1988 PLP rib (PTD)

MANZURUL HAQUE (MEMBER).--This appeal has been filed against the order of the learned Commissioner of Income-tax (A), Zone 2, Karachi. 2.Objection has been taken against taxing the technical fee claimed to be exempt from income-tax. Mr. Faizul Alam, the learned counsel giving brief history of the case stated that the company, a resident of United Kingdom had a branch in Pakistan until 1950. They set up Pakistan Cables Limited in Pakistan and continued trading in industrial cables. Majority of shares of Pakistan Cables Limited was held by BICC, which supplied heavy, duty cables to Pakistan Cables Limited. Messrs B. I. C. C. entered into Technical Services Agreement with Pakistan Cables Limited in 1954. It was renewed in the year 1964 for another five years. Under clause (6-A) of the said Agreement they were entitled to a fee at the rate of pounds 3,500 per annum payable in sterling in addition to that under section 6(B) of the said Agreement they were also entitled to remuneration equal to and at the rate of 6-2/3$ of the total net profit of the company in each of its financial years during the course of Agreement. This amount was to be paid in Pakistani rupees and was known as variable fee. The relevant clause 6(a) and (b) reads as under:- "(a) To pay to B.I.C.C. for their services as technical advisers hereunder remuneration at the rate of L.3,500 per annum payable in seterling such payment to commence on the said twenty-second day of April, 1973 and to be made quarterly on the 31st day of March the 30th day of June and 30th day of September and the 31st day of December in each year the first payment to be made on the 30th day of June, 1973. (b) In addition to pay to B.I,C.C. remuneration equal to and at the rate of 6-2/3rd $ of the total net profits of the Company in each of its financial years during the continuance of the Agreement such remuneration to be payable in rupees. The net profits of the Company for this purpose shall be deemed to be their profits of each financial year arrived at after crediting realised profits from sale capital assets and all income derived from trading and after charging all expenses of a trading nature reasonably and properly incurred including the above fixed payment and all salaries and administration expenses allowances for depreciation at normal commercial rates all social in respect of income-tax or super tax or any other tax or duty on income or revenue such as Excess Profits Tax or any similar tax whatsoever or for expenditure by way of interest on debentures, or otherwise on capital account or on account of any sum which may be set aside in each year out of the profits for reserve or any other special fund or this percentage." Messrs Pakistan Cables Ltd. went into production in 1956 and B.I.C.C. Ltd. became entitled to technical fee. In order to remit the amount of Messrs B.I.C.C. Ltd. they applied for exemption certificate vide their letter dated 28-4-1961 for production to the State Bank of Pakistan whose permission was essential for such remittance. The I.T.O. vide his letter, dated 29-3-1962 granted such certificate for the period ending 31-12-1956. Again vide letter, dated 25-8-1962 they requested the I.T.O. for grant of similar certificate for the period ending 31-12-1957 to 31-12-1960. At this point of time the I.T.O. raised objection as to why the technical fee should not be subjected to income-tax in terms of sub-clause (a) of clauses 3 and 8 of the Agreement for Avoidance of Double Taxation between Pakistan and the United Kingdom. Thereupon, the appellant vide its letter dated 10-10-1962 replied as under:- "

The services are not rendered in Pakistan and no employee of British Insulated Callender's Cables Limited in Pakistan is in any way concerned with the advice given, most of it being transmitted by correspondence. One of the facilities granted to the Company is the laboratory testing of samples of all raw material purchased by us. In this respect B.I.C.C. draws on the knowledge and experience of its large production staff and an efficient research organisation comprising of scientists and engineers at its disposal

" (2) The Technical Advice Agreement provides inter alia that 3.I.C.C. will make available to the Company free access and use of their technical knowledge, inventions, processes, forumlas and other technical information which items are covered by the term 'royalty' as defined in the double taxation agreement between the United Kingdom and Pakistan. Moreover, the fees can also be considered as 'commercial and industrial profits' as defined in the same agreement and exempted from taxation in Pakistan and we, therefore, contended that these fees are not liable to tax..." The I.T.O. did not agree with the above Explanation furnished by the appellant and vide Order under section 18(3)(B), dated 31-10-1962 charged 20 s of the total income to tax at the rate of 60$ stating; "... I do not agree with this explanation as the income has deemed to accrue or arise in Pakistan. I, therefore, proceed to frame the assessment by estimating the receipts at 20% under Rule 33 read with section 42(3r of the Income-tax Act, 1922," The learned counsel stated that the Agreement to tax 20$ of the total income was reached and the income was offered for taxation until 1969-70. During the assessment year 1970-71 the I , T. O , again raised the same issue, and wanted to tax the amount in the ratio of 50% before allowing the remittance. The appellant, therefore, informed the I.T.O. vide letter, dated 9-4-1973 not to disturb the Agreement already reached. The I.T.O. made the assessment subjecting the receipt to tax in the ratio of 50% as a result of which the appeal was filed before the Tribunal who gave decision vide order I.T.A. No.2154/KB of 1972-73, dated 11-12-1974 restoring the ratio of 20% as in the past. At the ratio of 20% the income was subjected to tax until 1976., However, in the assessment year 1978-79 the I.T,O. again raised the same objection and wanted to