Adit(It) Circle 3(2) v. Fabrikant And Sons Ltd.

ORDER

Vijay Pal Rao, Judicial Member. — These appeals by the revenue are directed against the different orders of CIT(A) - XXXIII, Mumbai for the assessment years 1999-2000 to 2002-03 and 2003-04.

2. The revenue has raised the following common grounds in these appeals :

"1. On the facts and in the circumstances of the case and in law the ld. CIT(A) erred in holding that the assessee's Liaison Office cannot be considered as a permanent establishment in India and no profits can be attributed to the permanent establishment as no profit accrues or arises in India,

2. On the facts and in the circumstances of the case and in law, the ld. CIT(A) erred in deleting the entire addition made by the AO of Rs. 26,32,87,542".

3.1 Since the facts in all the cases are same, therefore, the fact emerged from the record of the assessment year 2003-04 have been taken for consideration and adjudication of the issue for the sake of convenience. The controversy are that a survey under section 133A of the Act was carried out on 20-1-2006 in the premises of the assessee. The survey party has recorded he findings as under :

"3.1 M/s. M Fabrikant and Sons Inc is a company based in USA and is in the business of sale of loose diamonds and diamond jewellery. The India Liaison Office ( LO) has been opened in 1980 for purchase of finished loose diamonds from Indian Market. The Principals in the USA send their requirements to the LO most via-e-mails or sometime through telephone. One Mr. Shailesh Jhaveri is the Constituted Attorney of M/s. Fabrikant and Sons Inc. and is the main person in charge. He receives the requirement of Principals. The requirement contains details of size and quality of diamonds, the carats and the price in US Dollars. The price quoted is not the final price at which the Principals want to buy, but is indicative and the LO has to negotiate the price. Mr. Shailesh Jhaveri has been given the power to negotiate the price up to a certain level. This fact is established by the statements of approvers/assorters recorded during the course of survey. After receipts of requirements from the Principals, the same is displayed by the LO at the office board, which is placed outside the main entrance of the LO. This contains the size, quality and carats of diamonds required along with the price range at which thediamonds are desired to be bought. The size, quality and carats are written exactly as per the requirement from the principals but as regards to the price, a range is given so that the desired price of purchased is not disclosed. On the basis of this information, the local suppliers send their parcels to the LO. These parcels contain diamonds as per the details given and the same are accompanied by delivery memos/jhanjad slips, on which the person receiving the diamonds in the LO has to sign. On receipt of diamonds. The preliminary check regarding quality, size and carates is done by Mr. Shailesh Jhaveri. If in preliminary examination, the diamonds are found to be of desired standards, then Mr. Shailesh Jhaveri negotiates the price with the supplier and if the supplier agrees to sale the diamonds at the price that can be negotiated by Mr. Shailesh Jhaveri, then the deal is struck. But even after the negotiations, if the supplier does not agrees to sell at the desired price and then Shri Jhaveri has to contact the principals to take their approval before finalizing the deal. Once the desired price has been agreed upon, the parcel of diamonds is handed over to junior approvers, who verify the quality and size and with the help of assorters, selects the required diamonds and the reject that is given back to the supplier is kept by the LO. Normally, the selected diamonds and 30-40% of the total parcel. The selected diamonds are then packed and sealed by the LO and are handed over to courier agent who takes it to customs office for further processing. An intimation is send to the supplier, regarding the size, quality and carats of diamond that are selected and are kept in the parcel, on the basis of which the supplier prepares the invoice. The supplier also reaches the customs house along with a copy of invoice, which is kept with the parcel. Mr. Subhash Shah, employee from LO, reaches the customs house to get the parcel approver and examined by the Approver and examiner at customs and then the same is exported. The supplier directly receives the payment from the principals as stated by the assessee.

3.2 During the course of survey, it was found that the LO is involved in the following activities :

3.2 The AO issued a show-cause notice to the assessee calling upon it to show as to why the Indian Liaison Office should not be treated as Permanent Establishment in India. The assessee has contended that the Liaison Office cannot be treated as PE and no income is assessable in India. It was also contended that the LO is in operation only during the period of purchase and therefore there is no business activity in India. The AO was of the view that the LO is actually involved in other activities and business of preliminary check of diamonds, negotiation of price, assortion of diamonds, storage of diamonds and delivery of the diamonds to the custom house etc. and therefore, permanent establishment exists in this place. The AO recorded the statement of Shri Shailesh Jhavery under section 131. Accordingly, the AO has computed the total income of the assessee at the rate of 5% of the value of the diamonds imported through LO for the assessment year 2003-04. In view of the survey, the AO has also reopened the assessment for the assessment years 1999-2000 to 2002-03 and completed the re-assessment on similar line as for the assessment year 2003-04.

