ORDER
Deepak R. Shah, Accountant Member
1. ITA Nos. l733/Del/201, 2473/Del/2000, 2474/Del/2000 and 2475/Del/2000 pertaining to asstt. Year 1995-96 to 1998-99 respectively arc directed against orders of learned CIT(A)-XIX, New Delhi dated 5.3.2001 and 7.3.2000 in an appeal against assessment framed Under Section 143(3) read with Section 147 of the Income-tax Act, 1961 (the Act).
1.1 ITA Nos. 820 to 823/Del/2005 are directed against common order of learned CIT(A)XXIX, New Delhi dated 15.12.2004 in an appeal against assessment framed Under Section 143(3) read with Section 250 of the Act.
1.2 Cross Objection Nos. 47, 48, 49 and 50/Del/2006 by the Revenue are in respect of ITA No. 1733, 2473 to 2475/Del/2000. C.O. Nos. 51 to 54 of 2006 by the revenue are in respect of ITA Nos. 820 to 823 of 2005.
Since common issues are involved in all these appeals and cross objections were heard together and are being disposed of by this common order.
2. Galileo International Inc. (the ‘Appellant’), a resident of USA, is in the business of maintaining and operating the system for providing electronic global distribution services to airlines, hotels, tour and cab operators by connecting to travel agents (‘the TAs’) utilising a Computerised Reservation System (‘CRS’), which may, inter alia, include a system which receives, processes, stores and disseminates data about flight schedules, seat/room availability, fare information and provision for booking capabilities etc. As a CRS service provider to airlines, the Appellant performs the following:
• It receives all relevant information from the various Participant airlines, processes this information and stores it on its database in a standard format, and has processes in place for receiving updates to this information on a continuous basis
• It receives from the TAs requests for information contained in the database, booking requests, enables booking and requests for changes in bookings
• It forwards the booking initiation or update requests from the TAs to the Airlines Servers, receives responses thereto from the Airlines Server and forwards the responses to the TAs
• It provides reports to airlines about the bookings made through its CRS in various forms and using various parameters.
The appellant has entered into an agreement with various participants (hereinafter referred as Participating Carrier Agreement or PCA). A sample copy of such agreement has been filed at assessee’s Paper Book (APB) at pages 1-97. Relevant Clauses of said agreement are extracted herein:
Introduction:
Whereas, Galileo International provides computerized reservations and ticketing and other services.
Whereas, Participant wishes to purchase services from Galileo International, and Galileo International is willing to allow Participant to do so under the terms and conditions of this agreement.
Now therefore, in consideration of the premises and the mutual obligations set forth below, Galileo International Partnership, the Galileo Company, and Participant hereby agree to abide by the terms and conditions of this Agreement.
1. Definitions:
“CRS” means a computerised reservation system or computerized reservation system, as applicable, except that the term ‘CRS’ shall not refer to a system to the extent that it is used solely as an internal reservations system.
“Galileo International Software” means the software used in or with the System that is owned or licensed, in whole or in part, directly or indirectly by Galileo International or its predecessors for use by Participant in conjunction with the System, including any such software modified by Participant with the consent of Galileo International or its predecessors.
“Galileo International Subscriber” means any person that is authorised to use the system.
“Input” means any entry by a Galileo International subscriber in the System whereby a Direct Flight Segment is added in a new or an existing Booking File, or whereby the status code is changed in an existing Booking File counted on a per passenger, per Direct Flight basis, except that it shall not include a Cancel.
“Net Passenger Segment” means all Active Confirmed Segments, Passive Segments and other Segments less any cancels.
“Numeric AVS Message” means an AVSW message that indicates the actual number of seats available for sale.
“Participating Carrier” means any airline that has entered into a Global Airline Distribution Agreement with Galileo International.
“System: means any CRS operated by Galileo International, not including the Apollo by Gemini CRS.
2. Duties Of Galileo Interna Tional:
Galileo International shall maintain and operate the system and shall provide to Participant various standard services at the charges set out in Schedule 2, as it may be amended by Galileo International from time to time. Depending on the options selected by Participant under Schedule I, these services may include, among other things, display of schedules and fares, building of connections, display of flight availability status, and provision of booking capability. The scope of the standard services provided shall be determined, and may be amended from time to time, by Galileo International. Such standard services shall not incluue the optional services listed in Schedule 4.
Where Participant uses a computer to computer communications link between the System and Participant’s System, Galileo International shall offer certain point(s) of entry into the System communications network and will specify the connectivity parameters that must be used in order that Participant’s System can send and receive Type A and/or unsecured Type B messages. Subject to Article 3.F and 3G below Galileo International will pay all costs of communication between Participant’s point of entry, as specified by Galileo International, and the System.
Upon receipt of documented evidence from Participant of speculative booking or other abusive practices by a Galileo International subscriber involving the sale of Participant’s air transportation services, Galileo International shall assist efforts by Participant to initiate appropriate, timely and reasonable remedial measures against such Galileo International Subscriber.
3. Duties of Participant:
Participant shall indicate all appropriate choices, and shall provide any requested information on the applicable schedules below, including at a minimum Schedules 1 and 4.
Participant, at its own cost, shall provide Galileo International with data that are at least as complete, timely, accurate, and advantageous and that are delivered in as favourable a manner, as those it provides to any other CRS, including Participant’s CRS. Participant shall provide any such data in a format and through a supplier (if a supplier is used) that are acceptable to Galileo International.
Participant shall participate in every CRS in which Galileo International has a direct or indirect ownership interest in every country in which services of such a CRS are offered, to the extent that (i) the display of services does not discriminate against Participant and (ii) any charges to Participant are not discriminatory.
Participant shall not reject a booking that has been made through the System where Participant’s System has not responded to the System within twelve (12) hours of the message origination, even though overbooking may result therefrom and denied boarding compensation may be required. Participant shall not reject a booking for a passenger that has been made in the System where that booking has been made via an optional service described in Schedule 6, 7, 11 or 12. Participant shall accept for transportation any passenger presenting a ticket that bears an ‘OK’ status and that has been issued as a result of a booking made through the System consistent with data in the System and otherwise in accordance with this Agreement, even though no record of that booking may exist in Participant’s System, overbooking may result therefrom, and denied boarding compensation may be required. Participant shall accept a ticket for transportation at the fare shown on that ticket provided that the ticket was automatically issued by a Galileo International and Galileo International Subscriber shall have no liability to Participant (and Participant hereby waives any rights and remedies against Galileo International and Galileo International Subscribers) for any inaccuracies in the fares data shown on such a ticket. Participant hereby grants ticketing authority to issue Participant’s transportation documents through the System to Galileo International and all Galileo International Subscribers that hold validation approval to issue transportation documents on Participant’s behalf in each territory in which Participant is, at the subject time, a member of any authorized ticketing arrangement and in which the System is authorized to operate in the capacity of a “system Provider” or in another comparable capacity. Participant expressly agrees to execute promptly all agreements and other authorisations specified by the local settlement plan or any other operator of an authorised ticketing arrangement that Galileo International reasonably believes are necessary to implement such authority for the System.
4. Charges:
Participant shall pay to Galileo International (or such other Person as Galileo International shall direct) on a monthly basis the charges, for use of the System and other services rendered under this Agreement, as specified in the Schedules.
Schedule 2:
Charges for Standard Services:
This Schedule describes the charges for certain basic standard services and for segments created through the use of certain optional services provided to Participant and forms part of the Galileo International Global Airline Distribution Agreement.
Type of Direct Flight Segment Charge*
Territory 1 Per Input Per
Cancel
Active Confirmed Segment USD 1.150 USD
0.2625
Passive Segment USD 0.9975 USD
0.2625
Other Segment USD 0.5250 USD
0.2625
Territory 2 Per Net Passenger
Segment
Net Passenger Segment ECU2.0800 (prior to
1/1/94)
ECU2.1840 (effective
1.1.94)
Credit Card Authorization Per Authorisation
Territory 2 ECU 0.1300
*For purposes of this Schedule, Territory 1 and Territory 2 refer to the location of the Galileo International Subscriber that performs the activity that generates a charge. Territory 1 charges are stated in US Dollars (USD). Territory 2 charges are stated in European Currency Units (ECU).
Schedule 7:
Last Seat Availability
This Schedule describes the Last Seat Availability service offered in Schedule 4 and forms part of the Galileo International Global Airline Distribution Agreement. Available only in Territory 2; may be extended to Territory 1 at a later date.
2. Responsibilities of Galileo International:
(iii) The System will automatically display to Galileo International Subscribers in the primary availability display a numeric value equal to the Quotasale authorised by Participant as stated in Clause 3 of Schedule 1, or such lower value as may be stored in the System availability status tables as a result of Numeric AVS Messages received from Participant’s System.
B. Flight Specific Availability Procedure:
(v) Where a Direct Flight Segment is made in Territory 2 without reference to an availability display and Participant has not selected one of the optional booking services described in Schedule 11 or 12, the System will interrogate Participant’s System and, subject to seats being available, will send an “LK” or other applicable message to Participant’s System as if the sell had been made with reference to an overlaid availability display.
Schedule 10:
Inside Availability:
This Schedule describes the Inside Availability service offered in Schedule 4 and forms part of the Galileo International Global Airline Distribution Agreement.
1. General:
Inside Availability refers to the functionality whereby, via a computer-to-computer capability between the System and Participant’s System, Galileo International enables Participant to display real time flight availability information directly from Participant’s System within the primary availability displays of the System according to the journey requested by the Galileo International Subscriber.
2. Responsibilities of Galileo International:
B. The System will send to Participant s System information to facilitate the identification of each Galileo International Subscriber seeking an availability that involves one or more of Participant’s flights together with the city pair requested by the Galileo International Subscriber. The System will display availability data returned from Participant’s System in preference to the data stored in the System availability status tables, provided that Participant returns this information to the System within an agreed period of time from the point at which the initial interrogation request leaves the System.
Schedule 25:
Ticketing Facility:
This Schedule describes the Ticketing Facility service offered in Schedule 4 and forms part of the Galileo International Global Airline Distribution Agreement. Available only for Territory 2; may be extended to Territory 1 later.
1. General:
Ticketing Facility refers to the functionality whereby Galileo International enables a Galileo International Subscriber, via a computer-to-computer communications capability between the System and Participant’s System to retrieve a PNR created in Participant’s System and transmit the data in that PNR to the System, so that a Booking File is created and a ticket for the PNR can be issued through the System.
For this purpose, it maintains and operates a huge master computer system (‘MCS’) consisting of 18 main-frame computers and servers in Denver, in the State of Colorado, USA. This master computer system is connected inter alia to Airline Servers to/from which data is continuously sent and obtained, inter alia, regarding flight schedules, seat availability, fare structures, flight connections, meal preferences, the availability of special facilities, e.g. infant/senior citizen requirements, etc on a real-time basis. All input processing and output is managed, processed and stored by the Appellant through the MCS in the USA.
The Appellant in turn appoints Distributors to market and distribute the CRS services to the TAs. In India, the Appellant has entered into a Distribution Agreement (DA) dated 24 February 1995 with Interglobe Enterprises Pvt. Ltd. (‘Interglobe’), an unrelated company to market and distribute CRS services to the TAs in India.
Relevant Clauses of the DA are extracted herein:
This Agreement is made the 24th day of February 1995
Between
Galileo International Partnership (trading as “Galileo International”), A Delaware general partnership whose principal place of business is located at 9700 West Higgins Road, Rosemont, Illinois 60018,
USA,
And
Interglobe Enterprises P. Ltd. (a company constituted under the laws of India) its successor, nominees and assigns whose registered office is at 66, Janpath, New Delhi – 110001, India.
Recitals
A. Whereas Galileo International has developed and/or owns and is entitled to commercially exploit and distribute globally, and particularly in India, the software, hardware, Intellectual property rights and other properties relating to the Galileo System, CRS Services and connected services/facilities forming the subject matter of this agreement.
B. And whereas Galileo International and Interglobe have agreed to the latter distributing the said services and facilities in the Market Region on mutually agreed terms set out hereinafter.
Now therefore it is agreed as follows:
1. Definitions
1.1 As used in this agreement, the following terms will have the meaning provided for each:
“Booking” means in relation to an Air Vendor, a booking made in the Galileo System in respect of a Passenger Segment and, in relation to a Non-Air Vendor, the unit of measurement used by Galileo International for charging purposes;
“Computerised Reservation System” or “CRS” means an automated system which processes Booking data and other data to provide any or all of the following functions:
(a) the ability to display flight schedules and seat availability;
(b) the ability to display and/or quote airline fares;
(c) the ability to make airline seat reservations;
(d) the ability to issue airline tickets; and
(e) the ability to perform any or all of the functions similar to the above functions in respect of hotel, car and other travel related services other than air services;
“CRS Services” means services of the types described in the definition of CRS which are provided by a CRS directly or indirectly to subscribers;
“Data Processing Fees” means the fees payable by Galileo International to Interglobe as set forth in Schedule 3 read with Clause 8;
“Galileo System” means the systems of computer hardware and software operated by or for Galileo International for the provision of CRS Services. “Indian NDC ” means the entity which Interglobe with establish and control and which will act as Galileo International’s distributor in India.
“Market Region ” means the Republic of India:
“Node ” means the SITA telecommunications centre at Bombay or Delhi, as appropriate.
“Subscriber” means a travel agent or other person in the Market Region who is an actual or potential user of the distribution facilities of a CRS in a capacity other than that of Vendor and more particularly: “Individual Subscriber ” means a Subscriber who is not a travel agent, and “Multinational Subscriber” means a Subscriber which is a travel agent which has places of business, branches or offices in more than one country and to which Galileo International provides its CRS Services directly; and
“Vendor ” means a Person who sells or may wish to sell its products and/or services through a CRS, and more particularly:
“Air Vendor” means a Vendor which is an airline, whether scheduled, charter, domestic or international;
“International Vendor” means a Vendor who sells or may wish to sell its products and/or services in more than one country and shall include any Air Vendor.
2. Appointment oflnterglobe and Establishment of NDC:
2.1 Except as provided herein, Galileo International hereby appoints Interglobe as the sole and exclusive distributor of Galileo International’s CRS Services in the Market Region and Interglobe hereby agrees to act in that capacity, subject to the terms and conditions of this agreement.
2.2 Interglobe shall establish the Indian NDC, the name of which shall be “Galileo India “. Galileo India shall be, at Interglobe’s discretion, either a division or a subsidiary of Interglobe. In the event that the Indian NDC established as or is converted into a subsidiary of Inter globe, it shall by a amendment to this agreement be added as a party to this agreement. Notwithstanding any such amendment, Interglobe shall at all times ensur that the Indian NDC has sufficient share capital and/or funding (a appropriate) to enable it to acquire the necessary resources and personnel in order for it to fulfil its obligations under this agreement.
2.3 During the term of this agreement and of any extensions or renewals of this agreement Galileo International shall not:
(a) appoint any other person as its distributor or agent for the provision of its CRS Services in the Market Region, or
(b) supply its CRS Services to any other person in the Market Region for use by or provision to a subscriber.
2.8 Notwithstanding Clause 2.3:
(a) Interglobe undertakes to Galileo International that it is and will continue to be prepared to accept Air India or Indian Airlines as a participant, associate or shareholder in the Indian NDC on reasonable terms, and
(b) “Interglobe undertakes to Galileo International that, in the event that either party identifies a potential interested and commercially viable participant, associates or shareholder in the Indian NDC Interglobe will negotiate in good faith with such party with a view to accepting such party as a participant, associate or shareholder in the Indian NDC upon reasonable terms.
Provided that the induction of such participant, associate or shareholder shall not in any way affect the share holding pattern, control, management or functioning of Interglobe.
2.9 During the term of this agreement Interglobe shall not:
(a) either directly or indirectly provide or be concerned with any CRS Services in the Market Region other than Galileo International’s CRS Services.
(b) solicit customers for any CRS Services in any country which is outside the Market Region; or
(c) sell or provide Galileo International’s CRS Services to any customer or for use in any country which is outside the Market Region.
3. Establishment and Operation Networks and Routers:
3.1 Galileo International shall at its own cost procure the provision, operation and maintenance of a communication network and associated equipment for the distribution of its CRS Services from the Galileo International’s CRS Services from the Note or Router to subscribers in the Market Region. Interglobe may request Galileo International to arrange for such provision and operation of communication network services through Galileo International’s contractual relationships with SITA or other such network provider. Such services shall be provided in accordance with the then current Galileo International contract terms and conditions including cost with such network provider save that Interglobe shall pay for such services in Indian currency, in so far as it is possible to do so and subject always to Interglobe being at liberty to renegotiate the cost of such service with the network provider,
4. Provision of Galileo International’s CRS Services:
4.1 Galileo International shall at its own cost and responsibility provide such of its own cost and responsibility provide such of its CRS Services shall at its own cost and responsibility provide such of its CRS Services to the Note or Router as appear to both parties to be commercially desirable or necessary for the Market Region and whilst Galileo International will use all reasonable efforts to provide continuous CRS Services, both parties acknowledge that it is impossible for Galileo International to guarantee the provision of uninterrupted or error free CRS Services.
4.2 “Interglobe shall at its own cost and responsibility provide Galileo International’s CRS Services without alteration, except as may be mutually agreed, from the Node or Router to Subscribers in the Market Region and shall either provide equipment to Subscriber or facilitate the connection of equipment to access Galileo International’s CRS Services. Galileo International shall provide to Interglobe details of the hardware and software specifications approved from time to time by Galileo International for use in conjunction with Galileo International’s CRS Services and including, but not limited to, operating, performance or other parameter. Interglobe shall use its best endeavours to ensure that all hardware and software used to access Galileo International’s CRS Services in the Market Region comply with such specifications and including, but not limited to, any operating, performance or other parameter imposed by Galileo International”.
4.3 Galileo International shall apply to Interglobe licences for all such software products developed by Galileo International as are commercial desirable or necessary for use by Subscribers in the Market Region in conjunction with Galileo International’s CRS Services, to enable Interglobe to supply such software products to Galileo Subscribers in the Market Region provided always that nothing in this Clause shall oblige Galileo International to supply any particular software product.
4.5 Galileo International and Interglobe shall enter into a service level agreement based upon the Model Services Level Agreement which forms schedule 4 hereto. Galileo International and Interglobe shall use all reasonable endeavours to achieve the objectives set out in such service level agreement, which shall be reviewed at intervals of not less than one year.
6. Marketing to Subscribers:
6.1 Subject to Clause 6.2, Interglobe shall have exclusive responsibility for marketing Galileo International s CRS Services to Subscribers in the Market Region.
6.2 Interglobe shall at all times use all reasonable endeavours to promote the use of Galileo International’s CRS Services in the Market Region. In carrying out its marketing activities, Interglobe shall give reasonable consideration to all recommendations of Galileo International.
6.3 Interglobe shall be responsible for entering into contracts with Subscribers who wish to use Galileo International’s CRS Services in the Market Region. Such contracts shall be consistent with the terms of this agreement and consistent with the local laws of the relevant jurisdiction and shall provide that Interglobe is acting as a principal and not as agent for Galileo. Intergloe shall give reasonable consideration to Galileo International proposal with regard to the terms of such contracts. Schedule 5 contains Galileo International’s Model subscriber Agreement which Interglobe may use as a guideline in drafting its Subscriber agreements.
6.4 Interglobe will engage staff with appropriate experience and expertise and at all times during this agreement will retain such staff in sufficient numbers to perform its obligations hereunder efficiently.
6.5 All computer hardware for use by Subscribers in the Market Region which is required by Interglobe during the first two years hereof in order for Subscribers to use the Galileo System shall be provided by Galileo International at no cost to Interglobe. For the avoidance of doubt, it is the intention of the parties that the costs herein born by Galileo International are the cost of the hardware and the costs associated with delivery to Interglobe in India inclusive of freight and duty (duty to be initially paid by Interglobe and reimbursed by Galileo International) and that all costs incurred after delivery including but not limited to installation, testing, maintenance and post customs warehousing shall be the responsibility of Interglobe. Galileo International will retain title to all computer hardware supplied to Interglobe as contemplated in this Clause 6.5.
9.12 In the event of termination of these agreements under Clause 9.4 or 9.5, parts (b) through (f), upon the expiry of the notice period as specified hereunder:
(a) all subscriber Agreements concluded by Galileo India shall be automatically assigned to Galileo International at no cost to Galileo International and Galileo India shall physically deliver to Galileo International its signed originals of all such Subscriber Agreements within thirty (30) days of such termination takings effect, and
(b) Galileo International, at its sole discretion, may purchase all or part of the Subscriber hardware, title to which at the time of termination is vested in Interglobe at the lower of Net Book Value or market value in the India market where Net Book Value is defined to be original purchase price inclusive of freight and duty only and no other costs, depreciated on a straight line basis from the date of delivery to Interglobe, using a 6 (six) year useful life or existing market value in Indian market thereof at that point in time, whichever is the lower.
12. Intellectual Property Rights:
12.1 Subject to the conditions contained in this clause, Galileo International hereby authorises Interglobe to use Galileo International’s Trade Marks in the Market Region for the limited purpose of exercising its rights and performing its obligations under this Agreement.
14.3 Interglobe shall provide to Galileo International on a regular basis, but no less frequently than quarterly, such information as Galileo International reasonably requires relating to the activities of Interglobe under this agreement. The categories of information which may be required include, but are not limited to:
(a) sales projections for the forthcoming year;
(b) a list of Subscriber contracts entered into or renewed;
(c) a list of Subscriber contracts terminated or due to expire in the forthcoming year;
(d) staff training activities;
(e) customer support activities;
(f) competitor activities;
(g) operational service levels; and
(h) the standard terms of any Subscriber contracts, including the amount and terms of any payment.
14.4 After consultation with Galileo, Inter globe shall produce an annual marketing plan covering its objectives for the forthcoming year and setting reasonable performance targets. Prior to Interglobe producing its marketing plan, Galileo International shall provide to Interglobe details of its current marketing plans in so far as they relate to the Market Region. Interglobe shall use all reasonable endeavours to meet the performance targets set out in its marketing plan.
15.3 Interglobe shall ensure that the terms of its contracts with its Subscribers are consistent with the provisions of this agreement and in particular it shall include a provision whereby the Subscriber indemnifies Galileo International against any claim in respect of inaccurate data supplied by the Subscriber.
Interglobe in turn enters into Subscriber Agreements with various TAs to provide the TAs with access codes, equipment, communications link and support services. The TAs may chose to obtain access to the Appellant’s CRS through the access code provided by the Interglobe or they may chose to independently access the CRS of the Appellant’s competitor. A model subscriber agreement is prescribed as part of DA; As in Clause 6.3 is the DA, Interglobe enters into Subscriber agreement with the subscribers. Relevant Clauses of said Agreement are extracted herein:
Agreed:
1. Introduction
1.1 Galileo produces and/or obtains and distributes products and services to subscribers for the display of information on air carrier schedules, fares, seat availability and other travel related products and provides subscribers with the ability to make reservations and/or tickets and/or provide other related services.
1.2 Subscriber wishes to have access to and use of the products and services provided by Galileo.
“Communication Link” means the telecommunications lines and associated equipment which link the Galileo System to the Equipment at the location. “Computer Reservation System” or “CRS” means a computerised system containing or providing information about schedules, fares, seat availability and other services of air carriers and about the services of other travel related companies, through which reservations can be made.
“Galileo System” means the CRS operated or accessed by or for Galileo.
“Location ” means those premises at the address or addresses specified in the Appendices, where equipment and/or Software Products are installed under the terms of this agreement.
4. Location
4.1 Galileo will, at no cost to Subscriber, liaise with and provide information to Subscriber in relation to the preparation of the Location and the installation an operation of the Apparatus.
4.4 Relocation of any installed Equipment or any part of the Communications Link (including any relocation at the same premises) may only be undertaken by Galileo or its agent for this purpose, at Subscriber’s expense, unless Galileo’s prior written consent (which will not be unreasonably withheld or delayed) is obtained.
6.5 Subscriber will not remove or obscure any identifying marks from the Rented Equipment, the communications Links, the Software Products or the Media or subject any of them to any lien or encumbrance.
9. Supply and use of the Reservation Service:
9.1 Galileo hereby grants to Subscriber, in accordance with the terms and conditions hereof a non-exclusive licence to use that part of the Reservation service which relates to the Equipment and/or Software Products provided under this agreement, solely for the performance of the specific business functions designed in the Manuals.