tax technical fee as well as variable fee under section 42(3) of the repealed Income-tax Act. It was, therefore, submitted by the learned counsel that the I,T.O. had no ground to deviate from the percentage being followed for so many years when decision of .Tribunal was already available in this regard in support of the appellant and secondly, even if it was a technical fee, it was not taxable and he relied on 1982 P T D 31 and I.T.A. No. 701/K B of 21-6-1986, Both the cases are not relevant to the issue involved in this appeal. In the case referred to the High Court it was not in dispute that the fees earned by the assessee were in the nature of commercial profit and in I.T.A. No.704/ KB Tribunal had not set aside the, order depending on the facts and circumstances of the case. He further stated that there is a permanent establishment in Pakistan that is only available in respect of imported sale of cables and not for rendering any technical services. Mr. Muhammad Farid, the learned D.R. stated that the cases cited by the learned A.R. are not relevant at all. The Tribunal had categorically given its verdict in I.T.A. No. 2154/KB of 1972-73, dated 11-12-1974 in the following words:- " .... The departmental representative is not in a position to bifurcate the two types of receipts nor the appellant is prepared to furnish these details, and as such on the basis of the various terms of the Agreement which are couched almost in the same terms as the other Agreements referred to by us in our decisions relied upon by the appellant we are of the opinion that the element of Royalty receipts is no doubt included in these variable technical fees by whatsoever name the same may be called and. therefore, this part would remain exempt under Articles III and VIII of the Agreement of Avoidance of Double Taxation between United Kingdom and Pakistan..." Thus, he argued that the Tribunal had deliberately used the word Royalty' and held that the assessee had royalty income also. The learned D.R. further argued that the case is fully covered by section :(1)(c) of the Act which reads as under:- (1) ... Subject to the provisions of this Act, the total income of any previous year of any person includes all incomes, profits and gains from whatever source derived which- (b) ............................................................. (c) if such person is not resident in Pakistan during such year, accrue or arise or are deemed to accrue or arise to him in Pakistan during such year." The learned D.R. pointed out that they are maintaining permanent establishment in Pakistan, therefore, Article VIII of the Avoidance of Double Taxation Agreement is not attracted, He, therefore, justified the I.T.O's. action in departing from the past treatment. The learned D.R. also read out from the Technical Advice Agreement between Pakistan Cables Limited and B.I.C.C., clause 4(a), (b), (c), (d), (e), (f), (g), (h) and (i) as under:- "(4) B.I.C.C. as such technical advisers hereby undertake during the continuance of this Agreement to execute and do the acts and things hereinafter mentioned that is to say:- . (a) To provide or cause the Company to be provided with plans and specifications of buildings or of extensions thereof suitable for its manufacturing programme from time to time. (b) To provide or cause the Company to be provided with working plans and specifications for all plant and equipment required for the Company's manufacturing programme from time to time within the scope of this Agreement and to order and supervise and/or inspect the manufacture of such plant. (c) At the request of the Company to select, advise upon and as far as practicable supply or loan senior technicians for the factories of the Company the salaries pension fund payments bonuses and allowances due as from the date of departure from the United Kingdom to any of such staff as shall be loaned to the Company and all expenses involved in sending such staff to the factories of the Company to be repaid by the Company to B.I.C.C. on demand. (d) If and when reasonably required by the Company so to do and if it be practicable for B.I.C.C. to comply with such request to send to Pakistan at the expense of the Company fully experienced representatives to advise upon technical matters within the scope of this Agreement upon which the Company required advice and guidance in Pakistan. (e) As requested by the Company from time to time to furnish the company with all information in its possession (including information regarding the sources of supply and the requisite quality of raw materials) necessary to enable the Company to manufacture products within the scope of this Agreement in accordance with the manufacturing standards observed by B.I.C.C. in the United Kingdom. (f) As required by the Company from time to time to use its best endeavours to procure that the Company be granted licences to manufacture under Letters Patent of third parties or be given permission to utilise manufacturing processes of third parties appertaining to products within the scope of this Agreement at a minimum royalty or fee which shall with all reasonable costs involved in obtaining such licence or permission be paid by the Company. (g) In so far as the products within the scope of this Agreement made or the plant equipment and processes used for making such products by B.I.C.C. comprise inventions which are the subject of Letters Patent of B.I.C.C. in Pakistan to grant to the Company free and exclusive licences to make use and sell those inventions in Pakistan during the period hereof but without power to grant sub-licences but such exclusive licences shall be subject to any licences already granted by B.I.C.C. at the date of this Agreement particulars of which shall be disclosed by B.I.C.C. in writing to the Company. (h) In so far as the products within the scope of this Agreement made or the plant equipment and processes used for making such products by B.I.C.C. comprise inventions which are not the subject of Letters Patent