Indian Tax Tribunal (‘ITAT’) has held that profits on off-shore sale of equipment shall not be attributable to the Indian PE of the foreign taxpayer under ‘force of attraction’ rule.

Brief Background

• The taxpayer is a Singapore tax resident engaged in undertaking contracts for supply, installation and maintenance of security equipment and related spare parts. The supply of the equipment to the customer was effectuated outside India.
• The taxpayer had established a branch in India (‘hereinafter referred to as PE’) and the PE did not perform any functions in relation to supply of the security equipment. Further, the taxpayer had set-up a wholly owned subsidiary in India and the subsidiary was mainly involved in installation and maintenance of security equipment supplied by the taxpayer. The contracts for such installation and maintenance were entered separately by the subsidiary with the customers and the same was not part of the contract for equipment supply;
• The tax authorities passed an order wherein the profits of the taxpayer on account of off-shore supply of equipment was attributed to the PE and included as part of their taxable income under ‘Force of Attraction’ rule i.e., income from supply of equipment, installation and maintenance contracts were included in total income even though the PE did not perform any functions in relation to the said activities;
• The taxpayers filed an appeal before the Tribunal (‘ITAT’) against order passed by the tax authorities.

Key excerpts from the ruling

• ‘Force of Attraction’ rule requires all profits derived from a source jurisdiction to be attributed to the PE of the taxpayer irrespective of the fact whether said PE had engaged in the activities contributing to such profits. ITAT found the application of aforesaid rule by the tax authorities to be violative of Article 7(8) of the India – Singapore Tax Treaty (‘the Treaty’).
• Article 7(8) of the Treaty provides that profits attributable to a PE shall be determined based on involvement of the PE in the relevant transaction and the functions performed for the said transaction by the PE. In the present case under consideration, the ITAT emphasized that the PE of the taxpayer had no role to play with respect to supply/ sale of equipment since the supply was made overseas.
• Referring to the decision of Indian Apex Court in the case of Hyundai Heavy Industries Co. Ltd, ITAT held that only profits having economic nexus with PE shall be taxable in India for the taxpayer and not on all profits of the taxpayer arising from business connection in India.
• The property in the equipment supplied by the taxpayer had transferred to the Indian customers outside India since such equipment were received in India on Free On Board (‘FOB’) basis. The payments for such sale had also taken place outside India. In light of said facts, ITAT, referring to Explanation 1(a) of Section 9(1)(i), upheld that transaction of off-shore supply of equipment does not accrue/ arise in India.
• Therefore, drawing further precedence from the Apex Court ruling in Ishikawajima Harima Heavy Industries Ltd, the ITAT ruled in favor of the taxpayer, thereby the profit additions arising on account of off-shore supply of equipment in the impugned order were deleted.