9.4 Subscriber agrees that it will only seek access to the Galileo System and use the Reservation Service:
a. In strict accordance with any operating instruction given from time to time by Galileo.
b. Solely for the performance of the specific business functions designated in the Manuals; and
c. Solely in conjunction with the Equipment.
10. Operation of the Apparatus:
10.1 Subscriber shall allow representative of Galileo to enter the Location during the normal business hours of Subscriber for the purposes of installing, inspecting and viewing the Apparatus and its operation.
10.6 Where Subscriber has obtained the necessary Equipment and/or Software Products, Galileo will facilitate the automatic issuance of tickets for those scheduled airlines which participate in the Galileo System.
Within the DA, the appellant has also entered into an agreement with Interglobe called ‘Service Level Agreement’. The intent for such agreement is to outline the level of service each commits to deliver to the end subscriber i.e. the Travel Agents appointed by Interglobe who are to use the CRS System for booking the air tickets/hotel room etc. In the preamble of said agreement it is provided:
This agreement shall be valid for 12 months from the date of signing between Galileo International and XXXXXX as the National Distribution Company. It outlines the level of service each commits to deliver to the TA. Its purpose is to establish the responsibilities of each party involved and to clarify and establish expectations on all sides. It forms the foundation of the Galileo International Service Plan that aims to deliver stable, acceptable service to End Subscribers and provides the basis for improved communication between the Service Providers.
Other relevant Clauses of said agreement are extracted herein:
3. Service Plan
3.1 Concept:
There are two key areas of measurement when considering services to the End Subscriber. These are System Availability and Response Times. This document recognizes that both of these categories are affected by Global. Regional and Market based influences and that measurement of these services can effectively be divided into Host (H) Network (N), and Customer Premises (P) components.
The goal is that Service Level Measurement and Reporting will be the combined function of all Service Providers in the Galileo International Delivery Chain. End to End measurement of standard focal point sites will be catered for by Galileo International. Where non focal point installations exists it will become even more critical that the Partner or Associate, and other Network Provider that forms part of the Delivery Chain, contribute with measurement of the service within their control.
5. Service Controls
5.1 Availability:
The Goal is for continuous system availability throughout with the requirement that emphasis be placed on Prime Times.
5.1.1. Global Regional and Market:
– Host and Network functions are classified as being Global, Regional or Market based indicating their impact to the user community should these systems or functions incur an outage.
– Global functions will be available on a 24 hour basis. These are typically Host based systems or functions that affect or potentially affect the entire user community.
– Regional functions, those systems or functions serving a broad regional user community will receive maximum service possible during the scope of the Region’s Prime Times. These are typically Host based system or functions that affect or potentially affect a Regional based user community, however may also be network based such as the Galileo International Backbone Network.
– Market functions, those systems or functions serving a specific Galileo market, will receive maximum service possible during that Market’s Prime Time.
The goal is for maximum protection to be afforded to each system or function by virtue of the above category of service (refer to Category of Service Section in this document). This will be achieved through maximising up-time by minimising scheduled maintenance and initiating a rigid recovery sequence when appropriate.
5.1.2 Host Network & Premises:
Host availability represents the percentage of time the Galileo Host complexes were available for the end subscriber. This component shall be measured and reported by Galileo International.
Network availability is the combined availability of all relevant up-line and down-line components in the network for the Market represented by this agreement. This component shall be measured and reported by the Network Provider/s in accordance with joint requirements of all parties. Any Network components residing at the Host site will be monitored by Galileo International.
The Customer Premises component availability shall be deemd 100% ecept where the NDC has facilities in place to measure terminal hours available for the market. In this case, the responsibility for measurement and reporting of premises availability shall rest with the NDC.
6. Service Management
Problem Management
Refer to Galileo International’s Problem Management Procedures for complete documentation on the Problem Management System (PMS).
6. Host, Network and Premises
6.1 Problem Management:
Refer to Galileo International’s Problem Management Procedures for complete documentation on the Problem Management System (PMS).
6.1.1 : Host, Network and Premises:
For problems to be recognized and addressed they must be logged into the Galileo International PMS. Typically problems are recognized as originating at either Host, Network or the Customer Premises components. Currently all problems identified by the End Subscriber, the NDC, the Partner or Associate, and subsequently logged and esca;ated via PMS, are assigned a Business Impact value based on the nature of the problem as defined below:
– Critical: Critical impact on business. Severe loss of revenue. No workarounds or alternatives. (This value should be assigned with due regard to the nature of the problem).
– High: High impact on business. Complex work around required. Serious user dissatisfaction.
– Medium: Medium impact on business. User dissatisfaction but a tolerable work around available.
– Low: Limited impact. No anticipated effect on revenue. Inconvenience caused to user. One off problems.
6.1.2. Escalation and Resolution
Service providers in the Product Delivery Chain shall allocate resoureces in order to resolve problems based on business impact to the Global or Regional community.
A central problem log will be maintained by Galileo International with problem status assigned responsibility for resolution, estimated completion date and impact/dependency assessment.
End user subscribers will initially report all faults to their NDC Help Desk. It will be the responsibility of that local NDC to escalate local problems that cannot be solved to Galileo International, the Partner or 3rd party supplier on the subscriber’s behalf. Service impacting problems will be discussed via Service Management meetings held quarterly or as agreed by parties to this document.
6.4.1 Component Reporting:
Each participant (or Service Provider) in the Galileo International Product Delivery Chain must report on Availability and Response Times on a monthly basis and provide a year to date analysis of the overall performance. It will then be possible to assess each component in the Product Delivery Chain against the Targets set.
The MCS is connected to TAs in India through a communications network arranged by Societe Internationale de Telecommunications Aeronautiques (‘SITA’) under an agreement between the Appellant and SITA. SITA is unrelated to the Appellant and is an independent service provider SITA has nodes in India which it owns and the Appellant’s CRS connected to those nodes through communication links. The Appellant at its own cost, has obtained connectivity services from its Data Centre in USA to, inter alia the nodes of SITA in India. SITA does not own local communication lines within India and, therefore, contracts with the local telephone companies for the appropriate circuits.
2.1 There are therefore six players in this business, namely the passenger or the traveller, the TA, Interglobe, SITA, the Appellant and the Airlines. The TAs are remunerated by the airlines. The Appellant is also remunerated outside India only by the airlines and does not receive any remuneration from the TAs. The Appellant pays fees to Interglobe for acting as distributor. The Appellant also pays SITA for the communication services which it provide. Interglobe was entitled to charge fees from the TAs for providing support services, equipment etc. but is stated not to have charged the same.
2.2 The Appellant filed its return of income on January 28, 1999 pursuant to notice under Section 142(1) of the Income-tax Act, 1961 (the ‘Act’) for the assessment years 1996-97, 1997-98 and 1998-99 and under Section 148 for assessment year 1995-96 with NIL income contending that it does not have any income liable to be taxed in India under the Act, as:
1. No income accrued or arose to it in India nor could any such income be deemed to accrue or arise in India;
2. In any event, it had no operations in India which gave rise to taxable income under Section 5(2) or Section 9(1)(i) of the Act;
Without prejudice to its non-taxability under the Act, it contended that it did not have any Permanent Establishment (‘PE’) in India within the meaning of Article 5 of the Double Taxation Avoidance Agreement between India and USA (‘Treaty’) and therefore the booking fees received by the Appellant from the airline companies outside India, being business profits were not liable to tax in India under Article 7(1) of the Treaty.
3. The Assessing Officer (‘the AO’) held that all the activities in respect of bookings made by the TAs in India were completed in India through the hardware installed in and from TA’s in India. On this basis, he held that income accrued or arose in India under Section 5 of the Act. The AO held that even under the Treaty, the Appellant had a PE in India under Article 5 and so the income was held taxable as business income under Article 7 of the Treaty. The AO held that the computers are a PE in India. The AO observed that the computers installed in India and the mainframe situated outside India are connected through leased lines provided by the Appellant and thus became an extension of the mainframe computer of the Appellant when the booking is done through the computer and booking is completed. According to the AO, the Appellant earns profit on each segment booked through the computers installed and therefore the computers constitute a PE. On page 5 of his order, the AO observed as follows:
If no computer is installed and if this facility is not provided to the subscribers, i.e. travel agents, there will be no income for the CRS companies even though they have installed a mainframe and have displayed various informations of airlines. Their income is directly related to the booking done, and since that is completed in India through the hardwares installed in India, the income is taxable in India.
The AO also stated that Interglobe is a PE of the Appellant within the* meaning of Article 5(4) of the Appellant as, according to him Interglobe was economically dependent on the Appellant for its source of business and its activities were devoted wholly and exclusively for the Appellant and as, according to the AO, it enters into and concludes contracts on behalf of the Appellant. On page 11 of his order, he observed as follows:
In view of the above, it is clear that Galileo India ltd. (another name of Interglobe) is nothing but a dependent agent permanent establishment of Galileo International, and therefore, the income of Galileo International is taxable in India as per Article 7 read with Article 5 of the Double Taxation Avoidance Agreement between India and USA.
In addition to above, the AO observed that Interglobe was an agent covered under Article 5(5) of the Treaty as the transactions between the two were not at arm’s length as:
• there was close business connection
• hardware and software were provided by the Appellant
• training and help desk were provided by the Appellant
4. The Commissioner of Income-tax Appeals [‘the CIT(A)’] in his order held that the Appellant had a business connection India from which income accrued or arose in India as:
• information was carried to the TAs in India by providing connectivity and computers through Interglobe;
• operations in regard to booking were initiated and completed in India.
He even held that income was deemed to accrue or arise in India from the property owned by the Appellant and situated in India. He observed that the Appellant:
• has invested substantial money in computers which were given to the TAs without receiving any charges;
• provides continuous display of information through leased lines
He further held that activities of PE constitute display of information on the screen of the TAs. On page 15 of his order, the CIT(A) observed as follows:
I am in agreement with the ld. Counsel that the profit which can be brought to tax is only that amount which can be said to have been derived from the assets located in the PEs in India and the activities carried on by the appellant in India. Of course, these activities constitute display of information on the screen of the TAs located in India.
The CIT(A) held that the Appellant had a PE in India under Article 5(1) of the Treaty as the computers are fixed places of business through which the business is wholly or partly carried on by the Appellant. The CIT(A) observed that computers occupies a place and is connected with mainframe computer. According to the CIT(A), the computers of the TA and the CRS are integrated and, therefore, the Appellant’s CRS is brought in within the premises of TAs. He even held that the computers installed in India at the TAs premises for display of information constitutes “installation” PE under Article 5(2)(k) of the Treaty. The CIT(A) sought comparative information regarding fees paid by Appellant to its other distributors to ascertain whether the fees paid to Interglobe were paid at Arm’s Length but did not gave any findings on Agency PE. The CIT(A) however accepted that under Article 7(5) of the Treaty, only that portion of the Appellant’s income which could be regarded as derived from the Appellant’s assets and activities in India could be taxed in India and restored this issue to the AO for quantification of the Appellant’s income in accordance with the conditions prescribed under Article 7(5) of the Treaty.
Arguments on behalf of Appellant:
5. Learned Senior Counsel for the Appellant, Shri Dinesh Vyas, (‘AR’) argued at length. It was in this background, the learned AR submitted that the Appellant is in the business of CRS services. He further submitted that the Appellant being tax resident of USA is taxable outside India, airlines are taxable in India subject to Treaty benefit, Interglobe and TAs are taxable in India.
The learned AR submitted that based on the Participation Agreement between the Appellant and the Airlines, Appellant will offer various standard and optional services inter alia, display of schedules and fares, building of connections, display of flight availability status and provision of booking capability to the Participating Airlines. He referred to the Clause 2 of the Participant Agreement and schedules attached thereto and drew our attention to the fact that the Appellant receives booking fees from the Airlines for the vide range of services, inter alia, for:
• Enabling Airlines to determine the geographical locations where its tickets may be sold;
• Making available to the Airlines a point of sale table, to enable the Airlines to establish a series of rules by which the availability status of its tickets can be controlled;
• Enabling TAs to access the Airlines’s system for the purpose of creating and/or amending ground arrangement requests, such as stop-overs and mini-stays;
• Making available to the Airlines access to the data stored in the CRS relating to travel itinerary involving multiple Airlines;
• Making available Airline’s information pages in the CRS system for use of the TAs;
• Provision of data for transactions relating to Direct Flight Segments on a monthly basis;
• Supplying Billing Information Data Transfer (‘BIDT’) or Marketing Information Data Transfer (‘MIDT’) by magnetic tapes or other method as may be agreed upon by the parties on a monthly basis;
5.1 Shri Vyas contended that the database relating to seat availability, etc, is on the Appellant’s MCS, which is located outside the taxable territories and therefore, the AR argued, the Appellant’s services were rendered outside India and its income accrued outside India, relying upon the following observations from the decision of the Hon’ble Tribunal in the case of Wipro Ltd. v. ITO
The data server is indisputably located outside India. Consequently, the provision of services of offering the data base to its customers is an event outside the taxable territories of India.
He pointed out that under the Participation Agreement, it was Airlines responsibility to provide complete, timely, and accurate data and that data would be delivered to the Appellant, in as favourable a manner as it provides to any other CRS. (Refer Clause 3 of the Participation Agreement). He emphasised that the services under the agreement are rendered outside in India as also the agreement is executed outside India and is governed by the internal laws of the State of Illinois, USA. He also pointed out that agreement itself conveys that the agreement is on principal to principal basis and does not establish agency among the two (Clause 22 of the Agreement)
5.2 The learned AR then referred to the Distribution Agreement between the Appellant and the Interglobe. He emphasised that Interglobe is a completely independent Indian company having a number of activities and the Appellant does not have any financial or economic interest in Interglobe (clause 6.3 and 6.4 of the Distribution Agreement). He clarified that Clause 2.2 of the Distribution Agreement clearly preserves Interglobe’s fundamental obligation under the Distribution Agreement notwithstanding the formation of Galileo India Pvt. Ltd. which is dependent on Interglobe alone.
He further referred that in the agreement both the parties have agreed that Interglobe will exclusively markets Appellant’s CRS services to TAs in India and will engage its own staff with appropriate experience and expertise. Interglobe will provide, at its own cost, support services relating to hardware and software installation, hardware maintenance, training and help desk services to the Subscribers (Clause 7.2 of the Distribution Agreement). He emphasised that to facilitate the work of Interglobe, Appellant agreed to provide computer hardware for the first 2 years out of the initial term of 10 years (Clause 6.5 of the Distribution Agreement). He clarified that the agreement was for a initial period of 10 years and the computers was provided only in June 1995 i.e. A.Y. 1996-97 and only for 2 years, facility which was only by way of financial assistance to Interglobe. On page 8 of the submissions filed by the Appellant, it is mentioned that:
(i) the computers provided were of a value of only USD 495,712 and not USD 3,000,000, as wrongly alleged in the order of the CIT(A) and in the submissions made by the Revenue [the latter figure is contrary to the record (see Page 285 of PBI)];
(ii) the said computers have been provided by the Appellant to Interglobe only in A Y 1996-97 (see Page 283 of PBI) and not in the earlier or subsequent Appeal years;
(iii) the computers were rendered obsolete within 2 years;
(iv) these computers were provided to Interglobe whose responsibility was to provide computers to the TAs, to assist in market penetration.
(v) the computers have no role in the earning of the Appellant’s income as is shown by the fact that after AY 1996-97, (after which no computers were provided), the Appellant’s income from CRS not only continued but actually increased, as is shown below:
————————————————————
Gross revenue in the Assessment Years from 1996-97
————————————————————
Assessment Year Total revenues (In USD) ------------------------------------------------------------ 1996-97 2,662,519 ------------------------------------------------------------ 1997-98 7,339,024 ------------------------------------------------------------ 1998-99 9,041,702 ------------------------------------------------------------ 1999-2000 12,112,000 ------------------------------------------------------------ 2000-01 16,784,000 ------------------------------------------------------------ 2001-02 23,973,000 ------------------------------------------------------------ 2002-03 23,663,000 ------------------------------------------------------------ (vi) the computers so provided to the TAs do not process any data, and their role is merely that of a "dumb terminal"; (vii) the TA is free to use the computer in any manner he chooses and is not restricted to using it only to access the CRS.
The learned AR drew our attention to the financial arrangements between the Appellant and the Interglobe. He pointed out that Interglobe had the sole discretion in determining its charges to TAs and was entitled to receive all fees received from them. However, the Appellant was allowed to charge Interglobe for the use of its systems and communication link by the TAs. (Refer Clause 8.1 and 8.2 of the Distribution Agreement). He submitted that while the fee to Interglobe was called Data Processing Fees (clause 8.3 of the Distribution Agreement), the agreement does not refer to Data Processing nor does it envisage Interglobe processing any data.
He argued that Department’s allegation of booking being made in India, and that income accrues in India, is based upon an incorrect understanding of the booking/reservation process. The learned AR referred to Pages 2 and 3 of the Assessment Order for the Assessment Year 1996-97 and submitted that this is contrary to the AO’s own description of the Appellant’s business as reproduced below:
It is to be clearly understood how income accrues to each party. Once a customer goes to a travel agent and requests for a booking in a particular class on a particular date on a particular airline, the travel agent, with the help of certain commands, gets the information on his screen whether any seat is available on that date or not, and makes the fare calculation, prepares the itinerary, gets the details of connecting flights and tells it to the customer. Once the customer gives the clearance, the travel agent, with the help of certain other commands, books the ticket for that particular passenger. This whole process starts from the computer of the travel agent, goes to the modem of the travel agent which is provided by SITA, and from there through lease lines it goes to SITA node, from there, through lease lines it goes to VSNL office where an interface is installed and from there it goes to SITA international office. From there it goes to Galileo’s mainframe and from there it is distributed to the airline concerned. Through the same route the communication comes back. All this process takes a few seconds and once the travel agent receives back the communication, he issues the ticket.
He submitted that the display on the TA’s screen is only an invitation to offer. The TA, by punching in the seat requests, only makes an offer. The booking is concluded and the Appellant’s fee accrues, not when the TA clicks on his computer screen in India, but when the TA’s request is accepted on the Airline Server through the Appellant’s CRS. He referred to Clause 2B (i) and (ii) on Page 46 and 49 of APB-I
Upon request from a Galileo International Subscriber, the Systemjvill interrogate Participant’s System in order that the Galileo International Subscriber may view certain information stored in Participant’s System.
(Emphasis Added)
Upon request by a Galileo International Subscriber through a secondary “follow-up” input, the System will interrogate Participant’s System with a flight specific availability inquiry.
(Emphasis Added)
He submitted that the acceptance is not made in India and therefore the contract is not made in India. The TA in India, in response to the invitation to offer displayed on his screen, makes an offer which is accepted by the Airline Server abroad through the Appellant’s CRS. The delivery of the ticket is the mere physical evidence of the contract between the Airline and the passenger which has already been concluded abroad. Thus, the TA’s click does not generate the charge. The acceptance of the TA’s click on the server abroad generates the charge. He further submitted that schedules 7 and 10 clearly show that
(a) the acceptance is on the airline server
(b)the TA makes a request by clicking his computer screen display
(c) it is only after the airline server is interrogated that the booking is completed.
The learned AR also relied on the decision of the Queen’s Bench Division in the case of Fisher v. Bell [1961] 1 Q.B.D. 394 where it was held that display did not amount to an “offer for sale” but was a mere “invitation to treat” or an invitation to offer.
The learned AR, therefore summarised that in the Appellant’s case, the display of seat availability on the TA’s terminal is not an offer for sale of a ticket, but only an invitation to offer. The booking is concluded and the Appellant’s fee accrues, not when the TA clicks on his computer screen in India, but when the TA’s request is accepted on the Airline Server through the Appellant’s CRS.
He further argued that the existence of the link between TAs and the Airline through the Appellant CRS does not mean that the CRS has activities or operations in India or that its income accrues in India. Even in Wipro’s case (supra) there was a link between the server abroad and the user in India but yet the Hon’ble Tribunal gave due recognition lo the fact that the server was located outside India. The Appellant’s CRS was connected to TAs through the nodes owned by SITA and communication network hired by SITA in India. SITA, an unrelated third party, provides these services to the Appellant as an independent service provider/contractor on a principal-to-principal basis. SITA does not own local communication lines within India and therefore contracts with the local telephone companies for the appropriate circuits. The Appellant at its own cost, obtained connectivity services from its Data Centre in USA to, inter alia the nodes of SITA in India.
The learned AR clarified that the Appellant is not paying lease rent to SITA, but service charges. He further submitted that whether an activity adds value is irrelevant for determining accrual of income. If such value is added by the Appellant’s act of purchasing the services of an independent contractor/service provider, it does not lead to the Appellant’s income accruing in India as SITA’s activities are not the Appellant’s activities or operations at all but are merely services purchased by the Appellant. He further submitted that an argument similar to the Department’s argument viz. that but for SITA, the Appellant would not have been able to earn its revenue, was rejected by the Supreme Court in the case of Ishikawajima-Harima Heavy Industries Ltd. v. DIT Mumbai , where the Revenue had urged that but for the off shore services, the onshore services (which were admittedly taxable) could not have been performed and therefore even the offshore component was taxable. The Hon’ble Supreme Court, in this case, inter alia on pages 420 and 421 of the case, held that even if a contract was a lump sum, firm, fixed price, time certain, and indivisible turnkey contract, yet no Indian tax could be imposed in respect of activities outside India, rejecting the Department’s stand that the entire contract should be viewed as one composite whole. On page 429, Supreme Court observed that even for the purpose of taxability different components of a contract have to be considered independently. Reliance was also placed , in this regard, upon the case of ITO and Ors. v. Sriram Bearings Ltd. wherein the Hon’ble Supreme Court observed at Page 726:
The agreement is in two parts. It is true that the two parts are interdependent but yet the consideration for the sale of trade secrets and consideration of technical assistance is separately provided for and mentioned under separate sections. So far as the consideration for the technical assistance is concerned, its taxability is not in doubt. The only controversy is with respect to the taxability of 1,65,000 U.S. dollars which is stipulated as the consideration for sale of trade secrets. The agreement specifically says that the said sale is effected in Japan. We are unable to see on what basis it can be said that any part of the said amount has been earned in India.
Thus, in the above cases, even though the assessees were themselves carrying on activities in India, the Supreme Court held that the activities carried on outside India, though under the very same contract and though they were an inseparable and integral part of the activities carried out in India, were to be sequestered and segregated for levying Indian tax. He further submitted that the fallacy of the Department’s argument that without SITA connectivity the Appellant would not be able to earn its revenue is shown by the absurd consequences which would flow from its acceptance. Its acceptance would mean that a foreign supplier of equipment who is asked to deliver the equipment to a particular site would be regarded as carrying on business in India merely because he engages a specialised service provider to unload the equipment from ship, unpack it and transport it to the site where it is to be erected, on the argument that but for such unloading, unpacking and transport, the foreign supplier would not have been able to earn its revenue.
Therefore, it would be contrary to the above principles laid down by the Supreme Court to argue that the Appellant was providing a ‘platform’ or a ‘composite’ or ‘integrated service’ Also, when the Supreme Court has held that an assessee’s own activities carried on in India have to be separated from his activities outside India, there is even less of a basis for linking the Appellant’s activities outside India with the activities of unrelated entities in India. Thus, the telecommunication connectivity provided by SITA/local vendors in India and the computers provided by Interglobe in India cannot be “merged” with the Appellant’s CRS as:
(i) the telecommunication nodes and lines in India are provided to the Appellant as a service by an independent contractor/service provider (SITA) who is remunerated on an arm’s length basis by the Appellant. These are not assets or activities or operations of the Appellant, as contended in the in the written synopsis submitted by the learned DR.
(ii) the computers provided to the TAs are not in any way an essential part of the Appellant’s earning apparatus as is shown by the fact that even after the computers supplied by the Appellant were no longer used, the Appellant’s CRS earnings actually increased.
The learned AR contended that the Appellant’s booking fee accrues when the booking request is accepted through the Appellant’s MCS in USA. He emphasised that the Appellant has no operations of its own in India and therefore, no income can be regarded as accruing or arising to it in India. He referred to the principles laid down by the Supreme Court in CIT v. Ahmedbhai Umarbhai & Co. and the Anglo-French Textile Co. Ltd. v. CIT . He argued that that no business income can be said to ‘accrue’ in India unless a non-resident has his own business operations in India.
