Case Law Details
AAR Ruling: Architectural services provided by a limited partnership is liable to tax as “fees for technical / included services” as per the provisions of India- US Double Taxation Avoidance Agreement [HMS Real Estate Pvt. Ltd. (A.A.R. No. 832 of 2009)].
Facts:
HMS Real Estate Pvt. Ltd. (applicant) is an Indian company engaged in the business of development and management of commercial real estate. The applicant proposed to construct an international quality commercial office/ hotel complex in Gurgaon. For this purpose, the applicant has entered into an agreement with Hellmuth, Obata + Kassabaum L.P. (HOK), a limited partnership, which is a resident of USA, for provision of Architectural Design Services. Pursuant to the said agreement, M/s RSP Architects Planners and Engineers Pvt. Ltd. (RSP) have been appointed as an associate architect. HOK and RSP are to work jointly and on a co-operative basis in order to perform the entire design, construction documents and construction administration for the Project. Each of them would be responsible for their share of work but jointly responsible for providing the entire design, construction documents and construction administration services necessary to complete the Project.
The scope of work under the agreement can be summarised 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.
In respect of the above items of work, HOK will be compensated a fixed fee (net of taxes) as per the terms of the agreement on raising of the monthly invoices and the fees will be received by HOK in USA. Item nos. (a) to (c) above broadly fall under the first stage lead to finalisation of designs and drawings. Item no. (d) falls under the second stage which relates to construction documents and item nos. (e) to (g) above fall under the third stage i.e. technical consultancy and supervisory services. The compensation for each of the above stages has been separately identified in the Agreement. It is conceded by the applicant that payment received for the services rendered in the third stage i.e. during the construction are liable to be taxed as ‘fees for technical services’ (FTS). In addition to this compensation, a further amount is payable at various stages which is by way of reimbursement of compensation payable to the consultants in USA.
The services except the construction administration are to be performed outside India. The designs and drawings are transferred electronically to the applicant and the ownership including the copyrights of the drawings and designs vests in the applicant. Development of designs will be carried out by means of by-weekly tele-conferencing and video-conferencing. For the purpose of developing the designs, HOK will engage specialist consultant outside India. After the delivery of designs, the preparation of detailed construction documents will take place in India by the Indian Architects in consultation with HOK. HOK will provide advisory for preparation of construction documents. Employees of HOK have come to India for a maximum period of 50 days for providing supervisory services.
The schematic design and design development work has already been completed. Question before the Authority for Advance Rulings (AAR):
- Whether the compensation payable to HOK as per the terms of the 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?
- If the answer to the above is affirmative:-
-Whether consideration payable for sale of designs is taxable under the India- USA Double Taxation Avoidance Agreement (DTAA) in view of the facts that the US entity does not have any permanent establishment (PE) in India?
-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 Article 12(4) of the DTAA even though it is to be excluded from “included services” under Article 1 2(5)(a)?
-Whether fees for supervisory/ advisory services during the Construction Administration phase is taxable under Article 12(4) of the DTAA and, if so, would such fees attract tax at the rate of ten per cent as prescribed in Section 115A of the Income Tax Act (Act)?
- Whether reimbursement of expenses actually incurred by HOK without any mark-up is subject to provisions of Section 195 of the Act?
Contention of the Applicant:
- 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. Separate price is identified for each of these items and activities. If so viewed, only the payment received at the stage of construction administration are liable to tax as fees for included services at the percentage of rate provided for in Section 1 15A(1)(b)/BB of the Act.
- If the contract is viewed as a composite one without disintegrating it, the dominant nature and the 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.
- The payments made to HOK (excepting those at the ‘construction administration phase’) do not fall within the definition of royalty under Article 12(3)(a) of the DTAA;
- The payments do also not fall under ‘fees for included (technical) services’ within the meaning of Article 12(4) of the DTAA. Even if they are treated as ‘business profits’ accruing or arising in India, the same cannot be subjected to tax under the Act in the absence of a PE , having regard to the provision of Article 7(1) of the DTAA. 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.
- On termination of the agreement by the owner or on payment by owner to 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.
- HOK has sold the designs and the property including copyright has wholly passed to the applicant and therefore, it cannot be said that the consideration has been paid to HOK for permitting the use or right to use the design, model or plan. Once the designs and drawings relating to the project are delivered to the applicant by posting them on the project Web through the ‘servers’ located in USA, the applicant becomes the absolute owner thereof and the HOK is barred for making use of them for its own purpose. The payment for the designs etc. is received once and for all and the payment is not contingent on the productivity use or further alienation thereof as contemplated in the Article 12(3)(a) of the DTAA.
AAR Observation and Ruling:
- The AAR has not appreciated the contention of the applicant that on the basis of terms and conditions of the Agreement in relation to conveying the right, title and interest the Architect has in the drawings, specifications, models and work product (which are described as ‘products of services’), the transaction has to be regarded as one of sale of designs. The Agreement cannot be read in isolation and the components of the contract cannot be placed in water-tight components. The agreement shall be read as a whole. The approach should be to ascertain what is the true scope and dominant object of the contract. One should take stock of the predominant features of the contract. A holistic view needs to be considered in viewing the agreement without being carried away by the apparent tenor of some of the clauses of the agreement.
