative problems in that it made it unnecessary to determine whether particular activities were or were not related to the permanent establishment or the income involved attributable to it. That was the case especially with respect to transactions conducted directly by the home office within the country, but similar in nature to those conducted by the permanent establishment. However, after discussion, it was proposed that the "force of attraction" rule, should be limited so that it would apply to sales of goods or merchandise and other business activities in the following manner: if an enterprise has a permanent establishment in the other Contracting State for the purpose of selling goods or merchandise, sales of the same or a similar kind may be taxed in that State even if they are not conducted through the permanent establishment; a similar rule will apply if the permanent establishment is used for other business activities and the same or similar activities are performed without any connection with the permanent establishment." [Emphasis supplied]

13. We find that Article 7 of the applicable Indo Finnish tax treaty is based on the UN Model Convention and, to that extent, incorporates restricted force of attracted rule. The relevant treaty provision is reproduced below for ready reference :

"Article 7 - Business profits :

1.The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to (a) that permanent establishment; (b) sales in that other State of goods or merchandise of the same or similar kind as those sold through that permanent establishment; or (c) other business activities carried on in that other State of the same or similar kind as those effected through that permanent establishment.

2.Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment.

3.In determining the profits of a permanent establishment, there shall be allowed a deductions expenses which are incurred for the purposes of the permanent establishment, including executive and general administrative expenses so incurred, whether in the State in which the permanent establishment is situated or elsewhere, which are allowed under the provisions of the domestic law of the Contracting State in which the permanent establishment is situated. However, no such deduction shall be allowed in respect of amounts, if any, paid (otherwise than towards reimbursement of actual expenses) by the permanent establishment to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for the use of patents or other rights, or by way of commission, for specific services performed or for management, or, except in the case of a banking enterprise, by way of interest on money lent to the permanent establishment. Likewise, no account shall be taken, in determining the profits of a permanent establishment, for amounts charged (otherwise than toward reimbursement of actual expenses), by the permanent establishment to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for the use of patents or other rights, or by way of commission for specific services performed or for management or, except in the case of a banking enterprise, by way of interest on money lent to the head office of the enterprise or any of its other offices.

4.Insofar as it has been customary in a Contracting State to determine the profits to be attributed to a permanent establishment on the basis of an apportionment of the total profits of the enterprise to its various parts, nothing in paragraph 2 shall preclude that Contracting State from determining the profits to be taxed by such an apportionment as may be customary. The method of apportionment adopted shall, however, be such that the result shall be in accordance with the principles contained in this Article.

5.No profits shall be attributed to a permanent establishment by reason of the mere purchase by that permanent establishment of goods or merchandise for the enterprise.

6.For the purposes of the preceding paragraphs, the profits to be attributed to the permanent establishment shall be determined by the same method year by year unless there is good and sufficient reason to the contrary.

7.Where profits include items of income which are dealt with separately in other articles of this convention, then the provisions of those articles shall not be affected by the provisions of this article.

14. The main distinguishing feature of Article 7 of India Finland DTAA, vis-a-vis Indian tax treaties with most other countries, which are on OECD Model Convention, is that it incorporates a limited force of attraction rule inasmuch as not only the profits attributable to permanent establishment are taxable in the source State, but also the profits on direct transactions entered into by the head office of the PE in the State in which is situated to the extent these transactions are of the same or similar kind, are as well liable to be taxed in the source State. In other words, once a PE of a resident of a Contracting State is involved in certain activity in the other Contracting State, whether the head office of the PE enters into transactions relating to that activity directly or through the PE, in that other State, the profits on such transactions continue to be liable to be taxed in the source State. Article 7(1) is divided into three segments. Under Article 7(1)(a), the profits attributable to the PE are taxed in the source State. Under Article 7(1)(b), profits attributable to sales of such merchandise or goods, in that other State, as is sold through the PE is also liable to be taxed in the source State. Under Article 7(1)(c), profits attributable to business activities carried out in such other State, as is same or similar kind as those effected through the PE, is also taxable in the source State. The scope of Article 7 thus extends to only same or similar activities of the resident of a Contracting State, as are carried out through the PE in the other Contracting State, and not to all the activities of such an enterprise in the country the other Contracting State, as ‘force of attraction rule’, in its pure form, would have envisaged. To that extent, it is a case of restricted force of attraction principle being embodied in Article 7.

