Project Office is not PE; SC affirm substance over legal form

The Hon'ble Supreme Court in it's recent decision in the case of DIT vs. Samsung Heavy Industries (Civil Appeal No. 12183 of 2016) dismissed the appeal of the department and held that project office of the assessee is not permanent establishment within the meaning of the Article 5 of India-Korea DTAA. Although, it is settled position of law that the Project Office is PE (subject to threshold of numbers of days as per relevant DTAA), however, looking the facts of the case, the Hon'ble Supreme Court held that the Project Office in the question is not a PE withing the meaning of the Article 5(1) of DTAA rather it would fall within Article 5(4)(e) of the DTAA. Lets the discuss the facts of the case and findings of the each authority.

The critical fact of the case are that the ONGC awarded a “turnkey” contract to a consortium comprising of the Assessee, i.e. Samsung Heavy Industries Co. Ltd. (a Company incorporated in South Korea), and Larsen & Toubro Limited, being a contract for carrying out the “Work”, inter alia, of surveys, design, engineering, procurement, fabrication, installation and modification at existing facilities, and start-up and commissioning of entire facilities covered under the ‘Vasai East Development Project’

The Assessee set up a Project Office in Mumbai, India, which, as per the Assessee, was to act as “a communication channel” between the Assessee and ONGC in respect of the Project. Accordingly for the AY 2007-08 the assessee filed nil return and claimed the losses.

During the assessment proceedings, the AO concluded that "the Project in question is a single indivisible “turnkey” project, whereby ONGC was to take over a project that is completed only in India. Resultantly, profits arising from the successful commissioning of the Project would also arise only in India."

The DRP also concluded that "the Assessing Officer has given a specific finding that the assessee had a project office in India, when it was given the contract. The assessee has not contested the existence of the Project office in India but it has only contested that the project was used merely for preparatory and auxiliary activities. This submission of the assessee does not hold merit because if it wanted to perform only preparatory and auxiliary activities then it could have opened a liaison office. The opening of a project office clearly shows that the assessee was doing something more than what would have been done through liaison office. In any case nature and purport of activities undertaken in India determine the existence of PE. Considering the nature of activities undertaken in India it is clear that PE existed in the case of assessee."

During the hearing before the ITAT, the Ld. DR bought on record the resolution of Board of Directors meeting dated 3rd April, 2006. The opening para of said resolution provides that "the company hereby open one project office in Mumbai, India for coordination and execution of Vasai East Development Project for Oil and Natural Gas Corporation (“ONGC”), India". Based on such resolution, the Ld. DR concluded that these documents make it clear that all the activities to be carried out in respect of impugned contract will be routed through the project office only. However, it is noteworthy to state here that the Ld. DR only reproduce the first para of the Board Resolution, the second para of said resolution provides that "That the Company hereby does make and constitute Mr. Sangsoon Park Yard General Manager of the Company, as the Company’s true and lawful representative with full power and authority for the purpose of establishing a project office and coordinating and executing delivery of documents in connection with construction of offshore platform modification of existing facilities for ONGC above."

On other hand, the assessee before the ITAT argued that the Project Office was only an auxiliary office, and did not involve itself in any core activity of business, as accounts that were produced would show that there was no expenditure which related to execution of the project. The Hon'ble Tribunal disposed off that argument of the assessee by stating that "the way the terms of the contract are described and the way the work on contract has to proceed clearly describe that in all the activities of contract there will be the role of Mumbai project office as the same has to work as a channel between assessee company and ONGC. If PE of the assessee exists within the meaning of Article 5.1 and 5.2 and assessee claims that despite there being PE in terms of clause 5.1 and 5.2, it falls under exclusionary Article 5.4 then onus is on assessee to prove that activities of its PE are in the nature of preparatory or auxiliary in nature. No material has been brought on record by the assessee to prove the said fact. The arguments put forward in this respect are only by inference such as the accounts maintained by the assessee in India through which it is the argument of the ld. Counsel of the assessee that it does not contain any expenditure relating to execution of the contract. But such argument is not acceptable as the maintenance of account is in the hands of assessee and mere the mode of maintaining the accounts alone cannot determine the character of PE as the role of PE only will be relevant to determine what kind of activities it has carried on." However, the ITAT found that there was a lack of material to ascertain as to what extent activities of the business were carried on by the Assessee through the Mumbai Project Office, and therefore it was considered just and proper to set aside the attribution of 25% of gross revenue earned outside India – which was attributed as income earned from the Mumbai project office – the matter being sent back to the Assessing Officer to ascertain profits attributable to the Mumbai project office after examining the necessary facts.

