Holding

The contract is divisible; the PE arose only at the installation stage, so profits from the foreign design and fabrication are not taxable in India, and income attributable to the Indian PE is 10% of gross receipts from installation and commissioning.

Summary

The Supreme Court examined whether Mis. Hyundai Heavy Industries Co. Ltd., a Korean non‑resident, had a Permanent Establishment (PE) in India for a turnkey contract to design, fabricate, install and commission an oil platform for ONGC. The assessee argued that the contract was divisible, that the design and fabrication work was performed abroad and that the PE arose only at the installation stage, so profits from the foreign portion were not taxable under Article 7 of the India‑Korea Double Taxation Avoidance Agreement (CADT). The Revenue contended that the contract was a single integrated project, that a PE existed during the whole period, and that profits from the foreign activities were attributable to the Indian PE and taxable under Section 9 of the Income‑Tax Act. The Court held that the contract was indeed divisible, the PE was created only when installation began, and therefore profits from the Korean operations were not taxable in India. It affirmed that income attributable to the Indian PE should be computed at 10% of gross receipts from installation and commissioning, in line with Section 44BB and CBDT Instruction No. 1767. The civil appeals by the Department were partly allowed.

Issues considered

The contract is divisible into foreign (design/fabrication) and Indian (installation/commissioning) components.
Whether a Permanent Establishment of the Korean company existed in India during the period of the contract.
Whether profits from the foreign portion of the contract are taxable in India under Article 7 of the India‑Korea CADT and Section 9 of the Income‑Tax Act.
How the taxable income of the Indian PE should be computed – whether under Section 44BB/Instruction No. 1767 or by best‑judgment assessment.

Legislation cited

Income Tax Act, 1961s. 143(2), s. 144, s. 260A, s. 4, s. 44BB, s. 5(2), s. 9

Subjects

Permanent EstablishmentDouble Taxation Avoidance AgreementArticle 7Income Tax ActSection 44BBCBDT Instruction 1767contract divisibilitybest judgment assessmentforeign company taxationIndian tax jurisdiction

Judgment

A COMMISSIONER
.
OF INCOME TAX, MEER.UT
,·
AND ANR. ·
'

MIS. HYUNDAI HEAVY INDUSTRIES CO. LID ...

MAY 18,2007

B [SR KAPADIA AND B. SUDERSHAN REDDY, JJ.l ·

Income Tax Act, 1961-Sections 9, 44BB, 143 (2) & 144-Convetition
for Avoidance ofDouble Taxation-Article 7-Contract entered into by Indian
c company with assesseeforeign company for designing, fabrication,
·installation, and commis.sion' of an oil platform inlndia-Assessee declaring
nil income-Notice issued by Re\ienu~Assessee contending that the contract
is divisible into Indian operatio~ and foreign opera#om; · that income from
Indian operations is not liable to tax as it did not have Permanent
Establishment in India; and that the inco,,,e froni foreign operations. is not
D liable to tax·.as. it is earned outside JndiO-:.Asses#ng Officer rejecting the
content.ions and·made butjudgment assusment ·holding that the. contract iS
not divisible and treated entire receipts periaining to Indian. operations and
2% of receipt.pertaining to foreign operati(ins. as income-Comm~sioner
Appeals treatM· I% of receipts in r~pect offoreign. operations and· 10% of ..
E .receipts relating to Indian· operations as income-c-Tribuna/ allowing the
appeal of the assessee. and· held t~t the ·contra~t is divisible. ~1Ul that the
recei/Jts pertaining to foreign operations are n~t taxable; and that 10"/6 of . ·
receipts from Jndian-Operati~ns is taxab./e as inco~e-:-lfigh Court<f.ismissing
the appeal of the Revenue· summarily-<.;orf\ectness of-Held on facts,
Permane"1 Establishment cam(! into exisi~nce iii India ·after .designing and
F. fabrication outside India and handing over thef4bricat~dplat/'orm to Iiidian ~·.
company oulSide· India-Hence, profits .arising from ·actiVities :ouiside· India
. are not /i'able to tax and)O% of the receipts !from Indian operation$ are
liable to toX under the Acf.

