FINCANTIERI SPA,NOIDA vs. ACIT IT CIRCLE 2(3) (1), MUMBAI

During the course of assessment proceedings in response to notices issued by the ld. AO assessee submitted the details of project works contract executed by the assessee in India during relevant F.Y.2019-20 alongwith detailed explanation and bifurcation of income as income attributable to its project office (PO) and fees for technical services (FTS) and also copy of transfer pricing study report was also submitted. The ld. AO had also required the assessee to provide detailed working alongwith supporting documents for the income attributable to project office, and in response assessee submitted that income attributable to project office in India u/s.44DA has been calculated at arm’s length principle pursuant to transfer pricing study for the relevant year. Apart from that, assessee had submitted the details of activities undertaken under the contract with MDL. Further, assessee had also submitted in response to the specific query by the ld. AO to submit the role of head office and branch office in aligning the milestones under the contract with MDL. Copy of work completion certificate received from Fincantieri SPA, Mumbai MDL was submitted wherein all the activities undertaken by the head office is also provided. In so far as assessee’s response to the ld. AO’s notice to substantiate the attribution of income and as to how the income of head office is not attributable to the PE, assessee submitted detailed nature of activities alongwith involvement of head office and the project office for each of the activities. It was specifically submitted that once attribution of income to the PE had been determined at arm’s length then no further income can attributed to such PE and in support reliance was placed on the judgment of Hon’ble Supreme Court in the case of Director of Income-tax (International Taxation) vs. Morgan Stanley & Co. reported in 292 ITR 416 and the judgment of Ishikawajma-Harima Heavy Industries Ltd. vs. Director of Income-tax reported in 158 Taxman 259 (SC). Thus, it was stated that income of Rs.82,39,71,604/- pertaining to services directly performed by the head office is not attributable to project office in India and it cannot be taxed @40% plus applicable charges and cess.

However, the ld. AO rejected the assessee’s contention and held that PE did not play limited role in the project and had other major role also, therefore, income attributed to the project office is not acceptable. Without carrying out any ALP determination, he attributed income to the project office on adhoc basis of 50% of the total receipts as attributable to PE and no deduction of expenditure incurred for earning such income was allowed by the ld. AO. The ld. DRP has also confirmed the action of the ld.AO and finally the difference between the income Fincantieri SPA, Mumbai shown by the assessee in the return of income and attribution made by the ld. AO in his final assessment order is as under:- Particulars As per return As per of Assessment income Order Total receipts pertaining to work 95,25,24,717 95,25,24,717 performed in FY 2019-20 (a) Receipts attributed to PE (b)* 12,85,53,113 47,62,62,359 Less: Expenses incurred by PE 10.83,28,793 10,83,28,793 (c) Corresponding income of PE 2,02,89,942 36,79,99,188 offered to tax (d)=(b)-(c) Receipts (Income) attributed to 82,39,71,604 47,62,62,359 HO (e) = (a) - (b) Total income (f)=(d)+(e) (rounded 84,42,61,550 84,42,61,550 off u/s 288A of the Act)

Before us ld. Counsel vehemently objected to the adhoc attribution of income to the PE and drew our attention to the activities performed by head office and the activities performed by the project office for the contract with MDL which was given before the ld. AO and same is also reproduced hereunder:- Particulars Activities performed by HO Activities performed by PO Fincantieri SPA, Mumbai Build strategy  Undertaking audit of  Assisting HO in and build plan existing infrastructure undertaking minimal facilities. audit activities under the supervision and  Preparation of an guidance of HO infrastructural & capability study and gap analysis.  Preparation of a build strategy for customers. Preparation of  Preparation of detailed No role designs and designs as per the inputs production provided by customers, drawings formats, assembly production drawings etc. Project  Interacting with customer  No role Management and coordinating with and various internal departments Supervision  Ensuring that timelines are met, tracking  Monitoring costs incurred Technical  Supervising employees of  Providing assistance PO involved in providing on requisite onsite premise technical assistance technical assistance in understanding certain specific nuances of the drawings and designs, providing technical support required by customer in construction of ships Quality  Performing  adequate No role assurance equality checks, test procedures and inspection, as necessary, for the activities performed by employees of project office in India Fincantieri SPA, Mumbai 7. Thus, Ld. Counsel submitted that the activities of the project office were only to the limited extent and the significant portion of the contract has been undertaken by the assessee in Italy. Further, the employees deployed to the project office in India are not qualified to provide the deliverables envisaged under the contract with MDL and simply acted as liaison between assessee and MDL. He further submitted that ld. AO without referring to the activities required to be performed by the assessee under the contract or by the project office has made an adhoc attribution to the PE, it is not only unreasonable but also against principle of arm’s length principle which is embedded by attributing the profit of the PE.

