Recently, the Delhi Bench of the Income-tax Appellate Tribunal (the Tribunal) in the case of POSCO Engineering & Construction Company Ltd. dealt with the taxability of offshore and onshore supply of equipment and services. The Tribunal held that payment for offshore supply of equipment is not taxable in India since title to the goods have been passed outside India on high sea and the payment was also received outside India. The Tribunal observed that the payment for equipment also includes consideration for services like training, test and inspection performed in India. Accordingly, portion of sale price of offshore supply of equipment needs to be attributed to such activities performed in India and shall be taxed in India. Further, the Tribunal held that the payment for design and engineering services is taxable as Fees for Technical Services under Section 9(1)(vii) of the Income-tax Act, 1961.
Payment for offshore supply of equipment is not taxable in India. A portion of
consideration for offshore supply attributed to services performed in India
4 March 2014
Background
Recently, the Delhi Bench of the Income-tax Appellate Tribunal (the Tribunal) in the case of POSCO Engineering & Construction Company Ltd.
1 (the
taxpayer) dealt with the taxability of offshore and onshore supply of equipment and services. The Tribunal held that payment for offshore supply of equipment is not taxable in India since title to the goods have been passed outside India on high sea and the payment was also received outside India. The Tribunal observed that the payment for equipment also includes consideration for services like training, test and inspection performed in India. Accordingly, portion of sale price of offshore supply of equipment needs to be attributed to such activities performed in India and shall be taxed in India. Further, the Tribunal held that the payment for design and engineering services is taxable as Fees for Technical Services (FTS) under Section 9(1)(vii) of the Income-tax Act, 1961 (the Act).
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1 POSCO Engineering & Construction Company Ltd. v. ADIT (ITA No.
5787/Del/2013) – Taxsutra.com
Facts of the case
The taxpayer, a Korean company, engaged in engineering and construction of iron, energy and public works, etc. It entered into a contract (agreement or contract), as a consortium, with Nagarjuna Construction Company (NCC) and Steel Authority of India Ltd. (SAIL). The taxpayer was having a Permanent Establishment (PE) in India.
During the year under consideration, the taxpayer received mobilisation advance from SAIL on account of following:
− Offshore supply of equipments
− Design and engineering
− Foreign supervision charges (onshore services)
− Onshore supply of equipments
The Assessing Officer (AO) held that mobilisation charges in respect of offshore supply of equipment was treated as business income under Article 7 of the India-Korea tax treaty (tax treaty) and also under Section 9(l)(i) of the Act. Further design and engineering services was treated as royalty under Section 9(1)(vi) of the Act. Alternatively, it has also been held as FTS under Section 9(1)(vii) of the Act.
The consideration received in respect of onshore supply of equipments and foreign supervision charges were liable to be included in the total income of the taxpayer.
The AO restricted the income to 90 per cent of mobilisation advance as attributable to the PE in India and the profit margin of 30.65 per cent was applied thereon. Further, the AO included 90 per cent of the design and engineering services as attributable to the PE and clubbed the same along with offshore supply and computed total income of the taxpayer.
Tribunal’s ruling
Composite contract
The Tribunal held that the contract was not a composite one as all its major four components were distinctly identifiable with separate consideration for each.
The Supreme Court in the case of Ishikawajma-Harima Heavy Industries Ltd.
2 held that for taxation of income
from offshore supply and offshore services, even though it was a composite contract, the income from offshore supply of equipments and the offshore services did not fall within the purview of Section 9(l)(vii) of the Act, since the entire services were rendered outside India and the PE of the taxpayer had no role to play in the transaction.
If supply of equipment and the rendition of services are to one party and for a common purpose, there was no need to treat the entire amount as one composite payment attributable, commonly, both to the supply of equipment and rendering of services.
Income from offshore supply of equipments
Where title to the goods transferred
The Delhi Special Bench in the case of Motorola Inc3
has observed that it is open to the parties to agree that even where the property in the goods has passed, the seller may undertake the risk of deterioration in the goods during the course of transit. Merely because the risk is passed in India, it cannot be said that the sale took place in India.
The Tribunal relied on the decision of Ishikawajma-Harima Heavy Industries Ltd. and Motorola Inc. where it was observed that, the title to the goods shall be considered to have passed outside India when delivery was made on high sea and the payment was also received outside India. In the taxpayer’s case also, the delivery of goods was made outside India and also the payment was received outside India. Accordingly, the Tribunal held that the title of goods in respect of offshore supply of equipment was transferred outside India.
_______________ 2 Ishikawajma-Harima Heavy Industries Ltd. v. DIT [2007] 288 ITR 408 (SC)
3 Motorola Inc. v. DCIT [2005] 95 lTD 269 (Del) (SB)
Sale price includes consideration for services
Perusal to the agreement indicates that there is a charge for supply of offshore equipment and also there is a separate charge towards foreign supervision charges. However, such foreign supervision charges are incurred in India during erection, start-up, commissioning and performance guarantee tests.
