To explain this, the Tribunal referred to the commentary on Article 7 of the UN Model Convention.

It observed that in the discussion preceding the adoption of the commentary on Article 7, several member-countries expressed their view that they would adopt but limit the scope of application of the ‘Force of Attraction’ rule to business profits only and not to income from capital.

Some members from the developed countries pointed out that the ‘Force of Attraction’ rule was abandoned by them in recent treaties, as they found it undesirable to tax profits totally unrelated to the PE of the taxpayer and it was stressed that such an approach would create uncertainty amongst the taxpayers.

It was, therefore, proposed to adopt a restrictive scope of ‘Force of Attraction’ rule such that it applies only in respect of such activity which is ‘same’ or ‘similar’ in nature as those carried on by the PE of the taxpayer in that other country.

The Tribunal observed that Article 7 of Indo-Finnish DTAA was based on UN Model Convention and thus had a restrictive scope of the force of attraction rule.

Although the main reasoning of arriving at the decision of not taxing the profits from supplies outside India under Article 7(1)(a) was that the sale of equipment was concluded much before the installation PE of the taxpayer came into existence, the Tribunal has addressed the Revenue’s contention in respect of the rule for each of the clauses (b) and (c) of Article 7(1).

Important observation

Elucidating Article 7(1)(b), the Tribunal made a very important observation on the applicability of the ‘Force of Attraction’ rule that it only extends the scope of transactions which are to be taxed in the other country and not the nature of transactions.

Expounding this proposition, the Tribunal held that due to use of the words ‘same’ or ‘similar’ in Article 7(1)(b), the profits from sale of equipment could be taxed only if the PE of the taxpayer is for the purpose of selling goods or merchandise. It was held that the Installation PE was not covered by the attraction rule to tax profits from sale of goods.

In other words, it was held that as per the attraction rule, not all profits of a PE would be taxable in India but only so much of the profits as has economic nexus with the PE in India, would get taxed in India.

The Tribunal also observed that certain treaties which India has entered has protocol explaining that in case of contracts for supply, installation or construction, the profits are required to be determined only on the basis of that part of contract which is effectively carried out by the PE in the other country.

It has been held that these protocol provisions are clarificatory in nature and would apply in general. Taking recourse to this explanation, it was held that supplies made outside India being not connected to the PE in India were not taxable in India.

Alternative plea

In the concluding paragraph, though the Tribunal has mentioned about the alternative plea raised by the assessee, it has not adjudicated upon the same. The Appellant contended that as per explanation to Section 9(1)(i) of the Income-Tax Act, if a non-resident has a business connection in India, only so much of the profits are taxable in India which could be reasonably attributed to operations carried out in India. Since the supplies made outside India cannot be considered to be attributable to the operations carried on in India, the profits were not taxable under the domestic law.

In the absence of any decision taken on this alternative plea, it remains to be seen how far this proposition finds favour with the judicial authority, in cases where the ‘Force of Attraction’ rule is not so restrictive.