EY Tax Alert. Executive summary

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1 9 January 2015 EY Tax Alert Jabalpur Tribunal rules on interplay between provisions of PE and FTS for taxing installation/commissioning activities in composite contracts 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 summarizes a recent ruling of the Jabalpur Income Tax Appellate Tribunal (Tribunal), in the case of Birla Corporation Ltd. (Taxpayer) [1], on the issue of taxability of installation and commissioning charges of machinery in India under the Indian Tax Laws (ITL) and the seven applicable double taxation avoidance agreements (DTAAs). The installation and commissioning activities were in connection with machinery/equipment supplied by vendors from outside India. The Tribunal held that such activities do not create an installation permanent establishment (PE), since the activities did not exceed the threshold provided in the DTAAs. Furthermore, the payments would not be covered under the fees for technical services (FTS)/fees for included services (FIS) articles of the DTAAs. Hence, the payment towards installation and commissioning activities made to foreign vendors would not be taxable in India and the Taxpayer is under no obligation to deduct tax at source on such payments, under the ITL. [1] [TS-790-ITAT-2014(Jab)]

2 Facts and background The Taxpayer, an Indian company, is engaged in the business of manufacturing and selling cement. During the tax years under consideration, the Taxpayer imported certain plant and machinery from various vendors located in seven countries viz., Austria, Belgium, China, Germany, Switzerland, the UK and the US. These vendors also provided services for installation and commissioning of plants and machinery. Technicians of the respective vendor visited India for the purpose of the said installation/commissioning. The Taxpayer made remittances to the vendors, without withholding taxes in India. The Taxpayer was of the view that the payments were for supply of plant and machinery from outside India and, hence, not chargeable to tax under the ITL. Fee for installation and commissioning was paid separately at a later date and, on these payments, taxes were duly withheld at the rate of 10% under the ITL. determination of chargeable income element and the tax deductible thereon and, in the absence of the above, withhold tax on the entire payment [2]. The Tax Authority raised tax demands treating the Taxpayer as a defaulter for not withholding taxes which were computed at the rate of 42.25% on the total consideration payable for supply of plant and machinery. Aggrieved, the Taxpayer appealed to the First Appellate Authority which upheld the order of the Tax Authority. Against this order, the Taxpayer preferred an appeal before the Tribunal. Tribunal s ruling For application of tax withholding provisions under the ITL, it is a sine qua non that the payment to a nonresident must have an element of income liable to be taxed under the ITL. Taxability under the ITL The Tax Authority challenged the above and contended that: The contracts entered into by the Taxpayer for design, manufacture, supply, installation, testing and commissioning of the plant are in the nature of composite contracts or "works contracts. Payments made by the Taxpayer to vendors represented payment for both supply of plant and machinery, as well as for incidental services of installation and commissioning of such machinery. The separate payments made by the Taxpayer constituted additional remuneration to the technicians and reimbursement of certain expenditure. The actual consideration for rendition of these installation/commissioning services is not paid separately and the same is embedded in the consideration paid towards supply of this equipment, plant or machinery. The Taxpayer was required to approach the Tax Authority for Part of the consideration which can be attributed to installation, commissioning or assembly of the plant and equipment, or any supervision activity in connection thereto, is taxable under the ITL. Such portion clearly accrues and arises in India, since the related economic activity is performed in India. As the income accrues and arises in India, there is no requirement to look at the deeming fiction of the ITL, which provides for taxation of income which is deemed to accrue or arise in India. [2] Support drawn from the Supreme Court decision of GE Information Technology Centre Pvt. Ltd. [327 ITR 436]