Getting a separate charge for foreign supervision charges for the setting up of plant makes it clear that such supervision charges are not part and parcel of the price of equipment supplied from offshore.
On reference to the agreement it indicates that the taxpayer is obliged to provide training in India and prices for foreign supervision charge are distinct from training charges. The training services are the responsibility of the taxpayer alone and NCC is not liable to render such services.
If a seller has to incur training expenses or repair cost during the warranty period, then either there is a specific consideration for the same and if it is not there, then such costs are to be considered as in-built in the price of equipment.
Ordinarily, when any product is sold with warranty, the price charged by the seller always includes compensation for the repairs cost to be incurred during the warranty period. In contrast to that, if there is no warranty clause and similar product is sold by another seller, the sale price is bound to be at a lower level vis-a-vis the seller who sells its products with warranty.
Accordingly, when the taxpayer has undertaken to bear training costs at its own and there is no separate compensation for that, then such compensation is included in the sale price charged for offshore supply of equipments. In such a case, the price so charged is required to be split towards the price of goods simplicitor and compensation for training and other charges which the seller has undertaken to bear.
Apart from training charges, there are also other costs incurred by the taxpayer in connection with supply of such offshore equipments. There are certain other clauses of the agreement which indicates that the taxpayer has undertaken to bear expenses in connection with the supply of goods.
On perusal to the clauses of agreement, it indicates that the taxpayer undertook to incur some expenses towards test and inspection at site, that is in India; conduct repair during defect liability period again in India etc. These expenses are to be borne by the taxpayer.
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However, details of charges are not readily available, the matter has been remanded back to the AO to examine cost of tests, inspection, liquidated damages and defect liability along with any other cost. However, if on such analysis, the AO comes to the conclusion that there is no separate charge in respect of these items; a portion of sale price of offshore supply of equipment needs to be attributed to such activities performed in India.
Taxability of offshore supply of equipment and services
rendered in India
The price shown towards offshore supply of equipments has two components, viz. price for offshore supply of equipment simplicitor and the consideration for some services rendered in India.
It is not the case of the tax department that the income from offshore supply was received by the taxpayer in India. The expression 'income deemed to be received' in India has been defined in Section 7 of the Act and on reference to the section it is apparent that the nature of payment under consideration is quite distinct from the items specified therein.
Income from supply of offshore equipments cannot be in the nature of 'salaries', 'dividend', 'interest', 'royalty' or 'FTS', which items of income have been specifically dealt with in clause (ii) to (vii) of Section 9(1) of the Act.
The Supreme Court in the case of R.D. Aggarwal & Co.4
has held that mere sale does not result in business connection attracting the deeming provisions of Section 9(1)(i) of the Act. Further, the Supreme Court in the case of Seth Pushalal Mansinghka (P) Ltd.
5 has held that
income accrues at the place where the title to the goods passes to the buyers on the payment of price to the bankers of the taxpayer.
Relying on the decision in the case of Ishikawajma- Harima Heavy Industries Ltd., the Tribunal held that in so far as the price for offshore supply of equipment simplicitor is concerned, profit from the same cannot be charged to tax as the taxpayer is a non-resident and there is absence of territorial nexus of such income with India.
Provisions of the tax treaty are analogous to the Explanation (1)(a) to Section 9(1)(i) of the Act. As per the provisions, only that part of the business income of the non-resident can be charged to tax in India, which is attributable to operations carried out in India or is attributable to the PE as per Article 7 of the tax treaty.
In case of a composite income which is partly relatable to the operations carried out in India and partly to outside India, a proportionate part of income which is so relatable to the operations carried out in India, has to be charged to tax. This position has been accepted by the Supreme Court in the case of Ishikawajma-Harima Heavy Industries Ltd. and Hyundai Heavy Industries Co. Ltd
6.
The Tribunal held that the income for which everything is done in India is fully taxable, but the principle of apportionment applies to tax that part of the composite income which is relatable to operations carried out in India. Applying the above principle, it is clear that that the second component of the sale price of offshore equipments, which is quid pro quo for services rendered in India, is chargeable to tax in India.
Attribution of income to services rendered in India
The decision of the Uttarakhand High Court in the case of Samsung Heavy Industries Ltd.
7 relied on by
the taxpayer is distinguishable to the facts of the present case. In the present case, there is sufficient material to indicate that several activities concerned with offshore supply of equipments were to be carried out in India.
When the taxpayer is liable to incur certain expenses on Indian soil in connection with the offshore supply of equipment for which there is no separate charge, the consideration for rendering of such services is attributable to the operations carried out in India and, hence, chargeable to tax.
The decision of Hyundai Heavy Industries Co. Ltd relied on by the taxpayer is distinguishable to the facts of the present case since the price charged by the taxpayer for supply of offshore equipment also includes consideration for certain services rendered in India which was not in the case of Hyundai Heavy Industries Co. Ltd. Accordingly, the price for such services is liable for taxation under Section 9(1)(i) of the Act and the tax treaty.
