AAR Opines on Indian Taxation of Off-Shore Contracts and Related 'Association of Persons' Issues
In a case involving off-shore and on-shore contracts amongst three entities, the Authority for Advance Ruling (“AAR”) has in the case of Power Grid Corporation of India Ltd (“Power Grid”)1 followed the judgment of the Supreme Court of India in the case of Ishikawajma2and held that amounts paid to non-residents for off-shore contracts taking place outside India are not taxable in India. Interestingly, an aspect of this ruling which makes it unique is that the AAR has also examined whether or not such contracts with two separate entities may constitute an Association of Persons (“AOP“).
Power Grid invited bids for execution of works related to a certain project in 2005. M/s Hyosung Corporation (“Applicant”), a Korean company, was the successful bidder for this project. The terms and conditions of the bid allowed the Applicant to assign whole or part of the project to an independent contractor subject to approval of Power Grid. Power Grid accepted the bid proposal submitted by the Applicant and vide a Letter of Award (“LOA”) awarded the Off-Shore Contract to be performed outside India to the Applicant. The On-Shore Supply Contract and On-shore Services Contract was awarded to the Applicant’s assignee, namely, L&T. The LOA gave the Applicant the overall responsibility to ensure execution of all the three contracts to achieve successful completion of the entire project. A Deed of Assignment was executed between the Applicant and L&T. Thereafter, in terms of the LOA, Power Grid entered into three separate contracts viz. the Off-Shore Contract with the Applicant and the On-Shore Supply Contract and the On-Shore Services Contract with L&T.
With this background, the Applicant approached the AAR to determine whether the amounts receivable by the Applicant under the Off-Shore Contract are taxable in India and if yes, to what extent could they be attributed to the operations of the Applicant in India in terms of Section 9(i) of the Income Tax Act, 1961 (“ITA”) and Article 7 of the India-Korea Double Taxation Avoidance Agreement (“DTAA”). The AAR also framed an additional question as to whether the Applicant together with L&T would constitute an AOP and accordingly should be assessed as such under the ITA in respect of all three contracts.
Ruling and Analysis
The AAR analysed the provisions of the LOA and the Off-Shore Contract in detail and determined that the title of the goods passed on to Power Grid well before the goods reached the Indian port and Power Grid was the beneficiary in the insurance policy taken by the Applicant. Further, the AAR relied on the CBDT circular dated September 21, 1989 which states that profits from sale of equipment and materials on FOB basis would not be deemed to accrue or arise in India under section 9(1)(i) of the ITA as the title of the goods is passed outside India and the payments are also made outside India. The AAR also relied on the Supreme Court judgment inIshikawajma and held that the amounts received under the Off-Shore Contract would not be taxable in India for want of territorial nexus.
The Revenue’s contention that the Applicant has a permanent establishment (“PE”) in India was not accepted by the AAR. Instead, the AAR ruled that based on the facts of the case, the Applicant did not have a PE in India. The AAR stated that if on further inquiry that may be made by the tax assessing officer it is found that a PE exists, then the profits attributable and confined to the operations of the PE have to be estimated and subjected to income-tax in India. Having said that, the AAR clarified that activities incidental to the supply of imported goods such as transportation, storage and delivery should not be attributed to the PE.
The AAR also explored the possibility of whether or not the Applicant and L&T would constitute an AOP. The AAR ruled that mere collaborative effort and overall responsibility assumed by the Applicant for successful performance of the project is not sufficient to constitute an AOP in the eyes of law. The AAR determined that the present case lacked an essential feature of an AOP namely, the element of common intention to earn income. The AAR also determined that the individual identity of each party in doing the part entrusted to it is preserved, notwithstanding the coordination between the two and the overall responsibility of the Applicant. While the Revenue relied on the Geoconsult3 AAR Ruling and contended that the present arrangement between L&T and the Applicant would amount to an AOP, the AAR categorically stated that the facts involved in Geoconsult were vastly different from the facts of the present case.
Ironical indeed is the world of taxation
It is pertinent to note that the same AAR had has recently also questioned the Supreme Court’s judgment in Ishikawajma in the case of Worley Parsons4. In Worley Parsons on account of the distinctive feature of the services performed in India under an agreement, which were the pre-requisite for the services which were performed outside India, the AAR had ruled that services rendered inside and outside India had a territorial nexus with India and were therefore liable to tax in India. Now with this ruling where the same AAR has to a great extent relied on Ishikawajma, the uncertainty with respect to taxation of income earned from off-shore contracts has been clarified to a great extent.
It is important to note that rulings pronounced by the AAR are private in nature and are binding only on the Applicant and the tax authority with respect to the particular issue before it. Though such rulings do not have precedent value for other tax payers, they do have a persuasive value.
1 Ruling delivered on June 17, 2009.
2 Ishikawajma-Harima Heavy Industries Ltd. v. DIT, (2007) 288 ITR 408 (SC) wherein it was held that the consideration received by the non-resident under a contract for the supply of goods by means of transfer outside the territory of India cannot be subjected to tax in India.
4 WorleyParsons Services Pty. Ltd. dated March 30, 2009