Income Tax Appellate Tribunal - Delhi
Linmark Intl. (Hongkong) Ltd, vs Assessee
IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCH 'D' DELHI
BEFORE SHRI C.L. SETHI AND SHRI K.G. BANSAL
ITA Nos. 1942 to 1948(Del)/2008
Assessment years: 1999-00 to 2005-06
Linmark International (Hong Kong), Deputy Director of Income-tax
Ltd., India Liaison Office, Vs. Circle 3(1), International
26-B, Udhyog Vihar, Phase-V, Taxation, New Delhi.
Gurgaon.
PAN-AABCL1141R
(Appellant) (Respondent)
Appellant by : Shri Rajan Vohra
Respondent by : Shri Ashwani Mahajan, CIT, DR
ORDER
PER K.G. BANSAL : AM These seven appeals filed by the assessee emanate from the consolidated order passed by CIT(Appeals)-XXIX, New Delhi, on 14.3.2008 in appeal nos. 416 to 421/06-07 and 186/07-08, pertaining to assessment years 1999-00 to 2005-06. The appeals involve common grounds and were argued in a consolidated manner by the ld. counsel for the assessee and the ld. CIT, DR. Therefore, we find it convenient to 2 ITA Nos. 1942 to 1948(Del)/2008 pass a consolidated order. The grounds for assessment year 1999-00, which are typical in nature, are reproduced below:-
1. "That the ld. Commissioner of Income-tax (Appeals)-XXIX, New Delhi has erred in facts and in law in holding that the appellant is taxable in India in respect of the activities carried out by the Liaison office in India ("Indian LO") since the activities are limited to assistance in procurement of goods from India.
2. That the ld. CIT(A) has erred in facts and in law in holding that the Indian LO was engaged in carrying out almost all the functions of the commission business in India on behalf of the appellant.
3. That the ld. CIT(A) has erred in facts in attributing 72%of commission income on FOB value of exports to the operations of Indian LO without giving cognizance to the fact that the Indian LO was not involved in the main commission activity of the appellant.
4. That the ld. CIT(A) was not justified in not accepting the functional analysis and risk analysis furnished by the appellant providing weightage to all the functions performed by each entity and instead assigning his own weights to such functions and arriving at a higher attribution to the Indian LO then as submitted by the appellant.
That the ld. CIT(A) erred in facts in holding that the attribution to Indian LO on the basis of functions performed and risk assumed is 86% and 44% respectively without considering the submissions made by the appellant that the attribution to India on the basis of functions performed and risk assumed is 33% and 15% respectively.
5. That the ld. CIT(A) was not justified in law and on facts in directing the Assessing Officer to verify the turnover from Indian operations, actual commission and the expenses of Indian LO without taking into consideration that all the details were present before ld. CIT(A).
3 ITA Nos. 1942 to 1948(Del)/2008
6. That the ld. CIT(A) erred in facts and in law in confirming the charging of interest under sec. 234B and 234C of the Act on the ground that provisions of section 234B and 234C of the Act are mandatory in nature."
2. On perusal of the assessment order passed by the Dy. Director of Income-tax, Circle 1(1), International Taxation, New Delhi ("AO" for short) on 28.12.2006 for assessment year 1999-00, it is seen that the assessee-company is incorporated in Hong Kong and is a tax resident of that country. The assessee has set up offices in India in Delhi, Bangalore and Tirpur after obtaining permission from the Reserve Bank of India. These offices are termed as "liaison offices" ('LO' for short) by the RBI and the assessee. Survey operation u/s 133A of the Income-tax Act, 1961 ("the Act" for short), was carried out at the Bangalore office on 26.10.2005. In the course of survey, it was found that the office was engaged in the business of management of supply chain of garments, which included providing of multifarious services, such as product design and development, sourcing, merchandising follow-up, quality control, factory evaluation and shipping coordination. Certain documents were also found in the course of survey. In the course of survey and thereafter, statements of Ms. Farah Kadri, Global Sourcing Head, Shri Harish Shenoy, Administrative In-charge of Bangalore office, Shri Narayan Singh, 4 ITA Nos. 1942 to 1948(Del)/2008 Shri Sandip Seal, Ms. B. Sangeetha, Shri G. Krishna, Shri C.M. Kharbanda and Shri Sudhir Nair were recorded. On the basis of the facts discovered in the course of these inquiries, it was concluded that income of this year had escaped assessment. Therefore, notice u/s 148 was issued on 14.3.2006, which was responded to by the assessee by filing a return on 10.5.2006 declaring nil income. Thereafter, assessment proceedings were initiated by issuing notice u/s 143(2). On the basis of facts discovered in the course of survey, statements of various employees and the facts discovered in the course of assessment proceedings, the AO ascertained the nature of business activities carried on by the assessee in India offices. These activities have been summarized as under:-
• interaction with clients (purchasers) to find out product specifications;
• vendor development i.e., finding out who can manufacture the clients' requirement;
• visiting factories of different suppliers, studying their product design, developing the designs and showcasing the same to the foreign clients, getting such products designs approved after modifications, in the process helping the client as well as the vendors;
• finalization of vendor (supplier), booking of order;
• day-to-day control over production quality, process quality;5 ITA Nos. 1942 to 1948(Del)/2008
• preparation & approval of samples;
• price negotiations- through e-mail & with international meetings between clients, Linmark & suppliers;
• maintaining beak-up of cost into component so as to source at the cheapest for the client;
• order tracking involving sample & fabric approval, pre-production approvals Lab testing & control over production;
• production/process control from fabric selection to cutting to shipping of the goods;
• factory reporting for child labour and other HR related issues/ particulars to purchases from US/Europe;
• middle line quality audit, final packing inspection and shipment release;
• in respect of sourcing from India for the clients, Indian offices of the company are the only link between the clients and the vendors and these offices maintain the relationship and look into all operational aspects relating to supplies by the vendors. This particularly includes the supply chain management.
