Offshore supplies are tax free

The issue of taxability of 'offshore supply price' was settled by the Apex Court in the case of Ishikawa [288 ITR 408] wherein it was held that 'the entire transaction having been completed on the high seas, the profit on sale did not arise in India'. The Apex Court also observed that 'once the transaction relating of offshore supplies is excluded from the scope of taxation under the IT Act, the application of double taxation treaty would not arise.'

The Hon'ble Court also held that 'where different severable parts of the composite contract are performed in different places, the principle of apportionment can be applied, to determine which fiscal jurisdiction can tax that particular part of the transaction. This principle helps determine, where the territorial jurisdiction of a particular State lies, to determine its capacity to tax an event.'

 

The Hon'ble Court, in other words, clearly held that in case of offshore supplies India may not have any jurisdiction to tax income of a non-resident because of absence of sufficient territorial nexus of such income with India. The above principle is subject to an exception that the non-resident should not have a permanent establishment in India which could be economically connected with offshore supplies.

Despite a clear ruling from the Apex Court, divergent views have been taken by various authorities on the pretext of different facts. For example in case of Worley Parsons [312 ITR 317], the Authority for Advance Rulings observed that the observations of the Supreme Court relating to principle of apportionment can not be extended to a situation where there is a single agreement covering only one type of work.

In the above case the Authority ruled that 'even a small portion of work in India will provide sufficient territorial nexus for entire work including activities performed outside India.'

Similarly, in case of Samsung [133 ITD 413] , a part of profit on account of offshore supplies was held as taxable in India on the ground that 'the foreign company's permanent establishment was for the entire project, and therefore offshore supplies are also to be taken as connected with the permanent establishment.'

It is, however, heartening to note that in recent decisions of the AAR the ratio laid down in Ishikawa has been followed in its true spirit. In case of Sepco III [AAR No. 1008 of 2010] it was contended that the transaction was not merely for offshore supplies but the non-resident was also to do a considerable portion of the work relating to supply in India. The non-resident was required to have continued presence in India for atleast 90 days. The Authority did not digress from the principle laid down in Ishikawa case by observing that 'we are afraid that we are bound by the decision of the Supreme Court relied on, on behalf of the applicant and we are not free to travel outside it.'

Similarly, in case of CTCI [AAR No. 854 of 2009], the Revenue tried to distinguish the case of Ishikawa on the ground that the non-resident belongs to Hongkong with which India does not have a tax treaty and also that the non-resident has a 'business connection' in India.

The Authority, however, ruled that 'all such issues, including whether a contract is composite and indivisible, have been addressed in the case of Ishikawa and we are not free to travel outside the realm of the Supreme Court decisions, specially in a case where such a question arises on offshore supplies.'

The foreign enterprises can now take a sigh of relief that offshore supplies are outside the tax net in India. Nevertheless, it is advisable that foreign companies should meticulously ensure that if they have any entity in India like a project office, liaison office, branch or a PE such Indian entity should not be connected with the offshore supplies.

HP Agrawal The author is a Sr. Partner in S.S. Kothari Mehta & Co. hp.agrawal@sskmin.com