In the case of CIT v. Toshoku Ltd. , the Supreme Court held that no business income can accrue in India to a non-resident unless he has any business operations in India., even if he has a business connection in India. This decision was given in the context of Explanation 1(a) to Section 9(1)(i) of the Income-tax Act, 1961 [Similar to Section 42(3) of the Indian Income-tax Act, 1922].
It has been held by the Supreme Court in the case of Ahmedbhai Umarbhai & Co, that unless a non resident has his own operations in India, he cannot be taxed in India on account of the accrual or arising of income. The Supreme Court observed as follows:
This apportionment of profits between a number of businesses which are carried on by the same person at different places determines also the place of accrual of profits.
In the case of the Anglo-French Textile Co. Ltd. v. CIT , the Supreme Court held the principles set out in Section 42(3) of the 1922 Act are inherent in the words ‘accrue’ or ‘arise’ and therefore apply not only to “deemed accrual” under Section 9(1)(i) but also to accrual under Section 5. After referring to a passage in the Ahmedbhai Umarbhai judgment ending with the above sentence, the Court observed as follows:
The above passage is also sufficient in our opinion to establish that the apportionment of income, profits and gains between those arising from business operations carried on fn the taxable territories and those arising from business operations carried on without the taxable territories is based not on the applicability of Section 42(3) of the Act but on general principles of apportionment of income, profits and gains.
The decision of the Supreme Court in the case of Toshoku would therefore apply not only to ‘deemed accrual’ under Section 9(1)(i), but also to ‘accrual’ under Section 5. As such, in the absence of its own business operations in India, the income of the Appellant cannot be said to accrue in India.
Thus, there have to be operations in India for income to accrue under Section 5 of the Act (and not merely for deemed accrual under Section 9 of the Act). The operations of unrelated parties, viz. Interglobe and SITA cannot be considered as operations of the Appellant.
The Appellant’s income by way of booking fees also cannot be deemed to accrue or arise in India under Section 9 of the Act because its income as pointed out above, does not accrue or arise through or from:
(i) any asset in India
(ii) any source of income in India
The learned AR clarified that the computers at the TAs desk does not process the information, it only displays the information viz. seat availability, booking confirmation, generates the request. He further submitted that no business connection can exist, in law ,if the agent/person has no authority to bind the principal by concluding contracts and relied on the tests laid down by the Supreme Court in the case of CIT v. R.D. Aggarwal and Co. and Anr. inter alia, because:
1) the Appellant’s commercial connection, if any, with India, is far weaker than that of the assessee in the case of R.D. Aggarwal, where the Hon’ble Supreme Court nevertheless held that no business connection existed, in spite of acknowledging that there was undoubtedly commercial activity within India;
2) it is specifically provided in the agreement between the Appellant and Interglobe that Interglobe is not an agent of the Appellant and that the Agreement between the Appellant and Interglobe is on principal to principal basis; and
3) no evidence has been produced to show that Interglobe has in fact concluded contracts on behalf of the Appellant.
He also relied on the decision rendered in case of Inspecting Assistant Commissioner v. Cutler Hammer Europa Ltd. 16 ITD 280 (Bangalore Tribunal) wherein the Tribunal observed that no business connection could exist if the agent/person has no authority to conclude contracts.
Basech on the above tests , the AR submitted that Appellant has no agent in India so as to constitute a business connection. He contended that without prejudice to the fact that the Appellant has no business connection in India, no income accrues or arises to the Appellant through or from such alleged business connection as none of the activities of Interglobe are ‘income-earning’ activities, i.e. the TAs whom Interglobe contacts may choose never to utilise the Appellant’s system. TAs might prefer the system of one of the competitors of the Appellant instead. It should also be noted that the TAs are not customers of the Appellant; they neither buy goods or services from the Appellant, nor pay the Appellant for any goods or services.
5.3 The learned AR argued that without prejudice to the above, even if a person falls within the scope of Section 9(1)(i), unless he has operations in India, he would not be taxable in India as held by the Supreme Court in Commissioner of Income-tax, A.P. v. Toshoku Ltd. . Even in the case of Ishikawajima, it was held that “Mere existence of business connection may not result in income of the non-resident assessee from transaction with such a business connection accruing or arising in India”. Even in the case of Carborandum Co. v. CIT it was held that even assuming there is business connection, to tax income under Section 9(1), the non resident should have operations of its own in India. In the case of Citizen Watch Co. Ltd. v. Inspecting ACIT, Range-V, Bangalore and Ors. and CIT v. Dunlop Ltd. (U.K.) (Calcutta) it was observed that there exists no business connection as the assessee has not rendered any services on its own.
5.4 It was further contended by the Learned AR that without prejudice to the Appellant’s submission that no income accrues or arises or is deemed to accrue or arise in India and that the Appellant has no operations in India, in any event, even if it is assumed, while denying, that any income can at all be regarded as accruing, really or fictionally to the Appellant in India, such income is completely offset and exhausted, inter alia, by the arm’s length payments made by the Appellant as supported by the test/principle laid down by Supreme Court in the case of Morgan Stanley & Co. Inc. v. Director of Income-tax Mumbai [2007] 292 ITR 416 (SC) as under:
As regards attribution of further profits to the PE of MSCs where the transaction between the two are held to be at arm’s length, we hold that the ruling is correct in principle provided that an associated enterprise (that also constitutes a PE) is remunerated on arm’s length basis taking into account all the risk-taking functions of the multinational enterprise. In such a case nothing further would be left to attribute to the PE”
Arguments on behalf of revenue:
6. Learned Special Counsel for revenue Shri Kapila submitted that the business model of appellant needs to be understood. He submitted that the assessee is a U.S. resident company. It is engaged in the business of providing services to participating airlines, hotels, tour and cab operators (vendors) in order to enable them to sell their products directly to subscribers in India through the platform provided by the assessee. Both the vendors and the subscribers are integrated into an unified system, namely, Galileo CRS. Without integration of either in the CRS, the system would be of no business use and no income would accrue to the assessee as its income from the airlines etc. is generated from the bookings made by the subscribers. Whereas the vendors bear the entire cost of accessing and updating of information real-time on the system, the subscriber gets all necessary equipment free which is supplied to Galileo India for distribution to the Subscribers. Though the subscribers use the CRS at the cost of the assessee, they acquire the right access and use the CRS not under a contract with the assessee but under a separate contract between the subscriber and Galileo India. The host computer of the CRS is situated in Denver Colorado, USA. It cannot the used by the subscribers without the provision of electronic tele-communications between the vendors and the subscribers. It is for this reason that the assessee has entered into an agreement with SITA (a French company) for assured use of its tele-communication facilities outside India as also within India on a continuous basis. SITA’s ‘Nodes’ situated in India provide gateways to and from India both to the Airlines and the subscribers. The ‘nodes’ are situated in the premises of Telecommunications centre of SITA in Mumbai and Delhi. The expenditure on leasing the nodes and leasing of regional communications network within India, is borne by the assessee. The subscribers use the CRS through the computers installed in their premises. The telecommunications infrastructure right upto subscribers’ premises is set up by the assessee at its own cost. As a result, instant connectivity with the mainframe is available to the subscribers for booking reservations on the basis of real-time information displayed on his screen. Under the Participation Agreement, the vendor is contractually bound to honour the booking made by a subscriber. The booking by the Subscriber results in a confirmed travel ticket – either E-ticket or printed ticket, which is produced by the computer/printer, being part of the equipment supplied to a Subscriber by the assessee. Purchase order is made by the Subscriber in India – booking is made in India – sale of ticket by Airlines is made in India. The contract (booking) between the Subscriber and the Airlines is concluded in India. Subscriber makes the payment in rupees to the Branch office of the International Airlines in India or to a domestic airlines. Income accrues to the assessee in India from the bookings because of assets provided to the subscribers in India and the telecommunications infrastructure set up by the assessee in India at its own cost as also from the operations of Galileo India.
6.1 Shri Kapila submitted that the true nature of the assessee’s business in such a scenario can be compared with that of a stock exchange like National Stock Exchange (NSE), which provides a platform for trading. The system installed by NSE is accessed by brokers etc. from the specially secured computers. The moment access is allowed by the Exchange’s system, the computer of the broker is integrated with the main computer and the broker can carry out any permissible transaction of purchase or sale of securities. In other words, whereas earlier the broker had to go to the trading floor, he now conducts business on his computer. The broker’s computer becomes integral part of the exchange’s electronic platform (market place) and his bid is matched with a counter-bid of another broker and a contract is automatically generated.
What is the business of the Exchange in such a scenario? It is clearly that of running an integrated market place for which it receives fees/commission for every transaction put through the market, namely, Galileo System. To take another example, say London Stock Exchange (LSE) receives permission to operate in India and with a view to carry on business in India, it provides computers to traders and brokers and provides connectivity by leasing telecommunication network, can it be said that it has no fixed place in India through which its business is carried on. The assessee also brings together the Subscriber and the Airlines on computer to computer basis and the booking is automatically generated seamlessly on the CRS. Therefore, it is absolutely imperative for the assessee’s business that there is a continuous and instant two-way communications between the vendors and the subscribers. The booking is binding on the Airlines (Clause 31 & 3J/P. 14-15-APB) and also the subscribers unless he cancels it in accordance with the standard terms (the assessee earns fees on cancellations also). This is so not because of any contract between the vendor and the subscriber, but because of contract between the assessee and the vendor. On the other hand, the assessee has also not directly entered into an agreement with a subscriber in India, but always honours and abides by the terms of the contract between Galileo India and an Indian Subscriber. Indeed it has prescribed a standard Subscriber Agreement for use by Galileo India. Thus, the three contracts have to be read together in order to understand the exact legal obligations of the five parties; namely, assessee, vendor, Galileo India, SITA & Indian Subscriber. None of the four contracts could become operational without implementation of other two contracts. The making of booking and generations of tickets take place because of sifting of information by the Subscriber on the computer installed in his premises and the necessary commands punched by him on the computer. The moment a subscriber accesses the host computer, its computer gets integrated with the host computer. Neither the Airlines nor the Subscribers are concerned with the location of the host computer or how it processes the data. From practical and commercial point of view of the Airlines and the subscribers, what is material is that the online information supplied the Airlines is displayed on the computer screen of the subscribers for their decision making so that they can make bookings on their computers. The assessee is clearly in the business of running a technologically complex and state-of-the art electronic platform, which acts as a flight reservation exchange or ‘market place’ in India. The communication network in India, display on subscriber’s screen and accessability to the CRS for user by the subscribers are integral components of the commercial operations of the CRS. The business of the assessee can also be compared with that of a commission agent. Its business, as stated above, is to enable a travel agent to make a contract of reservation of a passenger flight with an Airlines. In other words, the Galileo system leads to the business between the travel agents and airlines. As observed by the Supreme Court in the case of CIT v. Rai Bahadur Jai Ram Valji .
It will be seen that the receipts, the chargeability of which was in question in the decisions cited for the respondent, were all payments made as compensation for the termination of agency contracts, whereas we are concerned with an amount paid as solatium for the cancellation of a contract entered into by a businessman in the ordinary course of his business, and that, in our judgment, makes all the difference in the character of the receipt. In an agency contract, the actual business consists in the dealings between the principal and his customers, and the work of the agent is only to bring about that business. In other words, what he does is not the business itself but something which is intimately and directly linked up with it. It is therefore possible to view the agency as the apparatus which leads to business rather than as the business itself on the analogy of the agreements in Van Den Berghs Ltd. v. Clark. Considered in this light the agency right can be held to be of the nature of a capital asset invested in business. But this cannot be said of a contract entered into in the ordinary course of business. Such a contract is part of the business itself not anything outside it as is the agency, and any receipt on account of such a contract can only be a trading receipt.
(emphasis supplied)
That there is a distinction between an agency agreement and a contract made in the usual course of business will further be clear, if we have regard to one of the reasons on which the conclusion that compensation paid for the cancellation of agency rights is a capital receipt is sometimes rested. It is that, in substance, the agent assigns the agreement to the principal and the compensation is price paid therefor.
The assessee therefore facilitates conclusion of contract between the airlines etc. and a subscriber in India for which it earns service fees from the airlines.
6.2 Shri Kapila submitted that the next question which needs to be addressed is: Does the Assessee either wholly or partly carry on any business in India? Put in other words, does the Assessee have any business operations though the asset owned or leased by it in India? The following operations are carried on in India on continuous basis by the Assessec on its own or hired by it at its own cost is providing for:
(i) Provision of the telecommunication ‘Nodes’ situated at Mumbai/Delhi owned by SITA.
(ii) Provision of telecommunication lines between the Node and the premises of the Subscribers.
(iii) The entire regional telecommunications network is maintained by the assessee at its own cost. The regional networks together with gateways to international network are essential parts of the inter-active world-wide CRS.
(iv) Without provision for telecommunication net-work, the host computer would not have any business value.
The fact that the Assessee may have entered into a worldwide contract with SITA (a French company) outside India is immaterial. As observed by the hon’ble Supreme Court in the case of Ishikawajama Harima 288 ITR 408, it is not the situs of making of the contract which is relevant but it is the situs where the services are rendered which is relevant. The assessee has rendered services to the vendors within India by way of maintaining communication network right upto the subscriber’s premises. SITA provides domestic connectivity to the various travel agents all over India with the gateways (Nodes at Mumbai/Delhi) for connectivity with the Host computer in USA. Likewise, dedicated telephone lines for the subscribes have been leased by Assessee’s in India. Provision of an elaborate telecommunication network is an integral and essential part of the CRS. As explained in paragraph 3(v) infra the assessee itself has recognized its business activities in three identifiable segments:
(i) HOST Computer (H in USA);
(ii) Network (N) which includes both international and regional telecommunication network; and
(iii) Customer Premises (P) which means provision of dedicated lease lines to keep the response time to minimum and also provision of dedicated hardware and software owned by the Assessee but distributed through its agent, namely, Galileo India.
Provision of telecommunication net-work is a service rendered to the airlines etc. from which it earns the fees. This service is rendered within India. Without the ‘net-work’, the vendors cannot receive the purchase orders from the subscribers.
6.4 Shri Kapila, therefore, submitted that in view of facts, the assessee’s income accrue or arise in India in terms of Section 5(2) of the Act for the reasons that
(i) The Airlines pay fees not for the setting up or maintenance of the CRS, but for the ‘use’ of the CRS by the travel agents in India. As explained earlier, CRS is ‘used’ only when a Subscriber makes the booking. Without the provision of active facilities in India for making of bookings, the CRS will not generate any income for the assessee. Activity of real-time updating of all information relating to flight schedules, latest position of availability of seats reservation etc. is carried out by the Airlines at its own cost through its own internal reservation system into the Assessee’s CRS (P. 14 & 15 – Clause 3B, 3C, 3E, 3F & 3G). But it will all come to naught if there is no facility for making the booking by a Subscriber.
(ii) Schedule 2 (P. 34/APB) give the charges for certain basic standard services and Schedules 4-11 at P. 38-57/APB). India falls in Territory 2. In all cases it is made clear that for the purposes of all these schedules, “Territory 1 and Territory 2 refer to location of the Galileo International subscriber that performs the activity that creates a charge”. It needs to be emphasized that the subscriber could not have made the booking but for the Node and the domestic network hired/leased by the assessee and the hardware and software provided to the Subscribers. The activity which creates the charge of fees from the Airlines is the booking made by the Subscriber in India. Therefore the source of income of the assessee is the bookings made by the Subscriber.
(iii) The Subscribers are resident of India. The assessee provides them with computers and connectivity for making bookings. They place the purchase order on the Airlines in India and the sale also takes place in India. Payment to Airlines is made by the Subscribers in India in Indian rupees. Without the bookings by Travel Agents, there is no business and no revenue. It is for this reason that the assessee provides at its own cost communication network in India as also equipment to the Travel Agents so that they can make bookings on its system and generate income for the assessee by way of commission from the Airlines. There is no merit in the assessee’s plea that such equipment is used by the subscribers for their own business and not for the business of the assessee. The very fact that the assessee has distributed computers etc. free of cost and maintains regional network at its own cost clearly establishes that this act is dictated by pure business need of the assessee. The assessee earns income from airlines etc. integrating subscribers into the CRS.
(iv) It is contended by the assessee that since the host computer is located in USA and the contracts with the Airlines are made outside India, the income also accrues outside India. This contention is misconceived. It is simplistic and it does not take into account the business model of the assessee. Neither the data processing in USA nor the contract with the Airlines can be said to be source of income of the first degree. The host computer would not by itself generate any income for the assessee. The ‘source of income’ of the assessee, if looked at from practical and commercial point of view, is the reservation (booking) made by the Subscriber in India. It is for this reason that the assessee at its own cost maintains the communication net-work and supplies hardware and software to Galileo India for distribution to the subscribers. It is the ‘use’ of the CRS by the Subscriber in India, which is the ‘source of income’.
As regards contention of learned Counsel for assessee that the assessee is remunerated outside India by the Airlines under contracts entered outside India, attention has invited to the inference by Supreme Court in Performing Rights Society v. CIT 106 ITR 11 for the proposition that these factors are immaterial in a case where income accrues in India. It is the use of the CRS by the subscribers in India which is the real source of income.
In CIT v. Kunwar Trivikarm Narain Singh 57 ITR 29 the Hon’ble Supreme Court followed the oft quoted observation of privy Council in Commissioner of Income Tax v. Raja Bahadur Kamakhaya Narayan Singh P. 1-6 of DPB, which construed the word ‘derived’ as follows:
The word ‘derived’ is not a term of Article Its use in the definition indeed demands an enquiry into the genealogy of the product. But the enquiry should stop as soon as the effective source is discovered. In the genealogical tree of the interest land indeed appears in the second degree, but the immediate and effective source is rent, which has suffered the accident of non-payment. And rent is not land within the meaning of the definition.
In the present case the assessee’s source of income is the booking made by a travel agent in India on the computer provided by the assessee. The booking is made by the Subscriber on the basis of display of information on the computer and necessary sifting of informations and commands made through the computer installed at his premises. Looked at from another angel, it is the business of maintaining the CRS, part of which (telecommunications – network, computers and modem etc. and other activities through the agent in India) has produced income in India. Enquiry must stop at this stage.
(v) The assessee has explained its business in its letter dated 26, January 1999 addressed to the Assessing Officer (P. 26 of Department’s Paper Book)(DPB) in the following words:
The CRS consists of software owned by the assessee. The software is accessed by the travel agent (the subscriber) by means of a modem for purpose of undertaking flight bookings for the Participant. The software enables the subscriber to access information such as display of schedules and fares, building of connections, display of fight availability status and provision of booking capability. Therefore, the booking fees paid by the Participant to the assessee constitute consideration for accessing and using the software of the assessee and/or consideration for providing electronic services to the Participant/Subscriber
That CRS is a holistic system is brought out in the “Service Agreement’ between Assessee and the Galileo India (P 142-206 APB), which has been entered into with twin objects of providing maximum availability of system to the Subscriber and minimum response time for booking a ticket. Clause 3 of the Agreement (P. 147 of APB) states:
There are two key areas of measurement when considering services to the End Subscriber. These are System Availability and Response Times. This document recognizes that both of these categories are affected by Global. Regional and market based influences and that measurement of these services can effectively be divided into HOST(H), NETWORK (N), and CUSTOMER PREMISES (P).
From the above it is clear that two of the three components constituting CRS (N and P) are situated in India.
vi) The assessee contends that it has not carried out any activity in India which could be said to contribute to the booking made by a Subscriber. This is not correct. The assessee’s contention is based on a wrong assumption that the ‘Host Computer’ alone constitutes the CRS. CRS is a ‘system’ which includes not only the Host computer in USA., but also telecommunication network in India (regional Network) as also hardware & software installed on the premises of the subscriber. All the three services, namely Host, Network and Customer services are provided by the assessee. In fact, the assessee has clearly identified these three vital components of the CRS as H, N&C in the ‘Service Agreement’ (P. 142-174 of APB), which is part of the Distribution Agreement.
6.5 Shri Kapila, therefore, submitted that the assesses has, either on its own, or through the agency of Galileo India, carried out following activities in India on a continuous basis:
(i)(a) The telecommunication ‘Nodes’ at Mumbai/Delhi hired by the assessee from SITA at its own cost.
(b) Telecommunication Lines between the Node and the premises of a Subscriber for which lease rent/service charges etc. are paid for by the assessee.
(ii) Providing free-of-charge its own equipment to the Subscribers for integrating them into the CRS:
(i) Two computers
(ii) Printer [Subscriber Agreement P. 46/DPB]
(iii) PAD MICRO card [Modem]
It is an admitted fact that hardware costing USD 0.5 Million was provided by the assessee free of cost in first two years. The economic life of hardware has been fairly estimated by the assessee to be six years (para 6.5 of Distribution Agreement/P. 110 read with para 9.12 (b)/P. 115 APB). The assessee has claimed and it has been allowed depreciation on this hardware for all the assessment years under appeal (including AY. 1998-99). Therefore, its statement before the CIT(A) that all the computers supplied to Interglobe during Financial Year 1995-96 were ‘junked’ within two years is patently wrong as no material has been produced to establish that the equipment was scrapped. On the other hand, the assessee itself has been claiming depreciation thereon in all of subsequent years.
(iii) Providing free of cost its proprietary software products (P. 46/DPB and Clause 4.3/P-107 APB). These have been provided to the subscribers through the agency of Galileo India for installation on their computers.
In the above mentioned activities in India form part of its business of running the CRS. Indeed, the assessee itself has claimed in the remand proceedings the expenses under the following heads as allowable business expenditure incurred for earning income from Indian operations:
1) Marketing expenses (para 5.1 of the CIT (A) order dated 15.12.2004)
2) Development expenses (para 8.1 of the CIT (A) order dated 15.12.2004)
3) Network expenses (para 9 of the CIT (A) order dated 15.12.2004)
6.6 Shri Kapila, therefore, submitted that the assessee have a ‘business connection’ resulting in deemed income Under Section 9 read with Section 5(2) of the Act. The facts narrated above clearly establishes that there is a real, intimate and continuous connection between the assessee’s business outside India and the activities within India, which has produced income.
Apart from the Clauses of the Distribution Agreement between the assessee and the Galileo India dt. 24.2.1995 referred to in the assessment order, the various Clauses of the Distribution Agreement read with relevant schedules bring out clearly a continuous, real and intimate connection of the assessee with its own activity and assets in India as well as the business activity of the Galileo India.
Apart from the various Clauses of the Distribution Agreement between the assessee and Galileo India the various Clauses of the Participation Agreement between the assessee and the Airlines are also relevant. These Clauses clearly establish that there is a continuous, real & intimate connection between the assessee’s business outside India and its activities as well as those of Amadeus India with in India:
In view of the relevant Clauses of Distribution and Participation Agreements and the extent of assessee’s activities in India, it is submitted that the assessee has business connection ‘source of income’ and also asset in India from which income is chargeable to tax in terms of Section 9(1)(1) read with 5(2) of the Act.
7. Replying to contention of learned DR that appellant has a business connection in India, Shri Vyas submitted that at the outset it is false to allege that it is an “admitted fact” that hardware costing US $ 3 Million was provided free of cost in the first two years, [refer to the Appellant’s grounds of appeal Nos. 7(c) for AY 1996-97, 1997-98 and 1998-99]. Hardware of the value of only US $ 4,95,712 was provided to Interglobe, and that too, only in AY 1996-97. No computers were provided in the first Assessment Year 1995-96 and therefore there was no depreciation claim in Assessment Year 1995-96. The computers were imported between June and October 1995 relevant to Assessment Year 1996-97. Two years from June 1995 expired in June 1997 relevant to Assessment Year 1998-99. Therefore depreciation was claimed in the three Assessment Years 1996-97 to 1998-99 as the two year period got over in Assessment Year 1998-99. Further, no depreciation was claimed on these computers from Assessment Year 1999-2000, consistent with scrapping of these computers after two years and is supported by the fact that scrapping of the computers was specifically averred to before the CIT(A) by letter dated 27 January 2000 (Page 285A of APB I) and this was recorded by the CIT(A) in Para 6.2 (Page 10) of his order but was not in any way controverted by him. An economic life of 6 years was adopted only for a limited purpose of calculating the depreciated value at which the Appellant was entitled to purchase the computers from Interglobe, but it was recognised that the market value could be lower (as it did, in fact, turn out to be nil, due to obsolescence, which is evidenced by the letter dated 27 January 2000 at Page 285A of APB I). Even otherwise, the fact that these computers (which were 486 models as evidenced from letter) were rendered obsolete is shown by the fact that in 1998 Interglobe was supplying to the TA’s , Pentium Computers as stated in the Subscriber Agreement between Interglobe and TAs submitted by the Department in its paper book. The economic and technical insignificance and irrelevance of the computers supplied by the Appellant is shoen inter alia by the facts that the TAs activities continued even when no computers were provided by the Appellant to Interglobe.