3.3 On appeal, the CIT(A) held that the LO is not making sale or involved in the manufacturing or production of article, therefore, no profit accrued or arises in India. He has relied upon the Board Circular No. 29. dated 7-7-1964. The CIT(A) has further held that in view of the provisions of Article 5(3)(d) of DTAA between India and USA, the appellant's Liaison Office in India cannot be considered as PE in India.

3.4 Before us, the learned DR has referred the finding of the survey party and submitted that the LO is not doing merely the activity of purchase on behalf of the principal but it was doing the activities of preliminary check of diamonds, negotiation of price, assortion of diamonds, packing of diamonds and, storage of diamonds and delivery of the diamonds to the custom house etc. He has pointed out that the LO has around 63 assorters, who are assorting the diamonds received from the suppliers for getting the rights selection and taking out the rejections. Thus, the LO involved in the series of process before supplying the diamonds to the assessee. He has submitted that once LO involved in the negotiation of price and other selection activity of the diamonds then the income on the imports made by the assessee through the LO arised accrued in India. The LO constitutes PE of the assessee in view of the nature of the activities carried out by LO. Thus, the entire process and activities carried out by the LO attributes the value addition to the goods imported by the assessee. He has submitted that the AO has given a finding that 5% of the value addition on the basis that M/s. Fabrikant and Sons Ltd. is subsidiary of the assessee supply the diamonds with 5.5 to 6% value addition, in the share held. In the said statement recorded under section 131 Shri Shailesh Zhaveri who is authorized person and constituted attorney of the assessee in the LO and also a director of the subsidiary company has stated that the subsidiary company purchases the rough diamonds and get it processed from outside party and finished diamonds are sold in open market. It also received rough diamonds from other companies of the assessee group then it process and sell it back after 5.5 to 6% value addition. The assessee purchase around 25% of the total purchases from its subsidiary through LO. Thus, the learned DR has submitted that the LO is also doing the same activities which are being done by the subsidiary company and accordingly there is a value addition of 5.5 to 6% in the diamonds purchased by the assessee through LO. He has relied upon the order of the AO.

3.5 On the other hand, the learned AR has submitted that as per clause (b) of Explanation 1 to section 9(1)(i) of the Act no income shall be deemed to be accrued in India to non-resident through or from operation which are confined to the purchase of goods in India for the purpose of exports. He has thus submitted that without prejudice to the other contentions of the assessee, even if, it is presumed that the LO is treated as PE, in view of the clause (b) of Explanation (1) of section 9(1)(i) no income shall be deemed to accrue in India from the activities of purchase of goods. He has referred the approval of Reserve Bank of India dated 26-7-1978 which is at pages 1 and 2 of the paper book and submitted that the assessee is having its LO since 1978 and it has been clearly mentioned in the said approval that the entire expenses of the office in India will be met exclusively out of remittances received from abroad through normal banking channels and no commission/fee will be charged or any other remuneration received for the liaison activities to be undertaken by the office. The LO shall not enter into any contract relating to the export from India. Thus, the LO of the assessee is only meant for purchase activities. He has referred the Circular No. 23, dated 23-7-1969 and submitted that as per paragraphs 5 and 7 of the said circular it has been clarified by the Board that non-resident will not be liable to tax in India on any income attributable to operations confined to purchase of goods in India for export, even though the non-resident has an office or an agency in India for this purpose. Further as per paragraph 7 of the said circular section 9 does not seek to bring into tax the net the profits of a non-resident which cannot reasonably be attributed to operations carried out in India. Thus, even if there be a business connection in India, only that portion of the profit which can reasonably be attributed to the operations of the business carried out in India will be deemed to be accrued or arises in India and liable to income-tax.

3.6 The learned AR has further referred the Circular No. 163 on the issue and submitted that the Board has further clarified in the said circulars that by virtue of clause (b) of Explanation to section 9(1)(i) the correct legal position is that in a case of non-resident no income shall be accrued or arises in India through or from operation which are confined to purchase of goods in India for the purpose of export. Accordingly, mere existence of an agency established by a non-resident in India is not sufficient to make the non-resident liable to tax, if the sole function of the agency is to purchase goods for export.

