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Apoorva Shantilal Shah v. Commissioner of Income-tax, Gujarat I, Ahmedabad, (SC) 1983(2) SCC 155

SUPREME COURT OF INDIA

JUDGMENT

Amarendra Nath Sen, J. – The Principal question for decision in this appeal by Special Leave is whether the father in exercise of his right as patria potes as or otherwise can effect a partial partition between himself and his minor sons of joint family properties of a Hindu joint family governed by the Mitakshara School of Hindu law.

2. The assessee, a Hindu undivided family (hereinafter referred to as H. U. F.), which consists of four members, namely, (1) Shri Apoorva Shantilal Shah, (2) his wife Smt. Karuna and their minor sons, (3) Chinton and (4) Tejal, is the appellant before us. The members of the H. U. F. are governed by the Mitakshara School of Hindu law. The assessment year in question is the year 1975-76, During the assessment pertaining to the assessment year under consideration, Shri Apoorva who is the father of the minor sons and husband of Smt. Karuna and the Karta of the H. U. F. made an application to the Income-tax Officer for recognising partial partition under Section 171 of the Income Tax Act, Act 1961 (hereinafter referred to as the Act), claiming that two partial partitions had taken place amongst the members of the said family, one on 24-12-1973 in respect of 200 shares of Gujarat Steel Tubes Ltd. and the other on 29-12-1973 in respect of 1777 shares of the same company.

3. On enquiry the Income-tax Officer (hereinafter for the sake of brevity referred to as I. T. O.) found that the partial partitions had been embodied in memoranda of agreement of partition. The I. T. O. however, refused to record that there had been a partial partition of joint family properties, as he was of the view that partial partitions in question could not be recognised inasmuch as the remaining shares, after making certain allocations in favour of the two minor sons were not allotted in their entirety to the remaining third coparcener, namely, Shri Apoorva, separately or to Shri Apoorva and his wife Karuna jointly, describing them as members of the H. U. F. The I. T. O. further held that the said partitions did not purport to have been made at the instance of the minor children, as this course would require the approval of the Court but the same had been purported to have been made at the instance of Shri Apoorva. The I.T.O. hinted in the order that the distribution of the shares had not been made equally either amongst the three members including the two minor sons or amongst the four members of the H. U. F., as Apoorva’s wife ‘Karuna also became entitled to an equal share on partition between the father and the sons.

4. Against the order of the I.T.O. the assessee H.U.F. presented an appeal before the Appellate Assistant Commissioner (hereinafter referred to as A. A. C. for the sake of brevity). The A. A. C. allowed the appeal and held that there had been genuine partial partitions between the coparceners in respect of the said shares. The A. A. C. held that it was not necessary to obtain Court’s sanction even in a case where some of the parties to the partition were minors. As regards the point that the distribution of share-holdings had not been made on equal basis, the A. A. C., taking into consideration some earlier partitions, came to the conclusion that the distribution had been equally made. The A. A. C. further observed that even if the distribution had not been made on equal basis that would not affect the validity of the partitions in question and the minor sons, if they felt aggrieved in this regard, could on attainment of majority seek to avoid the said partitions.

5. Aggrieved by the order of the A.A.C., the Revenue went up in appeal to the Income-tax Appellate Tribunal (referred to as Tribunal hereinafter for the sake of brevity) to challenge the A. A. C.’s recognition of the said partitions. The Tribunal held for reasons recorded in the order that partial partitions in the instant case were outside the frame work of the Hindu law and as such they could not be recognised as valid for the purposes of Section 171 of the Act. In that view of the matter the Tribunal set aside the A.. A.. C.’s order and restored the order of the I.T.O.

6. Under Section 256(1) of the Act, the Tribunal referred the following questions to the High Court :-

(1) Whether on the facts and in the circumstances of the case, the Tribunal was right in holding that Shri Apoorva Shantilal could not himself have given consent on behalf of his minor sons to the partitions proposed by him in his individual capacity as father ?

(2) Whether on the facts and in the circumstances of the case, the Tribunal was right in holding that the partial partitions were outside the framework of Hindu law ?

(3) Whether on the facts and in the circumstances of the case, the Tribunal was right in holding that the partial partitions could not be recognised as valid for the purpose of Section 171 of the Income Tax Act, Act 1961 ?

(4) Whether on the facts and in the circumstances of the case, the Tribunal was right in holding that partial partitions made by a Hindu father in exercise of his patria potestas cannot be recorded as a valid partition under Section 171 of the Income Tax Act, Act 1961 ?(5) Whether on the facts and in the circumstances of the case, the Tribunal was right in holding that the partial partition did not amount to a family arrangement in which the father acted as a natural guardian of the two minor sons after he had exercised his patria potestas ?

(6) Whether the Income-tax Department is competent to challenge the exercise of patria potestas by a Hindu father in respect of coparcenary property, making in partial partition ?
7. For reasons recorded in the judgment the High Court answered all the questions in the affirmative and against the assessee. The High Court in its judgment has held that the father under the Hindu law has no power of authority to effect any partial partition of joint family properties between himself and his minor sons. The High Court has observed that apart from the decision of the Madhya Pradesh High Court in the case of Commissioner of Income-tax v. Seth Gopaldas (H.U.F.), (1979) 116 ITR 577 ; there was no decision of any Court on the point. The High Court also considered other decisions and books and treatises on Hindu law. The High Court held that on a consideration of the authorities, the following propositions were established.

1. From the standpoint of ancient Hindu law, what was recognised was only a partition in respect of all the properties of the H. U. F., upon disruption of the status of H. U. F. regardless of whether the properties were actually divided by metes and bounds or whether these were thereafter (after disruption of joint status) held as tenants-in-common.

2. Partial partition in the sense of division in respect of part of the assets while continuing the status of HUF in respect of rest of the assets was not known to the ancient Hindu law and was not recognised by ancient Hindu law.

3. Partial partition in the sense of division of some of the properties whilst continuing the status of HUF in respect of other items of property originally belonging to the HUF came to be recognised only later on by evolution of custom and by Judge made law.

4. Such a partial partition was so recognised only if it was made by consent of all the coparceners. In other words, partial partition in respect of only some items of properly whilst continuing the status of HUF in respect of rest of the items of property could be effected only with the consent of all the coparceners. When there was a disruption of the status of the HUF only one or more of the coparceners could not insist for division of some items of the property without effecting division in respect of all the items of properties except by consent of all the coparceners.

5. In respect of a joint family consisting of a father and his sons, the traditional Hindu law recognised the right of a father in his capacity as patria potestas to exercise his extraordinary power to disrupt the status of HUF and to divide his sons inter se without their consent subject to the rider that ‘all’ assets of the HUF were subjected to partition..

6. The aforesaid extraordinary power is subject to the qualification that he gives to his sons an equal share and division is not unfair (vide Gupte’s Hindu Law 2nd Edn., page 259). ‘The power of the father to sever the sons inter se is a survival of the patria potestas and may be exercised by him without the consent of his sons” … … .. “Again, in all cases his power must be exercised by him bona fide and in accordance with law; the division must not be unfair and the allotment must be equal. He must give his sons equal share with himself”.

7. There is nothing in (1) either ancient Hindu Law or (2) customary or Judge-made law which authorises the father in exercise of his extraordinary power to effect a partial partition of HUF consisting of himself and his minor sons by dividing some items of properties whilst continuing the joint status in respect of the rest of the properties. The High Court observed :-

“The validity of the aforesaid propositions is incapable of being disputed and has not been disputed. What has been contended on behalf of the assessee is that whilst there is no express provision in so many words, either in the ancient Hindu texts or Judgement law, that the power of a Hindu father to effect partition of a HUF consisting of himself and his sons including minor sons in exercise of his power as patria potestas extends even to partition in respect of only some items of property it is required to be inferred by implication. In other words, it is argued that though there is no express reference to the power to effect that partial partition in the sense of division of some items of property while continuing the status of HUF in respect of the rest and though such power is not recognised in terms, it follows as a necessary corollary.”
The High Court noted that this contention has been negatived by the Madhya Pradesh High Court in the case of Gopaldas (supra) and the High Court for reasons recorded in the judgment rejected this contention. The High Court further held that the transaction in question was in any event invalid in the facts and in the circumstances of this case.

8. Aggrieved by the judgment of the High Court, the assessee with special leave granted by this Court has preferred this appeal.

9. In this appeal before us, two main contentions have been urged on behalf of the appellant. The first contention urged is that the High Court went wrong in holding that the father cannot effect any valid partial partition between himself and his minor sons of joint family property belonging to a Hindu undivided family consisting of himself, his wife and minor sons who are governed by the Mitakshara School of Hindu Law. The other contention raised is that the High Court erred in coming to the conclusion that in the facts and circumstances of this case, the partial partitions were invalid.

10. Mr. Desai learned counsel appearing on behalf of the appellant has advanced the following arguments.

1. According to the Mitakshara School of Hindu Law, the father has a power to divide ancestral property among his sons and the partition made by him is binding on his sons provided that the power is exercised bona fide and in accordance with law which regulates and restricts it in the interests of his sons. This power on the part of the father is recognised in text books on Hindu law and has been accepted in a number of decisions beginning with the case of Kandaswami v. Doraisami Ayyar, ILR (1880) 2 Mad 317.

2. A father in any such case of ancestral property has the power to separate from all or from even some of his sons remaining joint with the other sons or leaving them to continue as a joint family with each other. The consent of the sons is not necessary for the exercise of that power whether they are majors or minors. In this connection reference is made to para 323 of Hindu Law by D. F. Mulla and para. 458 at page 559 of Mayne’s Hindu Law (11th Edn.)

Para 323 of Mulla’s Hindu Law, 11th Edn. at pages 443 and- 444 reads as follows :-

“The father of a joint family has the power to divide the family property at any moment during his life, provided he gives his sons equal shares with himself, and if he does so, the effect in law is not only a separation of the father from the sons, but a separation of the sons inter se. The consent of the sons is not necessary for the exercise of that power. But a grandfather has no power to bring about a separation among the grand sons. The right of a father to sever the sons inter se is a part of the patria potestas still recognised by the Hindu Law.”

Para 458 of Mayne’s Hindu Law and Usage, 11th Edn. at pp. 559 and 560 reads as follows :-

“Partition may be either total or partial. A partition may be partial either as regards the persons making it or the property divided.

It is open to the members of a joint family to sever in interest in respect of a part of the joint estate while retaining their status of a joint family and holding the rest as the properties of an undivided family.

Any one coparcener may separate from the others, but no coparcener except the father or grandfather, can compel the others to become separate amongst themselves. A father may separate from all or from some of his sons, remaining joint with the other sons or leaving them to continue a joint family with each other. A separation between coparceners, for instance, between two brothers, does neither necessarily nor even ordinarily involve a separation between either of the coparceners and his own sons.”

3. So extensive and wide is this patriarchal power of the father that it has been recognised even in cases where all the sons were minors or an only son was a lunatic. Reference is made to the decision of the Bombay High Court in the case of Babu Hambira Patil v. Shankar Bhau Patil, AIR 1926 Bombay 160 and to the decision of the Madras High Court in the case of Venkateswara Pattar v. K. Mankayammal, AIR 1935 Madras 775.

4. Section 171 of the Income Tax Act, Act 1961 and Section 25-A of the earlier Act have been all along accepted as machinery provisions and not charging sections. In the earlier Act though there was no express reference to partial partitions, the preferable view expressed in decisions under that Act was that if there was a partial partition of an assets of the family or an asset of the family was divided and a partnership was constituted and the family continued joint as regards other properties, the assessment on the basis of undivided Hindu family would be confined to the income of the properties so remaining undivided and the income of the property partitioned would be excluded from the computation of the income for assessment. It was only income received from the properties not partitioned that would be considered to be the income of the joint family. Reliance has been placed on the decision in the case of Charandas Haridas v. C.I.T., Bombay, (1960) 39 ITR 202.

5. This power of the father has been described as his “superior power” or “peculiar power” or “patria potestas”. There is neither principle nor authority for the proposition that the exercise of this independent and extensive power of the father even in the context of minor sons could not take into its purview the lesser power to partition only some of the family properties without disrupting the status of the members of the joint family as regards other properties even when it is a genuine exercise of the lesser power. At no time was there recognised any limitation or inhibition on the power of the father though of course the partition effected by him had to be fair and equitable. There is no text of Hindu Law which prohibits partial partition whether as to person or as to property.

6. The decision of the Privy Council in the case of Appovier v. Rama Subba Aiyan, (1966) 11 Moo Ind App 75, when it speaks of partial partition of the joint family by agreement of the coparcener cannot possibly be read as restricting the patriarchal and superior power of the father to effect division of the entire joint family properties and to exclude operation in case of exercise of the lesser right of division of only some of the family properties.
11. Mr. Manohanda learned counsel appearing on behalf of the department has advanced the following arguments :

1. Under ancient Hindu Law, partial partition was unknown. Severance of status disrupted the family. The joint family need not necessarily have any property. If it has property, then its separation is only an incidence of the severance of status.

2. Partial partition is Judge-made law and the earliest case where this was mooted was in 1846 in the case of Rewun Prashad V. Radha Beeby, (1846) 4 Moo Ind App 137 at P. 165. This was followed in Appovier’s case (supra) and then in certain decisions of Indian Courts. Reference is also made to para 458 of Mayne’s Book on Hindu Law and Usage for contending that agreement between the parties is a sine qua non.

3. The powers of patria potestas are confined mainly to the power to sever the status of the joint family as a whole. Judge-made law which has recognised partial partition has attempted to extend the ancient, feudal archaic patriarchal powers of patria potestas to joint families so as to include the power of partial partition with the consent of the parties. There could be no justification for now extending it, particularly as the legislature itself, as per the Finance Act (2) 1980 w.e.f. 1-4-1980 has de-recognised partial partition altogether. Sub-section (9) has been added to Section 171 of the Act and by this provision partial partition of a HUF effected after 31-12-1978 will be de-recognised for income-tax purposes and this sub-section has been incorporated with the object of curbing the creation of multiple HUF by making partial partitions. Where a HUF is taxed in the status of HUF it will continue to be taxed as such unless there has been a total partition of the family properties by metes and bounds and an order to that effect is recorded by I. T. O.

4. The powers of patria potestas of a father have always been understood to be restricted and limited to a complete and whole partition. This power can only be exercised with regard to the entire property, provided the property is divided equally and fairly by the father.
12. We may observe that in course of the hearing, reference was made to a number of decisions of various Courts by the learned counsel for the parties.

13. We shall now proceed to consider the decisions which appear to us to have a material bearing on the question involved in the appeal. We shall first refer to the decision of this Court in the case of Charandas Haridas (supra). This decision which appears to have a clear bearing on the question and which considers an earlier decision of the Privy Council, does not appear to have been cited before the High Court. The material facts of this case may be briefly noted :-

Charandas Haridas was the Karta of a Hindu undivided family consisting of his wife, Shantaben, three sons and himself.” He was a partner in six managing agency firms in six mills. In previous years the income received by him as partner in these Managing Agencies was being assessed as the income of the Hindu undivided family. On Dec. 11, 1945 Charandas Haridas acting for his three minor sons and himself and Shantaben his wife entered into an oral agreement for partial partition. By that agreement Charandas Haridas gave one pie share to his daughter Pratibha in the managing agency commission from two of the six managing agencies held by the family. The balance together with the other shares in the other managing agencies was divided in five equal shares between Charandas Haridas, his wife and sons. This agreement was to come into effect from 1st January, 1946 which was the beginning of a fresh accounting year, On 11th Sept., 1946 Charandas Haridas acting for himself and his minor sons and Shantaben executed a memorandum of partial partition in which the above facts were recited, the document purporting to be a record of what had taken place orally earlier. In the assessment years 1947-48 and 1948-49, Charandas Haridas claimed that the income should no longer be treated as income of Hindu undivided family but as separate income of the divided members. The Income-tax Officer declined to treat the income as any but of the Hindu undivided family, and assessed the income as before. An appeal to the Appellate Assistant Commissioner was unsuccessful and the matter was taken to the Income-tax Appellate Tribunal. The Tribunal held that by the document in question, the division, if any, was of the income and not of the assets from which the income was derived inasmuch as “the agreements of the managing agency with the managed companion did not undergo any change whatever as a result of the alleged partitions.” The Tribunal, therefore, held that the arrangement to share the receipts from this source of income was not binding on the department, if the assets themselves continued to remain joint. It further held that the document was “a farce”, and did not save the family from assessment as Hindu undivided family. The following question as directed by the High Court on the application of Charandas Haridas was referred to the High Court :-

“‘Whether there were materials to justify, the finding of the Tribunal that the income in the share of the commission agency of the mills was the income of the Hindu undivided family ?”
The High Court held that though the finding given by the Appellate Tribunal could not be construed as a finding that the document was not genuine, the method adopted by the family to partition the assets was insufficient to bring about the results intended by it. According to the High Court the Tribunal was right in holding that the document was in effective and though the income might have been purported to be divided and might, in fact, have been so divided, the source of income still remained undivided as belonging to the Hindu undivided family. The High Court accordingly answered the question in the affirmative holding that there were materials before the Tribunal to enable the Tribunal to reach the conclusion that in so far as these income-bearing assets were concerned, they still belonged to the Hindu undivided family. The assess Charandas Haridas filed an appeal in this Court with special leave granted by this Court. This Court allowed the appeal. At page 207 (of ITR) , this Court referred to the following observations of the Privy Council in Appovier v. Rama Subba Aiyan (supra) :

“Nothing can express more definitely a conversion of the tenancy, and with that conversion a change of the status of the family quoad this property. The produce is no longer to be brought to the common chest, as representing the income of an undivided property, but the proceeds are to be enjoyed in six distinct equal shares by the members of the family, who are thenceforth to become entitled to those definite shares.”
Thereafter this Court proceeded to hold at page 208 (of ITR) :-

“In our opinion, here there are three different branches of law to notice. There is the law of partnership, which takes no account of a Hindu undivided family. There is also the Hindu Law which permits a partition of the family and also a partial, partition binding upon the family. There is then the income-tax law, under which a particulars income may be treated as the income of the Hindu undivided family or as the income of the separated members enjoying separate shares by partition. The fact of a partition in the Hindu Law may have no effect upon the position of the partner, in so far as the law of partnership is concerned, but it has full effect upon the family in so far as the Hindu Law is concerned. Just as the fact of a karta becoming a partner does not introduce the members of the undivided family into the partnership, the division of the family does not change the position of the partner vis-a-vis the other partner or partners. The Income-tax Law before the partition takes note, factually, of the position of the karta, and assessee not him qua partner but as representing the Hindu undivided family. In doing so, the Income-tax Law looks not to the provisions of the partnership Act, but to the provisions of Hindu Law. When, once the family has disrupted, the position under the partnership continues as before, but the position under the Hindu Law changes. There is then no Hindu undivided family as a unit of assessment in point of fact, and the income which accrues cannot be said to be of a Hindu undivided family. There is nothing in the Indian Income-tax Law or the law of partnership which prevents the members of a Hindu joint family from dividing any asset. Such division must, of course, be effective so as to bind the members; but Hindu Law does not further require that the property must in every case be partitioned by mates and bounds, if separate enjoyment can otherwise be secured according to the shares of the members. For an asset of this kind, time was no other mode, of partition open to the parties if they wished to retain the property and yet held it not jointly but in severalty, and the law does not contemplate that a person should do the impossible. Indeed, the result would have been the same, even if the dividing members had said in so many words that they had partitioned the assets, because in so far as the firms were concerned, the step would have been wholly income-sequential.”
This Court further observed at P. 209 (of ITR) :-

“No doubt, there were many modes of partition which might have been adopted; but the question remains that if the family desired to partition these assets only and no more, could they have acted in some other manner to achieve the same result ? No answer to the question was attempted. It is, therefore, manifest that the family took the fullest measure possible for dividing the joint interest into separate interests. There is no suggestion here that this division was a mere pretence; nor has the Appellate Tribunal given such a finding. The document was fully effective between the members of the family, and there was actually no Hindu undivided family in respect of these particular assets.”
In the case of Kalloomal Tapeswari Prasad (HUF) v. Commissioner of Income-tax, Kanpur, (1982) 133 ITR 690, this Court observed at p. 702 (of ITR) :

“Under Hindu Law partition may be either total or partial. A partial partition may be as regards persons who are members of the family or as regards properties which belong to it. Where there has been a partition, it is presumed that it was a total one both as to the parties and property but when there is a partition between brothers, there is no presumption that there has been partition between one of them and his descendants. It is, however, open to a party who alleges that the partition has been partial either as to persons or as to property, to establish it. The decision on that question depends on proof of what the parties intended – whether they intended the partition to be partial either as to persons or as to properties or as to both. When there is partial partition as to property, the family ceases to be undivided as regards properties in respect of which such partition has taken place but continues to be undivided with regard to the remaining family property. After such partial partition the right of inheritance and alienation differ according as to property in question belongs to the members in their divided or undivided capacity. Partition can be brought about, (1) by a father during his lifetime between himself and his sons by dividing equally amongst them, (2) by agreement, or (3) by a suit or arbitration.”
These two decisions of this Court clearly state that partial partition under Hindu Law is permissible.

