DECIDED BY: AUTHORITY FOR ADVANCE RULINGS (INCOME TAX), NEW DELHI
IN THE CASE OF: HMS Real Estate Pvt. Ltd., In re, APPEAL NO : A.A.R. No. 832 of 2009, DECIDED ON March 18, 2010
RULING
[By Hon’ble Chairman]
1. In this application under Section 245Q(1), the applicant seeks advance ruling on the following three questions :
2. Whether the compensation payable to Hellmuth, Obata + Kassabaum L.P., USA under clause VA of the Agreement dated October 15, 2008 can be disintegrated in three parts; viz., (a) for development and sale of designs (b) consultancy for construction documents, and, (c) for `Construction administration’ and `additional services’?
3. If the answer to Question No.1 is in the affirmative: –
(a) Whether consideration payable for sale of designs is taxable under the D.T.A.A. with USA (the Treaty) in view of the fact that the US entity has no permanent establishment in India?
(b) Whether payment of fees for technical advisory services to HMS/ Indian Associate Architects during the.Phase-2 of the Project (Construction Document) is taxable under the Art.12(4) of the Treaty even though it is to be excluded from “included services” under Art.12(5)(a) of the Treaty?
(c) Whether fees for supervisory/ advisory services during the Construction Administration phase is taxable under Art. 12(4) of the Treaty and, if so, would such fees attract tax at the rate of ten per cent as prescribed in S.115A of the Act?”
3. Whether reimbursement of expenses actually incurred by the US entity without any mark up is subject to provisions of section 195 of the Act?
Question No. 2 has been recast by the applicant after 1 st hearing.
The applicant is an Indian company engaged in the business of development and management of commercial real estate. The applicant proposes to construct an international quality commercial office/ hotel complex in Gurgaon. For this purpose, it has entered into an Agreement on 15 th Nov. 2008 with Hellmuth, Obata + Kassabaum L.P.(HOK) a limited partnership which is a resident of USA, for provision of Architectural design services. The agreement also provides for appointment of a local Architect as associate Architect. Accordingly, M/s RSP Architects Planners and Engineers Pvt. Ltd. (RSP) has been appointed as `Associate Architect’. Payments to the local associate Architect are to be made separately and are not under consideration in the application. As per the agreement, both, HOK-the Architect and RSP-the Associate Architect, have been retained “to work jointly and on a cooperative basis in order to perform the entire design, construction documents and construction administration for the Project, each responsible for its share of work but jointly responsible in providing the entire design, construction documents and construction administration service necessary to complete the Project”.
2.1. Under the head “Scope and Description of Services” – `Design Services’, the obligations of Architect are stated as follows:
The Architect will participate with and assist the Owner, as required, in developing and refining the general Project concept for the Project described in Exhibit A. The Architect will develop a detailed program for the Project based on in-depth interviews with the Owner and other parties designated by the Owner. The Architect shall review with the Owner, as requested, alternative approaches to design and construction of the Project and will prepare such schematic or conceptual drawings as may be required.
After the owner has approved the general Project concept and Project program, the Architect shall prepare, for review and approval by the Owner,
design development drawings and outline specifications adequate for obtaining preliminary cost and price estimates, and assist the Associate Architect in developing a set of construction drawings and specifications, which are adequate for complete pricing and construction of the Project as required (“Contract Documents”).
3. Upon completion of the construction drawings and specifications by the Associate Architect, and prior to submitting such documents to the Owner for issuance to contractors for prices and construction, the Architect review each such final construction drawing and specification with all other drawings and specifications for consistency with the approved design embodied in the Design Development documents, completeness and to avoid errors and omissions.
4. The Architect shall cooperate with the Associate Architect in obtaining approval of governmental authorities having jurisdiction over the Project and also assist him to ensure that the Contract Documents shall conform to applicable restrictions, laws, and regulations in effect. The Contract Documents shall consist of all necessary drawings, details, plans, elevations, sections, and schedules, dimension ed, noted, and coordinated, as well as specifications, and the Associate Architect shall seal and sign the drawings and specifications as the architect of record.
