Case Law Details
Brief Facts of the case
1. The assessee is a tax resident of Germany, engaged inter alia in the business of providing innovative and environmentally sound solutions for a variety of customers in metals and minerals processing industries. The assessee-company filed its return of income electronically for the relevant AY 2010-11 on 29-03.2012 declaring total income at Rs.1,85,60,360/-. The AO framed draft proposed assessment order u/s 143(3) r.w.s 144C of the Act proposing to assess the following income three incomes
a. Sale of equipment as taxable in India:- the assessee supplied equipment to seven Indian companies during the year under consideration relating to Steel Industry. The assessee raised invoices for sale of equipment amounting to Euro 79,776,994 equivalent Rs.475,71,02,152/- applying TT buying rate as on 31-03-2010. The assessee filed copies of contract for sale of equipment and AO after considering the submissions and documents proposed that a profit percentage @ 10% be chargeable to tax from sale of equipment.
Aggrieved, assessee carried the matter to DRP. DRP issued direction u/s 144C(5) r.w.s. 144C(8) of the Act, after considering the various clauses in the agreement, penal directed the AO to assesse the estimated profit @ 10% of sale of equipment.
b. Income from supervisory services provided in India:- Assessee had provided supervisory services in India during the relevant year and earlier years also. The assessee was engaged by its customers for supervising the detailed engineering, installation and commissioning activity undertaken independently by the customer/third party vendors appointed by the customers. The assessee before ITSC during FY 2007-08 and 2008-09 admitted that it has supervisory PE in India for supervisory services rendered on standalone basis. The assessee for the purpose of computation of profit for the assessment year under consideration computed the average profit margin earned by the comparable Indian Companies, which worked out to 17.93% of sales. The assessee, therefore, attributed profits of INR 1,85,60,360/- to the supervisory PE which was computed by applying a net profit rate of 17.93% on gross revenue of INR 10,35,15,673/- earned from supervisory services. The assessee before AO and DRP submitted that during the proceedings before the ITSC for the earlier assessment years the assessee disclosed a profit percentage of 25% on its revenue from the supervisory services. The ITSC enhanced the same to 27.5% for the relevant years. However, for those previous assessment years the assessee did not have the details relating to the net profit earned by comparable India companies. During the current year, based on the profitability of the comparable Indian companies a net profit percentage of 17.93% was arrived at and considered by the assessee. However, the AO has completely disregarded such comparable companies and has merely applied the net profit percentage of 27.5% as adjudicated by the ITSC for Financial Years 2007-08 and 2008-09.
c. Income from sale of designs and drawings: – The assessee provided drawings, designs & engineering documents relating to steel industry in India to the customers for the operation and maintenance of the plant. During the year under consideration, the assessee raised invoices to the tune of Rs.79,42,01,177/-. the AO holds that the income earned from supply of drawings and designs as taxable in India by treating it as taxable as Royalty under Article 12(3) of the DTAA read with the provisions of Section 9(1)(vi) of the Act.
Aggrieved, assessee-company filed appeal before Tribunal.
Issue
a. Whether income earned by the appellant from sale of equipment to the Indian customers accrues or arises in India and thus taxable in India under the provisions of the Act read with the provisions of India-Germany Double Taxation Avoidance Agreement (DTAA). Without appreciating fact that equipment passed on to the customer out of income, and by misinterpreting various clauses of Sales of Goods Act and the overall responsibility of the entire work is on the appellant the transfer of title to the customer on high seas of the equipment and entering into separate contracts would not make any difference without appreciating the fact that only in overall interest of the project and to facilitate co-ordination the appellant was given the overall responsibility and hence such responsibility would not have made any difference as far as sale of equipment outside India is concerned.
b. Whether AO/DRP erred in considering the net profit rate of 27.5% for computing the taxable income from supervisory services in India ignoring the net profit rat of 17.93%, as offered by assessee, on gross revenue based on the average margin of comparable companies as considered by the appellant for computing the taxable income from supervisory services in India without showing any cogent reason.
c. Whether Ld AOAO/DRP erred in holding that the income earned by the appellant from sale of designs and drawings is taxable as Royalty under Article 12(3) of the DTAA read with the provisions of Section 9(1)(vi) of the Act and is not in the nature of sale of product without appreciating the fact that the customers use these designs and drawings for internal purpose of setting up their plants and not for commercial exploitation and without appreciating fact that intellectual property in designs and drawings has not been transferred to the customer the nature of transaction will change from sale of goods to use of license.
