Consideration paid to a foreign company for operating and maintaining a power plant cannot be considered as fees for technical services

Court : Delhi bench of the Income-tax Appellate Tribunal

Citation : Rolls Royce Industrial Power Ltd. Vs. ACIT [2010-TII-139-ITAT-DEL-INTL]

Brief : Recently, the Delhi bench of the Income-tax Appellate Tribunal (the Tribunal) in the case of Rolls Royce Industrial Power Ltd. v. ACIT [2010-TII-139-ITAT-DEL-INTL] (Judgement date 5 October 2010 Assessment Years 1998-99 to 2004-05) held that consideration paid to a foreign company for performance of a works contract of operating and maintaining a power plant cannot be considered as Fees for Technical Services (FTS) both under the Income-tax Act, 1961 (the Act) as well as under India-UK tax treaty (tax treaty).

Further, the Tribunal held that the taxing of a foreign company i.e. the taxpayer in a manner which is more burdensome vis-a-vis an Indian company doing identical business in India would lead to discrimination. Accordingly the taxpayer is entitled to protection of Article 26 of the tax treaty and should not be subjected to tax on gross basis, but on net basis.
The Tribunal also held that for a correct and harmonious interpretation disallowance under section 44D of the Act would not apply wherever Article 7 of the tax treaty is being applied.

Consideration paid to a foreign company for performance of a works contract for operating and maintaining a power plant cannot be considered as fees for technical services both under the Act as well as under India-UK tax treaty

Facts of the case

• · The taxpayer, a tax resident of UK, was awarded a contract for operation and maintenance (O&M contract) of a power plant for 10 years by Spectrum Power Generation Ltd. The taxpayer declared income as business receipts under article 7 of the tax treaty.
• · The Assessing Officer (AO) held that the receipts from O&M contract are in the nature of FTS as per Section 9(1)(vii) of the Act. It was further held that such income was taxable as business profits under Article 7 of the tax treaty, but as it was FTS, it would be taxable on a gross basis @ 30 percent in terms of Article 7(5) of the tax treaty read with Section 44D (See Note 1) and 115A (See Note-2) of the Act.

Note-1 :- Section 44D of the Act provides no deduction in respect of any expenditure or allowance under section 28 to 44C of the Act in computing the income by way of royalty or FTS received by a foreign company.

Note-2 :- Section 1 15A of the Act taxes FTS at 30 percent if contract is entered before 1 April 1997.

Tax department’s contentions

• · The income from the said activity was liable to tax as business profits under article 7 of the tax treaty but the computation of the income has to be made in accordance with the limitation contained in paragraph 5 of the article 7 of the tax treaty.
• · Article 7(5) of the tax treaty provides that in determining the profits of the permanent establishment, the deduction for expenses shall be allowed under the provisions of and subject to the limitations of the domestic law of the contracting state in which the permanent establishment is situated.
• · Since section 44D of the Act states that no deduction is admissible in the case of FTS, it is to be taxed at gross basis under section 1 15A of the Act.
• · It was also contended that the receipts are also covered under the definition of FTS provided in the treaty between India and UK as the taxpayer also made available technical knowledge, experience, skill, know-how or processes to Spectrum.

Taxpayer’s contentions

• · Contract awarded by Spectrum was a works contract and not a contract for rendering services. Therefore the income received from Spectrum was not in the nature of FTS under the Act or the tax treaty.
• · The taxpayer has not made available to Spectrum any skill, technology, expertise, technical design or plant, therefore running of power plant by the taxpayer would not fall within the definition of FTS under Article 13 of the tax treaty.