14. We may mention that in the case of Moti Lal Shyam Sunder v. Commissioner of Income-tax, U.P., (1972) 84 ITR 186, a Division Bench of the Allahabad High Court also recognised the validity of partial partition. R. S. Pathak, J., (as his Lordship then was) who spoke for the Bench held for reasons stated in the judgment that the Tribunal was in error in holding that there was no valid partial partition in law on 1st July, 1961.

15. It may be noted that in the case of Charandas Haridas (supra) decided by this Court and in the case of Motilal Shyam Sunder (supra) decided by the Allahabad High Court, to which we have just referred, all the sons were minors.

16. We have earlier quoted the relevant passages on the subject from Mulla’s Hindu Law and from Mayne’s Hindu Law and Usage. We may now quote the following observations appearing at p. 18 in ‘Mitakshara and Daya Bhaga – Two Treatises on the Hindu Law of Inheritance translated by H. T. Colebrooke, Esq.’, in Chap. I, Section II(2) –

“When a father wishes to make a partition, he may at his pleasure separate his children from himself, whether one, two or more sons.”
17. In ‘History of Dharmashastra’ by Shri P.V. Kane (Second Edition, 1973) Vol. III at p. 592, it has been stated :

“The Manager is called Karta in modern times though the smritis and digests employ words like Kutumbin (Yaj IL 45), Grhin, Grhapali, Prabhu (Kat. 543) and not Karta. He has special powers of disposition (by mortgage, sale or gift) of family property in a season of distress (for debts), for the purposes and benefit of the family (maintenance, education and marriage of members and other dependents) and particularly for religious purposes (Sraddhas and the like). The father has the same powers as Manager and certain other special powers, which no other coparcener has. The father can separate his sons from himself and also among themselves if he so desires, even if they do not desire to separate. (Yaj. II. 114).”
There are observations more or less to the similar effect in the other commentaries on Hindu Law by other learned authors. We do not, therefore, consider it necessary to refer to the comments of the other learned authors placed before us in course of the hearing of the appeal.

18. The various commentaries on Hindu Law by the various learned authors go to indicate that ancient Hindu Law speaks of complete severance of joint family and partition of joint family properties and does not mention partial partition either with regard to the joint family properties or with regard to some of the members of the joint family. The right of the father to bring about the disruption of the joint family properties in exercise of his superior right as father or of his rights as patria potestas is recognised in ancient Hindu Law.

19. It is, however, well settled by judicial decisions, that partial partition of a joint Hindu family qua some joint family properties or qua some members of the joint family is permissible and valid in law. The High Court appears to have accepted this position but the High Court then proceeds to hold that the proposition laid down by judicial decisions with regard to partial partition will apply only when partial partition is effected with the consent of the members of the joint family and cannot be extended to a case where partial partition is sought to be brought about by father in exercise of his superior rights as father or his right, as patria potestas. On an anxious and careful consideration of the matter we are unable to agree with the view expressed by the High Court.

20. If the father in exercise of his superior right or of his right as patria potestas is entitled to bring about a complete disruption of the joint family and to effect a complete partition of joint family properties of a Hindu joint family consisting of himself and his minor sons even against the wishes of the minors and if partial partition be permissible with the consent of sons when they have all become major, we see no reason to limit the power or authority of the father to effect the partition only to a case where the partition is total. The superior right or the right of patria potestas which a father enjoys is always expected to be exercised in the best interest of the members of the family and more particularly his minor sons. The father, undoubtedly, enjoys the right to bring about a complete disruption of the joint family consisting of himself and his minor sons and to effect a complete partition of the joint family properties even against the Will of the minor sons. It is also now recognised that partial partition of joint family properties is permissible. When father can bring about a complete partition of joint family properties between himself and his minor, sons even against the Will of the minor sons and when partial partition under the Hindu Law is not accepted and recognised as valid by judicial decisions, we fail to appreciate on what logical grounds it can be said that the father who can bring about a complete partition of the joint family properties between himself and his minor sons will not be entitled to effect a partial partition of joint family properties between himself and his minor sons, if the father in the interest of the joint family and its members feels that partial partition of the properties will be in the best interest of the joint family and its members including the minor sons. Even if the test of consent is to apply, the father as the natural guardian of the minor sons will normally be in a position to give such consent and it cannot be said as a matter of universal application that in all such cases of partition, partial or otherwise, there is bound to be a conflict of interest between the father and his sons. If the father does not act bona fide in the matter when he effects partition of joint family properties between himself and his minor sons, whether wholly or partially, the sons on attaining majority may challenge the partition and ask for appropriate reliefs including a proper partition. In appropriate cases even during minority, the minor sons through a proper guardian may impeach the validity of the partition brought about by the father either in entirety of the joint family properties or only in respect of part thereof, if the partition had been effected by the father to the detriment of the minor sons and to the prejudice of their interests.

21. We may point out that in the case of Charandas Haridas to which we have earlier referred and in which this Court recognised the validity of partial partition brought about by the father of some joint family properties, the sons were all minors. Also in the case of Motilal Shamsunder (1972-84 ITR 186) earlier quoted, where the Allahabad High Court, recognised the validity of a partial partition brought about by the father between himself and his sons, all the sons were minors.

22. The decision of this Court in the case of Charandas Haridas and the observations of this Court in the case of Kalloomal Tapeswari Prasad (supra) which we have earlier quoted, in our opinion, clinch the decision of the question.

23. We must, therefore, hold that partial partition of properties brought about by the father between himself and his minor sons cannot be said to be invalid under the Hindu Law and must be held to be valid and binding. We wish to make it clear that this right of the father to effect a partial partition of the family properties between himself and his minor sons whether in exercise of his superior right as father or in exercise of right as patria potestas has necessarily to be exercised bona fide by the father and is subject, to the right of the sons to challenge partition if the partition is not fair and just.

24. Section 171 of the Income-tax. Act, 1961 provides as follows :

(1) A Hindu family hitherto assessed as undivided shall be deemed for the purposes of this Act to continue to be a Hindu undivided family, except where and in as far as a finding of partition has been given under this section in respect of the Hindu undivided family.

(2) Where, at the time of making an assessment under Section 143 or Section 144, it is claimed by or on behalf of any member of a Hindu family assessed as undivided that a partition, whether total or partial, has taken place among the members of such family, the Income-tax Officer shall make an enquiry thereinto after giving notice of the enquiry to all the members of the family.

(3) On the completion of the enquiry, the Income-tax Officer shall record a finding as to whether there has been a total or partial partition of the joint family property, and, if there has been such a partition, the date on which it has taken place.

(4) Where a finding of total or partial partition has been recorded by the Income-tax Officer under this section, and the partition took place during the previous year.

(a) the total income of the joint family in respect of the period up to the date of partition shall be assessed as if no partition had taken place; and

(b) each member or group of members shall, in addition to any tax for which he or it may be separately liable and notwithstanding anything contained in clause (2) of Section 10, be jointly and severally liable for the tax on the income so assessed.

(5) Where a finding of total or partial partition has been recorded by the Income-tax Officer under this section, and the partition took place after the expiry of the previous year, the total income of the previous year of the joint family shall be assessed at as if no partition had taken place; and the provision of clause (b) of sub-section (4) shall, so far as may be, apply to the case.

(6) Notwithstanding anything contained in this section, if the Income-tax Officer finds, after completion of the assessment of a Hindu undivided family that the family has already effected a partition, whether total or partial, the Income-tax Officer shall proceed to recover the tax from every person who was a member of the family before the partition, and every such person shall be jointly and severally liable for the tax on the income so assessed.

(7) For the purposes of this section, the several liability of any member or group of members thereunder shall be computed according to the portion of the joint family property allotted to him or it at the partition, whether total or partial.

(8) The provisions of this section shall, so far as may be, apply in relation to the levy and collection of any penalty, interest, fine or other sum in respect of any period up to the date of the partition, whether total or partial of a Hindu undivided family as they apply in relation to the levy and collection of tax in respect of any such period.

x x x x x x

Explanation : In this section. –

(a) “partition” means –

(i) where the property admits of a physical division, a physical division of the property but a physical division of the income without a physical division of the property producing the income shall not be deemed to be a partition; or

(ii) where the property does not admit of a physical division then such division as the property admits of, but a mere severance of status shall not be deemed to be a partition;

(b) “Partial partition” means a partition which is partial as regards the persons constituting the Hindu undivided family, or the properties belonging to the Hindu undivided family, or both.
It may be noted that the following further provision was included in the said section as sub-section (9) by the Finance (No. 2) Act, 1980 w. e. f. 1st April, 1980 :-

(9) Notwithstanding anything contained in the foregoing provisions of this section, where a partial partition has taken place after the 31st day of Dec., 1978 among the members of a Hindu undivided family hitherto assessed as undivided :-

(a) no claim that such partial partition has taken place shall be inquired into under sub-section (2) and no finding shall be recorded under sub-section (3) that such partial partition had taken place and any finding recorded under sub-section (3) to that effect whether before or after the 18th day of June, 1980 being the date of introduction of the Finance (No. 32) Bill 1980 shall be null and void;

(b) such family shall continue to be liable to be assessed under this Act as if no such partial partition had taken place;

(c) each member or group of members of such family immediately before such partial partition and the family shall be jointly and severally liable for any tax, penalty, interest, fine or other sum payable under this Act by the family in respect of any period whether before or after such partial partition;

(d) the several liability of any member or group of members aforesaid shall be computed according to the portion of the joint family property allotted to him or it at such partial partition;
and the provisions of this Act shall apply accordingly.

This sub-section (9) was not in existence at the relevant time and has no retrospective operation and it is of no material consequence in deciding the present case.

25. The aforesaid provisions of the Income Tax Act, as they stood at the material time, clearly recognise partial partition. The definition of partial partition in explanation (b) makes it clear that partial partition as regards the persons constituting the Hindu undivided family or as regards properties belonging to the Hindu undivided family, or both is recognised.

26. In the present case, the partial partition of the shares belonging to the Hindu undivided family cannot, therefore, be said to be bad either under the Hindu Law or under the Indian Income Tax Act. We must, therefore, hold that the High Court went wrong in deciding that partial partition of the joint family properties of the Hindu joint family by the father was invalid and could not be recognised under the Income Tax Act. The subsequent amendment of Section 171 by the inclusion of sub-section (9) does not require any consideration as the said sub-section was not in existence in the relevant assessment year and is only operative from 1st April, 1980.

27. The other question which falls for determination is whether the partition can be said to be bad as at the time of the partition there was no equal division of the shares by the father amongst himself and his minor sons and a part of the share holding had not been distributed to the father or to the father and mother jointly. We may point out that the A. A. C. has found that at the time of division of the shares, the shares had been distributed equally taking into consideration the shares which had earlier been distributed amongst the parties. In our opinion, a partial partition of any joint family property by the father between himself and his sons does not become invalid on the ground that there has been no equal distribution amongst the co-sharers. It is expected that the father who seeks to bring about a partial partition of joint family property will act bona fide in the interests of the joint family and its members, bearing in mind in particular the interests of the minor sons. If, however, any such partial partition causes any prejudice to any of the minor sons and if any minor son feels aggrieved by any such partial partition, he can always challenge the validity of such partial partition in an appropriate proceeding and the validity of such partial partition will necessarily have to be adjudicated upon in the proceeding on a proper consideration of all the facts and circumstances of the case. Till such partial partition has been held to be invalid by any competent Court, the partial partition must be held to be valid. It is not open to the Income-tax Authorities to consider a partial partition to be invalid on the ground that shares have not been equally divided and to refuse to recognise the same. It is undoubtedly open to the Income-tax Officer before recognising the partition to come to a conclusion on proper enquiry whether the partition is genuine or not. If the Income-tax Officer on enquiry comes to a finding that the partition is sham or fictitious, he will be perfectly within his right to refuse to recognise the same. In the instant case, there is no finding that the partial partition is sham or fictitious or that the partial partition is not a genuine one and has not been acted upon. As there is no finding that the partial partition is sham or fictitious or not a genuine one, on enquiries made by the Income-tax Officer, and as the partial partition is otherwise valid under the Hindu Law, the partial partition has necessarily to be recognised under the provisions of Section 171 of the Income Tax Act and the assessment must be necessarily made on the basis that there is partial partition of the said shares.

28. In the result, the appeal succeeds. The judgment and order of the High Court are hereby set aside. The partial partition is held to be valid and the Income-tax Officer is directed to recognise the same and to proceed to make the assessment on the basis that there has been a partial partition of the said shares between the parties. In the facts and circumstances of this case, we do not propose to make any order as to costs.

Appeal allowed.

Joint Family of Udayan Chinubhai v. Commissioner of Income- tax, Gujarat, (SC) 1967(1) SCR 913

SUPREME COURT OF INDIA

JUDGMENT

Shah, J. – Sir Chinubhai Madhavlal, Baronet, his wife Lady Tanumati and his three sons Udayan, Kirtidev and Achyut vere originally assessed to income-tax in the status of a Hindu undivided family by the First Income Tax Officer A-III Ward, Bombay. Sir Chinubhai filed suit No. 2176 of 1948 in the High Court of Judicature at Bombay for partition and separate possession of his share in the joint family estate. On March 8, 1950, the High Court of Bombay passed a decree by consent declaring that as from October 15, 1947 the joint family stood dissolved and that all the members of the family had become separate in food, worship and estate from that date and that each member of the family was entitled to a fifth share in the properties movable and immoveable belonging to the family subject to the right of maintenance in favour of the mother of Sir Chinubhai. In Schedule A Part I properties which were allotted to Sir Chinubhai were set out: In Parts II and III of Schedule A properties which there collectively allotted to the share of Udayan, Kirtidev, Achyut and Lady Tanumati were set out. It was declared by the decree that the properties moveable and immovable “described in Parts II and III of Schedule A shall absolutely belong to and vest in the four defendants’ the three sons and Lady Tanumati “in equal shares in full satisfactions of their respective rights in the joint family properties subject, as regards the properties described in Part II of Schedule A, to the provisions of the Baronetcy Act”. Schedules B. C and D set out the debts and liabilities of the joint family. Pursuant to the decree, Sir Chinubhai took his share in the properties allotted to him, separately. The other properties remained undivided between Udayan Kirtidev, Achyut and Lady Tanumati-each holding a fourth share as tenant-in-common, with the other co-sharers.

2. On December 3, 1952 Sir Chinubhai applied to the Income Tax Officer, A-III Ward, Bombay for an order recording the partitions and requesting that assessments be made of the members of the family separately in accordance with the provisions of Section 23 read with fit 25A of the Income Tax Act. The Income- tax Officer by order, dated January 6, 1953, granted the application. He observed that pursuant to the decree of the High Court for partition the properties of the “Hindu undivided family were distributed between two groups-one consisting of Sir Chinubhai and the other consisting of his wife and his three sons”, and since all the conditions of Section 25A of the Indian Income Tax Act had been satisfied, “from 8th March 1950 the Hindu undivided family is deemed to have been partitioned and assessment subsequent to that date will be made on the two groups separately”. The Income Tax Officer, Ahmedabad, thereafter assessed Lady Tanumati and the sons of Sir Chinubhai separately.

3. The Income Tax Officer, Ahmedabad, however, initiated proceedings under Section 34 of the Indian Income Tax Act, 1922, for the assessment years 1951-51, 1952-53 and 1953-54 for assessing the Hindu undivided family of the four members “Udayan, Kirtidev, Achyut and Lady Tanumati” – who will hereinafter collectively be called “the assessees” on the plea that the income of the family had escaped assessment. The assessees contended that they did not in the years of assessment referred to in the notice constitute a Hindu undivided family and the Income Tax Officer had no power, after the order passed on January 6, 1953, to assess them in the status of a Hindu undivided family. The Income Tax Officer rejected the contention.

4. In appeal to the Appellate Assistant Commissioner the order of assessment under Section 34 was set aside. The Appellate Assistant Commissioner held that the decree passed by the High Court of Bombay brought about a complete disruption and severance of the joint status of the original family, and merely because the assessees after severance had lived and traded together, they could not be assessed as a Hindu undivided family. He also held that after an order under Section 25A was passed by one Income Tax Officer, another Income Tax Officer had no power to modify it or to circumvent the same by seeking to assess the assessees as a Hindu undivided family.

5. In appeal by the Income Tax Officer, Ahmedabad, the Appellate Tribunal restored the order passed by the Income Tax Officer. In the view of the Tribunal, by the decree of the High Court there was severance of the joint status between the members of the joint Hindu family, but the partition was partial, and “it did not follow that as regards the remaining persons or the remaining properties which had not gone out of the fold of the Hindu undivided family the assessment in respect thereof could not be made in the status of a Hindu undivided family”. The Tribunal rejected the view that once an order under Section 25A(1) is passed, the Income-l-ax Officer is for ever precluded from making assessment in the status of a Hindu undivided family. The Tribunal thereafter referred at the instance of the assessees the following question for the opinion of the High Court of Gujarat :

“Whether on the facts and in the circumstances of the case, the assessments made on the assessee as on a Hindu undivided family consisting of the three sons of Sir Chinubhai Madhavlal, viz., “Udayan, Kirtidev and Achyut and the wife of Sir Chinubhai Madhavlal, viz., Lady Tanumati, were correctly so made?”
The High Court answered the question in the affirmative. Against that orders these appeals have been preferred by the assessees.

6. An application under sub-section (1) of Section 25A of the Income Tax Act, 1922, by a Hindu undivided family or any member thereof that a partition has taken place among the members of the family, invests the Income Tax Officer with authority to make an order recording that the joint family property has been partitioned, if he is satisfied on inquiry that the property of the family has been partitioned among the various members or groups of members “in definite portions”. The jurisdiction may be exercised by the Income Tax Officer, even if there be partition between groups of members of the family. A complete partition in definite portions among all the members of the family is not a condition of the exercise of that jurisdiction . We do not agree with the plea raised by counsel for the Department that by the expression :”group of members” it is intended to refer to a group consisting of a head of a branch and his sons who remain undivided. Section 25A(1) applies to families governed by the Dayabhaga School of Hindu Law as well as the Mitakshara school of law : and if the interpretation suggested by counsel for the Revenue be correct, the expression “group of members” will be meaningless in relation to a Hindu family governed by the Dayabhaga school of Hindu law.

7. But an order recording partition can be made only if the properties of the joint family are partitioned in “definite portions”‘ that is , the properties are physically divided if they admit of such division, otherwise in such division as they admit of. In Gordhandas T. Mangaldas v. Commissioner of Income Tax Bombay , 1943-11 ITR 183 the High Court of Bombay held that Section 25A contemplates a physical division of the joint family property: a mere division of interest in such property is not enough. Beaumont, C.J., in delivering the judgement of the Court observed at p. 195:

“I think that the expression “definite portions” indicates a physical division in which a member takes a particular house in which he can go and live , or a piece of land which he can cultivate, or which he can sell or mortgage, or takes particular ornaments which he can we or dispose of, and that expression “definite portions” is not appropriate to describe an undivided share in property where all a particular member can claim is a proportion of the income, and a division of the corpus, but where he cannot claim any definite portion of the property. * * * No doubt the expression “division in definite portions” will have to be construed with regard to the nature of the property concerned. A business cannot be divided into parts in the same manner as a piece of land; division may only be possible in the books, special cases will have to be dealt with by the Income Tax Officer when they arise. If he comes to the conclusion, that having regard to the nature of the property, what has been done amounts to a division in definite portions, he will record his finding under sub-section (1) ; if he comes to the conclusion that it does not , then he will have to go on assessing the family under sub-section (3)”.
8. There is no doubt that Sir Chinubhai took possession of his share in the family estate which was allotted to him. Between Sir Chinubhai and the assessee there was therefore partition of the joint family property in definite portions. The shares allotted to the assessees were however not divided in definite portions inter se. It is true that Part II of Schedule A of the decree described the settled properties under the Baronetcy Act 8 of 1924 and those properties were not capable of physical division. However Part III described properties movable and immovable which were not subject to any such statutory restrictions and those properties were not divided among the assessees. But the assessees constituted a group and between them and Sir Chinubhai there had been partition in definite portions- the portion of the property allotted to Sir Chinubhai being completely separated from the property allotted to the assessees.

