The Director of Income Tax vs Mondial Orient Ltd.

N. Kumar, J.—These appeals are by the Revenue challenging a common order passed by the Income Tax Appellate Tribunal, Bangalore branch holding that the assessee''s income is exempted under Section 9(i) Explanation 1(b) of the Income Tax Act, 1961 (for short hereinafter referred to as ''the Act'').

The assessee is a Hong-Kong based company, which has established a branch office in India, having three branches at Bangalore, Tirupur & Delhi. For the assessment years 2003-04, 2004-05 & 2005-06, the assessee filed the returns disclosing ''nil'' income. The assessing Officer noticed that the assessee claimed exemption under Section 9(1)(i)(b) on the ground that the assessee carried out its operations in India, which were confined to purchase of goods in India, for the purpose of exports and therefore, no income was deemed to have accrued or arisen in India. However, on verifying the profit and loss account of the Branch, the Assessing Officer formed an opinion that in fact, the Branch office is not involved in any purchase activity in India. Therefore, he concluded that the Branch office has not exported any goods from India. According to him, the Branch office is actually engaged in the business of supply chain management for garments, which include services like product design & development, sourcing, merchandising, follow up, quality control, factory evaluation and shipping coordination. All the branches of the company in India were actually engaged in similar activities only Therefore, a survey action under Section 133A of the Act was initiated on 12.01.2006. During the course of survey and also post survey statements were recorded from the officials of the assessee, which led to the conclusion that the assessee is not carrying out liaison activities, but in fact was carrying out business activities under the guise of liaison office.

A notice under Section 148 of the Act was issued and served on the assessee. In response to the notice, the assessee filed the return on 22.05.2006 showing ''nil'' income. The assessing officer recorded the statement of one Sri. Lalith Fernando, Country Manager on 16.01.2006 in respect of the details about the organization and activity of the Branch located at Bangalore. He also recorded the statements of Mr. P.J. Vora, Accounts Supervisor, Mondial Orient Ltd., of Indian Branch, Mr. Nihal Mudalige, Quality Manager , India sub-continent on 12.01.2006 and Mr. David D''Souza, MD of Garden City Fashions P. Ltd., was also recorded on 08.12.2006.

On consideration of the aforesaid material the assessing officer held that the assessee''s activities were not confined to liaison activities alone, but it consisted of substantial business activities also. The Indian Branch Office was doing the quality inspection services as per the agreement entered into between the assessee and the Indian Office The assessee was only receiving cost + 5% on the services rendered to the Branch offices in India. The Branch office in India was reimbursed for the cost of administration expenditure incurred by it. The assessee was only rendering certain services and certain quality inputs and received charges for the same for the services rendered. The said receipt is attributable to the activity in India and accordingly, taxable in India. Aggrieved by the said order, the assessee preferred an appeal before the Commissioner of Income Tax (Appeals).

The Appellate Commissioner came to the conclusion that the activities of the assessee Branch in India including the authority to enter into negotiations with local exporters/manufacturers would constitute course of dealing or continuity of relationship, which can be said to contribute directly or indirectly to the earning of income by the assessee outside India. Consequently, this activity of the Branch would tantamount to a "business connection" in India. It is not a casual connection or a stray nexus comprising of a few isolated transactions. It is rather a real and intimate relation, which contributes directly or indirectly to the earning of income by the assessee in its business. This is a regular course of dealing or relationship between the business of the assessee outside India and the activities of branch office in India. Therefore, the income would have deemed to accrue or arise through the Branch office in India and therefore, it is taxable under Section 91(i)(b) of the Act, in India.

However it is held that the Assessing Authority should have brought to tax the income of the appellant from rendering of service of supply chain management earned by the assessee at cost + 5% as specified in the agreement between the assessee and the MSL. Therefore the Assessing Authority was directed to re-compute the income of the assessee on the basis of cost + 5% as per the agreement between the parties and accordingly allowed the appeal in part. Aggrieved by the said order both the assessee as well as the revenue preferred appeals. That is how there are six appeals relating to three assessment years.

The Tribunal, on re-appreciation of the entire material on record, after taking note of the judgments on which reliance was placed, after interpreting Section 9(1) and explanation (1) held that it is not necessary that an assessee who directly export if the non-resident operates through assessee but confined to purchase of goods for the purpose of export is exempted. Therefore, purchase per se for the purpose of export is not the requirement of the Section. A careful reading of the Section will make it clear that first of all there is nothing in the Section to say that the assessee cannot purchase on behalf of any other party. The assessee should directly purchase and export it. In the case of a non-resident no income shall be deemed to accrue or arise in India to him (to such non-resident) through or from operations which are confined to the purchase of goods in India actually for the purpose of exports. In other words not only the purchase of goods as such but if the assessee does the operations which are limited to the purchase of goods in India for the purpose of export is exempted. Then they referred to explanation 3 of Section 9(1)(i) of the Act and held that income earned by the assessee is exempted from tax and accordingly allowed the appeal of the assessee, dismissed the appeal of the revenue. Aggrieved by the said order the revenue has preferred these appeals.

