(a) Income Tax Ordinance (XXXI of 1979)‑‑‑

‑‑‑‑Ss. 66‑A, 62, 11 & 12‑‑‑Convention for Avoidance of Double Taxation between Pakistan and Germany, Art. 7‑‑‑Permanent establishment in Pakistan ‑‑‑Assessee was a non‑resident German Company‑‑‑Supply and installation of turbines for Hydropower project‑‑ Return was filed declaring net losses attributable to its permanent establishment in Pakistan and the same was assessed after making certain add backs out of the expenses claimed by the assessee‑‑‑Assessment was cancelled by the Inspecting Additional Commissioner under S. 66‑A of the Income Tax Ordinance, 1979 on the ground that entire business transactions attributable to both on‑shore and off‑shore activities should have been subjected to tax as manufacturing activities carried on outside Pakistan being a part of a composite contract could not be split up for taxation purposes and off‑shore activities were directly connected to permanent establishment and were inseparable extension of on‑shore activities‑‑‑Validity‑‑‑Provisions of S.12(2) of the Income Tax Ordinance, 1979 provide that, in case of non‑resident, its income was chargeable to tax in Pakistan only on such portion as was attributable to the permanent establishment situated in Pakistan‑‑‑Order under S.62 of the Income Tax Ordinance, 1979 was passed by the Assessing Officer after examining various aspects of the case, the terms of contract and provisions of Art. 7 and para. 2(a) of the Convention and he had rightly decided that only so much of income of assessee was liable to tax in Pakistan as was attributable to the permanent establishment of the assessee in Pakistan i.e. on‑shore activities‑‑‑Order under S. 62 of the Income Tax Ordinance, 1979 was neither erroneous nor prejudicial to the interest of revenue and action under S. 66‑A of the Income Tax Ordinance, 1979 being uncalled for was set aside by the Tribunal and order of the Assessing Officer was restored.

(1999) 80 Tax 17 (Trib.); 172 ITR 358 and 116 ITR 868 ref.

CIT v. Gabriel India Ltd. 203 ITR 108 rel.

(b) Income Tax‑‑‑

‑‑‑‑No income‑‑‑No expense allowance‑‑‑Validity‑‑‑Inference that when no income, was declared, no expenses were to be allowed was not correct because expenses were admissible even if no income was earned or declared for the year‑‑‑Expenses claimed by the assessee against nil .income declared was allowed after confronting the assessee about the same.

AC v. Alpine I.T.A. No.772(PB) of 1999‑2000 rel.

Anjum A. Sheikh, F.C.A. for Appellant.

Qaiser Ali, D.R. and Abdul Wadood, I.A.C. for Respondent.

Date of hearing: 18th April, 2002.

ORDER

MRS. ABIDA ALI (ACCOUNTANT MEMBER).‑‑‑This appeal has been filed against the order dated 24‑10‑2001 of the learned Inspecting Additional Commissioner of Income Tax/Wealth Tax, Companies, Range‑01, Peshawar, passed under section 66‑A of the Income Tax Ordinance, 1979 (hereinafter called the Ordinance).

2. Facts of the case as per record are that Voith Hydro Kraftwerkstechnik GmbH & CO, KG (hereinafter called the appellant) is a German resident company and has been assigned the status of a Non resident company, for tax purpose in Pakistan. One of its major areas of expertise is the manufacturing and supply of turbines for hydropower projects. On 7th November, 1997, appellant signed two contracts with WAPDA (ME‑01(Lots 1 and 2)) for the supply and installation of turbines and auxiliaries for the Ghazi Barotha Hydropower Project (hereinafter called as GBHPP) located in N.W.F.P. in Pakistan. Both the contracts are with similar terms and conditions. ME‑01 is for three turbines financed by the Government of Japan and ME‑02 is for the balance three turbines financed by the Government of Germany.

Both these contracts comprise of two distinct activities. One component, which involves the design, testing, manufacture, packing and transportation, take place outside Pakistan and is principally paid for through foreign currency i.e. either Yen or DM and is referred to as "Off‑shore" part of the contract. This part is executed through the head office of the company "Principal Permanent Establishment (Germany).

The other component involves transportation at site, erection, commissioning, site testing, etc. These activities take place within Pakistan and are, therefore, attributable to the establishment of the company in Pakistan and hence are referred to as On‑shore part of the contract. This is paid for primarily through the local currency. This part is executed through the branch office of the company set up in Pakistan, which is also referred to as the "Pakistan Permanent Establishment" (hereinafter referred to as PE).

