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“taxability of turnkey contracts”         List of abbreviations
Co. Ed. IT ACT ITO Company Edition Income Tax Act

Objective

In this paper an attempt is made to analyze the law on taxability of turnkey contracts. An attempt has been made to analyze to what extent income is taxable in turnkey contract. An approach has been taken in this paper to study the statutory provision and different case laws regarding the taxability of turnkey contract and what is the current situation of law on imposing the tax liability.

Research Methodology

The nature of the project is purely doctrinal/ non-empirical. It is purely based on the data collected from books, statutes, journals, case laws and web resources. It is a literature review. The researcher has relied upon the primary as well on secondary sources. In the paper researcher has followed the uniform mode of citation.

Scope of the Paper

The scope of the research paper is limited to analyze the law and legislation on the taxability of turnkey contracts and what is the role played by the judicial pronouncement in deciding the cases on taxability of turnkey contracts. In this research an attempt has been made to analyze the statutory provision as well as judicial pronouncements delivered regarding the taxability of turnkey contract. The analysis can further help in locating the lacunas in the present law and how it can overcome by strengthening and regulating the prospective laws. The scope of paper is limited to laws releted to taxability of turnkey contracts.

INTRODUCTION

In today’s world infrastructure is considered as one of the leading factors for development. The Indian government has desire to make India as an upcoming superpower country for which they have been escalating their investment on enhancing the infrastructure of the country as it will help in its progress and development.[1] Because of the scale of the infrastructure projects and the complexities included, regularly these projects welcome tender from the whole way across the globe, the agreement signed with these companies are known as EPC contracts furthermore referred to as turnkey contracts. [2] A turnkey contract is a business plan in which a project is conveyed in a finished state. Rather than contracting with an owner to create a project in stages, the developer is enlisted to complete the whole project without owner information. The builder or developer is independent from the final owner or operator, and the project is turned over just once it is completely operational. Essentially, the developer is completing the project and "turning the key" over to the new owner. This sort of arrangement is normally utilized for construction projects extending from single structures to expansive scale developments. Because of the multifaceted nature of these projects it is certainly unrealistic for any one single commercial element to attempt the entire project, subsequently these projects are taken up by a consortium of different companies who handle diverse parts of the project as per their respective expertise.[3] Initially, these turnkey projects did not hold the tax liability but with the change in circumstances the finance ministry in its finance bill’06 has made these turnkey contracts tax liable. Prior the rendering of offshore services for an turnkey project and offshore supply of equipments and material for the project are considered to be the main bone of contention regarding the taxability of these projects[4], but after the amendment to section 9 of the Income Tax Act, offshore services have been made taxable and the law has been pretty much settled on this issue,[5] however the taxability of offshore supply of equipment and material under the turnkey projects is still an argumentative issue. Turnkey contract would bring about a few particularly identifiable streams of income to the contractor which include the following:
  1. Offshore supplies of equipment and material
  2. Offshore services
  3. Onshore supplies of equipment and materials
  4. Onshore supplies of servives

Research question

  • What is the extent of taxability of offshore supplies of equipment and materials and offshore sevives under turnkey contracts and the role of by judicial pronouncements in establishing law related to such turnkey contracts?

Taxability of offshore supplies of equipment and materials

To impose taxability on offshore supplies of equipment and materials, it has to be shown that the non- resident has permanent establishment and business connection. If there is no business connection or permanent establishment then there would be no tax liability. But, if there is business connection or permanent establishment then the tax can be imposed on the profit that is attributed to such business connection and permanent establishment.

Statutory Provision

For non-residents, section 5 of the Income Tax Act is the charging section for their income.[6] Section 5(2) of Income Tax Act impose tax on the income of non-residents which is received or deemed to be received in India by or on behalf of such person[7] or accrues or arise or is deemed to be arise.[8] Section 9 of Income Tax Act deals with income deemed to accrue or arise in India. Section 9 states that all income accruing or arising through or from any business connectionin should be considered as taxable in India.[9] The explanation clause attached to it points out the extent of income to be taxed by stating that only such part of income that is attributable to the business carried out in India woul be taxable.[10] Therefore, it is clearly mentioned in the statutory provision that in case of offshore supplies, income which is not attributable to the operations carried out in India would not be taxed.