of B.I.C.C. in Pakistan but are patentable there at the request of the Company to use its best endeavours to obtain Letters Patent therefor in Pakistan but at the cost of the Company and to grant to the Company free, and exclusive licences to make use and sell those inventions in Pakistan during the period hereof but without power to grant sub-licences but such exclusive licences shall be subject to any licences already granted by B.I.C.C. at ' the date of this Agreement particulars of which shall be disclosed, by B.I.C.C. in writing to the Company. (i) As far as is reasonably possible to keep the Company in the forefront technically in respect of the design and' manufacture of the products within the scope of this Agreement PROVIDED HOWEVER, that B.I.C.C. shall not be bound to make available or to communicate any data or information or take any other step hereunder if it would amount to a breach of any other agreement now existing or if premature disclosure would in the opinion of B.I.C.C. prejudice the development itself on the patent position in connection therewith. AND PROVIDED FURTHER that in the event of B.I.C.C. achieving major advances in technique as a result of special or long term development and research then such advances will be made available by B.I.C.C. to the Company if the Company so desire on terms to be mutually agreed between the Company and B.I.C.C. The learned D.R. explaining' the modus operandi pointed out that Messrs Pakistan Cables used to debit the account and credit the amount in their books of account which was payable to B.I.C.C. Limited. He relied on the following cases: 1971 P T D (Trib.) 80 and I.T.A. No. 1592/KB of 1984-85, dated 14-12-1987. In the case cited as 1971 P T D (Trib.) 80 it was held: "Held that the question of applying provisions of section 42(1) in this case would not arise. Income clearly accrues or arises in Pakistan by virtue of the appellant's managing agency business and the actual conduct of this business in Pakistan. No part of the income that accrues or arises in Pakistan can be attributed directly or indirectly to the activities allegedly carried on by the managing agents in the United Kingdom. The matter does not end there. On the basis of the evidence on record including the dispute with the State Bank of Pakistan whereby all the Managing Agents' remuneration is now being received by Steels Branch in Pakistan it is patent that this remuneration is also receivable in Pakistan. In fact, on the basis of case relied upon by the Departmental Representative, we must hold since the Attocks debit their accounts with the Managing Agents remuneration and credit to the Steels a lien on this income is created in favour of the appellant in Pakistan," In I.T.A. No. 1592/KB, Tribunal's findings were as under:- "However, they had to come in any case to Pakistan for purposes of studying the working conditions and collecting soil samples. It is thus clear that unless they could have studied the working conditions and collected the samples for testing they would not have been in a position to prepare feasibility report, which might have been found bankable document by international or Pakistani financial institutions. We are, therefore, of the considered view that study of samples and local conditions was wholly and essentially necessary for the respondent. In other words such a study was sine qua non of the contract and as such, in our judgment for the purposes of clause (a) of subsection (5) of section 12 such services should be wholly and essentially utilised outside Pakistan. In other words, we find territorial nexus between income earned by the respondent and Pakistan territory. We, therefore, with due respect to learned C. I. T. (A) find force in the submission of Mr. Mohammad Farid, the learned D.R. The submission of Mr. E.U., Khawaja, the learned counsel for the respondent that the entire work under the contract was executed at the office of the respondent in U.S.A., therefore, does not appear to be correct. The payment, therefore, is deemed to accrue or arise in Pakistan hence the earnings of the respondent to our mind are taxable in Pakistan. Let us also mention here that under explanation appended to subsection (5) of section 12 of the Income-tax ordinance the expression 'fees for technical services' means and includes any fees paid for consultancy services also which admittedly the respondent have rendered." In appeal the learned C.I.T. (Appeals) supported the action of the Income-tax Officer and dismissed the appeal filed by Messrs British Insulated Callendars Cables Limited (B.I.C.C.) without going into any further details. In agreement for Avoidance of Double Taxation contracted between various countries provisions for the following three types of Royalty are made: (a) royalty paid for using patents, secret processes etc. (b) royalty paid for Cinema and T.V, films. (c) royalty paid for operation of mints or extraction of the natural resources; The amount paid to the appellant is not covered definitely by (b) and (c) above, only(a) is attracted and this type of royalty is treated differently in different Conventions. Provisions, however, for, recurring royalty exist in every (invention. United Kingdom Convention provides that country of source will exempt royalty except where (i) the royalty-earner has a permanent establishment in the country of source. Now let us examine whether the appellant had a permanent establishment in Pakistan. Before discussing that, Article VIII of the Agreement for Avoidance of Double Taxation needs to be examined. "Article VIII: Any royalty derived from sources, within one of the territories by a resident of other territory who is subject to tax in that other territory and is not engaged in trade or business in the first mentioned territory through a permanent establishment situated therein shall be exempt from the tax in that first mentioned territory." In this connection it is worthwhile to quote appellant's objection filed before the I.T.O.

