INTRODUCTION
The taxation regarding the offshore services has been a matter of debate. In the case of Technip France SAS, AAR ruled that the off shore services is not taxable, but at the same time in cases of Roxar Maximum Performance WLL, the AAR applied a “look at approach” held that composite contracts for offshore supply of equipment and for installation and commissioning of a project in India cannot be dissected for the purpose of taxability of the contract, and therefore, an offshore supply of equipment was taxable in India. In this case, the authority rejected the contention regarding the divisibility of the contract and treated the entire contract as a single and integrated one.
Thus a contradictory position is evident in this aspect, in this article, we will analyse the position of the composite contract that is being taken into account regarding the taxability of the offshore services in India.
What are OFFSHORE services?
Offshore services refer to the practice of outsourcing business processes, functions, or services to a third-party provider located in a different country, typically to take advantage of cost savings, specialized expertise, or other benefits. This concept has gained significant traction in recent decades as globalization and advancements in communication technologies have made it easier for companies to collaborate with service providers across borders[1].
WHAT ARE COMPOSITE CONTRACTS AND TAXATION OF IT UNDER IT ACT.
Composite contracts are complex agreements that encompass multiple components or services bundled together as a single package. These contracts are designed to provide a comprehensive solution or deliver a specific outcome by combining various interrelated elements. The concept of composite contracts is crucial in the realm of taxation, as it has significant implications for how these agreements are treated and taxed by authorities.
One of the fundamental principles that govern composite contracts is the principle of indivisibility. This principle asserts that composite contracts cannot be artificially dissected or split into separate parts for tax purposes. Tax authorities recognize the inherent nature of these contracts as a unified whole, and attempting to isolate individual components within the contract may lead to misinterpretation and unfair tax implications[2].
The rationale behind the principle of indivisibility lies in the understanding that the essence of a composite contract is its holistic nature. Each component within the contract is integral to the overall purpose and cannot be treated as a standalone entity. Splitting the contract into separate parts would undermine its intended purpose and may result in a distorted view of the agreement[3].
When it comes to the taxation of composite contracts, the approach is to treat the contract as a single unit rather than focusing on isolated components. The tax liability is determined based on the dominant purpose or primary objective of the entire contract..
The determination of the dominant purpose is crucial in assessing the tax implications of composite contracts. It requires a careful examination of the contract as a whole, considering factors such as the nature of the services or goods provided, the value attributed to each component, and the overall intent of the parties involved.
In many cases, composite contracts involve payments to contractors, vendors, or service providers. Section 194C of the Income Tax Act specifically deals with Tax Deducted at Source (TDS) on payments made to contractors. However, when the contract is composite and includes both goods and services, certain considerations come into play.
To avoid double taxation and ensure fair treatment, it is essential to consider the invoice value excluding the cost of goods when determining TDS. The invoice should clearly specify the value of goods separately from the services rendered. If the invoice lacks this information, TDS should be deducted from the total invoice value. This approach helps in segregating the taxable components appropriately and prevents any undue burden on the parties involved.
Real-life examples can help illustrate the application of composite contracts and their tax implications. Consider a construction contract that includes both labor (services) and building materials (goods). In such a case, the entire contract is treated as a composite contract, and TDS is calculated based on the total payment made to the contractor, considering both labor and materials. The tax rate applicable depends on whether the dominant purpose of the contract is services (covered under Section 194C) or goods (governed by other relevant sections)[4].
Judicial precedents have consistently upheld the principle of indivisibility for composite contracts. Courts have emphasized that composite contracts should not be artificially dissected to subject a part of the contract to higher TDS or to prejudice the assessee. The Allahabad High Court, for instance, ruled that a composite contract cannot be bifurcated for tax purposes, highlighting the importance of treating the contract as a whole.
GENERAL UNDERSTANDING OF TAXATION OF THE OFFSHORE SERVICES.
The taxation of offshore services in India is a complex and multifaceted topic that involves navigating intricate legal provisions and international agreements. The legal framework surrounding this issue has evolved over time, with significant amendments and judicial precedents shaping the current landscape.
