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Background
In a recent ruling in the case of Cartier Shipping Co.
Ltd. 1 (“the assessee”), the Mumbai Income-tax Appellate Tribunal (“the Tribunal”) has held that any gain on the sale of an asset of an Indian Permanent Establishment (“PE”), as a part of its winding-up process, is taxable in India. Further, the Tribunal held that the assessing officer (“AO”) has the power to reassess the case if there is a failure on the part of the assessee to disclose fully and truly all the material facts necessary for its assessment.
Facts
• The assessee was a company registered under the laws of Cyprus. It was subsequently registered as a foreign company in Mauritius on 9 June, 1993 and based on this registration, the assessee was issued
1 Cartier Shipping Co. Ltd, Cyprus v. DDIT (International Taxation) [ITA No. 3036/Mum/07] dated 7 June, 2010
a Tax Residency Certificate by the Mauritius revenue authorities.
• The assessee owned a rig that was being used for drilling, prospecting and production of hydrocarbons in offshore oil fields, which it had given on charter basis to Amer Ship Management Ltd. (“ASML”). The income so earned by the assessee was offered to tax after claiming deduction for depreciation allowance on this asset in its tax return.
• For the assessment year (“AY”) 1998-99, the assessee filed a letter with the AO wherein it stated that the contract with ASML had been terminated on 3 October, 1997 and the assessee had discontinued its business operations in India. It also stated that the assessee had moved the rig from Indian territorial waters to international waters.
• For AY 1998-99, the assessee filed its tax return declaring nil income.
If sale of PE assets takes place as a part of the winding-up process of the PE, the sale is taxable in India Tax & Regulatory Services
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11 June, 2010
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• A tax evasion petition, containing information about evasion of capital gains tax on the sale of the rig, was received by the AO, who consequently reopened the case and issued a notice under section 148 of the Income-tax Act, 1961 (“the Act”).
• The Commissioner of Income-tax (Appeals) (“CIT(A)”) upheld the reassessment proceedings and observed that the assessee had not disclosed the particulars regarding the sale of the rig in its tax return or during the assessment proceedings.
Accordingly, there had been a concealment of particulars of income by the assessee.
• Aggrieved, the assessee filed an appeal with the Tribunal.
Issue
• Whether the reassessment proceedings initiated by AO under sections 147 and 148 of the Act were valid.
• Whether the gains on alienation of a PE asset as a part of the winding-up process of the PE were taxable in India.
Assessee’s contentions
• Though the assessee did not mention particulars regarding the sale of the rig in India in its tax return, this did not amount to any failure on the part of the assessee.
Once the assessee had wound up its business in India, it was of no concern to the tax authorities as to what it did with its assets. Since the assessee did not have any obligation to inform the Indian tax authorities about the disposal of its assets, the omission could not be construed as a lapse on the part of the assessee to disclose fully and truly all material facts, which was a sine qua non for initiating re- assessment proceedings. Thus, the assessee contended that the re-assessment proceedings be quashed.
• On the issue of taxability of gains on the alienation of the PE assets, the assessee contended that the sale of the rig took place on 6 October, 1997, since on that date the possession of the rig was transferred to the buyer in international waters and payment was received. Further, the certificate issued by the surveyor and the
delivery protocol documents supported the same position. The rig had actually moved out of the Indian territorial waters on 4 October, 1997. Accordingly, the assessee contended that the sale of the rig had taken place outside Indian territorial waters and that the gain on its alienation did not accrue / arise in India and hence, had no tax implications in India.
• Once the rig moved out of the territorial waters of India or was not operational, the assessee could not be said to have a PE in India and once the PE ceased to exist in India, the assessee’s taxability in India also ceased.
• If, under the terms of an agreement, an asset of a non-resident was to be handed over to an offshore buyer outside Indian territory, the gains on that sale could never be taxed in India.
• The assessee had claimed depreciation allowance so as to work out the profits attributable to its PE. The claim of depreciation allowance in India could not per se determine the situs of taxability on the sale of the related asset.
• Just because an assessee had a PE in India, the Indian tax authorities could not be inferred to have a permanent lien on the taxability of the sale of assets used by such a PE.
Revenue’s contentions
• Mere closure of the business of the assessee in India did not imply that the entire taxability had come to an end. The cessation of a PE was relevant only for the taxability of business profits and even after the cessation of a PE in India, a non- resident assessee could be liable for its taxability under the other heads of income in India, including under the head “capital gains”.
