Offshore supplies in a turnkey project

FOREIGN ENTERPRISE

In a case related to Ishikawajima (271 ITR 193) dealing with taxability of offshore supplies, the Authority for Advance Ruling observed that "when the consideration represents only the price of the goods and the transaction of sale is completed outside India, and not by or through the business connection in India, the profit cannot be deemed to accrue or arise on the sale of the goods in India.

But where the consideration is composite and covers not only the price of the goods but also the costs of other operations to be performed by or through the business connection in India in regard to the sale of goods, the profit accruing or arising there from would be deemed to accrue or arise in India".

The authority further observed that it is not just a case of an Indian company purchasing certain goods from the foreign company outside India. "In connection with the offshore supply on sale, certain operations are inextricably linked in India""signing of contract in India which imposes liability on the applicant to procure equipment and machinery in India, receiving, unloading, storing and transporting, paying demurrage charges and other incidental charges on account of delay in clearance. The price aforementioned covers not only the price of the goods but also of all the aforementioned operations which are carried out in India and from which income accrues to the applicant".

Based the above reasoning, the authority ruled that income accrues to non-residents from offshore supply through business connection in India. But the profit deemed to accrue or arise in India shall be only such part of profit as is reasonably attributable to the operations carried out in India.

The aforesaid judgment created practical difficulty in turnkey projects which invariably involve not only offshore supply but also same services like installation and commissioning etc. in India. In all such cases, as per Ishikawajima's case, part of the profit relating to offshore supply will become taxable in India.

It is also to be noted that the authority, in principle, ruled that in turnkey projects, the foreign company will normally have a "permanent establishment" in India.

Furthermore, where certain services are to be rendered in India, foreign company will also be deemed to have a "business connection" in India. Therefore, a part of the profits of offshore supply would be taxable both under the Income-tax Act as well as under the agreements for avoidance of double taxation.

On an SLP filed against the aforesaid case (SLP No. 5318 of 2005), the Supreme Court, in its judgment delivered on January 4, 2007, overruled the Ishikawajima's case relating to offshore supply. The court held that: "There exists a distinction between a 'business connection' and a 'permanent establishment'. As the permanent establishment cannot be said to be involved in the transaction, the aforementioned provision will have no application. The permanent establishment cannot be equated to a business connection, since the former is for the purpose of assessment of income of a non-resident under a double taxation avoidance agreement, and the latter is for the application of Section 9 of the Income-tax Act"

As far as Ishikawajima's case is concerned, the court held that entire transactions having been completed on the high seas, the profits on sale did not arise in India.

The position of law is quite clear now. Even in turnkey contracts, off shore supplies could be entirely out of the tax hook if the sale is completed out of India.

agar@bol.net.in