Tribunal’s ruling

Works contract not FTS

• · It is important to make a distinction between rendering of services and carrying out of work. Carrying out of work also may require technical expertise but it does not convert a works contract into a service contract. Reliance was placed on the decision of the Delhi High Court in the case of SRF Finance Ltd v. CBDT [1993] 211 ITR 861(Del) in this regard.
• · Keeping this distinction is kept in mind it is clear that when the taxpayer operates a power plant, it actually carries out work and gets paid a price for it. It does not render any service and is not paid any fee for rendering any service.
• · To ensure that there is no mishandling of the expensive facility while operating the plant, the taxpayer had to give detailed programme, plans as to how he would go about operating and maintaining the power plant. This is purely in line with normal prudent practice of carrying out of a works contract and does not make available any skills or knowledge etc. to the owner.
• · The taxpayer is neither making available technical knowledge, experience nor is it developing and transferring the technical plan or design and therefore 13(4)(c) of the tax treaty is not applicable. The expression “make available” enables the recipient of services to execute the job himself which was wholly absent in this contract. The services rendered under the O & M contract cannot be considered as ancillary or subsidiary to the enjoyment of any right described as ‘royalty’ and therefore 13(4)(a) and 13(4)(b) of the tax treaty are also not applicable. The services rendered by the taxpayer cannot be considered as FTS under article 13(4) of the tax treaty. Amounts received by the taxpayer are purely business receipts under Article 7 of the tax treaty.

Section 44D vis-à-vis Article 7

• · · Circular No.202 dated 5 July 1976 issued by the CBDT states that:

o where activities virtually amount to carrying on business in India for which considerable expenditure will have to be incurred by a non-resident, it will not be fair to tax such consideration in the hands of the foreign company on gross basis or to restrict the expenditure incurred for earning the same at 20 per cent of the gross amount as provided in the new section 44D of the Act.

o consideration for any construction, assembly, mining or like project will, therefore, be chargeable to tax on net basis, i.e. after allowing deduction in respect of costs and expenditure incurred for earning the same and charged to tax at the rates applicable to the ordinary income of the non-resident as specified in the relevant Finance Act.

• · The taxpayer has earned income through the activity of operation and maintenance of the plant. It is purely a business receipt under Article 7 of the tax treaty.
• · There is no dispute to the legal proposition that Article 7 speaks of profits and not gross receipts. Article 7(5) of the tax treaty restricts expenditure to such expenditure “which are allowed under the provisions of and subject to the limitations of the domestic law of the other State in which the permanent establishment is situated.” Article 7(5) of the tax treaty could never envisage a situation where entire expenditure is disallowed thereby converting profits into gross receipts.
• · The provisions contained in Section 44D of the Act speaks of no deduction whereas Article 7(5) of the tax treaty speaks of allowing of deduction subject to limitation of domestic law. The limitation cannot be read to being no deduction. Therefore, a correct and harmonious interpretation of Article 7(5) of the tax treaty with Section 44D of the Act would be that this dis allowance under section 44D(b) of the Act would not apply wherever Article 7 of the tax treaty is being applied.

Non discrimination clause

• · · The taxpayer which is a non-resident company undertaking works Contract in India is being discriminated against and subjected to tax on gross basis at 30 percent by artificially invoking section 44D read with section 11 5A of the Act, whereas a domestic company doing exactly the same works contract would be taxed at 2 percent under section 194C of the Act and also would be subject to tax on its net profits.
  • · The taxing of a non-resident U.K. company in a manner which is more burdensome vis-a-vis an Indian company would lead to discrimination. This would also amount to unfavorable treatment being meted out to the taxpayer vis-a-vis the Indian company doing identical business in India. Accordingly the taxpayer is entitled to protection of Article 26 of the tax treaty and should not be subjected to tax on gross basis in India.

Our Comments

In this important decision, the Delhi Tribunal has clarified the distinction between the performance of a works contract and the rendering of services, and held that fees received for performance of a works contract cannot amount to FTS under the Act or the Treaty.

It also held based on a harmonious reading of Article 7(5) of the tax treaty and section 44D of the Act that a dis allowance under section 44D of the Act could not be made in a case where Article 7 of a tax treaty is being applied. It noted that such dis allowance in the case of a non­resident company would violate the non-discrimination clause under Article 26 of the tax treaty.

This decision should provide relief to foreign companies engaged in executing works contracts in India.

NF