3. The return of total income for the year under appeal was filed, declaring net losses of Rs.4,27,11,875 attributable to its PE in Pakistan, which was later on revised and the net, losses of Rs.3,11,48,482 was declared as per following computation:

Assessment was finalized by the Assessing Officer whereby relying on Article‑7 of the Convention for the Avoidance of Double Taxation Treaty (CADT) only such income of assessee was assessed which was attributable to PE in Pakistan. Net loss of Rs.2,94,68,482 was determined after accepting the declared Nil income and making certain add backs out of the expenses claimed by assessee.

4. Later on, on examination of assessment record of assessee, the learned IAC Range‑I, Peshawar observed that business transactions attributable to "On‑shore" activities were considered by Assessing Officer for the year under appeal; whereas transactions relating to "Off shore" was totally ignored in the said order. Certain other serious defects were found in the assessment order which in his opinion was erroneous insofar as it was prejudicial to the interest of Revenue for the following reasons:

"(1) The terms and conditions of contract agreement ME‑01 entered into by the assessee with WAPDA for supply and installation of Turbines and auxiliaries stipulates composite activities inclusive of design, manufacture, delivery to site, erection, installation, testing and commissioning. It also contemplates a defect and liability period for removing the defects in all the above activities. All these activities are required to be accomplished exclusively by the assessee and as such the relevant contract is turn key in nature, and therefore, the entire business transactions i.e. those attributable to both on‑shore and off‑shore activities should have been subjected to tax.

(2) The manufacturing activities being carried on outside Pakistan i.e. in Germany being a part of a composite contract cannot be split up for taxation purposes in the light of treaty for avoidance of double taxation with Germany and its protocol. Off‑shore activities are directly connected to PE and are inseparable extension of on‑shore activities.

(3) Since business connections establishes in Pakistan in terms of section 12(2) of the Income Tax Ordinance, 1979 the entire receipts of the said contract being of the nature discussed above were required to be considered for the purpose of taxation under the Income Tax Ordinance, 1979. As such, action was taken in the relevant assessment order.

(4) Huge expenses claimed by the assessee's company have been allowed in the said assessment order without establishing their admissibility as well as genuineness.

(5) The relationship of expenses claimed with on‑shore, activities have not been established.

(6) Rs.3,13,55,850 claimed by the assessee's company as Engineering costs were termed as unvouched but addition of only Rs.15,00,000 was made. The nature of relevant claim was also not determined.

(7) Since no income was declared, expenses claimed should not have been allowed.

Accordingly, assessee was confronted vide show‑cause notices under section 66A issued vide Nos. 1196, 371, dated 27‑4‑2001 and 20‑10‑2001, respectively.

Appellant submitted a detailed reply vide letter dated 15-5‑2001, which is, summarized as under:

(a) Voith is a German resident company having a non‑resident status for the purposes of the income tax in Pakistan.

(b) In pursuance to a contract agreement with WAPDA, Voith has undertaken to supply and install turbines for the purpose of GBHPP.

(c) As the contract with Voith is part of GBHPP being executed by various other contractors, the same cannot by any stretch of imagination can be termed as "turnkey contract".

(d) The contractual activities of Voith can principally be bifurcated into two ‑broad categories in relation to the place where such activities are being undertaken i.e. Off‑shore (activities to be undertaken in Germany) and On‑shore (activities to be undertaken in Pakistan).

(e) For each and every activity of the contract, there is a separate price tag, as can be verified from the Price Schedule annexed to the contract documents read with the terms of payments envisaged in the contract. Primarily, the Offshore portion of the contract is, financed through foreign currency portion of the contract price whereas local currency portion of the contract price represents the On‑shore activities of the contract.

(f) The taxation of income of Voith is to be governed under the provisions of CADT between Pakistan and Germany, which have an overriding effect on the local legislation.

(g) Only that income of Voith is chargeable to tax in Pakistan as is attributable to its permanent establishment in Pakistan.

(h) Under the provisions of Article 7 of the above CADT read with the Protocol signed between the two Governments, the income from supply of goods whether connected with or independent of the activities undertaken by PE in Pakistan, if executed through Principal Office cannot be attributed to the PE in Pakistan.

(i) Without prejudice to the above, the income of Voith in relation to the FOB supply of turbines cannot be said to have accrued or arisen in Pakistan.