Respoildent-assessee, 'a non"'.resid~nt Jorelgn company entered lnto a
G contracfWith an Iridian eompany ror designing,.rabricatio~s, illstall8tion and
commisSion or an oii platform in India. The assessee filed lpcoine Tax ltenirnl ..
for relevant iissesslilent years d~claring nil income: In response to notices
issued by Revenue under. Section 143(2) ortbe Income. Tax Act, 1961, .the \,_..: I

assessee replied contending that it did not have a Permanent EstabliShment
H 288
COMMNR. OF INCOME TAX, MEERUT''· HYUNDAI HEAVY INDUSTRIES CO. LID. 289

~ (PE) in India and hence not assessable to tax in India under the Act and under A
Article 7 of the Convention for Avoidance of Double Taxation (CADT); that
the duration of the Indian operations of installation and commissioning was
less than nine months; that the contract is divisible and hence the income ar
aild fabrication activities carried outside India is not assessable to tax in India.

Assessing Officer rejected the contentions and the accounts produced B
by the assessee and made best judgment assessments for the relevant
...._ assessment years on receipt basis. The Assessing Officer held that the Project
y
extended beyond nine months; that the assessee had a PE in India; that the
contract was not divisible; that since designing and fabrications of the platform
had an application in India, a part of the income arising from the foreign
operations was also taxable in India. The Assessing Officer treated the entire
c
receipts pertaining to Indian operations and 2% of the receipts in respect of
the foreign operations as income liable to tax.

Commissioner of Income Tax (Appeals) dismissed the appeals preferred
by the assessee and directed the Assessing Officer to treat 1% of the receipts D
in re5pect of the foreign operations and 10% of the receipts relating.to Indian
:->~ operations as income liable to tax under the Act.

Income Tax Appellate Tribunal allowed the appeals preferred by the
' .. assessee holding that the contract was divisible; that the profits arising out
of activities done outside India are not taxable in India; and treated 10% of E
\ the receipts as income from Indian operations liable to income tax. The appeals
\ filed by the Revenue before High Court under Section 260A of the Act was
summarily dismissed.

In appeals to this Court, the Revenue contended that the contract entered
into by the respondent-assessee with the Indian company was a composite F
'-
contract; and that the activities done outside India are interliked with the
activities Indian activities and hence the profits accruing to the assessee from
activities performed outside India are also chargeable to tax in India under
Section 9 (1) of the Income Tax Act, 1961.
G
The respondent-assessee contended that the activities of designing and
fabrication took place in the foreign State and the fabricated platforms were
handed over to the agents of the Indian company outside India and hence it is
,.__,
not liable to income tax under the Act and under Article 7 CADT.

Partly allowing the appeals, the Court H
290 SUPREME COURT REPORTS [2007) 7 S.C.R.

A ·HELD: 1.1. As per Article 7 of the Convention for Avoidance of Double '<
Taxation (CADT), the profits earned by the respondent-non-resident foreign
company assessee on the supplies of fabricated platforms outsides India cannot
be made attributable to its Permanent Establishment (PE) in India since PE
came into existence only after the fabricated platform was delivered outside
· India to the agents of the Indian company. Therefore the profits on such
B supplies of fabricated platforms cannot be said to be attributable to the. PE.
[Para 11] [298-D, E, FJ
>..,.
1.2. In terms of Article 7 CADT, the profits to be taxed in the source
country were not the real profits but hypothetical profits which the PE would

c have earned. If it was wholly independent of the foreign company. Therefore,
even if the supplies were necessary for the purpose of installation activity of
the PE in India and were an integral part, still no party of the profits on such
supplies can be attributed to the independant PE unless it is established by
the Revenue that the supplies were not at Arm's length price. No such
taxability can arise as the sales were directly billed to the India company. No
D such taxablility can also arise as there was no allegation made by the Revenue
that the price at which billing was done for the supplies included any element
......
'>
for services rendered by the PE. Hence, the profitS that accrued to the assessee
outside India were not taxable in India. [Para 11) [298-F-H; 299-A]

1.3. The PE is set up at the installation stage while the entire Turkey
E project, including the sale of equipment is finalized before the installation
stage. There was no allegations made by the Revenue that the PE came into
existence even before the sale took place outside India; Similarly, there was
no allegation made by the Department that the price at which the Indian ·
Company was billed, invoiced by the assessee for supply of fabricated platforms
included any element for services rendered by the PE. Not all the profits of
F ',.
,....
the assessee company from its business connection in India (PE) would be
taxable in India, but only so much of profits having economic nexus with PE
in India would be taxable in India. Accordingly, the profits attributable to
operations outside India was not taxable in view of Article 7 CADT.
[Para 12] (299-C, D, E, F]
G
1.4. Under Instruction No. 1767 issued by CBDT, in cases where ·the
sales take place outside, only 10% of the gross receipts in respect of the
activities ofinstallation, commissioning etc. performed in India will be taxable. \.-·
In view ofthe stand taken by the assessee that is income from Indian operations
be computed under Section 44BB of the Act or under Instruction No. 1767
H issued by CBDT, CIT (A) was right in computing the taxable profits at 10%
COMMNR.OFINCOMETAX,MEERUTv.HYUNDAIHEAVYINDUSTRIESCO.LTD.[KAPADIA,J.)291

