Tax Deduction at Source (TDS) for Foreign Companies: Supreme Court Addresses Permanent Establishment in National Petroleum Construction Company vs. Deputy Commissioner of Income Tax (2022)

Date of the Judgment: July 29, 2022

Citation: 2022 INSC 662

Judges: Indira Banerjee, J. and J.K. Maheshwari, J. (Dissenting Opinion)

Can a tax authority demand tax on income earned by a foreign company for work done outside India? The Supreme Court of India recently heard a case regarding the taxability of a foreign company’s income and the applicability of Tax Deduction at Source (TDS) on payments made to it. This case, National Petroleum Construction Company vs. Deputy Commissioner of Income Tax, delves into the complexities of international taxation and the concept of a “Permanent Establishment” (PE) in India.

The core issue revolves around whether the National Petroleum Construction Company (NPCC), a company based in the United Arab Emirates (UAE), should have been subjected to a 4% TDS on its entire income, including the portion earned from work done outside India, by Oil and Natural Gas Corporation (ONGC). The court had to consider whether the company had a Permanent Establishment in India, which would make its income taxable in India.

The bench comprised Justices Indira Banerjee and J.K. Maheshwari. Justice Banerjee authored the main judgment, while Justice Maheshwari provided a dissenting opinion. Due to the difference in opinion, the matter was referred to the Chief Justice of India for the constitution of an appropriate bench.

Case Background

The National Petroleum Construction Company (NPCC), a company incorporated in the UAE, is engaged in the fabrication of petroleum platforms, pipelines, and other equipment. They also install these platforms and pipelines, both onshore and offshore. NPCC has been contracting with ONGC since 1996-97.

In 2005, ONGC awarded NPCC a contract for the Well Platform Project-3 II (LEWPP Contract). In 2006, another contract for the C-Series Project (C-Series Contract) was awarded. The scope of these contracts included surveys, design, engineering, procurement, fabrication, and installation. While the installation work was done in India, the platforms were designed and fabricated in Abu Dhabi.

NPCC has been filing income tax returns in India since the Assessment Year 1997-98. They computed their income by taxing gross receipts from activities in India at 10% (less verifiable expenses) and receipts from activities outside India at 1%. However, the Assessing Officer (AO) did not accept this method for Assessment Years 2007-08 and 2008-09.

The AO held that NPCC had a Fixed Place Permanent Establishment in India through its Project Office in Mumbai and that Arcadia Shipping Ltd. (ASL), NPCC’s agent, constituted a Dependent Agent Permanent Establishment (DAPE). The AO also stated that the contract was a composite one and not divisible. Therefore, the entire contractual receipts were taxable in India. The Dispute Resolution Panel (DRP) and the Income Tax Appellate Tribunal (ITAT) upheld the AO’s view regarding the PE but agreed that income from activities outside India could not be taxed in India.

The High Court of Delhi also agreed that the value of work done outside India was separable. Later, two more contracts were executed between NPCC and ONGC, one on September 30, 2016 (LEWPP Contract), and another on February 7, 2018 (R-series Contract), which led to the current dispute. For the Financial Year 2019-20, NPCC sought a certificate for nil TDS on payments for work done outside India, but the tax authorities directed ONGC to deduct TDS at 4% on all receipts.

Timeline:

Course of Proceedings

The Assessing Officer (AO) initially held that NPCC had a Permanent Establishment (PE) in India and that all its income was taxable in India. The Dispute Resolution Panel (DRP) and the Income Tax Appellate Tribunal (ITAT) upheld the existence of a PE but agreed that income from activities outside India could not be taxed in India.

The High Court of Delhi concurred with the ITAT on the separability of income from onshore and offshore activities. However, in the current case, the High Court dismissed NPCC’s writ petition challenging the TDS certificate, stating that the tax authorities’ decision was not perverse or irrational. The High Court also noted that the issue of whether NPCC had a PE could not be conclusively determined during an inquiry for a TDS certificate and that the principle of res judicata does not apply to income tax proceedings.

