The last few years have witnessed substantial economic growth in India, and the country has emerged as one of the fastest growing economies. However, that economic growth has been plagued to some extent by slower than desired infrastructure development in areas such as airports, ports, roads, power, metro rail projects, etc. Acknowledging the need for rapid infrastructure development, the government has liberalized the foreign investment norms in many of these areas and has undertaken various new infrastructure development projects.
Typically, infrastructure projects are awarded to a single contractor who undertakes to complete the entire project on a turnkey basis. This kind of arrangement is commonly known as an engineering, procurement and construction (EPC) contract. Several foreign companies have been executing a number of infrastructure projects in India on a turnkey basis. Considering that generally any mid- to large-scale EPC contract could involve several crores of rupees, even a slight variation in the tax impact can cause a difficult cash flow position for the contractors. And if that contractor is a non-resident earning income from an alien country (viz. India), the pinch of extra tax becomes more painful.
Further, any adverse tax implications can have a substantial effect on the profits of the contractor. Of late, foreign EPC contractors are increasingly being targeted by Indian tax authorities to garner tax revenues.
In this context, an 8 August decision of the Delhi tax tribunal dated 8 August in the case of LG Cables Ltd (LGCL) could potentially bring some relief.
Facts of the case
LG Cable Ltd, a company incorporated in South Korea, was awarded contracts by the Power Grid Corp. of India Ltd (PGCIL). The first contract related to offshore supply of equipment and the second contract was related to onshore services such as installation, erection and commissioning activities.
In the case of offshore supply, all the activities were carried out from South Korea. In particular, the sale price was also paid outside India. Further, while the equipment was directly transported to PGCIL’s site in India, the ownership of equipment was transferred in Korea. In view of these facts, LGCL, in its Indian tax return, did not offer any income arising from offshore supply to tax.
Relying on the judgement of the Authority for Advance Rulings (AAR) in the case of Ishikawajima Harima Heavy Industries Ltd (271 ITR 193), the revenue authorities taxed the income from offshore supply of equipment.
Supporting its contention that the income from offshore supply of equipment was not liable to tax in India, LGCL had emphasized that all the operations relating to offshore supply of equipment, such as consideration, transfer of title, etc., were carried out outside India. Further, the sale transaction was on a principal-to-principal basis, so income was not taxable in India in terms of the Central Board of Direct Taxes circular No. 23 dated 23 July 1969. One of the key arguments advanced by LGCL was that the AAR ruling relied upon by the revenue authorities was overruled by the Supreme Court in the Ishikawajima Harima Heavy Industries case (288 ITR 408).
The revenue authorities contended that the income from offshore supply was taxable in India since in substance, the two contracts awarded to LGCL were a composite and the income therefore could be deemed to accrue in India. Further, various activities such as port handling, customs clearance, inland transit insurance, handling and transportation to site, storage, etc., clearly showed that property in equipment passed to the buyer in India.
Tax tribunal ruling
The Delhi tax tribunal held that income from offshore supply of equipment was not taxable in India. While deciding on the issue, the tribunal accepted LGCL’s submissions on the applicability of the Supreme Court judgement in the case of Ishikawajima Harima Heavy Industries. The tax tribunal also held that there was no material on record to show that LGCL’s project office (a project office would qualify as a “permanent establishment”) in India had any role to play in the supply of offshore equipment. Accordingly, income relating to offshore supply of equipment was not attributable to the permanent establishment in India.
Further, the tax tribunal held that under the Sales of Goods Act, the property in goods would pass on to the buyer as per the intention of the parties. The terms of the agreement clearly indicated that the ownership was intended to pass as soon as the goods were loaded on to the ship and when the documents were handed over to the nominated bank where the letter of credit was opened. The objections of the revenue authorities on taxing the income arising from offshore supply of equipment is based on lack of proper appreciation of the terms of the agreement and the provisions of Sales of Goods Act. The tax tribunal also held that given that the income from offshore supply of equipment was not subject to tax in accordance with the provisions of the Income-tax Act, 1961, recourse to the Tax Treaty did not arise.
The structuring of EPC contracts in large infrastructure projects needs to be planned well in advance and appropriately due to unexpected results (in the form of adverse tax assessments). While there could be favourable tax decisions, which could be used to defend an assessee’s case, considering the time taken to get some kind of certainty on the tax position, planning an EPC contract (which could include contract structuring, identification of tax-efficient jurisdictions, etc.) assumes utmost importance. The ruling of the tax tribunal would come as much needed relief for a number of foreign EPC contractors currently undertaking large infrastructure projects in India on a turnkey basis.
In summary, the tax tribunal has upheld that import of goods, where the title and ownership has passed outside India to the Indian buyer, should not be subject to tax in India, especially when the permanent establishment of the foreign company has no involvement in such a transaction. What is also important is the observation of the tax tribunal that the signing of a contract in India does not result in any income accruing or arising in India.
Ketan Dalal is executive director and Manish Desai is associate director, PricewaterhouseCoopers. Your comments and feedback are welcome at firstname.lastname@example.org