*connectedthinking pwc
Background
The Mumbai Tribunal in a recent ruling1 held that to compute the threshold limit for the duration test to determine the Permanent Establishment (“PE”), the activities of the foreign enterprise on a particular site or a project, or for connected supervisory activities have to be seen separately for each project unless the activities are so inextricably interconnected or interdependent that it is essential they be viewed as a coherent whole, commercially and geographically.
Facts
The assessee, a tax resident of Mauritius was engaged in the business of marine and general engineering and construction. During the Assessment Year 2001-02, the assessee executed three contracts in India.
1 ADIT v. Valentine Maritime (Mauritius) Ltd. [2010-TIOL-195- ITAT-Mum]
One of these contracts was for the replacement of the main deck with a temporary deck and the other two contracts were to give barge on hire.
The assessee claimed that the duration of each of the contracts did not exceed the threshold limit of nine months as per the Article 5(2)(i) of the India-Mauritius tax treaty. Therefore, the assessee did not have a PE in India. In the absence of a PE, income from the contract for the replacement of the main deck with a temporary deck and from one of the barge hire contracts was not taxable in India.
For the other contract for barge hire, the assessee initially offered its gross receipts tax at a rate of 3.6 per cent under section 44B of the Income-tax Act, 1961 (“the Act”), on the basis of withholding tax order under section 197 of the Act issued to the assessee. However, during the course of the assessment proceedings, the assessee contended that the receipts under the contract were not taxable in India in the absence of a PE in India.
‘Duration test’ for determining permanent establishment is to be applied on each independent contract separately unless the treaty provides otherwise
Tax & Regulatory Services
News Alert*
22 April, 2010
PricewaterhouseCoopers
The Assessing Officer (“AO”) did not accept the assessee’s contentions and held that;
• Since the total duration of all the contracts exceeded the threshold limit of nine months, a PE was established in India. The AO referred to the protocol to the India-UK tax treaty which specifically provides that the duration test is to be applied separately to each contract. In the absence of any such specific protocol in the India-Mauritius tax treaty, the assessee cannot consider the duration test separately for each contract.
• In respect of the contracts for barge hire, the barge itself constitutes a ‘fixed place of business’ through which the business of the assessee is carried out as per Article 5(1) of the India-Mauritius tax treaty. Accordingly, the receipts under these contracts would be taxable under section 44BB of the Act. Furthermore, the AO stated that even if it is assumed that the assessee does not have a PE in India, income under the contracts for barge hire is covered within the definition of royalty as ‘use of industrial, commercial or scientific equipment’ and accordingly will be taxed at a rate of 15%. The AO ultimately proceeded to tax the income from all the contracts considering 10% of the gross receipts as income.
On appeal, the Commissioner of Income-tax (Appeals) allowed the appeal of the assessee against which the Revenue authorities filed an appeal before the Tribunal.
Tribunal Ruling
The summary of the ruling pronounced by the Tribunal is as under:
For the existence of a PE in the form of building construction, construction or assembly project, or connected supervisory activity, each of the projects have to be viewed on a stand-alone basis.
If aggregation is specifically provided for in the relevant PE definition clause2, then only the time spent on different projects would be aggregated. Even in such an aggregation, multiple counting of common days has to be avoided.
2 India tax treaties with Austria, Belgium, Bulgaria, Canada, China, Denmark, Italy, New Zealand, Norway, Spain, Turkey and USA.
The provisions set out in the protocol to the tax treaties is merely clarificatory and is apparently set out as a measure of abundant caution. The fact that the protocol to the India-UK tax treaty specifically mentions that the duration test has to be applied to each project would not warrant a different interpretation in the case of absence of such provisions in the India-Mauritius tax treaty.
The Tribunal recognised that the duration test in the treaty has created scope for its abuse. In this connection, the Tribunal referred to the OECD Commentary which has recognised the possibility of such abuse. The OECD Commentary provided that in addition to any legislative or judicial anti-avoidance rules which countries may adopt in the framework of bilateral negotiations, the aggregation principle for time spent on each set of relevant business activities should be considered in the following two situations even in the absence of a specific treaty provision to that effect:
• A building site should be considered as a single unit, even if it is based on several contracts, if it forms a coherent whole commercially and geographically, or
• The very nature of the construction or installation project may be such that the contractor’s activities are to be relocated continuously or at least from time to time: in which case the activities performed at each particular spot in a single project must be regarded as a single unit (e.g. construction of roads and canals, dredging of waterways or laying of pipelines).