.._, of the gross receipts in respect of the activities of installation, commissioning A
etc. performed in India. (Para 13) (300-D, E]

CIVIL APPELLATE JURISDICTION : Civil Appeal No. 2734 of2007.

From the Final Judgment and Order dated 30.03.2006 of the High Court
of Judicature of Uttranchal at Nainital in Income Tax Appeal No. 474 of2001. B

WITH
....""
C.A. No. 2735/2007.

G.E. Vahanvati, S.G., Dr. RG. Padia, Sr. Adv., Vikram Gulati, Laxmi Iyengar,
Hrishikesh Barauh, B.V. Balaram Das for the Appellants.
c
Soli J. Sorabjee, Sr. Adv., Ajay Vohra, O.P. Sapra, Vinay Yaish, Preteesh
Kaput and Sandeep S. Karhail Kavita Jha for the Respondent.
.- The Judgment of the Court was delivered by D
....~ KAPADIA, J. l. Leave granted.

2. These civil appeals filed by the Department concern computation of
the profits of the Indian permanent establishment (for short, "PE") of the
Korean company, Mis .Hyundai Heavy Industries Co. Ltd. (for short, 'HHi'). E
Assesses is a non-resident foreign company incorporated in South Korea. On
12.3.85 it had entered into an agreement with oil and Natural Gas Company
(for short, 'ONGC') for designing, fabrication, hook-up and commissioning of
South Basin field Central Complex facilities in Bombay High. In short the
contract was in two parts, one was for fabrication of platform and the other
was installation and commissioning of the said platform in South Basses in F
....... Field. In these civil appeals we are concerned with the assessment years 1987-
88 and 1988-89. The assesses is incorporated under the laws of Republic of
Korea. Its registered office is in Korea. As regards assessment year 1988-89,
assesses filed its return of income on 3.8.1988. The return indicated 'nil'
income. In response to notices under Section 143(2) of the Income-tax Act,
G
1961 (for short 'the Act'), the assesses stated that it did not have a PE in India
and, therefore, it was not assessable to tax in India; that its Indian Operations
.. consisting of installation and commissioning of the platform commenced in
. -I the taxable territory of India on l.l l.86 and got completed on 12.4.87 and,
therefore, the duration of the Project was less than nine months; that it was
entitled to exemption under Article 7 of the Convention for Avoidance of H
292 SUPREME COURT REPORTS [2007)7 S;C.R.

A Double Taxation (for short, 'CADT'); that in the alternative it was liable to. ~
be assessed on the basis of· the accounts annexed to the retilrn:s; that the .
accounts were based on the Completed Contract Method in its worldwide
accounts; that the accounts of its PE can be accepted in the Completed
• Contract Method basis ; that it was maintaining income· and expenditure
account of its PE in India; that the abo.ve contract was divisible irito two
B types of operations-one being fabrication in Korea and the other consisting
of installation in India nnd , therefore, any income arising from the activity
of fabrication in Korea was not assessable to tax in India and, therefore, any >.
income arising from the activity of fabrication in Korea was not assessable "
to tax· in India and to that extent the revenues receivable under the above .
c contract in respect of the activity of fabrication should be excluded· from the
profit and loss account together with the expenditure relating to the activity
of fabrication. It was further contended that the assesses had included the
revenues relating to installation (Indian Act~vity} in the p~ofit and.loss account
and· the ·expenditure relating to that activity was debited on the Matching
--:.
Principle Basis. It was further contended that the profit and loss account :
D consisted of two parts-the Korean and the Indian part; that the Korean part
recorded the entire revenue/income received in Korea as also the expenditUre .
incurred in .Korea relating to the Indian Project and debited to the Korean
..
\.