Taxability of offshore services

The taxability of offshore services is no more a bone of contention as after the amendment to section 9 of IT Act[11] these services have been made taxable.

Case laws

Ishikawajna-Harima Heavy Industries Ltd. V. Direct of Income Tax

In Ishikawajna- Harima Heavy Industies Ltd. v. Direct of Income Tax[12], it is Japan based company engaged in the business ofengineering and construction of storage tanks. The company formed a consortium with other companies and entered into an agreement with Petro LNG Ltd.situated in the state of Gujrat to set up liquefied Natural Gas storage tank and for degasification facility. It is a turnkey contract. Each member of consortium was specified about their separate role and responsibility and therefore, they receive separate payment. The time period for the project was 41 months. The question that arised in this case whether the company is liable to pay tax in India under Income Tax Act and India- Japan Tax Treaty. Therefore, the company filed an application before Authority for Advance Appellant. The decision of Supreme Court is given in two parts one for the offshore supplies and other for the offshore services. The Apex Court held the following decision ; “ only such part of the income which is attributed to the operations carried out in India can be taxed. Under the turnkey contracts, if all the transaction were operated outside India then these transactions cannot be taxed in India. It made the distinction between the permanent establishment and business connection. Existence of permanent establishment is a taxable entity but its presence does not create sufficient business connection. Therefore the profit attributable to the permanent establishment in India would be made taxable and the mere presence of permanent establishment in India does not made the income of assessee generated under turnkey contract does not made it taxable. Mere existence of of business connection is not sufficient, to make the income taxable the income should be arising or accruing out of such business connection. The turnkey contract need not to be be considered as an integrated contract just to make the contractor to pay tax in India. To make an income taxable under Income Tax Act, it should be shown that the services are not only utilized but rendered in India. To make the income taxable it is necessary to have enough territorial nexus between the rendition of services and territorial limits in India.”[13]

Hyundai Heavy Industries Co Ltd v. Director of Income Tax

This is the another landmark case on the taxability of turnkey contract decided by the supreme court. In Hyundai Heavy Industries Co. Ltd. v. director of Income Tax[14], the Hyundai Heavy Indutries is a Korean based company which eneterd into a turnkey contract with an Indian based company ONGC for fabricating, designing, installation and commissioning of platforms in Bombay High. Designing and fabricating of platform was performed outside India and rest of the activities like installationand commissioning of platform was performed in Bombay High. The Revenue officer issue a notive to the company, to which a company filed a return of income as ‘nil’ income. And responded to the revenue authorities, as they did not have permanent establishment in India and the activities like designing and fabrication were done outside India making them not liable to pay tax. They are only liable to pay tax for the net profit arising from the activities that are performed in India i.e. installation and commissioning of platforms. The revenue authority appealed to the Supreme regarding the contention that to what extent the profit attribuatable to company’s permanent establishment in India. The court held that “the establishment PE of HHI came into presence just on completion of fabrication exercises and supply of the fabricated platforms to ONGC outside India, no part of profits emerging from operation conveyed outside India could be said to have been earned through the Permanent Estabishment. Likewise, no part of profits from operation conveyed outside India could be credited to the PE and consequently accumulated to tax in India. In a turnkey contract comprising designing, fabrication, installation and commissioning work, benefits arising from the operation performed outside India can not be ascribed to the Permanent Establishment. In this way, such benefits can not be liable to tax in India, if the cost paid for work performed outside India is at a careful distance.[15]