The above reply was not accepted and order under section 66A was passed whereby assessment order under section 62 was set aside with directions to Assessing Officer to frame fresh assessment in the light of the aforementioned paras. of the show‑cause notice under section 66A.

Against this order, the present appeal has been filed on the following main grounds:-

That the learned IAC Was not justified to invoke the provisions of section 66A of the Ordinance as the assessment order of the Deputy Commissioner of Income Tax/Wealth Tax, Companies Circle 03, Peshawar was not erroneous insofar as it was prejudicial to the interest of Revenue warranting consideration for initiating action under section 66A of the Ordinance.

* That the action of the learned IAC to proceed under section 66A of the Ordinance is not based on his own objective judgment instead the proceedings have apparently been initiated on the behest of Inspection and Audit Department, hence proceedings are ab initio void.

* That the learned IAC fell into error by assuming that the income of the assessee, which is attributable to the activities carried out in Germany, is also chargeable to tax in Pakistan.

* That the learned IAC erred in drawing an inference that since the assessee has entered into a composite contract, all activities carried out in Germany are also attributable to its PE in Pakistan.

*That the learned IAC erred in holding that the assessee has entered into a "turnkey contract" without taking into cognizance of the fact that the contractual works performed by the assessee in pursuance to the contract with WAPDA are for the project named as Ghazi Barotha Hydropower Project, which is divided into various components being executed by several other contractors and unless each of the component is completed the project cannot operate.

*That the learned IAC erred to hold the assessment order of the DCIT as erroneous insofar as it is prejudicial to the interests of Revenue for the reason that the expenses have been allowed in the absence of underlying evidences and record produced as per the order.

* That the understanding of the learned IAC that the expenses cannot be allowed in the absence of any receipt for the year is totally incorrect.

5. Representatives of both the parties were heard. The learned DR defended the order under section 66A whereas the learned AR of appellant raised various objections against the impugned order.

6. The first objection of the learned AR of appellant was that proceedings under section 66A were initiated on the basis of observations of Audit and Inspection Authorities, hence the same are ab initio void. We are not convinced by his argument because as per record the audit observations were conveyed vide Letter No.AD/PR/2000‑01/64, dated 21‑8‑2001, whereas the first notice under section 66A was issued on 27‑4‑2001, which means that, action under section 66A was invoked prior to audit observation. As such, his this objection is rejected.

7. Next, objections were raised against assumption of the learned IAC mentioned at serial Nos. 1, 2 and 3 of the aforementioned notice under section 66A dated 27‑4‑2001. Objection was also raised against the assumption of the learned IAC that the contract in the case of appellant is a "turnkey contract" hence activities are inseparable. It was submitted that without prejudice to the fact that this question is totally irrelevant in determination of the income of a non‑resident chargeable to tax in Pakistan, the non‑resident are taxed only on such business profits, which are attributable to PE in Pakistan. Any interpretation through which the income of a non‑resident, not attributable to the PE in Pakistan, can be charged to tax would be in direct conflict with the principles of attribution laid down in the CADT. It was submitted that contractual works to be performed by Voith in pursuance to the contract with WAPDA are for the project (GBHPP). It was further explained that the said project will generate power and consists of three basic components and; that the work on these components has been assigned to various contractors; whereas the appellant has been assigned only the job of supply and installation of turbines. In these circumstances, where all these components are interrelated and without completion of each part, the whole project cannot be accomplished, it would be illogical and unfair to categorize activities undertaken by Voith alone as "turnkey" in nature because merely the supply and installation of these turbines, in no way, make the project complete when the integrated activities of whole project are independently carried out by different contractors. '

8. Regarding taxability income derived from Off‑shore activities, the learned AR argued that section 11 of the Ordinance lays down the principle as to which income is to be included in the total income of a non‑resident person. It was submitted that as the appellant is a German resident entity, the taxation of its income is to be governed under the provisions of Convention for Avoidance of Double Taxation Treaty (CDAT) entered into between Pakistan and the country of such resident belongs the taxability on its business are governed by Article‑7 of the said CADT. However, the business of attribution of business profit also finds support from the provisions of section 12(2) of the Ordinance. In support of his arguments, the learned AR also referred to para.2 (a) of the Protocol signed between the Islamic Republic of Pakistan and the Federal Republic Germany on 14‑7‑1994.

9. We have examined the provisions of section. 11 of the Ordinance, which are reproduced as under:‑---

"11. Scope of total income.‑‑‑(1) Subject to the provisions of this Ordinance, the total income, in relation to any assessment year, of a person, ................................................................