The appeals are admitted to consider the following substantial question of law.

Whether the Tribunal was correct in holding that the activity of a. Trading of most reliable, qualified suppliers of Textile products, b. Checking and expediting the production of merchandise, c. Attending upon buyers and other representatives of the buyers, d. To follow-up of orders, e. To provide quality assurance, f To arrange for inspection and g. To arrange for logistics and export as contended by the assessee, would amount to purchase of goods in India for the purpose of export and therefore as per Explanation to Section 9(1)(i)(b) of the Act the income earned was not liable to tax in India?

The learned counsel for the revenue assailing the impugned order contended that in the instant case neither the assessee nor it branch offices at India placed any orders for purchase of garment with the manufacturers. They are rendering services such as tracing of most reliable, qualified suppliers of textile products, checking and exporting, production of merchandise, attending upon buyers and other representatives of the buyers, to follow up the orders, to provide quality assurance, to arrange for inspection and to arrange for logistics and export. It is for the services which they render they are paid for. When they are not making purchase for the purpose of exporting goods explanation 1(b) is not attracted and the income accrued to the assessee for the services so rendered to the nonresident buyer cannot be exempted from payment of tax.

Per contra learned counsel appearing for the assessee supporting the impugned order contended that admittedly the foreign buyer do not approach the Indian manufacturer directly. He approaches the assessee, inform him about his requirements and also the price which he is willing to pay for the merchandise. It is thereafter the assessee approaches the Indian manufacturer, negotiates with him the price and when once the contract is concluded the assessee provides the necessary expertise for manufactured goods according to the specifications and see that the standards are maintained and thereafter the goods are exported outside the Country to the buyer. Therefore the income which arises in India to the assessee is on account of purchase and export of merchandise and therefore falls under Section 9(1)(i)(b) and the Tribunal rightly upheld the contention of the assessee. Therefore he submits that no case for interference is made out.

In order to appreciate the rival contentions first let us look at the undisputed facts. The assessee is a Hongkong based company which is a non-resident. It has branches in India at 3 places. According to the statement of Sri. Lalith Fernando, Country Manager each branch has four departments-merchandising, quality control, administration and shipping. The activities of the branch offices include evaluating correct manufacturers/suppliers and assessing their suitability to clients/buyers. Most of the times the suppliers approach the assessee through email or letters. Depending on information of suppliers, the quality technicians of the assessee and the merchandiser visit the factory premises and gives a report to the Office Manager. The Office Manager thereafter discusses with the Country Manager. After evaluation by the Country Manager, if found proper and suitable, the information is passed on to the Sourcing Product Manager who cross-verifies the information with the merchandiser and depending on client''s requirements, the supplier is either approved or rejected or kept in the panel for future reference and use. Thereafter when the buyer makes an enquiry either with the SPM or with the merchandiser the merchandising team of the branch office will decide on the appropriate supplier for the client, discuss the price and delivery period with the supplier and communicate the same either directing to the buyer with the copy marked to the SPM. If the terms are accepted, order is confirmed to the supplier. At this stage the order placement is completed. After this the merchandiser follows up the order to ensure that the delivery date is met. In the meantime the quality technicians obtain the approved samples from the suppliers and after checking send it to the buyer for final approval. If the product is approved then pre-production meetings are held by the quality department-inspectors with the production team of the supplier. Decisions taken at these meetings are binding on the buyer and the supplier. After this, in-line inspection meetings are held when goods are under production the quality technicians visits the supplier premises to check the quality of goods and the proceedings are discussed in these in-line inspection meetings. This is a meeting between the quality technicians of the company with the production staff of the supplier to ensure to quality parameters of the products are met. After the goods are ready, Inspectors carry out the final inspection of the products. During the in-line inspection stage, if there are defects found, the supplier is given an opportunity to correct these defects before the final inspection. If by chance the defects are found in the final inspection stage then a random sample is selected and sent to the buyer for final acceptance. The buyer reserves the right to refuse or reject the order at this stage or accept the order with a price negotiation. If the goods are found according to the required standard, then the supplier will hand over the goods to the shipping forwarder of the company who will coordinate the shipment. If the price is different from the target then price negotiations are made with the supplier by the assessee and the information is passed on to the buyer. The final say of price rests with the buyer and the assessee will not have any influence over it.

From the aforesaid facts it is clear that it is true that the assessee is not placing any orders with the manufacturers. The assessee is not purchasing the merchandise and the assessee is not exporting the merchandise but the fact remains that the entire effort put forth by the assessee results in a valid buyer placing orders with an Indian manufacturer and after the goods are manufactured according to the specifications, they are exported out of the Country. No foreign buyer is approaching an Indian manufacturer directly. They are approaching the assessee, giving him their requirements, informing him about the price which they are willing to pay and the assessee takes the responsibility of finding out the manufacturer, getting the merchandise manufactured according to the specifications and they also assure the quality of the goods manufactured and in the end, they also take the responsibility of seeing that the goods reach the destination. It is for these services the assessee is paid by the foreign buyer. It is in this background let us look at Section 9 of the Act which deals with the income deemed to accrue or arise in India. It reads as under:

Income deemed to accrue or arise in India

(1) The following incomes shall be deemed to accrue or arise in India:-

(i) all income accruing or arising whether directly or indirectly through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India [***] or through the transfer of a capital asset situate in India.

