Tax Insights
from India Tax & Regulatory Services
www.pwc.in
Consideration for installation services integral to contract for construction work not taxable as royalty or FTS in absence of PE of taxpayer in India
June 7, 2016
In brief
Recently, the High Court of Delhi (HC) in the case of the taxpayer, a Singaporean entity, held that consideration for installation services integral to a contract could not constitute fees for technical services (FTS). It rejected the Revenue’s attempt to re-characterise the arrangement as a contract for hiring of equipment.
In detail
Facts
The taxpayer1 was a company engaged in the business of offshore construction, engineering, project management and support services to the oil and gas industry worldwide. The taxpayer entered into a
contract with a client (ABC) for
“residual offshore construction work” at Paradip. The work involved installation of client- supplied Single Point Mooring (SPM), including anchor chains and floating and subsea hoses. The total contract value consisted of (a) mobilisation and demobilisation of marine spread (major portion), (b) pre- and post-erection work, and (c) actual installation work.
The taxpayer filed an application before the
1 W.P. (C) 7416/2012
Authority for Advance Ruling (AAR) for determining certain questions regarding its tax liability in respect of its services under this contract.
The taxpayer stated that it did not have any project office or other premises in India, and it fulfilled the obligations under the contract by deputing men and materials at the offshore site. The AAR noted that the payment made for use of equipment (payment for mobilisation/ demobilisation) comprised a substantial part of the payment and, therefore, was covered within the definition of royalty under Article 12.3(b) of the Double Taxation Avoidance Agreement between India and Singapore (the tax treaty). It further ruled that as the installation was ancillary and subsidiary to the use of equipment or enjoyment of the right for such use, the
payment for the installation would fall under the definition of FTS in terms of Article 12.4(a) of the tax treaty.
Before the AAR, the Revenue never argued that the taxpayer had Permanent Establishment (PE) in India in respect of this contract, and hence, the AAR did not comment on that aspect.
The taxpayer entered into another contract with another client (XYZ). This contract was the subject matter of a separate application before the AAR. In that case, the AAR had ruled that the taxpayer had a PE in India in respect of the XYZ contract, and accordingly, the consideration received was liable to tax in India under section 44BB of the Income- tax Act, 1961 (the Act).
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Aggrieved by the AAR’s ruling in respect of the ABC contract, the taxpayer filed a writ petition before the HC.
Issues before the High Court
Could the service contract can be re-characterised as
equipment hire, since the equipment was used to perform the services?
Based on the facts and circumstances, could the taxpayer be said to have a PE in India?
Should the income from mobilisation/ demobilisation charges be treated as royalty under section 9(i)(vi) of the Act or under Article 12.3(b) of the tax treaty?
Should the income from installation services be treated as FTS under section 9(i)(vii) of the Act or under Article 12.4 of the tax treaty.
Taxpayer’s contentions
Under the contract, ABC had no right to use or control the movement/ operation of any equipment, vessels, etc.
belonging to the taxpayer. The taxpayer alone used the equipment for rendering services for offshore
construction/ installation work.
The work involved installation of ABC-supplied equipment.
ABC had no control or dominion over the vessel movement or the equipment brought to the site and used by the taxpayer for rendering services under the contract.
The contract made it clear that in case of any damage or loss to any property, equipment, etc. supplied to ABC while being installed or during its movement, the taxpayer alone would be responsible.
2Asia Satellite Telecommunications Co.
Ltd. v. Director of Income Tax [2011] 332 ITR 340 (Delhi)
In view of the above, the taxpayer contended that the consideration received for mobilisation/ demobilisation did not constitute royalty. In support of its contention, it placed reliance on the Delhi HC decision in Asia Satellite Telecommunications Co. Ltd.2.
The purpose of mobilising the equipment was to install the ABC-supplied SPM. The primary purpose was the offshore construction work, i.e., the work of installing the ABC-supplied SPM, which included anchor chains and floating and subsea hoses.
Thus, the services were essentially technical services.
However, the consideration for such services did not qualify as FTS per Article 12 of the tax treaty or section 9(1)(vii).
Therefore, the taxpayer contended that no part of its income was taxable in India.
Revenue’s contentions
Referring to the AAR’s finding on the taxpayer’s contract with XYZ, the Revenue contended before the HC that the taxpayer had a PE in India for the ABC contract as well.
There was no single lump sum price for the whole contract.
The consideration for mobilisation/ demobilisation constituted 68% of the total consideration, and the actual installation constituted 25%.
Therefore, supply/ use of the equipment constituted a large proportion of the consideration.