The Finance Act of 2010 introduced a retrospective amendment to Section 9 (1) (vii) of the Income-tax Act, 1961, which had far-reaching implications for the taxation of offshore services.[5] According to this amendment, fees earned by non-residents for services rendered outside India to Indian residents, even without any performance of services within India, are deemed to accrue or arise in India. Consequently, such fees become chargeable to tax in India, subject to any beneficial provisions of Double Taxation Avoidance Agreements (DTAA) between India and the country of the non-resident service provider[6].
Prior to this amendment, the Finance Act of 2007 had already added an Explanation Clause to Section 9 of the Income-tax Act. This clause deemed income in the form of interest, royalty, and fees for technical services to accrue or arise in India for non-residents, regardless of their residence or business connection in India. The combination of these amendments has significantly expanded the scope of taxation for offshore services in India.
Recent judicial precedents have further solidified the taxability of offshore services in India. In the case of Ashapura Minechem Limited vs. ADIT,[7] the Mumbai Income-tax Appellate Tribunal (ITAT) held that technical services rendered from outside India were taxable in India under Section 9 (1) (vii) of the Act. The key factor in this decision was that the services were utilized in India, leading to tax liability. Similarly, in the case of Linklaters LLP vs. ITO,[8] fees earned by Linklaters LLP, a foreign law firm, for professional services rendered to Indian residents were deemed taxable in India as fees for technical services[9].
However, there are certain exceptions to the general rule of taxability of offshore services in India. If the fees for offshore services are payable outside India, they generally cannot be brought to tax under the provisions of Sections 4, 5 read with Section 9 (1) (vii) of the Income-tax Act. The taxability in such cases may depend on the specific facts and circumstances surrounding the transaction.
Double Taxation Avoidance Agreements (DTAA) play a crucial role in determining the tax liability for offshore services. These agreements are bilateral treaties between India and other countries that aim to prevent double taxation and provide relief to taxpayers. DTAA provisions generally override domestic tax laws, and their applicability can significantly impact the tax treatment of offshore services. The specific provisions of the relevant DTAA need to be carefully analyzed to determine the taxability and any available relief.
The taxation of offshore services in India is a nuanced and complex area that requires case-specific analysis. Factors such as the nature of services, the terms of the agreement between the parties, and the applicable treaties all contribute to the determination of tax liability. Legal interpretations and judicial decisions continue to shape the landscape, and businesses engaging in cross-border transactions must stay abreast of the latest developments[10].
UNDERSTANDING COMPOSITE CONTRACTS IN LIGHT OF TAXATION OFF SHORE SERVICES
In Ishikawajima-Harima Heavy Industries Ltd v. DIT, the composite contract are deemed to accrues or arise in India only when the same is reasonably attributable to operations carried out in India. Where only a part of operations is carried out in India, taxpayer is not liable for income arising from operations conducted in India.[11]
The 2017 decision of Shanghai Electric Group Co. Ltd. v. DCIT,[12] while ruling in this case that taxpayer had a business connection analysed that the clauses of the agreement and come to the conclusion that it was a composite contract. The agreement was entered to establish power plant in India at various places under the supervision of the taxpayer and tax payer was to be responsible for the successful functioning of them. It is important to note that here the tax payer had a supervisory Permanent Establishment in India.
In 2023, Chennai ITAT ruled that income earned by German Company from the turnkey contract it entered with Indian Company is taxable in India. It stated that components of turnkey contract – (a) Installation and commission project, (b) Offshore Supply and (c) Supervision Charge. Here these 3 contracts are treated as the part of composite contract. They ruled that mere composite nature of contract does not lead to taxation and the offshore supplies are not taxable if the title passes outside India and payment has been received in foreign exchange and Permanent Establishment has no role to play in this.[13]
In the case, where the offshore services involving the supply of drawing, design and planning which are even exclusively tailored made and linked with offshore supply of plants and equipment outside India, even that is also not taxable in India and no income is arising in India.[14]
In the cases where the contract has different parties and each party is required to perform different parts in the contract. In regard to this Supreme Court, ruled that a contract is a complex arrangement and it included other parties too, then even though it might be a turnkey contract even then it will not be treated as the integrated contract. The taxable events arise at different times and the supply obligation is different from the service obligation.[15]
Further, same has been taken into account in Technip France SAS,[16] ruling by AAR, in regard to the principle of apportionment of income on the basis of territorial nexus and stated that merely because the contract is turnkey one, it would not imply that it is a composite and integrated contract. The income which is to be taxed can arise at several stages, considering territorial nexus principle.
