Consideration received for executing turnkey contract not taxable in India in absence of PE in India

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1 from India Tax & Regulatory Services Consideration received for executing turnkey contract not taxable in India in absence of PE in India February 3, 2016 In brief In a recent decision in the case of a UAE based company, the Delhi High Court (HC) held that income earned from execution of turnkey contract was not taxable in India in absence of existence of a Permanent Establishment (PE) in India. The HC tested the principles of fixed place PE, installation PE and dependent agent PE as alleged by the Revenue against the facts, and decided in favour of the taxpayer. It found that: (i) the Project Office (Project Office) of the foreign company was engaged in activities which were preparatory and auxiliary, and would qualify for exclusion from fixed place PE; (ii) the duration of project activities did not breach the threshold prescribed for installation PE; and (iii) the agent who acted on the taxpayer s behalf could not be said to be dependent; even otherwise, it was not habitually authorised to conclude contracts in India on the taxpayer s behalf. In detail The taxpayer 1 was a tax resident of the UAE and was engaged in the business of fabrication and installation of petroleum platforms, submarine pipelines, pipelines coating at various sites. During the tax years and , the taxpayer entered into a contract with ONGC for design, engineering, procurement and fabrication of fully loaded offshore platform and its installation, testing and commissioning at an offshore facility of ONGC. 1 ITA No /2013 (Delhi) The platforms were designed, engineered and fabricated outside India, and activities relating to survey, installation and commissioning were done in India. To comply with contractual terms, the taxpayer had established a PO in India as per exchange control regulations. The taxpayer had also entered into a contract with an Indian company (ASL) to act as its sole and exclusive consultant in India for (a) providing assistance in gathering relevant market information; (b) assistance in obtaining work; (c) active representation and promotion of taxpayer s activities in India; and (d) providing assistance in obtaining services and facilities in India. For the tax years and , the taxpayer filed its tax return computing income on presumptive basis relying upon an instruction 2 of the Central Board of Direct Taxes (CBDT). The income was computed by taxing receipts pertaining to its activities in India, after claiming verifiable and receipts pertaining to activities outside The Tax Officer (TO), in his draft assessment order, held that the taxpayer 2 CBDT Instruction no dated 1 July

2 constituted a fixed place PE, an installation PE and a dependent agent PE in India. Further, the TO held that it was a turnkey, composite and indivisible contract. Accordingly, he sought to tax the entire contractual receipts in India. The Dispute Resolution Panel (DRP) concurred with the TO s findings. Aggrieved by the order, the taxpayer filed an appeal before Income-tax Appellate Tribunal, (Tribunal). While the Tribunal rejected the taxpayer s contentions on PE and concurred with TO, it accepted that the contract in question could be segregated into offshore and onshore activities. The Tribunal held that income pertaining to activities carried out outside India could not be attributed to the PE in India, and could not be taxed. The taxpayer and the Revenue both filed cross appeals before the HC. While the taxpayer challenged the Tribunal s order on PE, the Revenue challenged it on the point of divisibility of the contract. Issues before the HC Taxpayer s appeal holding that the company had a fixed place PE in India as defined in Article 5(2)(c) of the Double Taxation Avoidance Agreement (tax treaty) between India and the UAE? holding that the installation PE in India as per Article 5(2)(h) of the tax treaty was not dependent on the date of actual start of execution of the contract, but had come into existence on the date of execution of the contract? holding that the company had dependent agent PE as per Article 5(4) of the tax treaty? Had the issue of attribution of taxable income in India remained undecided by the Tribunal? Revenue s appeal Did the Tribunal err in holding that the contract with ONGC was divisible, and that no income accrued to the taxpayer on account of offshore supplies it made? Taxpayer s contentions The PO had acted merely as a communication channel, and was established only to comply with contractual requirements and the applicable exchange regulations. The PO was manned by only three employees, who were simple graduates and were not capable of participating in the execution of work. They were engaged in back office work for liaison, coordination and collection of information. The taxpayer relied on various precedents 3. POs of the company in the past were different and could not be linked to the PO established for the contract in question. Pre-engineering and preconstruction surveys were conducted by an independent third party which was engaged on a principal-to-principal basis. Meetings with ONGC were attended by employees coming directly from UAE, and the PO was not involved. 3 UAE Exchange Centre Limited v. UOI [2009] 313 ITR 94 (Delhi), CIT v. BKI/HAM V.O.F. [2012] 347 ITR 570 (Uttrakand), Cal Dive Marine Construction (Mauritius) Limited, In re [2009] 315 ITR 334(AAR) and IAC v. Mitsui & Co. Limited [1991] 39 ITD 59 (Delhi-ITAT) (SB) The only activities carried out by the taxpayer in India were installation and commissioning. The 9-month threshold for calculating installation PE could commence only when barges with fabricated platform reached the work site. Time taken for pre-bid activities, notification of award, signing of contract, and meetings with ONGC were irrelevant for calculating the existence of installation PE, since such works did not result in acquiring control over a work site. Pre-engineering and preconstruction surveys were conducted by an independent third party engaged on a principal-to-principal basis. Activities of independent subcontractor could not be included for calculating the period of installation PE. ASL was an independent entity and had carried out substantial business activities other than those related to the taxpayer. Revenue s contentions The taxpayer had admitted to having a PE in its return of income; a contrary claim could not be made at the time of assessment 4. The taxpayer could not be permitted to depart from its consistent stand that had been sustained over the past several years 5. As per exchange control regulations, a PO was a place of business to represent the interest of the foreign company executing a project in India, but excluded a liaison office. The taxpayer s contention that PO had no role to play in the contract was contrary to the record. 4 Goetze (India) Limited v. CIT [2006] 284 ITR 323 (SC) 5 Radhasoami Satsang v. CIT [1992] 193 ITR 321 (SC) PwC Page 2