15. The question then arises whether supplies made under a turnkey contract would also be covered by the scope of this restricted force of attraction principle, or, to put it differently, whether a turnkey project installation or construction PE can be said to attract profits from portion other than on account of work done on site of such a construction or installation PE.

16. Let us now examine this issue in the light of the provisions of all the three segments of Article 7(1).

17. As far as Article 7(1)(a) is concerned, the profits attributable to the supplies under the turnkey contract can be brought to tax in India only when we are to hold that the profits attributable to PE will include the profits on supplies under the turnkey contract. In our humble understanding, such an interpretation will be incorrect, for several reasons. Firstly, a profit earned by an enterprise on supplies which are to be used in a construction or installation PE for such supplies, cannot be said to be attributable to the PE because PE comes into existence after the transaction given rise to supplies materialized. The installation or construction PE, in such a case, is a stage posterior to the conclusion of transaction giving rise to the supplies. Such an installation or construction PE can come into existence after the contract for turnkey project, of which supplies are integral part is, concluded. The profits on such supplies cannot, therefore, be said to be attributable to the PE. The second reason is this. As per Article 7(2) profits attributable to a PE are the profits "which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment". Thus, the profits of the PE are to be calculated as if the PE is hypothetically independent of the enterprise of which it is a PE. The profits to be taxed in the source country are thus not the real profits made by the enterprise but hypothetical profits which the PE would have earned if it was wholly independent of the enterprise of which it is PE. Therefore, even if it is assumed that the supplies were necessary for the purpose of the activities of the PE and were integral part of the activities thereof, unless it is established that the supplies were not at an arm’s length price to the PE, no part of profits on such supplies cannot be treated as attributable to the PE. The arm length price is best indicated by the price at which enterprise is selling the same to the customer. The hypothetical sale to and the hypothetical sale by the PE being at the same price, there cannot be any profits on account of the transaction. No such taxability can therefore arise in the case before us because the sales are directly billed to the Indian customer and also because there is no suggestion that the prices at which billing is done includes any element for services rendered by the PE. The last reason is this. There are protocol clauses in certain recent Indian treaties, such as German treaty (223 ITR Stat 130). French treaty (155 CTR Stat 22) and Netherlands treaty (177 ITR Stat 2) which provide that in the cases of, inter alia, contracts for supply, installation or construction of industrial, commercial or scientific equipment or public works, the PE profits shall be determined only on the basis of that part of contract which is effectively carried out by the PE. In our considered view, these protocol provisions are clarificatory in nature and would apply to computation of PE profits in general. Therefore, in the case of a turnkey contract, which includes offshore supply of machineries etc. the profits which are to be taxed will only be the profits which can be attributed to the work effectively carried out by the PE. In the light of these discussions, we are of the considered view that Article 7(1)(a) has no application in the matter so far as profits earned by the foreign enterprise on sale of equipment to NSPT are concerned.

18. As regards the scope of Article 7(1)(b), what is taxable here are the profits attributable to sales of such merchandise or goods, in that other State, as is sold through the PE. As per terms of contract the assessee was required to execute turnkey scope of work, i.e., supply of certain equipments and its installation in India. According to the Assessing Officer, the supply is essentially linked to erection of the installation activities in India and ‘this is also a fact that without the supply of equipment there cannot be any installation work carried out in India’. It was on this basis that the Assessing Officer had held that the supply of equipment being invariably linked to the work performed inside India, has also given rise to the income taxable in India. By no stretch of logic Article 7(1)(b) would cover such a situation. The other aspect of the matter is that as per contract with NSPT, the assessee-company’s work in was to supply equipment and render services, and the same work was carried out from India as well as outside India. In other words, PE was engaged in supply of equipment and in rendering services. The same work, i.e., supply of equipment and rendering of services, was also done by the foreign company directly in respect of the same customer was carried out by the head office of the foreign concern directly. As the scope of Article 7(1)(b) is confined to sale of ‘same’ or ‘similar’ goods, we need to adjudicate upon taxability of profits from supply of equipments directly by the head office of foreign concern, to the Indian customer, i.e., NSPT.

