Director of Income Tax vs Hyundai Heavy Industries Co. Ltd.

Barin Ghosh, C.J.—In these two appeals, we are concerned with two assessment years. The assessee has Permanent Establishment in India. The assessee carries on business within India and outside India. From 1990-1991, the assessee has been submitting returns and is being assessed for payment of tax in India. In exercise of its right u/s 90 of the income tax Act, the assessee has opted for being taxed in the manner prescribed in the bipartite agreement between the Union of India and the Republic of Korea. During these assessment years, and also during the past assessment years, the Permanent Establishment of the assessee in India has been linked to certain projects in India, with which the assessee got involved. In relation to assessments during the assessment years, prior to the assessment years with which we are concerned in these appeals, the tax liability of the assessee was determined on the basis of 10 per cent of the gross receipt minus (-) expenses established or accepted. The same method was also applied during the assessment years with which we are concerned. This method was adopted in relation to within India activities, in respect whereof payments, within India, were received. During these two assessment years, with which we are concerned, the assessee submitted returns and, there, claimed to have suffered loss for India operations. It, accordingly, asked for return of tax deducted at source. The Assessing Officer found that, in relation to the Permanent Establishments, books of accounts are being maintained. It recorded that those were not produced. On the basis of the explanations given and forms submitted, it gathered that, in relation to certain expenditures, TDS was deducted and the same was deposited and, accordingly, proceeded to hold that there cannot be any dispute pertaining to those expenditures. The Assessing Officer deducted those accepted expenditures from the undisputed gross receipt, 10 per cent of the amount, so deduced, was assessed as the tax liability of the assessee. In addition to that, the assessee received certain payments, may be from Indian Enterprises, in relation to certain work. The Assessing Officer felt that those were pertaining to outside India activities of the assessee and, accordingly, those are not taxable. Subsequent thereto, power u/s 263 of the Act was exercised. In doing so, it was stated that the taxable liability should have been determined on the basis of receipt minus (-) expenditure established and there was no scope of applying 10 per cent deemed profit of the receipt minus (-) accepted expenditures. The notice was responded by the assessee, whereafter the assessment order was cancelled and the matter was remitted back to the Assessing Officer. We are told that the Assessing Officer acted on the basis of the said order and has made reassessment. In the meantime, being aggrieved against the order of the Director of income tax passed u/s 263 of the Act, the assessee went before the Tribunal. According to us, the Tribunal correctly held that, even in the notice issued u/s 263 of the Act and also in the order of the Director, there is not even an apprehension about the disclosures made, pertaining to outside India activities relating to receipt or the work done. Accordingly, there was no question of sending back the matter, pertaining to outside India activities, to the Assessing Officer by the Director of income tax.

However, the Tribunal has taken a strange stand purporting to express that, whereas the assessee had no taxable income, the Assessing Officer made assessment of taxable income and, accordingly, there was no prejudice to the Revenue. The Tribunal, as a fact, found that there was no dispute pertaining to the receipt by the assessee in relation to within India activities. The Tribunal, as a fact, has found that the assessee could establish only a part of the claimed expenditure. In income tax parlance, the deduction will be that the expenditure that the assessee has not been able to account for is the income of the assessee. The Tribunal has held that 10 per cent thereof assessed as taxable income will establish that the Revenue was not prejudiced in the instant case and, accordingly, exercise of power u/s 263 of the Act was inappropriate.

Before us, the learned counsel for the assessee has submitted that, what has been done by the Assessing Officer, the same is also permissible u/s 144 of the Act. The fact remains that there is not a single whisper in the order of the Assessing Officer or in course of submissions made to the Assessing Officer or to the Director of income tax or to the Tribunal on behalf of the assessee that the method that was adopted by the Assessing Officer was available to the Assessing Officer u/s 144 of the Act. Lastly, the question is, whether having had adopted a mechanism from 1990-1991, could the Revenue take recourse to what was taken to in view of paragraph 5 of Article 7 of the Treaty? The said paragraph is as follows:

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

The fact remains that this paragraph is required to be read with paragraph 3 of the Treaty. Paragraph 3 of Article 7 of the Treaty is as follows:

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 executive and general administrative expenses so incurred, whether in the State in which the permanent establishment is situated or elsewhere, which are allowed under the provisions of the domestic law of the Contracting State in which the permanent establishment is situated.

Therefore, the method referred to in paragraph 5 of Article 7 of the Treaty is a method known to the domestic law of the contracting State, in the instant case, India. The Assessing Officer and the Tribunal have failed to record anywhere that the method, that was adopted by the Assessing Officer to attribute profit of the assessee, is recognised by any law in India. This aspect of the matter goes to the root. In the event, a method, unknown to the law of the applicable State, is adopted for years, that can certainly be corrected and that will be good and sufficient reason for doing so. In India, profit may be attributed by taking recourse to Section 144 of the Act, only when the same is not ascertainable on the basis of cash or mercantile system, as is known in India. In the event, either of those systems is applied, but the assessee fails to satisfy that a particular expenditure has been incurred by it in course of business, the law permits the same to be added to the profit of the assessee. There is no question, when the assessee has represented that it has maintained accounts, either in cash or in mercantile system, but has failed to establish that it has, in fact, maintained any such accounts, of applying best judgment method of assessment. In other words, if the assessee has maintained the accounts and has established that its expenses are more than its income or receipt, it is not liable to pay any tax in India. In the event, however, it fails to establish all or any of its expenses, the expenses shown to have been incurred, which could not be established, will be treated as the income of the assessee. The manner, in which the assessee has represented, the question of the Assessing Officer using best judgment method did never arise. It, for not a single second, held out that it has not maintained accounts, but, according to the first assessment order, it failed to produce the same. In such circumstances, the extent of failure of establishing those expenses was required to be treated as income of the assessee, liable to be taxed.

We, accordingly, set aside the judgment of the Tribunal to the extent the same upheld assessment of profit arising out of within India transactions and remit back the same to the Assessing Officer for re-consideration. The Assessing Officer will call upon the assessee to produce not only the books of account, but all relevant papers pertaining to each entry shown in respect of each expenditure that the assessee has shown to have incurred in respect of such transactions. For that, the Assessing Officer will give a two months'' notice to the assessee. The appeals, accordingly, stand disposed of.