Legal Framework

The case primarily revolves around the interpretation of the following legal provisions:

• Section 197 of the Income Tax Act, 1961: This section allows the Assessing Officer to issue a certificate for deduction of tax at a lower rate or no deduction of tax if the recipient’s total income justifies it. “Subject to rules made under sub-section (2A), where, in the case of any income of any person or sum payable to any person, income-tax is required to be deducted at the time of credit or, as the case may be, at the time of payment at the rates in force under the provisions of sections 192, 193, 194, 194A, 194C, 194D, 194G, 194H, 194-I, 194J, 194K, 194LA, 194LBB, 194LBC, 194M, 194-O and 195, the Assessing Officer is satisfied that the total income of the recipient justifies the deduction of income-tax at any lower rates or no deduction of income-tax, as the case may be, the Assessing Officer shall, on an application made by the assessee in this behalf, give to him such certificate as may be appropriate.”
• Section 195 of the Income Tax Act, 1961: This section deals with tax deduction at source (TDS) on payments to non-residents.
• Section 5(2) of the Income Tax Act, 1961: This section defines the scope of total income for non-residents, stating that it includes income received or deemed to be received in India, or income that accrues or arises in India. “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.”
• Section 6(3) of the Income Tax Act, 1961: This section defines the residency of a company in India.
• Article 7 of the Agreement for Avoidance of Double Taxation (AADT) between India and UAE: This article states that the profits of an enterprise of a contracting state shall be taxable only in that state unless the enterprise carries on business in the other contracting state through a permanent establishment. “(1). The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that permanent establishment.”
• Rule 28AA of the Income Tax Rules, 1962: This rule specifies the conditions and procedure for issuing certificates for lower or nil TDS.

The legal framework also includes the principle that income accruing or arising outside India to a non-resident is not taxable in India, even if it is included in the balance sheet prepared in India. The AADT aims to prevent double taxation and specifies that the profits of an enterprise are taxable in the state where the enterprise has a permanent establishment.

Arguments

Appellant’s Arguments (National Petroleum Construction Company):

• The Appellant argued that the Respondent No.1 erred in not granting a Nil rate TDS certificate under Section 197 of the Income Tax Act for the financial year 2019-20, especially for payments related to activities outside India.
• NPCC contended that it did not have a Permanent Establishment (PE) in India, and therefore, income from activities outside India should not be taxable in India.
• The Appellant relied on previous decisions from the Income Tax Appellate Tribunal (ITAT) and the Delhi High Court, which had held that NPCC did not have a PE in India and that income from activities outside India was not taxable in India.
• It was argued that the R-Series and LEWPP Contracts for the Assessment Year 2020-21 were identical to those considered in previous years and that the Delhi High Court had already determined that its project office did not constitute a Fixed Base Permanent Establishment.
• The Appellant argued that the contracts were divisible, and the income for activities outside India should not be taxed in India.
• NPCC emphasized that the tax authorities had issued nil TDS certificates in previous years for similar contracts, and there was no change in circumstances to warrant a different approach.
• The Appellant submitted that the certificate of Nil TDS, for payments received in respect of activities outside India, should have been issued in deference to decisions rendered by various Appellate Authorities from the Assessment Years 2007-08 to 2015-16.
• NPCC argued that the High Court failed to consider the fact that the assessment proceedings for AYs 2007-08, 2008-09 and 2009-10 have already determined this question in favor of the petitioner and there is no change in any circumstances.

Respondent’s Arguments (Income Tax Department):

• The Income Tax Department argued that the contracts were composite and indivisible, and therefore, the entire contractual receipts were taxable in India.
• The department contended that NPCC had a Fixed Place Permanent Establishment in India through its Project Office in Mumbai and a Dependent Agent Permanent Establishment (DAPE) through Arcadia Shipping Ltd. (ASL).
• The department argued that the question of whether NPCC had a PE could not be determined during an inquiry for a TDS certificate under Section 197 of the Income Tax Act.
• The Income Tax Department relied on the fact that for the Assessment Years 2016-17 and 2017-18, the petitioner has been held to have a Permanent Establishment (PE) in India, and its total income from the contracts with ONGC have been held to be taxable under the IT Act.
• The department argued that the principle of res judicata does not apply to income tax proceedings, and each assessment year is treated separately.
• The Revenue contended that for the R-series contracts, the petitioner has made contradictory statements regarding the commissioning period and period of as-built documentation etc.
• The department argued that the two contracts are indivisible, and the petitioner cannot divide the contractual receipts in two categories viz. inside India and Outside India services.
• The Revenue argued that the installation PE will come into existence, if “project or activity continues for a period of more than 9 months” under Indo-UAE DTAA.