book of accounts'. All the above contentions were rejected by the A.0; it was
held that the duration of the Project consisting of installation and
E commissioning extended beyond nine months, that the project constitut~d. a
PE of the assessee in India in terms of Article 5(3) of CADT; that in any event
the office of HHI in Bombay constituted a PE under Article 5(2)(c), and
therefore, the claim of the assessee for exemption under Article 7 of the CADT
was not maintainable. Therefore, the profits attributable to the PE were liable
to be taxed inJndia in accordance with Article 7 of the CADT. The A.O. also
F rejected the Completed Contract Method as well as· the accounts submitted
~
by the assessee on the ground that the assessee had failed to produce the
relevant books of accounts in respect of the profit arid loss account; that they ~

had refused to produce books of accounts maintained in Korea; and that they
had failed to produced the accounting details perti.ining to the activities/
G operations carried out by its PE in India. For the said reasons the accounts
were rejectedby the A.O'. Therefore; the assessment was made for each of ·
the two assessment years on receipt basis. On the questiOn of quantum of
assessment, the A.O. held that income from designing, fabrication, procurement
\.-,
of material etc. was partly attributable to the PE of the assessee in India on
the ground that designing, fabrication and procurement of material \yere
H activities having nexus/linkage to the ultimate activity of installation and
COMMNR.OFINCOMETAX,MEERlIT".HYUNDAIHEAVYINDUSTRIESCO.LTD.(KAPADIA,J.) 293

commissioning of platform in Bombay High and, therefore, income to that A
-~
extent from the Korean Operations was taxable in India. According to the
A.O., the contract was not divisible. According to the A.O., the contract was
in respect of the Turnkey Project; that the consideration in the contract was
of lump sum price; that even when the fabricated structure was delivered for
. transportation to the representative of ONGC the accounts between the
parties remained to be settled; and since designing and fabrication of the B
. platform had an application.in Bombay High, (where the platform was to be
come into operation), a part of the profits arising even from Korean operations
. was taxable in India as such portion of the profits was attributable to the
. work of installation and commissioning of the platform in Bombay High.
Accordingly the A.O. estimated the net profit of the assessee under the c
contract at 20% of the gross receipts. Consequently, the A.O .. taxed the entire
revenue· relatable to the Indian Operations and he taxed 2% of the contract
revenue in respect of the Korean Operations.

3. Aggrieved by the foretasted decision the assessee carried the matter
- · in CIT (A) who took the view that the assessee did not maintain separate D
books of accounts for each Project; that they were asked to submit and
extract from the consolidated accounts and income and expenditure statement
for the Indian Operations which they failed to submit; that the assessee had
its PE in India as th.eir Indian Operations extended beyond nine months and
also in view of the fact that the they had a Project Office in Bombay; that
such an office in Bombay had a close link with the operations, namely,
E
installation and commissioning of the platform; that the Project was under
Turnkey Contract consisting of drilling platform, process. platform,
accommodation platform and flare platform and that each of these platforms
· constituted the total project under the contract. It was further held by CIT
(A) that the activity of designing and fabrication on one hand and the
activity of installation and commissioning of the platforms on the other had
constituted one integrated activity. He further found that the schedule in the
contract indicated payment of lump sum price. Under the schedule, the
assessee was to be paid U.S.$ 41.73 lakhs for Indian Operations. According
to CIT (A), the contract was required to be read in entirety. It was a Turnkey G
Contract. It included designing, fabrication, installation and commissioning
of the platform in Bombay High and on the reading of the entire contract it
was clear that payment of lump sum amount was for the entire operations
commencing from designing of platform right upto the work of commissioning
of the platforms. Therefore, according to CIT (A), the contract was indivisible
for the purposes of attributing the profits to the PE in India. Further, according H
294 SUPREME COURT REPORTS [2007] 7 S.C.R.

A to CIT(A), designing and fabrication of platforms, as an activity, did have an
element of income embedded in the said activity of designing and fabrication
which had nexus with the activity of installation and commissioning of the
platform attributable to the PE in Bombay High. According to CIT (A), although
the consideration paid by ONGC was a composite payment it cannot be said
that no part of the income from the Korean Operations was at all attributable
B to the PE in Bombay High. for the foretasted reasons, the CIT(A) held that
though the actual receipt on fabrication operations in Korea was not taxable
under the Income-tax Act, the work of designing and engineering of platfonns
>.
was taxable under the CADT read with Section 9(1) of the Act. "'
C 4. On the question of quantum of profits embedded in the Korean
Operations, the A.O. was of the view that since the assessee had invoked
Article 7 of the CADT, the assessee was not entitled to compute its income
under Section 44BB or under Instruction No. 1767 dated 1.7.87 issued by ·
CBDT as urged on behalf of the assessee. On this point, CIT(A) took the view
that the operations, namely, installati_on and commissioning of platfonn in
D Bombay High gave rise to profits and, therefore, t_hose profits were attributable
to the PE of the assessee in India and they were taxable at the rate of 10%
of the payments received by the assessee in respect of the Indian Operations· .....
').

from ONGC ori the basis prescribed in Section 44 BB as also under Instruction
NO. 1767. Consequently, the CIT(A) directed the A.O. to compute the profits
E of the assessee at the rate of l % on receipts in respect of the Korean
Operations and at 10% of the receipts relating to Indian Operations in terms
of CBDT Instruction No. 1767.