2.1 Based upon the aforesaid activities, it was concluded that the Indian operations had the effect that all business transactions except formation of contracts were carried out in India. Therefore, a show cause notice was issued to the assessee asking it to furnish its explanation as to why the income arising from Indian operations should not be brought to tax. It was submitted that Linmark Development (BVI) Ltd.6 ITA Nos. 1942 to 1948(Del)/2008
has been carrying on the business of buying and procuring agent for its customers located in the USA, Canada, Australia, Europe and other developed countries from various countries located in Asian region including India. In this connection, it has entered into a service agreement with Linmark International (Hong Kong) Ltd., the assessee, which is engaged in providing facilitation services in connection with buying of goods from various countries in Asia. Under the Agreement, the assessee is to render facilitating services to the buyers, which have been identified by Linmark Development (BVI) Ltd. In other words, the assessee acts as a communication and connecting link between Linmark Development (BVI) Ltd., its buyers and vendors in India. Therefore, the assessee is a conduit between the buyer and seller and it acts on the basis of instructions received from the buyers of Linmark Development (BVI) Ltd. The assessee and its liaison offices in India act only as a coordinating agency. Linmark Development (BVI) Ltd. receives commission from its buyers, calculated on a fixed percentage of the FOB value of the goods exported to its clients outside India. For its services, the assessee is remunerated @ 1% of FOB value of the goods. On these facts, it was argued that the assessee was not liable to pay any tax in India for the reason that no income could be deemed to accrue or arise u/s 7 ITA Nos. 1942 to 1948(Del)/2008 9(1)(i) in case the activities are confined to purchase of goods for the purpose of exports. However, the AO was not satisfied with this explanation. He was of the view that Linmark Development (BVI) Ltd. is a non-functional entity, in as much as it does not play any role in the goods sourced from India. The employees of the assessee in India directly correspond with the clients and vendors without involvement of any other person. He referred to the details available on the website of Linmark Group, Hong Kong, which mentions that it is one stop global sourcing and supply chain management solutions provider for leading retail chain operators, well known brands, whole sellers, mail order houses and departmental stores in the USA, Canada, Europe, South Africa, Asia and Australia, the global sourcing network encompassing presence in 36 cities across 25 countries and territories. It focuses on ensuring the quality and timely delivery of products to the clients. It offers a modular range of services precisely tailored to the needs of each client, emphasizing on management of their brands. The services include product development, designing, sourcing, merchandising follow-up, factory evaluation, quality control, social compliance auditing and shipping coordination. He also referred to the letter dated 5.12.2005 written by Shri C.M. Kharbanda to the Assistant Commissioner of Income-tax, International Taxation, 8 ITA Nos. 1942 to 1948(Del)/2008 Bangalore, in which it is stated that he had no idea as to how Linmark Development (BVI) Ltd. is remunerated for servicing the clients for shipment taking place from India. There is no direct relationship between Indian office and that company. Ms. Farah Kadri had also stated in her statement that she is not aware of the existence of Linmark Development BVI Ltd. In view thereof, it was held that the assessee is liable to be taxed under the Act. Coming to the attribution of income to the India offices, it was noted that the commission varied between 5% to 6% FOB of the value of the shipment. 90% thereof was attributed to the offices in India as bulk of the activities was carried on in India, the head office at Hong Kong having virtually no role to play in it. Accordingly, the total income of this year was computed at `5,38,81,432/-.
3. Various questions came up before the ld. CIT(A) for determination. The first question is-whether, the assessee is liable to be taxed in India u/s 9(1)(i) of the Act? In this connection, the admitted facts are stated to be that Linmark Development (BVI) Ltd. enters into agreements with various customers in UK, the USA, Canada etc. for assisting them in locating suppliers of apparels and garments in India. It sub-contracts this work to 9 ITA Nos. 1942 to 1948(Del)/2008 the assessee, who has offices in India. The functions of the two parties under the agreement are as under:-
a. "Party A has solicited customers in the USA, Canada, Australia, Europe and other developed countries and is principally engaged in the business of acting as a buying agent of export merchandise.
b. Party B is working closely with vendors and manufacturers in India and is principally engaged in the business of acting as a sub-agent to provide support and administrative services to buying agent."
3.1 The main responsibility of dealing with overseas buyers rests with Linmark Development(BVI) Ltd. and in particular it has the following responsibilities:-
a) Researching and developing.........in the developed countries;
b) Determining the requirement for specific buyers in respect of product quantity, quality, delivery schedule etc. ;
c) negotiating detailed purchase contracts with overseas buyers either on a specific basis or under a General Buying Agreement;
d) Making contracts with buyers and ensuring good business relationship to maintain buyers interest in using the services of party A and party B and in particular, dealing with any problems or complaints arising from the relationship;
e) Communicating all problems raised by buyers promptly to party B for the purposes of having them resolved by party B and the manufacturer;10 ITA Nos. 1942 to 1948(Del)/2008
f) Providing personal services to buyers traveling to India to assist them in negotiations in India;
g) Co-ordinating all matters relating to internal buying operations; and
h) Securing international market information as to buying trends, competitive activities, economic forecasts etc. in the developed countries.