9. Under the decree of the High Court of Bombay the assessees did not continue to remain members of an undivided Hindu family. It was expressly provided by the decree that the assessees were divided inter se and held the property allotted to them as tenants-in common. The effect of the order recording a partition was to recognise for purposes of income-tax administration that the joint family status was severed, and the property was divided in definite portions between groups of members of the family. After the order was recorded the original Hindu undivided family had no existence in fact or in point of law- personal or income-tax. Section 25-A(3) on which strong reliance was placed by counsel for the Revenue only requires the Income Tax Officer to continue to assess a Hindu undivided family which has been divided under the personal law so long as no order under Section 25-a (1) has been recorded. Once an order under Section 25-A has no application . If the members of the family who constituted a group between whom and the other group there has been partition in definite portions constitute a Hindu undivided family, that group may undoubtedly be assessed as a Hindu undivided family; they may be so assessed because of their relation inter se and not by virtue of Section 25- A(3).

10. The order passed by the Income Tax Officer ,Bombay, was apparently a valid order which he was competent to make . When as a result of that order , the property of the family was deemed for purposes of the Income Tax Act partitioned, it was not open to the Income Tax Officer, Ahmedabad, to ignore the order either for the year in which the partition of the joint family property was recorded, of for any subsequent year, and to assess the income in the hands of the assessees as if the original Hindu undivided family continued to exist. An order assessing the assessees as members of a Hindu undivided family could be made after an order under Section 25-A had been recorded, only it was proved that under the personal law they formed a joint Hindu family, and of that there was no evidence.

11. The contention raised on behalf of the Department which appealed to the Income Tax Officer and the Tribunal that the original Hindu undivided family of Sir Chinubhai Madhavlal continued to exist, notwithstanding the order of partition recorded under Section 25-A (1), in our judgment, cannot be sustained. When the Income Tax Officer, Bombay recorded an order that the property had been partitioned in definite portions, the family ceased to exist. It is true that among the assessees the property had not been divided by metes and bounds, but they could still not be assessed as members of a Hindu undivided family because such a relation did not exist between them after severance of the joint family status of the family in which Sir Chinubhai was the karta. The Income Tax Officer, Ahmedabad, in substance sought to revise the previous order passed by the Income Tax Officer, Bombay, recording partition under Section 25-A, and to revive the original family so as to make the income of the assessees as well as of Sir Chinubhai liable to be assessed as if no partition had taken place and no partition of the joint family properties had been recorded under the Income Tax Act. That, the Income Tax Officer was plainly incompetent to do.

12. Counsel for the Revenue sought to support the order passed by the Income Tax Officer, Ahmedabad, and confirmed by the Tribunal, on the ground that it was open to the Income Tax Officer, notwithstanding the order passed under Section 25-A (1) in a previous year to ignore that order in proceedings for assessment relating to a subsequent year, and to hold that there was no severance in fact between the members of the family and to assess them as a Hindu undivided family. as if no partition had taken place. It was said that each assessment year is a self-contained unit and whatever view may have been taken in proceeding for assessment of an earlier year, it is open to the Income Tax Officer to arrive at an independent conclusion contrary to that decision in respect of another year, if the circumstances of the case so warrant. It is true that an assessment year under the Income Tax Act is a self-contained assessment period and a decision in the assessment year does not ordinarily operate as res judicata in respect of the matter decided in any subsequent year, for the assessing officer is not a Court and he is not precluded from arriving at a conclusion inconsistent with his conclusion in another year. It is open to the Income Tax Officer, therefore, to depart from his decision in subsequent years, since the assessment is final and conclusive between the parties only in relation to the assessment for the particular year for which it is made. A decision reached in one year would be a cogent factor in the determination of a similar question in a following year, but ordinarily there is no bar against the investigation by the Income Tax Officer of the same facts on which a decision in respect of an earlier year was arrived at. But this rule, in our judgment, does not apply in dealing with an order under Section 25-A (1). Income from property of a Hindu undivided family “hitherto” assessed as undivided may be assessed separately if an order under Section 25-A (1) had been passed. When such an order is made, the family ceases to be assessed as a Hindu undivided family. Thereafter that family cannot be assessed in the status of a Hindu undivided family unless the order is set aside by a competent authority. Under Clause (3) of Section 25-A if no order has been made notwithstanding the severance of the joint family status, the family continue to he liable. to be assessed in the status of a Hindu undivided family, but once an order has been passed, the recognition of severance is granted by the Income Tax Department, and Clause (3) of Section 25-A will have no application.

13. In Commissioner of Income Tax, Delhi and Rajasthan v. Ganeshi Lal Sham Lal, 1960-61 ITR 408 (Punj), the High Court of Punjab held that when an order recognising the total disruption of a Hindu family has been passed under Section 25-A of the Indian Income Tax Act, 1922, and an order of assessment is made on the basis of such an order, it is not open to the Income Tax Officer to take proceedings for reassessment under Section 34 of the Act ignoring the earlier order under Section 25-A of the Act on the ground that he has received information that the order under Section 25-A was obtained by mis-representation. The proper course for the Income Tax Officer to adopt in such a case is to move the Commissioner of Income Tax to take action under Section 33-B of the Act to set aside the order under Section 25-A.

14. We agree with the High Court of Punjab that Section 34 of the Indian Income Tax Act confers no general power of reviewing an order passed under Section 25-A (1) which, is in its very nature effective for all subsequent years.

15. The answer to the question referred will be in the negative. The appellants will be entitled to their costs in this Court as well as in the High Court. One hearing.

Appeals allowed.

Chandrakant Manilal Shah v. Commissioner of Income-tax, Bombay, (SC) 1991(100) CurTR 91

SUPREME COURT OF INDIA

JUDGMENT

N.D. Ojha, J. – This appeal by special leave has been preferred against thejudgment dated 22nd July, 1975 of the Bombay High Court in I.T. Ref. No. 95 of 1965 made under Section 66(1) of the lodian Income Tax Act, 1922. The assessment year under reference was 1961-62.

2. Chandrakant Manilal Shah was the Karta of a Hindu undivided family (HUF) and the family was carrying on business of cloth. Naresh Chandrakant, one of the sons of Chandrakant Manilal Shah, joined the business on a monthly salary of Rs. 100/- since about April, 1959. It was asserted that with effect from I st November, 1959 the business had been converted into a partnership between Chandrakant Manilal Shah as Karta of HUF and Naresh Chandrakant. The deed of partnership executed in this behalf of 12th November, 1959 indicated that Naresh Chandrakant had been admitted as a working partner with effect from I st November, 1959 having 35 per cent share in the profits and losses of the firm and the remaining 65 per cent share was held by Chandrakant Manilal as the Karta of the HUF. An application was made for registration of the firm which was dismissed by the Income-tax Officer on the ground that there was no valid partnership. The view taken bv the Income-tax Officer-was upheld in appeal by the Appellate Assistant Commissioner. On further appeal, the Income-tax Appellate Tribunal also came to the same conclusion that there was no valid partnership and the business consequently must be taken to continue in the hands of the joint family. However, at the instance of the assessee the following question was referred by the Tribunal to the High Court for its opinion.

3. Whether on the facts and in the circumstances of the case, there was a valid partnership under Annexure ‘A’ between Shri Chandrakant, as the Karta of the HUF and Shri Naresh, a member of the family ?

4. The High Court by the judgment under appeal answered the aforesaid question in the negative, in favour of the Revenue and against the assessee. In doing so, it relied on an earlier decision of that Court in Shah Prabhudas Gulabchand v. Commissioner of Income-tax, Bombay, (1970) 77 ITR 870 . It is against this judgment that, the assessee has come up in appeal to this Court.

5. It has been urged by the learned counsel for the appellants that the mere fact that Naresh Chandrakant had neither separated from the HUF nor brought in any cash asset as his capital contribution to the partnership but was contributing only his skill and labour, could not in law detract from a valid partnership being created. Learned counsel for the respondent, on the other hand, contended that the view taken in this behalf by the Tribunal and the High Court was correct and was not only supported by the decision relied on by the High Court referred to above but also by another decision of the Gujarat High Court in Pitamberdas Bhikhabhai and Co. v. Commissioner of Income-tax, Gujarat, (1964) 53 ITR 341.

6. Having heard learned counsel for the parties, we are inclined to agree with the submission made by learned counsel for the appellants. In our view, this contention derives full support from the view of the Judicial Committee of the Privy Council in Lachhman Das v. Commissioner of Income-tax, Punjab, (1948) 16 ITR 35. There the question which fell for consideration was .-

“Whether in the circumstances of this case, there could be a valid partnership between Lachhman Das as representing a Hindu undivided family on the one hand and Daulat Ram, a member of that undivided Hindu family in his individual capacity, on the other ?”
7. In other words, the question was the same as the one arising in the present case but for the difference in the factual background that, whereas in the case before the Judicial Committee the member had brought in his separate capital, the member in the present case claims only to be a working partner. Does this difference in facts make a difference in principle ? That is the question..

8. In Lachhman Das AIR 1948 PC 8, it had been urged before the High Court for the assessee that, when a Karta of a HUF could enter into a partnership with a stranger as held by the Privy Council in P.K.P.S. Plchappa Chettlar v. Chockalingam Pillai, AIR 1934 PC 192, there was no reason why a copareener also could not enter into such a partnership by making contributions in his individual capacity from his separate funds. This plea was repelled bv the High Court on the ground that a coparcener could not be regarded as a stranger so long as he continued his connection with his undivided family in the capacity as a coparcener. While reversing the judgment of the High Court, it was held by the Privy Council (paras 16 and 17 of AIR)..-

“After careful consideration, their Lordships cannot accept this view and on general principles they cannot find any sound reason to distinguish the case of a stranger from that of a coparcener who puts into the partnership what is admitedly his separate property held in his individual capacity and unconnected with the family funds. Whatever the view of a Hindu joint family and its property might have been at the early stages of its development, their Lordships think that it is now firmly established that an individul coparcener, while remaining joint, can possess, enjoy and utilise, in any way he likes,property which was his individual property, not acquired with the aid of or with any detriment to the joint family property. It follows from this that, to be able to utilise this property at his will, he must be accorded the freedom to enter into contractual relations with others, including his family, so long as it is represented in such transactions by a definite personality like its manager. In such a case he retains his share and interests in the property of the family, while he simultaneously enjoys the benefit of his separate property and the fruits of its investment. To be able to do this, it is not necessary for him to separate himself from his family. This must be dependent on other considerations, and the result of a separate act evincing a clear intention to break away from the family. The error of the Income-tax Officer lay in his view that, before such a contractual relationship can validly come into existence, the “natural family relationship must be brought to an end”. This erroneous view appears to have coloured this and the subsequent decisions of the Income-tax authorities. In this view of the Hindu Law,it is clear that if a stranger can enter into partnership, with reference to his own property, with a joint Hindu family through its karta, there is no sound reason in their Lordships’view to withhold such opportunity from a copareener in respect of his separate and individual property.”
9. The aforesaid view of the Privy Council was approved by this Court in Firm Bhagat Ram Mohanlal v. Commr. of Excess Profits Tax, Nagpur, (1956) 29 ITR 521, but on the facts of that case it was held that the partnership set up in that case was not valid.

10. The above principle has been applied by several High Courts to uphold the validity of a partnership between the Karta of HUF and an individual member of the family where the latter is taken in as a working partner. In I.P. Munavalli v. Commissioner of Income-tax, Mysore, (1969) 74 ITR 529, it was held by the Mysore High Court, after referring to the decision of the Privy Council in the case of Lacchmandas, (supra) and of this Court in the case of Bhagat Ram, (supra) :-

“So it is clear that the Supreme Court did not dissent from the opinion expressed by the Privy Council that “in respect of their separate or divided property” the coparceners of a Hindujoint family, even though they had not become divided from one another and there had been no partition of the family properties, could become partners of a firm of which the Joint Hindu family represented by its karta is itself a partner.

If a partner by putting into the partnership by way of his capital his separate property or the property which he obtained at a partition on division and thus can become a partner with the family represented by its karta, it is difficult to understand how such a partnership cannot come into being and why a coparcener who continues to remain a member of the coparcenary cannot become a working partner of a firm of which he and the family represented by its karta are the partners. In Lachhman Das’s case the coparcener placed at the disposal of the firm as his capital his separate property, and in the case of a working partner he contributes his skill or labour or both as the case may be. If the partnership is permissible in one case, it would be difficult to assign any reason for reaching the conclusion that it is not permissible in the other.”
11. In Ramchand Nawalrai v. Commissioner of Income-tax, M.P., (1981) 130 ITR 826 : (1981Tax LR 448), it was held by the Madhya Pradesh High Court as hereunder (at pp. 45253 of Tax. L.R.) :-

“It will be clear from the facts of the case of Firm Bhagat Ram Mohanlal (1956) 29 ITR 521, that the question whether a coparcener can enter into a valid partnership with the karta of his family by contributing merely skill and labour did not arise for decision. The only question in the case was whether the individual members of a HUF can, without contributing anything, become members of a partnership constituted between, the karta and strangers. This question had necessarily to be answered in the negative on the settled view that when a karta enters into a partnership with strangers it is the karta alone who becomes the partner. The observations of the Supreme Court that (p. 526) (of ITR) : “If members of a coparcenary are to be regarded as having become partners in a firm with strangers, they would also become under the partnership law partners, inter se, and it would cut at the very root of the notion of a joint undivided family to hold that with reference to coparcenary properties the members can at the same time be both coparceners and partners”, as contained in the passage quoted above, must be limited to the facts on which Firm Bhagat Ram Mohanlal’s case, (1956) 29 ITR 521, was decided. The Supreme Court in the same passage referred to the decision of the Privy Council in Lachhmandas’case, and did not disapprove of it. If a coparcener by contributing his separate property can enter into a valid partnership with the karta of his family, as held by the Privy Council in Lachhmandas’ case, there seems no valid reason why a coparcener cannot, by contributing merely his skill and labour, enter into a partnership with the karta. If the former does not cut at the root of the notion of the joint Hindu family, the latter also does not. Even in the case of the former, the partnership property will consist of the contribution made by the karta from the coparcenary property and the contribution made by the coparcener of his individual property. Both taken together would become partnership property in which all the parwers would have interest in proportion to their share in the joint venture of the business of partnership (Narayanappa v. Bhaskara Krishnappa, AIR 1966 Supreme Court 1300, 1304 (para 5). If in such a situation the coparcener entering into the partnership can be a partner in relation to coparcenary property contributed for the partnership business, there can be no difficulty in holding that the same result would follow when the coparcener entering into a partnership only contributes his skill and labour. In the former case, as stated by the Privy Council in Lachhman Das’case (1948) 16 ITR 35 : AIR 1948 PC 8, the copareener entering into the partnership, retains his share and interest in the family property while simultaneously enjoying the benefit of his separate property and the fruits of its investment. In the same way, it can be said that in the latter case the coparcener retains his share and interest in the property of the family while simultaneously enjoying the benefits of his skill and labour which he contributes as consideration for formation of the partnership and for sharing profits.

Learned standing counsel for the department further submitted that as the profits earned by a partnership in which the contribution of capital is only of joint family funds from the side of the karta would enure to the benefit of the entire joint family being earned with the help of the joint family funds, a coparcener who only contributes his skill and labour for becoming a partner cannot claim any share in the profits as his separate property and, therefore, there cannot be any valid partnership. Learned counsel in this connection relied upon the case of V.D. Dhanwatey v. Commissioner Income Tax, (1968) 68 ITR 365. Dhanwatey’s case has to be read along with the case of Commissioner Income Tax v. D.C. Shah, (1969) 73 ITR 692. In Dhanwatey’s case, a karta of a HUF who entered into a partnership was paid a salary from the partnership and it was held that the salary income was the income of the HUF. The basis of the decision was that the salary was paid because of the investments of the assets of the family in the partnership business and there was a real and sufficient connection between the investments from the joint family funds and the remuneration paid to the karta. In Shah’s case, also the karta entered into a partnership and was paid remuneration. But as the remuneration was paid for the specific acts of management done by the karta resting on his personal qualification and not because he represented the HUF, it was held that the remuneration was his individual income. Applying the same principle, if a coparc’ener becomes a working partner in a partnership with the karta and gets a share in profits in consideration of the skill and labour contributed by him, his share in the profits would be his separate property for the profits coming to his share would be directly related to his skill and labour and not to the investments of the joint family funds in the business. The question, however, whether a coparcener entering into a partnership with the karta does really contribute any labour or skill for the management of the partnership business in which he is given a share in profits is a question of fact which will have to be determined in the light of the circumstances of each case. In case it is found that there is no real contribution of skill or labour by the coparcener for sharing the profits, the partnership will be held to be unreal and fictitious but that is an entirely different thing from saying that there cannot at all be a valid partnership between the karta and a coparcener when the latter only contributes his skill and labour and is merely a working partner. In our opinion, the argument that as the capital investment in the partnership is only of the funds of the undivided family, there cannot be any partnership, cannot be accepted.

The conclusion reached by us is fully supported by a decision of the Mysore High Court in I.P. Munavalli v. Commissioner Income Tax, (1969) 74 ITR 529, with which we respectfully agree. The Bombay High Court in Shah Prabhudas Gulabchand v. Commissioner Income Tax, (1970) 77 ITR 870 , took a contrary view. With great respect and for the reasons given above, we are unable to agree with it”.
12. In Commissioner of Income-tax, Lucknow V. Gupta Brothers, (1981) 131 ITR 492 : (1980 Tax LR 1491 the Allahabad High Court took the same view when it said :-

“The observations of the Privy Council that a partnership can be formed with a junior member by the karta qua his separate property is by way of illustration of a particular eventuality when the separate property constitutes consideration for the induction of a junior member into the partnership. It cannot be read as being exhaustive of cases where consideration may take other forms. Now, as labour and skill would also be consideration as contemplated by the Contract Act, a valid partnership had come into existence, which ought to have been registered.”
13. Learned counsel for the respondent has laid considerable emphasis on two points. Firstly, it was urged that Hindu Law does not recognise any contract among the coparceners inter se except in two cases, namely, where there is a partial partition and where a coparcener has separate property and brings in such separate property as capital towards consideration for becoming a partner. While elaborating the first point, it has been urged that if, even in a case where there is neither partial partition nor any separate property is brought in by the coparcener as consideration for the partnership it is held that a valid partnership can still come into existence, it would create an anomalous situation inasmuch as such coparcener would be having an interest in the coparcenary property both as a coparcener and partner. Reliance in this behalf has been placed on the following observations made in the case of Bhagat Ram Mohanlal, (supra) :

“If members of a coparcenary are to be regarded as having become partners in a firm with strangers, they would also become under the partnership law partners, inter se, and it would cut at the very root of the notion of a joint undivided family to hold that with reference to coparcenary properties the mernhers can at the same time be both coparceners and partners.”
14. The second point emphasised by learned counsel for the respondent is that skill and labour cannot be treated as property.

15. It must be confessed that the observations made in the case of Bhagat Ram Mohanlal, (supra) relied upon do appear to support the contention of the Revenue. In the case of Firm Bhagat Ram Mohan Lal v. CEPT, (1956) 29 ITR 521, a partnership had been entered into in 1940 between Mohan Lal (M) and two outsiders (R and G), M admittedly representing a HUF consisting of himself and his two brothers Chotelal (C) and Bansilal (B). In 1944, the HUF got divided and, consequently, the firm was reconstituted with five partners viz. the two outsiders (R and G), M, C and B. This, according to the Revenue, had resulted in a “change in the persons carrying on the business” leading to certain consequences adverse to the assessee in the context of the Excess Profits Tax Act. The firm attempted to get over the difficulty in two ways :

(a) It was contended that, even initially, in 1940, the firm must be considered as having been constituted with all the five persons, R, G, M, C and B, as partners; in other words when M entered into the partnership on behalf of the HUF, the consequence was that not only he but his two undivided brothers B and C also became partners in the firm in their individual capacity; and

(b) It was suggested that when M entered into the partnership agreement in 1940, all the three coparceners M, C and B. could be regarded as having entered into the contract as kartas of (i.e. representing) the HUF.
16. Both these contentions were negatived. So far as the first contention was concerned, the Court observed that it could be disposed of as being an afterthought opposed to the factual findings in the case. However, the Court proceeded to observe that it was difficult to visualise a situation, which the appellants contended for, of a HUF entering into a partnership with strangers through its karta and the junior members of the family also becoming its partners in their personal capacity. After referring to Lachchman Das, (supra) and Sunder Singh Majlthia v. Commissioner Income Tax, (1942) 10 ITR 457 where divided members of a family were held competent to carry on the erstwhile joint family business in partnership, the Court pointed out :

“But in the present case, the basis of the partnership agreement of 1940 is that the family was joint and that Mohanlal was its karta and that he entered into the partnership as karta on behalf of the joint family. It is difficult to reconcile this position with that of Chotelal and Bansilal being also partners in the firm in their individual capacity, which can only be in respect of their separate or divided property”.

(Emphasis supplied.)