Thereafter, our attention was also drawn to the terms and conditions of the contract under the agreement and the key allocation of work under the contract and submissions qua the terms of contract is as under:- Particulars Details and submission Name of Services as Know-how Provider for Technology the contract Upgradation and Capability Enhancement for Facilitating Integrated Construction of Project 17A Ships. The name in itself depicts the essence of the contract that the Appellant has been engaged as a know-how provider for construction of ships for Indian Navy - 4 at Mumbai site and 3 at Kolkata site. Meaning of Methodology facilitating extensive pre-outfitting so as to Integrated realize a significant reduction in the overall build construction period. Accordingly, the purpose of the contract is to assist MDL with know-how to build ships in a reduced timeframe. Responsibility MDL has signed contract with the Ministry of Defence, Fincantieri SPA, Mumbai to construct Government of India for construction of 7 ships. ships Accordingly, the responsibility to construct ships is of MDL Inputs required On signing of the contract, the customers are to provide by FC HO with the list of inputs as requested for providing the services Detailed listing of inputs to be provided by MDL to the Appellant to render the services are also captured in the contract basis which it is evident that the necessary inputs are provided by MDL Copy of inputs received by the Appellant from MDL on a sample basis are also submitted Audit of The personnel of the Appellant conducted audit on the MDL Facilities premises of MDL in initial phases of the subject contract. Under the contract, the Appellant is to suggest only minor improvements in the infrastructure while process innovation techniques are only to be suggested in detail. Thus, the major role of the Appellant is to suggest necessary improvements in the processes followed by MDL with a view to reduce the build process for ships. Deliverables Basis the detailed listing of deliverables under the under the contract, your Honours would note that the majority of contract the deliverables are either 'Design/ Drawings' or a 'Review report' which are prepared by the Appellant in Italy basis the inputs from MDL. While the Appellant, under the contract, has also undertaken to provide technical assistance to MDL and trainings to MDL employees, the crux of the contract remains to be the design documents developed by the Appellant in Italy basis the inputs from MDL. This fact is also affirmed by the customer MDL, a Government of India undertaking vide its letter dated 17 October 2022 which in fact stated that all deliverables under the contract are prepared by the Appellant in Italy.

Fincantieri SPA, Mumbai Delivery The delivery of the deliverables under the contract, of Deliverables being for the benefit of the Indian Navy which is a matter of Defense, is made through the secured data exchange (SDE) set up for this purpose. The Appellant is also subject to its resident country i.e. Italy's regulations in this regard and accordingly, in respect of the deliverables sent to MDL, 'Register of File Transfer' (ROFT) is maintained and submitted with the Italian Government. Airwaybills and proforma invoice evidencing the transfer of deliverables from Italy to India are also submitted. Contract price The contract price is a lumpsum amount of Euros 40 million for the agreed deliverables. Additional clauses covering man day rates are also provided for any additional services that the customer may require Taxes to be All taxes arising in respect of the subject contract borne outside India are to be borne by FC whereas all taxes by arising in India are to be borne by MDL

Thus, he submitted that on conjoint reading of the above and it is also evident from the contract, it is clear that deliverables are prepared in Italy on the basis of inputs from MDL and then delivered to India through SDE or in hard copy into relevant documentation have been maintained. Apart from that, for the required on-site support, assessee has set up the project office in India and during the year only eight employees were deputed to the project office to provide the necessary technical on-site assistance under the contract. Out of 8 employees, 3 worked on the site in Kolkata and 5 on the site in Mumbai. Based on these deliverables and the basis the payment milestones agreed, the Fincantieri SPA, Mumbai assessee had received Rs. 95,25,24,717 (on grossed up basis), out of which Rs.12,85,53,113 being attributed to PE on an arm's length basis after deduction of expenses as per section 44DA and balance as income of the head office as FTS.