It was not necessary that the equipment should be in the direct dominion and control of the taxpayer for the payment to constitute royalty. As long as the equipment could be exploited by, or by the order of the taxpayer, the requirement
3Ishikawajima-Harima Heavy Industries Ltd v. DIT [2007] 288 ITR 408 (SC)
of dominion/ control would stand satisfied, and payment for the same would qualify as royalty.
The work of mobilisation/ de- mobilisation and the work of installation were separate components and thus should be taxed separately. In support of this contention, the
Revenue placed reliance on the Supreme Court (SC) decision in Ishikawajima-Harima Heavy Industries Limited.3.
Based on the above, the Revenue contended that (a) the taxpayer had a PE in India; (b) the contract was for equipment hire, and thus consideration for mobilisation/ demobilisation should be taxable as equipment royalty; and (c) installation services were ancillary to use of equipment, and thus taxable as FTS per tax treaty provisions.
High Court ruling
Re-characterisation of contract
The HC concluded that the Revenue’s attempt to re- characterise the contract as one for hire of equipment was not valid. It reached this conclusion based on the following reasoning:
- It was evident from various clauses of the contract that ABC did not have dominion or control over the
equipment.
- It was clear that at all times during the execution of the contract, control over the equipment brought by the taxpayer was to remain with the taxpayer.
Thus, the HC concluded that the AAR had proceeded on a factual misconception that the dominion and control of the equipment was with ABC. The HC accepted that the contract
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was for installation and erection of the equipment, and mobilisation/ demobilisation constituted an integral part of the contract.
PE in India
The HC observed that the AAR’s finding that the taxpayer had a PE in India was rendered in the context of the taxpayer’s contract with XYZ. The Revenue did not argue about the existence of PE before the AAR in respect of the ABC contract. Accordingly, the HC held that it was not open to the Revenue to now contend that the taxpayer had a PE qua the contract with ABC.
Having said this, the HC also examined the factual aspects for existence of a PE in respect of the ABC contract. It
observed, based on facts, that the taxpayer was present for 41 days during financial year 2008–09 for rendering services to ABC, and that the taxpayer did not have any project office in India. Thus, the taxpayer could not be said to have an installation or construction PE in India, as the activity carried on in India was for less than 183 days in any fiscal year.
Income from mobilisation/
demobilisation services
The HC held that it was clear from the contract itself that the control of the equipment remained with the taxpayer throughout, and was not transferred to ABC. It clarified that there was a difference between use of the equipment by the taxpayer “for” ABC and the use of the equipment “by”
ABC. As the equipment was
4Visual Inc. v. Asst. CCT 124 STC 426 (Kar)
used for rendering services to ABC, it could not be converted to a contract of hiring of equipment by ABC.
It confirmed the taxpayer’s reliance on the ruling of Asia Satellite Telecommunications Co. Ltd.2, and further placed reliance on the Karnataka HC’s ruling in Visual Inc.4. Income from installation services
The HC held that the entire contract was a composite contract for residual offshore construction work at Paradip.
ABC paid the taxpayer for execution of a composite contract. Based on the above, the HC rejected the Revenue’s reliance on the Ishikawajima- Harima3 decision.
As the HC held that payment received by the taxpayer for mobilisation/ demobilisation could not be treated as equipment royalty under article 12.3(b) of tax treaty, the question of treating the installation work as ancillary to such mobilisation/
demobilisation work, and thereby holding the payment for installation as FTS under Article 12.4(a), did not arise.
The HC observed that services provided by the taxpayer did not constitute FTS under Article 12.4 of the tax treaty, since they did not involve transfer of any technology, skill, experience or know-how to enable ABC to undertake such activities on its own.
From the domestic law perspective, the HC accepted the taxpayer’s contention that the services it rendered to ABC under the contract were covered under the exclusionary
portion of Explanation 2 of section 9(1)(vii) of the Act (i.e.
“...consideration for any construction, assembly , mining or like projects undertaken by the recipient”).
Accordingly, the HC held that the income earned by the taxpayer was not taxable as FTS as per provisions of the Act.
The takeaways
This is an important decision impacting foreign EPC companies earning income from India. This judgement has laid down the principle for determining when the consideration for use of equipment can be treated as equipment royalty under the respective tax treaties. In addition, the HC established the difference between a service contract and a contract for equipment hire.
This judgement is based on specific facts, and before applying this decision, the facts of each case need to be carefully analysed. Further, the principle enunciated in this decision should not be construed as final, as the chances of the Revenue appealing to the SC cannot be ruled out.
Let’s talk
For a deeper discussion of how this issue might affect your business, please contact:
Tax & Regulatory Services – Direct Tax
Gautam Mehra, Mumbai +91-22 6689 1154
[email protected] Rahul Garg, Gurgaon +91-124 330 6515 [email protected]
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