17. This was followed by the observations on which Sri Manchanda, learned counsel for the Revenue has placed considerable reliance. Similarly, so far as contention (b) was concerned, the Court observed that “even if such a contention could be raised consistently with the principles of Hindu Law”, it was in the teeth of the pleadings in the case and so could not be allowed to be raised. These passages no doubt suggest that, in the Court’s view, an undivided member of a HUF cannot be a partner along with the karta of the family, except where he furnishes capital in the form of property belonging to him in his individual right or obtained by him on a partition of the family and that the Court left open the question whether more than one member of a HUF can represent the family in a partnership with outsiders.

18. It will be apparent that this Court had rejected both contentions of the assessee as being an afterthought or contrary to the factual findings in the case. This was sufficient to dispose of the case. However, the further expressions of opinion, coming from such an eminent Judge as Venkatarama Ayyar, J., are entitled to the greatest weight and respect. We, however, think that the scope of these observations, made in the context of the special facts and circumstances of the case, has been magnified by the learned counsel for the Revenue. We may observe, at the outset that his basic postulate that, under the Hindu Law, there can be no contract inter se between the undivided members of the family is basically incorrect. This Court has recognised the validity of such contract in various situations. For instance, an undivided member of a HUF (including its karta) can be employed by the HUF for looking after the family business and paid a remuneration therefor : vide, Jitmal Bhuramal v. Commissioner Income Tax, (1962) 44 ITR 887 (SC) and Jugal Kishore Baldeo Sahai v. Commissioner Income Tax, (1967) 63 ITR 238. Again on the second contention which was left open, subsequent decisions of this Court have held that it is open to more than one member of a HUF to represent the family in partnership with strangers. In Commissioner of Income-tax V. Sir Hukumchand Mannalal and Co., (1970) 78 ITR 18 , it was held by this Court :

“The Indian Contract Act imposes no disability upon members of a Hindu undivided family in the matter of entering into a contract inter se or with a stranger. A member of a Hindu undivided family has the same liberty of contract as any other individual : it is restricted only in the manner and to the extent provided by the Indian Contract Act. Partnership is under Section 4 of the Partnership Act the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all : if such a relation exists, it will not be invalid merely because two or more of the persons who have so agreed are members of a Hindu undivided family.”
19. This position has also been recognised in Ratanchand Darbarilal v. Commissioner of Income-tax, (1985) 155 ITR 720 . In that case, there were two firms, one at Katni and one at Satna, constituted by two members of an undivided family with others. The question posed however was whether the Satna firm could be treated as an independent unit of assessment. This Court held that it was a question of fact on which the Tribunal’s findings were conclusive. In this view, it left unanswered, as academic, the following question on which the Commissioner had sought a reference :

“Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in directing that the firm owning the Satna business should be registered in spite of the fact that the members of the two HUFs entered as partners inter se without their effecting in the first instance a severance of joint status by partitioning either partially or totally, the assets of the respective HUFS ?”
However, in the course of its judgment, the Court observed :

“The High Court obviously fell into an error in proceeding on the footing that, without a partition or a partial partition, one of the members belonging to the Hindu undivided family could not constitute themselves into a partnership firm. We do not think this view is correct in law. It is a well settled proposition applicable to Hindu Law that members of the joint family and even copareeners can, without disturbing the status of a joint family or the coparcenary, acquire separate property or run independent business for themselves.”
20. Turning now to the specific obserations on which reliance has been placed, we do not think that they should be read as permitting a partnership between the karta of a HUF and its individual member only when he brings in some capital but not otherwise. In tne context in which they were made, it is seen that they were only limited to point out that there was no claim before the Court, as in Lachchmandas or Majithia that the other member had brought in any separate or divided property as capital. On the contrary, the claim was that the coparceners of the HUF other than the karta, who was the eo nominee partner, should be regarded as partners, though they had not entered into any such agreement and had placed neither capital nor services at the disposal of the firm. It was this claim that was held untenable. Much more significance cannot be read into these observations for, if construed too strictly and in the manner suggested, they will militate against the possibility of a valid partnership being formed in two classes of cases about which there can be no doubt. The first is where an undivided member seeks to become a partner by furnishing capital which has been held permissible in Lachmandas, AIR 1948 PC 8 and approved in Firm Bhagat Ram Mohanlal, AIR 1956 Supreme Court 374 itself. The other is the case of a partnership firm on which more than one partner represents a HUF, the validity of which has been upheld in the cases referred to earlier. The observations cannot, therefore, be read as precluding altogether a claim by an undivided member of a HUF that he has in fact agreed to become a partner along with the karta for genuine and valid reasons. In our view, the Allahabad, Madhya Pradesh and Mysore decisions rightly held that the observations in Firm Bhagat Ram Mohanlal do not militate against the formation of a valid partnership in such cases.

21. This takes us on to the second point made by Sri Manchanda that, though an undivided member can, by contributing separate capital, enter into a partnership with the karta qua the family business, he cannot do so by offering as his contribution to the firm not material capital but only his labour and skill. With regard to this submission made by the learned counsel for the respondent that skill and labour cannot be equated with property, it may not be out of place to refer to some earlier history. As has been stated in Mulla’s Hindu Law, before the commencement of the Hindu Gains of Learning Act, 1930 (hereinafter referred to as the ‘Act’) it was settled law that income earned by a member of ajoint family by the practice of a profession or occupation requiring special training was joint family property if such training was imparted at the expense of joint family property. This being so, if such a member of a joint family were to enter into a partnership with the karta of the family to carry on business, the fruits even of his skill and labour would have been property of the joint family and the very purpose of entering into a partnership namely having a share of his own in the profits of the business would have been defeated. In this state of law if an agreement was reached between such member of the joint family and the karta that out of the profits of the business a defined share will be payable to and be the separate property of such member, the agreement would have been illegal. Indeed such a member would have been getting a separate share in the profits of the business without making any contribution of his own.

22. However, an almost complete transformation in the legal position was brought about by the Act. Sections 2 and 3 of the Act which are relevant in this behalf read as hereunder :

“2. In this Act, unless there is anything repugnant in the subject or context,-

(a) “acquirer” means a member of a Hindu undivided family, who acquires gains of learning;

(b) “gains of learning” means all acquisitions of property made substantially by means of learning, whether such acquisitions be made before or after the commencement of this Act and whether such acquisitions be the ordinary or the extraordinary result of such learning; and

(c) “learning” means education, whether elementary, technical, scientific, special or general, and training of every kind which is usually intended to enable a person to pursue any trade, industry, profession or avocation in life.

3. Notwithstanding any custom, rule or interpretation of the Hindu law, no gains of learning shall be held not to be the exclusive and separate property of the acquirer merely by reason of-

(a) his learning having been, in whole or in part imparted to him by any member living or deceased, of his family, or with the aid of the joint funds of his family or with the aid of the funds of any member thereof, or

(b) himself or his family having, while he was acquiring his learning, been maintained or supported, wholly or in part, by the joint funds of his family, or by the funds of any member thereof.”
23. As seen above, the definition of the term “learning” is very wide and almost encompasses within its sweep every acquired capacity which enables the acquirer of the capacity “to pursue any trade, industry, profession or avocation in life”. The dictionary meaning of “skill”, inter alia, is : “the familiar knowledge of any science, art, or handicraft, as shown by dexterity in execution or performance; technical ability” and the meaning of “labour” inter alia is : “physical or mental exertion, particularly for some useful or desired end.” Whether or not skill and labour would squarely fall within the traditional jurisprudential connotation of property e.g. jura in re propria, jura in re aliena, corporeal and incorporeal etc. may be a moot point but it cannot be denied that skill and labour involve as well as generate mental and physical capacity. This capacity is in its very nature an individual achievement and normally varies from individual to individual. It is by utilisation of this capacity that an object or goal is achieved by the person possessing the capacity. Achievement of an object or goal is a benefit. This benefit accrues in favour of the individual possessing and utilising the capacity. Such individual may, for consideration, utilise the capacity possessed by him even for the benefit of some other individual. The nature of consideration will depend on the nature of the contract between the two individuals. As is well known, the aim of business is earning of profit. When an individual contributes cash asset to become partner of a partnership firm in consideration of a share in the profits of the firm, such contribution helps and at any rate is calculated to help the achievement of the purpose of the firm namely to earn profit. The same purpose is undoubtedly achieved also when an individual in place of cash asset contributes his skill and labour in consideration of a share in the profits of the firm. Just like a cash asset, the mental and physical capacity generated by the skill and labour of an individual is possessed by or is a possession of such individual. Indeed, skill and labour are by themselves possessions. “Any possession” is one of the dictionary meanings of the word ‘property’. In its wider connotation, therefore, the mental and physical capacity generated by skill and labour of an individual and indeed the skill and labour by themselves would be the properties of the individual possessing them. They are certainly assets of that individual and there seems to be no reason why they cannot be contributed as a consideration for earning profit in the business of a partnership firm. They certainly are not the properties of the HUF but are the separate properties of the individual concerned.

24. To hold to the contrary, we may observe, would also be incompatible with the practical, economic and social realities of present day living. We no longer live in an age when every member of a HUF considered it his duty to place his personal skill and labour at the services of the family with no quid pro quo except the right to share ultimately, on a partition, in its general prosperity. Today, where an undivided member of a family qualifies in technical fields – may be at the expense of the family he is free to employ his technical expertise elsewhere and the earnings will be his absolute property; he will, therefore, not agree to utilise them in the family business, unless the latter is agreeable to remunerate him therefor immediately in the form of a salary or share of profits. Suppose a family is running a business in the manufacture of cloth and one of its members becomes a textile expert, there is nothing wrong in the family remunerating him by a share of profits for his expert services over and above his general share in the family properties. Likewise, a HUF may start running a diagnostic laboratory or a nursing home banking on the services of its undivided members who may have qualified as nurses and doctors and promising them a share of profits of the ‘business’ by way of remuneration. This will, of course, have to be the subject matter of an agreement between them but, where there is such an agreement, it cannot be characterised as invalid. It is certainly illogical to hold that an undivided member of the family can qualify for a share of profits in the family business by offering moneys – either his own or those derived by way of partition from the family – but not when he offers to be a working partner contributing labour and services or much more valuable expertise, skill and knowledge for making the family business more prosperous.

25. For the reasons discussed above, we have reached the conclusion that the decisions referred to above which support the contentions of learned counsel for the appellants lay down the correct legal position. The two decisions relied on by the learned counsel for the respondent in the cases of Pitamberdas Bhikhabhai and Co., (1964 (53) ITR 341) and Shah Prabhudas Gulabchand, (1971 Tax LR 1400) of the Gujarat and Bombay High Courts respectively turned on their particular facts and, if read as laying down a contrary rule, do not lay down good law. In this view of the matter, it cannot be said that when a coparcener enters into a partnership with the karta of a HUE and contributes only his skill and labour, no contribution of any separate asset belonging to such partner is made to meet the requirement of a valid partnership. Reverting to the facts of the instant case it is noteworthy that it is not the case of the Revenue that the partnership between Chandrakant Manilal Shah as karta of HUE and Naresh Chandrakant was fictitious or invalid on any other ground. Consequently, the judgment of the High Court cannot be sustained.

26. In view of the foregoing discussion, this appeal succeeds and is allowed. The judgment of the High Court is set aside and the question referred to the High Court is answered in the affirmative in favour of the assessee and against the Revenue. In the circumstances of the case, however, there shall be no order as to costs.

Appeal allowed.

GVK Industries Ltd. v. The Income Tax Officer (S.C.) 2015(371) ITR 453

NON RESIDENT COMPANY – NRC

SUPREME COURT OF INDIA

JUDGMENT
Dipak Misra, J. – The appellant No. 1 is a company incorporated under the Companies Act, 1956 for the purpose of setting up a 235 MW Gas based power project at Jegurupadu, Rajahmundry, Andhra Pradesh at an estimated cost of L 839 crores and the appellant No. 2 is a director of the company. The main object of the appellant company is to generate and sell electricity.

2. With the intention to utilise the expert services of qualified and experienced professionals who could prepare a scheme for raising the required finance and tie up the required loan, it sought services of a consultant and eventually entered into an agreement with ABB – Projects & Trade Finance International Ltd., Zurich, Switzerland, (hereinafter referred to as “Non-Resident Company/NRC”). The NRC, having regard to the requirements of the appellant-company offered its services as financial advisor to its project from July 08, 1993. Those services included, inter alia, financial structure and security package to be offered to the lender, making an assessment of export credit agencies world-wide and obtaining commercial bank support on the most competitive terms, assisting the appellant loan negotiations and documentation with lenders and structuring, negotiating and closing the financing for the project in a coordinated and expeditious manner. For its services the NRC was to be paid, what is termed as, “success fee” at the rate of 0.75% of the total debt financing. The said proposal was placed before the Board meeting of the company on August 21, 1993 and the Board of Directors approved the appointment of the NRC and advised that it be involved in the proposed public issue of share by the company. The NRC rendered professional services from Zurich by correspondence as to how to execute the documents for sanction of loan by the financial institutions within and outside the country. With advice of NRC the appellant-company approached the Indian Financial Institutions with the Industrial Development Bank of India (IDBI) acting as the Lead Financier for its Rupee loan requirement and for a part of its foreign currency loan requirement it approached International Finance Corporation (IFC), Washington DC, USA. After successful rendering of services the NRC sent invoice to the appellant-company for payment of success fee amount i.e., US $.17,15,476.16 ( L 5.4 Crores).

3. As the facts would unfurl after the receipt of the said invoice the appellant-company approached the concerned income tax officer, the first respondent herein, for issuing a ‘No Objection Certificate’ to remit the said sum duly pointing out that the NRC had no place of business in India; that all the services rendered by it were from outside India; and that no part of success fee could be said to arise or accrue or deemed to arise or accrue in India attracting the liability under the Income-tax Act, 1961 (for brevity, ‘the Act’) by the NRC. It was also stated as the NRC had no business connection Section 9(1)(i) is not attracted and further as NRC had rendered no technical services Section 9(1)(vii) is also no attracted. The first respondent scanning the application filed by the company refused to issue ‘No Objection Certificate’ by his order dated September 27, 1994. Being dissatisfied with the said order passed by the first respondent the appellant-company preferred a revision petition before the commissioner of Income-tax, Hyderabad, the second respondent herein, under Section 264 of the Act. On March 21, 1995 the second respondent permitted the appellant-company to remit the said sum to the NRC by furnishing a bank guarantee for the amount of tax. The company took steps to comply with the said order but afterwards on October 25,1995 the revisional authority revoked the earlier order and directed the company to deduct tax and pay the same to the credit of the Central Government as a condition precedent for issuance of the ‘No Objection Certificate’. Thus, the order passed by the first respondent was affirmed and resultantly the revision petition was dismissed.

4. The non-success in revision compelled the company to approach the High Court in W.P. No. 6866 of 1995 for issue of writ of certiorari for quashing of the orders passed by the Income-tax officer and that of by the revisional authority. In the writ petition, the stand and stance put forth before the authorities were reiterated.

5. On behalf of the revenue a counter affidavit was filed contending, inter alia, that the NRC was very actively associated not only in arranging loan but also in providing various services which fall within the ambit of both managerial as well as consultancy services.

6. A reference was made to the letter dated July 8, 1993 wherefrom it is evident that NRC is a financial advisor with a worldwide experience and has been engaged in India and requested that it be appointed as “financial consultant” for the project. The company responded by appointing the NRC as the financial advisor vide its letter dated 2.8.1994. On behalf of the revenue, the proceedings of the Board of Directors meeting was highlighted stating that they disclosed that the NRC was appointed not only to arrange for the loan but also to render several other financial and general services and also to involve itself in the public issue of the company and on that bedrock it was urged that it squarely falls within the ambit of Section 9(1)(vii)(b) of the Act. It was also averred that NRC is a financial segment of the ABB which is participating in the equity of the appellant company besides IFC, Washington. The further stand of the revenue was that Section 5(2) read with Section 9(1)(i)(vii)(b) will apply to the remittance to be made by the company to the NRC as the income would be deemed to have accrued or arisen in India and hence, the Indian company was liable to deduct tax at the prescribed rate before remitting any money to the NRC. The order passed by the authorities below were supported on the foundation that there is a business connection between the NRC with the company in India and the voluminous correspondence between the two wings discloses the said connection. It was also contended that the services rendered by the NRC were not a one time affair as alleged, for the company itself had acted on behalf of the NRC for processing, negotiating and obtaining loans from IDBI India and IFC, Washington. Emphasis was laid on the fact that the company had contracted the NRC not only for the limited purpose of getting loan but also for the further participation in its business activity which was evincible from the correspondence made between the two and, therefore, the income will accrue or deemed to have accrued or arisen to the NRC in India within the provisions of the Act. Justifying the order of revocation by the Commissioner of Income-tax, it was set forth that order dated 21.03.1995 was only an interim order and the final order came to be passed on 25.10.1995 by which the revision was dismissed. It was asserted by the revenue that the services of the NRC, as demonstrable from the material brought on record, was rendered within India and, therefore, the company is obliged in law to deduct income-tax before remitting “success fee” to the NRC. On this premise, the denial of ‘No Objection Certificate’ (NOC) was sought to be justified.

7. A rejoinder affidavit was filed by the appellant company asseverating that the NRC is an independent unit and is, in a way, subsidiarised by ABB. That apart, merely because expert advice was obtained, it could not be said that it pursued the application for loan/financial assistance on behalf of NRC and further the advisory services were rendered from outside India. The stand of the revenue that there has been an admission by the company to the effect that there was business connection with the NRC by the company, was controverted. It was put forth that the company was always the principal directly concerned with the making of application for financial assistance for the project and pursuing the same; that the NRC did not have any office or establishment in India at any relevant point of time; that it operated from Zurich; that there was no business connection between the company and the NRC; and that the success fee did not accrue or arise to the NRC in India and hence, no income is deemed to have accrued or arisen to NRC in India. In addition to the aforesaid it was urged Section 9(1)(i) and Section 9(1)(vii) have to be read together and in that case the stand of the revenue was absolutely unjustified and assuming Section 9(1)(vii) of the Act is read in isolation, the plain interpretation could not be applicable regard being had to the nature of service rendered by NRC. It was also pleaded that merely because the amount of success fee was paid by the appellant-company to NRC in India for the services rendered from outside India, the income of NRC would not deemed to have accrued or arisen in India.

8. The High Court framed the following two issues for consideration:

“(1) Whether ‘success fee’ payable by the petitioner-company to the NRC or any portion thereof is chargeable under the provisions the Act; and

(2) Whether the petitioner-company is entitled to ‘No Objection Certificate’.”
9. The High Court referred to clause (b) of sub-section 2 of Section 5 and Section 9 of the Act and adverted to the expression all income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through from any asset or source of income in India or through the transfer of a capital asset situate in India and thereafter referred to Section 163(1)(b) which uses the expression “business connection” and thereafter referring to various authorities, culled out the principles as to what the expression “business connection” conveys. It observed that expression “business connection” is too wide to admit of any precise definition though it has some well known attributes; that whether there is a business connection between an Indian company and a non-resident company is a mixed question of fact and law which is to be determined on the facts and circumstances of each case; that the essence of “business connection” is existence of close, real, intimate relationship and commonness of interest between the NRC and the Indian person; that in a case where there is control of management or finances or substantial holding of equity shares or sharing of profits by the NRC of the Indian company/person, the existence of close/intimate relationship stand substantiated; and to constitute business connection, there must be continuity of activity or operation of the NRC with the Indian company/person and a stray or an isolated transaction is not enough to establish a business connection.

