Income taxable under both FTS and PE would be taxable as FTS: AAR
Recently, the Authority of Advance Ruling (‘AAR’) has rendered a ruling1 on the applicability of presumptive taxes2 under the Income-tax Act, 1961 (‘the Act’) on the income received by non-resident companies engaged in rendering services in connection with exploration and extraction of oil in India. The issues involved were whether the income received/ receivable by the applicant in respect of services rendered in connection with the exploration and extraction of oil would either be exempt from the definition of fees for technical service (‘FTS’)3 or would fall within the ambit of presumptive tax.
The applicant is a non-resident company engaged in the business of acquisition and processing of seismic data that help geologists to draw a conclusion about the existence of hydro-carbon in the concerned area based on which companies engage in the exploration and production of mineral oil in various countries. A contract was awarded to Essar Oil Limited and Essar Engineering Holdings Limited (‘the Indian Companies’) by the Government of India for the exploration of oil.
The applicant was subsequently awarded a contract by the Indian Companies to acquire and process seismic data of over 50 sq.kms in a block by way of an agreement. In pursuance of the above work being awarded to the applicant, the applicant entered into a Memorandum of Understanding with an Indian company, M/s. Hardson Oil Fields Services Pvt Ltd. (‘the sub-contractor’) and assigned the work to it. Admittedly, the sub-contractor was a permanent establishment (‘PE’) in India of the applicant.
Subsequently, the applicant raised three invoices on the Indian Companies in pursuance of the services rendered. The Indian companies, while making the payment withheld taxes believing it to be FTS. The applicant approached the AAR to determine whether it had absolute exemption from Indian taxes on the payments received by it from the Indian companies.
The issue before the AAR was whether the income that is received by the applicant was FTS and/ or would it fall under specific presumptive tax provision which deals with foreign companies having PEs in India and receive FTS through such PEs4.
Presumptive tax is a tax on certain flat percentage of the book profits as determined under the Indian Companies Act, 1956. Presumptive tax is to facilitate foreign companies from maintaining separate books of account for tax purposes and for easy computation of their income-tax liability in India. However, presumptive tax would be levied only if the foreign company elects for it and in the absence of such an election, it would be taxable under other regular provisions of the Act.
Arguments and Ruling
Contentions of the Taxpayer
The activity undertaken by it is a mining activity which falls under the exception to the definition of FTS and therefore, no withholding taxes would apply on the payments received by it.
Since the services do not fall under FTS, the applicant could be taxed under the presumptive tax provision5 only if it had elected to be taxed as such. Since the applicant did not elect to be taxed under presumptive tax provision and since the regular provisions are more beneficial to it (exemption from FTS), the applicant enjoyed absolute exemption from Indian taxes.
Reliance was placed by the applicant in the decision of the AAR6, wherein it was held that if the activity was in connection with prospecting for, or extraction or production of mineral oils, the compensation received shall only be taxed under the presumptive tax provisions, if the taxpayer had elected for it.
Since the payments received did not fall within the definition of FTS, the applicant cannot be taxed under section 44DA, since to be taxed under section 44DA the income received should fall within the definition of FTS.
Contentions of the Revenue
Payments received by the applicant was not exempt from the definition of FTS since the exemption is applicable only to those who are actually engaged in mining or like project and the applicant is not actually engaged in such activities. Since the applicant had only engaged a sub-contractor to render services related to mining, it cannot be said that the applicant had actually engaged in mining activities. Therefore, the payments received by the applicant are FTS and liable to tax in India. For this, the Revenue relied on two case laws i.e. AAR Ruling in P No.6 of 1995 234 ITR 371 and decision of the Delhi High Court in DIT vs. Rio Tinto Technical Services 340 ITR 507.
Further, the Revenue argued that an amendment was made to section 44BB by making a carve out whereby foreign companies rendering technical service through a PE in India would be taxable under section 44DA and not 44BB. Therefore, the argument of the applicant that it falls under section 44BB and since it had not elected for it is a submission on thin air. The applicant would fall under the specific provision of 44DA and the FTS received would be attributable to the PE and taxable as business income of such PE.