Conclusion

The Supreme Court's decision in HHI case settles the discussion encompassing the taxability of oil field administration suppliers in admiration of fabrication and designing exercises performed outside India under a turnkey contract. The ruling accept increased noteworthiness since it maintains the principle that supply outside India won't be taxable in India indeed where such supply is made as per a single turnkey contract which includes onshore and offshore extent of work and accommodates a protuberance entirety thought.[16] The Apex Court follows its choice in the instance of Ishikawajma Harima Heavy Industries Ltd, affirmed prior, on taxability of offshore supplies. The Court had decided that a non-resident would not be obligated to tax in India in appreciation of exercises performed outside India if such exercises are not viably joined with a business association in India.[17]

BIBLIOGRAPHY

STATUTES:
  • Income Tax Act, 1961
  • Finance Act
The Assessing Officer (“AO”) held that the contract between HHI and ONGC was a turnkey contract for a lumpsum price and is an indivisible contract. The designing and fabrication of platform under the contract is intrinsically linked to installation and commissioning activities performed in India. As regards the taxability of Indian operations, the AO held that the activities of HHI constituted a PE in India under Article 5(3) of the DTAA, and therefore, profits attributable to Indian operations were liable to tax in India. In addition, designing and fabrication activities, though performed outside India, are interlinked to the ultimate activity of installation and commissioning; and therefore, a portion of the profits from such operations would also be liable to tax in India. The Supreme Court’s ruling in HHI case settles the controversy surrounding the taxability of oil field service providers in respect of fabrication and designing activities performed outside India under a turnkey project . The ruling assumes increased significance since it upholds the principle that supply outside India will not be taxable in India even where such supply is made pursuant to a single turnkey contract which includes onshore and offshore scope of work and provides for a lump sum consideration.


[1] Funding the Infrastructure Gap, http://www.deloitte.com/assets/DcomIndia/Local%20Assets/Documents/Thoughtware/Funding_the_InfrastructureInvestment_Gap.pdf [2] Rajesh Dhawan Engineering Procurement and Construction-Tax Implication, http://www.taxmann.com/TaxmannFlashes/Flashart5-1-10_2.htm [3] Satish Aggarwal, Averting double tax in EPC, The Hindu Business, http://www.thehindubusinessline.com/todays-paper/tp-opinion/averting-double-tax-in-epc/article1638687.ece [4] Taxation of EPC Contracts- A Treatise, 59 The Chartered Accountant Journal 103, 99-105 (2011). [5] Linklaters & Paines v. ITO [2012] 28 taxmann 250 (Mum). [6] Ankit Shah, Taxability of Income from Offshore Supply of Goods To India in a Tunkey contract, 61 The Chartered Accountant Journal 100, 98-103 (2013). [7] Section 5(2) (a) of Income Tax Act, 1961. [8] Section 5(2) (b) of Income Tax Act, 1961. [9] Section 9(1) (i) of Income Tax Act, 1961. [10] Section 9 (1) explaination, Income Tax Act, 1961. [11] Income Tax Act, 1961. [12] Ishikawajana- Harima Heavy Indutries Ltd. v. direct of Income Tax (2007) 3 SCC 481. [13] Ishikawjama- Harima Heavy Industries ltd. V. Director of Income Tax (2007) 3 SCC 481, www.manupatrafast.in/pers/Personalized.aspx [14] Hyundai Heavy Industries Co. Ltd. v. Director of Income Tax2011 (12) ITR(Trib) 168 (Delhi). [15] Taxability of Turnkey Contracts- SupremeCourt ruling in Hyundai Heavy Indutries Co. Ltd.’s case, Tax Edge, june 2007, http://www.bmradvisors.com/upload/documents/Taxedge-Special%20bulletinJune141248414019.pdf [16] Taxability of Turnkey Contracts- Supreme Court ruling in Hyundu Heavy Industries C. Ltd’s case, Tax Edge, June 2007 , http://www.bmradvisors.com/upload/documents/Taxedge-Special%20bulletinJune141248414019.pdf [17] Ibid.
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