5. Aggrieved by the aforestated decision the assessee carried the matter
in appeal to the Tribunal. It was held that the Department was right in
F invoking best judgment assessment. It was held that the question as to
whether the PE existed in India or not was not material as no part of the
income attributable to the Korean Operations was required to be taxed. It was
further held that the PE did exist in India in tenns of Article 5(3) of the CADT.
On the point of computation of income regarding Indian Operatfons, it was
held that Instruction No. 1767 was applicable. It was further held that Section
G 44 BB of the Act was also applicable and, therefore, the A.O. had erred in
computing the income on the Indian Operations on only Accounting Principles
without taking into account the provisions of Section 44BB as well as
Instruction No. 1767. It was further held that profits from Indian Operations
shoµld be worked out at the rate of 3% and not at the rate of 10% as done
.H by ClT(A), The Tribunal further held that the contract in. question was
. COMMNR. OFINCOMETAX,MEERUTi·. HYUNDAIHEAVYINDUSTRIES CO. LTD. [KAPADIA,J.) 295

divisible contract. According to the Tribunal, the work of fabrication in Korea A
-.... was separate for from the work of installation and commissioning of platfonn
in India; that the fabricated platform was handed over to ONGC in Korea in
September 1987 and, therefore, before coming into existence of the PE of the
assessee in India the work of fabrication was completed in Korea was not
divisible. According to the Tribunal, the Installation PE came into existence B
only after the work in Korea got completed and, therefore, only .the income
from Indian Operations was attributable to the PE which was alone taxable in
India. For the above reasons, the appeal filed by the assessee was allowed.

6. Aggrieved by the aforestated decisions of the ITAT, the matter was
carried in appeal to the High Court under Section 260A of the Act WHICH C
APPEAL was summarily dismissed. Hence, these civilappeals are filed by the
Department.

7. A short question which needs to be answered in the present case is
what are the profits reasonable attributable to the assessee's PE in India. In
order to answer ihe above question we are required to analyse the scheme D
ofthe Act. Under Section 4 of the Act it is the total income of every "person"
which is taxable. A foreign company which is not wholly controlled or managed
in India is a non-resident so far as its residential status is concerned. Section
5(2) of the Act lays down that as far as a non-resident assessee is concerned
scope of total income of such an assessee is confined to an income which
accrues or arises in India or is deemed to accrue or arise in India and which E
income is received or deemed to be received by such foreign company.
Therefore, it is clear that under the Act, a taxable unit is a foreign company
and not its branch or PE in India. A non-resid~nt assessee may have several.
incomes accruing or arising to it in India or outside India but so far as
taxability under Section 5(2) is concerned, it is restricted to income which F
accrue or arise .or is deemed to accrue or arise in India. The scope of this
deeming fiction is mentioned in Section 9 of the Act. Therefore, as far as the
income accruing or arising in India, an income which accrues or arises to a
foreign enterprise in India can be only such portion of income accruing or
arising to such a foreign enterprise as is attributable to its business carried
out in India. This business could be carried out through its branch(s) or G
through some. other form of its presence in India ~uch as office, project site,
faetory, sales outlet etc. (hereinafter called as "PE of foreign enterprise"). It
is, therefore, important to note that under the Act, while the taxable subject
is the foreign general enterprise (for short, "GE"), it is taxable only in respect
of the income including business .profits, which accrues or arises to that H
296 SUPREME COURT REPORTS [2007] 7 S.C.R.

