Large infrastructure contracts, often referred to as engineering, procurement and construction (EPC) contracts, are generally awarded to a single contractor who undertakes to complete the project on a turnkey basis. Typically, these contracts are awarded through global tenders inviting bids from companies with proven track record and experience in completing complex projects.
Such bids are often made by foreign firms in collaboration or conjunction with Indian firms. Alternatively, a part of the contract won by foreign corporations could be sub-contracted to Indian companies. However, in most cases, the overall responsibility for successful implementation of the contract rests with the foreign contractor.
EPC contracts have a combination of both offshore and onshore activities. While offshore activities mainly comprise supply of equipment, designs and drawing, and engineering services, onshore activities include local supply of equipment, materials, and assembly and installation services. These components are embedded either under a composite contract or separate contracts are entered into for each activity.
Although some controversies have been put to rest by the Supreme Court in a couple of decisions summarized below, the taxation of EPC contract revenues, especially revenue earned from offshore supplies of equipment, has remained a vexed tax issue for many years now.
The Supreme Court in the case of Ishikawajima Harima Heavy Industries Ltd dated 4 January 2007 has held that in the case of a composite contract involving various operations within and outside India, amounts received by a non-resident company in respect of offshore supply of equipment and materials as well as in respect of offshore services are not liable to tax in India.
In an 18 May 2007 decision in the case of CIT v. Hyundai Heavy Industries Ltd, the apex court held that the profits of Hyundai from offshore operations of designing and fabricating a facility outside India and its supply to Indian customers would not be taxable in India.
In a 17 June ruling, the Authority of Advance Ruling (AAR), in the case of Hyosung Corp., South Korea, held that income under the EPC contract for offshore equipment supply should not be subject to tax in India.
Hyosung is a South Korean company engaged in the business of power stations. Power Grid Corp. of India Ltd (PGCIL) accepted its bid proposal submitted and awarded it an offshore contract covering all works to be performed outside India, including supply of all offshore equipment and materials (on cost, insurance and freight to an Indian port on a disembarkation basis).
The onshore supply contract and the onshore services contract, including civil works, training in India, etc., was awarded by PGCIL to Hyosung’s assignee Larsen and Toubro Ltd (L&T).
Hyosung sought a ruling from AAR on the following:
• Whether the applicant, together with L&T, can be said to constitute an association of persons (AoP).
• Whether the consideration for offshore supply of equipment, materials, etc., was subject to tax in India.
• In the event the offshore supply of equipment was subject to tax, to what extent would the amounts be reasonably attributable to the operations carried out in India.
The memorandum of understanding signed between Hyosung and L&T states that the parties shall be jointly and severally responsible for the execution of the contract. Accordingly, the amounts received by L&T and Hyosung from PGCIL are assessable in the status of an AoP.
It was asserted that notwithstanding the nomenclature of “offshore supply”, in reality, the transfer of property in goods and the sale was completed within India, since testing and successful commissioning of the project were conducted in the country.
It was contended that the applicant had had an office in India since 17 October 2007 and that supervisory activities through this office would be in excess of nine months’ constituting under the treaty. As L&T was the applicant’s sub-contractor, the activities carried out by L&T should also be taken into account for counting the period of nine months. It was also contended that the presence of Hyosung’s employees at another site of the applicant in an unrelated project should also be aggregated for the purpose of arriving at the period of nine months.
The applicant contended that as per the documents pertaining to offshore supply/sale of goods, the property and title in the goods passed outside India and the payment was also received outside. Accordingly, income from offshore supply should not be taxable in India.
In determining how long the site or project has existed, it was contended that no account should be taken of the time previously spent by the contractor concerned on other unrelated sites or projects. The supervisory activities of testing and commissioning the plant are auxiliary in character and, therefore, the maintenance of a fixed place of business for that purpose cannot be regarded as a permanent establishment of the company.
AAR observed that PGCIL had awarded separate contracts to both Hyosung and L&T. Further, AAR took note of the fact that L&T was entitled to raise bills for the work carried out by it separately and such bills shall be payable directly to L&T. Hence, it could not be said that the two contractors had promoted a joint enterprise with a view to earning income jointly. It also held that a collaborative effort and the overall responsibility assumed by Hyosung for the successful performance of the project were not sufficient to constitute an AoP for the purpose of tax assessment.
AAR held that under the terms of the contract, the sale of offshore equipment and materials took place outside the territories of India. It also held that the risk need not pass simultaneously with the title of goods. Hence, Hyosung, by taking care of goods at the site in India till installation, assumed the capacity of a bailee. The stipulation that the supplier shall continue to be responsible for the quality and performance of the goods, until the final takeover on the testing of equipment, could not be construed to be a condition which postponed the transfer of title to the goods till that time.
AAR held that the applicant should not have a supervisory permanent establishment under the treaty.
It held that both “building site, construction, and assembly or installation project” and the “supervisory activities in connection therewith” should extend beyond nine months in order to constitute a supervisory permanent establishment.
The authority said Hyosung could not be brought within the “building site, construction, and assembly or installation project” limb of the treaty because the construction and installation work was being undertaken by L&T.
AAR disregarded Hyosung’s contention that its supervisory activities were “auxiliary” in nature. However, it held that if the other contract being executed by the applicant was a separate and distinct contract, it was not permissible to combine the duration of two different projects for the purpose of arriving at the threshold period of nine months for permanent establishment constitution.
This is a welcome ruling with respect to the fact that AAR has dealt with various issues relevant to infrastructure contracts. Additionally, the ruling on non-taxability of offshore supplies, even in an overall contract scenario, as well as the pragmatic addressing of the time threshold issue vis-a-vis permanent establishment exposure, would be a welcome relief to infrastructure companies.
Ketan Dalal is executive director and Manish Desai is associate director, PricewaterhouseCoopers. Your comments and feedback are welcome at email@example.com