7.1 The learned AR replied that the Clauses 3I, J, K, L and M of Participation Agreement are in the nature of indemnity Clauses and provide for exceptional situation. They nowhere show that the booking is completed when the TA clicks but in fact confirm that the TA, by clicking, merely sends a request to the CRS which then interrogates the Airline Server before a booking is concluded. He argued that the click by the TA, on his computer screen displays, does not result in a concluded contract. The display, through the CRS, on the TA’s screen, is not an offer, because the airline is not bound by the TA’s click on his screen. The display on the TA’s screen is merely an invitation to offer, pursuant to which the TA, by clicking the screen makes an offer. It is only when this offer of the TA is accepted by the Airline Server through the CRS that a binding contract occurs. The schedule 2 referred by the learned DR has been provided only to identify the territory where the TA is located.
7.2 The AR further submitted that it is factually incorrect to allege that Nodes or Land Lines were “hired” from SITA. SITA only provided telecommunication services to the Appellant as an independent service provider. Further, the Appellant does not maintain the telecommunication network which belongs to, and is maintained by, SITA or local owner of the communication network e.g. VSNL, at their own cost. Even SITA does not own the local communication network. SITA/VSNL are merely independent Service Providers. SITA is engaged by the Appellant under separate principal to principal arm’s length contracts. These words have been misinterpreted and twisted out of context. They only mean that the Appellant “makes arrangements” e.g. through VSNL, for the provision, operation and maintenance of network to the SITA node. They do not in any way mean that these arrangements, which are with independent third party service providers like VSNL, are the Appellant’s operations.
7.3 He clarified that reliance placed by DR on the case of Performing Rights Society Limited v. CIT 106 ITR 77 is misplaced. The decision of the Hon’ble Supreme Court is completely distinguishable because in that case royalty income received by the Performing Rights Society for broadcasting, from stations of All India Radio within India, was held to be taxable in India on the ground that the same arose in India. Also, since the case involved a non-profit making organisation, it is not a relevant precedent for a profit-making business enterprise
7.4 The learned AR further submitted that it is also contrary to the following uncontroverted factual clarification given by the Appellant pursuant to the specific queries of the CIT(A) on which the learned DR has himself relied upon:
The CRS does not contain airline inventory, but rather contains the status of an airline flight as provided by the airline. Typically, the travel agent begins the booking process by looking at flight availability between an origin and a destination. The status of a flight is maintained by the airline. If the flight status indicates that a seat is available, the agent will initiate a sell request. Most airline vendors provide real-time access to their inventory and thus control their inventory when they receive a sell request. The majority of airline inventory is accessed real-time. If an airline vendor does not provide real-time access to their inventory, then the sell is performed in the CRS and a sell request message is sent to the airline when the booking is ended. It is possible that the flight status on the CRS could indicate seats are available, and multiple travel agents could request those seats at the same time. When they end their booking requests, a sell request will be sent to the airline and it would be up to the airline to either accept or reject the request. In either case, the CRS booking is updated to reflect the airline answer and a message is sent to the travel agent to advise them of success or failure. In the end, inventory is managed by the airline. It is their responsibility to update flight status on the CRS and to accept/reject sell requests.
7.5 Regarding the reliance placed by the Department on the case of the automatic car park, the learned AR argued that the case is not-relevant as two out of the three Judges specifically refused to go into the question of when the contract was concluded. Also it was a case where on money being put into an automatic parking ticket vending machine, a ticket was automatically issued unlike the Appellant’s case where, even as per the Assessment Order, the TA’s click has to travel to the Airline’ server for a positive response, only after which the booking is made. Further, the booking process, though done at high speed, is not automatic as alleged. In the case of so called “automatic” contracts the general principles of offer and acceptance still apply. Hence, as it is indisputable that till the TA’s seat request is accepted by the Airline Server through the CRS, the Airline is not bound, no contract takes place till then.
7.6 The learned AR argued that the Departments allegation that the activity of the Airlines, Appellant, Interglobe, TAs is an integrated and seamless activity is erroneous and untenable as this argument and approach has been specifically rejected by the Hon’ble Supreme Court in three separate decisions namely Ishikawajima-Harima Heavy Industries Ltd.(supra), Sriram Bearings Ltd.(supra) and Commissioner of Income-tax and Anr. v. Hyundai Heavy Industries Co. Ltd.
7.7 It was argued that the analogy with the NSE is completely inapt and erroneous because, in the Appellant’s case, the Airline, SITA, Interglobe and the TAs are independent parties dealing with each other at arm’s length. In any case, no contracts are concluded on the Appellant’s server. Hence, the Appellant’s server is neither a trading platform nor an integrated market place.
He contended that the allegation of the Department that the moment a subscriber accesses the host computer, its computer gets integrated with the host computer is erroneous as it is not uncommon for a computer to access two servers at the same time. For instance, with today’s technology, a person might access his bank account in one window, while he is trying to book a train ticket in another, while at the same time, his access to Google and Yahoo is on in two other windows. This, in fact, does often happen. In such a case, by the logic of the Department, the computer will be integrated with each of the host computers, which seems impossibility.
Alternatively, on the basis of this argument, all the various servers, together with all the computers connected with them, would become integrated. In effect, on the basis of this argument, given the number of computers in any network, ultimately, the world would either gravitate towards a single integrated’ computer, or at least, a very few computers into each of which a very large numbers of computers are ‘integrated’
7.8 He clarified that the Department contention that the Appellant has rendered services to the vendors within India by way of maintaining communication network right upto the subscriber’s premises and that all the three services, namely Host, Network and Customer services are provided by the Appellant is misconceived. None of these are the Appellant’s operations at all, but are services of independent contractors availed of by the Appellant. Further, the engaging, by the Appellant, of independent service providers like SITA and VSNL, cannot be regarded as the rendering of services by the Appellant, in India, to the Airlines. Just as the services of an independent transport contractor in India, availed of on arm’s length payment, by a foreign supplier, to transport the foreign supplier’s goods to destinations within India cannot be regarded as the foreign supplier’s operations in India, or as services provided by the foreign supplier in India, so also, the communications services purchased by the Appellant on arm’s length payment, from SITA or VSNL (who, admittedly, are independent third parties), cannot be regarded as the Appellant’s operations in India, or as services provided by the Appellant in India. He further argued that to allege that the services of VSNL and SITA are a part of the Appellant’s core activities is like alleging that the activities of the Department of Posts in acting as a carrier of documents/cheques from an overseas contracting party to an Indian party are the overseas contracting party’s core activities and therefore expose the overseas contracting party to Indian taxation.
He further reiterated that the Appellant provides computers, not to the TA’s, but to Interglobe, and it is wrong to allege that computers/modems etc. are provided “so that” TA’s can use the CRS, because the CRS can be used even without the computers/modems provided by the Appellant to Interglobe as is shown inter alia by the facts that:
• the TA’s business continued even after the 2 years when the computers were provided to Interglobe.
• only 265 out of 800 TAs were provided computers by Interglobe
It is therefore submitted that:
(i) there is no business connection under Section 9(1)(i) of the Act. The case law cited by the Appellant in the case of Cutler and Hammer has not been dealt with by the Department.
(ii) in any event, there are no activities of the Appellant in India.
and therefore there is no tax liability in India
Finding as to existence of Business Connection.
8. We have heard the parties at length. In our opinion, following questions arise for consideration:
(1) Whether the assessee has any income chargeable to tax in India Under Section 5(2) of the Act and whether the assessee has any business connection in India as per Section 9(1)(i) of the Act? If yes, to what extent it is taxable in India.
(2) If the answer to Question No. 1 is in affirmative, whether, in terms of DTAA between India and USA, the appellant has any PE in India?
(3) If answer to Question No. 1 is in affirmative what is the extent of income earned in India and whether the same can be held as paid by the appellant to Interglobe and no further income is attributable to the PE in India?
(4) If the answer to Question No. 3 above is in negative, to what extent the income arises in India which can be charged to tax in India.
(5) Whether interest Under Section 234A and 234B is chargeable?
8.1 The first question before us is whether there is any business connection in India within the meaning of Section 9(1)(i) of the Act. The scope of total income is described in Section 5 of the Income-tax Act. As per Section 5(2), the total income of a person, who is a non resident to the extent which is received or deemed to be received in India, or accrue or arise or deemed to accrue or arise in India is taxable in India. As per Section 9(1)(i) of the Act, all income accruing or arising whether directly or indirectly through or from any business connection in India shall be deemed to accrue or arise in India. As per Clause (a) of Explanation 1, in the case of a business of which all the operations are not carried out in India, the income of the business deemed under this Clause to accrue or arise in India shall be such part of the income as is reasonably attributable to the operations carried out in India. Thus, as per the conjoint reading of Section 5(2) and Section 9(1)(i) of the Act, only if the income is arising directly or indirectly through or from any business connection in India can be taxed in India. The expression ‘business connection’ was earlier not defined in the Act. The Finance Act, 2003 w.e.f. 1st April, 2004 i.e. as applicable to Asstt. Year 2004-05 and onwards has inserted two new Explanations to Clause (i) of Section 9(1) clarifying that expression ‘business connection’ will include a person acting on behalf of non resident and who carried on certain activities. However, for the purpose of our present discussion, the amended provision has no relevance as the same are w.e.f. Asstt. Year 2004-05 onwards. Since these appeals are for the years prior thereto, we shall discuss only the unamended provisions. The expression ‘business connection’ has a wide though uncertain meaning. It admits of no precise definition and the solution to the question must depend upon the particular facts of each case. Even the amended definition will not determine as to what constitute business connection as the same is not an exhaustive definition but is a definition which also include some of the activities to be termed as business connection. We shall, therefore, revert to some of the judicial pronouncements in this regard. Hon’ble Supreme Court in the case of CIT v. R.D. Agarwal & Co. 56 ITR 20 held thus:
The expression business connection undoubtedly means something more than business. A business connection in Section 42 involves a relation between a business carried on by a non-resident which yields profits or gains and some activity in the taxable territories which contributes directly or indirectly to the earning of those profits or gains. It predicated an element of continuity between the business of the non-resident and the activity in the taxable territories, a stray or isolated transaction is normally not to be regarded as a business connection. Business connection may take several forms. It may include carrying on a part of the main business or activity incidental to the main business of the non-resident though an agent or it may merely be a relation between the business of the non-resident and the activity in the taxable territories, which facilitates or assists the carrying on of that business. In each case, the question whether there is a business connection from or through which income, profits or gains arise or accrue to a non-resident must be determined upon the facts and circumstances of the case.
A relation to be a business connection must be real and intimate, and through or from which income must accrue or arise whether directly or indirectly to the non-resident. But it must in all cases be remembered that by Section 42, income, profit or gain which accrues or arises to a non-resident outside the taxable territories is sought to be brought within the net of the income-tax law, and not income, profit or gain which accrues or arises or is deemed to accrue or arise within the taxable territories. Income received or deemed to be received, or accruing or arising or deemed to be accruing or arising within the taxable territories in the previous year is taxable by Section 4(1)(a) and (c) of the Act, whether the person earning is a resident or non-resident. If the agent of a non-resident receives that income or is entitled to receive that income, it may be taxed in the hands of the agent by the machinery provision enacted in Section 40(2). Income not taxable under section4 of the Act of a non-resident becomes taxable Under Section 42(1) if there subsists a connection between the activity in the taxable territories.
Hon’ble Bombay High Court in the case of Blue Star Engineering Co. v. CIT 73 ITR 283 at page 291, after referring to the decision of R.D. Aggarwal and Co. (supra) held as under:
It would thus be seen that in order to constitute a “business connection” as contemplated by Section 42, there must be an activity of the non-resident and contributing to the earning of profits by the non-resident in his business. The business connection must undoubtedly be a commercial connection but all commercial connections will not necessarily constitute business connection within the meaning of the concept unless the commercial connection is really and intimately connected with the business activity of the non-resident in the taxable territories and is contributory to the earning of profits in the said trading activity.
8.2 In light of the above provisions in the Income-tax Act and the judicial pronouncements, we may appreciate the facts and deal with the issue. The appellant has developed a fully automatic reservation and distribution system known as Galieleo system with ability to perform comprehensive information, communication, reservation, ticketing, distribution and related functions on a worldwide basis. Through this Galileo system, the appellant provides service to various participants i.e. Airlines and hotels etc. whereby the subscribers who are enrolled through the efforts of NMC can perform the functions of reservations and ticketing etc. Thus the Galieleo system or the CRS is capable not only processing the information of various Airlines for display at one place but also enables the subscribers to book tickets in a way which is a seamless system originating from the desk of the subscriber’s computer which may or may not be provided by the appellant but which in all cases are configured and connected to such an extent that such computers can initiate or generate a request for reservation and also receive the information in this regard so as to enable the subscriber to book the Airlines seat or hotel room. The request which originated from the subscriber’s computer ended at the subscriber’s computer and on the basis of information made available to the subscriber, reservations were also possible. It is to be noted that all the subscribers in respect of which income is held taxable are situated in India. The equipment i.e. computer in some cases and the connectivity as well as configuration of the computer in all the cases are provided by the appellant. The booking takes place in India on the basis of the presence of such seamless CRS system. On the basis of booking made by the travel agent in India, the income generates to the appellant. But for the booking no income accrues to the appellant. Time and again it is contended that the whole of the processing work is carried out at host computer situated at Denver in Colorado, USA and only the display of information is in India for the proposition that there is no business connection in India. We are unable to agree with such proposition. The CRS extends to Indian territory also in the form of connectivity in India. But for the request generated from the subscriber’s computer’s situate in India, the booking is not possible which is the source of revenue to the appellant. The assessee is not to receive the payment only for display of information but the income will accrue only when the booking is completed at the desk of the subscriber’s computer. In such a situation, there is a continuous seamless process involved, at least part of which is in India and hence, there is a business connection in India. The computers at the subscriber’s desk are not dumb or are in the nature of kiosk incapable of performing any function. The computers along with the configuration has been supplied either by the appellant or through its agent Interglobe and the connectivity being provided by the appellant enables the subscribers to access the CRS and perform the ticketing and booking functions. The existence of business connection can be summarised thus:
1) Assessee hires SITA nodes in most major cities in India together 800 land lines for maintaining telecommunication network in India as evident at page Nos. 278 to 281 of the assessee’s paper book No. 1.
2) Assessee secures the provision of the operation of the communication network from SITA node to travel agent as evident at page 281 of assessee’s paper book No. 1
3) By Clause 15.3 of the Distribution Agreement, the assessee specifically authorises Interglobe (Galileo India) to conclude agreements with the Travel agents in India in accordance with the model Subscriber Agreement which forms an annexure to the said Agreement.
4) Assessee lays down targets and closely supervise and reviews the performance of Galileo India on day today basis in accordance with the Annual Plan and the service manual prescribed by it as per Clause 14 of Distribution Agreement.
5) Assessee allots access code to the travel agents for using the CRS.
6) The assessee’s business comprises of:
a) Maintenance and running of CRS;
b) Providing computer modem and software to the travel agents in India so that they can use the CRS for making the bookings which generate charge on the airlines;
c) Assessee hires from SITA and maintains and operates telecommunication network in India so that travel agents could make the bookings.
All these activities are integral part of the core business carried on by the assessee and these are not auxiliary or preparatory in nature.
The contention of Shri Vyas regarding reliance on the decision in the case of Fisher v. Bells (supra) in this case is misplaced. Whether the contract for sale of ticket is completed in India or outside is irrelevant for the purpose of present discussion as we are not to determine the taxability of income of various airlines accruing as a result of sale of tickets through the CRS in India. Thus, the availability of the tickets displayed through the CRS at the desk of travel agents in India is whether offer for sale or an invitation to an offer is not a deciding factor. What we find is that part of the Galileo system exists in India in the form of configuration and connectivity of such system through which booking activities can be performed in India. The decision of ITAT, Bangalore Bench in the case of Wipro Ltd. (supra) is also misplaced as in that case no part of the data processing facility was performed in India but wholly outside India. In the present case, the appellant operates the Galileo system which is the source of revenue and part of such system exists in India. Thus there is a direct business connection established in India and hence in terms of Section 9(1)(i) of the Act, the income in respect of the booking which takes place from the equipment in India can be deemed to accrue or arise in India and hence taxable in India.
9. The next question therefore, arises is whether having held that there is business connection in India, how much income is chargeable to tax in India. As per Section 9(1)(i) of the Act, income accruing or arising whether directly or indirectly through or from any business connection in India shall be deemed to accrue or arises in India. As per Clause (a) of Explanation 1 to Section 9(1)(i) in the case of a business of which all the operations are not carried out in India, the income of the business deemed under this Clause to accrue or arise in India shall be only such part of the income as is reasonably attributable to the operations carried out in India. Thus in a given case if all the operations are not carried out in India, the income has to be apportioned between the income accruing in India and income accruing outside India. In the present case, we find that only part of CRS system operates or functions in India. The extent of work in India is only to the extent of generating request and receiving end result of the process in India. The major functions like collecting the database of various airlines and hotels, which have entered into PCA with the appellant takes place outside India. The computer at Denver in USA processes various data like schedule of flights, timings, pricing, the availability, connection, meal preference, special facility, etc. and that too on the basis of neutral display real time on line takes place outside India. The computers at the desk of travel agent in India are merely connected or configured to the extent that it can perform a booking function but are not capable of processing the data of all the airlines together at one place. Such function requires huge investment and huge capacity, which is not available to the computers installed at the desk of subscriber in India. The major part of the work or to say a lion’s share of such activity, are processed at the host computer in Denver in USA. The activities in India are only minuscule portion. The appellant’s computer in Germany is also responsible for all other functions like keeping data of the booking made worldwide and also keeping track of all the airlines/hotels worldwide that have entered into PCA. Though no guidelines are available as to how much should be income reasonably attributable to the operations carried out in India, the same has to be determined on the factual situation prevailing in each case. However, broadly to determine such attribution one has to look into the factors like functions performed, assets used and risk undertaken. On the basis of such analysis of functions performed, assets used and risk shared in two different countries, the income can be attributed. In the present case, we have found that majority of the functions are performed outside India. Even the majority of the assets i.e. host computer which is having very large capacity which processes information of all the participants is situated outside India. The CRS as a whole is developed and maintained outside India. The risk in this regard entirely rests with the appellant and that is in USA, outside India. However, it is equally important to note that but for the presence of the assessee in India and the configuration and connectivity being provided in India, the income would not have generated. Thus the initial cause of generation of income is in India also. On the basis of above facts we can reasonably attribute 15% of the revenue accruing to the assessee in respect of bookings made in India as income accruing/or arising in India and chargeable under Section 5(2) read with Section 9(1)(i) of the Act.
10. Next question to be decided is if it is found that the income accruing in India is consumed by the payment made to the agents in India, whether any income still is left to be taxed in India. The activities of the appellant in India are entirely routed through the efforts of NMC namely Interglobe India P. Ltd. (Interglobe). Interglobe is responsible for monitoring the activities of the subscribers enrolled in India. The request originated from the computers at the desk of travel agent is once again routed through the facility of processing such information at Interglobe. If Interglobe finds that the subscriber accessing the CRS is authorized to do so, the request is further forwarded. InteglobeL is also responsible for establishing connectivity of the computers of the subscribers and maintaining them. Interglobe is also responsible for training of the subscribers in respect of use of CRS. For all these services rendered by Interglobe to the appellant, it is being paid remuneration in terms of distribution agreement. Broadly the assessee receives three ‘Euros’ as fees per ‘net booking’ i.e. gross booking minus cancellation. The assessee passed one dollar to Interglobe for each net booking processed through Galileo system by subscriber. Thus in respect of the activities carried out in India and considering the income accruing in India, remuneration paid to the Indian agents consumes the entire income accruing or arising in India. It is also to be noted that the entire payment made by appellant to Integlobe has been allowed as expenses while computing total income of the appellant. In such a situation in view of Circular No. 23 of 23rd July 1969 no income can be further charged to tax in India. As rightly contended by Shri Vyas the Circular equally applies to the sale of goods as well as rendering of services. The Hon’ble Supreme Court has taken judicial note of said Circular in the case of Morgan Stanley & Co. 292 ITR 406 and have held that once associated enterprise which is considered as PE of the non-resident assessee is remunerated at arms-length, nothing further would be left to be attributed to the PE of the non-resident. We, therefore, hold that in view of the above facts, no income is taxable in India.
Whether a Permanent Establishment Exists:
11. Shri Vyas submitted that without prejudice to the fact that the Appellant is not subject to tax under the domestic law, the liability to tax in India has also to be examined under the provisions of the Treaty. It was highlighted that the objective of the Treaty is to grant relief in respect of income on which income-tax has been paid both under the Act and income-tax in that country; or avoid double taxation of income under the Act and under the corresponding law in force in that country.
The learned AR cited that in the case of Wipro supra, wherein it was observed that
the correct recognition of national interest is rule of law impartially applicable to one and all without fear and favour to any one giving full meaning to the Act and the Constitution, so as to achieve the dreams of the founding fathers as found in the preamble to the Constitution.
It was submitted that based on Section 90(2) the provisions of the Act shall apply to the extent they are more beneficial to that taxpayer. Hence, unless the Appellant’s income is taxable in India under the provisions of the Treaty, it would not be liable to tax in India, regardless of the position under the domestic law, and vice versa.
The double tax treaties jointly constitute a separate regime of taxation and they should not be construed as a proviso to the Act or as an exemption provision. In the determination of the Appellant’s income, any relief available under the Treaty does not operate as an exemption from tax (similar, say, to an exemption under Section 10 of the Act). Such relief operates so as to alter the scope of the taxable income under Sections 4 and 5 of the Act. In this context, he placed reliance on the observations of the Andhra Pradesh High Court in the case of CIT v. Visakhapatnam Port Trust and Union of India and Anr. v. Azadi Bachao Andolan and Anr. [2003] 263 ITR 706 (SC).
The learned AR submitted that the burden is still on the A.O. under the Treaty and it is for him to prove, even under the Treaty, that a particular receipt is taxable. It is only thereafter that the burden would shift to the Appellant to point out any provision of the Treaty under which the receipt does not become taxable and this rule is substantiated by the observation of the Special Bench in the case Motorola Inc. v. Deputy Commissioner of Income-tax, Non-Resident Circle [2005] 95 ITD 269 (Delhi) in Para 124 at Page 399.
He further submitted that under the Treaty, India and USA have agreed, reciprocally, to define the extent to which taxes may be levied in each country on residents of the other. This is achieved by specifying conditions which have to be satisfied before different classes of income may be taxed, and where such conditions are satisfied with reference to any class of income, by specifying the limitations subject to which, and the manner in which such income may be quantified, or the rate at which it may be taxed. In the context of business income, the conditions to be satisfied are set out in Article 7(1) of the Treaty, and include the requirement that a non-resident should have a permanent establishment, as defined in Article 5 of the Treaty. Where these conditions are satisfied, the further condition is that the income which may be taxed must be attributable to the permanent establishment1 and must be derived from the assets and activities of the permanent establishment. It should be noted that the conditions specified in Article 7(1), read with Article 5, and in Article 7(5) are intended to achieve the objective of the avoidance of double taxation.
11.1 In this background, the learned AR submitted that for good and cogent reasons, the dominant aim of the Treaty is the avoidance of double taxation and the provisions of the Treaty should be interpreted with that aim in mind. Therefore, any interpretation which is likely to lead to double taxation is to be avoided. Consequently, for instance, if there is a doubt regarding the existence of a PE, it should be held that there is no PE. The Courts should adopt a liberal approach, especially in case of a doubt, in favour of the taxpayer. This is especially so because, as stated above, a tax Treaty is basically not a Taxing Code, but a Code for NOT Taxing, or for Limiting Taxation. Any ‘purposive’ or other interpretation which moves away from the words of the Treaty would be impermissible, except insofar as it is directed at the aim behind the Treaty.