This ruling is especially important since it provided the much needed clarity that consideration received in regard to supply of offshore equipment is not taxable in India except the installation activities. This stance taken up by the authority is in line with Shanghai Electric Group case where the tribunal ruled that taxpayer who had a supervisory PE in India and profits from offshore and onshore services were connected with it.
Considering that this judgment provided much needed clarity on the concept of services interconnectivity especially in the aspect where the supervisory and advisory services are regarded unrelated to the business of the supply of offshore equipment activity. Although this judgment is opposite to case of Roxar Maximum Performance WLL,[17] where they stated that composite contract for the offshore supply of equipment and for commission and install services in India cannot be dissected and thus it will taxable as a single contract. It is important to consider over here that these cases cannot be uniformly applied one needs to look at terms of contract for an instance under the Roxar Maximum Perfomance WLL, they analysed the terms of agreement and distinguished it by stating that sale transaction of equipment’s was not completed outside but in India. And they further stated that considering clauses of contract there is no distinction between offshore supplies and onshore services.
With respect to taxation under the FTS, it has been accordingly ruled that when the supply, manufacture of the material and services is so inextricably linked with each other, then they form any integral part of the supply and the same is not covered under the Fees for Technical Services.[18]
ANALYSING THE POSITION OF TAXATION OF OFFSHORE SERVICES
In the case of the unrelated parties which are involved in the turnkey contract, it may be less difficult to distinguish the role and responsibilities and risk element involved for the purposes of the tax treatment. While for the related parties, the parent entity is the one who bears responsibility even if Indian Party can execute its services this is the one which triggers litigations.
It needs to be taken into account that factual aspects play an important role therefore the same needs to be taken into account before uniformly applying the judicial decisions. Presently the taxation of the offshore supplies is a complex and litigation prone issue. The terms of agreement and tax treaties entered between the respective countries also occupies a central role in deciding these cases.
Considering that there is mixed batch of decisions dealing with this issue. The factors which are considered in one case for the taxation of the offshore service would not be considered in the same manner in the other case. For an instance in case of Technip France SAS, here they noted in regard to taxability of offshore services that basic engineering design and detailed engineering services even if developed in France they were not final and can’t be rendered without involvement of the Project office in India. Here in this case Project office assumed importance and it was accordingly ruled that services are rendered in India.
Whereas in the case of Roxar Maximum Performance WLL, they rejected the contention of the applicant to divide the contract into offshore supply and services and had taken up the contract as single composite contract only. The authority analysed the clauses of contract- payment terms, contractor responsibility, delivery terms and design, engineering, supply are interlinked with one another and culminated into one system. Therefor they rejected the artificial bifurcation.
With coming of Technip France SAS ruling, the judgment has provided clarity on the concept of connectivity of the services. But at the same time this judgment only has persuasive value, it is the factual matrix of the situation that would play an important role.
CONCLUSION
The taxation of offshore services in India has been a contentious issue, with various judicial precedents and legal interpretations shaping the landscape. The complex nature of composite contracts, which involve multiple components and services bundled together, adds another layer of complexity to this already intricate topic. The interplay between domestic tax laws, international tax treaties, and the specific terms of the contracts themselves has led to a diverse range of opinions and rulings on the taxability of offshore services.
The landmark case of Ishikawajima-Harima Heavy Industries Ltd v. DIT established the principle that income from a composite contract is deemed to accrue or arise in India only when it is reasonably attributable to operations carried out within the country. This ruling emphasized the importance of the territorial nexus principle, suggesting that only the portion of income derived from activities conducted in India should be subject to taxation. However, subsequent cases and amendments to the Income Tax Act have further complicated the application of this principle.
Recent judicial precedents, such as the Ashapura Minechem Limited vs. ADIT and Linklaters LLP vs. ITO cases, have further reinforced the taxability of offshore services in India. These rulings have emphasized the importance of the utilization of services in India as a key factor in determining tax liability. However, the applicability of Double Taxation Avoidance Agreements (DTAA) between India and other countries can provide relief to taxpayers, as DTAA provisions generally override domestic tax law.