10. After culling out the principles, the High Court referred to the contents of the correspondence, the nature and extent of services which the NRC had undertaken under the agreement, the resolution passed by the Board of Directors which had perused the letter dated July 8, 1993 addressed by the NRC stipulating the scope of services to be undertaken by NRC; the decisions of the Board to pay a fee to NRC and came to hold thus:

“On a careful reading of the letter of proposal of the NRC and the extract of resolution of the Board of Directors of the petitioner-company, it is clear to us that it was no part of the services to be provided by the NRC to manage public issue in India to correspond with various agencies to secure loan for the petitioner-company, to negotiate the terms on which loan should be obtained or to draft document for it. The NRC has only to develop a comprehensive financial model, tie up the rupee/foreign currency loan requirements of the project, assess export credit agencies worldwide and obtain commercial bank support, assist the petitioner-company in loan negotiations and documentation with the lender. It appears to us that the service to be rendered by the NRC is analogous to draw up a plan for the petitioner-company to reach the required destination indicating roads and highways, the curves and the turns; it does not contemplate taking the petitioner-company to the destination by the NRC. Once the NRC has prepared the scheme and given necessary advice and assistance to the petitioner-company for obtaining loan, the responsibility of the NRC is over. It is for the petitioner-company to proceed on the suggested lines and obtain loan from Indian or foreign agencies. On the petitioner-company obtaining loan, the NRC becomes entitled to ‘success fees’.”
11. The High Court scanned the letters with due consideration and opined that the business connection between the petitioner company and the NRC had not been established. Thereafter, the writ court adverted to the proposition whether success fee could fall within clause (vii)(b) of Section 9(1) of the Act. Interpreting the said provision, the High Court opined that:

“Thus from a combined reading of clause (vii) (b) Explanation (2) it becomes clear that any consideration, whether lump sum or otherwise, paid by a person who is a resident in India to a non- resident for running any managerial or technical or consultancy service, would be the income by way of fees for technical service and would, therefore, be within the ambit of “income deemed to accrue or arise in India”. If this be the net of taxation under Section 9 (1) (vii) (b), then ‘success fee’, which is payable by the petitioner-company to the NRC as fee for technical service would be chargeable to income tax thereunder. The Income-tax officer, in the impugned order, held that the services offered by the NRC fell within the ambit of both managerial and consultancy services. That order of Income-tax officer found favour by the Commissioner in revision. In the view we have expressed above, we are inclined to confirm the impugned order.”
12. At this juncture, it is necessary to note that a contention was advanced before the High Court by the assessee that the NRC did not render any technical or consultancy service to the company but only rendered advise in connection with payment of loan by it and hence, it would not amount to technical or consultancy service within the meaning of Section 9(1)(vii)(b) of the Act. While not accepting the said submission, the High Court observed that for the purposes of attracting the said provision, the business of the company cannot be divided into water-tight compartments like fire, generation of power, plant and machinery, management, etc. and to hold that managerial and technical and consultancy service relate to management, generation of power and plant and machinery, but not to finance. Elaborating further, the High Court observed that advice given to procure loan to strengthen finances may come within the compartment of technical or consultancy service and “success fee” would thereby come within the scope of technical service within the ambit of Section 9(1)(vii)(b) of the Act. Being of this view, the High Court opined the assessee was not entitled to the “No Objection Certificate”.

13. Be it stated, the constitutional validity of Section 9(1)(vii)(b) of the Act was challenged on the ground of legislative competence and violation of Article 14 of the Constitution. The Court referred to the earlier Division Bench decision in Electrical Corporation of India Ltd. v. C.I.T. rendered in W.P. No. 105/1987 on March 24, 1987 and also took note of the fact that the said case was quoted with approval in Electrical Corporation of India Ltd. v. C.I.T., (1990) 183 ITR 43 (SC) : (1989) Supp. 2 SCC 642 In the ultimate eventuate, High Court rejected all the contentions advanced by the assessee-company and dismissed the writ petition.

14. Being aggrieved, the petitioner company approached this Court. When the matter came up for consideration before a two-Judge Bench of this Court, which taking note of the far-reaching issues of constitutional purport and the fact that they were earlier referred to in the case of Electrical Corporation of India Ltd. (supra), which was ultimately withdrawn, it, by order dated 28.11.2000, referred the instant matter to a larger Bench. On 13.7.2010, the matter again came up for consideration before a three-Judge Bench and vide its order of the same date, the matter was referred to the Constitution Bench, which answered the reference as per decision on 1.3.2011 reported in (2011) 4 SCC 36. The issue before the Constitution Bench stated by the Court is thus:

“It is necessary for purposes of clarity that a brief recounting be undertaken at this stage itself as to what was conclusively decided in ECIL and what was referred to a Constitutional Bench. After conclusively determining that clauses (1) and (2) of Article 245, read together, impose a requirement that the laws made by Parliament should bear a nexus with India, the three- Judge Bench in ECIL asked that a Constitutional Bench be constituted to consider whether the ingredients of the impugned provision i.e. Section 9(1)(vii) of the Income Tax Act (1961) indicate such a nexus.”
15. Before the Constitution Bench the appellant withdrew its challenge to the constitutional validity of Section 9(1)(vii)(b) of the Act and elected to proceed on the factual matrix as to the applicability of the said provision. However, as the learned Attorney General pressed upon for reconsideration, the decision in three-Judge Bench in ECIL case, the larger Bench considered the validity of the requirement of a relationship to or nexus with territory of India as a limitation on the powers of Parliament to enact laws pursuant to clause (1) of Article 245 of the Constitution. The Court adverted to the ratio in ECIL, took note of propositions of the learned Attorney General and the principles relating to interpretation of the Constitution, textual analysis of Article 245, analysed the constitutional topological space of Article 245 and the wider structural analysis of Article 245 in the context of Article 260 and came to hold thus:

“It would appear that the concerns of the learned Attorney General may have been more with whether the ratio in ECIL could lead to a reading down of the legislative powers granted to Parliament by Article 245. A thorough textual analysis, combined with wider analysis of constitutional topology, structure, values and scheme has revealed a much more intricately provisioned set of powers to Parliament. Indeed, when all the powers necessary for an organ of the State to perform its role completely and to effectuate the constitutional mandate, can be gathered from the text of the Constitution, properly analysed and understood in the wider context in which it is located, why should such unnecessarily imprecise arrogation of powers be claimed? To give in to such demands, would be to run the risk of importing meanings and possibilities unsupportable by the entire text and structure of the Constitution. Invariably such demands are made in seeking to deal with external affairs, or with some claimed grave danger or a serious law and order problem, external or internal, to or in India. In such circumstances, it is even more important that courts be extra careful.”
16. Thereafter, the Court reiterated the two questions it had set out in the beginning. The first question reads thus:

“(1) Is Parliament constitutionally restricted from enacting legislation with respect to extra-territorial aspects or causes that do not have, nor expected to have any, direct or indirect, tangible or intangible impact(s) on or effect(s) in or consequences for:

(a) the territory of India, or any part of India; or

(b) the interests of, welfare of, well-being of, or security of inhabitants of India, and Indians?”
Answering the same, the Court observed:

“The answer to the above would be yes. However, Parliament may exercise its legislative powers with respect to extra-territorial aspects or causes-events, things, phenomena (howsoever commonplace they may be), resources, actions or transactions, and the like-that occur, arise or exist or may be expected to do so, naturally or on account of some human agency, in the social, political, economic, cultural, biological, environmental or physical spheres outside the territory of India, and seek to control, modulate, mitigate [pic]or transform the effects of such extra-territorial aspects or causes, or in appropriate cases, eliminate or engender such extra-territorial aspects or causes, only when such extra-territorial aspects or causes have, or are expected to have, some impact on, or effect in, or consequences for: (a) the territory of India, or any part of India; or (b) the interests of, welfare of, well-being of, or security of inhabitants of India, and Indians.”
And thereafter:

“Whether a particular law enacted by Parliament does show such a real connection, or expected real connection, between the extra- territorial aspect or cause and something in India or related to India and Indians, in terms of impact, effect or consequence, would be a mixed matter of facts and of law. Obviously, where Parliament itself posits a degree of such relationship, beyond the constitutional requirement that it be real and not fanciful, then the courts would have to enforce such a requirement in the operation of the law as a matter of that law itself, and not of the Constitution.”
17. The second question that was posed by the Constitution Bench is as follows:

“(2) Does Parliament have the powers to legislate “for” any territory, other than the territory of India or any part of it?”
The aforesaid question was answered thus:

“The answer to the above would be no. It is obvious that Parliament is empowered to make laws with respect to aspects or causes that occur, arise or exist, or may be expected to do so, within the territory of India, and also with respect to extra- territorial aspects or causes that have an impact on or nexus with India as explained above in the answer to Question 1 above. Such laws would fall within the meaning, purport and ambit of the grant of powers to Parliament to make laws “for the whole or any part of the territory of India”, and they may not be invalidated on the ground that they may require extra-territorial operation. Any laws enacted by Parliament with respect to extra-territorial aspects or causes that have no impact on or nexus with India would be ultra vires, as answered in response to Question 1 above, and would be laws made “for” a foreign territory.”
After the reference was answered, the matter was directed to be listed before the appropriate Bench.

18. We have heard Mr. U.A. Rana, learned counsel for the appellants and Mr. Arijit Prasad, learned counsel for the respondents.

19. At the very outset, it is necessary to mention as the challenge to the constitutional validity of the provision has been withdrawn, and the same accordingly has not been gone into by the Constitution Bench, there is no necessity to dwell upon the same. The crux of the matter is whether, in the obtaining factual matrix, the High Court was justified in concurring with the view expressed by the revisional authority that the assessee-company was not entitled to “No Objection Certificate” under the Act as it was under the obligation to deduct the tax at source pertaining to payment to the NRC as the character of success fee was substantiated by the revenue to put in the ambit and sweep of Section 9(1)(vii)(b) of the Act.

20. At this juncture, it is demonstrable that NRC is a Non-Resident Company and it does not have a place of business in India. The revenue has not advanced a case that the income had actually arisen or received by the NRC in India. The High Court has recorded the payment or receipt paid by the appellant to the NRC as success fee would not be taxable under Section 9(1)(i) of the Act as the transaction/activity did not have any business connection. The conclusion of the High Court in this regard is absolutely defensible in view of the principles stated in C.I.T. v. Aggarwal and Company, (1965) 56 ITR 20, C.I.T. v. TRC, (1987) 166 ITR 1993 and Birendra Prasad Rai v. ITC, (1981) 129 ITR 295. That being the position, the singular question that remains to be answered is whether the payment or receipt paid by the appellant to NRC as success fee would be deemed to be taxable in India under Section 9(1)(vii) of the Act. As the factual matrix would show, the appellant has not invoked Double Taxation Avoidance Agreement between India and Switzerland. That being not there, we are only concerned whether the “success fee” as termed by the assessee is “Fee for technical service” as enjoined under Section 9(1)(vii) of the Act. The said provision reads as follows:

“9. Income deemed to accrue or arise in India – (1) The following income shall be deemed to accrue or arise in India —

(vii) income by way of fees for technical services payable by-

(a) the Government ; or

(b) a person who is a resident, except where the fees are payable in respect of services utilised in a business or profession carried on by such person outside India or for the purposes of making or earning any income from any source outside India ; or

(c) a person who is a non-resident, where the fees are payable in respect of services utilised in a business or profession carried on by such person in India or for the purposes of making or earning any income from any source in India :

[Provided that nothing contained in this clause shall apply in relation to any income by way of fees for technical services payable in pursuance of an agreement made before the 1st day of April, 1976, and approved by the Central Government.]

[Explanation 1.-For the purposes of the foregoing proviso, an agreement made on or after the 1st day of April, 1976, shall be deemed to have been made before that date if the agreement is made in accordance with proposals approved by the Central Government before that date.]

[Explanation 2.]-For the purposes of this clause, “fees for technical services” means any consideration (including any lump sum consideration) for the rendering of any managerial, technical or consultancy services (including the provision of services of technical or other personnel) but does not include consideration for any construction, assembly, mining or like project undertaken by the recipient or consideration which would be income of the recipient chargeable under the head “Salaries”.]
21. Explanation to the Section 9(2) was substituted by the Finance Act 2010 with retrospective effect from 1.6.1976. Prior to the said substitution, another Explanation had been inserted by the Finance Act, 2007 with retrospective effect from 1.6.1976. The said Explanations read as under:

“As amended by Finance Act, 2010

Explanation.- For the removal of doubts, it is hereby declared that for the purposes of this section, income of a non-resident shall be deemed to accrue or arise in India under clause (v) or clause (vi) or clause (vii) of sub-section (1) and shall be included in the total income of the non-resident, whether or not,-

(i) the non-resident has a residence or place of business or business connection in India; or

(ii) the non-resident has rendered services in India.]

As amended by Finance Act, 2007

Explanation.-For the removal of doubts, it is hereby declared that for the purposes of this section, where income is deemed to accrue or arise in India under clauses (v), (vi) and (vii) of sub- section (1), such income shall be included in the total income of the non-resident, whether or not the non-resident has a residence or place of business or business connection in India.”
22. The principal provision is Clause (b) of Section 9(1)(vii) of the Act. The said provision carves out an exception. The exception carved out in the latter part of clause (b) applies to a situation when fee is payable in respect of services utilised for business or profession carried out by an Indian payer outside India or for the purpose of making or earning of income by the Indian assessee i.e. the payer, for the purpose of making or earning any income from a source outside India. On a studied scrutiny of the said Clause, it becomes clear that it lays down the principle what is basically known as the “source rule”, that is, income of the recipient to be charged or chargeable in the country where the source of payment is located, to clarify, where the payer is located. The Clause further mandates and requires that the services should be utilised in India.

23. Having stated about the “source rule”, it is necessary to appropriately appreciate how the concept has developed. At the time of formation of “League of Nations” at the end of 1920, it comprised of only 27 countries dominated by the European States and the United States of America. The United Nations that was formed after the Second World War, initially had 51 members. Presently, it has 193 members. With the efflux of time, there has been birth of nation States which enjoy political independence and that has led to cross-border and international trade. The State trade eventually has culminated in formulation of principles pertaining to international taxation jurisdiction. It needs no special emphasis to state that the said taxation principles are premised to promote international trade and to allocate taxation between the States. These rules help and further endeavour to curtail possibility of double taxation, tax discrimination and also to adjudicate resort to abusive tax avoidance or tax evasion practices. The nation States, in certain situations, resort to principle of “tax mitigation” and in order to protect their citizens, grant benefit of tax abroad under the domestic legislation under the bilateral agreements.

24. The two principles, namely, “Situs of residence” and “Situs of source of income” have witnessed divergence and difference in the field of international taxation. The principle “Residence State Taxation” gives primacy to the country of the residency of the assessee. This principle postulates taxation of world-wide income and world-wide capital in the country of residence of the natural or juridical person. The “Source State Taxation” rule confers primacy to right to tax to a particular income or transaction to the State/nation where the source of the said income is located. The second rule, as is understood, is transaction specific. To elaborate, the source State seeks to tax the transaction or capital within its territory even when the income benefits belongs to a non-residence person, that is, a person resident in another country. The aforesaid principle sometimes is given a different name, that is, the territorial principle. It is apt to state here that the residence based taxation is perceived as benefiting the developed or capital exporting countries whereas the source based taxation protects and is regarded as more beneficial to capital importing countries, that is, developing nations. Here comes the principle of nexus, for the nexus of the right to tax is in the source rule. It is founded on the right of a country to tax the income earned from a source located in the said State, irrespective of the country of the residence of the recipient. It is well settled that the source based taxation is accepted and applied in international taxation law.

25. The two principles that we have mentioned hereinabove, are also applied in domestic law in various countries. The source rule is in consonance with the nexus theory and does not fall foul of the said doctrine on the ground of extra-territorial operation. The doctrine of source rule has been explained as a country where the income or wealth is physically or economically produced. [See League of Nations, Report on Double Taxation by Bruins, Einaudi, Saligman and Sir Josiah Stan (1923)]. Appreciated on the aforesaid principle, it would apply where business activity is wholly or partly performed is a source State, as a logical corollary, the State concept would also justifiably include the country where the commercial need for the product originated, that is, for example, where the consultancy is utilized.

26. From the aforesaid, it is quite vivid that the concept of income source is multifaceted and has the potentiality to take different forms [See Klans Vogel, World-wide V. Source Taxation of Income – Review and Revision of Arguments (1988)]. The said rule has been justified by Arvid A. Skaar in Permanent Establishment; Erosion of Tax Treaty Principle on the ground that profits of business enterprise are mainly the yield of an activity, for capital is profitable to the extent that it is actively utilised in a profitable manner. To this extent, neither the activity of business enterprise nor the capital made, depends on residence.

27. The purpose of adverting to these aspects is only to highlight that the source rule has been accepted by them in the UN Commentaries and the Organisation of Economic Corporation and Development (OECD) Commentaries. It is well known that what is prohibited by international taxation law is imposition of sovereign act of a State on a sovereign territory. This principle of formal territoriality applies in particular, to acts intended to enforce internal legal provisions abroad. [See the Introduction in Klaus Vogel on Double Taxation Convention, South Asean, Reprint Edition (2007)]. Therefore, deduction of tax at source when made applicable, it has to be ensured that this principle is not violated.

28. Coming to the instant case, it is evident that fee which has been named as “success fee” by the assessee has been paid to the NRC. It is to be seen whether the payment made to the non-resident would be covered under the expression “fee for technical service” as contained in Explanation (2) to Section 9(1)(vii) of the Act. The said expression means any consideration, whether lumpsum or periodical in rendering managerial, technical or consultancy services. It excludes consideration paid for any construction, assembling, mining or like projects undertaken by the non-resident that is the recipient or consideration which would be taxable in the hands of the non-recipient or non-resident under the head “salaries”. In the case at hand, the said exceptions are not attracted. What is required to be scrutinised is that the appellant had intended and desired to utilise expert services of qualified and experience professional who could prepare a scheme for raising requisite finances and tie-up loans for the power projects. As the company did not find any professional in India, it had approached the consultant NRC located in Switzerland, who offered their services. Their services rendered included, inter alia, financial structure and security package to be offered to the lender, study of various lending alternatives for the local and foreign borrowings, making assessment of expert credit agencies world-wide and obtaining commercial bank support on the most competitive terms, assisting the appellant company in loan negotiations and documentations with the lenders, structuring, negotiating and closing financing for the project in a coordinated and expeditious manner.

29. In this context, it would be appropriate to reproduce the letter dated 8.7.1993 addressed by the NRC. It reads as follows:

“We propose the following scope of services to be performed by ABB PTF:

Assisting GVK Industries Limited (“GVK”) in putting together the financial structure and security package to be offered to the lenders;

Evaluating the pros and cons of various lending alternatives, both for the local and the foreign borrowings;

Developing a comprehensive financial model to evaluate the project and to perform various sensivity studies;

Preparing a preliminary information Memorandum to be used as the basis for placing the foreign and local debt;

Accessing Export Credit Agencies world wide obtaining commercial bank support on the most comprehensive terms;

Assisting GVK in loan negotiations and documentation with lendors; and

Structuring, negotiating and closing the financing for this project in a coordinated and expeditious manner.

We propose a compensation structure based only on success. As an exception, ABB PTF does not propose either any retainers or any reimbursement for travel and other expenses incurred by ABB PTF.

The success fee will be 0.75% of the total debt, payable at financial closing.”
30. The said letter was placed before the Board of Directors of the appellant company in its meeting held on August 21, 1993. The relevant part of the resolution passed by the Board is extracted hereinbelow:

“…..It was explained to the Directors that ABB-PTF’s scope of service for the project include:

Developing a comprehensive financial model;

Tying up the rupee/foreign currency loan requirements of the project;

Assessing Export Credit Agencies worldwide and obtaining commercial banks support on the most competitive terms;

Assisting GVK in loan negotiations and documentation with lenders.

For the above scope of service ABB PTF would be paid a fee of 0.75% of the loan amount which is payable only on successful financial closing. The Directors while approving this arrangement, advised that ABB-PTF should also be involved in the public issue of the company.”
31. From the aforesaid two documents, it is clear as crystal that the obligation of the NRC was to:

(i) Develop comprehensive financial model to tie-up the rupee and foreign currency loan requirements of the project.

(ii) Assist expert credit agencies world-wide and obtain commercial bank support on the most competitive terms.

(iii) Assist the appellant company in loan negotiations and documentation with the lenders.
32. Pursuant to the aforesaid exercises carried out by the NRC, the company was successful in availing loan/financial assistance in India from the Industrial Development Bank of India (IDBI) which acted as a lead financier for the rupee loan requirement. For foreign currency loan requirement, the appellant approached International Finance Corporation, Washington D.C., USA and was successful. In this backdrop, “success fee” of L 5.4 crores was paid to the NRC.

33. In this factual score, the expression, managerial, technical or consultancy service, are to be appreciated. The said expressions have not been defined in the Act, and, therefore, it is obligatory on our part to examine how the said expressions are used and understood by the persons engaged in business. The general and common usage of the said words has to be understood at common parlance.

34. In the case at hand, we are concerned with the expression “consultancy services”. In this regard, a reference to the decision by the authority for advance ruling In Re.: P.No. 28 of 1999 : (1999) 242 ITR 280, would be applicable. The observations therein read as follows:

“By technical services, we mean in this context services requiring expertise in technology. By consultancy services, we mean in this context advisory services. The category of technical and consultancy services are to some extent overlapping because a consultancy service could also be technical service. However, the category of consultancy services also includes an advisory service, whether or not expertise in technology is required to perform it.”
35. In this context, a reference to the decision in C.I.T. v. Bharti Cellular Limited and others, (2009) 319 ITR 139, would be apposite. In the said case, while dealing with the concept of “consultancy services”, the High Court of Delhi has observed thus:

“Similarly, the word “consultancy” has been defined in the said Dictionary as “the work or position of a consultant; a department of consultants.” “Consultant” itself has been defined, inter alia, as “a person who gives professional advice or services in a specialised field.” It is obvious that the word “consultant” is a derivative of the word “consult” which entails deliberations, consideration, conferring with someone, conferring about or upon a matter. Consult has also been defined in the said Dictionary as “ask advice for, seek counsel or a professional opinion from; refer to (a source of information); seek permission or approval from for a proposed action”. It is obvious that the service of consultancy also necessarily entails human intervention. The consultant, who provides the consultancy service, has to be a human being. A machine cannot be regarded as a consultant.”
36. In this context, we may fruitfully refer to the dictionary meaning of ‘consultation’ in Black’s Law Dictionary, Eighth Edition. The word ‘consultation’ has been defined as an act of asking the advice or opinion of someone (such as a lawyer). It means a meeting in which a party consults or confers and eventually it results in human interaction that leads to rendering of advice.