Thereafter, ld. Counsel has given rebuttals against various observations and the presumptions made by the ld. AO wherein multiple contentions have been raised by the ld. AO regarding receipt of PO under the contract. The contention of the ld. AO and the rebuttal of the assessee qua every observation are reproduced hereunder:-

Contentions of the learned Appellant's remarks AO The Assessee attempted to shift As captured at para 12 to 14 and the major activities in the hand para 19 above, your Honours would of HO and considered limited appreciate that the arrangement and role for Project office in India deliverables under the contract is such that the major deliverables are completed outside India in Italy basis inputs from MDL. And PO's role is restricted to on-shore support. However, the learned AO without any supporting, made the statement that the Appellant tried to shift major activities to HO which does not represent the facts of the case. It is seen from the above that The man day rates mentioned in the employees deputed to India are contract are in respect of services that highly qualified graduates and may be needed by MDL post having experience of 5 to 6 completion of the contract, Further, years in their role. Also, seen such rates are agreed at which FC from copy of agreement they are would charge MDL in case such paid well in India (Euro 1675 services are availed by MDL in the per man day in India as future. Accordingly, the said rates are Fincantieri SPA, Mumbai compared to Euro 879 in Italy). not in respect of current employees of As can be seen from above, all FC engaged in providing services to are specialist in their role and MDL. Depending upon where the work performing specialized work is performed, such rates are divided into Italy and India. Further, the If only assistance work was reference by the learned AO to pay per man day of employees of HO and PO being provided by the PE office then there was no need of is irrelevant as these rates are in engaging highly qualified, relation to service to be provided on experienced, technically requirement basis post completion of the contract competent employees at the project office The learned AO has incorrectly understood such rates to be the man day rates at which the employees of FC are currently paid. The said rates are for future employees who may or may not be required to be deputed to India based on MDL's requirement post completion of contract Further, 5 to 6 years of experience cannot be considered as highly experienced Also, the employees are only graduates. The contention that few employees can complete half of the contract is incorrect. They are only providing minimal on-site assistance to MDL to understand the deliverables under the contract Employees in India regularly The feedback report shared by assist and represent M/s employees of PO captures details in Fincantieri to MDL and shares relation to data exchange, technical feedback report of the project assistance provided at MDL's premise which helped HO branch to and payment status etc. Information deliver the services Employees captured in said feedback reports are from Italy other than placed in preliminary and in relation to general the project office also visited understanding of the project. Thus, it India and used to interact with doesn't provide any key inputs for employees of MDL and developing of deliverables. As employees of PE in India. Even, captured at para 10 above, inputs for preparing the deliverables are it is admitted fact that they Fincantieri SPA, Mumbai were staying with the provided by MDL to the Appellant employees of PE in India. Further, the contention of the Therefore, the submission of learned AO that it is admitted fact the assessee that PE has that the employees from Italy limited role is not correct. visited to India and were staying Further, it is submitted by the with the employees of PE in India is assessee that the project incorrect and without any basis. office has helped the HO The Appellant submits that no constantly through video employee from Italy visited India in conference and provided the subject year. required assistance to HO to accomplish the project.

Thus, ld. Counsel concluded that the ld. AO without taking into cognizance the deliverables under the contract which by nature reflects that they have developed in Italy is simply on Fincantieri SPA, Mumbai adhoc basis income of the head office in Italy cannot be attributed to the project in India.

On the other hand ld. DR strongly relying upon the order of the ld. AO and ld. DRP, had reiterated the contentions of the ld. AO which has been reproduced above.

We have heard rival submissions and also perused the relevant finding given in the impugned orders as well as various materials referred to before us. The only issue involved is whether ld. AO was correct in contributing 50% of the gross receipts to the branch office i.e. PE @50% which was on adhoc basis without carrying out in arm’s length determination.

