1. Factual Background and Procedural History
The appellant, Pride Foramer S.A., a French-incorporated non-resident company, was engaged in offshore oil drilling operations for the Oil and Natural Gas Corporation (ONGC). The company had been awarded a ten-year drilling contract spanning from 1983 to 1993. Following the expiration of that contract, Pride Foramer secured a new drilling contract only in October 1998, which was formalised in January 1999.
Between 1993 and 1998, although the company had no active drilling operations, it continued to engage in systematic business communications with ONGC from its Dubai office and headquarters in France, including the submission of a bid in 1996 for an oil exploration contract. During this interim period, the appellant incurred administrative and professional expenses such as audit and consultancy fees and also received interest income on tax refunds from the Income Tax Department.
For Assessment Years (AY) 1996–97, 1997–98, and 1999–2000, the company filed returns showing ‘nil’ income but claimed deductions for business expenditure and carry-forward of unabsorbed depreciation.
The Assessing Officer (AO) disallowed these claims on the ground that the appellant had ceased business operations in India. The CIT (Appeals) affirmed this finding. On appeal, however, the Income Tax Appellate Tribunal (ITAT) held that the company had only experienced a “lull in business,” not a cessation, and allowed deduction of expenses under Section 37(1) and set-off under Section 71 of the Income Tax Act, 1961.
The Uttarakhand High Court, reversing the ITAT, held that since the appellant had no permanent office in India and no subsisting contract during the relevant years, it could not be said to be “carrying on business in India.” This decision was challenged before the Supreme Court of India, resulting in the present judgment delivered on 17 October 2025 by a Bench comprising Justice Manoj Misra and Justice Joymalya Bagchi.
2. Identification of Legal Issues
The Supreme Court examined the following legal questions:
- Whether a temporary lull in business activity constitutes a cessation of business for the purposes of claiming deductions under Section 37(1) of the Income Tax Act.
- Whether the absence of a Permanent Establishment (PE) in India precludes a non-resident company from being regarded as “carrying on business” or having a business connection in India.
- Whether business expenditure incurred during a lull period can be set off against income from other sources under Section 71, and whether unabsorbed depreciation can be carried forward under Section 32(2).
3. Arguments of the Parties
Appellant (Pride Foramer S.A.)
The appellant argued that the absence of an active drilling contract did not imply cessation of business. Its continuous correspondence with ONGC, submission of tenders, and incurrence of administrative expenses reflected a continuing intent to carry on business.
It contended that “business” under the Act has a wide connotation, encompassing all organized activities undertaken with a commercial purpose.
Therefore, even in the absence of active operations or a PE in India, the company remained engaged in business. It further argued that Section 37(1) permits deduction of any expenditure incurred “for the purpose of business,” which is broader than expenditure “for the purpose of earning profits.”
Respondent (Revenue Authorities)
The Revenue contended that since the appellant had no office or contract in India during the relevant years, it could not be said to be carrying on business in India. The communications from abroad did not amount to “business connection” within India. Hence, the expenditure could not be allowed as business deduction or set-off, nor could unabsorbed depreciation be carried forward.
4. Court’s Analysis and Reasoning
A. Section 37(1) – Business Expenditure During a Lull Period
The Supreme Court emphasized that a temporary lull in business does not constitute cessation of business. Relying on CIT v. Vikram Cotton Mills (1988) 169 ITR 597 (SC) and Hindustan Chemical Works Ltd. v. CIT (124 ITR 561 Bom), the Court held that a lean phase or transition period does not extinguish the existence of a business entity.
It noted that Pride Foramer had demonstrably continued business-related activities—maintaining professional staff, incurring administrative costs, and making bids for contracts—all of which showed an intent to continue operations. Hence, the expenditures were allowable under Section 37(1).
B. Definition of “Business” under Section 2(13)
Reiterating settled principles, the Court stated that “business” implies a real, substantial, and organized course of activity with a definite purpose. Referring to Narain Swadeshi Weaving Mills v. C.E.P.T. (1954) 26 ITR 765 (SC), it observed that even preparatory or ancillary actions undertaken in furtherance of business objectives fall within this definition.
The Court also cited CIT v. Malayalam Plantations Ltd. (1964) 53 ITR 140 (SC), underscoring that the phrase “for the purpose of business” is wider than ‘for earning profits’, encompassing measures to preserve or protect the business, pay statutory dues, or rationalize administration.
C. Section 71 – Set-Off of Losses
Even though the only income credited during the relevant assessment years was interest on tax refunds (classified as “income from other sources”), the Court upheld the ITAT’s view that such business expenditure could be set off under Section 71 since the appellant was still carrying on business.
D. Section 32(2) – Carry Forward of Unabsorbed Depreciation
The Court noted that the first proviso to Section 32(2) (which restricted carry-forward unless the business continued) had been omitted by the Finance Act, 2001. Nevertheless, for the relevant years, continuation of business was established on facts; hence, carry-forward of depreciation was permissible.
E. Permanent Establishment Not a Precondition
Rejecting the High Court’s view, the Supreme Court clarified that existence of a Permanent Establishment (PE) in India is not a statutory requirement for being treated as carrying on business or having a business connection in India.
The issue of PE, the Court observed, is relevant only in the context of Double Taxation Avoidance Agreements (DTAAs), not for determining tax liability under the domestic law.
The Court denounced the High Court’s restrictive approach as “wholly fallacious and contrary to the very scheme of the Act” and “anachronistic in the era of globalization and cross-border trade.”
F. Policy Context
The judgment aligns with India’s commitment to ease of doing business and sustainable development goals, recognizing the realities of modern commerce, where cross-border communication and remote business activity are integral features.
5. Final Conclusion and Holding
The Supreme Court allowed the appeals, set aside the Uttarakhand High Court’s judgment, and restored the ITAT’s findings. It held that:
- The appellant’s business had not ceased but merely experienced a temporary lull.
- Business expenditure during this period was deductible under Section 37(1).
- The expenditure could also be set off under Section 71 against income from other sources.
- The appellant was entitled to carry forward unabsorbed depreciation under Section 32(2).
- Permanent establishment is not mandatory for establishing business connection or continuity under the Income Tax Act.
The case reinforces a liberal interpretation of “carrying on business,” reflecting a pragmatic, modern approach to cross-border taxation.
FAQs:
1. What does the Supreme Court mean by a “lull in business”?
A “lull in business” refers to a temporary pause in operations where the company still intends to continue business. It does not equate to closure or cessation, allowing business deductions to continue.
2. Can a non-resident company operate in India without a permanent establishment?
Yes. A permanent establishment is not mandatory for recognizing a business connection under Indian tax law. It becomes relevant only under Double Taxation Avoidance Agreements (DTAAs).
3. Is business expenditure during non-operational years deductible?
Yes, if the expenses are incurred for maintaining business readiness or pursuing contracts, they qualify as allowable business expenditure under Section 37(1).
4. Can business losses be set off against income from other sources?
Yes. Under Section 71 of the Income Tax Act, business losses or expenses can be set off against income from other heads, provided the assessee continues to carry on business.
5. What principle did this case reinforce about taxation of non-residents?
The judgment reaffirmed that the intention and organized pursuit of business activities—even from abroad—are sufficient to establish continuity of business for taxation under Indian law.
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