Madras HC rules income under time charter arrangement for ships as royalty

Transcription

1 23 October mber 2012 EY Tax Alert Madras HC rules income under time charter arrangement for ships as royalty Executive summary Tax Alerts cover significant tax news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your EY advisor. This tax alert summarises a recent ruling of the Madras High Court (HC) in the case of Poompuhar Shipping Corporation Ltd. (PSCL) and West Asia Maritime Ltd. (WAML) [1] on the issue of whether hire charge for chartering Indian coastal shipping vessels (ships) for plying within Indian ports under time-charter arrangement (TCA) and bare-boat charter-cum-demise (BBCD) arrangement, with various foreign shipping companies (FSCs), is taxable in India as royalty, under the Indian Tax Laws (ITL) as well as under the Double Taxation Avoidance Agreement (DTAA). While determining taxability under TCA and BBCD, the HC dealt with a number of issues, viz., (a) whether a ship qualifies as equipment, (b) whether charges under TCA and BBCD are for the use or right to use such equipment and, consequently, taxable as royalty, (c) availability of benefit of Article 8 of the DTAA dealing with shipping income, (d) trigger of permanent establishment (PE) for FSCs by virtue of presence of ships in India, (e) whether parallel proceedings, as payer-in-default and representative agent (Agent) against the payer, is permissible under the ITL. [1] ITA Nos. 2841,1191&2842/Mds/05; ITA Nos. 2376&2377/Mds/2005; ITA Nos. 145 to 153/Mds/2012; ITA Nos. 145 to 148/Mds/2012

2 While ruling in favor of the Tax Authority, the HC held that payments under TCA are for the use and hire of ships and not for rendition of any service. Further, the ship qualifies as equipment for the purposes of equipment royalty under the ITL as well as the DTAA and thus, taxable as royalty. FSCs cannot avail the benefit of Article 8 of the DTAA as the ships are not plying in international traffic but between two ports in India. Furthermore, operating through FSCs, ships constitute PE and, the income from letting out ships is not effectively connected/attributable to the said PE and could be taxable as royalty on gross basis. The Tax Authority is permitted to initiate parallel proceedings against the payer (a) as a payer-in-default for failure to withhold tax and (b) as an Agent for assessment of FSCs taxable income in India as both the proceedings operate in different streams. Background and facts of PSCL and WAML: PSCL, a Government undertaking, was engaged in the business of moving coal from various ports in India to a particular location within India. For this purpose, PSCL entered into TCA with various FSCs for chartering ships. PSCL did not withhold taxes on payments to FSCs as it was of the view that the payment was in the nature of service and was accordingly, not taxable in India under the ITL as well as the DTAA. Further, WAML, a public limited company, was engaged in the business of shipping, had hired a ship from a Cyprus company (CyprusCo) under BBCD arrangement. WAML claimed that the payments under BBCD were towards option to purchase ship and hence, not taxable. The Tax Authority scrutinized TCA and observed that PSCL was required to pay a fixed sum irrespective of the quantum of freight carried or the number of journeys undertaken by the ships. Accordingly, the Tax Authority held that the arrangement was not a service but constituted royalty as the same was for the use or right to use industrial, commercial or scientific equipment (equipment royalty). Accordingly, PSCL was treated as a payer-in-default for not withholding taxes. Additionally, PSCL was also treated as a representative agent (Agent) of FSCs under the ITL. In the case of WAML, the Tax Authority observed that WAML had an option to exercise purchase of the ship at the end of each year, which however, was not exercised. As the ship was deployed on the coastal line between ports in India, benefit of the DTAA was not available. Aggrieved, PSCL and WAML appealed before the First Appellate Authority (FAA). The FAA upheld the findings of the Tax Authority and ruled that: Payment to FSCs was not for rendering services but for hiring ships. As PSCL had control over the captain of the ships and FSCs acted as agents of PSCL, the payment for the ships was for the use or right to use of equipment and accordingly, taxable as equipment royalty. In the case of WAML, WAML was not the owner of the ship until the last month s hire instalment was paid to CyprusCo. Thus, till the option to purchase was not exercised, WAML was not to be treated as the owner but only as a hirer of the ship. Thus, the consideration paid periodically was in the nature of hire charges for the use of the ship and not deferred payment of consideration. Accordingly, the payment constituted royalty. FSCs (including CyprusCo) cannot rely on Article 8 of the DTAA (shipping income), as the DTAA benefit was restricted only to incomes earned by FSCs from transportation of passengers, goods etc. in international traffic. In the present case, the ships are engaged in carrying goods between ports in India and not outside, and the requirement of plying in international traffic (between different countries) is not satisfied. Aggrieved, PSCL and WAML appealed before the Second Appellate Authority (Tribunal). The Tribunal however, dismissed the appeals filed by PSCL and WAML and upheld the order of FAA.