It is not in dispute that assessee is providing services as a know-how provider for technology upgradation and capability enhancement for construction of ships for Indian Navy by Mazagon Dock Shipbuilders Limited (MDL). As per the contract the assessee was to provide MDL with know-how to build ships in a given time frame. MDL has signed a contract with Ministry of Defense, Government of India for construction of seven ships and accordingly, the responsibility to contract ship was purely of MDL. The MDL entered into an agreement with the assessee to render the technical services for providing design and technology upgradation. The deliverables as per the contract was mainly design / drawings or a review report which was prepared by the assessee in Italy on the basis of inputs from the MDL. Under the contract assessee also has undertaken to provide technical assistance to MDL and training of MDL employees. However, the Fincantieri SPA, Mumbai crux of the contract remains to be designed document developed by the assessee in Italy on the basis of inputs given by the MDL. This fact has also been affirmed by the MDL vide its letter dated 17/10/2022 which clearly state that all the deliverables are prepared by the assessee in Italy. All the delivery of the deliverables has been made through Secured Data Exchange (SED) set up for this purpose. The assessee has also submitted airways bills and proforma invoice to evidence that transfer deliverables has been made from Italy to India. The contract price on a lump sum amount was €40 million for the agreed deliverables and additional contracts, man day rates were also provided for any additional services for MDL may require. All the taxes in respect of sub-contract outside India were to be borne by the assessee, because all the taxes arising in India was to be borne by MDL. Thus, as per the agreement / contract deliverables were prepared in Italy on the basis of inputs given by MDL for the construction of Navy ships and then delivered to India was set up with eight employees to provide necessary technical support and on-site assistance under the contract.

In a succinct manner, the activities highlighting the contract can be summarized in the following manner:-  The responsibility to construct the ships is of MDL.  Assessee is only required to prepare the deliverables (design and review documents) basis.  the inputs provided by MDL which is done in Italy.

For attributing the profit of the PE (herein branch office), the most important factor which needs to be taken into consideration is, whether the PE was remunerated on arm’s length basis which has to be judged based on functions, assets and risk analysis. As noted above, the detailed transfer pricing study was conducted based on FAR analysis to justify the remuneration / attribution of income to the PO. From the perusal of the TP study report, it is seen that following FAR analysis have been taken into consideration which are being summarized by us in the following manner in the table given below:- Type of Functions Fincantieri Fincantieri HO (Italy) PO (India) Bidding for contract (including Yes No Pre-bidding) Contracting with customers Yes No Strategy and planning for contract Yes No execution Build strategy and build plan Yes Limited Design and production drawings Yes Limited to explain drawings Project management and Yes Limited

The summary of key activities performed by the Head Office in Italy and project office in India specific to the sub-contract is highlighted herein below:- Particulars Activities performed by Activities performed HO by PO Build strategy  Undertaking audit of  Assisting HO in and build plan existing infrastructure undertaking minimal facilities. audit activities under  Preparation the supervision and of an infrastructural & guidance of HO capability study and gap analysis.  Preparation of a build strategy for customers Preparation of  No role Preparation of designs and detailed designs as per production the inputs provided by drawings customers, formats, assembly production drawings etc. Project  Interacting  with No role Management customer and and coordinating with various Supervision internal departments  Ensuring that timelines are met, tracking  Monitoring costs incurred Technical  Supervising employees  Providing assistance of PO involved in requisite onsite providing on premise technical assistance in technical assistance understanding certain specific nuances of the Fincantieri SPA, Mumbai drawings and designs, providing technical support required by customer in construction of ships Quality  Performing adequate  No role assurance equality checks, test procedures and inspection, as necessary, for the activities performed by employees of project office in India

Likewise summary of risk borne by the PO and HO pertaining to the provisions of technical consultancy services is summarized in the following manner:- Type of Risks Fincantieri Fincantieri HO (Italy) PO (India) Market risk Yes No Product/ service liability risk Yes No Contract risk Yes No Technology Obsolescence risk Yes No Data privacy risk Yes Limited Credit and collection risk Yes No Foreign exchange risk Yes No Idle capacity risk Yes No Manpower risk Yes No Fincantieri SPA, Mumbai 19. From the above FAR it is manifest that the major functions and the activities are carried out by the head office in Italy and the PO in India has practically very limited role and no risk. Thus, according to FAR analysis, the revenue from the said contract mostly pertains to assessee in Italy and only a limited attribution can be made to the PO i.e. PE.