37. As the factual matrix in the case at hand, would exposit the NRC had acted as a consultant. It had the skill, acumen and knowledge in the specialised field i.e. preparation of a scheme for required finances and to tie-up required loans. The nature of activities undertaken by the NRC has earlier been referred to by us. The nature of service referred by the NRC, can be said with certainty would come within the ambit and sweep of the term ‘consultancy service’ and, therefore, it has been rightly held that the tax at source should have been deducted as the amount paid as fee could be taxable under the head ‘fee for technical service’. Once the tax is payable paid the grant of ‘No Objection Certificate’ was not legally permissible. Ergo, the judgment and order passed by the High Court are absolutely impregnable.

38. Consequently, the appeal, being devoid of merit, stands dismissed. However, in the facts and circumstances of the case there shall be no order as to costs.

Ishikawajma-Harima Heavy Industries Ltd. v. Director of Income-tax, Mumbai., (SC) 2007 AIR (SC) 929

NON RESIDENT COMPANY

SUPREME COURT OF INDIA

JUDGMENT

S. B. Sinha, J. – Leave granted.

2. Appellant herein is a company incorporated in Japan. It is a resident of the said country. It pays its taxes in Japan. It is engaged, inter alia, in the business of construction of storage tanks as also engineering etc. It formed a consortium along with Ballast Nedam International BV, Itochu Corporation, Mitsui and Co. Ltd., Toyo Engineering Corporation and Toyo Engineering (India) Ltd. With the said consortium members, it entered into an agreement with Petronet LNG Limited (hereinafter referred to as “the Petronet”) on 19.01.2001 for setting up a Liquefied Natural Gas (LNG) receiving storage and degasification facility at Dahej in the State of Gujarat. A supplementary agreement was entered into by the parties on 19.03.2001. The contract envisaged a turnkey project. Role and responsibility of each member of the consortium was specified separately. Each of the member of the consortium was also to receive separate payments. Appellant was to develop, design, engineer and procure equipment, materials and supplies, to erect and construct storage tanks of 5 MMTPA capacity, with potential expansion to 10 MMTPA capacity at the specified temperatures i.e. -200 degree Celsius. The arrangement also was to include marine facilities (jetty and island break water) for transmission and supply of the LNG to purchasers; to test and commission the facilities relating to receipt and unloading, storage and re- gasification of LNG and to send out of re-gasified LNG by means of a turnkey fixed lump-sum price time certain engineering procurement, construction and commission contract. The project was to be completed in 41 months. The contract indisputably involved : (i) offshore supply, (ii) offshore services, (iii) onshore supply, (iv) onshore services, and (v) construction and erection. The price was payable for offshore supply and offshore services in US dollars, whereas that of onshore supply as also onshore services and construction and erection partly in US dollars and partly in Indian rupees.

3. Liability to pay income tax in India by the appellant herein being doubtful, an application was filed by the same before the Authority for Advance Rulings (Income Tax) (hereinafter referred to as ‘the Authority’) in terms of Section 241(Q)(1) of the Income Tax Act, 1961 (hereinafter referred to as ‘the Act’). The following questions were proposed by the appellant for determination :

“1. On the facts and circumstances of the case, whether the amounts, received/receivable by the applicant from Petronet LNG for offshore supply of equipments, materials, etc. are liable to tax in India under the provisions of the Act and India- Japan Tax Treaty ?

2. If the answer to (1) is in the affirmative in view of Explanation (a) to section (1)(i) of the Act and/or Article (1) read together with the Protocol of the India-Japan Tax Treaty, to what extent are the amounts reasonably attributable to the operations carried out in India and accordingly taxable in India ?

3. On the facts and circumstances of the case, whether the amounts received/receivable by the applicant from Petronet LNG for offshore services are chargeable to tax in India under the Act and/or the India-Japan Tax Treaty ?

4. If the answer to (3) above is in the affirmative, to what extent would the amounts received/receivable for such services be chargeable to tax in India under the Act and/or the India-Japan Tax Treaty ?

5. If the answer to (3) above is in the affirmative, would the applicant be entitled to claim deduction for expenses incurred in computing the income from offshore services under the Act and/or the India-Japan Treaty ?
4. Before the Authority no issue was raised as regards the liability of the appellant to pay income-tax on onshore supply and onshore services and on its activities relating to construction and erection. The dispute centered round its exigibility to pay tax in respect of ‘offshore supply’ and ‘offshore services’.

5. It is also not in dispute that the Government of India and the Government of Japan entered into a bi-lateral treaty in regard to the tax liabilities.

6. Contention of the appellant before the Authority was that the contract being a divisible one, it did not have any liability to pay any tax in regard to offshore services and offshore supply. Revenue, on the other hand, contended that the contract being a composite and integrated one, they were so liable.

7. The Authority referred to a large number of decisions governing the field and opined that having regard to the provisions contained in Section 5 read with Section 9 of the Act, following propositions of law would emerge :

“(1) In a case of sale of goods simpliciter by a non-resident to a resident in India, if the consideration for sale is received abroad and the property in the goods also passes to the purchaser outside India, no income accrues or arises or deemed to accrue or arise to the seller in India.

(2) In a case of transaction of sale of goods by the non- resident to an Indian resident which is a part of a composite contract involving various operations within and outside India, income from such sale shall be deemed to accrue or arise in India if it accrues or arises through or from any business connection in India.

(3) In the case of a business of which all operations are not carried out in India, the deemed accrual or arising of income shall be only such part of the income as is reasonably attributable to the operations carried out in India.

(4) Whether there is business connection in India or/and whether all operations of the business are not carried out in India are questions of fact which have to be determined on the facts of each case.”
8. Applying the said principles to the facts of the present case, the Authority opined that the appellant was liable to pay direct tax even under the Treaty having regard to Articles 5 and 7 thereof as also Clause 6 of the Protocol. It was held :

“The substance of the Protocol quoted above, represents the consensus reached between the parties to the Treaty in regard to the meaning of the phrase “directly or indirectly attributable to that permanent establishment” employed in Paragraph 1 of Article 7. Further, profits shall also be regarded as attributable to the permanent establishment to the extent indicated in the said Protocol even when the contract or order relating to the sale or provision of goods or services in question is made or placed directly with the overseas head office of the enterprise rather than with the permanent establishment.

It would be clear that having regard to provisions of Article 7(1) of the Treaty read with Para 6 of the Protocol supply of equipment of machinery (sale of which was completed abroad, having placed the order directly overseas office of the enterprise) the same should be within the meaning of the phrase directly or indirectly attributable to that permanent establishment.”
9. As regards taxability of the amounts ‘received’ and ‘receivable’ by the appellant from Petronet for offshore services, it was held :

“Insofar as the Treaty is concerned, both Section 115A(1)(b)(B) and Para 2 of Article 12 of the Treaty clearly indicates that the whole technical fee without any deduction is chargeable to tax, however, the tax so charged shall not exceed 20% of the gross amount of the royalty or fee for technical services.”
10. Question Nos. 4 and 5 were held to be the consequential ones. It was opined :

“In the light of the above discussions we rule on :

(i) Question No.1 that on the facts and in the circumstances of the case, the amounts received/receivable by the applicant from Petronet LNG in respect of offshore supply of equipment and materials is liable to be taxed in India under the provisions of the Act and the India-Japan Treaty.

(ii) Question No. 2 that in view of the Explanation (a) to Section 9(1)(i) of the Act and/or Article 7(1) read with the Protocol of the India-Japan Treaty the amounts that would be taxable in India is so much of the profit as is reasonably attributable to the operations carried out in India, we decline to answer the other part of the question in regard to quantification of the amount taxable in India as the parties produced no evidence and did not address in this regard.

(iii) Question No. 3 that the amount received/receivable by the applicant from Petronet LNG for offshore services is liable to be taxed in India both under the provisions of the Act as well as under Indo-Japan Treaty.

(iv) Question No. 4 that the entire amount received for offshore services is chargeable to tax under the Act and under the Treaty but at the rate not more than 20% of the gross amount.

(v) Question No. 5 that the applicant would not be able to claim any deduction in computing the income from offshore service under the Act, and/or under the Indo-Japan Treaty.”
11. Before us, the following findings of the Authority are not disputed :

“(i) the Petitioner has a business connection in India;

(ii) if consideration accrues only for supply of goods and the sale is completed outside India no profits can accrue in India;

(iii) however, if a contract envisages a composite consideration for the various obligations to be performed and if certain operations are to be performed by or through the business connection, then, profits would be deemed to accrue in India;

(iv) property in the goods, which were the subject-matter of the offshore supply, passed outside India; and

(v) the petitioner has a permanent establishment in India within the meaning of the said term in paragraph 3 of Article 5 of the Double Taxation Avoidance Agreement entered into between the Governments of India and Japan (hereinafter referred to as “the DTAA”).”
12. Mr. Harish N. Salve, the learned Senior Counsel appearing on behalf of Appellant, urged :

(i) The Authority misconstrued and misinterpreted the contract in arriving at its aforementioned findings, as from a bare perusal thereof, it would appear that the payments were made in US dollars in respect of ‘offshore supply’ and ‘offshore services’ and furthermore title to the goods passed on to Petronate outside the territories of India and services had also been rendered outside India;

(ii) The fact that the contract signed in India was of consequences as converse could not have made the appellant not liable to pay the tax;

(iii) The Authority committed a manifest error in arriving at its findings insofar as it failed to properly construe Explanation-2 appended to Section 9(1)(vii) of the Act as it was nobody’s case that the consideration related to a construction, assembly, mining or like project so as to fall outside the scope thereof;

(iv) Although fee received by Appellant is effectively connected to the contract but it is not attributable to the permanent establishment and, therefore, Article 12(5) of the Double Taxation Avoidance Agreement (DTAA) is not attracted;

(v) Appellant being a non-resident in terms of Section 5(2) of the Act, it would be chargeable to tax in India only in the event income accrues or arises in India or is deemed to accrue or arise in India or income is received or is deemed to be received in India and not otherwise;

(vi) As no part of the income for the ‘offshore supply’ or ‘offshore services’ is received in India, the Authority misdirected itself in passing the impugned judgment;

(vii) A legal fiction raised under the Act cannot be pushed too far. Also, as all operations in connection with the offshore supply are carried out outside India, the question of any portion of the consideration to be regarded as deemed to accrue or arise in India would not arise;

(viii) The requirement of the appellant to perform certain services in India, such as unloading, port clearance, transportation of the equipments supplied would not render the appellant eligible to tax as the consideration thereof is embedded in the consideration for the offshore supply;

(ix) Although the appellant was required to carry out certain activities in India, the consideration for offshore services had separately been provided for.

(x) Assuming that the income from the offshore supply is chargeable to tax in India on the premise that Section 9(1)(i) applies, it was required to be examined by the Authority as to whether it would also be chargeable in accordance with the provisions of the Double Taxation Avoidance Agreement (DTAA) in terms whereof no charge to tax in India was leviable in respect of the consideration for offshore supply.
13. Mr. Mohan Parasaran, the learned Additional Solicitor General appearing on behalf of the respondent, on the other hand, submitted :

(i) The question as to whether terms of the contract constitute a composite contract or not is essentially a question of fact and the findings of the Authority being final, therefore, should not ordinarily be interfered with;

(ii) The Authority having found in favour of the Revenue two primary tests to determine as to whether the contract in question was a composite one for execution of a turnkey project viz. :

(a) whether the ‘offshore’ and ‘onshore’ elements of the contract are so inextricably linked that the breach of the ‘offshore’ element would result in the breach of the whole contract;

(b) whether the dominant object of the contract is the execution of a turnkey project and the question whether the title to the goods supplied passes offshore or within India is secondary to the execution of the contract, the impugned judgment should not be interfered with;

(iii) Each component of the contract was directly relatable to the performance of the integrated contract as violation and/or breach on the part of the parties thereto would affect the entire contract;

(iv) The contract itself providing for milestone dates, the breach of any of the terms thereof would result in the breach of the entire contract and not just the particular obligation;

(v) The turnkey project contemplated a permanent establishment and in that view of the matter Explanation appended to Section 9(1)(i) of the Act is directly applicable.

(vi) The appellant has business connection in India and in that view of the matter the causal connection between the offshore supply and offshore services being interlinked with the entire project, the opinion of the Authority cannot be faulted;

(vii) By reason of DTAA, the parties thereto can always allocate the jurisdiction to tax the entire income attributable to such permanent establishment to the country in which it is established;

(viii) Supply of goods whether offshore or onshore as well as rendition of service whether offshore or onshore are attributable to the turnkey project and, thus, it would be wrong to contend that in terms of Article 7 of DTAA, no tax could be levied upon the appellant.
Contract : The Material Part :

14. Petronat LNG Limited, on the one hand, and five members of the consortium, on the other, are parties to the contract. The contract contained broad items. It has its own interpretation clauses. Clause 2.1 provides for scope of the work in the following terms :

“2.1 The Work

Except as otherwise expressly provided in this Contract, Contractor shall provide, furnish and perform, or cause to be provided, furnished and performed, on a turnkey basis all necessary design, engineering, procurement, supplies, installation, erection, construction, testing, commissioning, operation and turning over services, activities and work (including all rectification and remedial services, activities and work relating to defects and deficiencies) for the Equipment and Materials and the Facilities in accordance with the Scope of Work (Exhibit A) and the other terms, provisions and requirements of this Contract, including the Contract Schedule, and shall provide all necessary and sufficient Contractor’s Equipment and experienced personnel having the requisite expertise for such purposes.

After Mechanical Completion of the Facilities, Contractor shall carry out Commissioning, start-up and testing of the Facilities and, if requested by Owner, shall provide advisory assistance in connection with the operation and maintenance of the Facilities and shall provide all necessary and sufficient experienced personnel having the requisite expertise for the prompt performance of any rectification and remedial work required until Final Acceptance of the Facilities, in accordance with this Contract.

The Parties acknowledge and agree that this Contract is a lump- sum firm fixed price time certain turnkey contract and Contractor’s obligation to provide, furnish and perform its services, activities and work under this Contract includes Contractor providing Owner with the operating and completed Facilities, complete in every detail within the time and for the purposes specified in this Contract and to do and furnish Owner everything necessary in connection herewith.

The foregoing obligations, work, services, activities and responsibilities of Contractor are more fully set forth in this Contract, including the Scope of Work (Exhibit A). The Technical Documents and the obligations under Clause 2.2 are herein collectively referred to as the “Work”.

Except as otherwise expressly provided in this Contract, Contractor agrees and acknowledges that Contractor shall perform all of its obligations and responsibilities under this Contract at its own risk, cost and expense.”
15. Clause 2.2 provides for additional responsibilities of the appellant, which reads as under :-

“2.2 Additional Responsibilities

Except as otherwise expressly provided in this Contract, Contractor shall be responsible for providing, or causing the provision of, design,engineering, procurement, erection, construction and commissioning and testing services, activities and work, and personnel and labour, and all Equipment and Materials (and components thereof) and Contractor’s Equipment, and any other items not specifically described in the Scope of Work (Exhibit- A) and/or the Technical Documents if (a) it reasonably may be inferred in accordance with Good Industry Practice that the providing, or causing the provision, of such additional items was contemplated as part of the Work (including the Technical Documents), or (b) the providing, or causing the provision, of such additional items is necessary in order for Contractor to satisfy the Completion and Performance Guarantees and the warranties set forth, in this Contract and to make the Facilities operable and capable of performing as specified in the Technical Documents or as otherwise necessary in order to comply with the requirements of this Contract. Without limitation to the foregoing, wherever this Contract describes any portion of the Work in general terms, but not complete in detail, Contractor agrees that the Work shall include any incidental work, activities and services which may be reasonably inferred as required or necessary to complete and render operable the Facilities in accordance with the terms and conditions of the Contract, and owner shall have no obligation or responsibility whatsoever (except as specifically set forth in this Contract) with respect to the completion of the Facilities.

Contractor shall ensure that the Facilities shall be fit and suitable for its intended purpose (including attaining the Completion and Performance Guarantees) as evidenced by, or reasonably to be inferred from, this Contract, and shall fully comply with the Contract.

Work undertaken, Equipment and Materials (including components thereof), Contractor’s Equipment, labour and personnel, and additional items provided pursuant to this Clause 2.2 shall not give rise to any adjustment in this Contract Price, the Contract Schedule or any other terms of this Contract, and shall be included in and comprise the Work for all purposes of this Contract.
16. Clause 7.1 provides for shipment in the following terms :

“7.1 Notice of Shipment

Contractor shall comply with and follow the procedures for shipment set forth in Section E of Exhibit H (General Project Requirements and Procedures). In particular,at least prior to arrival of each shipment in India, Owner and Owner’s insurance company providing insurance will receive from the Contractor, the notice of shipment, such notice shall set forth the following information concerning such shipment : (a) a reference to the date, parties and subject-matter of this Contract; (b) a description of, or that part of, the Equipment and Materials contained in such shipment; (c) the date of embarkation and departure; (d) the port of origin; (e) the means of shipment (air or sea); (f) the estimated date of arrival in India; (g) the port of entry in India; (h) the value of the shipment; (i) the approximate weight and volume (gross and net); (j) the name, flag and owner of the vessel if shipment by sea or the designation of aircraft if ship is by air; and (k) the number and value of bill of lading or airfreight bill. Contractor shall ensure that a provision similar to this Clause 7.1 is included in all agreements with Suppliers.

Contractor shall be responsible for packing, loading, transporting, receiving, unloading, storing and protecting all Equipment and Materials and/or Contractor’s Equipment and other things required for the Works.”
17. Price is specified under Clause 13.1 in the following terms :

“13.1 Contract Price

The total price to be paid by or on behalf of Owner to Contractor in full consideration for the performance by Contractor of its obligations and responsibilities under this Contract, including the Work, shall be a fixed and firm lump sum price of US$ 151,044,192 (One hundred fifty one million forty four thousand one hundred ninety two US Dollars) (the “US Dollar Portion”) and Rs. 7,602,796,324 (Seven billion six hundred two million seven hundred ninety six thousand three hundred twenty four Indian Rupees) (the “Indian Rupee Portion”), which shall be subject to adjustment only as provided under Clause 13.4 (the US Dollar Portion and the Indian Rupee Portion, as the same may be so adjusted, together, the “Contract Price”).”
18. The contract envisages that the appellant may do the job itself or get the same done by sub-contracting. It may only do a part of the job itself.

19. The contract splits in dollar and rupee components separately. Clause 14.8 provides for general terms of payment, effect of payment and methodology of payment. Pursuant to or in furtherance whereof separate payment in US dollars and Indian rupees is to be made depending upon the nature of supply viz. offshore supply and offshore services and onshore supply and onshore services.

20. Clause 22.1 deals with passing of title to the goods supplied in the following terms :

22.1 Title to Equipment and Materials and Contractor’s Equipment

Contractor agrees that title to all Equipment and Materials shall pass to Owner from the Supplier or Subcontractor pursuant to Section E of Exhibit H (General Project Requirements and Procedures). Contractor shall, however, retain care, custody, and control of such Equipment and Materials and exercise due care thereof until (a) Provisional Acceptance of the Work, or (b) termination of this Contract, whichever shall first occur. Such transfer of title shall in no way affect Owner’s rights under any other provision of this Contract.”
The interpretation of different components of contract has been dealt within Annexure-A appended thereto. So far as ‘offshore services work items’ are concerned, the same has been defined to mean the items of work set forth as item numbers D-2.2.1, 2.2.2 and 2.2.3 of the Contract Price Schedule; details whereof have been mentioned in the said Annexure, which, inter alia, provides :

Notes

General

1. xxx xxx xxx

2. Offshore supply (Exhibit D-2.1) is the price of Equipment & Material (including cost of engineering, if any, involved in the manufacture of such Equipment & Material) supplied from outside India on CFR basis, and the property therein shall pass on to the Owner on high seas for permanent incorporation in the Works, in accordance with the provisions of the Contract.

3. Offshore Services (Exhibit D-2.2) is the price of design and engineering including detail engineering in relation to supplies, services and construction & erection and cost of any other services to be rendered from outside India.

4. Onshore Supply (Exhibit D-2.3) is the price of Equipment & materials supplied from within India for direct delivery at Site and permanent incorporation in the Works.