A foreign GE in India. The Income-tax Act does not provide for taxation of PE
of a foreign enterprise, except taxation on presumptive basis for certain types ~

of income such as those mentioned under Section 44BB, 44BBA, 44BBB etc.
Therefore, since there is no specific provision under. the Act to compute
profits accruing in India in the hands of the foreign entities, the profits
..J
attribi..table to the Indian PE of foreign enterprise are required to be computed
B under normal accounting principles and in terms of the general provisions of
the Income-tax Act. Therefore, ascertainment ofa foreign enterprise's taxable
business profits in India involves an artificial division between profits earned
->t
in India and profits earned outside India.
"' l-
'
c earned8.inTheIndiaIndian Income-tax Act, 1961 is concerned only with the profits
and, therefore, a method is to be found out to ascertain the
profits arising in India and the only way to do so is by treating the Indian
PE as a separate profit centre vis-a-vis the foreign enterprise (the Korean GE,
in the present case). This demarcation is necessary in order to earmark the
tax jurisdiction over the operations of a company. Unless the PE is treated as
D a separate profit centre, it is not possible to ascertain. the profits of the PE
which, in tum, constitutes profits arising to the foreign GE in India. The
computation of profits in each r'E (taxable jurisdiction) decides the quantum
of incoine on which the source country can levy the tax. Therefore, it is
necessary that the profits of the PE are computed as independent u.nits.
However, in a case where Government of India has entered into a ~ treaty
E a
with foreign county (Korea, in the present case) then in relatio11 to an
assessee on whom such tax treaty applies, the provisions of the Act shall
apply only to the extent to which the provisions thereof are more beneficial
to ·the assessee.

F 9. Now, coming to the present case, the main argumentadvanced on
. behalf of the Department was that the assessee was in receipt of consideration .....,.._~~

which formed part of execution of Turnkey Project with ONGC; that there was
one integrated contract; that the contract was not divisible in tenils of separate
activities and, therefore, the Tribunal had erred in holding that profits accruing
to the assessee from activities performed outside India were not chargeable
G to taX in India. According to the Department, the work of designing and
fabrication under the Turnkey Project was totally interlinked with installation
and commissioning and, therefore, there was no ·merit in the assessee's claim
in respect of receipts attributable to the activates performed outside India as
.......
not chargeable to tax in India. According to the Department, the assessee was
required to execute turnkey work, that is, to supply certain equipments and
H
COMMNR. OFINCOMETAX,MEERUT1'. INUNDAIHEAVYINDUSTRIES CO.LTD. [KAPADIA,J.) 297

install the same in India. According to the Department, the supply of fabricated A
platfonn was essentially linked to installation of the platfonn in the Bombay
High. Thus, according to the Department, there was a business connection
and the supplies were linked to the Project in };1ombay High. For this reason,
according to the Department, the consideration received by the assessee for
supplies fonn outside India were taxable in India in tenns of Section 9(1) of
the Act. On the other hand, the assessee placed reliance on Article 7 of the B
CADT and submitted that on completion of the work of fabricated of platforms
the same were handed over to the Agents of the ONGC in Korea and,
therefore, the assessee was not liable to be taxed in respect of the profits
attributable to the operations of designing and fabrication in Korea. In this
connection, the assessee placed reliance on Article 7 of CADT. C
IO. We quote hereinbelow Article 7 of CAPT between Government of
India and Government of Korea which reads as under:

"ARTICLE 7 -Business profits-I. the profits of an enterprise of a
contracting State shall be taxable only in that State unless the enterprise D
carries on business in the other Contracting State through a pennanent
;f 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 pennanent
establishment.
E
2. Subject to the provisions of paragraph (3), where and enterprise of
a Contracting State carries on business in the other Contracting State
through a pennanent establishment situated therein, there sbll in
each Contracting Stat be attributed to that pennanent establishment
the profits which it might be expected to make if it were a distinct and
separate enterprise engaged in the same or similar activities under the F
same or similar conditions and dealing wholly independently with the
enterprise of which it is a pennanent establishment.

3. In the detennination of the profits of a pennanent establishment,
there shall be allowed as deductions expenses which are incurred for G
the purposes of the pennanent establishment including executive and
general administrative expenses so incurred whether in the State in
which the permanent establishment is situated or elsewhere, which are
allowed under the provisions of the domestic law of the Contracting
State in which the permanent establishment is situated.
H
298 SUPREME COURT REPORTS [2007] 7 S.C.R.

A 4.. No profits shall be attributed to -a permanent establishment by
reason of the mere purchase by that permanent establishment of
goods or merchandise for the enterprise.

5. For the pµrpose of the preceding paragraphs, the profits to be
attributed to the permanent establishment shall be determined by he
B same method year by year unless there is good and sufficient reason
to the contrary.

