3 July 2015 EY Tax Alert SC rules on presumptive taxation; activities inextricably linked with prospecting, extraction or production of mineral oil eligible for presumptive taxation 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 decision of the Supreme Court (SC) in the case of Oil and Natural Gas Corporation Ltd. [1] (Taxpayer). The Taxpayer was treated as a representative assessee on behalf of various nonresident (NR) companies (FCos) with which the Taxpayer had entered into separate agreements for availing of diverse services. The services rendered by the FCos to the Taxpayer included various services, such as provision of personnel with expertise and experience in operation and management of an oil rig, engineering and technical support, processing of seismic data, consultancy and training service, analysis of data, geological and feasibility study, inspection and repair service etc. The issue was whether the income of the FCos from such services is governed by the scheme of presumptive taxation provided under the Indian Tax Laws (ITL). The SC held that the services rendered by the FCos were inextricably linked with prospecting, extraction or production of mineral oil and, hence, were mining and related/ancillary services, so as to get excluded from the definition of fees for technical services (FTS) as provided under the ITL. Accordingly, the FCos would be governed by the provisions of presumptive taxation under the ITL. [1] [TS-363-SC-2015]
Background and facts The ITL provides for a scheme of presumptive taxation under Section 44BB, whereby the taxable income is presumed at 10% of specified receipts in case of an NR engaged in the business of provision of services or facilities in connection with or supply of plant and machinery to be used in prospecting, extraction or production of mineral oil. The ITL generally provides for gross basis of taxation for FTS earned by an NR. Furthermore, FTS has been defined to mean any consideration for rendering managerial, technical or consultancy services (including the provision of services of technical or other personnel). However, the FTS definition specifically excludes consideration for construction, assembly, mining or like project undertaken by the recipient. Having regard to the diverse provisions of the ITL, income in the nature of FTS is kept outside the purview of the presumptive taxation provisions. As a corollary to this, presumptive taxation benefit is available if income consideration for services rendered by an NR is, inter alia, in the nature of mining or like project and, hence, not FTS. The Central Board of Direct Taxes (CBDT), the apex administrative body for taxation in India, issued Instruction No. 1862 on 22 October 1990 (Instruction) to clarify that operations of prospecting for, or extraction or production of, mineral oil are mining operations and the expression mining or like project would cover rendering of services like imparting of training and carrying out drilling operations for exploration or exploitation of oil and natural gas. Accordingly, consideration for such services will not be treated as FTS under the ITL and will be taxable under the scheme of presumptive taxation. The Taxpayer, an Indian company, entered into separate agreements with various FCos for availing diverse services (listed below) in connection with prospecting, extraction or production of mineral oil by the Taxpayer. These agreements were broadly classified as falling into the following categories: Carrying out seismic surveys and drilling for oil and gas. Services starting/re-starting/enhancing production of oil and gas from wells. Services for prospecting for exploration of oil and/or gas. Planning and supervision of repair of wells. Repair, inspection or equipment used in the exploration, extraction or production of oil and gas. Imparting training. Consultancy in regard to exploration of oil and gas. Supply, installation etc., of software used for oil and gas exploration. The Taxpayer was regarded as a representative assessee on behalf of all the FCos for concluding tax assessment. The Tax Authority regarded income to be in the nature of FTS and denied benefit of presumptive taxation as prayed for. The Appellate Authority had accepted the claim of the Taxpayer. The High Court reversed the order of the Appellate Authority by holding that the services of the FCos are in the nature of FTS. The issue before the SC was whether the services rendered by the FCos were eligible to be taxed under the presumptive basis of taxation under the ITL. Taxpayer s contentions Consideration received by the Taxpayer under various contracts is for mining or like project and, hence, not FTS. In the absence of any definition of the term mining under the ITL, it should be understood based on the provisions of the Oil Fields (Regulation and Development) Act, 1948, read with the Petroleum and Natural Gas Rules, 1959. The provisions of the said Acts support the view that any service in connection with prospecting and extraction is an integral part of mining. The eventual test is one of pith and substance of the agreement, namely,
whether the works contemplated or services to be rendered under the agreement are directly and inextricably linked with the prospecting, extraction or production of mineral oil. Each of the agreements entered into by the Taxpayer satisfied this condition. The Instruction, being binding on the Tax Authority, should be applied in the present facts and, accordingly, income should be assessed under presumptive basis. Tax Authority s contentions The primary service rendered by the FCos is not for prospecting, extraction or production of mineral oil, but is in the nature of FTS. operations that would be crucial for the applicability of the presumptive scheme of taxation. The crucial test is one of pith and substance of the agreement. Where the dominant purpose of the agreement is for carrying on any activity which is directly associated or inextricably connected with prospecting, extraction or production of mineral oil, it will be covered by the scheme of presumptive taxation provided under the ITL. The fact that certain ancillary work is contemplated thereunder will not alter this conclusion. Accordingly, the SC held that the income received by the FCos is taxable under the provisions of the presumptive scheme of taxation under the ITL. Though the services rendered by the FCos, such as training of personnel, may have some connection with prospecting, extraction or production of mineral oil, it only has a remote connection with the business of prospecting, extraction or production of mineral oil. Even if it is argued that the Courts ought to have examined each agreement to evaluate its true intent, the matter needs to be remanded to the Tax Authority for examining the scope of the various agreements. SC s ruling The ITL does not define the expression mines or minerals. Having regard to the provisions of the Mines Act, 1952 which defines mines and minerals and the Oil Fields (Regulation and Development) Act, 1948 which specifically deals with prospecting and exploration of mineral oil, it is clear that even drilling operations would amount to a mining activity or a mining operation. This view is also upheld by the Instruction. Thus, it is the proximity of the work contemplated under the agreement with mining activities or
Comments There is a plethora of decisions which has analyzed the scope of the expression mining or like project. However, the Courts have been taking divergent views and there was no consensus on its interpretation. The present SC decision is a welcome step in this regard. It has given a broad interpretation to the expression mining or like project and has taken a view that, as long as the activities contemplated by an agreement with an NR are inextricably linked to prospecting, extraction or production of mineral oil, the benefit of presumptive taxation should be available. It also held that where the dominant purpose of the agreement is for prospecting, extraction or production of mineral oil, the consideration will be covered by the presumptive taxation provision, though there may be certain ancillary works contemplated thereunder.
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