11.2 The learned AR, submitted that the Appellant’s business profit is not taxable by virtue of the Treaty for the reasons which he summarised as under:
(1) It has no “Permanent Establishment (“PE”)” in India under Article 5(1) or 5(2) of the Treaty as the phrase is generally or normally understood
(2) It particularly does not have
(a) a fixed place PE
(b) an installation PE
(c) an agency PE under Article 5(4), read with Article 5(5)
(3) Without prejudice to the above, the activities of the alleged PE, if any, are only of a preparatory or auxiliary character.
(4) Without prejudice to the above, the Appellant does not carry on any business in India, whether through the alleged PE or otherwise
(5) Without prejudice to the above, even if it is assumed, while denying, that the Appellant has a PE, no profits are derived by the Appellant from any assets or activities of the alleged PE.
(6) Without prejudice to all the above, the alleged income, if any, attributable to the alleged PE is exhausted by the arm’s length payment made by the Appellant.
The above propositions were elaborated subsequently as under:
11.3 Based on Article 5(1), the words ‘fixed place of business’ were most crucial in interpreting the term” PE”. He submitted it was necessary to ensure that the essential meaning of the words “permanent establishment” should not be destroyed.
It is further submitted that the expression ‘Permanent Establishment’ has been judicially recognised in CIT v. Vishakapatnam Port Trust as requiring the following:
The expression ‘Permanent establishment’ used in the Double Taxation Avoidance Agreements postulates the existence of a substantial element of an enduring or permanent nature of a foreign enterprise in another country which can be attributed to a fixed place of business in that country. It should be of such a nature that it would amount to a virtual projection of the foreign enterprise of one country into the soil of another country.
It was submitted that the Appellant has nothing in India which satisfies the above tests of a “Permanent Establishment”, as generally understood as above, at all, and hence is saved from Indian taxation.
Without prejudice to the above, in order for a non-resident to have a Fixed Place PE in India:
• He should have a fixed place of business in India; and
• His business should be carried on through that fixed place.
The learned AR submitted that the Supreme Court in the case of Vishakapanam (supra) and jurisdictional Tribunal in the case of Motorola (supra) and Western Union Financial Services Inc. v. ADIT has interpreted the meaning of fixed place of business as a specific geographical point at the disposal of the non resident through which a business is carried on.
He submitted that the test of a Permanent Establishment and a Fixed place of business as laid down by the Special Bench of the Tribunal in the case of Motorola are as under at Page 401:
Article 5:1 states that the term “Permanent Establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on.
The OECD commentary on Double Taxation refers to a “fixedplace ” as a link between the place of business and a specific geographical point. It has to have a certain degree of permanency. It is emphasized that to constitute a “fixed place of business”, the foreign enterprise must have at its disposal certain premises or a part thereof Phillip Baker in his Commentary on Double Taxation Conventions and International Tax Law (3rd edition) states that the nature of the fixed place of business is very much that of a physical location, i.e. one must be able to point to a physical location at the disposal of the enterprise through which the business is carried on.
However, the revenue has failed to establish that ECI had made certain space available to the assessee at its disposal. In other words, there is nothing to indicate that whenever any employee of the assessee visited India, he could straightaway walk into the office of ECI and occupy a space or a table.
at Page 402
Therefore, in the light of this discussion, it cannot be said that the assessee had a PE in India as envisaged in Article 5.1 of the DTAA.
In the case of Western Union (supra), the tests laid down for a fixed place of business is as follows:
(i) A PE should project the foreign enterprise in India.
(ii) The assessee can, as a matter of right, enter and make use of the premises for its business.
11.4 The learned AR further submitted that whenever it was desired to deem a plant or an equipment to be a PE, it has been specifically so provided. For instance, in the Indo-Australian Treaty Article 5(3)(a) which specifically includes ‘substantial equipment’ within the definition of a PE. The deeming provision has been inserted to artificially create a PE out of assets in India. Even then, the artificial extension applies only to ‘substantial equipment’. As there is no such provision in the Indo-US Treaty, there would be no basis for deeming an equipment to be a PE. In any case, and without prejudice, the computers of the Appellant of the value of US$ 4,95,712 cannot be called ‘substantial equipment’, and the value of these was insignificant as compared to the revenues earned. One point to be noted is that, even in the Indo-Australian Treaty, the need was felt to specifically incorporate a double deeming, firstly that ‘substantial equipment’ would be deemed to constitute a PE, and, secondly, that the enterprise concerned would be deemed to carry on business through that deemed PE.
Had it been intended that the term ‘fixed place of business’ should include assets or equipment, a provision to that effect would have been expressly included in the Treaty. This proposition is observed by the Supreme Court in the case of Azadi Bachao (supra) at 747, as follows:
It is urged by learned Counsel for the appellants, and rightly in our view, that if it was intended that a national of a third state should be precluded from the benefits of the DTAC, then a suitable term of limitation to that effect should have been incorporated therein.
The appellants rightly contend that in the absence of a limitation clause, such as the one contained in article 24 of the Indo-US Treaty, there are no disabling or disentitling conditions under the Indo-Mauritius Treaty prohibiting the resident of a third nation from deriving benefits thereunder.
In summary, from the above judicial precedents, three tests to determine fixed place of business could be laid down as under:
• Place of business test;
• Right to use test;
• Business activity test
The learned AR then elaborated the above tests as under:
(i) Place of business test: There should be certain premises at the disposal of the Appellant and not at the disposal of the agents. Reference was drawn to the commentary by Arvid A. Skaar in his Treatise on “Permanent Establishment”. There the following test of a Fixed place PE was laid down as under:
The “fixed place of business test” therefore qualifies the objective presence of the enterprise in the other country. “The “fixed place of business test” is in fact composed of three cumulative tests. (As per OECD Commentary 1977) The enterprise must (J) have a “place of business,” and (2) the right to use the place of business has to be maintained with a certain degree of permanence at (3) a distinct geographical place within the jurisdiction of the treaty.
(ii) Right to use test: Appellant should have legal right to use the property. It is not necessary to have an exclusive right to use a property. Extract from the commentary by Arvid A. Skaar in support of this was cited as under:
Thus, the “right to use test” is met when the enterprise has a legal right of use to the place of business as an owner or a lessee. Exclusive right to use the premises is not required.
The present author’s hypothesis concerning tax-treaty law is that the “right of use test” is met if the taxpayer’s use of the place of business cannot be prevented without his consent.
It was further submitted that the Court of Session, while interpreting the expression “place of business” in Section 274 of the Companies (Consolidation) Act, 1908, of the UK, in the case of The Lord Advocate v. The Huron And Erie Loan And Savings Co. and Ors. [1911] Session Cases 612 laid down that the test of a ‘place of business’ is Company must have a local habitation of its own.
(iii) Business activity test: Fixed place through which business is carried out. In this connection following reference was drawn to commentary by Skaar (supra)
at Page 155
The definition of the basic-rule PE of the modern tax treaties explicitly requires the enterprise’s “objective ” presence in the other country through the existence of a “fixed place of business.” It also requires a “business” activity as a condition for PE. Furthermore it is a clear condition that there must be a connection between the place of business and the activity, i.e. that the activity has to be conducted “through” the place of business.
It is common ground, for instance, that a warehouse owned by a foreign enterprise and at the entire disposal of a domestic enterprise (consignment stocks) does not constitute a PE for the foreign enterprise.
at Page 229
The PE definition not only examines the physical connection of a taxpayer’s business to a foreign territory and the duration of his right to use a fixed place of business, but also the activities carried out there. Tax treaties characterize a fixed place of business as a PE only if the enterprise undertakes a “business” activity through the place of business. The basic rule requires the activity performed through the place of business to be “the business of an enterprise” (emphasis added). The definition of PE in the tax treaties thus presupposes the performance of a “business activity (As per OECD Commentary 1977 as Article 5).
at Page 230
To constitute a PE, the business activity must be performed “through ” the place of business. This is the “business connection test”;
The performance of a business activity through a fixed place of business is the definition of a PE. Thus, a taxpayer who “has” or “operates” a PE is always engaged in “business ” (hat constitutes a PE, but he is not conducting “business through a PE.
It was submitted that the Appellant does not satisfy the above tests at all, it had no local habitation of its own in India, there is no projection of the Appellant into India, the Appellant’s presence is not visible through an establishment in India, and no business is carried on in India through a fixed place PE. Thus, neither the computers provided by Interglobe to the TAs, nor the Telecommunication nodes/lines provided by SITA, can be regarded as satisfying the tests of a Fixed place PE.
11.5 Based on the judicial precedents and commentary, the learned AR further elaborated why computers and telecommunications lines cannot be regarded as fixed place which is as under: Regarding Computers
– A movable machine can never be regarded as a local habitation which is a pre-requisite for a Fixed place PE
– The argument that computer software constituted a fixed place PE was repelled by the Jurisdictional Bench of the Tribunal in the case of Western Union (Supra)
– If computers are regarded as a fixed place of business, it would lead to the absurd situation that the Appellant would be regarded as having 50 places of business in the single office of a TA who has been supplied 50 computers
– A place of business connotes a specific geographical location. A movable machine can never be a place or a location
– the Appellant has no right to enter the TA’s premises as a matter of right and to make use of the same for the purpose of the Appellant’s business
In any event, and without prejudice to the above, even if the Node is regarded as a fixed place of business,:
– it is not the Appellant’s fixed place of business, as it is SITA’s place of business, and because the Appellant has no right to use the said place for the purpose of its own business.
– the telecommunication Lines/Nodes can by no stretch be regarded as the Appellant’s local habitation in India or as a projection of the Appellant in India.
-a place through which the Appellant’s business is carried on.
If a view is taken that the Appellant is also carrying on its business operations through the Nodes/Telecommunication Lines, it would lead to an absurd situation that both SITA and the Appellant are carrying on their business operations through the Nodes/Telecommunication Lines. SITA, by providing the Nodes/Telecommunication Lines, is carrying on its own operations of providing telecommunication services to the Appellant, which services the Appellant is purchasing as a means or tool to conduct its business of providing CRS services.
For example, if an independent car hire company is engaged by a foreign engineering consultant firm to transport its engineers whom it has sent to India to conduct a preparatory survey, the engineering firm cannot be regarded as carrying on its operations in India through the car hire company. The provision of transport is the car hire company’s business operations in India and not the business operations of the engineering firm, which is only using the services of the car hire company as a means or a tool to conduct its own business.
11.6 The learned AR clarified that the Appellant does not have an Installation PE as defined in the Treaty, which speaks of Installation PEs only in relation to installation projects [Article 5(2)(k)] or to installations for the exploration or exploitation of natural resources [Article 5(2)(j)], both of which are obviously absent in the Appellant’s case
12. Shri Kapila would submit that the object of Indo-US DT AA is to avoid Double Taxation. This object is achieved by allocating profits of the ‘General Enterprise’ to the extent of profits derived from the assets and activities which are attributable to the ‘Permanent Establishment’ in India. He further contended that Treaties, being drafted by diplomats, should not be construed as the words of Statute.
12.1 He submitted that discussion in the preceding paragraph relating to ‘business connection’ is equally relevant for deciding whether the assessee has a Permanent Establishment in India. However, following are the places of Assessee’s business in India:
(i) ‘Nodes’ in Telecommunication centre at Mumbai & Delhi hired by the assessee from SITA and leased lines/network in India arc at the disposal of the assessee for the purpose of connecting Travel Agents to the Node on a continuous basis 24 hours of the day throughout the years.
As explained by the Assessing Officer page 2 of his order,
Once a travel agent is identified by the local company, i.e. Galileo India, it refers to Galileo International that the travel agent be provided connectivity. Galileo International then, due to their contract with SITA, request them to provide node and lease lines to the travel agents. Once that is provided, the Indian company is provided the connectivity code by the international company, which it passes on to the travel agent. With the help of that code command on the computer the travel agent gets connected to the mainframe of Galileo International.
(ii) Continuing ownership of the equipment and software provided to Galileo India for distribution to the Travel Agents. These equipments, are situated and used in India in the assessee’s business. So long as these equipment owned by the assessee and used in India under assessee’s authority (express or implied) in assessee’s business, it is quite immaterial as to who actually operates it.
The assessee has explained the nature of telecommunication expenses, which is reproduced in para 9.1 of the order of the CIT(A) dt. 15.12.2004, which reads as under:
(i) Nature of telecommunication expenses
Galileo avails itself of the services of SITA to provide communication links to all parties that need to be connected to the data centre i.e. the travel agencies. In consideration for such telecommunication services, it pays monthly connection charges to SITA in accordance with the telecommunication agreement with SITA.
ii) Nature of network expenses
SITA also provides network connections (routers) for processing of data, for which Galileo pays network charges to SITA. Network expenses also include manpower costs, software costs and maintenance costs for network identified equipment.
Therefore, network expenses include the following costs:
• Telecommunication expenses paid to SITA;
• Telecommunications expenses paid to other telecommunications providers;
• Manpower costs;
• Software costs; and
• Maintenance and depreciation costs for the network identified equipment.
The SITA and other telecommunications providers’ expenses are specifically allocated to the country identified on the bills from these providers.
The remainder of the network expenses, manpower, software, maintenance and depreciation are allocated based on a formula. Specific cost centres are identified for the network costs to be allocated.
Relevant Clauses of the Distribution Agreement are listed below:
Clause 3.1(3.2), (P. 106 of APB)
Galileo International shall at its own cost procure the provision operation and maintenance of a communications network and associated equipment for the distribution of its CRS Services from the Galileo System to the Node or Router in India.
Clause 4.2 (P. 107 of APB)
Interglobe shall at its own cost and responsibility provide Galileo International’s CRS Services without alteration, except as may be mutually agreed, from the Node or Router to Subscribers in the Market Region and shall either provide equipment to Subscriber or facilitate the connection of equipment to access Galileo International’s CRS Services. Galileo International shall provide to Interglobe details of the hardware and software specifications approved from time to time by Galileo International for use in conjunction with Galileo International’s CRS Services and including, but not limited to, operating, performance or other parameter. Interglobe shall use its best endeavours to ensure that all hardware and software used to access Galileo International’s CRS Services in the Market Region comply with such specifications and including, but not limited to, any operating, performance or other parameter imposed by Galileo International.
Though such Clause exists in the DA, this Clause was never implemented. The assessee & not Interglobe maintained the Indian network at its own cost.
The above quoted Clauses of the Distribution Agreement establish:
i) Nodes and routers hired by the assessee are located in a ‘fixed place’ in the premises of Telecommunication Centre at Mumbai and Delhi in India. Leased lines/network maintained at its own cost by the assessee in India is a fixed place within India. As observed in para 10 of OECD commentary (P 199 of Decision Paper Book) “a permanent establishment may nevertheless exist if the business of the enterprise is carried on mainly through automatic equipment….”
ii) It is pertinent to mention that the leased communication network is permanently at the disposal of the assessee who has further made it available to the airlines & travel agents for use round the clock for the entire year,
iii) Provision of Node and communication network within India is not for any preparatory or auxiliary activity. It is an integral and essential part of the core business activity of the assessee for earning commission form the Airlines. It is also not necessary that the assessee itself should own the network and nodes. Suffice it for our purpose if the assessee has based such equipment on a continuous and ‘permanent’ basis,
iv) ‘Location’ of the ‘liquipment’ (hardware supplied to a Subscriber) is ‘fixed’ in the premises of the Travel Agent,
v) All these assets in India taken together constitute a fixed market place in India for flight reservation,
vi) A Travel Agent cannot relocate the computers without permission Ref. Clause 2.1 read with Clause 4 of the Model Agreement (P. 175-206) in terms of Clause 6.5 of the Model Distribution Agreement. (P. 109-110/APB),. The specimen Subscriber Agreement between Galileo India and Bajaj Travels (Subscriber) contains similar terms (P. 35 of DPS). Clause 10.1 (P.184/APB) of the specimen Subscriber Agreement specifically provides that Galileo’s representative can enter the subscribers office premises for “installing, inspecting and view the apparatus and its operation”.
vii) It is contended by the assessee that (a) that equipment provided to the Travel Agents is relatively of little value and (b) a distinction has to be made between “substantial machinery and light portable equipment”. This contention is misconceived. It is not the value or the size of the equipment which is relevant but it is its operational and economic significance to the business operations of the enterprise which is the deciding factor. Without display on the computers at the premises of the Subscribers, without sifting of information and punching of commands with the help of software installed in these computers, no booking can be made CRS will be at stand still and no income will be generated. Regarding portability of equipment, the facts noted in (ii) and (iii) make it clear that the equipment provided to the Travel Agents is not portable but it is installed at a specified location within the premises of the Subscribers and cannot be shifted by the subscriber without the permission of the assessee agent in India.
Philip Baker has referred to a decision of German Supreme Court wherein a Dutch company having a gas pipeline running through Germany without any of its personnel being in Germany attending to it, held that the part of the gas pipeline constituted PE of the Dutch company in Germany,
viii) The following observations of the CIT(A) in paragraph 6.4 of his order are apt:
The customers and the Subscribers know with certain amount of certainty that the airlines information is displayed on the computers placed in Subscriber’s premises and it can be used for getting the information and booking the tickets with minimal effort. Therefore, the computer, which occupies the place and which is connected with mainframe computer, does answer to the description of fixed place of business form which the appellant business is wholly and partly carried on.
The CIT(A) has rightly repelled the assessee’s contention that communication, display and sifting of information on the computers at the Subscribes premises is not very important to processing of information in the Host computer,
ix) As observed by Klaus Vogel (3rd Edition page 286), “In the same vein para 4 OECD MC Comm. Article 5 stales that it was immaterial whether the premises, facilities of installations were owned or rented by, or were otherwise at the disposal of, the enterprise. A similar view was held earlier by FC Munster which stated that it was not necessary for the power of disposition to be legally confirmed by ownership or a lease. All that was required to satisfy the power of disposition test was actual disposition which did not need to go any further than necessary for allowing the permanent establishment to function.”
The Assessee satisfies the following four conditions, which have come to signify the expression “fixed places of business” employed in Article 5(1) of the Treaty.
• There must be a place of business in India – Place of husiness test
• The place of business should be at the disposal of the Applicant – Disposition test;
• The activities performed through the place of business must constitute a business activity of the Applicant – Business Activity Test
• The place of business must be fixed and the activity should last for a certain period of time – Permanence test
The Nodes in India and hired by the Assessee is clearly fixed place of business so are the premises of the travel agents who use the computers and network provided by the Assessee for making the bookings. The Network and Nodes are always at the disposal of the Assessee from where Assessee’s business activities are carried out. Since these activities are continuous over past several years, it also satisfies the permanence test.
Learned DR accordingly submitted that there is Nexus of fixed place with assessee’s business through Network in India.
He next submitted that the question as to who is responsible for paying for the communication network in India needs further elaboration. During the assessment proceedings, the assessee, vide letter dated 22 January 1999 (P. 25-32 at P. 30/DPB) stated that:
As per Para 4.2 of the Distribution Agreement between Galileo International and Interglobe Enterprises, Interglobe shall at its own cost and responsibility provide Galileo International’s CRS Services form the Node or Router to the travel agents and shall either provide equipment to subscribers or facilitate the connection of equipment to access Galileo International’s CRS Services.
As Per Para 4.3 of the Distribution Agreement Galileo International shall supply to Interglobe licences for all such software products developed by Galileo International for use by the travel agents in conjunction with Galileo International’s CRS Services.
Therefore, the equipment for facilitating access to the CRS Services is provided by Interglobe and software to be used by the subscriber is owned by Galileo International and licensed to Interglobe.
Para 6.5 and Para 6.6 of the Distribution Agreement enables Interglobe to request Galileo International to provide computer hardware for use by the travel agent at no cost to Interglobe for the fist two years.
Hence as late as January, 1999 the appellant made a categorical but misleading statement of fact that cost of maintaining the network in India right from the inception and provision of equipment to the subscribers after first two years was borne by the Galileo India and not by the assessee.
iii) This is clearly a deliberate misstatement of facts. When it was found out that the above-quoted paras 4.2 and 4.3 of the Distribution Agreement were actually given a go-bye and these costs were in fact borne by the assessee right from the inception, the assessee tried to explain it in its written submissions filed with the CIT(A), (P. 218-276, at P. 266/APB), wherein the assessee made the following contradictory statement of fact:
Data processing fees US $ I was paid by the Appellant as against US $ 1.52 specified in the schedule as the original fee was based on the fact that the communication costs from the SITA node to the travel agents computer would be borne by the Distributor. However, as the Distributor did not bear such costs, the fee agreed upon was revised accordingly so that the Appellant could meet such telecommunication costs. It is well accepted commercial principle that remuneration should be commensurate with the services provided. Accordingly, the data processing fee payable to the Distributor had to be scaled down to reflect this position.
The letter of appellant to Interglobe dated 12.12.95 clearly establishes that even this statement is misleading. The documents produced by the assessee clearly show that the revision in price had no nexus with the fact that the assessee eventually had to pay for the maintenance of nodes and the regional net – work in India.
However, even going by the second version it is clear that the assessee has not only hired the facilities of the teleepmmunication centre of SITA at Delhi/Mumbai, for uplinking and down linking the host computer in USA with the computer installed in the premises of the subscribers in India, but it also maintains the entire communication network within India enabling the travel agents to make booking on the CRS. Hence, the network in India together with the equipment and software provided to the travel agents in India constitute fixed place of assessee’s own business in India without which it could not have carried on its business.
12.3 Learned DR further submitted that the Computers belonging to the assessee were supplied to the travel agents free of charge for distribution to the travel agents. The assessee has claimed depreciation on such equipment for all these years and it has been allowed by the AO being assets owned by the assessee and used in its business in India of earning revenue from the Airlines on the basis of bookings made by Travel Agents. Hence, the assessee had a fixed place of business where assets either leased or owned by the assessee in India in all the years under appeal.
13. In reply, Shri Vyas contended that entering into of Treaties is a matter falling under the CBDT. The President has, under Article 77 assigned the powers to CBDT chairman for all matters and references relating to avoidance of double taxation under various. He submitted that Tax Treaties are to be considered as mini legislations and interpreted as such. The objective of framing the Tax Treaties should be kept in mind, while interpreting the same.
He argued that an equipment or plant is not regarded as a PE under the Indo-US Treaty. It is submitted that the absence of “plant” or “equipment” in the definition of PE in the Indo-US Treaty is conclusive that “plant” and “equipment” cannot be a PE thereunder, particularly in view of the specific inclusion of “plant” or “equipment”. This follows from the principle laid down by Supreme Court in Azadi Bachao Andolan’s case referred to at Page 28 of the Appellant’s written submissions Article 5.3(a) of the Australian Treaty is examined in detail below to remove the confusion caused in this regard by the Department:
5.3. An enterprise shall be deemed to have a permanent establishment in one of the contracting states and to carry on business through that permanent establishment if:
(a) substantial equipment is being used in that state by, for or under a contract with the enterprise.
This clearly means that the Australian Treaty not only:
(i) deems substantial equipment used by an enterprise in a contracting state to be a PE but Also Separately and in Addition
(ii) deems that such enterprise is carrying on business in that contracting state through such PE.
It is therefore beyond doubt that the Indo-Australian Treaty specifically treats substantial equipment as a PE whereas the Indo-US Treaty does not. Therefore, applying the tests of the Supreme Court in Azadi Bachao Andolan’s case (supra), the conclusion is that the US Treaty did not envisage “plant” or “equipment” to constitute a PE.
Even apart from Article 5.3 of the Indo-Australian Treaty, Article 5.2(j) of the Indo-Australian Treaty further makes it clear that the Indo-Australian Treaty, unlike the Indo-US Treaty, specifically indicates “plant” or “equipment” in the definition of a PE.
Article 5.2(j) : an installation or structure, or a plant or equipment used for the exploration or exploitation of natural resources.
Therefore, it is clear that a plant or equipment cannot be a PE under the Indo-US Treaty. Therefore computers, nodes or lines, cannot be regarded as constituting a PE under the Indo-US Treaty at all.
Further, the Indo-US Treaty in Article 5(2)(j) refers only to a specific and limited installations or structures e.g. those which are used for exploration or exploitation of natural resources but only if so used for a period of more than 120 days in any 12 months period. All other installation or structures are excluded. It is therefore clear that even if it is accepted (while denying) that SITA nodes and lines constitute installations, they would not come within the definition of a PE in the Indo-US Treaty.