The case of Shanghai Electric Group Co. Ltd. v. DCIT highlighted the importance of analyzing the clauses of the agreement to determine whether a contract is a composite one.
The factual aspects and the terms of the agreement play a crucial role in determining the tax treatment of offshore services, especially in cases involving related parties. The mixed batch of judicial decisions dealing with this issue highlights the need for a case-by-case analysis, considering factors such as the nature of services, the terms of the agreement, and the applicable tax treaties between the respective countries. In conclusion, the taxation of offshore services in India remains a complex and litigation-prone issue. The interplay between domestic tax laws, international tax treaties, and the specific terms of composite contracts creates a challenging landscape for businesses and tax authorities alike. The principles established in landmark cases, such as the territorial nexus principle and the apportionment of income, provide guidance, but their application depends on the unique circumstances of each case.
While recent judicial decisions, such as the Technip France SAS ruling, have provided some clarity on the concept of services interconnectivity, the persuasive value of these rulings must be balanced against the specific facts of each case. The taxation of offshore services in India is likely to remain a contentious issue, with ongoing developments in legal interpretations and amendments to tax laws shaping the landscape.
Written by: Manik Tanwar & Yugantar Singh
[1] Adam Hayes, “Offshore: Definition, How It Works, Pros and Cons.” Investopedia, updated August 31, 2023. https://www.investopedia.com/terms/o/offshore.asp.
[2] PwC Tax Insights, Offshore Supplies Held on Facts to Be Taxable in India in Case of Composite Contract for Supplies and Services; Supply Transaction Not Completed Outside India (Sept. 13, 2016), https://www.pwc.in/assets/pdfs/news-alert-tax/2016/pwc_news_alert_13_september_2016_offshore_supplies_taxable_in_india_for_composite_contract_for_supplies_and_service.pdf.
[3] Poonam Gandhi, Composite Contract Cannot Be Bifurcated to Subject Part of Contract to Higher TDS, Taxguru (Nov. 16, 2023), https://taxguru.in/income-tax/composite-contract-bifurcated-subject-part-contract-higher-tds.html.
[4] Tax2win, Section 194C of Income Tax Act – TDS on Payment to Contractor, https://tax2win.in/guide/section-194c-under-income-tax-act (last updated Jan. 29, 2024).
[5] Section 9 (1) (vii), Income Tax, 1961.
[6] Rajvi, Taxability of Fees from Offshore Services – Post Finance Act, CAClubIndia (Sept. 10, 2010), https://www.caclubindia.com/articles/taxability-of-fees-from-offshore-services-post-finance-act-6859.asp.
[7] Ashapura Minechem Ltd. v. ADIT, ITA 638/MUM/2018.
[8] Linklaters LLP v. ITO, ITA no.7307/Mum./2017.
[9] Id.
[10] Poonam Gandhi, Receipts from Offshore Services Doesn’t Give Rise to any Income Accruing or Arising in India Hence Not Taxable, TaxGuru (Dec. 6, 2023), https://taxguru.in/income-tax/receipts-offshore-services-give-rise-income-accruing-arising-india-hence-taxable.html.
[11] Ishikawajima-Harima Heavy Industries Ltd v. DIT, (2007) 288 ITR 408 (S.C.).
[12] Shanghai Electric Group Co. Ltd. v. DCIT, (2017) 84 Taxmann 44 (Del).
[13] Durr Systems AG vs. DCIT, TS-5398-ITAT-2023(CHENNAI)-O.
[14] DSD Noell GMBH Vs ACIT, ITA No. 3186/Del/2016.
[15] Ishikawajima-Harima Heavy Industries Ltd v. DIT, (2007) 288 ITR 408 (S.C.).
[16] Technip France SAS, A.A.R. No. 1413 of 2012.
[17] Roxar Maximum Reservoir Performance WLL, (2012) 349 ITR 189 (AAR).
[18] Linde AG, Linde Engineering Division v. Dy. DIT, (2014) 365 ITR 1 (Delhi).
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