Larger Bench rules tax holiday not available to a contractor/executor under the Income Tax Act

This alert summarizes a recent ruling of the Larger Bench (LB) of the Mumbai Income Tax Appellate Tribunal (ITAT) [2009-TIOL-692-ITAT-MUM-LB] in the case of M/s B.T. Patil & Sons Belgaum Construction Pvt. Ltd.(Taxpayer) Vs. ACIT. Due to contradictory views expressed by the two-member bench of the ITAT, an LB was constituted to examine the issue of whether the Taxpayer, who is engaged in executing construction contracts for and on behalf of the Government/statutory bodies, is eligible for tax holiday under the Indian Tax Law (ITL).

The LB held that the Taxpayer was a mere contractor/executor of the construction activity on behalf of the Government/statutory bodies and not a developer of infrastructure facility. The LB concluded that the Taxpayer did not satisfy the eligibility conditions, as stipulated under the relevant provisions of the ITL, for claiming tax holiday with respect to the construction activity undertaken by it and, was therefore, not eligible for tax holiday. The LB also concluded that a taxpayer who does not undertake development of the entire facility but develops only part of it, would not be entitled to tax holiday benefits.

 Background

 The ITL provides for tax holiday benefits in respect of any profits and gains derived from any business of an industrial undertaking or enterprise engaged in developing and operating infrastructure facility.

• The tax holiday benefits, as operative up to the tax year 2000-01 (assessment year 2001-02), provided for tax holiday to an enterprise engaged in the business of (i) Developing (ii) Operating and maintaining or (iii) Developing, operating and maintaining any infrastructure facility, on fulfillment of certain conditions.
• The other conditions of eligibility were:

-The project is owned by a company registered in India or a consortium of companies.

-An agreement is entered into with the Government/ statutory bodies.

-The infrastructure facility developed should be transferred to the Government/statutory bodies within the period stipulated in the agreement.

-The enterprise has started or starts operating and maintaining the infrastructure facility on or after 1 April 1995.

• Later, by an amendment (first amendment) to the ITL, effective from tax year 2001-02 on wards, tax holiday was made available to taxpayers, in respect of profits derived from the business of (i) Developing or (ii) Maintaining and operating or (iii) Developing, maintaining and operating any infrastructure facility. The amendment permitted benefit to an enterprise which is engaged only in the activity of development.

• A retrospective amendment (second amendment) was brought out by the Finance Act 2007, effective from tax year 1999-00. The amendment provided that the benefit of tax holiday would not be available to the taxpayers who were merely involved in the execution of civil construction work.

• Another retrospective amendment (third amendment)was brought out by the Finance (No. 2) Act 2009, substituting the second amendment with effect from tax year 1999-00, wherein, it was specified that a taxpayer executing any works contract awarded by any person, including the Government, was not eligible for tax holiday.

• In the case of Patel Engineering Ltd. Vs. DCIT  [94 ITD 411 (MUM)]   the taxpayer was allowed the benefit of tax holiday for the tax year 1999-00, in respect of part of the infrastructure facility developed by it under the agreement with the Government. The decision was rendered prior to the second and third amendments.

Facts of the case

• The Taxpayer, a civil contractor, is engaged in the execution of various construction activities for and on behalf of the Government/statutory bodies.

• The construction activities undertaken by the Taxpayer were either in the capacity of sub-contractor or as a joint venturer to a contract.

• Illustratively, under a contract, pursuant to a tripartite agreement entered into between the Government of Maharashtra (GOM), the principal contractor (another Indian company) and the Taxpayer (sub-contractor), the GOM had assigned a portion of the construction of the tunnel, in connection with the Koyna Hydroelectric Project, to the Taxpayer.

• Right from its inception, the ownership of the said project vested with the GOM.

• The Taxpayer claimed tax holiday, in respect of the profits derived from the construction activities, on the ground that they are derived from the business of developing an infrastructure facility and fulfilled all the conditions of eligibility for tax holiday.

• The Tax Authority denied tax holiday to the Taxpayer on the ground that the Taxpayer merely constructed the facility owned by the Government/statutory bodies, for or on behalf of the Government, and did not operate any infrastructure facility, as contemplated by the relevant tax holiday provisions of the ITL.