5. Onshore services (Exhibit D-2.4) is the price of design engineering, detail engineering, customs clearance, inland transportation, procurement services, supervision services, project management, testing and commissioning and any such service in relation to the Works rendered in India.”

21. The break down of contract price is as under:

Exhibit No./ Sl.No. Description of scope In Indian Rupees In Us Dollars Name and address of Contracting entity

D-2.1 Offshore Supply (Total of 2.1.1, 2.1.2. and 21.3) Nil 81,711,877 IHL.BNL & TEIL

D-2.2 Offishore Services (Total of 2.2.2 to 2.2.3) Nil 19,756,225 IHI,BNL,& TEIL

D-2.3 Onshore Supply (Total of 2.3.1. to 2.3.3) 1,869,978,658 Nil IHI,BNL & TEIL

D-2.4 Onshore Services (Total of 2.4.1 to 2.4.3) 1,77,353,282 12,780,467 IHI,BNL,& TEIL

D-2.5 Construction and Erection (total of 2.5.5.1 to 2.5.3) 3,958,464,384 36,795,623 IHI,BNI & TEIL

D-2.0 Total (D-2.1 to D-2.5) (See Note 9) 7,602,796,324 151,044,192

Treaty: Double Taxation Avoidance Agreement (DTAA):

22. Article 5 of the Double Taxation Avoidance Agreement (DTAA) between India and Japan, inter alia, provides as under :

“1. For the purposes of this Convention, the term “permanent establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on.

2. The term “permanent establishment” includes especially :

(a) a place of management;

(b) a branch;

(c) an office;

(d) a factory;

(e) a workshop;

(f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources;

(g) a warehouse in relation to a person providing storage facilities for others;

(h) a farm, plantation or other place where agriculture, forestry, plantation or related activities are carried on;

(i) a store or other sales outlet; and

(j) an installation or structure used for the exploration of natural resources, but only if so used for a period of more than six months……………………………………………………”
23. Clause 1 of Article 7 of the said agreement reads as under :

“1. The profits of an enterprise of a Contacting State shall be taxable only in that Contracting 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 that other Contracting State but only so much of them as is directly or indirectly attributable to that permanent establishment.”
24. Clauses 1, 2 and 5 of Article 12 which are relevant for the purpose of this case, read as under :

“1. Royalties and fees for technical services arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other Contracting State.

2. However, such royalties and fees for technical services may also be taxed in the Contracting State in which they arise and according to the laws of that Contracting State, but if the recipient is the beneficial owner of the royalties or fees for technical services, the tax so charged shall not exceed 20 per cent of the gross amount of the royalties or fee for technical services.

5. The provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the royalties or fees for technical services, being a resident of a Contracting State, carries on business in the other Contracting State in which the royalties or fees for technical services arise, through a permanent establishment situated therein, or performs in that other Contracting State independent personal services from a fixed base situated therein, and the right, property or contract in respect of which the royalties or fees for technical services are paid is effectively connected with such permanent establishment or fixed base. In such case, the provisions of article 7 or article 14, as the case may be, shall apply.”
25. The Treaty contains the Japanese notes, clause 6 whereof reads as under :

“6. With reference to paragraph 1 of article 7 of the Convention, it is understood that by using the term “directly or indirectly attributable to the permanent establishment”, profits arising from transactions in which the permanent establishment has been involved shall be regarded as attributable to the permanent establishment to the extent appropriate to the part played by the permanent establishment in those transactions. It is also understood that profits shall be regarded as attributable to the permanent establishment to the above-mentioned extent, even when the contract or order relating to the sale or provision of goods or services in question is made or placed directly with the overseas head office of the enterprise rather than with the permanent establishment.”
Statutory provisions :

26. Sections 5(2), Section 9(1)(i), Section 9(1)(vii) of the Act, which are relevant for our purpose, read as under :

“5(2) Subject to the provisions of this Act, the total income of any previous year of a person who is a non-resident includes all income from whatever source derived which-

(a) is received or is deemed to be received in India in such year by or on behalf of such person; or

(b) accrues or arises or is deemed to accrue or arise to him in India during such year.”

“9(1). The following incomes shall be deemed to accrue or arise in India :

(i) all income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India or through the transfer of a capital asset situate in India.

(vii) income by way of fees for technical services payable by-

(a) the Government; or

(b) a person who is a resident, except where the fees are payable in respect of services utilised in a business or profession carried on by such person outside India or for the purposes of making or earning any income from any source outside India; or

(c) a person who is a non-resident, where the fees are payable in respect of services utilised in a business or profession carried on by such person in India or for the purposes of making or earning any income from any source in India :

Provided that nothing contained in this clause shall apply in relation to any income by way of fees for technical services payable in pursuance of an agreement made before the 1st day of April, 1976, and approved by the Central Government.”
Analysis :

27. For the purpose of taxation, the authority had proceeded on the basis that the element of tax consisted of : (i) onshore supply and onshore services; and (ii) construction of offshore supply and offshore services. It is not denied or disputed, as indicated hereinbefore, that in respect of the first element of onshore supply and onshore service, and construction tax would be payable in India.

28. Two basic issues which, thus, arise for our consideration are : (a) the taxation of the price of goods supplied, by way of offshore supply price of which is specified in Ex. D, Clause 2.1; and (b) the taxation of consideration paid for rendition of services described in the contract as offshore services at Ex. D.

29. The contract is a complex arrangement. Petronat and Appellant are not the only parties thereto, there are other members of the consortium who are required to carry out different parts of the contract. The consortium included an Indian company. The fact that it has been fashioned as a turnkey contract by itself may not be of much significance. The project is a turnkey project. The contract may also be a turnkey contract, but the same by itself would not mean that even for the purpose of taxability the entire contract must be considered to be an integrated one so as to make the appellant to pay tax in India. The taxable events in execution of a contract may arise at several stages in several years. The liability of the parties may also arise at several stages. Obligations under the contract are distinct ones. Supply obligation is distinct and separate from service obligation. Price for each of the component of the contract is separate. Similarly offshore supply and offshore services have separately been dealt with. Prices in each of the segment are also different.

30. The very fact that in the contract, the supply segment and service segment have been specified in different parts of the contract is a pointer to show that the liability of the appellant thereunder would also be different.

31. The contract indisputably was executed in India. By entering into a contact in India, although parts thereof will have to be carried out outside India would not make the entire income derived by the contractor to be taxable in India. We would, however, deal with this aspect of the matter a little later.

32. Scope of work is contained in Clause 2.1 of Ex. A appended to the contract which includes supply of equipment, materials and facilities. The said exhibit spells out different systems to be set in place. It imposes an obligation on the contractor to supply equipments required therefor. It was to arrange for the engineering services in relation thereto. It was also required to render various other services within India. Ex. D, however, provides for the prices to be paid in respect of offshore supplies and offshore services, onshore supply and onshore services, construction and erection. Payment schedule has also been separately specified in respect of each of the components separately.

33. It is not in dispute that title in the equipments supplied was to stand transferred upon delivery thereof outside India on high-sea basis as provided for in Article 22.1. Similarly, Article 13.1 provides for a lump sum contract price, whereas Article 13.3.2 specifically refers to the cost of offshore supplies. The provisions with regard to offshore supplies and offshore services were to be read with the provisions contained in Ex. D which formed the basis of customs duty. Clause 13.4 refers to Ex. D as the basis for price escalation.

34. The question of imposition of tax on income arising from a business connection may, thus, have to be considered keeping in view the aforementioned factual backdrop.

35. Section 9(1)(i) of the Act states that income accruing or arising whether directly or indirectly, through or from any business connection in India shall be deemed to accrue or arise in India. Appellant is a non-resident assessee.

36. Section 9 raises a legal fiction; but having regard to the contextual interpretation and furthermore in view of the fact that we are dealing with a taxation statute the legal fiction must be construed having regard to the object it seeks to achieve. The legal fiction created under Section 9 of the Act must also be read having regard to the other provisions thereof. [See Maruti Udyog Ltd. v.. Ram Lal and others,

37. For our benefit we may notice the provisions of Section 42 of the Income Tax Act, 1922. It provided that only such part of income as was attributable to the operations carried out in India would be taxable in India.

38. Territorial nexus doctrine, thus, plays an important part in assessment of tax. Tax is levied on one transaction where the operations which may give rise to income may take place partly in one territory and partly in another. The question which would fall for our consideration is as to whether the income that arises out of the said transaction would be required to be proportioned to each of the territories or not.

39. Income arising out of operation in more than one jurisdiction would have territorial nexus with each of the jurisdiction on actual basis. If that be so, it may not be correct to contend that the entire income ‘accrues or arises’ in each of the jurisdiction. The Authority has proceeded on the basis that supplies in question had taken place offshore. It, however, has rendered, its opinion on the premise that offshore supplies or offshore services were intimately connected with the turnkey project.

40. The learned Additional Solicitor General in support of his contention that the contract is a composite one, has relied upon the following decisions : N. Khadervali Sahib (Dead) by L.Rs. and another v. N. Gudu Sahib (Dead) and others [(2003) 3 SCC 229]; Hindustan Shipyard Ltd. v. State of A.P. [(2000) 6 SCC 579]; State of Rajasthan v. M/s. Man Industrial Corporation Ltd. [(1969) 1 SCC 567]; K.S. Subbiah Pillai v. Commissioner of Income Tax [(1999) 3 SCC 170]; M/s. Patnaik and Co. Ltd. v. Commissioner of Income Tax, Orissa [(1986) 4 SCC 16]; BSES Ltd. (Now Reliance Energy Ltd.) v. Fenner India Ltd. and another [(2006) 2 SCC 728]. The said decisions, in our considered view, are not applicable herein.

41. In Khadervali Sahib (supra), the question which arose for consideration was whether an award amounted to creation of or transfer of any fresh rights in respect of movable or immovable properties so as to require registration under Section 17 of the Registration Act, when the same related to the properties of a partnership firm. Therein by reason of an award, the residue upon settlement of accounts on dissolution of the partnership firm was allocated to the partners. It was held that the award did not require any registration.

42. In Hindustan Shipyard (supra), the question which arose for consideration was whether a contract constituted a sale or works contract. Laying down the tests therefor, having regard to the terms and conditions contained therein, it was opined that a contract of sale of goods was separate from a contract for works and labour. In regard to the categories of contract, it was stated :

“(i) the contract may be for work to be done for remuneration and for supply of materials used in the execution of the work for a price;

(ii) it may be a contract for work in which the use of the materials is accessory or incidental to the execution of the work; and

(iii) it may be a contract for supply of goods where some work is required to be done as incidental to the sale.”
43. Whereas the first contract was held to be a composite contract, the second was held to be a contract for work and labour not involving the sale of goods; and the third was held to be a contract of sale where the goods were sold as chattels and the work done was merely incidental thereto.

44. The view taken in State of Madras v. Gannon Dunkerley and Co.(Madras) Ltd. [1959 SCR 379] is sought to be applied. The contract in such a case must stipulate that the equipment would be supplied on CRF basis. It spells out the price for supply of goods, in which event, for the purpose of sales tax, the contract would involve sale of goods. The principle of Gannon Dunkerly (supra), does not appear to be of much relevance in the instant case.

45. Decisions of this court under the Sales Tax Laws referred to by the learned counsel, moreover, may have to be considered on a different footing.

46. In this case, we are faced with a different situation. It is only for the purpose of taxability that the terms of the contract are required to be construed. A turnkey contract may involve supply of materials used in the execution of the contract for price as also for use of the materials by works and labour; but the same may not have any relation with the taxability part of it.

47. It is interesting to note that Instruction No.1829 issued by the Central Board of Direct Taxes on 21.09.1989 provides for certain guidelines having regard to the possibility of undertaking of Hydro Electric Power Project by a consortium of a foreign company, stating :

“The concept of turnkey execution of the project involves total and complete responsibilities of the persons undertaking the contracts for commissioning the project and they are accordingly required to furnish performance guarantees for timely completion.”
48. It was further stated :

“Apart from the separate contracts for the jobs mentioned in Para 4 above, there would be an overall co-ordination agreement between the public sector company on the one hand and the foreign contracting parties referred to in Paragraph 4 on the other hand to ensure guaranteed performance of all the contracts in a co-ordinated manner, and within an agreed time-frame and for undertaking to meet necessary liabilities and responsibilities including payments of liquidated damages for delays etc. One of the companies would, for this purpose, act as leader to ensure supervision and co-ordination of inter-related tasks.”
49. In M/s. Man. Industrial Corporation Ltd. (supra), this Court held :

“16. Our attention was invited to a judgment of the Court of Appeal in Love v. Norman Wright (Builders) Ltd. [1944] 1 KB 484, In that case the respondents contracted with the Secretary of State for War to do the work and supply the material mentioned in the Schedules to the contract, including the supply of black-out curtains, curtain rails and battens and their erection at a number of police stations. It was held by the Court of Appeal that the respondents were liable to pay purchase-tax. Reliance was placed upon the observations made by Godiard, L.J. at p. 482 :

“If one orders another to make and fix curtains at his house the contract is one of sale though work and labour are involved in the making and fixing, nor does it matter that ultimately the property was to pass to the War Office under the head contract. As between the plaintiff and the defendants the former passed the property in the goods to the defendants who passed it on to the War Office.”

We do not think that these observations furnish a universal test that whenever there is a contract to “fix” certain articles made by a manufacturer the contract must be deemed one for sale and not of service. The test in each case is whether the object of the party sought to be taxed is that the chattel as chattel passes to the other party and the services rendered in connection with the installation are under a separate contract or are incidental to the execution of the contract of sale.”
50. In M/s. Patnaik and Co. (supra), whereupon reliance has been placed by the learned Additional Solicitor General, the question which arose for consideration was as to whether the investment in the loan by the assessee out of the advance payment made by the Government departments was a capital asset and the loan was a capital loan or not. We are not herein concerned with such a situation. The said decision, therefore, cannot be said to have any application at all.

51. In BSES Ltd. (supra), this Court was concerned with the construction of bank guarantees. The question which arose for consideration therein was as to whether in the fact-situation of the case, customer faced irretrievable injuries so as to obtain an order of injunction. In view of the terms and conditions of the contract, it was opined, although for the sake of convenience, the same had been split up into four sub-contracts, it constituted a composite contract executable on a turnkey basis. The question which arose for consideration, thus, was whether in terms of the contract having been reduced into writing by the “wrap around agreement”, Appellant therein had a right to negotiate any or all the guarantees for any breach of any of the four contracts. The said decision again has no application in the facts of the present case.

52. Tax under the Act has to be assessed under different heads. Income under one head may be subject to exemption; under same head, deductions may be claimed; yet under another, no tax may be payable at all. Whether a part of the income of the assessee would be taxable or not depends upon the fact of each case. Even there is nothing to prevent the income accruing or arising at the sources.

53. In Union of India and another v. Azadi Bachao Andolan and another [(2004) 10 SCC 1], this Court was dealing with a Double Taxation Treaty. It was held :

“6. The Agreement provides for allocation of taxing jurisdiction to different contracting parties in respect of different heads of income. Detailed rules are stipulated with regard to taxing of dividends under Article 10, interest under Article 11, royalties under Article 12, capital gains under Article 13, income derived from independent personal services in Article 14, income from dependent personal services in Article 15, directors’ fees in Article 16, income of artists and athletes in Article 17, governmental functions in Article 18, income of students and apprentices in Article 20, income of professors, teachers and research scholars in Article 21 and other income in Article 22.
54. In Commissioner of Income Tax, Bombay v. Ahmedbhai Umarbhai and Co., Bombay [(1950) SCR 335], this Court, having regard to the provisions contained in Section 42 of the Income Tax Act, 1922, held that profits accrued to the assessee of a part of the business in an Indian State having accrued out of such business carried on in such State are exempted under the third proviso to Section 5 of the Excess Profit Tax Act.

55. Opining that the source of income can never be the place where the income accrues or arises, Kania, C.J., stated :

“………In my opinion there is nothing to prevent income accruing or arising at the place of the source. The question where the income accrued has to be determined on the facts of each case. The income may accrue or arise at the place of the source or may accrue or arise elsewhere, but it does not follow that the income cannot accrue or arise at the place where the source exists. Therefore it is necessary to ascertain whether that part of the business which is capable of being treated as one separate unit in the Hyderabad State has given rise to the income or profit sought by the assessee to be exempted from taxation in the present case…………”
56. Patanjali Sastri, J. approved the application of the principle underlying the decision in Commissioner of Taxation v. Kirk [(1900 AC 588], namely, the principle of apportioning profits as between different processes employed in producing those profits and the different places where they were employed.

Mahajan, J. held :

“….For instance, where a person carries on manufacture, sale, export and import, it is not possible to say that the place where the profits accrue to him is the place of sale. The profits received relate firstly to his business as a manufacturer, secondly to his trading operations, and thirdly to his business of import and export. Profit or loss has to be apportioned between these businesses in a businesslike manner and according to well- established principles of accountancy. In such cases it will be doing no violence to the meaning of the words “accrue” or “arise” if the profits attributable to the manufacturing business are said to arise or accrue at the place where the manufacture is being done and the profits which arise by reason of the sale are said to arise at the place where the sales are made and the profits in respect of the import and export business are said to arise at the place where the business is conducted. This apportionment of profits between a number of businesses which are carried on by the same person at different places determines also the place of the accrual of profits. To hold that though a businessman has invested millions in establishing a business of manufacture, whether in the nature of a textile mill or in the nature of steel works, yet no profits are attributable to this business or can accrue or arise to the business of manufacture because the produce of his mills is sold at a different place and that it is only the act of sale by which profits accrue and they arise only at that place is to confuse the idea of receipt of income and realisation of profits with the idea of the accrual of profits. The act of sale is the mode of realising the profits. If the goods are sold to a third person at the mill premises no one could have said that these profits arose merely by reason of the sale. Profits would only be ascribed to the business of manufacture and would arise at the mill premises. Merely because the mill owner has started another business organisation in the nature of a sales depot or a shop, that cannot wholly deprive the business of manufacture of its profits, though there may have to be apportionment in such a case between the business of manufacture and business of shop keeping. In a number of cases such apportionment is made and is also suggested by the provisions of Section 42 of the Indian Income Tax Act, reference to which has also been made in Proviso (2) of Section 5 of the Excess Profits Tax Act.”
57. In Anglo-French Textile Co. Ltd. v. Commissioner of Income Tax, Madras [(1954) SCR 523], the question which arose for consideration, inter alia, was :

“(2) Can the income received in India be said to arise in India within the meaning of Section 4-A(c)(b) of the Act ? If not, should only those profits determined under Section 42(3) as attributable to the operations carried out in India be taken into account for applying the test laid down in Section 4-A(c)(b), and remanded the case to the High Court with the direction that it should give its opinion on these two questions.”
58. In regard to the first question, it was opined that Section 42(3) had nothing to do with the determination of the income arising in the taxable territories as distinguished from the income arising without taxable territories as understood in Section 4A(c)(b) of the Act, it was held :

“The phraseology of Section 42(3) of the Act also repels the contention insofar as the profits and gains of the business which are referred to therein and which are capable of apportionment as therein mentioned are deemed to accrue or arise in the taxable territories thus using the words “accrue” and “arise” as synonymous with each other.

The above passage is also sufficient in our opinion to establish that the apportionment of income, profits or gains between those arising from business operations carried on in taxable territories and those arising from business operations carried on without the taxable territories is based not on the applicability of Section 42(3) of the Act but on general principles of apportionment of income, profits or gains……..”
59. While the first question was answered in negative, question No. 2 was answered in the following terms :

“Question 2- The income received in British India cannot be said to wholly arise in India within the meaning of Section 4-A(c)(b) of the Act and that there should be allocation of the income between the various business operations of the assessee-company demarcating the income arising in the taxable territories in the particular year from the income arising without the taxable territories in that year for the purposes of Section 4-A(c)(b) of the Act.”
60. In Carborandum Co. v. Commissioner of Income-Tax, Madras [(1977) 108 ITR 335 : (1977) 2 SCC 862], this Court referring to its earlier decision in Commissioner of Income Tax, Punjab v. R. D. Aggarwal and Co. and another [(1965) 56 ITR 20], opined :

“15. On a plain reading of sub-sections (1) and (3) of Section 42 it would appear that income accruing or arising from any business connection in the taxable territories – even though the income may accrue or arise outside the taxable territories – will be deemed to be income accruing or arising in such territory provided operations in connection with such business, either all or a part, are carried out in the taxable territories. If all such operations are carried out in the taxable territories, sub-section (1) would apply and the entire income accruing or arising outside the taxable territories but as a result of the operations in connection with the business giving rise to the income would be deemed to accrue or arise in the taxable territories. If, however, all the operations are not carried out in the taxable territories the profits and gains of the business deemed to accrue or arise in the taxable territories shall be only such profits and gains as are reasonably attributable to that part of the operations carried out in the taxable territories. Thus comes in the question of apportionment under Sub-section (3) of Section 42.”
61. In Commissioner Income Tax v. Mitsui Engineering and Ship Building Co. Ltd. [259 ITR 248], on which reliance was placed; the contention was that the finding that the contract for designing, engineering, manufacturing, shop testing and packing up to f.o.b port of embarkation could not be split up since the entire contract was to be read together and was for one complete transaction. It was in the said fact-situation held that it was not possible to apportion the consideration for design on one part and the other activities on the other part. The price paid to the assessee was the total contract price which covered all the stages involved in the supply of machinery.