19. To understand the scope of Article 7(1)(b), it could be useful to refer to the Commentary on UN Model Convention extracted earlier in this order. It is interesting to note that this Commentary states that, by way of Article 7(1)(b). "it was proposed that the ‘force of attraction’ rule, should be limited so that it would apply to sales of goods or merchandise . . . . in the following manner : if an enterprise has a permanent establishment in the other Contracting State for the purpose of selling goods or merchandise, sales of the same or a similar kind may be taxed in that State even if they are not conducted through the permanent establishment. . . ." [Emphasis supplied]. The commentary thus envisages that direct sales by an enterprise of the one Contracting State to customers in the other Contracting State will be covered by the force of attraction rule only when that enterprise has a PE in the other State ‘for the purpose of selling goods or merchandise’ and the direct sales by the enterprise is of the same or similar kind of goods or merchandise. The installation PEs are thus to be excluded ab initio so far as application of Article 7(1)(b) is concerned. The contents of the Commentary on UN Model Convention, bearing in mind the fact that the UN Model Convention Commentary is to be treated as contemporanea expositio since the treaty Article in question is based on the UN Model Convention, suggests that installation PE is not covered to be covered by the force of attraction principle even if installation PE is selling the same or similar goods as sold directly by the enterprise abroad. The reason appears to be that while in the case of an installation PE, it may only be incidental to the main activity of installation and commissioning of a project that some local supplies may have to be made to the customer, the direct sales by a foreign enterprise in the PE State are to be covered by the force of attraction principle only when the PE is ‘for the purpose of selling goods or merchandise’. As we have noted earlier, there are protocol clauses in certain recent Indian treaties, which provide that in the cases of, inter alia, contracts for supply, installation or construction of industrial, commercial or scientific equipment or public works, the PE profits shall be determined only on the basis of that part of contract which is effectively carried out by the PE. We have held these protocol provisions to be clarificatory in nature and applicable to computation of PE profits in general. Therefore, in the case of a turnkey contract, which includes offshore supply of machineries etc., the profits which are to be taxed will only be the profits which can be attributed to the work effectively carried out by the PE. Now, in this light let us see the effect of the interpretation canvassed by the revenue. If we are to hold that the supplies by the foreign enterprise directly to Indian customer will be taxable in India in view of the provisions of Article 7(1)(b), it will result in an absurdity that while direct sales by Indian PE to Indian customer will not be taxable because of the scope of Article 7(1)(a) in general, supply by foreign enterprise to the Indian PE will be taxable because it will be deemed to be actually attributable to Indian PE though not routed through a PE. That results in a situation in which direct transactions are not taxable but indirect transactions are taxable. That is clearly an unintended incongruity Article 31(1) of the Vienna Convention on the Law of Treaties, which governs the interpretation of international treaties, undoubtedly states that a treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of treaty in their context, and in the light of its objects and purpose but Article 32 of the said Vienna Convention, also does add that a recourse may be had to supplementary means of interpretation, including the preparatory work of the treaty, which, to our mind, includes the scope of commentary on the Model Convention on which the relevant treaty is based, and the circumstances of its conclusion, inter alia, "to determine the meaning such an interpretation (a) leaves the meaning ambiguous or obscure; or (b) leads to a result which is manifestly absurd or unreasonable". In such a situation, as was also the case before a co-ordinate Bench of this Tribunal in the case of Hindalco Industries Ltd. v. Asstt. CIT [2005] 94 TTJ (Mum.) 944¹, an interpretation leading such incongruity is to be avoided. In our considered view, due to operation of force of attraction principle, a transaction between an enterprise and PE State cannot be held to be taxable in source State when such a transaction directly by the PE to customer in source State does not lead to taxability in the source State. In other words, force of attraction only extends the scope of transactions which are to be taxed in the source State and not the nature of transactions which are to be taxed in the source State.