In view of the above, it is evident that, under the Indo-US Treaty, computers, nodes and communication lines are not contemplated at all as constituting a PE.
It was further submitted that the computers are portable. Merely because care and safeguards are provided for shifting them, does not alter, but in fact confirms, the fact that they are portable. Under Clause 10 of the Distributorship Agreement, Interglobe is given only a limited licence to enter the TA’s office specifically only for the purpose of installing, inspecting and viewing the computers. The Appellant or Interglobe therefore, do not have the premises of the TA at their disposal. This does not at all satisfy the right to use test set out in detail at Pages 27 to 30 of the Appellant’s Paper Book and particularly by the jurisdictional ITAT in the case of Motorala (supra) in the following words at P 401 of the Report.
However, the Revenue has failed to establish that EC I had made certain space available to the assessee at its disposal. In other words, there is nothing to indicate that whenever any employee of the assessee visited India, he could straightaway walk into the office of ECI and occupy a space or a table.
Article 5.1 states that the term “Permanent Establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on.
The OECD commentary on Double Taxation refers to a “fixedplace” as a link between the places of business and a specific geographical point. It has to have a certain degree of permanency. It is emphasized that to constitute a “fixed place of business”, the foreign enterprise must have at its disposal certain premises or a part thereof Philip Baker in his Commentary on Double Taxation Conventions and International Tax Law (3rd edition) states that the nature of the fixed place of business is very much that of a physical location, i.e. one must be able to point to a physical location at the disposal of the enterprise through which the business is carried on.
14. Addressing the arguments as to whether there exists a PE within the meaning of Article 5(4) or Agency PE, the learned AR submitted that the relationship between Appellant and Interglobe is that of supplier and distributor of products and services. Neither party has any authority to bind the other party, nor hold itself out as the agent of the other party (Clause 16.1 and 16.2 of the Distribution Agreement). He referred that the agreement provided an option that the distribution of CRS services can be undertaken by Interglobe through a division or a subsidiary (GIPL) of Interglobe and if a subsidiary is established it can be added as a party to the Agreement. (Clause 2.2 of the Agreement) and the primary responsibility would be of Interglobe. He submitted that based on the Distribution Agreement, the Appellant agreed to the following services:
• Procure the provision, operation and maintenance of a communication network and associated equipment from the Appellant’s MCS to the Nodes in India (Refer Clause 3.1 of the Agreement)
• Provide licences for software products developed by Appellant which are necessary for use by the Subscribers in conjunction with the CRS services (Refer Clause 3.1 of the Agreement)
• Share technological innovation, advancements and additions with Interglobe (Refer Clause 4.6 of the Agreement)
He argued that the Appellant does not have any Agency PE in the form of Interglobe because Interglobe carries on its own business in India and hence, it is not a person acting on behalf of the Appellant in India within the meaning of Article 5(4) of the Treaty; and without prejudice to above, Interglobe does not carry out on behalf of the Appellant, any of the activities specified in Clauses (a), (b) or (c) of Article 5(4) of the Treaty; and without prejudice to immediately above, Interglobe is not a dependent agent as described under Article 5(5) of the Treaty.
14.1 Shri Vyas contented that the scope of agency envisaged in Article 5(4) is much more limited than the scope of the term under general law and submitted that Section 182 of the Indian Contract Act, 1872 (‘the Contract Act’), defines an ‘agent’ to mean ‘a person employed to do any act for another OR to represent another in dealings with third persons’. The first limb of the definition of ‘agent’ (doing any act for another) covers any technical, executive or administrative act performed by one person for another without representing that other person in dealings with third parties. The second limb of the definition of ‘agent’ (to represent another in dealings with third persons) covers the kind of agency where the agent deals with third parties representing another. This is a case where there are two or more principals, with an agent of one principal representing him in his dealings with others. This could include passive dealings like acting as a conduit without authority to act, or active dealings, like negotiating and concluding contracts. The agents falling within the second limb of the definition of ‘agent’, has authority to represent the principal in dealings with others and to sell the goods of, or to otherwise carry on the business of, the principal.
The learned AR submitted that as per Article 5(4) there should be a person in India acting on behalf of the Appellant. The term acting on behalf of another is narrower than the term representing another in dealings with third persons, used in the second limb of the definition of ‘agent’ (supra), since a person may represent another without the authority to act on his behalf. The scope of Article 5(4) is further circumscribed by restricting the activities which can constitute a permanent establishment in the course of one person acting on behalf of another, to those specified in Clauses (a) to (c) of Article 5(4). Article 5(4) does not use the term ‘agent’ in specifying what may constitute a permanent establishment but for, what would not constitute a permanent establishment. Hence, Article 5(4) only encompasses a part of the second limb of the definition of ‘agent’ when he were to act on behalf of a non-resident, and that too only if his actions fell within the categories specified in Clauses (a) to (c) of Article 5(4). An agent falling only within the first limb of the definition would not constitute an Agency PE. Hence, any judgments or commentaries on what constitutes an agent under general law have to be read with great caution while interpreting Treaty, and a person who may be an agent under the Contract Act need not be an ‘agent’ under the Treaty.
14.2 The learned AR without prejudice to above, contended that Interglobe does not carry out any of the activities specified in Clauses (a) to (c) of Article 5(4), so as to attract the provisions of Article 5(4) of the Treaty and the activities of the alleged agent are not ‘income-earning’ activities. The learned AR elaborated that under Article 5(4)(a) of the Treaty, only a person having, AND habitually exercising, an authority to conclude contracts on behalf of a US resident can lead to the creation of a PE for the US resident. Thus, Article 5(4)(a) requires the existence of, inter alia, ALL the following components:
a) Existence of a non-resident principal, a resident principal, and a resident agent of the non-resident principal;
b) Hxistence of an authority in favour of the resident agent to conclude contracts on behalf of the non-resident principal;
c) The holding out by the resident agent to the resident principal that he is an agent of the non-resident principal;
d) The habitual conclusion by the resident agent of contracts with the resident principal on behalf of the non-resident principal; and
e) Resultant contracts between the non-resident principal and the resident principal.
The learned AR reiterated that Clause 16 of the Agreement between the Appellant and Interglobe, expressly provides, inter alia, that neither party to the agreement has any authority to bind the other party; nor can either party hold itself out as the agent of the other party. This negates the existence of any authority on the part of Interglobe “to conclude contracts on behalf of the enterprise” viz. the Appellant, so as to attract Article 5(4)(a). Also, this Clause would also be a complete defence should Interglobe (or a TA) ever allege that the Appellant is bound to a TA by any contract entered into by Interglobe with him. Hence, it cannot be said that Interglobe has any authority to conclude contracts on behalf of the Appellant.
The learned AR highlighted that no material has been brought on the record to show that Interglobe habitually exercises, or even purports to exercise, or has even once exercised, any such authority, by concluding any contract with an Indian TA on behalf of the Appellant. Also no material has been placed on the record to indicate that Interglobe held out to the TAs that it was entering into contracts with them as an agent, in law, and not as a principal, and that the contracts would not be binding on Interglobe.
He further submitted that no contract subsists between the Appellant and the TAs in India. A contract is an agreement enforceable at law. The TA would have nothing to enforce against the Appellant, and the Appellant is not in any way legally bound to the TA to do anything for him. Similarly, the Appellant would have nothing to enforce against the TAs.
If Interglobe were to conclude contracts with TAs on behalf of the Appellant, any contract entered into by Interglobe should, in terms of its legal effects, be a contract between the Appellant and the TAs and that there should be consideration flowing from the Appellant to each TA, and vice versa; and the Appellant should have the legal right to sue the TA to enforce contractual terms, and vice versa.
He argued that the contention of the department that the Appellant grants access to the TAs with whom Interglobe has contracts, indicates that there are binding contracts between the Appellant and those TAs is inconsistent with the law of contract, which requires mutual agreement, mutual consideration and, above all, mutual enforceability, for a contract to exist between two parties. He pointed out that it is quite common for hotels, airlines, credit card companies, and other companies to tie up with each other or with other businessmen to provide benefits to each other’s customers. Such granting of benefits does not result in a contract between the airlines, etc, and the customers, and no enforceable rights accrue to the customers.
Thus the allegation of the AO that the Distributor is concluding contracts on behalf of the Appellant is plainly erroneous, and unsupported and in the absence of any authority to conclude contracts on behalf of the Appellant, the relationship between the Appellant and the Distributor cannot constitute a PE in India, under Article 5(4)(a) of the DTAA.
14.3 The learned AR further argued that Article 5(4)(b) – Maintenance of stocks cannot apply to the Appellant because there is no question of goods or merchandise being stocked or delivered in the Appellant’s case. Further, it is clear from the express terms of Clause (b) that this Clause does not apply to any and every kind of goods or merchandise, but only to goods or merchandise which are sold.
14.4 Learned AR further argued that Clause (c) of Article 5(4) has no application to the facts of this case, inter alia, because it can apply only if an agent habitually secures orders in India wholly or almost wholly for a US resident. Since the only function of Interglobe is to provide an access code to the TA, which access code the TA has no obligation to use and which access code the TA may never in fact use as he may prefer to use the CRS of one of the competitors of the Appellant, it is clear that Interglobe, by merely providing the access code, does not in any way secure orders or sell goods or merchandise for the Appellant in India.
He emphasised that unless an agent’s activities were income-earning activities, there would be no income derived from the assets and activities of the alleged permanent establishment, as required by para 5 of Article 7, for any income to be chargeable to tax in India.
14.5 The learned AR contended that without prejudice to his contentions as regards the non-applicability of Article 5(4) of the Treaty, Interglobe is an independent agent within Article 5(5), and, therefore, cannot be regarded as constituting an agency PE for the reasons given below:
a. Interglobe is an agent of independent status. Interglobe is a part of the Interglobe Group which is a huge independent business house having diverse business interests including the running of its own Airline, Indigo.
a. Interglobe’s activities are not devoted wholly or almost wholly to the appellant
b. In any event, the Appellant’s transactions with Interglobe are made under arm’s length conditions.
He highlighted that reference in Article 5(5) to the transactions between the non-resident principal and the agent being “made under arm’s-length conditions” is intended to deal with those cases where the parties are related and the dealings between them are not at arm’s length. In the ordinary sense, the term “arm’s length” refers to dealings between two unrelated parties and in the present case, it cannot be disputed that the Appellant and interglobe are unrelated parties, and hence the dealings between them, by definition, are arm’s length dealings. For the said test for Arm’s length, reliance was placed on meaning of “Arm’s length” in Black’s Law Dictionary, Seventh Edition. It was pointed out that the reference in Article 5(5) is to the conditions under which the transactions are made, and not to specific prices. He further submitted that the Department has not suggested why the payment of US $ 1 per segment was not made under arm’s length conditions or why the amount of US $ 1 was inadequate. A commission of 33.3% can never be treated as anything but reasonable and at ami’s length. Further, the rate of 33.3% was higher than the rates paid to distributors in other countries as was evident from the letter dated 27 January 2000 filed before the CIT(A) and appearing at page 285A of APB-I.
The AR argued that the Department itself has separately alleged that the consideration is at more than an arm’s length. It was pointed that there is a clear conceptual misunderstanding on the part of the Department in alleging that the transactions between the Appellant and Interglobe were not at arm’s length as there was an alleged concessional treatment by the Appellant to Interglobe, which allegedly violated the arm’s length principle. It is well established that it is only if the treatment of Interglobe by the Appellant were detrimental to Interglobe that the arm’s length principle could be regarded as violated in the context of Article 5(5) of the DTAA. In this connection, reference was made to the following observations of the Jurisdictional Bench in the case of Western Union Financial Services at Page 82:
There is no material to show that the rates of compensation are higher in other cases so us to indicate that the agents were discriminated against.
Thus there seems to be no basis for the charge that the compensation paid is not adequate for the services rendered by the agents.
The learned AR clarified that GIPL, a separate undertaking of Interglobe, was formed on 17-03-1997. As Interglobe on its own volition and at its own option, decided lo perform the distribution function through this separate company. Thus, the allegation made by the Department based on this fact cannot, in any event, be applied to the Assessment Years 1995-96 and 1996-97 and also, for all practical purposes, to Assessment Year I997-98. GIPL is funded and owned wholly by Interglobe and, even assuming that its entire income is from the Appellant, this does not mean that GIPL is economically dependent upon the Appellant as GIPL, being funded entirely by, and being part of the entire Interglobe organisation, can, without any doubt, survive economically even without the Appellant’s business, given that it has the support and backing of the Interglobe Group. Further the allegation by the Department that GIPL was claiming Section 10A/80HHE benefits in no way establishes that GIPL is a dependent agent, inter alia, because such claim has been made by GIPL on its own only qua its own tax authorities.
15. Shri Kapila, on the contrary, would plead that the assessee have a ‘dependent agent’ in India under Article 5(4) read with (5) of the DTAA. Me invited our attention to Article 5(5) of the Indo-US D.T.A.A. extracted herein:
An enterprise of a Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because it carries on business in that other State through a broker, general commission agent, or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business. However, when the activities of such an agent are devoted wholly or almost wholly on behalf of that enterprise and the transactions between the agent and the enterprise are not made under arm’s length conditions, he shall not be considered an agent of independent status within the meaning of this paragraph.
He invited our attention to some of the relevant Clauses of the Distribution Agreement are reproduced below:
Clause 4.3(P. 107 of APB)
Galileo International shall supply to Interglobe licences for all such software products developed by Galileo International as are commercially desirable of necessary for use by Subscribers in the Market Region in conjunction with Galileo International’s CRS Services, to enable Interglobe to supply such software products to Galileo Subscribers in the Market Region provided always that nothing in this Clauses shall oblige Galileo International to supply any particular software product.
Clause 4.5(P. 108 of APB)
Galileo International and Inter globe shall enter into a service level agreement based upon the Model Services Level Agreement which forms schedule 4 hereto. Galileo International and Interglobe shall use all reasonable endeavours to achieve the objectives set out in such service level agreement, which shall be reviewed at intervals of not less than one year.
Clause 4.6(P.108 of APB)
Galileo International undertakes to share with and provide to Interglobe any such innovations, technological advancements, improvements and additions to its CRS Services and related services and facilities as it deems commercially desirable or necessary for the Market Region. Galileo International will give due weight to any recommendation which Interglobe may make with respect to such innovation and its introduction in the Market Region. From time to time Galileo International may provide to Interglobe new releases of the software products, in order to provide enhancements or modifications of existing software products. Galileo International will provide to Interglobe as much advance notice as possible of the content of any new release. Galileo International will discuss with Interglobe the implementation date for the new release and wilt deliver any new release to Interglobe, on an agreed implementation date.
Clause 7.1 (P. 111 of APB)
Galileo International and Interglobe shall devise and adequate training programme for the relevant employees of Interglobe engaged in the distribution of Galileo International’s CRS Service, such training to be carried out at Company’s premises in the United Kingdom, or any other venue acceptable to both parties with due regard to cost effectiveness. Galileo International shall be responsible, at its own cost, for the provision of the training course. Including all documentation, and the services of a trainer. Interglobe shall be responsible for all incidental costs, whether incurred by its own personnel (where, such training is held at Company’s premises or premises outside the Market Region) or Galileo International s (there such training is held within the Market Region), associated with such training, including transport and accommodation.
15.1 On the basis of above calsues, Shri Kapila submitted that Galileo India is a dependent agent of Galileo International for the following reasons.
i). Galileo India has been set up first as an independent division as a separate undertaking in terms of Section 10A of the Act of Inter Globe. This undertaking was subsequently taken over w.e.f. 1.4.1997 by Galileo India (P) Ltd., exclusively for providing distribution and support services to Galileo International
Ref. Clause 2.1 & 2.2 of the Distribution Agreement (P. 104/APB)
ii). Initially, Interglobe had undertaken the activities under the Distribution Agreement for one year not in the ordinary course of its business. Indeed, the undertaking was set up exclusively for assisting the Indian operations of the assessee. Interglobe was carrying on business of travel agency, tour operator etc. The business started by Interglobe under the Distribution Agreement is totally a different kind of business which cannot be said to have been under taken in ordinary course of business hitherto carried on by Interglobe. The new business of providing support services to Galileo International is a distinct business requiring specialized skills for which the employees of the Indian company received specialized training from the assessee.
iii). Clause 2 of the Agreement make it clear that Interglobe entered into a distinct and new business venture which had no nexus with its existing business. It is not an extension of business. Right from the inception it has been treated as a unique and separate undertaking and relief Under Section 10A & 80 HHE have been claimed on the profits derived from this undertaking. Clause 2.1 & 2.2 of the Agreement envisage a separate company for carrying on the Galileo business. It was carried on by an independent and distinct undertaking of Interglobe. Until this business was taken over by a new company (Galileo India (P) Ltd.) with effect from 1.4.1997. Therefore, on facts of the case, the proviso to first sentence of Article 5(5) applies and the 10A undertaking Interglobe or Galileo India cannot be considered to be an independent agent, as this business was economically wholly dependent on the assessee.
iv). Activities of Galileo India (Pvt.) Ltd. are wholly and exclusively devoted to provide service to Galileo International. (Ref. Clause 2.9 of the Agreement). The company was incorporated to take over the ‘Galileo’ business of Interglobe (P. 68-81 of DPB). Therefore, a company which has been set up exclusively to carry on the Galileo business, ab-initio cannot be said to carry on such business in the ordinary course of its business. The expression “course of business” axiomatically assumes a preexisting business in the course of which the new business is undertaken.
v). The Distribution Agreement between Galileo International and Galileo India creates essentially a dependent agency for the following reasons:
a) Under the Agreement the assessee has supplied US$ 0.5 Million worth of equipment to Galileo India not by way of sale or lease, but only for distribution of the equipment to the Subscribers in India on its behalf. The assessee continues to be the owner of this equipment, but it is Galileo India which distributes the equipment to the subscribers.
b) It supplies/licenses its proprietory software free of charge to Galileo India for supplying the same to the subscribers under the ‘Subscriber Agreement.
c) Under the Distribution Agreement, the assessee has authorised Galileo India to conclude ‘Subscriber Agreement’ with the Travel Agents which allows them to use the CRS owned by it. The assessee has also ensured in its agreements with the Airlines that the bookings made by the Subscribers under the ‘Subscriber Agreement’ with Galileo India must be honoured by the Airlines. In other words, the terms of the ‘Subscriber Agreement’ concluded independently by Galileo India with the subscribers has not only been honoured by the assessee, but it has also ensured that the vendors (Airlines etc.) are contractually committed to honour it.
d) The Distribution Agreement clearly states that Galileo India would be paid ‘data processing fees’ for processing data received from the subscribers in India. The assessee is therefore not factually correct when it says that the data inputs received directly from the subscribers is processed in the host computer in USA. Indeed, it has been specifically contended by Galileo India that as a matter of fact it processes the data inputted by the subscribers in India before its transmission to the host computer in USA. Galileo India also undertakes the task of suitably modifying the configuration of the computers supplied to the subscribers in order to make them compatible to the host computer in USA.
e) On termination of the Distribution Agreement, all Subscriber Agreement between Galileo India and travel agents automatically vest in the assessee without cost. Relevant Clause 9.12 (Pg. 114/APB) reads as under:
Article 9.12 of Distribution Agreement (Pg. 114/APB)
In the event of termination of these agreements under Clause 9.4 or 9.5, parts (b) through (f), upon the expiry of the notice period as specified hereunder:
(a) all subscriber Agreements concluded by Galileo India shall be automatically assigned to Galileo International at no cost to Galileo International and Galileo India shall physically deliver to Galileo International its signed originals of all such Subscriber Agreements within thirty (30) days of such termination takings effect, and
(b) Galileo International, at its sole discretion, may purchase all or part of the Subscriber hardware, title to which at the time of termination is vested in Interglobe at the lower of Net Book Value or market value in the India market where Net Book Value is defined to be original purchase price inclusive of freight and duty only and no other costs, depreciated on a straight line basis from the date of delivery to Interglobe, using a 6 (six) year useful life or existing market value in Indian market thereof at that point in time, whichever is the lower.
f) The three agreements – Vendors Agreement, Distribution Agreement and Subscriber Agreement – must be read together as none is operationally feasible without the existence of the other two. When read together, the agreements clearly establish that Galileo is not only assessee’s agent, but it is economically wholly dependent on it.
The subscriber’s rights vis-a-vis the airlines are secured in the Participation Agreement to which it is not a party. Similarly, Distribution Agreement (Clause 15.3, Pg. 124/APB) between the assessee and Galileo India indemnifies the assessee “against any claim in respect of inaccurate data supplied by the Subscriber.”
vi) Even if Galileo India is held to be an agent acting in ordinary course, of its business, it is still a dependent agent for the reasons stated above and also because the conditions laid down in second sentence of Article 5(5) are satisfied:
a. Galileo India is wholly and exclusively carrying on business for Galileo International. It is economically dependent on it. This is its only source of income.
b. The alleged certificate from Interglobe at P. 308 of the assessee’s Paper Book is not on the record of the AO. It is not indicated when it was made out and to whom was it submitted. It has neither been referred to in the assessment order and nor in the appellate order. It is therefore not admissible. In any case, it pertains to Assessment Year 1995-96 only and therefore has no relevance for other years under appeal. In these years, it was Galileo India (P) Ltd., which was set up exclusively for providing support service in India to the assessee. Further, it has been explained that the undertaking of Interglobe providing various support services to the assessee is a separate Section 10A undertaking independent of other business of that company. It is settled law that business of such an undertaking must not be confused with or identified with the other business of the company owning the undertaking.
c. The nature of work done by Galileo India for which ‘data processing fees’ was paid has been explained by the assessee in the remand proceedings, which has been reproduced by the CIT(A) in para 6.1(h) at page of his order dated 15.12.2004, which reads as under:
Nature of data processing fees
Marketing expenses are different from data processing fees.
Data processing fees are paid to the Indian distributor, pursuant to the Distribution Agreement.
These payments arc made in consideration for the provision of the following services:
• Provision of facilities to the subscribers to access Galileo International’s CRS services
• Undertaking marketing activities directed at the national vendors.
• Providing the following support services to the subscribers in the market region:
• Hardware and software installation
• Hardware maintenance {?}
• Training
• Help-desk services
d. As per Clause 9.8(b) of the Distribution Agreement, in ease of valid termination of the Distribution Agreement all hardware belonging to Galileo India would vest in the assessee. Further, under 9.12, (a) all subscriber agreements would vest in the assessee; These terms clearly show that the agreement is not between two principals.
e. A perusal of the Service Agreement (P. 142 to 206/APB) between assessee and the Galileo India clearly shows that a detailed and continuous procedure has been put in place for the reporting, reviewing and monitoring of the performance of the Galileo India with a view to increasing efficiency of the CRS and thereby reducing the response time to the end user (Subscriber). Further, it also provides for monitoring and referring top ten problem tickets by the Galileo India to the assessee for resolution. This again indicates a relationship of principal and agent and dependent not that of principal and a dependent agent.
Article 14 of the Distribution Agreement read with Service Agreement annexed to it clearly brings out the tight monitoring and supervision of the activities of Galileo India by the assessee. For instance,
Article 14 of Distribution Agreement (Pg. 122/APB)
Reporting and Planning Procedures
14.1 Galileo International shall provide to Inter globe on a regular basis, but no less frequently than quarterly, the following information for the purposes of Inter globe’s activities under this agreement:
a) all information needed by Intergolbe in relation to Galileo International’s marketing activities as anticipated by Clauses 5 and 14.3;
b) vendor contract progress;
c) product delivery, development and specification progress;
d) product prices;
e) levels of booking activity;
f) system performance;
g) hardware prices
h) other relevant information related to the Galileo CRS and related facilities.
Article 3.1 of Service Agreement in terms of Distribution Agreement (Pg. 147/APB)
Service Plan
There are two key areas of measurement when considering services to the End Subscriber. These are System Availability and Response Times. This document recognizes that both of these categories are affected by Global. Regional and Market based influences and that measurement of these services can effectively be divided into Host (H) Network (N), and Customer Premises (P) components.
Responsibility for the stability and performance of Core Host Service, and any part of the Network that exists at a Core Host site, rests with Galileo International. Further down the Service Delivery Chain is the Network component.
Responsibility for stability and performance of this component shall rest with the Partner or Associate and/or the Network Provider in cooperation with Galileo International, as detailed in the Market Specific section.