Your contention that the royalty received by B.I.C.C. Ltd. is through branch in Pakistan is erroneous because as pointed out earlier advice is transmitted through correspondence directly from U.K. and not through the branch in Pakistan therefore, the royalty is also remitted directly to B.I.C.C U.K. by Pakistan Cables itself and not through the branch The branch is in no way concerned with the giving of technical advice to Pakistan Cables Limited. Not satisfied with the explanation offered by the` appellant, the I.T.O. concluded in the following words,-- "In fact the whole issue is quite simple. The question whether assessee is engaged in trade or business through permanent establishment in Pakistan? Can be answered only in affirmation." Assessee's contention that: (a) Advice is transmitted through correspondence directly from U.K. and. (b) Royalty is remitted directly to B.I.C.C. U.K. are not borne out by the record. The Income-tax Officer failed to call for the correspondence exchanged. So far payment of royalty is concerned it-used to be debited in the books of Messrs Pakistan Cables Ltd. and then credited to the A/c of Messrs B.I.C.C. Nothing very clear can be stated on the issue of royalty, which was not properly examined by the Assessing Officer. As-regards appellant's alternative claim that the technical fee is covered by the term 'industrial or commercial profits' and hence exempt, I.T.O. made the following observation:- "

Evidently what is royalty cannot, at the same time, be held to be industrial or commercial profits. If the receipts are industrial or commercial profits their taxability or otherwise is to be determined with reference to Article III above. And if the receipts are in the nature of royalty then their taxability is to be determined with reference to Article VIII above. The assessee has been confusing the two and blowing hot and cold in the same breath by claiming exemption under both the Articles without first deciding as to nature of the receipts." Let us examine how far his claim is warranted for exemption under Agreement for Avoidance of Double Taxation under the term 'industrial or commercial profits'. This term has been defined in clause (K) of Article II of the Avoidance Double Taxation Agreement which reads as under:- "The term 'industrial or commercial profits' includes rent or royalties in respect of motion picture films and films for use in connection with television but does not include income in the form of dividends, interest, or royalties, or a fee or, other remuneration derived by an enterprise from the management, control or supervision of the trade, business or other activity of another enterprise or concern, or remuneration for labour or personal services, or income from the operation of ships or aircrafts." A careful reading of the above clause suggests the following. "(1) The term 'industrial or commercial profits' includes rents royalties in respect of motion picture films and films for use in connection with television, but does not include: (2) income in the form of dividends, interest, or royalties, or fee, or other remuneration derived by an enterprise from the management, control or supervision of the trade, business or', other activity of another enterprise or concern or remuneration' for labour or personal services ..." We may now conveniently turn to clause 6(a) and (b) of the Agreement between Messrs Pakistan Cables Limited and Messrs B.I.C.C. Ltd. It says: "(a) To pay to B.I.C.C. for their services as technical advisers hereunder remuneration at the rate of b.3,500 per annum payable in sterling such payment to commence on the said twenty-second day of April, 1973 and to be made quarterly on the 31st day of March the 30th day of June and 30th day of September and the 31st day of December in each year the first payment to be made on the 30th day of June, 1973. (b) In addition to pay to B.I.C.C. remuneration equal to and at the rate of 6-2/3rd$ of the total net profits of the Company in each of its financial years during the continuance of the Agreement such remuneration to be payable in rupees. The net profits of the Company for this purpose shall be deemed to be the profits of each financial year arrived at after crediting realised profits from sale capital assets and all income derived from trading and after charging all expenses of a trading nature reasonably and properly incurred including the above fixed payment and all salaries and administration expenses allowances for depreciation at normal commercial rates all social in respect of income-tax or super tax or any other tax or duty on income or revenue such as Excess Profits Tax or any similar tax whatsoever or for expenditure by way of interest on debentures or otherwise on capital account or on account of any sum which may be set aside in each year out of the profits for reserve or any other Special Fund or this percentage." Whether it is a fee or royalty; it definitely is not covered by (1) on page 18 above as it only talks of motion picture film or film for use in connection with television. Now let us see whether according to our analysis above; (2) on page 18 is applicable or not. It says that if any