3 Aggrieved, PSCL and WAML filed an appeal with the HC. HC s ruling Whether TCA is for rendition of a service or for use and hire of ships? TCA between FSCs and PSCL provides that (a) PSCL has the liberty to sub-let the vessel for all or any part of the time covered by TCA; (b) PSCL shall pay for the use and hire of the ships for each day, commencing from the date of delivery; (c) the usual places of loading shall be at PSCLs disposal; (d) the place of re-delivery of ships is at PSCLs option; (e) the masters/captains and others working in the ships are at the disposal of PSCL; and (f) PSCL is to provide for all operating expenses such as fuel, port charges, pilotages, agencies, commissions, consular charges etc. The Supreme Court (SC) in Gosalia Shipping P. Ltd. [2] considered similar clauses in TCA and ruled that the payment by hirers was not on account of carriage of service, but was payable on account of use and hire of ships. The SC, thus, ruled that a TCA is essentially for the use and hire of ships and the amount payable to FSCs is irrespective of what use the ship is put to, by the hirers. Accordingly, payments under TCA are for the use and hire of ships and not for rendition of any service. Whether payments to FSCs are for use or right to use and consequently, royalty? Under the ITL as well as the DTAA, royalty means the consideration paid for the use or the right to use. Consideration paid for use or right to use simplicitor is sufficient for characterization as royalty. The SC in Rashtriya Ispat Nigam Ltd. [3] observed that by giving possession to the hirer who has control and custody, the condition of use or right to use is satisfied. Thus, so long as the hirer is given the right to use (with a right to put the equipment to beneficial use for itself, or to keep it idle, or the right to sublet) and accesses the ships to its advantage economically then, the requirement of use or right to use is met. The term use or right to use is intended to take its ordinary meaning and needs to be applied in the broader sense, i.e., employing for any purpose. Thus, presence or absence of possession, effective or general control, and custody with the payer may not be relevant while evaluating the character of a payment. PSCL, as per TCA, had right to use ship, select the time and decide route as per its requirement. Though PSCL did not have physical possession of the ship, the payment is for the use or right to use the ship. Accordingly, where PSCL derives an economic benefit from the ships, consideration paid thereof constitutes royalty. In the case of WAML, under BBCD, WAML was not the owner of the ship and the consideration was, therefore, in the nature of hire charges for the use of the ship. Whether ship qualifies as equipment for royalty purposes? The term equipment has not been defined under the ITL or the DTAA. However, the term plant has been defined in the ITL for depreciation purposes while computing income under the head business or profession, in an inclusive manner. This inclusive definition embraces within its fold a ship, book, medical equipment, apparatus etc. [2] [113 ITR 307] [3] [77 STC 182]