• Even if the assessee was of the bona fide view that the capital gains arising on the sale of the rig were not taxable in India, it was its statutory obligation to disclose the fact of this sale in the tax return. As per the compliance requirements of filing the return of income, details of even exempt income were required to be disclosed in the tax return. Thus, there was clearly a failure on the part of the assessee to disclose fully and truly all material facts necessary for assessment and the assessee was not
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operating in a fair and transparent manner. It was thus submitted that the assessee’s case was clearly covered by the proviso to section 147 of the Act which permitted re-opening of an assessment even after the expiry of four years from the end of the relevant AY.
• A series of steps had taken place to effect the sale of the rig during the period when the assessee had a PE in India and when the asset was being used for the PE, eg initial agreement, deposit of earnest money, drawing bill of sale, obtaining clearance for the movement of the rig, termination of the contract and allowing access to the surveyors in order to monitor movement of the rig to international waters, etc. Just because one last step was completed outside Indian territory, i.e.
handing over the rig in international waters, it could not be said that the sale of the rig took place outside India. The sale took place as a part of the winding-up operations of the PE and therefore, even if, the time of sale was shortly after the PE itself came to an end, the sale was to be treated as a part of the winding-up operations of the PE.
Tribunal ruling
• The Tribunal held that the gains from the alienation of the assets were taxable as per the provisions of the Act as well as the provisions of the Double Taxation Avoidance Agreement between India and Mauritius (“tax treaty”).
• The Tribunal referred to the judgment of the Supreme Court in the case of Hyundai Heavy Industries Ltd.2, wherein it was held that since there was no specific provision under the Act to compute profits accruing in India in the hands of foreign entities, the profits attributable to an Indian PE of a foreign enterprise were required to be computed under normal accounting principles and in terms of the general provisions of the Act. The PE was to be treated as a separate profit centre vis-a-vis the non-resident. Accordingly, the assets of the PE were also to be recognised as such. Viewed from this perspective, profit or gains on the sale of assets of a PE were to be treated as profits of the PE.
2 CIT v. Hyundai Heavy Industries Ltd. [2007] 291 ITR 482 (SC)
• When a PE ceased to exist, there could not be a gain on the transfer of an asset back to the non-resident, as no consideration was attached to such a transfer. However, when the PE assets were being alienated to an outsider, the gains or losses on such an alienation were to be treated as gains or losses to the PE with consequential tax implications.
• The rig was a PE asset and even if the sale had taken place as a part of the winding- up process of the PE, the sale was still taxable in India.
• The situs of taxability of profits on the alienation of an asset was the same as the situs of taxability of income from such asset. The income of the PE, generated from the chartering of the rig, was taxable in India, and therefore, the profits on the sale of the rig were also held to be taxable in India.
• A PE may not continue to exist during its winding up process, but that did not obliterate the treaty provisions to the effect that gains on the alienation of the PE or the PE’s movable assets would be taxed in the tax jurisdiction in which the PE was situated. If it was held that capital gains on the alienation of a PE or its movable assets could be taxed in the source country only when the PE existed, then the provisions of Article 13(2) of the tax treaty regarding taxability of gains from the alienation of a PE in the source country would be rendered redundant, because at the point of time when the PE was alienated or assets were alienated, the PE could not continue to exist.
• The sale invoice was drawn on 17 September, 1997; thus the process of moving the rig to international waters was a result of a sale of the rig. The mere fact that the receipt of sale consideration, or even the sale transaction itself, was deferred, had no bearing on the taxability of the transaction so long as the transaction itself led to taxability in India.
• The date of delivery and the date of payment were relevant in as much as they completed the sale transaction. However, the date of sale was to be taken as the date on which the sale invoice was signed and delivered.
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Conclusion
This judgement emphasises the fact that all material information / documents / facts must be disclosed in the tax return, even if the assessee is of the bona fide view that certain income is not taxable in India in order to avoid the re-assessment proceedings.
Failure to do so provides sound ground to the tax authorities to commence valid re- assessment proceedings.
Furthermore, the decision assumes significant importance in those cases where the PE or PE assets (depreciable) are being sold. The decision concludes that even if the sale of an asset takes place as a part of the winding-up process of the PE, the gain on its alienation would still be taxable in India.
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