Issues Framed by the Supreme Court

The Supreme Court did not explicitly frame issues in a separate section. However, the core issues that the court addressed can be summarized as follows:

1. Whether the High Court was correct in upholding the decision of the tax authorities to apply a 4% TDS on the entire contractual revenue of NPCC, including the portion attributable to activities outside India.
2. Whether the Assessing Officer could determine the existence of a Permanent Establishment (PE) in India during proceedings for the issuance of a certificate under Section 197 of the Income Tax Act.
3. Whether the principle of consistency should be followed when issuing certificates under Section 197 of the Income Tax Act, considering the previous years’ decisions.
4. Whether the contracts between NPCC and ONGC were divisible, allowing for the segregation of income from onshore and offshore activities.
5. Whether the letter dated 22nd June 2019, where NPCC requested a 4% TDS, could be used against them in the proceedings.

Treatment of the Issue by the Court

Authorities

The Supreme Court considered the following authorities:

Judgment

The Supreme Court delivered a split verdict in this case. Justice Indira Banerjee dismissed the appeal, upholding the High Court’s decision, while Justice J.K. Maheshwari dissented, allowing the appeal and directing the tax authorities to reconsider the application of the appellant.

How each authority was viewed by the Court:

• G E India Technology Centre Pvt. Ltd. v. Commissioner of Income Tax and Another [2010] 327 ITR 456:* This case was cited to emphasize that the obligation to deduct TDS is limited to the appropriate proportion of income chargeable to tax.
• Ishikawajima-Harima Heavy Industries Ltd. v. Director of Income Tax, Mumbai [2007] 288 ITR 408:* This case was cited to support the principle that a non-resident entity should carry on business through a permanent establishment in India to be taxed in India. Justice Banerjee noted that the judgment would only be attracted if there were a definite finding that the Appellant did not have any PE in India.
• Commissioner of Income Tax and Anr. v. Hyundai Heavy Industries Co. Ltd. [2007] 291 ITR 482:* This case was cited to support the principle that a non-resident entity should carry on business through a permanent establishment in India to be taxed in India. Justice Banerjee noted that the judgment would only be attracted if there were a definite finding that the Appellant did not have any PE in India.
• New Jehangir Vakil Mills Co. Ltd. v. CIT [1963] 49 ITR 137:* This case was cited to emphasize that the principle of res judicata is not applicable to income tax proceedings.
• Instalment Supply (P) Ltd. v. Union of India AIR 1962 SC 53:* This case was cited to emphasize that each year’s assessment is final only for that year and does not govern later years.
• M/s Radhasoami Satsang, Saomi Bagh, Agra v. Commissioner of Income Tax (1992) 1 SCC 659:* This case was cited by Justice Maheshwari to emphasize the principle of consistency in tax matters.
• Bharat Sanchar Nigam Limited and Anr. v. Union of India and Ors. (2006) 3 SCC 1:* This case was cited by Justice Maheshwari to emphasize the principle of consistency in tax matters.
• Section 197 of the Income Tax Act, 1961:* This section was discussed in detail as the core provision for issuing certificates for lower or nil TDS.
• Section 195 of the Income Tax Act, 1961:* This section was discussed as the provision for tax deduction at source on payments to non-residents.
• Section 5(2) of the Income Tax Act, 1961:* This section was discussed as the provision that defines the scope of total income for non-residents.
• Section 6(3) of the Income Tax Act, 1961:* This section was discussed as the provision that defines the residency of a company in India.
• Article 7 of the Agreement for Avoidance of Double Taxation (AADT) between India and UAE:* This article was discussed as the provision that specifies that the profits of an enterprise are taxable in the state where the enterprise has a permanent establishment.
• Rule 28AA of the Income Tax Rules, 1962:* This rule was discussed as the provision that specifies the conditions and procedure for issuing certificates for lower or nil TDS.

Justice IndiraBanerjee’s Opinion:

• Justice Banerjee upheld the High Court’s decision, stating that the High Court did not err in holding that the issue of whether the Appellant had a Permanent Establishment (PE) in India could not be conclusively determined in proceedings under Section 197 of the Income Tax Act.
• She noted that the High Court had correctly held that the principle of res judicata does not apply to income tax proceedings.
• Justice Banerjee held that the Appellant was estopped from questioning the TDS certificate because it was issued as per their request in their letter dated 22nd June 2019.
• She stated that the judgments in Ishikawajima-Harima Heavy Industries Ltd. v. Director of Income Tax, Mumbai and Commissioner of Income Tax and Anr. v. Hyundai Heavy Industries Co. Ltd. would only be attracted if there were a definite finding that the Appellant did not have any PE in India.
• She concluded that the High Court had rightly dismissed the writ petition and that there was no reason to interfere with the impugned judgment.