20. There is one more aspect of the matter. On a conceptual framework, the force of attraction rule only implies that when an enterprise sets up a permanent establishment in another country, it brings itself within the fiscal jurisdiction of that another country to such a degree that such another country can properly tax all profits that the enterprise derives from that country - whether through the PE or not. It is the act of setting up a PE, therefore, which triggers the taxability of direct transactions in the source State. Therefore, unless the PE set up, the question of taxability does not arise - whether of direct transactions or the transactions routed through the PE. In the case of a turnkey project, the PE is set up at the installation stage while the entire turnkey project, including sale of equipment embedded in the turnkey project, is essentially finalized much before the installation stage begins. The setting up of PE, in such a case, is a stage subsequent to the conclusion of contract. It is as a result of the sale of equipment really that installation PE comes into existence. In these circumstances, setting up of a PE, by any stretch of logic, cannot result in earlier direct transactions being held as taxable in the source country. In the present case, it is not in dispute that the PE came into existence only after the sale was completed outside India.

21. In any case, this clause could have been invoked only if the Indian PE was found to be engaged in selling the equipment which is same or similar to the equipment sold by the assessee-company to Indian customer. That admittedly is not the case here. Just because some equipments were locally procured and used in installation and commissioning of the equipment sold by the assessee-company, one cannot come to the conclusion that the assessee was engaged in selling same or similar goods or merchandise through the PE. There is no material whatsoever to even suggest that the equipments sold by the enterprise directly to the customer were same or similar to the equipments sold through the PE. It is also important to appreciate that although India Finland tax treaty provides for force of attraction clause, such clause is restrictive in nature as the words ‘same’ and ‘similar’ have been used in clause (b) of Article 7(1). Accordingly, not all the profits of the assessee-company from its business connection in India would be taxable in India, but only so much of profits as have economic nexus with PE in India, would be taxable in India. This economic nexus should be in relation to sale of goods or merchandises of same or similar nature as sold or effected through the PE. This condition, in our considered opinion, is not satisfied in the case before us.

22. In the light of the above discussions, we are of the considered view that under the provisions of Article 7(1)(b), on the facts of this case, sale of equipment directly by the head office of the foreign enterprise directly to NSPT does not lead to taxability of profits thereon in India.

23. We now take up the provisions of Article 7(1)(c). The issue before us is only of taxability of profit on sale of equipment and not, as is the scope of Article 7(1)(c), profits on any ‘business activities carried on in the source State’. Therefore, the provisions of Article 7(1)(c) has no application in the matter. Revenue thus derives no advantage from the same.

24. Since the profits on sale of equipments are admittedly in the nature of business profits, which can only be taxed under Article 7 these profits cannot be taxed under any other provision of the treaty either. As these profits are not taxable in the hands of the assessee, on the basis of provisions of the India Finland tax treaty, there is no need to refer to the provisions of the Act which would have had application in the present case only if these were, in terms of section 90(2), more favourable to the assessee. When taxability in the hands of the assessee fails in terms of the applicable tax treaty, as is the settled law, there is no need to examine the matter on the touchstone of the legal provisions under the Indian Income-tax Act. We are, therefore, of the considered view that the profits on sale of equipment, on the facts of the present case, are not taxable in India.

25. Learned counsel also contends that even if it is assumed that the profits earned by the assessee-company from sale of equipment are taxable in India, in accordance with the provisions of India Finland tax treaty, such profits should not be taxable in India from the perspective of Indian Income-tax Act. It is contended that as per Explanation to section 9(1)(i) of the Act, where a non-resident has business connection in India, only so much of profits could be taxed in India which could reasonably be attributed to the operations carried on in India by the non-resident. It is pointed out that provisions of the Act, in the light of the provisions of section 90(2) of the Act, continue to be applicable to the extent these provisions are more beneficial to the assessee vis-a-vis the provisions of the applicable tax treaty.

26. In the light of the conclusions that we have arrived at, earlier in this order, to the effect that the assessee does not have any tax liability in respect of its Finland based head office directly exporting equipment to NSPT in India, we see no reasons to adjudicate on this alternate plea which would have been relevant only in the event of taxability being upheld on the basis of tax treaty provisions. We, therefore, reject this plea as infructuous and not calling for any adjudication at this stage.

27. For the detailed reasons set out above, we hold that the profits from sale of equipments in question, on the facts of this case, were not taxable in India. We, therefore, see no reasons to interfere in the matter.

28. In the result, the appeal is dismissed.