4 The term plant is judicially understood as an apparatus used by a businessman for carrying on his business, including goods and chattels (movable or immovable), which is meant for permanent employment in such business. Thus, plant includes every tool, apparatus, equipment or machinery, not limited to machinery used in tool. The word "equipment", when construed in light of the equipment royalty clause, extends the normal or ordinary meaning of the word. Also, the equipment royalty clause uses the term any before the term equipment. This clearly points out the need for construing the said term widely, so as to embrace every article employed by the taxpayer for the purposes of its business. So long as the equipment is employed for the purposes of one's income, they shall also fall within the ambit of equipment royalty, even if it is referred to as an apparatus or plant or machinery. Thus, a ship is an equipment of the business of a ship owner on a natural and ordinary meaning of the word. Therefore, a ship, being a plant, with which FSCs operate their business, and commercially exploit for earning income, qualifies as an equipment and accordingly, user charges thereof are taxable as equipment royalty under the ITL. Whether income earned by FSCs is not taxable in India by virtue of Article 8? Under Article 8 of the DTAA, payment to FSCs which are operating only in international traffic is taxable in the country in which FSCs have a place of effective management. In the present case, FSCs (including CyprusCo) had let out the ship for use for plying within Indian coastal waters. As the ship operated between the coastal lines of two ports in India and thus, the test of international traffic is not met. Accordingly, the payer could not invoke Article 8 for determining taxability of payments to FSC for the purposes of tax withholding. Whether a PE exists for FSC in India? As per Article 5 of the DTAA, a PE is a fixed place of business through which the business of FSC, i.e., the FSC based out of Cyprus, is wholly or partly carried on in India. FSC is the owner of the ship which is let out on hire to WAML. The ship is designated as a coastal vessel, i.e., which is exclusively employed for plying between ports in India. The ship is used continuously, in excess of 90 days, in India. The hiring of the ship is not occasional but for a continuous period. In order for a PE to exist, there must be a fixed place for the business to be carried on. In the case of equipment, a fixed place can be found to exist even though the equipment, for a single customer under one integrated contract, may be relocated from one place to another. A movable place of business is thus, treated as fixed when most of the equipment is used at fixed points within a proximate area on a repetitive continuous basis for sufficient period of time as required by the business. Thus, when the business activities are peripatetic and the equipment moves between neighbouring locations, a single place of business exists, which presents a coherence in commercial and geographical aspect with regard to the conduct of business. The moving ship has a place of business where the ship is docked and the fact that the ship moved from one point to another is the result of the nature of business contract and such movement is an integrated one having business and geographical coherence. This leads to an inference that FSC has a PE in India. However, the receipt of hire charges is not attributed as the income earned from the PE but, for the use or right to use the ship and consequently, is taxable as royalty and not as business profits since the income is not effectively connected/attributed to the said PE.

5 Whether parallel proceedings can be initiated under the ITL? The ITL treats any person as an Agent when such person has a business connection with a nonresident (NR) in India or when a NR earns income directly/indirectly, through or from, such person. In such circumstances, the person is treated as an Agent of the NR for recovery of taxes payable by the NR. Further, where the payer fails to withhold tax or after withholding the tax, fails to deposit the same then, the payer would be treated as a payer-in-default. Proceedings as payer-in-default have no correlation with the status of PSCL as an Agent. As long as the Tax Authority is able to justify that the income falls within the deeming fiction of the source rule under the ITL, the proceedings as an Agent stands attracted. The contention that both the proceedings cannot be initiated together is incorrect as both operate in different spheres, i.e., payer-in-default proceeding is on account of failure to withhold taxes and proceedings as an Agent is for the purposes of assessment of income of FSCs. Comments Taxability under a time-charter arrangement has been a contentious issue. In a recent decision of the Chennai Tribunal in the case of Poompuhar Shipping Corporation Ltd. (ITA No. 145 to 148/ 2012), it was held that hire charges paid to FSCs, under a time- charter arrangement are towards service and may not be considered as payment for use of equipment and hence, not royalty. The HC however, has rejected this ruling and has taken a divergent view on the matter. By observing that the features of the time-charter arrangement were comparable to the arrangement before the SC in the case of Gosalia Shipping P. Ltd. (supra), the HC held that the consideration was for the hire of the ship and since a ship is an equipment, TCA charges constitute royalty. This ruling would not apply to cases where TCA is in respect of ships plying in international traffic. Since the ships, in the present case, were plying along the Indian coastal line and not in international traffic, the benefit of the shipping article of the DTAA was not available. The observations of the HC on initiation of parallel proceedings on the Indian payers as (a) payer-indefault, and (b) an Agent, may also merit special attention. In fact, the Chennai Tribunal in the case of Poompuhar Shipping Corporation Ltd. (supra) had restored the matter back to the Tax Authority with an instruction to initiate proceedings either as a payer-in-default or as an Agent, but not under both. Such initiation of proceedings would certainly be severe and harsh on the Indian payer. It is therefore, advisable to obtain clarity on withholding requirement before discharging the payments to NRs.

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