3 Additionally, the deeming provision for taxing FTS income excludes consideration for any construction, assembly, mining or like project from its purview. The expression installation, commissioning or erection of plant and equipment belong to the same genus as the expression assembly used in the exclusion clause and, hence, such activity would be out of the deeming provision of the ITL concerning FTS taxation. Taxability under the DTAAs On installation PE (all the seven DTAAs contain the provision) [3]. The Taxpayer s work of installation and commissioning in respect of all transactions does not exceed the time threshold prescribed under the installation PE clause of all the DTAAs. In terms of the India-Belgium and the India-UK DTAAs which provide an additional condition of value of such installation/commissioning services to be more than 10% of the sale value, this condition is also not fulfilled. An installation PE is not created under all the applicable DTAAs. Interplay between installation PE versus FTS/FIS. Services in the nature of installation and commission would, de facto, amount to technical services. There is an overlapping effect, such that, there is a general provision (of FTS/FIS) for rendering technical services and a specific provision (of installation PE) for rendering technical services in the nature of construction, installation and supervision activities. If there is an apparent conflict between two independent provisions, a specific provision must prevail over the general provision [4]. [3] The time threshold provided in the seven DTAAs ranges between 120 to 183 days. [4] The Supreme Court ruling in the case of Union of India v. India Fisheries (P) Ltd. [57 ITR 331(1965)] and ITO v. Titagarh Steels Ltd.. [79 ITD 532(2001)] If one were to proceed on the basis that, even if the PE fails, taxability can be held under the FTS provisions, such an approach would render the PE provisions meaningless. Such an approach would also be contrary to the spirit of the UN Model Commentary which states that, in terms of business income, a source country does not have the right to tax income unless time thresholds are satisfied as specified in the PE provisions of a DTAA. In a situation where there is a specific PE clause in relation to a particular type of service and such services are also covered by the scope of FTS/FIS provision, the taxability of consideration for such services must remain confined to the relevant specific PE clause. The provisions of taxability as FTS/FIS will not come into play in such cases. Characterisation under FTS/FIS article Without prejudice to the above, even if the FTS/FIS article is applied to the instant case, the payment may not qualify as FTS/FIS under the India-UK and the India-US DTAAs, since the make available condition is not satisfied. Installation or commissioning by the vendors does not even involve transfer of technology, in the sense that the recipient of these services (i.e., the Taxpayer) cannot perform such services on its own, without recourse to the service provider. Hence, make available condition is not satisfied. The same position would apply with regard to the India-Belgium DTAA in terms of the most favoured nation (MFN) clause. The MFN clause allows benefit of restricted scope of FTS provided under any DTAA entered into by India after the signing of the India-Belgium DTAA. In view of the India-UK DTAA and the India-US DTAA, non-applicability of such fees as FTS due to non-fulfilment of make available condition would apply for vendors located in Belgium also.

4 Others Under the India-Switzerland DTAA, installation and commissioning charges would not fall under the definition of FIS, because it specifically excludes services which are ancillary and subsidiary, as well as inextricably and essentially linked to the sale of property i.e., plant and machinery in the instant case. As per the DTAAs, taxability as FTS or FIS arises at the point of time when the payment is actually made for technical services arising in one country and paid to a resident of the other country. The event of triggering taxability under the DTAAs is the payment, and not accrual. The FTS/FIS provisions cannot be invoked for taxing a nonresident on the basis of accrual of liability, whether credited or not, or on the notions of fiction of an element of FTS or FIS being embedded in the business receipts for sale of plant, equipment or machinery. The receipts in the hands of the vendors are in the nature of business income and the same are not taxable in India in the absence of creation of a PE under the relevant DTAAs. The matter was remanded to the file of the Tax Authority to verify the existence of a PE of foreign vendors in light of the facts and provisions of relevant DTAAs. Comments This ruling rules on non-applicability of FTS/FIS articles after a PE is not created under the specific PE clause of the applicable DTAA. A similar view had been upheld in the past by the Mumbai Tribunal in the case of Aditya Birla Nuvo Ltd [5]. Interplay between applicability of FTS or PE rule is a contentious issue. The Jabalpur Tribunal took a view that rendition of installation, commissioning or assembly services would be covered by Article 5 (on PE), being a specific article applicable in respect of services which are in the nature of construction or installation project or in the nature of supervisory services in connection with such a project. [5] For more details, refer EY Tax Alert Mumbai ITAT rules payments for reassembling of machinery not taxable dated 9 December 2010.

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