Assessee’s Contention
1. Regarding income from sale of Equipment
a. That operations relating to designing, fabrication and manufacturing of equipment, and sale of equipment took place outside the territory of India. That the relevant extract of delivery/title transfer and other clauses under various contracts for which equipment has been supplied during the year under consideration to demonstrate that the sale has taken place outside India has already been explained before the AO and now filed in its paper book as Annexure-I. He contended that the sample bills of landing which clearly demonstrate that the title in equipment was transferred to the customers outside India, and this document is enclosed as Annexure-II.
b. That the consideration was also received outside India in foreign currency by the assessee, no part of revenue from sale of equipment can be considered as received or deemed to be received in India. Therefore, the only point that needs to be discussed is whether any income from the sale of equipment can be said to accrue or arise or deemed to accrue or arise in India. section 5 read with section 9(1)(i) that income shall accrue or arise or deemed to accrue or arise in India if the same is earned through any business connection in India. However, Explanation 1(a) to section 9(1)(i) of the Act provides that where some operations are carried out in India then income only to that extent resulting from such operations can be taxed in India. In other words, if no operation is carried out in India, then no profit can be taxed in India. Project agreement clearly demonstrate that all the activities relating to designing, fabrication and manufacturing took placed outside India and 75% of the payment for each and every part of shipment becomes payable upon delivery of equipment on FOB foreign port of shipment once shipping and other documents are submitted to the customer and such payment has to be made through irrevocable letter of credit. It is needless to mention that no buyer would make the substantial payment for equipment of which the property has not been transferred to him. The irrevocable letter of credit further makes it clear that even if the ship does not sail or deliver the goods to the destination, the assessee receives payment out of L/C, guaranteed by the bank, upon FOB delivery.
c. In view thereof, no portion of the receipts from sale of equipment can be taxed in India under the provisions of the Act. According to Ld. Counsel, since the income is not liable to tax in India under the provisions of the Act, therefore, the assessee is not required to examine the taxability under the provisions of the DTAA as mentioned by the Hon’ble Supreme Court in the judgment of Ishikawajma-Harima Heavy Industries Ltd. vs DIT (2007) 288 ITR 408 (SC) on page no. 444 of report wherein it has been held that “The entire transaction having been completed on the high seas, the profits on sale did not arise in India, as has been contended by the appellant. Thus, having been excluded from the scope of taxation under the Act, the application of the double taxation treaty would not arise.”
2. Regarding income from supervisory services
With regards to Supervisory services, The assessee for the purpose of computation of profit for the assessment year under consideration computed the average profit margin earned by the comparable Indian Companies, which worked out to 17.93% of sales and During the current year, based on the profitability of the comparable Indian companies a net profit percentage of 17.93% was arrived at and considered by the assessee.
3. Regarding income from sale of design and drawings.
a. That the scope of the assessee was limited to designs and drawings being in the nature of basic engineering for which work was done primarily outside the territory of India. Basic engineering includes sale of designs and drawings to the customers that pertain to the location of plant, layout drawings, placement of various equipment, types of equipment to be installed, process description, manufacturing of indigenous equipment in India etc. that are needed as per specifications by the customers to erect the plant.
b. The designs and drawings sold by the assessee were used by the Indian customers for internal business purpose of setting up of their plants and not for any commercial exploitation. Sale of designs and drawings has also effected outside India.
c. that the basic engineering packages sold by the assessee company to the Indian customers have been designed largely on the basis of standard technologies available with it. The consideration received by the assessee was therefore for the sale of a product which is embedded in the plant set up by the Indian customers. Accordingly, the income earned from the sale of designs and drawings is in the nature of business income, being the consideration received from the sale of a product and no further income can be assessed.