The combined availability of H, N and P forms the total System Availability as the End Subscriber would experience. Similarly the sum of the response time, within each component forms the total Response Time as perceived by the End Subscriber.
The goal is that Service Level Measurement and Reporting will be the combined function of all Service Providers in the Galileo International Delivery Chain. End to End measurement of standard Focalpoint sites will be catered for by Galileo International. Where non-Pocalpoint installations exists it will become even more critical that the Partner or Associate, and other Network Provider that forms part of the Delivery Chain, contribute with measurement of the service within their control.
Service Management
Problem Management
Refer to Galileo International’s Problem Management Procedures for complete documentation on the Problem Management System (PMS).
Host, Network and Premises
For problems to be recognized and addressed they must be logged into the Galileo International PMS. Typically problems are recognized as originating at either Host, Network or the Customer Premises components. Currently all problems identified by the End Subscriber, the NDC, the Partner or Associate, and subsequently logged and esca;ated via PMS, are assigned a Business Impact value based on the nature of the problem as defined below:
• Critical: Critical impact on business. Severe loss of revenue. No work-arounds or alternatives. (This value should be assigned with due regard to the nature of the problem).
• High: High impact on business. Complex work around required. Serious user dissatisfaction.
• Medium: Medium impact on business. User dissatisfaction but a tolerable work around available.
• Low: Limited impact. No anticipated effect on revenue. Inconvenience caused to user. One off problems.
Escalation and Resolution
End user subscribers will initially report all faults to their NDC Help Desk. It will be the responsibility of that local NDC to escalate local problems that cannot be solved to Galileo International, the Partner or 3r party supplier on the subscriber’s behalf Service impacting problems will be discussed via Service Management meetings held quarterly or as agreed by parties to this document.
f. The assessee has given the basis for claiming marketing expenses as deductible business expenditure, which clearly brings out that Galileo India is a dependent agent.
15.2 Shri Kapila would submit that the transactions between Galileo International. & Galileo India are not at arm’s length for following reasons:
i. The AO at P. 16 of his order has given a clear finding that assessee has not established arm’s length payment. That the actual commission has been arbitrarily & without any justification reduced to US$ 1 per segment booked as against US$ 1.52 stipulated in Schedule 3 of the Distribution Agreement (P. 140/APB).
The assessee subsequently tried to explain before the CIT(A) that Galileo India refused to bear cost of networking in India, i.e., payments for leased lines from SITA Node to Travel Agents premises and the “fees agreed upon was revised accordingly”. The assessee has not furnished any explanation as to how reduction of fees by 52 cents per segment (33%) is justified as compared to the additional expenditure it had to incur on Indian net-work. The whole exercise is arbitrary and against principles of arm’s length negotiations for revision of fees. Further, hiring of SITA’s nodes in India is a part of world-wide contract between the assessee & SITA. Therefore, there could be no question of Galileo India entering into a separate contract with SITA.
ii) Evidence on record clearly suggests that the parties to the Distribution Agreement never intended to implement Clause 3(P. 106/APB) of the Agreement read with Schedule 3. The subsequent version of the assessee submitted before the CIT(A) that the assessee reduced the fees payable to Galileo India from US$ 1.52 to US $ 1 per segment because Galileo India refused to incur these costs is without substance. Firstly, no evidence to this effect has ever been produced. Secondly, this contention is also belied by the assessee’s letter dated December 12, 1995 addressed to Interglobe (P. 215/APB) extracted herein:
To: Interglobe
Re: Reduction in segment fees
Effective November 1995, Inter Globe has crossed the 100,000 segment barrier. Congratulations to you and your team.
Our projections reveal that Inter Globe should be cash positive. Taking into account the advances available with you and increased efforts on our part in facilitating sharp increases in your productivity, we propose the data processing fees payable by Galileo International to Inter Globe shall be one dollar per booking.
The payment shall be the same for air and non-air bookings effective November 1, 1995.
(emphasis supplied)
It will be seen form the above, the decision was clearly not to reduce but to ‘fix’ the fees, a decision which was taken by the assessee unilaterally and simply intimated to Galileo India, which clearly had no say in the matter. There is also no mention whatsoever of the ‘reduction of fees1 because of the assessee having to take on the responsibility for maintaining the communication network in India. On the other hand, congratulatory terms of the letter clearly suggest that the fees was fixed by the assessee for good work on the part of the dependent agent.
It may be also noted that the actual expenditure on network expenses bear no relationship with the substantial reduction in tees payable to Galileo India (P. 60-61 and 94-97 of Assessee’s Paper Book in ITA 820-822 for A. Y. 95-96 to 98-99). It is also clear that the assessee had been making ‘increased efforts in facilitating sharp increases’ in Galileo India’s, productivity.
iii) There was a clear breach of Clause 3.2 contract by Galileo India (P. 106/APB) and yet the assessee did not invoke penal provisions contained in Clauses 9.5 to 9.13 of the Distribution Agreement (P. 113-114/APB). This once again establishes that the dealings between the assessee and Galileo India are not at arm’s length, but that of a principal and its dependent agent.
iv) The equipment and software was provided to Galileo India free of charge. The concessional treatment granted to the Galileo India is violative of arm’s length principle. Incidentally, the fact that Galileo India has been authorised to distribute assets (both hardware and Software) of which Galileo International continue to be the owner clearly establishes that the premises in which Galileo India stores the equipment for distribution is a ‘fixed place’ of assessee’s business.
v) As per Schedule 5 of the Distribution Agreement, Galileo International also earns service fees from the Airlines for optional services booked by the travel agents and yet no commission is paid to the Galileo India on this account.
15.3 Learned DR would submit that appellant has an agency PE inthe form of Dependent Agent Interglobe in terms of Article 5(4) of Treaty.
1). Clause 6.3 of the Distribution Agreement clearly authorises the Galileo India to conclude contiacts with the Subscribers broadly in accordance with terms of that Agreement. A Model subscriber Agreement is also annexed to that Agreement. (P. 175-206 of APB)
Some of the relevant Clauses of the Distribution Agreement etc. below:
i) Clause 2.4 (P. 105 of APB)
Notwithstanding Clauses 2.1 and 2.3 and subject to Clause 10, nothing in this agreement shall prevent Galileo International from distributing Galileo International’s CRS Services, to either:
a) a place of business, branch or office in the Market Region of a Multinational Subscriber, or
b) an Individual Subscriber in the Market Region whoKgains access to Galileo International’s CRS Services directly or indirectly via a third party on-line service network or any other means which allow any Individual Subscriber access to Galileo International’s CRS Services provided that, prior to the introduction of the supply of CRS Services to Individual Subscribers in the Market Region, the parties hereto shall agree upon the commercial arrangements applicable to Bookings to be made in the Market Region by means of such supply, including the payment of Data Processing Fees therefor.
ii) Clause 2.8(b) (P. 105 of APE)
Interglobe undertakes to Galileo International that, in the event that either party identifies a potential interested and commercially viable participant, associates or shareholder in the Indian NDC, Interglobe will negotiate in good faith with such party with a view to accepting such party as a participant, associate or shareholder in the Indian NDC upon reasonable terms.
Clause 5.1 (P.109 of APB)
Galileo International shall have exclusive responsibility for undertaking marketing efforts directed at International Vendors and shall have the exclusive right to enter into contracts with International Vendors. In the case of any International Vendor whose principal place of business is within the Market Region Galileo International will initiate such efforts after consultation with Interglobe, and, where appropriate, Galileo International and Interglobe shall together conduct negotiations with such International Vendors.
Clause 5.2 (P. 109 of APB)
Interglobe shall have exclusive responsibility for undertaking marketing activities directed at National Vendors and shall have the exclusive right to enter into contracts with National Vendors. Galileo International shall at Interglobe’s request assist Interglobe in such marketing activities where such assistance, appears to Galileo International to be appropriate. Galileo International if it considers it reasonable to do so, shall give timely provision of costing if requested by Interglobe (including usage costing under Sub-clause 8.2).
Clause 6.3 (P.109 of APB)
Interglobe shall be responsible for entering into contracts with Subscribers who wish to use Galileo Inter national’s CRS Services in the Market Region. Such contracts shall be consistent with the terms of this agreement and consistent with the local laws of the relevant jurisdiction and shall provide the Interglobe is acting as a principal and not as agent for Galileo. Interglobe shall give reasonable consideration to Galileo International proposals with regard to the terms of such contracts. Schedule 5 contains Galileo International’s Model Subscriber Agreement which Interglobe may use as a guideline in drafting its Subscriber agreements.
Article 3 Duties of Participant (P. 91 of APR-I)
B) Participant, at its own cost, shall provide Galileo International with data that are at/east as complete, timely, accurate, and advantageous, and that are delivered in as favourable a manner, as those it provides to any other CRS, including Participant’s CRS. Participant shall provide any such data in a format and through a supplier (if a supplier is used) that are acceptable to Galileo International.
D) Participant shall ensure that Participant’s CRS offers services to all air carriers with an ownership interest in Galileo International to the same extent and on terms conditions that are at least as favourable as those on which Participant’s CRS offers those services to other air carriers, including Participant.
F) participant shall accept for transportation any passenger presenting a ticket that bears an “OK” status and that has been issued as a result of a booking made through the System, consistent with data in the System and otherwise in accordance with this Agreement, even though no record of that booking may exist in Participant’s System, overbooking may result there from, and denied boarding compensation may be required.
2). However Clause 8.1 of the Agreement (P. 111/APB) grants freedom to Galileo India to fix its own charges to the Subscribers. Indeed, whereas Model Subscriber Agreemenl prescribes various charges payable by subscribers for the use of ‘equipment’ & other services to be provided by the domestic company the Galileo India7 does not charge the Subscribers for any of its services or for the use of equipment owned by the assessee.
Hence, whereas the Galileo India is authorised to conclude contracts which involve the assessee’s equipment and software as also network and the system for booking orders by the Subscribers Agreement, yet it is independent to fix its own financial charges. Needless to say, the nodes and ‘equipment’ hired or owned by the assessee have been allowed by it to be used by travel Agents and other ‘direct subscribers’ in India for booking of orders.
Further, Clause 5.2 of the Distribution Agreement allows Galileo India to conclude contracts with domestic Airlines. However, such contracts would bind the assessee to allow such Airlines to use CRS on which assessee would earn income.
The assessee has clearly allowed itself to be bound by the terms of the Subscriber Agreement between Galileo India and a Subscriber and it has been always abiding by it. Indeed, not only docs it honour the contracts which Galileo India has been making on its behalf with the subscribers, but the assessee has also ensured by the terms of the Vendor Agreement that the Airlines also honour it. It also cannot be denied the activities mentioned in both the agreements are intimately interwoven with the business operations of the Assessee.
Relevant Clauses of the Distribution Agreement read as under:
Clause 4.3 (P. 107 of APB)
Galileo International shall supply to Interglobe licences for all such software products developed by Galileo International as are commercially desirable of necessary for use by Subscribers in the Market Region in conjunction with Galileo International’s CRS Services, to enable Interglobe to supply such software products to Galileo Subscribers in the Market Region provided always that nothing in this Clauses shall oblige Galileo International to supply any particular software product.
Clause 4.5 (P.108 of APB)
Galileo International ami Interglobe shall enter into service level agreement based upon the Model Services Level Agreement which forms schedule 4 hereto. Galileo International and Interglobe shall use all reasonable endeavours to achieve the objectives set out in such service level agreement, which shall be reviewed at intervals of not less than one year.
Clause 4.6 (P.108 of APB)
Galileo International undertakes to share with and provide to Interglobe any such innovations, technological advancements, improvements and additions to its CRS Services and related services and facilities as it deems commercially desirable or necessary for the Market Region. Galileo International will give due weight to any recommendation which Interglobe may make with respect to such innovation and its introduction in the Market Region. From time to time Galileo International may provide to Interglobe new releases of the software products, in order to provide enhancements or modifications of existing software products. Galileo International will provide to Interglobe as much advance notice as possible of the content of any new release. Galileo International will discuss with Interglobe the implementation date for the new release and will deliver any new release to Interglobe, on an agreed implementation date.
The provisions of Article 5(4)(a) are therefore attracted.
Ref. (i) TVM Ltd. 237 ITR 220
(ii) Western Union Financial Services (2006) 101 TTJ 56.
15.4 Learned DR would also submit that Para 5(4)(b) would also apply to hold an agency PE in India for the reason that the assessee is supplying stock of hardware equipment, software and manuals to the Galileo India which the latter maintains on its behalf and distributes to the travel agents in India under the ‘Subscriber Agreement’. Refer Article 6.5 of the Distribution Agreement (P.110/APB), which read as under:
Clause 6.5 (Clause 110 APB)
All computer hardware for use by Subscribers in the Market Region which is required by Interglobe during the first two (2) years hereof in order for Subscribers to use the Galileo System shall be provided by Galileo International at no cost to Interglobe. For the avoidance of doubt, it is the intention of the parties that the costs herein borne by Galileo International are the cost of hardware and the costs associated with delivery to Interglobe in India inclusive of freight and duty (duty to be initially paid by Interglobe and reimbursed by Galileo International) and that all costs incurred after delivery including but not limited to installation, testing, maintenance, and post customs warehousing shall be the responsibility of Interglobe. Galileo International will retain title to all computer hardware supplied to Interglobe as contemplated in this Clause 6.5.
[Note: Galileo India does not pay any rent towards the use of computer hardware]
15.5 Shri Kapila lastly submitted that even Article 5(4)(c) of the Indo US D.T.A.A. would also apply to hold an agency PE in India as per Clause 5 and 6.1/6.2 the Distribution Agreement at page 109/APB. Every contract concluded by the Galileo India with travel agents and Airlines in India clearly establish that Galileo India habitually secures order for the assessee for use of the CRS from which the assessee earns income.
15.6 Summing up the arguments, Shri Kapila submitted that
(A) The assessee’s income is taxable interms of Section 9 read with Section 5(2) of the Act as it has assets in India, source of income in India as also business connection in India.
(B) The assessee has a PE in India on account of:
i) having ‘fixed place of business’ through which its business is carried on in India as per Article 5(1) of the Indo-US DTAA.
ii) It also has an agency PE in terms of the proviso to the first sentence of Article 5(5).
iii) Without prejudice, it also has an agency PE in terms of second sentence of Article 5(5).
iv)The activities of the assessee do not fall under any of the negative items mentioned in Article 5(3).
v) The fees payable to the dependent Indian agent is not an arm’s length price.
vi) Conditions laid down in Article 4(a), 4(b) & 4(c) are also satisfied.
vii) The assessee is taxable both under the provisions of the Act as well as those of Indo-US DTAA.
16. As regards the exclusivity Clause in the contract between Interglobe and the Appellant, the learned AR replied that this does not mean that there is no principal to principal relationship nor does it mean that Interglobe is an agent of the Appellant. There can be exclusive distributors acting on a principal to principal basis just as there can be agents acting on a nonexclusive basis
The learned AR submitted that the Appellant and Interglobe agreed to enter into a yearly Service Level Agreement which outlines service quality parameters, the tasks required to be performed in relation to system controls, system management and customer services. For the benefit of both the parties a Model Service Level Agreement was provided in the Distribution Agreement (Schedule 4 of the Agreement). He argued that the model agreement pointed out the basic technical requirements to provide compatibility and ensure high quality of services to be rendered. Clause 4.2 of the agreement merely provided that “IntergJobe is to use its best endeavour” to ensure that the hardware and software used to access the CRS conforms to certain specifications. It does not show the Appellant’s control over IntergJobe. This is merely an Operating Agreement, setting out the parameters and level of service which both the Appellant and IntergJobe are committed to deliver to the End Subscriber see Clause 1.2 of the Service Level Agreement which is reproduced below:
This document is an agreement between Galileo International and xxxxx as the National Distributor Company. It outlines the level of service each commits to deliver to the End Subscriber.
He argued that this is in no way inconsistent with Interglobe being an independent contractor because even an admittedly independent contractor may be directed to ensure that his work, and the materials he uses to perform the same, conform to certain specifications. For example, an architect or a contractor appointed by a person to design and execute interior work in his flat may specify that only wiring or switches bearing the ISI mark or the ISO – 9000 mark or bearing a particular brand name should alone be used.
He further submitted that the Appellant provided the format/model Subscriber Agreement to help/guide Interglobe in drafting its subscriber agreement for renting the hardware and software to the TAs on a principal to principal basis and not as an agent of the Appellant. As per the agreement:
• Interglobe would provide assistance to the TAs relating to:
• Rented equipment, communications link and all other equipments
• Information of the Location, the installation and operations of the equipment, software and communication links (‘Apparatus’)
• Non-exclusive licence to TAs to use Software Products and the Manuals
• TAs would prepare the appropriate Location and ensure that the installation and operation is safe and satisfactory
• Interglobe is the owner or licensee of the Rented Equipment and the Software Products and does not warranty the accuracy or reliability of any schedule, fare quotation or any other information
• Interglobe would charge specified fees for the equipment/services to TAs
16.1 The learned AR emphasised that the training cost incurred by the Appellant shows that Interglobe is being given beneficial and preferential treatment rather than being discriminated against or dominated by the Appellant and hence, as per the Jurisdictional Tribunal decision in the case of Western Union, this established that Interglobe was being remunerated at more than arm’s length.
He argued that the allegation of the Department that there is a control of the Appellant over Interglobe as on termination of the Distribution Agreement, Interglobe’s contracts will get assigned to the Appellant is erroneous. This Clause applies only upon termination of the Distributorship Agreement. It is a standard Clause to protect a contracting party in the event of an agreement being terminated on account of the insolvency of the other party. It is natural that on an agreement between two parties being terminated on account of the bankruptcy or insolvency or for other similar reasons affecting one party, the other party would take steps to ensure the continuity of its business operations. It was further submitted by the learned AR that to protect the interest of either party, in case the agreement is prematurely terminated, both parties have agreed that the Appellant shall at its own discretion purchase all or part of the Subscribers’ hardware, title to which rest in Interglobe. The Appellant and Interglobe shall endeavour smooth transition of the day to day business from Interglobe to Appellant on termination. It was also agreed that the Appellant and/or Interglobe may terminate the agreement any time by serving notice on other party in case of material breach of the terms of the agreement, which is non-remedial or otherwise. If the Appellant legally terminates the Agreement in the event of liquidation, encumbrance etc, than Interglobe will not provide any CRS services in India for 5 years and titles to the entire Subscribers’ hardware vested in Interglobe shall immediately vest in Appellant. On the other hand, if Interglobe legally terminates in the event of liquidation, encumbrance etc, than titles to all Subscribers’ hardware vested in Appellant shall immediately vest in Interglobe and Appellant shall waive all outstanding amounts owe to Interglobe.
The learned AR emphasised that the Department’s allegation that the reduction in fees from USD 1.52 to USD 1 was unilateral is based on pure conjecture, suspicion and surmise. The fact that it was not unilateral is shown by the fact that it was only a proposal since the said letter itself stated:
…we propose that the data processing fees payable by Galileo International to Interglobe shall be one dollar per booking
Further, the letter filed by the Appellant, itself shows that the reduction was not arbitrary but was based on relevant factors e.g.
• the increase in booking turnover shown by the remark: “Effective November 1995, Interglobe has crossed the 100,000 segment barrier”;
• the projection that Interglobe should be cash positive;
• the advances available with Interglobe;
• the Appellant’s efforts to increase Interglobe’s productivity
16.2 It was further submitted that, without prejudice to the above and in any event what is relevant to determine whether the payment to Interglobe is at arm’s length is not why the processing fee was reduced from $ 1.52 to $ 1.00 but whether such processing fee after the reduction (i.e. US $ 1.00) was at ami’s length. It was reiterated that even the reduced fee worked out to a 33% rate of commission and was much higher than the commission of US $ 0.62 to 0.91 paid to other National Distributors as indicated in the Appellant’s letter to the CIT dated 27 January 2000 (at Page 285A of APBI) Further, interest free advances given by the Appellant to Interglobe would be advantageous and not detrimental to the latter. It is only the latter which would make a payment not at arm’s length.
It was stressed that the comparable data of other National Vendors at page 285A of APB I was given pursuant to a specific request of the CIT(A) and has not been controverted or questioned by the CIT(A) as being inadequate or insufficient. It cannot now be questioned on the allegation that it is “mere raw data.” In any event and strictly without prejudice to the above this data regarding commission payable in other countries at rates of $ 0.62 to $ 0.90 at Page 285B speaks for itself. It does not relate only to “Central European Countries” as falsely alleged but also relates to the UK and Netherlands where competition between CRS companies was far greater than in India in AYs 1995-96 to 1999-2000 and yet a lower rate of commission was paid in those countries, despite the much higher cost base in those countries.
He emphasised that Arm’s length analysis already done on the basis of material produced leads one to an irresistible conclusion that the Appellant is not discriminated against and the Department’s inability to produce any other comparable data concludes this issue in Appellant’s favour.
16.3 He further submitted that Clause 5.2 and 8.2 of the Distribution Agreement relied upon by the Department do not deal with Airlines at all. They deal with “National Vendors” which are “Non-Air” vendors (definition of “National Vendors” in the agreement). In any case, if it is the Department’s case that the Appellant does not charge fee for the said services and let Interglobe earn profits, it establishes that Interglobe is not been dominated by the Appellant but treated favourable by it He contented that even if it is assumed ,while denying, that Interglobe falls within Article 5(4) of the Treaty, it is completely saved by Article 5 (5) thereof in view of what is shown below:
1. As established in detail above, the transaction between the Appellant and Interglobe are made under arm’s length conditions. On this ground alone, Interglobe would fall outside Article 5(4) of the Treaty and the Appellant would not be regarded as having an Agency P.E.
2. However, apart from the above, it has not been shown by the Department (as it is required to further show) that the transactions of Interglobe are devoted wholly or almost wholly on behalf of the Appellant as.
– For the first three AY’s 1995-96, 1996-97 and 1997-98, when GIPL was a mere division of Interglobe, it is clear from P. 308 of APB I, as the Department itself has conceded, that GIPL’s revenue contributed a minimal part of Interglobe revenues.
– For AY 1997-98, when GIPL came into existence as a 100% subsidiary of Interglobe (at Interglobe’s option), the fact remains that even this company was effectively and in substance and reality a part of the Interglobe group so that even in this Assessment Year it cannot be said that GIPL was wholly or almost wholly dependent upon the Appellant. GIPL was dependent upon the Interglobe group alone.
3. There is no material whatsoever in support of the allegation that Interglobe is authorised by the Appellant to store the computers.
In fact both, the Distribution Agreement (Clause 16.1 and 16.2) and the Model Subscriber Agreement (Clause 20.3) specifically provide that Interglobe is not an agent of the Appellant. Even the Subscriber Agreement filed by the Department in the Paper Book relied upon by it contains similar provisions in Clause 17.1 and 17.2 of DPB I Page 42 which are reproduced below:
7.1 – The parties hereto are entering into this Agreement on a principal-principal basis.
17.2 – Nothing to this Agreement will create, or be deemed to create a joint venture, partnership or the relationship of principal and agent between the parties.
The burden of proving that these Clauses have no effect and are to be treated as a dead-letter is entirely on the Department as it is now well established that the burden of proving that the apparent is not the real, lies entirely and heavily on the person who makes such allegation.
These specific contractual provisions cannot be displaced by mere allegations or the ipse dixit of the Department. They could, if at all, have been rebutted by examining the contracting parties to ascertain if, in fact and reality, the above Clauses were not implemented. No such thing has ever been done. The mere existence of independent, allegedly back-to-back obligations cannot negate the legal effect of these clauses. The reliance upon back to back obligations was categorically rejected by the Supreme Court in Ishikawajima’s case. These Clauses can be displaced only by establishing that the Appellant could be sued by the TA or vice versa. It is nobody’s case (as it cannot be) that the Appellant could sue the TA or vice versa.
Clause. 15.3 of the Distributorship Agreement (see P. 124 of APB I) contains no such authority but merely provides that the principal to principal arm’s length agreements which Interglobe/GIPL enters into in its own right, and on its own account with the TA’s are not inconsistent with the Distributorship Agreement and provide that the Airlines alone are responsible for the correctness of the data supplied.
The provision regarding performance monitoring is also not in any way inconsistent with a principal to principal relationship. For example, a principal manufacturer may naturally wish to monitor the performance of his distributors (who are operating or a principal to principal basis) by laying down targets for them and monitoring their performance.