Surprisingly, the Hon'ble High Court pronounced its decision on entire different footing. The core grievance of the assessee was regarding considering the PO as PE by the lower authorities looking to the peculiar facts and circumstances of the case. However, the High Court re-framed the question of law as "can it be said that the Agreement permitted the India Taxing Authority to arbitrarily fix a part of the revenue to the permanent establishment of the appellant in India?”

Accordingly, the Hon'ble High Court held - "that being the situation we allow the appeal, set aside the judgment and order under appeal as well as the assessment order insofar as the same relates to imposition of tax liability on the 25% of the receipt upon the appellant in the circumstances mentioned above, and observe that the questions of law formulated by us, while admitting the appeal, have not, in fact, arisen on the facts and circumstances of the case, but the real question was, whether the tax liability could be fastened without establishing that the same is attributable to the tax identity or permanent establishment of the enterprise situate in India and the same, we think, is answered in the negative and in favour of the appellant."

However, the Supreme Court while pronouncing its decision, gone into details and considered the findings of the all lower authorities. The critical findings of the Hon'ble Supreme Court are with regards to documents filed by the assessee before the RBI and which was heavily relied by the ITAT also. The Hon'ble quote the Board Resolution of the assessee company and held that "A reading of the Board Resolution would show that the Project Office was established to coordinate and execute “delivery documents in connection with construction of offshore platform modification of existing facilities for ONGC”. Unfortunately, the ITAT relied upon only the first paragraph of the Board Resolution, and then jumped to the conclusion that the Mumbai office was for coordination and execution of the project itself. The finding, therefore, that the Mumbai office was not a mere liaison office, but was involved in the core activity of execution of the project itself is therefore clearly perverse. Equally, when it was pointed out that the accounts of the Mumbai office showed that no expenditure relating to the execution of the contract was incurred, the ITAT rejected the argument, stating that as accounts are in the hands of the Assessee, the mere mode of maintaining accounts alone cannot determine the character of permanent establishment. This is another perverse finding which is set aside."

The Hon'ble Supreme Court further observe that "Though it was pointed out to the ITAT that there were only two persons working in the Mumbai office, neither of whom was qualified to perform any core activity of the Assessee, the ITAT chose to ignore the same. This being the case, it is clear, therefore, that no permanent establishment has been set up within the meaning of Article 5(1) of the DTAA, as the Mumbai Project Office cannot be said to be a fixed place of business through which the core business of the Assessee was wholly or partly carried on. Also, as correctly argued by Shri Ganesh, the Mumbai Project Office, on the facts of the present case, would fall within Article 5(4)(e) of the DTAA, inasmuch as the office is solely an auxiliary office, meant to act as a liaison office between the Assessee and ONGC."

Therefore, it is rightly to conclude here that for the purpose of applying the DTAA, the legal form is not much relevant where the facts says something different. In this case, even the office of the assessee was registered as Project Office with the RBI, however, the Supreme Court went on the facts, considered the actual activities carried out by such office, considered the purpose of such office and concluded that the Project Office in question is not a PE rather it would fall within Article 5(4)(e) of the DTAA, inasmuch as the office is solely an auxiliary office, meant to act as a liaison office between the Assessee and ONGC.

(views are personal, for more details, it is advisable to go through with the order of the SC)