Revenue contention
1. Regarding income from sale of Equipment
a. The assessee provided drawings, designs & engineering documents relating to steel industry to Indian customers for the operation and maintenance of the plant and claimed that supply of drawings, designs & engineering documents constituted ‘outright’ sale, not connected with assessee’s PE in India and hence not taxable in India.
b. The AO gave a finding that the payment for supply of drawings, designs & engineering documents constituted “royalty” under Explanation 2 to section 9(1)(vi) of the Income Tax Act as well as under Article 12(3) of the India-German DTAA.
c. The AO, in his order, noted from the assessee’s contract with TATA Steel, Jamshedpur in which clause 12.2 clearly stipulates that “The Intellectual Property of all designs, processes, drawings and other documentation shall remain vested with the Contractor. The purchaser is granted a license to use such designs, process, drawings and other documentation for the operation and maintenance of the plant.” Such an identical clause is present in all the contracts with other Indian customers to whom, the assessee supplied the impugned drawings, designs and engineering documents. It makes it evident that in reality, it is not pertaining to any sale of goods but mere granting of a license to use the intellectual property embedded in such drawings, designs & engineering documents.
d. that the DRP have found that on identical facts based upon the same contract, the Income Tax Settlement Commission (in short ITSC) in its order dated 30.12.2011 in assessee’s own case gave elaborate findings that the payment for supply of drawings, designs & engineering documents constituted “royalty” under Explanation 2 to section 9(1)(vi). The decision of ITSC on this issue still holds the field in the absence of any contrary decision by any higher judicial forum in the assessee’s case. Since there have been no change on facts and circumstances even in the assessment year under consideration, there is no reason to make a departure from the ITSC’s decision on the same issue. He explained that under the contact, the assessee had actually granted a license to use i.e. right to use know-how and engineering information to enable the Indian customers not only to design, engineer, erect and set up the plant but also to commission, operate, test and maintain the plant and to manufacture the product in the plant.
e. Though physical records of know-how such drawings, designs, engineering and manufacturing data is imparted to another person, know-how is not lost to its owner who still continues to retain it for his own use. In the present case what was transferred in the form of drawings designs, engineering information, documents, etc., covered the usage of industrial, commercial or scientific experience to ensure the successful set up, operation of the plant as well as maintenance of the process of manufacture, at the same time the transferee was required to maintain the confidentiality involved in the transferred records under a strict secrecy clause as contained in the relevant agreement. As mentioned earlier, in such a transfer the know-how is not lost to its owner who still continues to retain it for his own use.
Regarding income from supervisory services
a. That the assessee reported to have earned gross revenue from supervisory services amounting to Rs.10,35,15,673/- out of which Rs.1,85,60,360/-, being 17.93% of the gross revenue, was allocated to the Indian PE. In assessment, AO had enhanced this allocation to 27.50% which works out to Rs.2,84,66,810/-. The DRP also confirmed the action of the AO for the reason that on identical facts and circumstances, the ITSC attributed profits @ 27.50% in the assessee’s own case for AYs 2008-09 and 2009-10 respectively.
Regarding income from sale of design and drawings.
a. When the contract is for the erection and commissioning of the plant, the equipment may not remain as a property and the whole contract becomes a project for plant erection. It is the assessee whoop agreed to erect the plant and for the sake of convenience the terms of supply of equipment, designs, supervision, etc., were specified. Given the fact that the assessee had a PE in existence to undertake the project, it should have undertaken a robust transfer pricing methodology while allocating prices to different work segments and the supply for equipment should have been proved by the assessee to be at arm’s length, which was evidently not done by the assessee.
