A recent ruling of the Authority for Advance Rulings (AAR) [2009-TIOL-23-ARA-IT] in the case of Pintsch Bamag (Taxpayer). The issue before the AAR was whether the sub-contractor’s workplace and work duration should be considered in determining the existence of a permanent establishment (PE) of the Taxpayer, under the India-Germany Tax Treaty (Tax Treaty).
Considering the facts of the case, the AAR observed that the work carried out by the sub-contractor was independent of any control by the Taxpayer. Thus, the time spent by the subcontractor should not be considered in determining the time threshold under the Tax Treaty. Since the time proposed to be spent by the Taxpayer was within the time threshold specified under the Tax Treaty for creating a PE, the AAR held that the Taxpayer’s activities will not constitute a PE under the Tax Treaty and, thus, it was not taxable in India.
Facts of the case
- The Taxpayer, a company incorporated in Germany, was awarded a contract by an Indian customer to design, fabricate, install and maintain navigational equipment for a shipping channel.
- The Taxpayer sub-contracted most of the work to an unrelated Indian concern. However, the sub-contracting agreement did not absolve the Taxpayer of any liabilities under the contract with the Indian customer. The Taxpayer also furnished a performance guarantee to the Indian customer.
- The Taxpayer carried out the contract for design of essential equipment and supply of critical components to the sub-contractor, from Germany. Such material and equipment was provided at the workplace of the subcontractor, who carried out the manufacturing activities therein.
- The time schedule for execution of the main contract was 16 months. However, the process of supervision was for less than 60 days. The supervision work was carried out by the Taxpayer’s employees.
- Under the Tax Treaty, the term PE is defined to include a building site or construction, installation or assembly project or supervisory activities in connection therewith, where such site, project or activities continue for a period exceeding 6 months.
Issues before the AAR
- In view of the activities carried out by the Taxpayer, whether it has earned any taxable income in India, and if so, how should such income be computed?
Contentions of the Taxpayer
- The income that would be earned by the Taxpayer is in the nature of ‘business profits’.
- Under the Tax Treaty, business profits are taxable in India only if a taxpayer carried out business in India through a PE. In case a PE exists, only so much of the profits as are attributable to the operations of the PE, are liable to be taxed in India.
- The supervisory operations which the Taxpayer proposed to carry out at the time of installation and commissioning, would be for a period of less than 2 months. Accordingly, the Taxpayer did not have a PE in India and, therefore, it was not liable to be taxed in India.
- The Taxpayer also placed reliance on the decision of the Andhra Pradesh High Court in the case of CIT vs. Vishakhapatnam Port Trust [144 ITR 146].
Contentions of the Tax Authority
- The work undertaken by the sub-contractor at his workplace constituted core activities of the contract assigned to the Taxpayer. The sub-contractor acted as a nominee of the Taxpayer, in connection with the execution of the contract.
- The place of manufacture of the sub-contractor is to be treated as a part of a PE of the Taxpayer.
- In computing the time duration, for the purposes of determining the existence of a PE, the time spent by the sub-contractor will also have to be considered. Since the duration of the work, including the work done by the subcontractor, exceeds 6 months, the Taxpayer will have a PE in India under the Tax Treaty.
- The Tax Authority relied on the OECD Model Tax Convention Commentary on Article 5 (OECD Commentary) which states that, if an enterprise (general contractor) which has taken the performance of a comprehensive project sub-contracts parts of such a project to other enterprises (subcontractors), the period spent by a sub-contractor working on the building site must be considered as being time spent by the general contractor on the building project.
Ruling of the AAP
- As the contract relates to an installation and assembly project, whether the Taxpayer has a PE or not, has to be evaluated under the specific rule dealing with such projects and the time threshold prescribed under this rule, even if the Taxpayer has a fixed place of business for undertaking this activity.
- The AAR held that the place of manufacture of the subcontractor cannot be treated as the PE of the Taxpayer. It observed that the place where the sub-contractor carried out the manufacture was far away from the installation site and was carried out independent of any control by the Taxpayer.
- The fact that the Taxpayer was not absolved of the liabilities under the contract has no bearing on the analysis and this, by itself, will not result in deeming the subcontractor’s place of work to be the PE of the Taxpayer.
- The occasional and brief visits by the Taxpayer’s employees at the inception of the project should not be taken into account in determining whether a PE is created.
- In response to the Tax Authority’s reliance on the OECD Commentary to suggest that the time spent by a subcontractor should be included in the time spent by the main contractor for making a PE determination, the AAR distinguished the context of the OECD Commentary from the Taxpayer’s fact pattern.
- The AAR was of the view that the observations in the OECD Commentary apply to a situation where there is a conjoint effort viz. where a building site has been set up by the main contractor and the services of the sub-contractor are also deployed in aiding the execution of the building project, in which case, the building site of the contractor and the subcontractor are inseparable. In the present case, the fabrication and assembly work was carried out by the subcontractor at his workplace, which was far away from the installation site and independently run by it.
- The AAR concluded, by holding that, the Taxpayer did not have a PE in India under the Tax Treaty and was, therefore, not liable for tax in India.
- A ruling by the AAR is binding only on the taxpayer, in respect of the transaction in relation to which the ruling is sought and on the Tax Authority, in respect of the taxpayer and the said transaction. However, it does have persuasive value and the Indian Courts, the Tax Authority and the Appellate Authorities do recognize the principles and ratio laid down by the AAR, while deciding similar cases.
- It is common for foreign companies to execute construction and installation contracts, through the use of sub-contractors. This ruling should provide useful guidance to foreign contractors in circumstances where a subcontracting arrangement may not create a PE for the foreign company.