3.2 The assessee is responsible for dealings with the vendors in India. It has the following responsibilities:-
a) Sourcing of manufactured merchandise suitable for export from India;
b) Assisting buyers to find the appropriate manufacturer and aiding in negotiations on specifications, quality, quantity, delivery and all incidental matters;
c) Supervising manufacture and inspecting merchandise and providing quality-control services;
d) Assist the manufacturers in checking shipping schedules and verification of shipping documents;
e) Pursuing on behalf of Party A all customers' queries, complaints and claims with a view to resolving all such problems;
f) Providing information on local markets as to general price trends, suitability of particular industries, competitive activities and general economic information.11 ITA Nos. 1942 to 1948(Del)/2008
3.3 In consideration of the services rendered by the assessee, it is mentioned that the fees shall be charged on arm's length basis, which will be determined at 1% of the FOB value of all shipment of orders placed through the assessee. This fees shall be reviewed on an annual basis or whenever the parties consider it appropriate. 3.4 The assessee is responsible for meeting expenses incurred by it in performance and fulfillment of its duties including the expenditure on salaries and wages, the cost of labour services and stationery and invoices. It is entitled to collect fees and charges from the vendors to recover some of the incidental expenses incurred by it on their behalf, such as courier, colour testing, air freight, claims etc. 3.5 It is also mentioned that the admitted facts which emerge from the survey and subsequent enquiries are as under:-
• That assessee was maintaining offices in Delhi, Bangalore and Tirupur for carrying of business in India. The Bangalore office started operation in year 1994 whereas Delhi office was established in the year 1998.
• That the business activity of the assessee in India could be classified under following categories:-12 ITA Nos. 1942 to 1948(Del)/2008
o Factory and product sourcing o Product development o Factory evaluations o Price negotiations o Following up of sampling o Merchandising following-up o Quality control inspections o Shipping coordination • That clients of Bangalore office are HBC, Mothercare, CK, Metro Jaya, Mydin, Cotton Traders, Edgars, whereas the customers for the Tirupur office are Mothercare, HBC, Jockey, Metro Jaya, Mydin, Cotton Traders and Edgars.
• That at least 16 factories of vendors in Bangalore and 25 factories of vendors in Trupur are in the active list of suppliers/vendors.
• That the assessee was maintaining quality control department in Bangalore and Tirupur wherein third party audit and inspection has been carried out under controlled conditions. The strength of quality approval department in Bangalore and Tirupur was seven and ten in numbers. It was disclosed during survey that due to exclusive QA platform the assessee was able to improve the quality of merchandise by 350% as compared to earlier years.
• That assessee has a fabric technical team responsible for all fabric issues in India and the unit is supervised by Mr. Carlos.
• That the copies of inspection reports found during the course of survey have revealed that assessee's quality assurance team checks each consignment material, accessories cutting, critical construction check point, washing, finishing, pressing, packing, critical measurement.
• That in respect of each customer and vendor, the LO office of assessee prepares a status report which contains detailed information in respect of all customers, their respective vendors, total shipped quantity and total shipped FOB value in US$. It also 13 ITA Nos. 1942 to 1948(Del)/2008 contains information about total claim made by customers and other proposed corrective actions.
• That assessee arranges textile testing and lab instruments testing for all the supplies and incurs expenditure for the lab testing charges.
• For Delhi office, the assessee has three managers, four person in HBC Bay team, two persons in Blair team, two persons in Nelson team, three persons in mothercare team, five persons in hard goods team, five person in Q.A. department, five persons in EDP and three persons in administration and shipping department.
• During the course of survey and post survey proceedings, statements of Ms. Farah Kadri, Global Sourcing Head, Shri Harish Shenoy, Administrative in charge at I.O. Bangalore, Shri C.M. Kharbanda, Head of Finance, Delhi and Shri Sudhir Nair, Qualaity in charge, all employee of I.O. were recorded.
3.6 The ld. CIT(A) also summarized the salient features of statements of various employees. Thereafter, it is held that the offices in India have been carrying on the following activities:-
• Understanding the requirement of the customers regarding their preferences for material, quality and other specific concerns by making direct interaction by the employee of LO office of appellant in India;
• Identifying most appropriate and feasible suppliers in India;
• Evaluation of suppliers manufacturing facilities;
• Communication of requirements of the customer to suppliers of goods in India;14 ITA Nos. 1942 to 1948(Del)/2008
• Development of sample with close coordination with potential suppliers and approval of samples;
• Obtaining the proto samples from suppliers and sending it to customer in USA, U.K., Canada for its approval;
• Fabrics and accessories bookings;
• Holding price negotiation through E-mail or international muting with customer at time in presence of suppliers;
• Maintaining break-up of cost of component so as to source the merchandise at the cheapest rate for client;
• Holding pre-production meetings with the suppliers with respect of quality related issues;
• Order trading which involve sample, fabric approval, pre-production approval lab testing and control order production;
• Production/process control from fabric selection to cutting to shipping of the goods;
• Inspection and control over production of merchandise;
• quality control work through quality assurance teams and quality control facilities and instrument at Bangalore, Tripur and Delhi;
• product development;
• timely dispatch of goods, shipping and shipping coordination;
• factory reporting for child labour and other HR related issues particularly purchase from USA and Eurpe.