ITAT decision / observations
Sale of Equipment
a. Tribunal has held that from the facts of the case that the designing, procurement of material, fabrication and manufacturing of equipment was undertaken outside India. From the facts of the case it is clear that the Company is not involved in the manufacturing of equipment and such equipment were sourced from third party vendors based outside India. From the agreements and documents it is clear that the equipment was directly sold by the assessee on export sale basis and the title/ownership in the equipment was transferred outside India i.e. before the equipment reached India. This was held on following facts:
b. The consideration/payment for sale of equipment was received outside India in foreign currency and majority of the payment (80% – 85% including 10% advance) for each and every part of shipment becomes payable upon delivery of equipment on FOB foreign port of shipment once shipping and other documents are send to the customer.
c. Indian customers who were independent and unrelated parties and purchased the equipment from the assessee on their own account. From the agreements it can be gathered that the contracts for the sale of equipment were concluded on a ‘principal to principal’ basis. The contracts, customers’ inspection of the equipment was to be taken place outside India and assessee did not have any office or place of business in India. The transaction was at arm’s length and the consideration was also received outside India in foreign currency.
d. The case law of Hon’ble Supreme Court in the case of Ishikawajma-Harima Heavy Industries Ltd.(supra), wherein dealing with the case of a Japanese Company, one of the similar issues that was whether the amounts received/receivable by the assessee a foreign company, for the off-shore supply of equipment and materials to an Indian Company was liable to be taxed in India under the provisions of the Act or the India-Japan Tax Treaty. That was a case wherein break-up of contract price for each of the segments i.e. for supply, services and construction and erection were separately given in the Agreement.
e. On delivery of equipment on a foreign port, generally 85% (including advance payment) of the total contract price for each and every part of shipment becomes due to the assessee from the customer and merely 15% of contract price is receivable by the assessee. this 15% payment is merely a deferred payment and the acceptance tests clauses mentioned under the contract are merely in the nature of warranty provisions and cannot be construed to mean that the acceptance of goods by the customer has taken place in India and any portion from sale of equipment can be taxed in India. Further, the act that deferred payment does not have any impact on the sale of goods is also supported by the relevant portion of definition of “sale”.
Income from Supervisory Services
The assessee contended that the comparable companies relied on by the assessee are involved in the business of engineering and technical services and such comparable companies have been rightly relied upon by assessee in order to arrive at the net profit margin of 17.93% on gross revenue earned from supervisory services. It was contended that the final order of the ITSC for FY 2007- 08 and 2008-09, the margins of comparable companies was not a basis before the ITSC and hence, the ITSC did not had an occasion to analyse the same. It was contended that the decision of ITSC was accepted to buy peace and to avoid protracted litigation with the revenue. We find that even now before us the assessee could not file any reason to deviate from the decision of the ITSC wherein the profit
Margins were rightly applied at 27.5%. Hence, this issue of assessee’s appeal is dismissed.
Income from sale of design and drawings.
a. From the facts and legal position, it is clear that the basic engineering packages sold by the assessee to the Indian customers have been largely designed on the basis of standard technologies available with it. The consideration was, therefore, for the sale of the product, which is embedded in the plant set up by the Indian customers and does not constitute royalty and is in the nature of business income. Since the work was done outside India and sale was taken place outside India, such income is not taxable under the provisions of the Act and DTAA. Retaining intellectual property in designs and drawings is similar in the nature to the retaining of patented rights in any goods/machinery.
b. Restriction on the intellectual property in designs and drawings sold by the assessee for the purpose of setting up a plant in India does not change the character of the transaction from the sale of the product to the use of licence/know-how. Normally, designs and drawings sold by foreign customers were used by Indian customers for internal business purposes for setting up of their plants and not for any commercial exploitation. Accordingly, the designs and drawings sold by the assessee tantamounts to the use of copyrighted article rather than use of a copyright and is, therefore, in the nature of business income. This issue of assessee’s appeal is allowed.