62. This case is clearly distinguishable from the facts of the present case, since the payment for the offshore and onshore supply of goods and services was in itself clearly demarcated and cannot be held to be a complete contract that has to be read as a whole and not in parts.

63. The principle of apportionment is also recognised by Clause (a) of Explanation I. Thus, if submission of the learned Additional Solicitor General is accepted that the contract is a composite one, then offshore supply would be of equipment designed and manufactured in one territory (Japan), and then sold in another tax territory, leading to division of profits arising in two tax territories, which is not envisaged under our taxation law.

64. It gives rise to the question as to what would be the meaning of the phrase ‘business connection in India’. Mere existence of business connection may not result in income of the non-resident assessee from transaction with such a business connection accruing or arising in India.

65. In Mazagaon Dock Ltd. v. Commissioner Income Tax and Excess Profits Tax [34 ITR 368], whereupon again reliance placed is distinguishable. In that case a non- resident carried on business with a resident, and the issue adjudicated upon by the Court was that whether there was a clear and close connection between them that produced profits or not, and whether any such income generated by the non-resident company sending its ships for repairs to the resident company is taxable, if it amounted to business. The Court answered both questions affirmatively.

66. The principle laid down therein has no application to the current fact-situation because there was an extremely close connection between the appellant company and non-residents in that the two non-resident (British) companies beneficially owned the entire share capital of the appellant- company. In the present situation there is no such connection, which can be said to give rise to a business connection between the permanent establishment in India and the transaction that is sought to be taxed.

67. Yet again in Anglo French Textile Co. Ltd. v. Commissioner Income Tax, Madras [23 ITR 101], in the fact-situation obtaining therein, it was held that when there was a continuity of business relationship between the person in India who helps make the profits and the person outside who receives or realizes this profit, a business connection exists.

68. In that case, the assessee-company incorporated in the UK, owned a textile company in French Pondichery and had appointed another limited company in Madras to act as its constituted agents. The same was held to be a business connection within British India. Such a close connection cannot be envisaged in the present case since it does not involve any such principal-agent relationship between the PE and the non-residents.

69. Barendra Prasad Ray v. ITO [129 ITR 295] whereupon reliance has been placed, is not apposite. Therein, the Court held that the professional relationship of a solicitor, who was a non-resident, with an Indian firm will be a business connection. There was a connection between the Indian firm and the British solicitor which was real and intimate and not just a casual one and the fees earned by the solicitor was only through this connection, and could not have done so without associating himself with the firm. Thus, the income earned by the solicitor was subject to tax in India, and payable by the firm as agents of the solicitor.

70. The principle of this case, is again not applicable in the present scenario since the nature of the relationship between the permanent establishment, the foreign firms and the Indian firms are evidently contractual and not professional. And the transaction of sale and supply of goods offshore have not taken place with the involvement of the permanent establishment, therefore excluding this transaction from the scope of taxation in India.

71. In Commissioner of Income-Tax, A.P. v. Toshoku Ltd [(1980) 125 ITR 525 : (1980) Supp SCC 614], this Court interpreted Section 9(1)(i) and the Explanation thereto on the factual matrix obtaining therein that the statutory agent exported his goods to Japan and France where they were sold through the assessee and the entire sales price was received in India by the said agent who made credit entries in his accounts books regarding the commission amounts payable to the assessees and remitted the commission amounts to them subsequently. Having regard to the fact that the Japanese company was a non- resident company, distinguishing the case Raghava Reddi and Another v. Commissioner of Income Tax, A.P. [(1962) 44 ITR 720] , it was held :

“…..It is not possible to hold that the non-resident assessees in this case either received or can be deemed to have received the sums in question when their accounts with the statutory agent were credited, since a credit balance without more only represents a debt and a mere book entry in the debtor’s own books does not constitute payment which will secure discharge from the debt. They cannot, therefore, be charged to tax on the basis of receipt of income actual or constructive in the taxable territories during the relevant accounting period.”
72. A Division Bench of the Karnataka High Court presided over by Venkataramiah, J., in VDO Tachometer Werke, West Germany etc. v. Commissioner of Income-Tax, Karnataka-I etc.[(1979) 117 ITR 804] following Carborandum Co. (supra), held that notwithstanding the amendment of Section 9 of the Act by the addition of Clauses (vi) and (vii), the cases continued to be governed by the provisions of Section 9 of the Act. 1979 Tax LR 818

73. In Commissioner of Income-Tax v. Atlas Steel Co. Ltd. [(1987) 164 ITR 401], a Division Bench of the Calcutta High Court following Carborandum (supra) and other decisions held :

“35. The expression “business connection” in the context of the Income Tax Act has come to acquire a special meaning as laid down by the Supreme Court in R. D. Aggarwal and Co.’s case. A business connection contemplated under Section 42 of the Indian Income Tax Act, 1922 (corresponding to Section 9 of the Income Tax Act, 1961, involved “a relation between a business carried on by a non-resident and some activity in the taxable territories which are attributable directly or indirectly to the earnings, profits or gains of such business”. It was laid down by the Supreme Court that there must be trading activity both outside and within the taxable territory. In the facts of this case, for the supply of inventions, patents, application for patents, secret knowledge and know-how, no trading activity had been or was required to be carried on by the assessee within the taxable territory. Further, on a consideration of the agreement, it cannot be said that the trading activity which was intended to be carried on by the assessee as production adviser of Hindustan Steel Ltd., in future was relatable to or connected with the past supply of the said know-how and other items.
[See also Income-Tax Officer and Others v. Shriram Bearings Ltd. (1987) 164 ITR 419]

74. A similar view was taken, when the matter came before this Court in Income-Tax Officer and others v. Shriram Bearings Ltd. [(1997) 224 ITR 724 : (1997) 10 SCC 332], wherein B.P. Jeevan Reddy, J. speaking for the Division Bench, opined :

“We are not prepared to agree that the High Court has not correctly understood the purport of the agreement between the respondent and M/s. Nippon Seike Kabushiki Kaisha (NSK). The agreement is in two parts. It is true that the two parts are interdependent but yet the consideration for the sale of trade secrets and consideration of technical assistance is separately provided for and mentioned under separate sections. So far as the consideration for the technical assistance is concerned, its taxability is not in doubt. The only controversy is with respect to the taxability of 1,65,000 US Dollars which is stipulated as the consideration for sale of trade secrets. The agreement specifically says that the said sale is effected in Japan. We are unable to see on what basis it can be said that any part of the said amount has been earned in India.”
75. In construing a contract, the terms and conditions thereof are to be read as a whole. A contract must be construed keeping in view the intention of the parties. No doubt, the applicability of the tax laws would depend upon the nature of the contract, but the same should not be construed keeping in view the taxing provisions.

76. In Commissioner of Income-Tax, Tamil Nadu-V v. Fried Krupp Industries [(1981) 128 ITR 27], a Division Bench of the Madras High Court opined :

“…..Now-a-days 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 ……….”
77. The term ‘permanent establishment’ has not been defined in the Income Tax Act.

78. Since the appellant carries on business in India through a Permanent Establishment, they clearly fall out of the applicability of Article 12(5) of the DTAA and into the ambit of Article 7. The Protocol to the DTAA, in paragraph 6, discusses the involvement of the permanent establishment in transactions, in order to determine the extent of income that can be taxed. It is stated that the term ‘directly or indirectly attributable’ indicates the income that shall be regarded on the basis of the extent appropriate to the part played by the permanent establishment in those transactions. The permanent establishment here has had no role to play in the transaction that is sought to be taxed, since the transaction took place abroad.

79. Clause 1 of Article 7, thus, provides that if an income arises in Japan (Contracting State), it shall be taxable in that country unless the enterprise carries on business in the other Contracting State (India) through a permanent establishment situated therein. What is to be taxed is profit of the enterprise in India, but only so much of them as is directly or indirectly attributable to that permanent establishment. All income arising out of the turnkey project would not, therefore, be assessable in India, only because the assessee has a permanent establishment.

80. It is relevant to note that the tax treaty between India and Japan is essentially based on OECD model, providing :

“a) the income of a resident, including of the kind that would fall under would be table under Section 9, would be taxed in the State of residence, save and except the income attributable to a Permanent Establishment, and

b) even in the case of a permanent establishment, income from business would be taxable in the State of residence.”
81. In Klaus Vogel on Double Taxation Conventions, it is stated :

“g) No force of attraction principle : The second sentence of Article 7 (1) allows the State of the permanent establishment to tax business profits, ‘but only so much of them as is attributable to that permanent establishment’. The MC has thus decided against adopting the so-called ‘force of attraction of the permanent establishment’, i.e. against the principle that, where there is a permanent establishment, the State of the permanent establishment should be allowed to tax all income derived by the enterprise from sources in that State irrespective of whether or not such income is economically connected with the permanent establishment. In line with the domestic law then prevailing in the USA, such a ‘force of attraction’was, for instance, incorporated in Germany’s 1954 DTC with USA (second sentence of Article III (I). In contrast, the second sentence of Article 7(1) MC allows the State of the permanent establishment to tax only those profits which are economically attributable to the permanent establishment, i.e. those which result from the permanent establishment’s activities, which arise economically from the business carried on by the permanent establishment (cf. also para 5 MC Comm. Article 7, supra m. No. 10). As regards the profits made by the enterprise in the State of the permanent establishment, a distinction must always be made between those profits which result from the permanent establishment’s activities and those made, without any interposition of the permanent establishment, by the head office or any other part of the enterprise (also for mere assembly permanent establishment : BFH 37 RIW 258 (1991). It is only when there is a connection with the permanent establishment that the State of the permanent establishment is entitled to impose tax. Conversely, losses incurred in connection with direct transactions may not be set-off against a permanent establishment’s profits. Since a DTC may not increase tax liability, the USA, it is true, imposes tax at the lower amount that would ensue if the permanent establishment’s business and direct transactions were combined and treated as if no DTC existed (of course, the taxpayer may, in such event, not only set off the result of individual direct transactions, which amounted to a loss against the permanent establishment’s positive operating result : I.R.S. Rev. Rul. 84-17, 1984-I Cum. Bull. 308). According to that ruling, the taxpayer is in such cases entitled to elect taxation which discounts the DTC. (see supra Article I, at m. No. 44).”
82. We generally agree with the said statement of law.

83. The distinction between the existence of a business connection and the income accruing or arising out of such business connection is clear and explicit. In the present case, the permanent establishment’s non-involvement in this transaction excludes it from being a part of the cause of the income itself, and thus there is no business connection.

84. Article 5.3 provides that a person is regarded as having a permanent establishment if he carries on construction and installation activities in a Contracting State only if the said activities are carried out for more than six months. Paragraph 6 of the Protocol to India-Japan Tax Treaty also provides that only income arising from activities wherein the permanent establishment has been involved can be said to be attributable to the permanent establishment. It gives rise to two questions, firstly offshore services are rendered outside India; the permanent establishment would have no role to play in respect thereto in the earning of the said income. Secondly, entire services having been rendered outside India, the income arising therefrom cannot be attributable to the permanent establishment so as to bring within the charge of tax.

85. For attracting the taxing statute there has to be some activities through permanent establishment. If income arises without any activity of the permanent establishment, even under the DTAA the taxation liability in respect of oversea services would not arise in India. Section 9 spells out the extent to which the income of non-resident would be liable to tax in India. Section 9 has a direct territorial nexus. Relief under a Double Taxation Treaty having regard to the provisions contained in Section 90(2) of the Income Tax Act would arise only in the event a taxable income of the assessee arises in one Contracting State on the basis of accrual of income in another Contracting State on the basis of residence. Thus, if Appellant had income that accrued in India and is liable to tax because in its State all residents it was entitled to relief from such double taxation payable in terms of Double Taxation Treaty. However, so far as accrual of income in India is concerned, taxability must be read in terms of Section 4(2) read with Section 9, whereupon the question of seeking assessment of such income in India on the basis of Double Taxation Treaty would arise.

86. In cases such as this, where different severable parts of the composite contract is performed in different places, the principle of apportionment can be applied, to determine which fiscal jurisdiction can tax that particular part of the transaction. This principle helps determine, where the territorial jurisdiction of a particular state lies, to determine its capacity to tax an event. Applying it to composite transactions which have some operations in one territory and some in others, is essential to determine the taxability of various operations.

87. It is, therefore, in our opinion, the concepts profits of business connection and permanent establishment should not be mixed up. Whereas business connection is relevant for the purpose of application of Section 9; the concept of permanent establishment is relevant for assessing the income of a non-resident under the DTAA. There, however, may be a case where there can be over-lapping of income; but we are not concerned with such a situation. The entire transaction having been completed on the high seas, the profits on sale did not arise in India, as has been contended by the appellant. Thus, having been excluded from the scope of taxation under the Act, the application of the double taxation treaty would not arise. Double Tax Treaty, however, was taken recourse to by Appellant only by way of an alternate submission on income from services and not in relation to the tax of offshore supply of goods.

88. We would in the aforementioned context consider the question of division of taxable income of offshore services. Parties were ad idem that there existed a distinction between onshore supply and offshore supply. The intention of the parties, thus, must be judged from different types of services, different types of prices, as also different currencies in which the prices are to be paid.

89. Section 9(1)(vii)(c) of the Act states that “a person who is a non- resident, where the fees are payable in respect of services utilised in a business or profession, carried on by such person in India, or for the purposes of making or earning any income from any source in India”. Reading the provision in its plain sense, it can be seen that it requires two conditions have to be met – the services which are the source of the income that is sought to be taxed, has to be rendered in India, as well as utilised in India, to be taxable in India. In the present case, both these conditions have not been satisfied simultaneously, therefore excluding this income from the ambit of taxation in India. Thus, for a non-resident to be taxed on income for services, such a service needs to be rendered within India, and has to be a part of a business or profession carried on by such person in India. The Petitioners in the present case have provided services to persons resident in India, and though the same have been used here, it has not been rendered in India.

90. Section 9(1)(vii) of the Act whereupon reliance has been placed by the learned Additional Solicitor General, must be read with Section 5 thereof, which takes within its purview the territorial nexus on the basis whereof tax is required to be levied, namely, (a) resident; and (b) receipt or accrual of income.

91. Global income of a resident although is subjected to tax, global income of a non-resident may not be. The answer to the question would depend upon the nature of the contract and the provisions of DTAA.

92. What is relevant is receipt or accrual of income, as would be evident from a plain reading of Section 5(2) of the Act. The legal fiction created although in a given case may be held to be of wide import, but it is trite that the terms of a contract are required to be construed having regard to the international covenants and conventions. In a case of this nature, interpretation with reference to the nexus to tax territories will also assume significance. Territorial nexus for the purpose of determining the tax liability is an internationally accepted principle. An endeavour should, thus, be made to construe the taxability of a non-resident in respect of income derived by it. Having regard to the internationally accepted principle and DTAA, it may not be possible to give an extended meaning to the words ‘income deemed to accrue or arise in India’ as expressed in Section 9 of the Act. Section 9 incorporated various heads of income on which tax is sought to be levied by the Republic of India. Whatever is payable by a resident to a non- resident by way of fees for technical services, thus, would not always come within the purview of Section 9(1)(vii) of the Act. It must have sufficient territorial nexus with India so as to furnish a basis for imposition of tax. Whereas a resident would come within the purview of Section 9(1)(vii) of the Act, a non-resident would not, as services of a non-resident to a resident utilise in India may not have much relevance in determining whether the income of the non-resident accrues or arises in India. It must have a direct live- link between the services rendered in India, when such a link is established, the same may again be subjected to any relief under DTAA. A distinction may also be made between rendition of services and utilisation thereof.

93. Section 9(1)(vii)(c) clearly states ” ….where the fees are payable in respect of services utilised in a business or profession carried on by such person in India……” It is evident that Section 9(1)(vii), read in its plain, same envisages the fulfillment of two conditions : services, which are source of income sought to be taxed in India must be (i) utilised in India and (ii) rendered in India. In the present case, both these conditions have not been satisfied simultaneously.

94. The provisions of Section 9(1)(vii) of the Act are plain and capable of being given a meaning. There, therefore, may not be any reason not to give full effect thereto. However, even in relation to such income, the provisions of Article 7 of the DTAA would be applicable, as services rendered outside India would have nothing to do with permanent establishment in India. Thus, if any services have been rendered by the head office of Appellant outside India, only because they were connected with permanent establishment. Even in relation thereto, principle of apportionment shall apply.

95. The Authority, in our opinion, has committed an error in this behalf, as if services rendered by the head office are considered to be the services rendered by the permanent establishment, the distinction between Indian and foreign operations and the apportionment of the income of the operations shall stand obliterated.

96. It would be contrary to the intent and purport of the Double Taxation Convention which is a part of the scheme under the Income Tax Act.

97. We, therefore, hold as under :

Re : Offshore Supply :

(1) That only such part of the income, as is attributable to the operations carried out in India can be taxed in India.

(2) Since all parts of the transaction in question, i.e. the transfer of property in goods as well as the payment, were carried on outside the Indian soil, the transaction could not have been taxed in India.

(3) The principle of apportionment, wherein the territorial jurisdiction of a particular state determines its capacity to tax an event, has to be followed.

(4) The fact that the contract was signed in India is of no material consequence, since all activities in connection with the offshore supply were outside India, and therefore cannot be deemed to accrue or arise in the country.

(5) There exists a distinction between a business connection and a permanent establishment. As the permanent establishment cannot be said to be involved in the transaction, the aforementioned provision will have no application. The permanent establishment cannot be equated to a business connection, since the former is for the purpose of assessment of income of a non-resident under a Double Taxation Avoidance Agreement, and the latter is for the application of Section 9 of the Income Tax Act.

(6) Clause (a) of Explanation 1 to Section 9(1)(i) states that only such part of the income as is attributable to the operations carried out in India, are taxable in India.

(7) The existence of a permanent establishment would not constitute sufficient ‘business connection’, and the permanent establishment would be the taxable entity. The fiscal jurisdiction of a country would not extend to the taxing entire income attributable to the permanent establishment.

(8) There exists a difference between the existence of a business connection and the income accruing or arising out of such business connection.

(9) Paragraph 6 of the Protocol to the DTAA is not applicable, because, for the profits to be ‘attributable directly or indirectly’, the permanent establishment must be involved in the activity giving rise to the profits.
Re : Offshore Services :

(1) Sufficient territorial nexus between the rendition of services and territorial limits of India is necessary to make the income taxable.

(2) The entire contract would not be attributable to the operations in India viz. the place of execution of the contract, assuming the offshore elements form an integral part of the contract.

(3) Section 9(1)(vii) of the Act read with Memo cannot be given a wide meaning so as to hold that the amendment was only to include the income of non-resident tax payers received by them outside India from Indian concerns for services rendered outside India.

(4) The test of residence, as applied in international law also, is that of the taxpayer and not that of the recipient of such services.

(5) For Section 9(1)(vii) to be applicable, it is necessary that the services not only be utilised within India, but also be rendered in India or have such a “live link” with India that the entire income from fees as envisaged in Article 12 of DTAA becomes taxable in India.

(6) The terms ‘effectively connected’ and ‘attributable to’ are to be construed differently even if the offshore services and the permanent establishment were connected.

(7) Section 9(1)(vii)(c) of the Act in this case would have no application as there is nothing to show that the income derived by a non- resident company irrespective of where rendered, was utilised in India.

(8) Article 7 of the DTAA is applicable in this case, and it limits the tax on business profits to that arising from the operations of the permanent establishment. In this case, the entire services have been rendered outside India, and have nothing to do with the permanent establishment, and can thus not be attributable to the permanent establishment and therefore not taxable in India.

(9) Applying the principle of apportionment to composite transactions which have some operations in one territory and some in others, is essential to determine the taxability of various operations.

(10) The location of the source of income within India would not render sufficient nexus to tax the income from that source.

(11) If the test applied by the Authority for Advanced Rulings is to be adopted here too, then it would eliminate the difference between the connection between Indian and foreign operations, and the apportionment of income accordingly.

(12) The services are inextricably linked to the supply of goods, and it must be considered in the same manner.
98. For the reasons aforementioned, the appeal is allowed in part and to the extent mentioned hereinbefore. No costs.

Appeal partly allowed.