3.7 On these facts, he did not agree with the assessee that the offices in India are carrying on preliminary or auxiliary activities only.15 ITA Nos. 1942 to 1948(Del)/2008
On the other hand, it was held that these offices were carrying on substantial activities pertaining to the business of the assessee. Therefore, it had also business connection in India. These offices were also the Permanent Establishment of the assessee in India. Accordingly, it was also held that the assessee was liable to be taxed in India on the income attributable to India offices.
3.8 The second question before him is - whether, the AO was justified in computing the income @ 6% of the FOB value of the goods shipped from India to the clients of Linmark Development (BVI) Ltd.? The submissions of the assessee were that the rate of commission paid to Linmark Development (BVI) varied from customer to customer and it ranged between 4.4% to 8% of the FOB value. Therefore, a uniform rate of 8% cannot be applied. The rate of commission earned from each customer was available and the income can be computed accordingly. In this connection, the ld. CIT(A) directed the assessee to file master buying agreement in respect of each buyer along with the rate of commission paid to Linmark Development (BVI) Ltd. in various years. These details were furnished. On the basis of these details, the commission incomes earned by Linmark Development (BVI) Ltd. for 16 ITA Nos. 1942 to 1948(Del)/2008 various years were computed. Such computation for various years is available on page nos. 22 to 26 of the impugned order. On this calculation, it was found that the commission received in each year was lower than the amount of commission computed by the AO, as depicted from the following table:-
A.Y. Actual commission Commission amount
received by Linmark adopted by Assessing
BVI Officer
1999-2000 22,855,323 59,868,258
2000-01 27,596,572 59,868,258
2001-02 54,484,576 59,868,258
2002-03 83,954,248 90,959,022
2003-04 108,924,070 1,30,780,710
2004-05 74,375,331 89,246,809
2005-06 77,024,963 95,786,156
449,214,082 586,377,472
3.9 The next question before him is - what percentage of the aforesaid
commission earned by Linmark Development (BVI) Ltd. should be
attributed to the permanent establishment of the assessee in India? In this connection, FAR analysis was submitted before him. The first part of the analysis is in respect of the functions performed by the Linmark Development BVI; the head office of the assessee and the branch offices of the assessee. The assessee broke up the functions in 20 parts and thereafter attributed 60% of the functions to Linmark Development BVI, 2% to the head office of the assessee, 33% to the permanent 17 ITA Nos. 1942 to 1948(Del)/2008 establishment of the assessee in India and 5% to the others. The second part of the analysis comprised of the assets used. It was represented that out of assets used for the purpose of the business, 50% belonged to Linmark Development BVI, 32% to the head office of the assessee company and 18% to the permanent establishment of the assessee in India. The third and the last part was the risk analysis. It was held out that 94% of the risk was borne by Linmark Development BVI, 3% by the head office of the assessee company and 3% by the offices of the assessee in India.
3.10 The ld. CIT(A) considered the analysis furnished by the assessee company. He also considered the facts discovered in the course of survey and in the assessment proceedings. The assessee had broken up the overall functions into 20 activities and attributed them to one or the other entity or branch thereof. The ld. CIT(A) was of the view that items mentioned in column nos. 2, 3, 5, 6, 7, 9, 10, 11, 12, 13 etc. Were attributed to Linmark Development (BVI) Ltd. but, in fact, performed by the offices of the assessee in India. Further, he was of the view that certain functions performed by the Indian offices, namely, product development, price negotiations and day-to-day control over production 18 ITA Nos. 1942 to 1948(Del)/2008 at the factories of the vendors were not considered as core functions of the business. He was also of the view that Linmark Development (BVI) Ltd. identified customers in overseas markets and signed Master Buying Agreements with them. Most of the customers are old. Therefore, weightage of 10% was given to this activity in the overall activities. He was also of the view that at the time of finalisation of the master-buying agreement, the most appropriate geographical area in sourcing the goods was also identified. Therefore, he assigned 2% weightage to this function in this year. Looking to statements of various employees, he was of the view that the head office conducted only tri-monthly meeting for coordination purposes. Therefore, he assigned 2% weightage only to this function. On the basis of this analysis, it was concluded that 12% of the activities were carried out by Linmark Development (BVI) Ltd. 2% by the head office of the assessee and 86% by the offices in India. 3.11 He also considered the risk analysis carried out by the assessee in the light of statements of various employees and the master-buying agreements. He was of the view that there were four types of risks, namely, the risk of quality or incorrect design of the merchandise, risk of samples-rejection, risk of late delivery and risk of employment of child 19 ITA Nos. 1942 to 1948(Del)/2008 labour in the vendors' factories. He apportioned 56% of the risk to the Linmark Development (BVI) Ltd. and 44% to the offices in India. No risk was apportioned to the head office of the assessee-company. 3.12 The last component of the analysis was in respect of the assets employed. In this connection, it was mentioned that there is no evidence that any asset located in the head office was actually used for the purpose of earning the commission income. It was further mentioned that there is no evidence that all assets held by Linmark Development (BVI) Ltd. at British Virgin Irelands were actually used for the purpose of business. 3.13 Finally, he came to the conclusion that 86% of the activities were carried out in India and 44% of the risks pertained to the Indian offices. All Indian assets were used for the purpose of business. Therefore, he came to the conclusion that 72% of the commission earned by Linmark Development (BVI) Ltd., is attributable to the activities carried out in India.
