Activities carried out before entering into the contract and not carried out at site in source country will not to be constructed as a Permanent Establishment

Facts of the Case:

• The Assessee (Bellsea Ltd) is a foreign company incorporated in Cyprus. During the year, the Assessee had earned income by entering into a contract for the development of gas field located in India. The date of contract was from 04.01.2008 upto 30.09.2008 i.e for a period less than 12 months. Before entering into the contract, one of the employee of the Assessee company had visited India for the purpose of collecting data, like pre-survey engineering, investigation of site, and information necessary for tendering purpose and bid for the contract. However, these activities were carried out before the contract was granted to the Assessee.
• It is for this contract that theAssessing officer (“AO”) held that due to presence exceeding over a period of 12 months in India for undertaking installation activities, the Assessee had satisfied the conditions of installation Permanent Establishment in India as defined under Article 5(2)(g) of the Double Taxation Avoidance Agreement between Indian and Cyprus. Since, there was a PE of Assessee in India, therefore, income earned by on the contract executed shall be taxable as per Article 7 of DTAA. Relevant extract of article 5(2)(g) has been reproduced herewith:

“a building site, construction, assembly or installation project or supervisory activities in connection
therewith, but only where such site, project or activities continues for a period of more than twelve months”.

• For calculation the period, the Assessing Officer (AO) concluded that activities carried out by the Assessee had started in September, 2007 i.e., prior to the contract date. It was contended that activities carried out before entering the contract for collection of data and information for tendering purpose are related and incidental to installation of project for the development of gas field and therefore, period of performance of these activities shall be counted while calculating the threshold period i.e., 12 months.

The order of the AO was upheld by the Commissioner of Income Tax. Aggrieved with the order, the Assessee appealed before the tribunal which rejected the order of first appellate and passed order in favor of the Assessee. It was against this order of the tribunal, that income tax authorities went to the High Court. The High Court, while deciding the case referred to the order of the tribunal and issued order in favor of the Assessee.

The High Court held:

• The reliance of tribunal holding that any kind of preparatory work under the contract shall be reckoned when such activities are carried out after entering into the contract is correct. The period wherein activities were carried out before entering into the contract shall not be counted while calculating the threshold period of 12 months as provided under Article 5(2)(g) of the India – Cyprus DTAA.
• Further, for construing a fixed place PE, it is activities which are undertaken at the project site which should be considered. Activities, though related to the project or site but not carried out at the construction site in the source country would clearly not to be considered for counting the time to construe permanent establishment in India. Therefore, preparatory work which relates to planning or actual execution of construction works shall be excluded from it due to it not been undertaken at the project site.
• Since, in the present case, preparatory activities were commenced before entering the contract and same are not carried out at project site. Therefore, such period shall be excluded while calculating the threshold period of 12 months. Hence, due to no PE of the Assessee in India, the income earned by the Assessee shall not be taxable as per Article 7 of DTAA.

Further, the High Court also upheld the reliance of tribunal on the judgement National Petroleum Construction Co. v. DIT (International Taxation) wherein it was held that duration of a permanent establishment would commence with the performance of business activities at building site or assembly project. Therefore, the order of tribunal was held valid and accordingly appeal by revenue was dismissed.

SW Point of View:

For construing construction PE, it is the time spent at construction site which should be taken into consideration while calculating the threshold limit under the provisions of Article 5(2)(g) of India – Cyprus DTAA. Time spent prior shall be excluded from such threshold.  However, it will be interesting to see applicability of this judgement in cases where there is force of attraction clause in Article 5. 

Virendra Virkam, Tax Associate, SW India