3.7 The learned AR has referred the Article 7(4) of the DTAA between India and US and submitted that as per article 7 no profit shall be attributable to PE by reasoning of the mere purchases by that PE of goods or merchandise for the enterprise. Then, the learned AR has pointed out that as per Article 5 of Indo-US Treaty the PE shall deemed not to include inter alia the maintenance of fixed place of business and solely for the purpose of purchase of goods or merchandise to collecting information for the enterprise. Thus, the learned AR of the assessee has submitted that no income arisen or accrued in India from the activities or operation of the purchases made by the assessee through its LO. Further the LO for the purpose of purchasing goods or merchandise or collecting the information does not constitutes PE. He has relied upon the decision in the case of CIT v. N.K Jain [1994] 206 ITR 692/77 Taxman 13 (Delhi) and the decision in the case of Nike Inc v. Asstt. CIT [2010] 122 TTJ 201/125 ITD 35 (Bang.) .

3.8 We have heard the rival contentions and perused the relevant record. Undisputedly, the LO of the assessee was performing the activities of assorting of diamonds, checking of the right quality of diamonds and price negotiation as per the instructions and specification of the assessee. These activities of the LO is only part of the purchasing process of the diamonds and did not bring any physical or qualitative change in the goods purchased. Even otherwise, the function of the LO as mentioned above are prior to purchase of the diamonds and not subsequent to the purchases. Therefore, no quality change is brought by the LO while doing the operation of purchasing in India for export purposes. It is a case of purchase of goods through LO and all the activities carried out by the LO are basic and preliminary requirement of the purchasing process/operation. Selection of right goods and negotiation of price as per the instructions of the assessee are essential part of the purchasing activity. Thus, the case is fully covered by the clause (b) of Explanation (1) to section 9(1)(i) of the Act. Further in view of the Circular Nos. 23 and 163, the board has clarified as under :

Circular No. 23

"(5) NON-RESIDENT PERSON PURCHASING GOODS IN INDIA - A non-resident will not be liable to tax in India on any income attributable to operations confined to purchase of goods in India for export, even though the non-resident has an office or an agency in India for this purpose. Where a resident person acts in the ordinary course of his business in making purchases for a non-resident party, he would notnormally be regarded as an agent of the non-resident under section 163. But, where the resident person is closely connected with the non-resident purchaser and the course of business between them is so arranged that the resident person gets no profits or less than the ordinary profits which might be expected to arise in that business, the Income-tax Officer is empowered to determine the amount of profits which may reasonably be deemed to have been derived by the resident person from that business and include such amount in the total income of the resident person.

(7) EXTENT OF THE PROFIT ASSESSABLE UNDER SECTION 9 - Section 9 does not seek to bring into the tax net the profits of a non-resident which cannot reasonably be attributed to operations carried out in India. Even if there be a business connection in India, the whole of the profit accruing or arising from the business connection is not deemed to accrue or arise in India. It is only that portion of the profit which can reasonably be attributed to the operations of the business carried out in India, which is liable to income-tax.

To constitute a business connection, some continuity of relationship, between the person in India who helps to make the profits and the person outside India who receives or realises the profits, is necessary. Where all what has happened is that a few transactions of purchases of raw materials have taken place in India and the manufacture and sale of goods have taken place outside India, the profits arising from such sales cannot be considered to have arisen out of a business connection in India. Where, however, there is a regular agency established in India for the purchase of the entire raw materials required for the purpose of manufacture and sale abroad and the agent is chosen by reason of his skill, reputation and experience in the line of trade, it can be said that there is a business connection in India so that a portion of the profits attributable to the purchase of raw materials in India can be apportioned under Explanation (a) to section 9(1)(i) . [ The taxability of such portion of the profits will, however, be subject to the exemption provided in clause (b) of the Explanation to section 9(1)(j) .]"

Circular No. 163

"2. The above sentence may convey the impression that a non-resident is liable to be taxed on a portion of the profits attributable to the purchase of raw materials required for the purposes of manufacture and sale abroad, if the purchases are made in India through a regular agency established in India for this purpose. By virtue of clause (b) of the Explanation to section 9(1)(i) , the correct legal position is that in the case of a non-resident, no income shall be deemed to accrue or arise in India through or from operations which are confined to purchase of goods in India for the purpose of export. Accordingly, the mere existence of an agency established by a non-resident in India will not be sufficient to make the non-resident liable to tax, if the sole function of the agency is to purchase goods for export. This legal position has also been explained in para 3( 5) of the Boards Public Circular cited above."

3.9 In view of the above discussions and facts and circumstances of the case as well as the decisions cited supra, we hold that no income arises or accrued in India to the assessee by virtue of the purchases made by the assessee for export.

4. The appeals of the revenue are dismissed.