3.14 The last question before him in this connection was- whether expenditure incurred by Indian offices is deductible in computing the 20 ITA Nos. 1942 to 1948(Del)/2008 income attributed to the Indian offices? The AO had allowed the expenditure in assessment year 2005-06, but did not allow the same in earlier years. The ld. CIT(A) was of the view that the expenditure incurred in India is in respect of the income attributed to Indian offices and, therefore, the same is deductible in computing the income. Further, he was of the view that what is chargeable to tax is income (profits) and not gross receipts. Therefore, he allowed the expenditure after making some adjustments. Thus, the expenditure allowed in various years was worked out as under:-
S.No. A.Y. Expenditure of LO
office from April to
March
1. 1999-00 1,81,55,763
2. 2000-01 2,08,70,236
3. 2001-02 3,56,94,251
4. 2002-03 4,85,18,639
5. 2003-04 5,64,75,186
6. 2004-05 6,55,24,922
7. 2005-06 6,79,03,325
4. Before us, the ld. counsel for the assessee summarized the facts of the case. It has been submitted that the assessee had three offices in Bangalore, Tirpur and Delhi. Survey u/s 133-A of the Act was conducted at the Bangalore office in October, 2005, and statements of various 21 ITA Nos. 1942 to 1948(Del)/2008 employees were recorded. The offices in Bangalore, Tirpur and Delhi have been designated as liaison office ("LO" for short) by the Reserve Bank of India. In view of one of the conditions imposed for opening these LOs, the assessee has been furnishing year-wise accounts and certificates to the RBI. The central bank, entrusted with the regulatory responsibilities, has not found any fault with the accounts. The offices in India have been selecting the garments to be supplied to the customers of Linmark Development (BVI) Ltd. abroad. The orders are directly placed by the customers with the vendors. The goods are shipped by the Indian vendors directly to the customers. The commission is received by Linmark Development BVI outside India. Thus, the functions of Indian offices are to locate Indian vendors for supply of goods and shipping them to the customers of Linmark Development (BVI) Ltd.. 4.1 Our attention has been drawn towards the provision contained in clause (b) of Explanation-1 to section 9(1), which provides that in case of a non-resident person, no income shall be deemed to accrue or arise in India to him through or from their operations which are confined to the purchase of goods in India for the purpose of export. It is argued that the case of the assessee is covered under this Explanation and, thus, no income 22 ITA Nos. 1942 to 1948(Del)/2008 can be deemed to accrue or arise to the assessee in India as its operations are confined to the operations of purchase of goods in India for the purpose of exports. As it is the case of the assessee that it is not exporting goods out of India, but the goods are exported by the vendors directly to the customers and the Linmark Development (BVI) Ltd. abroad, for which the commission was received outside India, the ld. counsel was requested to further elaborate on the interpretation of this provision. In this connection, reliance has been placed on the decision of Hon'ble Delhi High Court in the case of CIT Vs. N.K. Jain (1993) 206 ITR 692. Further, reliance has been placed on the decision of Bangalore Bench of the Tribunal in the case of Mondial Orient Ltd. Vs. ACIT (2010) 129 TTJ 560. Reliance has also been placed on the decision of Bangalore Bench of the Tribunal in the case of Nike Inc. Vs. ACIT (2009) 122 TTJ 201 and the Ruling of the Authority for Advance Ruling in the case of Aramco Overseas Company BV (2010) 322 ITR 612. It is also submitted that earlier a part of the profit was attributed to and was deemed to arise from purchase of goods in British India by way of purchase of cloth, as held in the case of Anglo-French Textile Co. Ltd. Vs. CIT (1953) 23 ITR 101 and Bikaner Textile Mercanatile Merchandise Ltd. vs. CIT (1965) 58 ITR 169 (Rajasthan), but due to specific 23 ITA Nos. 1942 to 1948(Del)/2008 provision incorporated in section 9 subsequently, as discussed above, and Board circular no. 20 dated 7.7.1964, the ratio laid down in these cases longer represents the position of law now. Accordingly, it has been argued that no income can be deemed to accrue or arise in India. 4.2 In this connection, the ld. counsel was also requested to state his case of non-taxability of income in India u/s 5(2)(b), under which the total income of a non-resident person inter-alia includes income which accrues or arises to him in India in any previous year. His submission is that no income accrues or arises to the assessee as discussed earlier. Further, section 9 deals with the situation obtained in the case of the assessee. This is a specific provision and, thus, the aforesaid provision is not applicable to its case. In the alternative, it has been submitted that if it is held that income accrues or arises to the assessee, then, the working submitted by the assessee before the ld. CIT(A) regarding attribution of income to the operations carried out in India may be accepted.
5. In reply, the ld. CIT, DR submitted that the assessee is carrying on a host of activities in India through the three branches. In the FAR analysis submitted by the assessee, 33% of the activities have been 24 ITA Nos. 1942 to 1948(Del)/2008 attributed to the Indian offices, which leads to a clear inference that income accrues to the assessee in India. In such a situation, there is no necessity to go to the provision contained in section 9(1)(i) and the Explanation thereto, which excludes the income arising from activities of mere purchase of goods for the purpose of exports outside India. In this case, the assessee is not an exporter of goods. The Indian offices, termed by the assessee as LOs, are functioning offices, contributing to the profits of the assessee company. Therefore, the income accrues or arises in India. Under the treaty also, the assessee has three fixed places of business in India from which income accrues to it. Accordingly, it has been argued that the assessee is liable to be taxed on income arising out of Indian operations.