The Architect shall assist the Associate Architect and Owner in the preparation of any necessary bidding information, and any forms of agreement between the general contractor and the sub-contractors for the Project.
2.2. The architect’s basic services are classified broadly into 6 heads:
(a) Master plan/Concept design
(b) Schematic design
(c) Design development phase in which design is finalised after reviewing the detailed design prepared by the local design consultants
(d) Construction document phase wherein the architect will provide coordination and drawing review with the associate architect, preparation of designs sketches to clarify design intent and review of specifications for design content. (e) Bidding and contract selection process
(f) Construction phase :
(i) key selected shop drawings prepared by the associate architects;
(ii) consultation and site visits;
(iii) review and evaluation of cost saving proposals submitted up to start of construction of the contractor.
2.3. There is also a provision for rendering additional services not otherwise included in the Agreement or not customarily furnished as per the prevailing architectural practices. For such additional services, additional payment has to be made according to an 4.agreed formula. Reimbursable expenses are also specified in the Agreement.
The above scope of work under the Agreement has been summarised by the applicant as follows :
a) Development of program and master plan concept Design;
b) Development of Schematic design concepts;
c) Preparation of Design Development drawings;
d) Coordination and drawing review of documents;
e) Assisting the owner in bidding and contractor selection process;
f) Observing construction progress;
g) Review of cost saving and alternative proposals;
and
h) Additional services as may be required.
3.1. In respect of the above items of work, HOK is entitled to a fixed fee (net of taxes) as per cl V of the Agreement on submission of monthly invoices and the fee will be received by HOK in US dollars outside India. It is pointed out that items (a) to (c) above which broadly fall under the first phase lead to finalisation of designs and drawings. Item (d) which relates to construction documents is the second stage. Items (e) to (g), it is stated, comes under the third stage i.e. technical consultancy and supervisory services. It is conceded by the learned counsel for the applicant that as far as the payments received by HOK in the third stage
during construction are liable to be taxed as `FTS’ (`fees for technical services’).
3.2. The Agreement contemplates the retention by the Architect of consultants specialised in various fields who shall participate in the design of project. The selection of consultants by the architect is subject to the approval of the owner. Cl VII B provides : “the architect shall be responsible for contracting with the international or US based consultants and shall coordinate all design activities of said consultants. Compensation for the professional services rendered by each of the consultants shall be paid directly to each consultant of the architect.” It is stated that the consultants in US have been engaged in terms of this clause.
3.3. Clause V deals with `Compensation’ which is nothing but fee payable to the Architect. It is stipulated that the architect shall receive as compensation for all basic services the fixed price sum (excluding local taxes) of 2,114,000 US dollars based on a building size of 1,300,000 sq.ft. payable in response to monthly invoices based upon the amount of basic services and additional services. The counsel for the applicant has clarified that the applicant has to bear the taxes and pay TDS. The break-up of the stipulated fee of 2,114,000 US dollars is given as follows : Project Phase Amount in USD (Original Agreement)
Master/Concept Design 275,000
Schematic Design 449,000
Design Development 542,000
Construction Document 375,000
Construction
Administration
473,000
Total 2,114,000
3.4. As per the amendment to the Agreement, a further amount of Rs. 1,508,000 is payable at various stages which is by way of reimbursement of `compensation’ payable to the consultants in USA. Thus, the total consideration payable under the contract is Rs. 3,622,000. The applicant states that the aforesaid functions except construction administration are performed from outside India. The designs and drawings are transferred electronically to the applicant
and ownership therein vests in the applicant. Development of designs is carried out by means of bi-weekly teleconferencing and video conferencing. For the purpose of developing the designs, HOK will engage specialist consultants outside India. After the delivery of designs, the preparation of detailed construction documents will take place in India by the Indian Architect in consultation with HOK. HOK, it is stated, will provide advisory for preparation of construction documents.
3.5. It is stated that the employees of HOK have come to India for a maximum period of 50 days for providing supervisory services. The applicant states that the completion of the project is likely to take three years.