The attribution cannot be done arbitrarily as the question of fact varies from case to case. In the present case, the nature of services to be rendered may be costly or labour intensive, while in another case, it may not be so. Therefore, profit attribution issue has been restored to the file of the AO for determining as to whether the testing charges in India and repair charges during the defect liability period, etc. were included in sale price of goods.
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6 CIT & Anr. v. Hyundai Heavy Industries Co. Ltd. [2007] 291 ITR 482
(SC) 7 Samsung Heavy Industries Ltd. v. DIT [2014] 42 taxmann.com 140 (Utt)
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Further, compensation for training in India is a part and
parcel of sale price of offshore supply of equipments. The value of such training is directed to be assigned by the AO.
Income from onshore supply of equipments and
onshore services
The taxpayer had accepted that income from onshore supply of equipment and services are chargeable to tax in India in the correct year, which is also a settled by the Supreme Court in Ishikawajma-Harima Heavy Industries Ltd. Therefore, it has been held that the payment towards onshore supply of equipments and services are chargeable to tax in the correct year.
Income from design and engineering services
The design and engineering services cannot be related to the offshore supply of equipments. Such design and drawings deal with every aspect of the erection and commissioning of the plant, right from the foundation of buildings and roads till the completion of the entire project. It is incorrect to say that such drawings and designs were to be considered as offshore supply of equipments, and hence not chargeable to tax.
Relying on the decision of the High Court in the case of Rio Tinto Technical Services
8 it has been held that in the
absence of any bifurcation, an estimated allocation has to be made for tax purposes. Accordingly, the fees for design and drawing should not be considered as part of supply of offshore equipment.
On perusal of Section 9(1)(vi) of the Act, the Tribunal held that the payment for design and engineering services was not in the nature of royalty.
As the nature of drawings and designs customised to the taxpayer's requirements are result of the rendering of technical services, it has been held that the consideration for the same qualifies as FTS. A bare perusal of the Explanation defining the term FTS makes it clear that it refers to rendering of any of technical services apart from managerial or consultancy. It also includes the provision of services of technical or other personnel.
As per the Explanation of Section 9(2) of the Act, it is clear that FTS shall be deemed to accrue or arise in India and shall be included in the total income of non-resident whether or not it has rendered services in India. The amendment made by the Finance Act, 2010 has nullified the effect of Ishikawajma-Harima Heavy Industries Ltd. to the extent it provided that technical services must be rendered in India to qualify for taxation.
The provision of Section 9(1)(vii)(b) is applicable to the facts of present case as the FTS has been paid by SAIL, who is resident of India, and the services provided by the taxpayer are not going to be used by SAIL for carrying
_____________ 8 DIT v. Rio Tinto Technical Services [2012] 340 ITR 507 (Del)
on its business outside India or for earning income from any source outside India. Accordingly, it has been held that the consideration for design and drawings is liable for inclusion in the total income of the taxpayer under Section 9(1)(vii) of the Act.
Our comments
The issue of taxability of offshore supply of equipments and services has been a matter of debate before the Courts.
In the present case, the Tribunal held that payment for offshore supply of equipment is not taxable in India since title to the goods have been passed outside India on high sea and the payment was also received outside India. The Tribunal observed that the payment for equipment also includes consideration for services like training, test and inspection performed in India. Accordingly, a portion of the sale price of offshore supply of equipment needs to be attributed to such activities performed in India and taxed in India. Further, the Tribunal held that the payment for design and engineering services is taxable as FTS as per the the Act. In this case, the Tribunal observed that the composite contract should be segregated into the different types of services from the consideration for equipment to tax the services which were rendered in India.
It is pertinent to note the decision of the Delhi High Court in the case of Nokia Networks OY
9 following the
decision of Ishikawajma-Harima Heavy Industries Ltd., has held that in case of one composite contract, supply has to be segregated from the installation and only then the question of apportionment arises under the Act. The High Court held that since the property in goods had passed on to the buyer outside India, said agreement would not be taxable in India.
However, in the cases of Alstom Transport SA10
, Roxar Maximum Reservoir Performance WLL
11 and Linde
A.G.12
, the AAR relying on Vodafone International Holding B.V.
13 applied ‘look at’ approach and held that
composite contract for installation and commissioning of project in India cannot be dissected for the purpose of taxability of the contract.
The Mumbai Tribunal in the case of Toyo Engineering Corporation
14 upheld taxation of income under offshore
design contract as FTS under Section 9(1)(vii) of the Act. It was held that rendition of services in India is not a pre-condition for taxation of FTS, where the payer is a resident.
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9 DIT v. Nokia Networks OY [2012] 25 taxmann.com 225 (Del)
10 Alstom Transport SA [2012] 208 Taxman 223 (AAR)
13 Vodafone International Holdings B.V. v. UOI [2012] 341 ITR 1 (SC)
14 Toyo Engineering Corporation v. DDIT [2013] 60 SOT 241 (Mum)
.
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