Can contract be bifurcated to decide tax jurisdiction?

The issue of taxability of offshore services was settled by the Supreme Court in case of Ishikawa (288 ITR 408) wherein it was observed that there are two conditions which are required to be met in order to bring the income from services in the tax net in India. The two conditions both of which are to be met are that services should be rendered in India and that the services should be utilised in India. Thus where services are rendered/provided outside India, then the consideration therefore will not be taxed in India even if the services are utilized in India.

The Apex court also held that whatever was paid by a resident to a non-resident cannot be taxed in India unless there is sufficient territorial nexus with India.

The Apex Court in the context of territorial nexus further observed that where there are different severable parts of a composite contract which are performed in different places, the principle of apportionment should be applied to determine fiscal jurisdiction. This helps determine where the territorial nexus lies.(see para 88 pg. 443 of 288 ITR)

However, a careful analysis of a recent ruling of Authority for Advance Rulings(312 ITR 317)reveals that despite reasonably clear wordings of the Apex Court the controversy is far from over. In the said case an Australian Company entered into a contract with Sterlite India for setting up a refinery in Orissa.

The Australian Company is responsible for development of a set of basic engineering documents which involves preparation of various diagrams, designs, drawings and lay out plans. The Australian Company has its design centre at Perth - Australia from where the design services were performed. However, for the purpose of gathering inputs for the preparation of designs and documents, the personnel came to India. The staff of the Australian Company also visited India to "explain deliverables to the officers/engineers of Sterlite". Therefore, there are three steps involved in the whole process i.e. collection of data, preparation of deliverables and transfer of deliverables and testing the same.

The Australian Company avers that the collection of data and transfer of deliverables had taken place in India. However, preparation of deliverables which is the crucial activity in the transaction was done in Perth- Australia.

The case of the foreign company is that on the application of principles laid down in the Ishikawa case, the services rendered outside India cannot be taxed in India. Thus, according to the Australian Company, only that part of the receipts attributable to Indian operations which relate to services rendered and utilized in India could be taxed under the Act.

Surprisingly the Authority made distinction from Ishikawa case in the following words:“We cannot understand the observations of the Supreme Court as extending the principle of apportionment to a situation where there is a single Agreement covering only one particular type of work/services, as in the present case. It does not follow from what has been stated by Supreme Court that the services or work covered by such agreement should be split up depending on the actual place of performing them and the profits should be apportioned accordingly. Proportionate deemed income in respect of a single agreement which does not have severable elements was not contemplated by the Supreme Court as a concomitant of the principle of apportionment.”

As per the AAR, even a small portion of work in India will provide sufficient territorial nexus for the entire work including activities performed outside India. Further the principle of apportionment of various services in a contract cannot be applied where there is a single agreement covering only one particular type of work or services.

With utmost respect the decision of the AAR requires a review because the said decision completely upsets the principle followed in large number of settled cases.