(b) Who is a non‑resident, includes all income from whatever source derived, Which‑‑‑

(i) is received or is deemed to be received in Pakistan in the Income year by, or on behalf of, such person; or

(ii) accrues or arises; or, is deemed to accrue or arise, to him in Pakistan."

The above provisions clearly lay down the principle that following income is to be included in the total income of a non‑resident, which in turn is chargeable to tax in Pakistan:

(a) Income received or deemed to be received in Pakistan; or

(b) Income which accrues or arises, or is deemed to accrue or arise in Pakistan.

We have also gone through the provisions of section 12(2) of the Ordinance, for sake of convenience, the same are produced as under:

"12. Income deeded to accrue or arise in Pakistan:‑‑‑

(1) ......................................................

(2) Any, income accruing or arising, whether directly or indirectly, through or from;

(a) Any business connection in Pakistan;

......................................................

......................................................

......................................................

Provided that, in the case of a business all the operations of which are not carried out in Pakistan, the income of all the business deemed under this subsection to accrue or arise in Pakistan shall be only such part of the income as is reasonably attributable to the operations carried out in Pakistan.

It is clear from the above provisions of section 12(2) that in. case of non resident, its income is chargeable to tax in Pakistan only on such portion as is attributable to the PE situated in Pakistan,

10. Arguments of the learned AR that, in case of a non‑resident the issue of chargeability of its income is to be primarily determined/resolved under the provisions of CADT entered into between Pakistan and the country to which, such non‑resident belongs is convincing as the same is supported by section 163(2)(b) of the Ordinance. Article 7 of the said, CADT has been examined by us and for the sake of reference the same is reproduced below:‑

ARTICLE 7

BUSINES PROFITS

The profits of an enterprise of a contracting 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 business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that permanent establishment

In view of the above Article, income/profits of appellant is taxable only in Germany except its profits of business carried on through a PE in Pakistan attributable to such PE.

Para. 2(a) of the Protocol was also examined by us which provides as under:

"(a) In the Contracting State in which the, permanent establishment is situated, no profits shall be attributed to a building site or construction or installation project except those which are the result of such activities themselves. Profits derived from the supply of goods connected with, or independent of, such activities and affected by the principal permanent establishment or any other permanent establishment of the enterprise or by a third party shall not be attributed to the building site or construction or installation project, provided that the said profits reflect normal open‑market commercial terms (arm's length basis)".

The above provisions of Protocol being an integral part of the CADT has an overriding effect over the local legislation) clearly provides that income from supply of goods whether connected with the PE in Pakistan or not, if executed by the Principal Permanent Establishment (Head Office of Voith at Germany) cannot be attributed to the PE in Pakistan. In the case in hand, the entire Off‑shore activities pertaining to supply of the contract has been executed by the Principal Permanent Establishment, the income insofar as relating to these activities cannot be attributed to the PE of Voith in Pakistan.

In addition to the above provisions of law and Article‑7 and para. 2(a) of the Protocol referred to by the learned AR in support of his arguments; the following case laws were cited:

(1) (1999) 80 Tax 17 (Trib.), (2) 172 ITR 358 and (3) 116 ITR

11. After having heard the arguments of the learned AR with reference to paras. 1, 2 and 3 of the show‑cause notice under section 66A, dated‑27‑4‑2000 and examining the relevant section of the Ordinance; Article‑7 of the CADT and the Protocol as well as the case laws; we are of the considered opinion that only so much of assessee's income is taxable in Pakistan as is attributable to the PE of assessee in Pakistan i.e. On‑shore activities.

12. Finally, objections were raised against the inference drawn by the learned JAC regarding claim of expenses as mentioned at Serial Nos.4, 5, 6 and 7 of the notice under section 66A dated 27‑4‑2001. The learned A.R. of appellant stated that expenses under the head "Engineering Cost", "Marketing' and Traveling Cost" were allowed with certain add backs and the declared NIL receipts were accepted after confronting the appellant and examining books of accounts. We have examined the record and have observed that appellant was confronted through notice under section 62 issued vide No. 296, dated 3‑11‑1999 and Nil contract receipts declared by appellant were also verified.

13. As far as inference drawn by the learned IAC that when no income is declared, no expenses are to be allowed, the same is not correct because this Tribunal in its order vide I.T.A. No. 772 (PB) of 1999‑2000, dated 10‑11‑2001 (AC v. Alpine) has held that expenses are admissible even if no income is earned or declared for the year.