3.6. In the course of hearing, the applicant furnished an Event Summary Chart starting from October 2008 in which the details of visits of HOK personnel are set out. It is mentioned therein that the schematic design and design development work has already been completed. The applicant has also furnished a note on certain aspects relating to preparation of Designs and Delivery.
4. The case of the applicant as set out in Annexure- II is as follows :
“The designs and drawings developed by the non resident recipient are sold to applicant; therefore the receipts arising to the non-resident are in the nature of business profits. Since, the recipient does not have any permanent establishment in India, the receipts cannot be taxed as business profits. The receipts also are not taxable as `royalty’ as defined in section 9(1)(vi) of the Income-tax Act, 1961 and also under Article 13 of Indo-US DTAA as the said transaction involves outright sale of designs and the property in these goods vest in the applicant. This sum is also not taxable as `fee for technical services’ in terms of section 9(1)(vii)(b) of the Income-tax Ac, 1961 for the reason that the recipient has used its technical expertise for preparing and selling chattels, which are designs. This being a case of sale, there could be no question of transfer of use or right to use any plant or equipment.”
4.1. Learned counsel for the applicant has reiterated the stand taken in the application. It is contended that the Agreement can be disintegrated into three parts; (a) for development and sale of designs (b) consultancy for construction documents and (c) `Construction administration’ and `Additional services’. It is submitted that separate price is identified for each of these items and activities. If so viewed, only the payment received at the stage of construction administration in relation to services which are basically performed in India during the phase of construction are liable to be taxed as fees for included services at the percentage of rate provided for in Section 115A(1)(b)/BB of the IT Act, according to the counsel. The learned counsel for the applicant has 8.strenuously contended that if the contract has to be viewed as a composite one without disintegrating it, the dominant nature and object of the contract has to be looked into. If so, it is nothing but outright sale of designs and technical documents delivered through website from outside India and on such delivery, the applicant becomes the owner as the entirety of rights over those designs have been conveyed to the applicant. Therefore it is submitted that the payments made to HOK (excepting those at the `construction administration phase’) do not fall within the definition of royalty under Art.12(3)(a) of the India-US DTAA. For the same reason, it is submitted that they do not fall under `fees for included (technical) services’ within the meaning of Art.12(4) of the India-US DTAA. Even if they are treated as `business profits accruing or arising in India, the same cannot be subjected to tax under the Income-tax Act, 1961 in the absence of Permanent Establishment( PE), having regard to the Treaty provision in Art.7(1). As the number of days of presence of HOK employees in India will be much less than the prescribed number of days, a service PE cannot be inferred, submits the counsel.
4.2. The applicant’s counsel has in particular drawn our attention to Clause VIII of the Agreement which bears the heading “Copyright Assignment and Ownership of Documents”.
“Architect hereby acknowledges and confirms the intention of Architect to convey all right, title and interest it may have in and to all drawings, specifications, models, renderings and work product, excluding the Preexisting Materials, prepared in connection with the Project (“Products of Service”), including, without limitation, the copyrights and any copyright registrations issued therefor, to Owner. Architect does hereby sell, assign and transfer of owner, its successors, assigns and legal representatives, for the United States of America and throughout the world, all right, title and interest it may have in and to the Products of Service, including the copyrights and any copy right registrations issued therefor, the rights to prepare derivative works, the right to apply for copyright registration and future renewals or extensions of copyright terms, and the right to sue for copyright infringement, whether occurring in the past, present or future.”
4.3. The last para of the same clause provides that on termination of the Agreement by the owner or on payment by owner to the Architect of all sums due, all drawings, specifications, models and work product prepared in connection with the project shall become the property of the owner. “Nevertheless, it is understood by the owner that all such drawings etc. may be in appropriate for use in any other project.” Reference has also been made to Clause XIX which says that Architect shall not use or disclose confidential information without owner’s prior written approval. Before proceeding further, we may refer to Art.12 of the Tax Treaty (DTAA).
Article 12 – Royalties and fees for included services 1. Royalties and fees for included services arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State.
