Taxation – Whose tax is it anyway?
Whose tax is it anyway?
Taxability of income earned from the offshore supply and services has been a subject matter of litigation in the past. Ramesh Bangera throws more light
India has witnessed accelerated economic growth in the past few years. A substantial portion of this growth can be attributed to the infrastructure sector, which has been spurred up due to various regulatory changes like liberal foreign direct investment (FDI) norms, tax holiday for companies engaged in the business of generation and distribution of power, development of road, ports and so on, and exemption of Custom duty on import of capital goods used in infrastructure projects.
Normally, execution of infrastructure projects is awarded to Engineering, Procurement and Construction (EPC) contractor on a turnkey basis. Where foreign EPC contractors execute the projects, it would typically involve the following components:
• Offshore supply of equipment;
• Offshore services involving designing/ engineering/ planning the layout of the equipment;
• Onshore supply of equipment; and
• Onshore works/ services involving installation/ commissioning/ testing of the equipment.
The EPC contractor may allocate each category to a number of sub-contractors or in certain cases, a consortium may bid for the contract. Taxability of income earned from the offshore supply and services has been a subject matter of litigation in the past.
Bone of contention
The Supreme Court, in the case of Ishikawajima Harima Heavy Industries (‘IHI’) [288 ITR 408 (SC)] had laid down the principles for determining the taxability of such EPC contracts and held that income from offshore supply of equipment is not taxable in India.
This is provided the consideration is received outside India and the title in the offshore equipment has also passed outside India. Further, income from offshore services was held not to be taxable in India.
However, recently the issue of taxability of income from offshore supply and services has once again become a matter of contention between the taxpayer and the revenue authorities. While, there have been rulings in favour of the assessee wherein courts have held that offshore supply and services should not be taxable in India, based on specific facts, some courts have held that offshore components is taxable in India. It is in this context that this article highlights the key points which were notably discussed in the recent judgments.
Taxability of offshore supply
In the case of Hyosung Corporation (‘Hyosung’) (314 ITR 343) (AAR), the Advance Authority for Ruling (‘AAR’) held that the offshore supply was not taxable in India on the grounds that the title was transferred outside India considering the facts that the documentation i.e. bill of lading/ invoice were in the name of the owner of the project and the custom duty, insurance policy were also on behalf of the owner.
The AAR also held that the stipulation requiring the contractor to be responsible for quality / performance till final takeover could not postpone the transfer of title in the goods till the completion of the contract.
Similarly, the Mumbai ITAT in the case of Xelo [ITA Nos. 4107 & 4108/Mum/2002] and the Delhi ITAT in the case of LG Cable Ltd (314 ITR 301 (TDEL) have held that offshore supply was not taxable in India, despite there being a single contract for both offshore supply and installation.
Reasons being separate consideration were identified, and the title and consideration were passed outside India.
However, in the case of Ansaldo (310 ITR 237) (MAD), wherein the onshore part was executed by the subsidiary of the foreign entity, the Chennai High Court held that part of the consideration for offshore supply should be taxable in India based on the following observations.
• The role of the taxpayer did not end with transferring the title overseas. The foreign entity had responsibility for fabrication and erection of the equipment in India.
• The price of the other three contracts i.e. offshore services, onshore supply and onshore services had been loaded onto the offshore supply contract.
• There is an intimate, real and continuous relationship with the subsidiary.
Taxability of offshore services
Most of the recent ruling (Clifford Chance (221 CTR 1 (BOM) and Jindal (2009–IOL–302–HC–KAR – IT)) have relied on the decision of IHI and have held unless the twin conditions of rendering and utilising services in India are not satisfied; the offshore services cannot be taxable in India.
Further, the insertion of Explanation to section 9 by Finance Act 2007 to overrule the aforesaid Supreme Court decision does not change this stand.
Constitution of a PE/business connection by foreign EPC contractor
Recent judgments have indicated that for computing the threshold of a construction permanent establishment (PE) by the foreign EPC contractor (Krupp Uhde Gmbh 28 SOT 254 (TBOM) separate projects have to be considered separately.
However, where they are not connected and occasional short visits of contractor’s personnel for negotiations or for taking the soil samples (Cal Dive (224 CTR 447 (AAR) needs to be excluded. It
would be relevant to note that in case the foreign EPC contractor has control over the personnel deputed for the onshore work, it could constitute a business connection/PE.
Further, where the offshore contract is inextricably linked to the onshore contract, the revenue authorities could contend that there is a business connection (Ansaldo).
Withdrawal of instruction 1829
Recently, the Revenue authorities have by a notification withdrawn Instruction number 1829, which provided for non taxability of offshore supply. The reason given for withdrawal of the instruction was that the instruction was meant only for power projects and specific cases of consortium of foreign companies.
However, the instruction was being referred to for all projects where the contracts were being split into offshore and onshore parts to take advantage of the instruction. Another reason was that the profits were loaded in the exempt offshore component resulting in the onshore component ending up in a loss or low profits.
It would be pertinent to note that withdrawal of the above instruction does not seem to change the position regarding taxability of the offshore components given that the income does not accrue or arise in India.
Aforementioned rulings and withdrawal of the instruction indicate the revenue authorities’ appetite for long drawn litigation to tax the income received from offshore supply and services. In the light of these rulings, certain measures could be identified, which could help mitigate the risk of offshore supply/ service income being brought to tax in India.
Segregation of scope of work and consideration between offshore and onshore is imperative. This will clearly demarcate the delink between the contracts to ensure that the contracts are not viewed as a single composite turnkey project.
Also, the price for the offshore component should be at arm’s length, i.e. the onshore profit should not be loaded onto the offshore component. Moreover, the assessee may be required to demonstrate that the transaction of offshore supply/ services has been concluded outside India such as consideration being received outside India, title in goods being passed outside India. Merely stating in the contract may not be sufficient to claim non taxability.
However, there continues to remain ambiguity about the taxability of EPC contracts and based on the recent rulings summarised above, long drawn litigation cannot be ruled out despite some favourable judgments.
The CBDT is proposing to introduce the new direct tax code, which is kept open for public comments. It proposes to tax the offshore services at 20% on gross basis. However, it also leaves certain questions unanswered as to whether branch profit tax would apply for offshore supply and onshore supply and services. We may have to wait and watch once the direct tax code comes into effect.
Ramesh Bangera is a senior tax professional with Ernst & Young
The opinions expressed in this column are of the author and not of the publisher.