5.1 Coming to attributation of income to the Indian offices, it was submitted that the ld. CIT(A) has carried out detailed FAR analysis, on the basis of which 72% of the total commission income earned by Linmark Development (BVI) Ltd. has been attributed to the Indian operations. While there could be some case of minor adjustment to the ratio, it can certainly not be as low as 1% of the FOB value of goods exported as agreed between the assessee and Linmark Development BVI. 25 ITA Nos. 1942 to 1948(Del)/2008 5.2 Coming to the deduction of expenses incurred by Indian offices, it was fairly conceded that the expenditure was incurred for earning the income and the same is deductible in computing the profits from the business.
6. We have considered the facts of the case and the submissions made before us. The first question before us is- whether, any income accrues or arose to the assessee in this and other years? Section 5(2)(b) of the Act brings to tax any income from whatever source derived which accrues or arises or is deemed to accrue or arise to a non-resident person in India during the year. This provision has two components, (a) income which accrues or arise in India; and (b) is deemed to accrue or arise in India. The second component of this provision is amplified in section 9 regarding "income deemed to accrue or arise in India". The primary case of the assessee is built upon section 9 i.e., the second component of the provision contained in section 5(2)(b). Further, the assessee is a buying agent of the Linmark Development (BVI) Ltd. and it is not the exporter of goods and merchandise. It receives commission @ 1% of the FOB value of the goods exported by the vendors in India to the customers of that 26 ITA Nos. 1942 to 1948(Del)/2008 company. The question whether any income accrues or arises or is deemed to accrue or arise to the assessee in India has to be seen from the stand point of its business and not the business of Linmark Development (BVI) Ltd.
6.1 In the case of N.K. Jain (supra), the facts are that the assessee is a non-resident person carrying on business in ready-made garments in Japan. He has an arrangement with a commission agent in India to purchase readymade garments on his behalf and to export them to him. The agent also purchases dress material on the instruction of the assessee and gets it stitched into garments through the tailoring establishments in India and exports such garments to the assessee. The assessee is registered with Handloom Export Promotion Council as a merchant- exporter. The Hon'ble Court held that the case of the assessee is fairly covered by clause (b) of the Explanation to section 9(1)(i). It is immaterial whether the assessee had an agent or an office in India or whether he carried out any manufacturing process here. The assessee is entitled to exemption from the operation of section 9(1)(i) as long as it could be assumed that his case is covered by circular no. 20 dated 7.7.1964. Thus, no income shall be deemed to accrue or arise to a non-resident person 27 ITA Nos. 1942 to 1948(Del)/2008 which accrued through him from the operations which were confined to purchase of goods in India for the purpose of export. It was also a finding of fact recorded by the Tribunal that the assessee is carrying on the business of ready-made garments and the arrangement is only to purchase readymade garments through an agent, which clearly entitles the assessee to the benefit of aforesaid clause (b). The facts of this case are distinguishable in as much as the assessee is not an exporter of goods or merchandise. It is a commission agent, rendering services to Linmark Development BVI Ltd., who is the exporter of goods and merchandise to its clients in the USA and Europe. Therefore, the position of the assessee is not similar to N.K. Jain but similar to the agent of N.K. Jain located in India who purchases dress materials and gets them stitched into garments through tailoring establishments in India.
6.2 In the case of Mondial Orient Ltd. (supra), the facts are that the assessee is a Hong Kong based company, which established branch offices in India at Bangalore, Tirpur and Delhi. It claimed that its income was not liable to be taxed in India u/s 9(1)(i) as its operations in India were confined to purchase of goods for the purpose of export. The enquiries by the AO revealed that the India offices were engaged in 28 ITA Nos. 1942 to 1948(Del)/2008 business of supply chain management of garments which included services like product design and development, sourcing, merchandising follow up, quality control, factory evaluation and shipping coordination. Therefore, it was held that substantive business transactions were being undertaken in India. On the other hand, the assessee relied on the decision in the case of N.K. Jain and claimed that it was entitled to the benefit of clause (b) of Explanation 1 to section 9(1)(i). The Tribunal did not accept the argument of the revenue that the assessee is not purchasing the goods but it is only rendering services on behalf of its head office. The provision is applicable not only in respect of purchase of goods as such but also in respect of operations which are limited to purchase of goods in India for the purpose of export. Therefore, it was held that no income can be deemed to accrue or arise to the assessee in India. The facts of this case are also distinguishable. Actually, the revenue tried to distinguish between the head office of the assessee and its branches in India, which are only parts of the same entity. The services were rendered by Indian branches in respect of export of goods outside India. However, in this case the Indian vendors are the exporter of goods. Even if it is assumed that the facts of the case are not distinguishable, what can be said is that no income can be deemed to accrue or arise to the 29 ITA Nos. 1942 to 1948(Del)/2008 assessee in India from the operations of rendering services to Linmark Development (BVI) Ltd. The question of applicability of section 5(2)(b) is still open.