6. Where income or profits include items of income which are dealt-
with separately in other articles of this Convention, then the provisions -
of those articles shall not be affected by the provisions of this article."
c
I I. On reading Article 7 of the CADT, it is clear that the said Article
is based on OECD Model Convention. Para (I) of Article 7 states the general
rule that business profits of an enterprise of one Contracting State may not
be taxed by the other Contracting State unless the enterprise carries on its
business in the Other Contracting State through its PE. The said para 91)
D further lays down that only so much of the profits attributable to the PE is
taxable. Para 9 I) of Article 7 further lays down that the attributable profit can
be determined by the apportionment of the total profits of the assessee to its
various parts OR on the basis of an assumption that the PE is a distinct and
separate enterprise having its own profits and distinct from GE. Applying the
E abvve test to the facts of the present case, we find that profits earned by the
Korean GE on -supplies of fabricated platforms cannot be made attributable
to its Indian PE as the installation PE came into existence only after the
transaction stood materialized. The installation PE came mto _~xistence only
on conclusion of the transaction giving rise to the supplies of the fabricated
platforms. The Installation PE emerged only after the contract with ONGC
F stood concluded. It emerged only after the fabrjcated platform was delivered
in Korea to the Agents of ONGC. Therefore, the profits on such supplies of y.
fabricated platforms cannot be said to be attributable to the PE. There is one
more reason for coming to the aforestated conclusion. In terms of para (1) of
Article 7, the profits to be taxed in the source country were not the real profits
G but hypothetical profits which the PE would have earned if it was wholly
independent of the GE. Therefore, even if we assume that the supplies were
necessary for the purposes of in:;tallation (activity of the PE in India) and
even if we assume that the supplies were an integral part, still no part of
profits on such supplies can be attributed to the independent PE unless it is
established by the Department that the supplies were not at arm's length
H price. No such taxability can arise in the prtsent case as the sales were
COMMNR.OFINCOMETAX,MEERUTv.HYUNDAIHEAVYINDUSTRIESCO.LTD.[KAPADIA,J.] 299

directly billed to the Indian Customer (ONGC). No such taxability can also A
arise in the present case as there was no allegation made by the Department
that the price at which billing was done for the supplies included any element
for services rendered by the PE. In the light of our above discussion, we are
of the view that the profits that accrued to the Korean GE for the Korean
operations were not taxable in India.
B
12. There is one more aspect to be discussed. The attraction rule implies
that when an enterprise (GE) sets up a PE in another country, it brings itself
within the fiscal jurisdiction of that another country to such a degree that
such another country can tax all profits that the GE derives from the sources
country-whether though PE or not. It is the act of setting out a PE which C
triggers the taxability of transactions in the source State. Therefore, unless
the PE is set up, the question of taxability does not arise-Whether the
transactions are direct or they are through the PE. In the case of a Turnkey
Project, the PE is set up at the installation stage while the entire Turnkey
Project, including the sale of equipment, is finalized before the installation
stage. The setting up of PE, in such a case, is a stage subsequent to the D
conclusion of the contract. It is as a result of the sale of equipment that the
installation PE comes into existence. However, this is not an absolute rule. In
the present case, there was no allegation made by the Department that the
PE came in!o existence even before the sale took place outside India. Similarly,
in the present case, there was no allegation made by the Department. that the E
price at which ONGC was billed/invoiced by the assessee for supply of
fabricated platforms included any element for services rendered by the PE. In
the present case, we are concerned with assessment years 1987-88 and 1988-
89. Therefore, we are not inclined to remit the matter to the adjudicating
authority. We reiterate, in the circumstances, not all the profits of the assessee
company from its business connection in India (PE) would be taxable in India, F
but only so much of profits having economic nexus with PE in India would
be taxable in India. To this extent, we find no infirmity in the impugned
judgment of the Tribunal. Accordingly, we are of the view that the Tribunal
was right in holding that profits attributable to the Korean Operations was
not taxable in view of Article 7 of CADT.
G
13. Now coming to the question of the quantum of taxable profits
attributable to the Indian PE of the assessee relating to the work of installation
and commissioning of the platforms in Bombay High, we are of the view that,
for the reasons mentioned hereinafter, profits arising from the activities of
installation and commissioning were taxable at I 0% of the payments relating H
I