fee or royalty or other remuneration is derived from the management control or supervision of the trade, business or other activity of another concern, it will not fall under the term industrial or commercial profit and hence will not qualify for exemption as per clause 6(a)(b). For exemption the head excluded are: (a) dividends. (b) interest or rent. (c) royalty. (d) fee. (e) other remuneration. The elements, which must be present for taxing are: (a) Management, (4) Control, (c) Supervision of the-- (i) trade (ii) business or (iii) other activity of another enterprise or concern. For taxing the five heads enumerated above, the tax authorities must' establish that the payment made was for management, control or supervision of the trade, business or other activity. For the payment of: (a) remuneration for labour. (b) personal services; or (c) operation of ships or aircraft; no such condition has been laid down. These three categories are quite independent of management, control or supervision. However, as we read the various clauses of the Agreement particularly 4(a) to (i) and 7(b), we find B.I.C.C. fully in control of the situation. Clause 7(b) reads as under:- "7(b) The Company shall appoint a General Works Manager approved by B.I.C.C. and such General Works Manager will be responsible under the Board of Directors of the Company to B.I.C.C. for all technical matters and methods of production and any change in such appointments shall receive the prior agreement of B.I.C.C." It is but natural that the consultancy services for which fees are received by the non-resident Company will have to originate at the Head Office of the non-resident Company and will be routed to the site of the project either by post or by deputed personnel of the non-resident to the site or through the General Works Manager as was the position in the instant case. As long as the existence of services provided is not denied and the utilisation thereof ultimately at the site is not denied, it is not of relevance whether the services have been rendered within Pakistan or the situs of performance of services remained outside Pakistan. The only fact to be confirmed was that the services rendered by non-resident Company were relatable, to operations being carried out in Pakistan. In view of the position explained above it is quite clear that the services rendered by B.I.C.C. were in connection with the operations of the Projects in Pakistan. The services were rendered in Pakistan through representatives as well as admittedly through correspondence as borne F out by relevant Articles of the Agreement between the two companies. This arrangement had been made with the purpose to give the impression that the services were being provided by the non-resident Company outside Pakistan. This could not deter the department from arriving at the correct conclusion that business connection was established irrespective of the situs of performance of the contract to provide consultancy services. For the sake of argument if it is presumed, that there was n supervision involved. Even then there is no dispute regarding the payment of fees by the Pakistani company to the non-resident Company for services utilized in Pakistan. This fact alone takes such amounts outside the scope of 'Industrial or Commercial Profits' rendering Articles III of the Tax Avoidance Treaty between U.K. and Pakistan inapplicable. As regards the payments deemed to accrue or arise in Pakistan we are fortified in our conviction by our recent judgment cited as 1977 P T D (Trib.) 184: "We are, therefore, of the considered view that study of samples and local conditions was wholly and essentially necessary for the respondent: In other words, such a study was sine qua non of the contract and as such, in our judgment for the purposes of clause (a) of subsection (5) of section (12) such services should be wholly and essentially utilised outside Pakistan. In other words, we find territorial nexus between income earned by the respondent and Pakistan territory. We, therefore, with due respect to learned C.I.T. (A) find force in the submission of Mr. Muhammad Farid, the learned D.R. The submission of Mr. E.U. Khawaja, the learned counsel for the respondent that the entire work under the contract was executed at the office of the respondent in U.S.A., therefore, does not appear to be correct. The payment, therefore, is deemed to accrue or arise in Pakistan hence the earnings of the respondent to our mind are taxable in Pakistan. Let us also mention here that under explanation appended to subsection (5) of section 12 of the Income-tax Ordinance the expression 'fee for technical services' means and includes any fees paid for consultancy services also which admittedly the respondent have rendered. In view of the above discussion we hold both the technical fee under clause 6(a) and remuneration received under clause 6(b) to be taxable. However, since the assessing officer has not made out a t case for deviation from past method of computation when only 20% of such income used to be taxed and the balance allowed as expenditure' we direct that the same ratio should be maintained. M.B.A./516/T Order accordingly.