• The first appellate authority confirmed the Tax Authority’s order.

• At the ITAT level, contradictory views were expressed by the two-member bench of the ITAT. One member was of the view that the Taxpayer was eligible for tax holiday. Based on the retrospective amendment made, the other member was of the view that the tax holiday was not available to the Taxpayer as it was a mere contractor, executing civil/works contract.

• Considering such contradictory views, an LB was constituted to examine the issue.

Contentions of the Taxpayer

• A developer simplicitor is eligible for tax holiday under the ITL. It is not necessary that the developer should also maintain and operate the infrastructure facility developed by it.

• A developer is a person who develops the facility, provides technological inputs, deploys funds and manpower, undertakes risk and reward of the facility and is accountable for the development carried on. The Taxpayer was the developer of infrastructure facility, as the risk and responsibilities of the development was on it.

• As civil construction is an important segment of an infrastructure facility, any person executing even a part of the job concerning the infrastructure facility is eligible for tax holiday.

Contentions of the Tax Authority

• The Taxpayer was not the owner of the infrastructure projects it undertook. Only projects owned by the Taxpayer are eligible for tax holiday under the ITL.

• To be eligible for tax holiday, an agreement has to be entered into by the taxpayer with the Government/ statutory bodies. In the present case, no agreement had been entered into by the Taxpayer with the Government/statutory bodies.

• The Taxpayer did not carry out any business in infrastructure facility, as it had only constructed the facilities as per the requirements of the Government/ statutory bodies.

• The work carried on by the Taxpayer was for and on behalf of the Government/statutory bodies and not for operating any infrastructure facility.

• The developer is a person who brings in additional resources, by way of investment and technical expertise, for developing the infrastructure facility. The Taxpayer had simply done a part of the work of civil construction relating to the infrastructure facility. Hence, it is not eligible for tax holiday. Construction is a minor part of the development of an infrastructure facility.

Ruling of the LB

 The provisions of the ITL, prevalent during the year under reference, required that the infrastructure facility should not only be developed but also be operated by the taxpayer. This, therefore, indicates that the benefit of tax holiday would commence only upon the facility being developed and becoming operational. The Taxpayer was out of the loop much before the actual operation of the project. Hence, it cannot fit into the mandatory requirement of the relevant provisions of the ITL.

• The first amendment to the ITL, permitting tax holiday benefit to the enterprises engaged in (i) developing or (ii) maintaining and operating or (iii) developing, maintaining and operating any infrastructure facility, became operative from the subsequent year and, hence, is not applicable to the tax year under reference.

• The development should be that of an infrastructure facility as a whole and not a particular part of it. The Taxpayer did not develop the entire infrastructure facility.

• The Taxpayer is merely an executor of the projects owned by the Government/statutory bodies. The Taxpayer was required to do only the work specified under the contract and was not involved in the development or planning of the infrastructure facility as a whole. Hence, the Taxpayer was a mere contractor and not a developer.

• To be eligible for tax holiday, the taxpayer is also required to be the owner of the infrastructure facility that it develops. Since the Taxpayer carries out the specified job and the property in it vests with the Government/statutory bodies, the Taxpayer does not own the construction activity carried out by it.

• As the Taxpayer was not the owner of the infrastructure facility, requirement of transferring the facility to the Government cannot be fulfilled, as required by the tax holiday provisions of the ITL.

• As the Taxpayer does not satisfy the conditions envisaged in the relevant provisions of the ITL for claim of tax holiday but merely executes the construction activity as a contractor, the Taxpayer is not eligible for tax holiday in respect of the construction activity undertaken by it. The second and third amendments made to the relevant provisions of the ITL only clarify the position that a contractor is not entitled to tax holiday, with respect to the development of an infrastructure facility.

Comments:- Taxpayers in the infrastructure sector are often engaged in the execution of construction activities, which form a minor portion of a contract for the development of an infrastructure facility. This ruling provides guidance on whether a contractor simplicitor would be entitled to tax holiday under the ITL, in respect of the construction activities carried out by it. This ruling makes it clear that tax holiday would be denied to a person who merely executes any works contract/construction activity but does not own the infrastructure developed by it. The ruling also holds that the person who does not undertake development of the entire facility but develops only part of it would not be entitled to tax holiday benefit.

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