14. In view of the foregoing arguments, the learned AR of the appellant stressed that the order under section 62 for the year under appeal was not erroneous in so far it is prejudicial to the interest of Revenue, therefore, proceedings under section 66A being unwarranted need to be set aside/cancelled. His observation regarding action under section 66A taken by the learned IAC are worth considering. Here the question before us to decide as to whether or nor the order of Assessing Officer under section 62 is erroneous in so far it is prejudicial to the interest of Revenue. To arrive at a proper conclusion; we would like to reproduce the relevant portion of a case reported as 203 ITR 108 CIT v. Gabriel India Ltd;

"The power of suo motu revision under subsection (1) is in the nature of supervisory jurisdiction and the same can be exercised only if the circumstances specified therein exist. Two circumstances must exist to enable the Commissioner to exercise power of revision under this subsection, viz. (i) the order is erroneous; (ii) by virtue of the order being erroneous prejudice has been caused to the interests of the. Revenue. It has, therefore, to be considered firstly as to when an order can be said to be erroneous. We find that the expression `erroneous', `erroneous assessment' and `erroneous judgment' have been defined in Black's Law Dictionary. According to the definition, `erroneous' means `involving error; deviating from the law'. `Erroneous assessment' refers to an assessment that deviates from the law land is, therefore, invalid, and is a defect that ' is jurisdictional in its nature, and does not refer to the judgment of the Assessing Officer in fixing the amount of valuation of the property. Similarly, `erroneous judgment' means `one rendered according to course and practice of Court, but contrary to law, upon mistaken view of law, or upon erroneous application of legal principles'.

From the aforesaid definitions it is clear that an order cannot be termed as erroneous unless it is riot in accordance with law. If an Income Tax, Officer acting in accordance with law makes a certain assessment, the same cannot be branded as erroneous by the Commissioner simply because, according to him the order should have been written more elaborately. This section does not visualize a case of substitution of the judgment of the Commissioner for that of the Income Tax Officer, who passed the order, unless the decision is held to be erroneous. Cases may be visualized where the Income Tax Officer while making an assessment examines the accounts, makes enquires, applies his mind to the facts and circumstances of the case and determines the income either by accepting the accounts or by making some estimate himself. The Commissioner, on perusal of the records, may be of the opinion that the estimate made by the officer concerned was on the lower side and left to the Commissioner he would have estimated the income at a figure higher than‑the one determined by the Income Tax Officer. That would not vest the Commissioner with power to re‑examine the accounts and determine the income himself at a higher figure. It is because the Income Tax Officer has exercised the quasi‑judicial power vested in him in accordance with law land arrived at a conclusion and such a conclusion cannot be termed to be erroneous simply because the Commissioner does not feel satisfied with the conclusion. It may be said in such a case that in the opinion of the Commissioner the order in question is prejudicial to the interests of the Revenue. But that by itself will not be enough to vest the Commissioner with the power of suo motu revision because the first requirement, viz., that the order is erroneous, is absent. Similarly, if an order is erraneous but not prejudicial to the interests of the Revenue, then also the power of suo motu revision cannot be exercised. Any and every erroneous order cannot be the subject‑matter of revision because the second requirement also must be fulfilled. There must be some prima facie, material on record to show that tax which was lawfully exigible has not been imposed or that by the application of the relevant statute on an incorrect or incomplete interpretation a lesser tax that what was just has been imposed. "

15. In the case in hand, the order under section 62 was passed by the‑ Assessing Officer after examining various aspects of the case, the terms of contract and provisions of Article 7 and para. 2(a) of the Protocol. In our opinion, he has rightly decided that only so much of income of appellant is liable to tax in Pakistan as is attributable to the PE of the appellant in Pakistan i.e. On‑shore activities.

16. As regards expenses claimed by appellant and Nil income declared for the year; as earlier mentioned the same was allowed after confronting assessee about the same. Thus the Assessing Officer has consciously applied his mind while determining the income of appellant and while allowing certain expenses claimed by it.

17. In view of the aforementioned reasons, we have no l hesitation to hold that the order under section 62 was neither erroneous nor prejudicial to the interest of Revenue, therefore, the action under section 66A invoked by the learned IAC was uncalled for. As such, the same is set aside and that of the Assessing Officer is restored.

19. As a result, this appeal succeeds as above.

C.M.A./M:A.K./447/Tax(Trib.)Appeal accepted.