- By taking the view, that the essence of the transaction is the sale of designs, models and plans and everything else is incidental thereto, is to distort and stultify the true nature and dominant purpose of the contract. The agreement is in reality nothing different from what is described in the opening sentence i.e. “design and consultancy services”.
- At every stage starting from the conceptual stage till construction, the applicant looks for the services and expert advice of HOK. HOK acts in close collaboration with the Owner (applicant), the associate Architect and the Consultant. Bi-weekly meetings through teleconferencing are regularly held. The applicant’s role in the project is all-pervasive. The applicant does not go out of picture once the so-called sale of drawings and designs take place nor can it be said on a reasonable basis that everything else done or performed by HOK is merely incidental or subordinate to the transfer of plans, drawings and designs. The fact that there is separate specification of price for convenience of payments and adhering to schedules or that a major portion of the amount is payable at the design development stage is not conclusive.
- Having regard to the scope, objective and predominant features of the Agreement, the HOK must be said to have received payment in the nature of FTS or included services within the meaning of Article 12.4(b) of the DTAA, irrespective of whether ‘royalty’ clause is attracted or not.
- It is significant to note that the latter part of clause (b) of para 4 speaks of “development and transfer of a technical plan or technical design. This limb of clause (b) is squarely attracted to the present case because technical services rendered by HOK resulted in the development and transfer of technical plan and design to the applicant. If an out-right transfer of a design or plan for consideration has to be treated as an independent transaction unrelated to the services, the scope of latter part of clause (b) will be considerably diluted and the very purpose for which the said words were included in the definition of FTS will be defeated.
- The architectural services rendered by HOK can also be brought within the fold of the expression ‘make available’. However, it is unnecessary to express a final view in the matter.
- The AAR has not expressed an opinion on the question whether the consideration attributable to the transfer of designs and plans can be brought within the scope of the clause – “payment received for information concerning industrial, commercial or scientific experience” occurring in the definition of ‘royalty’ under provisions of Article 12.3(a) of the DTAA.
- The basic(design) services which include preparation of Master Plan, concept design, schematic design, design development and construction documents, assistance in bidding and contractors’ selection process and consultancy during construction phase are all part of architectural services undertaken by HOK as per the Agreement and the payment received by HOK for furnishing all these documents and services to the applicant fall appropriately within the meaning of ‘fees for included services’ under Article 12.4(b) of the DTAA. They cannot be disintegrated and viewed in water-tight compartments.
- The reliance placed by the applicant on Davy Ash more India Ltd. (190 ITR 626) and International Tyre Engineering Resources (319 ITR 228) are clearly distinguishable from the applicant’s case.
- The remittances to HOK for the purpose of making payments to Consultants under the Agreement can also fall under Article 12(4) (b) as they also render architectural services. However, since HOK is not the beneficiary of the said payments and the same are to be passed on to the consultant in USA for the services rendered outside India such payments will not attract tax liability under the Act in India. But, it is made clear that the actual payments made to the consultant can be verified by the Revenue and, if any, adverse material comes to light, appropriate steps according to law can be taken. Thus, the receipts by HOK on account of consultancy fee payable to the consultant on actual basis will not give rise to taxable income in India and therefore, withholding of tax under Section 195 is not necessary.Therefore, entire consideration receivable by HOK from the applicant is liable to be taxed in India as ‘fees for included services’ as per Article 12(4) of the DTAA. However, the amount payable to the consultants in USA has to be excluded while computing the chargeable income. As regards the payment of fees for technical advisory services at the construction documents stage, it cannot be considered as ancillary and subsidiary to the sale of property and therefore, does not get excluded from Para 4 of Article 12 by virtue of clause (a) of Article 12.5 of DTAA.
- The rate of 10 per cent as Section 115A( 1 )(b)/(BB) is applicable in regard to the taxation of income arising from fees for technical/included services as the said rate is less than the rate specified in the DTAA.
Our View:
Normally, the professional services provided by an individual professional or a firm of individuals are covered by the Article 15 ‘Independent Personal Services’ of the Tax Treaty. In this ruling, the applicant is a limited partnership concern and therefore, in the absence of any fixed base of such entity in India, as well as the stay of persons in India was less than 90 days, we believe that the fees received by the applicant would not be chargeable to tax in India as per Article 15 of the DTAA. However, the applicant has not brought out this argument before the AAR.
Further, as per section 115A of the Act if the fees for technical services is paid in pursuance of the agreement entered into on or after 1 June 2005, the same would be liable to tax at 10% plus applicable surcharge, provided the agreement is approved by the Central Government; or where it relates to the matter included in the Industrial Policy, for the time being in force, the agreement is in accordance with that policy. However, whether these conditions were fulfilled or not is not clear in this ruling.
As regards the reimbursement of payments made to consultants in USA is concerned, the AAR held that it is not taxable as per the provisions of the Act. However, there is no detailed discussion on this aspect in the ruling. We probably believe that the AAR may have ruled on the basis of the decision of the Supreme Court in the case of Ishikawajima-Harima Heavy Industries Limited vs. DIT (288 ITR 408) and the Bombay High Court decision in the case of Clifford Chance Vs. DCIT (176 Taxman 458).
Although the AAR Ruling is applicable only in the case of an applicant who has sought it, it nevertheless carries a persuasive value.
We have similar kind of case but the recepient is a firm of companies. Would those are also covered by Article 15 of India – uS tax treaty.
pls guide.
thanks abhishek