Justice J.K. Maheshwari’s Dissenting Opinion:

• Justice Maheshwari dissented, stating that the High Court erred in distinguishing previous orders and that the principle of consistency should be followed.
• He held that the Assessing Officer (AO) is required to follow the procedure under Rule 28AA of the Income Tax Rules, 1962, while issuing a certificate under Section 197 of the Income Tax Act.
• Justice Maheshwari stated that the High Court wrongly distinguished the contracts and that the letter dated 22nd June 2019 cannot influence the Court.
• He emphasized that the AO must consider the income of the recipient and other relevant factors as per Rule 28AA while issuing the certificate under Section 197.
• Justice Maheshwari cited the cases of M/s Radhasoami Satsang, Saomi Bagh, Agra v. Commissioner of Income Tax and Bharat Sanchar Nigam Limited and Anr. v. Union of India and Ors. to support the principle of consistency.
• He concluded that the High Court erred in dismissing the writ petition and that the tax authorities should reconsider the application of the appellant.

Ratio Decidendi

The ratio decidendi, or the legal principle upon which the decision is based, can be summarized as follows:

• Split Verdict: Due to the split verdict, there is no single ratio decidendi. The matter was referred to the Chief Justice of India for the constitution of an appropriate bench.
• Section 197 Proceedings: The majority opinion (Justice Banerjee) held that the existence of a Permanent Establishment (PE) cannot be conclusively determined during proceedings for the issuance of a certificate under Section 197 of the Income Tax Act.
• Res Judicata: The majority opinion (Justice Banerjee) held that the principle of res judicata does not apply to income tax proceedings.
• Estoppel: The majority opinion (Justice Banerjee) held that a taxpayer is estopped from questioning a TDS certificate if it was issued as per their request.
• Consistency: The dissenting opinion (Justice Maheshwari) emphasized that the principle of consistency should be followed, and previous decisions should be considered.
• Rule 28AA: The dissenting opinion (Justice Maheshwari) held that the Assessing Officer must follow the procedure under Rule 28AA of the Income Tax Rules, 1962, while issuing a certificate under Section 197.
• Divisibility of Contracts: The dissenting opinion (Justice Maheshwari) stated that the High Court wrongly distinguished between contracts and that the contracts should be considered divisible.

Obiter Dicta

The obiter dicta, or statements made by the court that are not essential to the decision, can be summarized as follows:

• Scope of Section 197: The court noted that the proceedings under Section 197 of the Income Tax Act are summary in nature and are primarily for determining the rate of tax deduction at source. It is not the appropriate forum to conclusively determine the existence of a Permanent Establishment (PE).
• Res Judicata in Tax Matters: The court reiterated that the principle of res judicata does not apply strictly to income tax proceedings, as each assessment year is considered separately.
• Importance of Consistency: Justice Maheshwari emphasized the importance of consistency in tax matters and stated that the tax authorities should consider previous decisions while issuing certificates under Section 197, unless there is a material change in the facts and circumstances.
• Procedure under Rule 28AA: Justice Maheshwari highlighted the importance of following the procedure under Rule 28AA of the Income Tax Rules, 1962, while issuing a certificate under Section 197, to ensure a fair and reasoned decision.
• Divisibility of Contracts: Justice Maheshwari, in his dissenting opinion, stated that the High Court wrongly distinguished between contracts and that the contracts should be considered divisible, which is a point that was not directly essential for the decision.

Flowchart of the Case

Ratio of the Case

Conclusion

The Supreme Court’s split verdict in National Petroleum Construction Company vs. Deputy Commissioner of Income Tax highlights the complexities of international taxation, particularly concerning the taxability of foreign companies and the concept of a Permanent Establishment (PE). While Justice Indira Banerjee upheld the High Court’s decision, emphasizing the limitations of proceedings under Section 197 and the non-applicability of res judicata, Justice J.K. Maheshwari dissented, stressing the importance of consistency and the need for the Assessing Officer to follow the procedure under Rule 28AA.

The split verdict underscores the differing interpretations of the legal provisions and the factual matrix of the case. The matter has been referred to the Chief Justice of India for the constitution of an appropriate bench, which will hopefully provide a conclusive resolution to the issues raised. This case serves as a reminder of the need for clarity and consistency in the application of tax laws, especially in the context of international transactions. It also highlights the importance of carefully considering all relevant factors, including previous decisions and the specific circumstances of each case, when determining tax liabilities.