3 The PO had made substantial payments in India. Also, the scope of work under the contract indicated that the PO s role was not only limited to auxiliary or preparatory activities. The contract specifically stated that the date of notice of award would be the effective date of commencement of the contract. Various surveys were included in the scope of work. The Revenue had relied on a commentary by an international author that time spent on onsite planning would be included in computing the duration while considering installation PE Under the terms of consultancy agreement, ASL agreed not to represent a competitor of the taxpayer. ASL had participated in the pre-bid and kick-off meetings. Though ASL had substantial revenues from other activities, it could not be construed as an independent agent so far as the project in question was concerned. Contracts in question were composite contracts, as all activities were closely linked. The contract could not be split between the activities carried out overseas and activities carried out in India. Ownership of platforms was transferred to ONGC only on issuance of completion certificate by the ONGC. The Supreme Court s ruling in the case of Ishikawajima-Harima 6 and Hyundai Heavy Industries 7 as transfer of properties in those cases were outside India, whereas in the instant case, it was in India. 6 Ishikawajima-Harima Heavy Industries Limited v. DIT [2007] 288 ITR 408 (SC) 7 CIT v. Hyundai Heavy Industries Co. Limited [2007] 291 ITR 482 (SC) Delhi HC Ruling The PO was established only to comply with the contractual requirements and the applicable exchange regulations. It was used only as a communication channel, and not for execution of contracts. There was no material to support the contention that employees who attended the meetings with ONGC were employees of the PO. There was no material evidence to controvert the taxpayer s claim that its PO was only used as a communication channel, and hence, would fall under the exclusionary clause for PE. The HC did not agree with the revenue s contention that taxpayer was not entitled to contend that no PE existed. Its return of income was not accepted, and the TO had questioned the attribution of income to the PE. In view of the enquiry, it would always be open for the taxpayer to explain that the PO was not involved in any main activities for execution of projects, and was only a communication channel. Secondly, Goetze 4 did not fetter the Appellate Authorities from considering the taxpayer s claim. A building site could be construed as a fixed place PE only when an enterprise commenced its activity at the project site. Duration of activities carried out by an independent sub-contractor would not count towards the duration of taxpayer s PE. There was a large gap between initial activities of preengineering survey and commencement of initial installation works. Considering that the taxpayer did not have access to the site during that period, that period needed to be excluded. As the taxpayer s business activities at the site were completed in less than 9 months, the taxpayer could not be said to constitute an installation PE in India as per Article 5(2)(h) of the tax treaty. While ASL acted as a sole and exclusive consultant for the taxpayer, the consultancy agreement did not fetter ASL from carrying on its regular activities, including providing consultancy services to persons other than taxpayer s competitors. ASL was an independent entity as it acted in the normal course of its business. Also, the agreement between the parties was entered into on principal-toprincipal basis. ASL had also carried out substantial business activities other than those for taxpayer. Even otherwise, there was no material to support the view that ASL was habitually authorised to conclude the contracts on behalf of taxpayer. Hence, ASL could not be considered as the taxpayer s dependent agent PE. Considering no PE situation, the question of splitting business profits between attributable to activities in India and outside India was not relevant. However for the sake of completeness, HC referred to section 4, 5 and 9 of the Income-tax Act, 1961 and the Article 7 of the tax treaty to reiterate that only such income as was attributable to the taxpayer s PE in India, could be taxed. Consideration for various activities had been specified in the contract. Invoices raised by the taxpayer identified the work done inside India, as well as outside India. Thus, even though it was a turnkey contract, the value of work done outside India was ascertainable. The Tribunal rightly held that consideration for the activities carried on overseas could not be PwC Page 3

4 attributed to the taxpayer s PE in India. The takeaways It is a welcome judgement, reemphasising that even in a turnkey contract, only income attributable to activities carried out in India could be taxed in India. It also re-emphasised that merely because a contract lasted for two years could not give rise to a presumption that a PE is constituted. However, PE being a fact-based concept, each case is required to be tested based on facts of each case. 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 Rahul Garg, Gurgaon PwC Page 4

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