6.3 The facts of the case of Nike Inc. (supra) are that it is a world known name or brand in sports apparels. It has its main office in the USA and associated enterprises or subsidiaries in various parts of the world. The head office in USA arranges for all its subsidiaries various brands of sports apparels for sale to various customers. The arrangement is through procurement by manufacture from manufacturers who directly dispatch the apparels to various subsidiaries all over the world. From the point of view of procurement of various apparels by manufacture with the assistance of various manufacturers from various parts of the world, it approached the Reserve Bank of India to allow it to pen a liaison office in India with the explicit condition that no activity of the nature of trading, commerce or industrial will be carried out without the previous approval of the RBI. It was also committed that the assessee will not charge commission or fees or remuneration in regard to any of the services rendered by it in India. It was also committed that the entire expenditure of the liaison office in India will be borne by the assessee from the 30 ITA Nos. 1942 to 1948(Del)/2008 USA by sending funds through regular banking channels to India. It was also undertaken that the liaison office in India shall not borrow or lend without the previous approval of the RBI. It was submitted that the activities in India were confined mainly to purchase or procurement of apparels from India for the purpose of export by those manufacturers directly to various exporters of the assessee in various places all over the world. The liaison office had no source of income in India and it was meeting its expenses out of remittances received from the USA. It was held that the assessee in the USA is a world wide organisation and carries on the business as agent for its various subsidiaries or clients, who ultimately buy the goods and sell the goods. It is one window control to ensure quality of the product world over. The purchase of goods for the purpose of exports need not necessarily mean purchase by the ultimate user, but include purchase of goods combined with its export out of India, which is achieved by placing orders in India with manufacturers, who export it out of India. The manufacturers receive consideration for the export in foreign currency. Therefore, all the services that are rendered by the non-resident company through its liaison office are for purchases for export, and hence, no income is earned in India. In other words, clause (b) of Explanation 1 regarding purchase for purpose of export 31 ITA Nos. 1942 to 1948(Del)/2008 applies to the assessee. Hence, no income is derived by it through its operations of the liaison office in India. This case is also based on interpretation of section 9 of the Income-tax Act.
6.4 In the case of Angel Garment Ltd. (supra), the ld. AAR mentioned that a plain reading of the provision contained in clause (b) of Explanation 1 would show that no income shall be deemed to accrue or arise to a non-resident person through or from operations which are confined to purchase of goods in India for the purpose of exports. The admitted position is that activities carried on by the liaison office are confined to purchase of goods for the purpose of exports. It is immaterial whether the export of goods is to Hong Kong or to any other country as the provision does not specify that the export should only be to the country of which the applicant is a resident. Accordingly, it was held that from the nature of proposed activity to be carried on by and the nature of powers of the liaison office which is proposed to be set up in India by the assessee, a non-resident company, it cannot be said that the applicant could earn any income taxable in India under the provisions of the Income-tax Act, 1961. It may be mentioned here that the ld. AAR considered only the provisions contained in section 9 and thereafter 32 ITA Nos. 1942 to 1948(Del)/2008 made a sweeping statement that it cannot be held to have earned any income taxable in India under the provisions of the Income-tax Act, 1961, as if all other provisions had also been considered, which is not the case. 6.5 On the other hand, the case of Performing Right Society Ltd. & Another Vs. CIT & Others (1977) 106 ITR 11 (SC) was also discussed with the ld. counsel in the course of hearing before us. The facts of the case are that the society is a non-resident person. It receives income out of the agreement executed outside India in England. On behalf of the assessee, it was contended that the source of income was the agreement which was entered into in England. The Hon'ble Court did not agree with this view and it was mentioned that the question as to the source of income is irrelevant because sub-section (2) of section 5 provides that all income from whatever source derived is to be included in the total income of the non-resident assessee if the income accrues or arises in India during the relevant year. It is further mentioned that a reference was also made to section 9 which enumerates the income that shall be "deemed to accrue or arise in India" though actually accruing elsewhere, to establish that income in question could not be deemed to accrue or arise in India. But the income in this case has, in fact, accrued in India and 33 ITA Nos. 1942 to 1948(Del)/2008 no question arises whether it should be deemed to accrue or arise in India. This decision clearly establishes the proposition made by us earlier that section 5(2)(b) has two independent components, one dealing with accruing or arising of income in India and the other with income which is deemed to accrue or arise in India. The Hon'ble Court also mentioned that the question whether a certain income accrues or arise in India within the meaning of section 5(2) is a question of fact, which should be looked at and decided in the light of common sense and plain thinking. In that case, the assessee had copyright in certain western musical discs. On payment of royalty, the All India Radio broadcast the music from its stations and the question was- whether, the royalties received by the assessee were taxable in India? The question was decided in favour of the revenue and against the assessee. Therefore, in spite of the decisions cited by the assessee, most of which are distinguishable on facts, it has still to be decided whether income accrues or arises to the assessee in India. 6.6 In this connection, we may refer to the activities carried on by the Indian offices, as mentioned by the ld. CIT(A) and enumerated by us in paragraph 2.6 (supra). By no stretch of imagination, it can be said that these activities are not in the normal course of business of the assessee 34 ITA Nos. 1942 to 1948(Del)/2008 as a commission agent. The Indian offices practically carry out all operations of the business of the commission agent except the formation of the contract between the vendors and the buyers, which in any case cannot be done by a commission agent. While carrying out FAR analysis, the assessee attributed 33% of the business functions to the Indian offices. 18% of the assets employed in the business belong to the Indian offices. It is also admitted that 3% of the risk was taken by Indian offices. It may be mentioned that the corresponding figures, arrived at by the ld. CIT(Appeals) are much higher than these percentages. Nonetheless, it remains a fact admitted by the assessee that substantial part of business operations of commission agent is carried out in India by the Indian offices. In such a situation, it cannot be argued that no income accrues or arises in India from the commission to which the Linmark Development (BVI) Ltd. is entitled to. Accordingly, relying on the decision in the case of Performing Right Society Ltd. & Another ( supra), it is held that notwithstanding the nomenclature of liaison office, the Indian offices are carrying out real and substantive business operations of the assessee , the income from which accrues or arises in India.