14.4 The AR then submitted that without prejudice to what is stated earlier and even if it is assumed, while denying, that the Appellant does have a PE in India, its income cannot be taxed in India because it is not derived from the assets and activities of the alleged PE. He argued that it is now well settled, by the decisions of the Supreme Court in CIT v. Sterling Foods and Pandian Chemicals Ltd. v. CIT that the term ‘derived’ requires an immediate and direct nexus between the income and the source. Applying these tests, it is clear that alleged PE is not the source of the Appellant’s income as the immediate and direct source of the Appellant’s income lies elsewhere. The Appellant’s income is derived only from its MCS in the USA, as it is only there and then that the booking request is accepted and the Appellant’s income results. The alleged activities and assets of the Appellant in India are certainly not the direct and immediate source of the Appellant’s income by way of booking, fees.
Hence, the Appellant’s income by way of the CRS booking fee cannot be taxed in India by virtue of Article 7(5) of the DTAA
16.5 Learned AR further submitted that strictly without prejudice to what has been stated earlier, the amount of income which can be considered to be attributable to India is a negligible and minuscule proportion of the booking income. It was submitted that, if at all any of the Appellant’s income is to be attributable to India under Sections 5 or 9 of the Act, or under Article 7(1), read with Article 7(5), of the DTAA, it can only be a negligible or minuscule part of the Appellant’s income. The learned CIT(A) himself, at Page 15 of his appellate order for AY 1996-97, has observed:
I am in agreement with the ld. Counsel that the profit which can be brought to tax is only that amount which can be said to have been derived from the assets located in the PEs in India and the activities carried on by the appellant in India. Of course, these activities constitute display of information on the screen of the TAs located in India.
He accordingly pleaded that since the income accruing in India is only a miniscule sum and since M/s. Interglobe has been paid at arm’s length, which will consume the income accruing in India, no further income is taxable in India. Reliance was placed on the circular No. 23 of 1979 issued by CBDT which has also been ‘judicially noted and approved by Hon’ble Supreme Court in case of Morgan Stanley 291 ITR….
Findings as Regards Existence of Permanent Establishment:
17. The next question to be decided is whether the appellant has any permanent establishment in India within the meaning of Article 5 of DTAA between India and USA 187 ITR (st) 102. Article 5 of the Treaty provides as under:
INDO- US TREATY
Article 5 – Permanent Establishment
1. For the purposes of this convention, the term “permanent establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on.
2. The term “permanent establishment” includes especially:
(a) a place of management;
(b) a branch;
(c) an office;
(d) a lac lory; (c) a workshop;
(f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources;
(g) a warehouse in relation to a person providing storage facilities for others.
(h) a farm, plantation or other place where agriculture forestry, plantation or related activities are carried on;
(i) a store or premises used as a sales outlet;
(j) an installation or structure used for the exploration or exploitation of natural resources, but only if so used for a period of more than 10 days in any twelve-month period;
(k) a building site or construction, installation or assembly project or supervisory activities in connection therewith, where such site, project or activities (together with other such sites, projects or activities, if any) continue for a period of more than 120 days in any twelve months period;
(l) the furnishing of services, other than included services as defined in Article 12 (royalties and fees for included services), within a Contracting State by an enterprise through employees or other personnel, but only if:
(i) activities of that nature continue within that State for a period or periods aggregating to more than 90 days within any twelve-month period; or
(ii) the services are performed within that State for a related enterprise (within the meaning of paragraph 1 of Article 9 (associated enterprises)).
3. Notwithstanding the preceding provisions of this Article, the term “permanent establishment” shall be deemed not to include any one or more the following:
(a) the use of facilities solely for the purpose of storage or display or occasional delivery of goods or merchandise belonging to the enterprise;
(b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage or display or occasional delivery;
(c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;
(d) the maintenance of a fixed place of business solely for the purpose of purchasing goods and merchandise, or of collecting information for the enterprise;
(e) the maintenance of a fixed place of business solely for the purpose of advertising, for supply of information, for scientific research or for other activities which have a preparatory or auxiliary character, for the enterprise.
4. Notwithstanding the provisions of paragraphs 1 and 2, where a person-other than an agent of an independent status to whom paragraph 5 applies- is acting in a Contracting State on behalf of an enterprise of the other Contracting State, that enterprise shall be deemed to have a permanent establishment in the first- mentioned State, if:
(a) he has and habitually exercises in the first mentioned State an authority to conclude contracts on behalf of the enterprise, unless his activities are limited to those mentioned in paragraph 3 which, if exercised through a fixed place of business, would not make that fixed place of business a permanent establishment under the provisions of that paragraph.
(b) he has no such authority, but habitually maintains in the first-mentioned State a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the enterprise and some additional activities conducted in that State on behalf of the enterprise have contributed to the sale of the goods or merchandise; or
(c) he habitually secures orders in the first-mentioned State, wholly or almost wholly for the enterprise.
5. An enterprise of a Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because it carries on business in that other State through a broker, general commission agent or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business. However, when the activities of such an agent are devoted wholly or almost wholly on behalf of that enterprise and the transactions between the agent and the enterprise are not made under arm’s length conditions, he shall not be considered an agent of independent status within the meaning of this paragraph.
6. The fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State, or which carries on business in that other State (whether through a permanent establishment or otherwise), shall not of itself constitute either company a permanent establishment of the other.
Paragraph 1 of the Treaty gives a general definition of the term “Permanent establishment” which brings out its essential characteristic of a permanent establishment in the sense of convention i.e. a distinct sites, a fixed place of business through which the business of an enterprises is wholly or partly carried on. Thus what is to be seen is whether there is existence of a place of business i.e. a facility such as a premises or in certain instances machinery or equipment. The place of business must be fixed i.e. it must be established at a distinct place where a certain degree of permanence can be attached. Carrying on of the business of the enterprise should be through such fixed place of business. This means that the person who is in one way or the other is dependent on the enterprise, conduct the business of the enterprises in which such fixed place is situated. The term place of business covers any premises, facility or installation used for carrying on the business of the enterprise, whether or not they are used exclusively for that purpose. A place of business may also exist where no premises are available or required for carrying on the business of the enterprise and it simply has a certain amount of space at its disposal. It is immaterial whether the premises, facilities or installations are owned or rented or are otherwise at the disposal of the enterprise. A place of business may thus be constituted by a pitch in a market place or by a certain permanently used area. The place of business can be situated in the business vicinity of another enterprise. What is to be seen is that on fact an enterprise has a certain amount of space at its disposal, which is used for business activities and then it is sufficient to constitute a place of business. No formal legal right to use that place is visualized or required. A PE could exist even where an enterprise unauthorizingly or illegally occupies certain locations where it carried on its business. For a place of business to constitute a PE, the enterprise using it must be carrying on its business wholly or partly through it. It is not necessary that whole of the business should be carried on through such PE or fixed place. Time and again it is being contended on behalf of appellant that for application of paragraph I of Article 5 of the Treaty to apply, it must have a productive character i.e. contribution to the profits of the enterprise. However, considering paragraph 1 of Article 5 of the Treaty, it is not so mentioned within the framework of established business. It will be appropriate to presume that each part of the activities carried on contributes to the productivity of the whole. Thus even if some contribution is made in carrying on the business as a whole, even then it can be said that the business of an enterprises would partly be carried on from such place and accordingly a PE of such enterprise. Where the business of an enterprise is carried on mainly by the entrepreneur or employees who receive instructions from the enterprise, the rights of such persons in its relationship with third parties are irrelevant. So far as paragraph 1 of Article 5 is to apply whether or not, the dependent agent is authorized to conclude contracts is irrelevant so long as he operates from the fixed place of business. The PE will nevertheless exist if the business of the enterprise is carried on mainly through automatic equipment and the activities of the personnel being restricted to setting up and operating such equipment. A PE will still exist if the enterprise which sets up machine also operates and maintains them for its own account and whether operated by itself or by a dependent agent.
17.1 In the present case it is seen that the CRS, which is the source of revenue is partially existent in the machines namely various computers installed at the premises of the subscribers. In some cases, the appellant itself has placed those computers and in all the cases the connectivity in the form of nodes leased from SIT A are installed by the appellant through its agent. The computers so connected and configured which can perform the function of reservation and ticketing is a part and parcel of the entire CRS. The computers so installed require further approval from appellant/Interglobe who allows the use of such computers for reservation and ticketing. Without the authority of appellant such computers are not capable of performing the reservation and ticketing part of the CRS system. The computer so installed cannot be shifted from one place to another even within the premises of the subscriber, leave apart the shifting of such computer from one person to another. Thus the appellant exercises complete control over the computers installed at the premises of the subscribers. In view of our discussion in the immediately preceding paragraph, this amounts to a fixed place of business for carrying pry the business of the enterprise in India. But for the supply of computers, the configuration of computers and connectivity which are provided by the appellant either directly or through its agent Interglobe will amount to operating part of its CRS system through such subscribers in India and accordingly PE in the nature of a fixed place of business in India. Thus the appellant can be said to have established a PE within the meaning of paragraph 1 of Article 5 of Indo-Spain Treaty.
17.2 The next question to be considered is if there is a permanent establishment, whether the exception provided in paragraph 3 of Article 5 applies so as to hold that there is no permanent establishment in India. The case of the appellant is that the existence of such computers are merely for the purpose of advertising and the activities are preparatory or auxiliary in character and hence there is no fixed place PE in India in view of the Exception provided in paragraph 3 of Article 5. We are unable to accept such a contention. The function of the PE in India is not to advertise its products. The activity of the appellant is developing and maintaining a fully automatic reservation and distribution system with the ability to perform comprehensive information, communication, reservation, ticketing, distribution and related function on a worldwide basis. The computers installed at the premises of the subscribers are connected to the global CRS owned and operated by the appellant. Using part of the CRS System, the subscribers are capable of reserving and booking a ticket. Thus it cannot be considered as “solely for the purpose of advertisingn” of such CRS system. Similarly it is not in the nature of ‘preparatory or auxiliary’ character. It is difficult to distinguish between the activities which are ‘preparatory or auxiliary’ character and those which are not. The decisive criteria is whether or not the activity of the fixed place of business in itself forms an essential and significant part of the activity of the enterprise as a whole. Since part of the function is operated in India which directly contributes to the earning of revenue, the activities as narrated above carried out in India is in no way of ‘preparatory or auxiliary’ character. Thus the exception provided in Paragraph 3 of Article 5 will not apply and hence as stated above, the assessee shall be deemed to have a permanent establishment in India.
17.3 The next question arises is whether the assesee has a PE in India in the form of a dependent agent. It is commonly accepted principle that an enterprise should be treated as having a PE in a state if there is under it a person acting for it, even though the enterprise may not have a fixed place of business. Thus there can be two forms of permanent establishment, (i) fixed place or (ii) through the dependent agent. An agent is a person employed to do any act for another or to represent another in dealing with third person. What an enterprise can do directly but if not so done directly but done through an agent appointed for the purpose, it will be deemed to have been done indirectly. Even in such a situation it can be said that the enterprise carrying on the business through the efforts of such agent and hence can be said to have established a PE. In the present case the appellant avails the services of Interglobe to promote the use or CRS in India and for that purpose, to appoint subscribers in India. Interglobe is authorized to enter into contract with the subscribers in terms of authority generated under Distribution Agreement (DA). The appellant binds itself in respect of booking made by subscriber using the CRS. Thus what could have been done directly by appellant is achieved through the service of Interglobe. Hence, Interglobe is to be treated as agent of appellant in India. Even though in the agreement between appellant and Interglobe, the existence of agency is denied, yet that will not be conclusive if on facts it is found to be agency. That will be relevant only for the limited purpose of agreement between these two parties but not relevant for third parties if on facts the existence of agency is found. However, all the persons other than agent of an independent status cannot be deemed to be a PE of the enterprise. The agents can be considered as PE only and only if when a person other than agent of an independent status, (i) has and habitually exercise in that state an authority to conclude contract or (ii) though he has no such authority but habitually maintains stock of goods from which he regularly delivers goods on behalf of the enterprise. Thus the first question to be decided is whether the agent is of a dependent status or of an independent status. In the present case we find that Interglobe is totally dependent on the appellant in respect of rendering services to subscribers in India. Thus that part of Interglobe’s activities which earns its revenue by rendering services to the subscribers is earned on solely for the appellant. Though Interglobe might be carrying on any other activities, like a full fledge travel agency business, yet in respect of activity relating to installing CRS system of appellant at Subscribers Computers Provide connectivity, configuring the computers to enable it to access CRS, train the subscribers etc. is only and only for the appellant. Such type of activities are not carried on for any other person. Hence, the appellant and Interglobe are interdependent in this regard. The business of Interglobe is to provide data processing and software development services together with relative distribution of Galileo System’ to the subscribers in India. Interglobe has also an authority to enter into agreements with the subscribers. Interglobe installs the computers, configures the computers for accessing the CRS and also provides connectivity through SITA notes. Thus functionally as well as financially it is dependent entirely on the appellant. It can therefore, be said that Integlobe is a dependent agent of the appellant.
17.4 The next question to be decided is whether Interglobe is habitually exercising an authority to conclude contracts on behalf of the appellant. Under the distribution agreement entered into by the appellant with Interglobe, it is responsible for effecting and contracting with subscribers in the Indian territory and is to use reasonable efforts to provide access to all the ‘Galileo System’ out of Indian territory. Though the appellant and even the participating airlines are not party to the agreement entered into by Interglobe with the subscribers, yet the appellant through the PCA has ensured that the subscribers were authorized to use ‘Galileo System’. Under an authority granted to them, subscribers use such products. The reservations and ticketing done using the CRS product are being honoured by the participants and for which the remuneration will be payable by the participants to the appellant. Thus Interglobe can be said to have and having exercised an authority to conclude contracts on behalf of the appellant. What the appellant could have done directly by entering into an agreement with the subscribers, was done through Intetglobe. The subscribers agreement were entered into by Interglobe under an authority available to it in view of the distribution agreement. What could have been done directly is now done indirectly through the offices of Interglobe under an authority granted to it. The phrase “authority to conclude contracts on behalf of the enterprise” does not confine to application of paragraph 4 to an agent who enters into contract literally m the name of enterprise. The paragraph applies equally to an agent who concludes contracts which are binding on the enterprise even if those contracts are not actually in the name of enterprise. Lack of activity involved by enterprise in the transactions may suggest of an authority being granted to the agent. It is contended on behalf of the appellant that the agent to be called dependent agent should have an authority to conclude such contract which contributes to the income of appellant and no other ancillary contract. It is contended on behalf of the appellant that the contracts which generates revenue are the contracts with participating airlines and since the dependent agent has no authority to conclude contracts with such participants, Interglobe cannot be branded as a dependent agent within the meaning of paragraph 4 of Article 5 of the Treaty. On the other hand, the learned DR has submitted that on the plain reading of Treaty, there is no such provision that the contract to be habitually concluded should contribute to the revenue. In our opinion, what is relevant is that such contract shall have a nexus with the business operations as such and not merely contracts for hiring employees, premises etc. What is taxable in the contracting state is the income accruing to such enterprise and the activities are carried on either through the PE namely fixed place or through a dependent agent. The dependent agent is not Ho be considered as PE unless he has authority to conclude contract on behalf of such enterprise. The authority to conclude contracts must be in respect of contracts relating to operations, which constitute the business proper of the enterprise. The appellant in the present case in order to enhance its business operations has appointed Interglobe as its agent who promote the ‘Galileo System’ in India. Interglobe m its turn has appointed various subscribers for use of ‘Galileo System’. Though the revenue flows only from participants who have entered into PCA with the appellant, yet the revenue could not have been generated but for the subscribers using the “Galileo System’. In a way the revenue is generated from the participants but only-on the basis of use of CRS by the subscribers. But for such use no revenue would accrue to the appellant. Thus the agreements entered into by the Interglobe with the subscribers under an authority granted to it, are contracts relating to operations which constitute business proper and not merely in the nature of internal operations. Such contracts are habitually exercised and there is nothing on record to suggest that such authority was cancelled at any point of time. We, therefore, hold that Interglobe is dependent agent of the appellant who has habitually exercised the authority to conclude contracts on behalf of the appellant. To that extent the appellant has a PE in India. Since we have held that Interglobe is a dependent agent of appellant in India, we need not discuss para (5) of Article 5 of the treaty regarding independent agent form of PE.
17.5 The next question that arises is whether the appellant has PE in India within the meaning of Clause (b) of paragraph 4 of Article 5 of the Treaty. Clause (b) of paragraph 4 of Article 5 will apply only where the dependent agent habitually maintains stock of goods from which he regularly delivers goods on behalf of the enterprise. In the present case, it is seen that the appellant is not dealing in any stock of goods. Since the appellant is not dealing in any goods, the question of delivery of such goods does not arise. The contention of learned DR that Interglobe maintains stock of computers which are delivered to the subscribers should be treated as delivery of goods. He also submitted that what is mentioned in Treaty is that mere should be delivery of goods which may not necessarily be sale of goods. We are unable to accept such contention of the learned DR. The reference to “stock of goods” in Clause (b) of paragraph 4 of Article 5 has to be understood in the sense the business proper carried on by the enterprise. The delivery should be from the stock of goods which if considered in proper prospective will only be of the stock of goods dealt with by the assessee in regular course of its business. If the agent is to deliver the goods either the goods should be such in which the enterprise deals in or which are regularly hired out which may be considered as given on bailment from which the revenue is to be generated. But in the present case the computers supplied by Interglobe to the subscribers are not dealt with by the assessee or which is by itself is the source of revenue. Thus Clause (b) of paragraph 4 of Article 5 will not apply to consider the dependent agent as PE of the appellant in India.
Attribution of Profits:
18. Having considered that the appellant has a PE in India in two forms namely (1) fixed place (PE) under paragraph 1 of Article 5 and (2) Agency PE under Clause (a) of paragraph 4 of Article 5, we shall examine as to what is the profit attributable to the PE in terms of Article 7 of the DTA between India and USA. We shall also examine whether the income so computed would be absorbed by the expenses incurred to earn such income which will prima facie extinguish the assessment.
Paragraph 1 to 3 of the Article 7 of the DTA are extracted hereunder:
Article 7
Business Profits
1. The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent 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 fa) that permanent establishment; (b) sales in that other State of goods or merchandise of the same or similar kind as those sold through that permanent establishment; or (c) other business activities carried on in that other State of the same or similar kind as those effected through that permanent establishment.
2. Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and independent enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly at arm’s length with the enterprise of which it is a permanent establishment and other enterprise controlling, controlled by or subject to the same common control as that enterprise. In any case where the correct amount of profits attributable to a permanent establishment is incapable of determination or the determination thereof presents exceptional difficulties, the profits attributable to the permanent establishment may be estimated on a reasonable basis. The estimate adopted shall, however, be such that the result shall be in accordance with the principles contained in this article.
3. In the determination of the profits of a permanent establishment, there shall be allowed as deductions expenses which are incurred for the purposes of the permanent establishment, including a reasonable allocation of executive and general administrative expenses, research and development expenses, interest and other expenses incurred or the purpose of the enterprise as a whole, (or the part thereof which includes the permanent establishment) whether incurred in the State in which the permanent establishment is situated or elsewhere, in accordance with the provisions of and subject to the limitations of the taxation laws of that State. However, no such deduction shall be allowed in respect of amounts, if any, paid (otherwise than towards reimbursement of actual expenses) by the permanent establishment to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for the use of patents, know-how or other rights, or by way of commission or other charges, for specific services performed or for management, or, except in the case of a banking enterprise, by way of interest on moneys lent to the permanent establishment. Likewise no account shall be taken, in the determination of the profits of a permanent establishment, for amounts charges (otherwise than towards reimbursement of actual expenses), by the permanent establishment to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for the use of patents, know-how or other rights, or by way of commission or other charges for specific services performed or for management, or, except in the case of a banking enterprise, by way of interest on moneys lent to the head office of the enterprise or any of its other offices.
Reading the above Article 7 of the Treaty it is clear that the profit of an enterprise will be taxable only to the extent as is attributable to that permanent establishment. This is in pari materia with Clause (a) of Explanation 1 to Section 9(1)(i) of the Income-tax Act. Paragraph 5 of Article 7 of the Treaty prescribes as to how the profits to be attributed to the PE is to be arrived at. It oprovides that only the profits derived from assets and activities of the PE shall be treated as attributable to the permanent establishment. It is argued that the Clause ‘derived from’ should have narrower meaning and only the immediate and direct nexus should be between earning of income and assets and activities of the PE which can be brought to tax. For this purpose, heavy reliance is placed on the decision of Hon’ble Supreme Court in the case of Sterling Foods 237 ITR 579 and Panidan Chemicals Ltd. v. CIT 262 ITR 278. While we broadly agree that the profits to be attributed to the PE as provided in Paragarph 1(a) of Article 7 shaJl include only the profits derived from assets and activities of the PE, the reference to the judgment of Hon’ble Supreme Court in this regard is misplaced. The judgment rendered by Hon’ble Supreme Court while interpreting the Clause ‘profit derived from industrial undertaking’ for the purpose of computing deduction Under Section 80HH/80] cannot be applied in relation to computation of profits to be attributed to the PE. Hon’ble Supreme Court was not called upon to interpret the Indo US Treaty or as to how the profit should be attributed to the PE. Thus, the judgment of Hon’ble Supreme Court in India rendered in the context of interpreting one of the incentive provision cannot be applied in relation to the Clauses in the treaty. The wordings in the treaty are not to be interpreted Jike a provision of the statute. In a way there should be some rational connection between existence of PE and the profits from the assets and activities of the PE which can be brought to tax and no further artificial meaning should be given as to the Clause ‘derived from1. Just in a case to be decided outside India the decisions rendered by the apex court in another country cannot be held as a binding precedent in that country in relation to interpretation of a Clause in treaty, same way the judgment of the apex court cannot be applied even in the country where such decision is rendered particularly when the decision is not rendered interpreting the Clauses of the treaty entered into between two countries. However, in all circumstances only that much of the profit as are arising due to the assets and activities of the PE can be brought to tax and if whole of the activities of the business are not carried out in India, the profit should be apportioned between that arising in India and that arising outside India. Thus where the entire activity of an enterprise are not carried out in a contracting state where the PE is situated, than only so much of the profit as is attributable to the functions carried through the PE can be taxable in such source state. While dealing with the question as to what is such part of income as is reasonably attributable to the operations carried out in India, we have held that only 15% of the revenue generated from the bookings made within India is taxable in India. The same proportion has to be adopted here while computing profit attributable to the PE. We have also held that since the payment to the agent in India is more than what is the income attributable to the PE in India, it extinguish the assessment as no further income is taxable in India. It is to be noted that even in the first assessment framed by the Assessing Officer, the entire expenses in the form of remuneration paid to Interglobe was held as allowable deduction and was reduced while computing the income of appellant. If that be the case, the income attributable to PE in India being less than the remuneration paid to the dependent agent, it extinguishes the assessment and requires no further exercise for computation of income. We accordingly hold so and in view of the same the income of the appellant will be NIL.
18.1 Since we have held that the remuneration paid to the dependent agent is exceeding the income attributable to the PE in India, the question of allowability of various expenses as are in appeal in ITA Nos. 820 to 823/Del/2005 do not survive. The question of charging interest under Section 234A & 234B will also not survive.
19. In the Cross Objections, the revenue has contended that the assessment was completed after issue and service of notice Under Section 143(2). Thus, the ground raised by the appellant that the assessment was framed without issue of notice Under Section 143(2) is incorrect. In the Cross Objection, it is also submitted that the tax rate applied are as applicable to a foreign company and is in accordance with the tax rate payable by foreign companies. It docs not amount to discrimination. Thus, the grounds raised by the assessee that the rate applicable to the assessee at higher rate is misconceived. At the time of hearing, learned Counsel for the assessee has not pressed the ground regarding non service of notice Under Section 143(2). Thus, the validity of the assessment framed is upheld. The assessee has also not raised any objection to the rate applied. Thus, the grounds raised by the appellant in this regard are to be dismissed. According the Cross objections raised by the revenue are treated to be allowed.
20. Various case laws have been cited during the course of hearing. We have considered the same to the extent, in our opinion, are applicable to the facts of the case. Other case laws not being decisive of the issue in the present appeals are not considered.
In the result, the appeals by appellant are partly allowed and the cross objections raised by revenue are allowed.
Pronounced in the open court on 30th November, 2007.