[Explanation 1]-For the purposes of this clause-

a) 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;

b) in the case of a non-resident, no income shall be deemed to accrue or arise in India to him through or from operations which are confined to the purchase of goods in India for the purpose of export

c) in the case of a non-resident, being a person engaged in the business of running a news agency or of publishing newspapers, magazines or journals, no income shall be deemed to accrue or arise in India to him through or from activities which are confined to the collection of news and views in India for transmission out of India;

d) in the case of a non-resident, being-

an individual who is not a citizen of India; or

a firm which does not have any partner who is a citizen of India or who is resident in India; or

a company which does not have any shareholder who is a citizen of India or who is resident in India, no income shall be deemed to accrue or arise in India to such individual, firm or company through or from operations which are confined to the shooting of any cinematograph film in India.]

The aforesaid provisions makes it clear what are the incomes which are deemed to accrue or arise in India for the purpose of levying tax. However, explanation (1)(a) introduces a deeming clause, i.e., though income accrues or arises in India as mentioned in the aforesaid provisions, for the purpose of this clause which shall be deemed not to have accrue or arise in India, i.e., the income earned by an assessee through or from operations which are confined to the purchase of goods in India for the purpose of export. In other words, if an assessee earns income through or from operations out of purchase of goods in India for the purpose of export only it is deemed not to accrue or arise in India. The argument is, for attracting this provision the assessee must be a purchaser of goods and after such purchase he should export the goods. Then only he can have the benefit of this provision. Nowhere in this section it is mentioned that the assessee should purchase the goods in India for the purpose of export. On the contrary it is expressly mentioned any income accruing or arising in India to him through or from operations which are confined to purchase of goods in India for the purpose of export alone is exempt from payment of tax. In other words if an assessee carries on operations which results in purchase of goods in India for the purpose of export and the income so accrued or arising out of such transactions are exempted from payment of income tax. The whole object of this provision being to encourage export of merchandise from India which enables Indian manufacturer to earn and when it is exported the country would earn foreign export. An incentive is given to a non-resident to carry on business in India. Otherwise the explanation would have no meaning and that is precisely what the Tribunal has held.

Reliance is placed on a judgment of this Court in the case of Commissioner of Income Tax International Taxation Vs. Nike Inc. reported in (2013) 217 Taxman 1 (Karnataka) where a non-resident assessee was placing order with an Indian customer for purchase of goods which were supplied by the Indian manufacturer not to the non-resident assessee but to its affiliates. It was contended that the benefit of this provision was given because the non-resident assessee was placing orders directly for purchase of goods. In the instant case as there is no order placed for purchase of goods by the non-resident assessee he is not entitled to the said benefit. We do not find any substance in the said contention. In the aforesaid judgment it has been held that if the definition is read with Clause (b) of Explanation 1 to sub-section (1) of Section 9 in the case of a non-resident, no income shall be deemed to accrue or arise in India to him whether directly or indirectly through or from any business connection which are confined for the purpose of export. In the first place the assessee is not purchasing any goods. The assessee is enabling the manufacturers to purchase goods of a particular specification which are required by a foreign buyer to whom the manufacturer sells. As the orders are placed by the assessee with the manufacturer and the goods are manufactured according to their specification which is the requirement of the buyer and even if it is held, though the goods are supplied to the buyer, it is deemed to be supplied to the assessee, the whole object of this transaction is to purchase goods for the purpose of export. Once the entire operations are confined to the purchase of goods in India, for the purpose of export, the income derived therefrom shall not be deemed to accrue or arise in India and it shall not be deemed to be an income under Section 9 of the Act. The object is to encourage exports thereby the Country can earn foreign exchange. The activities of the assessee in assisting the Indian manufacturer to manufacture the goods according to their specification is to see that the said goods manufactured has an international market, therefore, it could be exported. In the instant case also the whole object of the respondent assessee is giving its services both to the foreign buyer and the Indian purchaser is to export the merchandise to the foreign buyer which results in earning foreign exchange. Merely because the assessee do not place orders for purchase, in law it makes no difference. Without placing an order in its name the assessee is enabling a foreign buyer to place order directly with the manufacturer after the assessee approves the manufacturer and requirement and the assessee takes the responsibility of maintaining quality and dispatch of the goods to the destination. The purchase and export of merchandise takes place and therefore the object with which the said provision is inserted is achieved. Therefore the assessee is entitled to the benefit of exemption.

In that view of the matter we do not see any error committed by the Tribunal in passing the impugned order. The substantial question of law accordingly is answered in favour of the assessee and against the revenue.