In the case of Hyosung Corporation (the applicant), which involved off-shore and on-shore contracts among three entities, the Authority for Advance Ruling (AAR) held that amounts paid to non-residents for off-shore contracts taking place outside India are not taxable in India.
Power Grid Corporation of India Ltd (Power Grid) invited bids for execution of works related to a certain project in 2005. The applicant, a Korean company, bid successfully; Power Grid accepted the bid proposal and awarded the off-shore contract (that is, for work to be performed outside India) to the applicant by means of a Letter of Award (LOA). The on-shore supply contract and on-shore services contract were awarded to the applicant’s assignee, L&T.
The LOA gave the Applicant overall responsibility to ensure execution of all three contracts in order to complete the entire project. A Deed of Assignment was executed between the applicant and L&T. In the terms of the LOA, Power Grid entered into three separate contracts: the off-shore contract with the applicant, and the on-shore supply contract and on-shore services contract with L&T.
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The applicant approached the AAR to determine whether the amounts receivable by it under the off-shore contract were taxable in India, and if so, to what extent they could be attributed to the operations of the applicant in India in terms of Section 9(i) of the Income Tax Act, 1961 (the tax act) and Article 7 of the India-Korea Double Tax Avoidance Agreement. Relying on the Supreme Court’s judgment in the case of Ishikawajima (2009), the AAR determined that the title of the goods had passed on to Power Grid well before the goods reached the Indian port, and that Power Grid was the beneficiary of the insurance policy taken out by the applicant.
The AAR also relied on the CBDT circular of 21 September 1989 which states that profits from the sale of equipment and materials on a free-on-board basis would not be deemed to accrue in India under the tax act, as the title of the goods is passed outside India and the payments are made outside India.
The AAR ruled that the applicant did not have a permanent establishment (PE) in India, dismissing the Revenue’s contention to the contrary. In doing so, the AAR clarified that activities that are incidental to the supply of imported goods – such as transportation, storage and delivery – should not be taken to establish the existence of a PE.
The AAR also considered and dismissed the possibility that the relationship of the applicant and L&T constituted an association of persons (AOP), ruling that mere collaborative effort and overall responsibility assumed by the applicant for successful performance of the project is not sufficient to constitute an AOP. The AAR held that an essential feature of an AOP – the element of common intention to earn income – was not present in this case, and that the individual identity of each party in doing the part entrusted to it was preserved, notwithstanding coordination between the two and the overall responsibility of the applicant.
Interestingly, the same AAR which previously questioned the Supreme Court’s judgment in Ishikawajima has now relied on that judgment in pronouncing this ruling, which clarifies to a great extent the previous uncertainty with respect to taxation of income earned from off-shore contracts.
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The legislative and regulatory update is compiled by Nishith Desai Associates, a Mumbai-based law firm. The authors can be contacted at nishith@nishithdesai.com. Readers should not act on the basis of this information without seeking professional legal advice.