The Tribunal held in the case of the possibility of such abuse of duration test, the onus to prove, beyond a reasonable degree of doubt, that there is an abuse of treaty provisions by artificially contriving the affairs, by alleged artificial splitting of contracts, or other alleged maneuvering to enter into sham arrangements to wrongfully entitle the assessee to treaty benefits lies on the Revenue authorities3. In order to discharge this onus, the assessee must comply with the reasonable requisitions of the Revenue authorities and truthfully share the information available with them. As no such exercise has been carried out in the assessee’s case, the aggregation principle cannot be applied.
The other situation according to the Tribunal in which an aggregation principle should be applied is when the activities are so inextricably interconnected or interdependent that it is essential they be viewed as a coherent whole.
3 Supreme Court, in the case of K P Varghese v. ITO [1981] 131 ITR 597 (SC)
PricewaterhouseCoopers
The Tribunal emphasised that the fact that projects are for the same principle or on nearby locations would not necessarily mean that these projects are to be seen as a coherent whole - geographically and commercially. In this regard, reliance was placed on the decision of Delhi Tribunal in the case of Sumitomo Corporation4.The true test is to examine, whether or not the activities are so inextricably interconnected that these cannot be viewed in isolation but only in conjunction with each other.
The Tribunal held that as the three contracts were for different purposes, these contracts cannot be viewed as interconnected or interdependent, and accordingly, the duration of each project cannot be aggregated.
On the issue whether a barge given on hire can be viewed as a fixed place of carrying on its business, the Tribunal held that since the assessee is in the business of hiring out barges, that activity cannot be carried out on the barge so hired out. Accordingly, the Tribunal held that the barge could not be a PE of the enterprise.
In the absence of a PE, the business profits cannot be brought to tax.
However, based on the decision of the Madras Tribunal in the case of Poompuhar Shipping Corporation Ltd.5 were in receipts from barge hire were held to be royalty, the Tribunal held that the assessee’s receipts from contracts for barge hire were taxable under section 44BB of the Act as held by the AO.
4 Sumitomo Corporation v. DCIT [2008] 114 ITD 61 (Delhi)
5 Poompuhar Shipping Corporation Ltd. v. ITO [2008] 297 ITR 219 (Mad)
Conclusion
The decision upholds the principle that the duration of each project, site or location has to be seen separately unless the treaty provision specifically provides for such aggregation.
Even in the absence of the specific wording for aggregation, the duration of the projects, sites or locations can be aggregated if the tax authorities prove beyond doubt that the transaction has been structured to circumvent the duration test or where the activities are so inextricably interconnected or interdependent that it is essential the same be viewed as a coherent whole.
PricewaterhouseCoopers For private circulation only Contact
Ahmedabad
President Plaza, 1st Floor Plot No 36 Opp Muktidham Derasar
Thaltej Cross Road, SG Highway Ahmedabad, Gujarat 380054 Phone +91-79 3091 7000
Bangalore
6th Floor, Millenia Tower 'D' 1 & 2, Murphy Road, Ulsoor, Bangalore 560 008 Phone +91-80 4079 6000
Bhubaneswar
IDCOL House, Sardar Patel Bhawan Block III, Ground Floor, Unit 2 Bhubaneswar 751009
Phone +91-674-253 2279 / 2296
Chennai
PwC Center, 2nd Floor 32, Khader Nawaz Khan Road Nungambakkam
Chennai 600 006
Phone +91-44 4228 5000
Hyderabad
#8-2-293/82/A/113A Road no. 36, Jubilee Hills, Hyderabad 500 034,
Andhra Pradesh Phone +91-40 6624 6600
Kolkata
Plot No.Y-14, 5th Floor, Block-EP, Sector-V, Salt Lake Kolkata 700 091, West Bengal Phone +91-33 2357 9100 / 2357 7200
Mumbai
PwC House, Plot No. 18A, Guru Nanak Road - (Station Road), Bandra (West), Mumbai - 400 050 Phone +91-22 6689 1000
New Delhi / Gurgaon Building No. 10, Tower - C 17th & 18th Floor, DLF Cyber City, Gurgaon Haryana -122002 Phone : +91-124-3306000
Pune
'Muttha Towers' 5th Floor, Suite No. 8,
Airport Road, Yerwada, Pune 411 006 Phone +91-20 4100 4444
For more information :
The above information is a summary of recent developments and is not intended to be advice on any particular matter. PricewaterhouseCoopers expressly disclaims liability to any person in respect of anything done in reliance of the contents of these publications. Professional advice should be sought before taking action on any of the information contained in it. Without prior permission of PricewaterhouseCoopers, this Alert may not be quoted in whole or in part or otherwise referred to in any documents
©2010 PricewaterhouseCoopers. All rights reserved. "PricewaterhouseCoopers", a registered trademark, refers to PricewaterhouseCoopers Private Limited (a limited company in India) or, as the context requires, other member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity.