35 ITA Nos. 1942 to 1948(Del)/20086.7 Further, the provision contained in section 9(1)(i) is subject to the limitation contained in clause (b) of the Explanation 1. This provision scales down the rigor of section 9 in a certain situation. Such a limitation can not obviously be read into the first part of the provision contained in section 5(2) (b) which, as mentioned earlier, stands independent of section 9. In fact, section 9 is an appendage to section 5 and not the vice- versa. It is also an admitted fact that profit accrues from mere purchase of goods, as held in the case of Bikaner Textile Merchants Syndicate Ltd. (supra). The relevant portion of the judgment is reproduced below:
"The point to be noted is that the assessee here was able to secure a clear profit of one and half per cent on the goods purchased by it in British India and as no intermediary operation or process was required in order to earn those profits, there can be little doubt that the profits arose merely as a matter of course as soon as the goods were purchased and were brought into the Bikaner State. It was held in Chas J. Webb Sons and Co. Inc., Philadelphia v. Commissioner of Income-tax that the purchase in British India of wool by a non-resident company as raw material for use in manufacturing carpets is an operation carried out in the course of its business by a person or firm which manufactures carpets and that the purchase contributes to an appreciable degree to the ultimate profit which is realized on the sale of the manufactured articles. The learned judges further observed that a wise purchase of raw materials must contribute to a considerable extent to the profits realized on the sale of manufactured products and one way in which this can be brought about is by the manufacturers' direct purchase of raw materials in the countries where they are best available.36 ITA Nos. 1942 to 1948(Del)/2008
There can be no doubt that the present case stands on a much higher footing. The acquisition of goods which were manufactured at the time with which we are concerned, having regard to their scarcity in the market, was the main thing, and, therefore, we have no hesitation in holding that a part of the profits was certainly attributable to, and should be deemed to arise, on the mere purchase of the goods in British India and we would answer question no. (4) in the affirmative."
6.8 Thus, it is held that income accrues or arises to the assessee from its Indian operations.
7. In regard to the computation of the commission income of Linmark Development (BVI) Ltd., no particular argument has been made by the ld. counsel. We find that the ld. CIT(A) had computed this commission income on the basis of master buying agreements provided by the assessee. No error has been pointed out by the ld. counsel in this computation. Therefore, we do not find any reason to interfere with the computation of commission income of various years earned by Linmark Development (BVI) Ltd. from Indian operations.
8. Coming to the question of attributation of income, it is seen that the ld. CIT(A) has examined the allocation of functions, assets used and risks taken by Linmark Development (BVI) Ltd., the head office of the assessee 37 ITA Nos. 1942 to 1948(Del)/2008 company and the Indian offices. No particular error has been pointed out in various charts prepared by the ld. CIT(A) in regard to allocation of business activities and risks taken. However, it is agitated that in the computation of the assessee, allocation of 33% of the commission received by Linmark Development (BVI) Ltd. to the Indian operations may be accepted. We have considered this matter. We do find that the ld. CIT(Appeals) has over-stated the role of the Indian offices in the overall conduct of business of the Linmark Development (BVI) Ltd. Nonetheless, it is also a fact that some employees of the assessee were not even aware of the existence of this company. They were dealing directly with the vendors and the buyers. Further, our attention has not been drawn towards any error in the analysis of the ld. CIT(A). Therefore, we are of the view that relief is due to the assessee in the matter. We take the allocation of commission at 50% (fifty per cent) to the Indian operations.
9. There cannot be any exception taken to the finding of the ld. CIT(A) that the expenditure incurred by the Indian offices is deductible in computing the income as what is taxable under the Act as well as under the DTAA is profit and not the gross receipts.
38 ITA Nos. 1942 to 1948(Del)/20089.1 We may also mention here that the whole issue of attributation of profits to Indian offices is only of academic interest as even the order of the ld. CIT(A) by and large leads to a conclusion that the profit earned by Indian offices after deducting the expenses is more or less nil or loss.
10. Thus, ground nos. 1 to 5 are partly allowed.
11. Ground no. 6 is against charging of interest u/s 234B and 234C of the Act. In view of our finding above, these grounds have also become of academic interest. Nonetheless, it may be stated that the assessee is a non-resident company, which receives income from another non-resident company outside India. All payments to a non-resident person are liable for deduction of tax at source u/s 195 of the Act. Therefore, all receipts of the assessee are liable to tax deduction at source. It is also a matter of fact that since payments are made by a non-resident company, the enforcement of the provision contained in section 195 becomes difficult if not impossible. However, as the whole income is liable for deduction of tax at source at appropriate rate, the advance-tax payable by the assessee can be computed only at nil. Since there is no liability to pay advance-tax, there cannot be any reason for charging interest under sections 234B 39 ITA Nos. 1942 to 1948(Del)/2008 and 234C for failure to pay advance-tax, which was not payable in the first place. The assessee has quoted a number of decided cases in the matter, which may not be repeated here as the issue is otherwise clear from statutory language contained in section 209.
11.1 Thus, this ground is allowed.
12. The facts and grounds of all other years are stated to be similar and, therefore, the order of this year is made applicable to all other years also.
13. In the result, all the appeals are partly allowed.
The order was pronounced in the open court on 12 November, 2010.
Sd/- sd/- (C.L. Sethi) (K.G.Bansal) Judicial Member Accountant Member Date of order: 12th November, 2010. SP Satia Copy of the order forwarded to:
Linmark International (Hong Kong) Ltd., Gurgaon.
Deputy Director of IT, Circle 3(1), Intl. Taxation, New Delhi.
CIT(A) CIT The DR, ITAT, New Delhi. Assistant Registrar.