300 SUPREME COURT REPORTS [2007) 7 S.C.R.

A to the said servici!s/facilities carried out in Bombay High. Firstly, in the
present case, it is important to note that the accounts submitted by the
assessee were rejected and the A.O. had to invoke the provisions of the Act
by way of best judgment assessment. Secondly, in the present case, the
assessee themselves contended in the assessment proceedings that the A.O.
B should have computed the income relating to Indian Operations under Secticm
44BB or under Instruction No. 1967 issued by CBDT dated 1.7.87. Thirdly, it
is important to note that Chapkr IV of the Act contains provisions for
presumptive taxation of business income in certain cases as prescribed in
Sections 44B, 44BB, 44BBA and 44BBB of the Act. In the scheme of
presumptive taxation, the assessee is presumed to have earned income at the
C rate of a certain percentage of his total turnover or gross receipts. If the
assessee agrees to be taxed on presumed income, he is not required to
maintain books of accounts. If, however, he claims that his income is less than
the presumed figure, he is required to support his claim by producing books
of accounts. In the present, as indicated above, the A.O. has rejected the
accounts submitted by the assessee. This has not be challenged. Moreover,
D the assessee appeared before the Department and submitted that its income
from Indian Operations be computed under Section 44BB or under Instruction \__
No. 1767 issued by CBDT. Under the said Instruction, in cases where the
· sales take place outside, as in this case, only 10% of the gross receipts in
respect of the activates of installation, commissioning etc. performed in India
E will be taxable. In view of the stand taken by the assessee, we are of the view
that the CIT (A) was right in computing the taxable pron~ at 10% of the gross
receipts in respect of the activates of installation, commissioning etc. performed
in India. In the present case, no reasons have been given by the Tribunal for
reducing the rate from 10% to 3%. Fourthly, it is important to note the scope
of Section 44BB of the act. Once that section applies then two conclusions
F follow. The first is that 10% of the receipts by the foreign resident is chargeable
to tax and the other conclusion is that 90% of the receipts of that foreign
resident as well as receipts/gains, other than those mentioned in Section
44BB, is also not chargeable to tax. Lastly, there is a concept in accounts
which called as the concept of Contract Accounts. Under that concept, two ·
G methods exist for ascertaining profit for contracts, namely, "Completed Contract
Method" and "Percentage of Completion Method". To know the result of his
operations, the contractor prepares what is called as Contract Account which
is debited with various costs and which is credited with revenue associated
:~
with a particular contract. However, the rules of recognition of costs and
revenue depend on the method of accounting. Two methods are prescribed
H in Accounting Standard No. 7 They are- "Completed Contract Method''. and
COMMNR. Of INCOME TAX. MEER UT 1•. HYUNDAI HEAVY INDUSTRIES CO. LTD. [KAPADIA. J.) JQ}

"Percentage of Completion Method". In the present case, the A.O. has rejected A
the Completed Contract Method which is not challenged. Therefore, we have
to fall back on Percentage of Completion Method under which reasonable
profit is calculated on the basis of the value of the work certified and the
profit attributable to the work certified. For example, ifthe value of the work
certified is 1/. or more but less than Y:z of the contract price, then a certain
percentage of the profit accruing to the certified work is taken to the profit B
and loss account.. In the present case, the assessee has not given these
details, particularly, regarding the value of the work duly certified. If the
contract is almost complete, then profit if normally estimated by charging the
actual cost and the costs estimated for completing the remaining contract to
the Contract account. This procedure is called as procedure of Contract C
costing. When the assessee does not given particulars above-mentioned then
CIT (A) was right in estimating the profits of the assessee at I 0% of the gross
receipts in respect of the activities of installation, hook-up and commissioning
performed by the Indian PE in Bombay High. To this extent we set aside the
impugned decision of the Tribunal.
D
14. Before. concluding, we may point out that the High Court had erred
.Y in holding that no substantial question of law arose in this case under section
260A of the act. In our view substantial questions of law did arise. We did
not remit the matter to the High Court, particularly, when the appeal is in
respect of the assessment years 1987-88 and 1988-89.
E
15. For the aforestated reasons, we hold as follows:

(A) In the facts and circumstances of the case, profits, if any, form
the Korean Operations (designing and fabrication) arose outside
India, hence not taxable.
F
(b) As regards the quantum of profits embedded in the Indian
Operations attributable to the Indian PE of the assessee, we hold
that the CIT (A) was right, in the facts and circumstances of this
case, in attributing the profits to the Indian PE at I 0% of the
gross receipts in respect of its activities of installation,
commissioning etc. performed in India. The same shall be taxable G
accordingly.

16. For aforestated reasons, civil appeals preferred by the Department
are accordingly partly allowed with no order as to costs.

B.S. Appeals partly allowed. H