Ruling of the Tribunal
The services rendered by the applicant are technical in nature and do not fall within the exception provided in the definition of FTS since the applicant has not actually carried out any mining or like project. It can at best be said that the services were rendered “in connection with” the mining activity undertaken by the Indian Companies.
The applicant cannot be taxed under section 44BB since it had merely contracted to render some prospecting services through a sub-contractor in India.
On academic point of view, the AAR held that since it is admitted that the applicant had a PE in India, any income received by the applicant through the PE would be taxable under section 44DA. However, since the applicant would be taxable under FTS there would be withholding at the rate of 10% (plus applicable surcharge and cess) on the payments made to it.
The result of the ruling was more on a question of fact as to whether the applicant actually involved in mining activities or did it provide facilities like equipment and machineries to the enterprise conducting mining activities or did it provide technical services through a PE in India.
Since the applicant did not actually do the mining activities, it could not avail the benefit of exemption under the definition of FTS. Neither did the applicant fulfill requirements to be taxed under section 44BB (i.e. providing equipment and machineries). However, the applicant provides technical service through a PE in India which would fall within specific provision under section 44DA.
Since the issue before the AAR was only to determine whether the services rendered are technical in nature to be taxed under FTS and whether such services would fall under section 44BB, the AAR held that the services rendered are taxable under FTS and not under section 44BB. The AAR did not go into the aspect of whether the applicant would be taxable under section 44DA as it was not an issue before it.
Under any tax treaty, taxability of passive income like FTS is by way of withholding tax on the gross payment as long as there is no PE in the country of source. If there exists a PE, then any income attributable to such PE would be taxed as its business income. Articles dealing with these two are mutually exclusive i.e. an income can be taxed either under FTS or under PE but not under both. However, the AAR has held that despite there being a PE of the applicant in India, it would still be taxable only by way of withholding tax under FTS.
It is now unclear as to how an applicant having a PE in India and rendering technical service would be taxed especially when the tax impact and tax rates are different. Even in the tax treaties, as per article on business income, if any profits are taxable under other articles then article on business income would not apply. Also, in the articles dealing with royalties and FTS, if there exists a PE then such income would be taxable under the article on business income. However, by practice, whenever there is a PE, then entire income whatsoever attributable to such PE would be taxable as its business income. This is supported in the case of DIT vs. Rio Tinto Technical Services (cited supra) where the Delhi High Court held that FTS connected to a PE would be taxable as its business income and the expenditure are allowed in accordance with the Act.
On the other hand, the same AAR in another case decided on the next day in Spectrum Geo Limited in AAR No.954 of 2010 held that when a foreign company is taxable under both FTS and under section 44BB, the applicant can be taxed under the latter provision since section 44DA was not attracted as the payments were neither received from an Indian company nor from the Government of India. Further, the applicant in that case was eligible to be taxed under presumptive provisions under section 44BB since the services were provided in connection with exploration and extraction of mineral oil.
*Special assistance from Bharath Jana
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1 C.A.T.Geondata Gmbh Kaerntner Ringh, A.A.R.No.1119 of 2011
2 Sec.44BB provides for presumptive basis of taxation which a non-resident can opt when he provides services or facilities in connection with the prospecting for or exploration and extraction of mineral oil or for supply of plant and machineries for the same. It provides that 10% of the income shall be deemed to be the income taxable under as business income
3 The exemption is available under Explanation 2 of section 9(1)(vii) of the Act which defines “Fees for technical services”
4 44DA of the Act which provides that when a non-resident having a permanent establishment receives an income in the nature of fees for technical services, then such income shall be taxed as business income of such PE
5 Section 44BB of the Act
6 Geofizyka Torun Sp.zo.o, In re  320 ITR 268 (AAR)