Before us it has been stated that assessee has adopted Transaction Net Margin Method (TNMM) to be the most appropriate method and assessee had selected 12 comparables and the following weighted average of operating profits on operating cost was given in the TP study report in the following manner:- Sr. Name of the company Weighted average of No. operating profits on operating cost (%) 1 Blackstone Group Technologies -4.15% Private Limited 2 Semac Consultants Private Limited -2.67% 3 Desein Private Limited 1.94% 4 Intercontinental Consultants and 4.46% Technocrats Private Limited 5 Balaji Rail Road Systems Private 5.31% Limited 6 ASM Technologies Limited 7.81% 7 Development Consultants Limited 8.82% Fincantieri SPA, Mumbai 8 Tata Consulting Engineers Limited 15.20% 9 Satyam Venture Engineering Services 15.83% Private Limited 10 DRA Consultants Limited 19.36% 11 Mahindra Consulting Engineers 21.60% Limited 12 Consulting Engineers Group Limited 23.85% Arm's Length Range 5 35th percentile 5.31% 6&7 Median 8.31% 8 65th percentile 15.20%

Since the operating margin by the PO was 19.36% which was higher than the arm’s length range of the margins of the comparable companies, the international transaction pertaining to provision of technical consultancy services between PO and HO has been stated to be at arm’s length on the basis of Indian transfer pricing regulations. This ALP has neither been rebutted nor has been considered by the ld. AO nor was any reference made to the ld. TPO. The AO while attributing profit of PE was required to carry on FAR analysis to allocate profit or income to the PE. The arm’s length principle is embedded in Article 7, when income or profit is to be attributed to the PE after examining the role and function of the Foreign Enterprise (FE) through PE; Fincantieri SPA, Mumbai assets deployed to the PE for carrying out the activity and risk assumed by the PE in performing the function for the FE.

Another important fact here is that the PO worked under control and the supervision and guidance of head office and the functions of the project office (herein referred to as Designer) were identified in the TP study report was mainly:-  Designers who assist customers in understanding the design deliverables prepared and shared by Head Office. The Designers act as an interface between Head Office and customer.  Planning and production management specialist(s) who assist customers in following the plan developed by Head Office for the construction of the ships with the objective of reducing the time taken to build a ship. However, the responsibility of construction of the ships remains with customer.  Production specialists who provide technical advice to customers in relation to the construction of blocks, assemblies, etc under the guidance of Head Office.

Thus, ALP was determined on the basis of Rule 10B of Income Tax Rules for comparing the international transaction of provision of technical services keeping in mind the FAR analysis. Based on this TP study analysis, attribution of income to the branch office was made at Rs.12,85,53,113/- based on arm’s length principle and was determined by adding up a suitable mark-up of 19.36% to the total cost incurred in the year by the Fincantieri SPA, Mumbai said project office in India. The ld. TPO has simply brushed aside the TP study report in a very casual manner stating that in TP study report calculation of income attributable to the PE based on transfer pricing study method is done by taking comparables from other sectors instead of highly technical services as in the instant case. Nowhere, ld. AO has either referred the matter to the ld. TPO or has discussed why any of the comparables or the method applied to the assessee is incorrect. Thus, without carrying out FAR analysis no further income can be attributed to the PE. Accordingly, we hold that the allocation / attribution of income to the PE are at arm’s length and no further attribution is required to be there.

Even otherwise also ld. AO without any TP study analysis or reference to the ld. TPO has attributed 50% of the total receipts when major functions and activities were carried out in Italy and all the risks were assumed in Italy. Accordingly, such an adhoc attribution without FAR analysis or even going through the functions and activities carried out by Italy that most of the deliverables were only from Italy, cannot make further attribution for the production of technical or consultancy services. Accordingly, the attribution made by the ld. AO is rejected.

As regards various presumptions made by the ld. AO, we had gone through the rebuttals and the explanation of the assessee and we are in agreement with such an explanation that observations of the ld. AO and the contentions raised by him Fincantieri SPA, Mumbai cannot stand. Accordingly, the addition made by the ld. AO for making adhoc attribution with the PE is deleted.

Since we have deleted the addition, there is no requirement to deal with other grounds, however, for the sake of completeness, the issue whether computation of income attributable to PE can be made without referring the matter to the ld. TPO is discussed in brief. The stand of the ld. DRP is that ld. AO is not empowered to refer the matter to the ld. TPO for determination of arm’s length price in the present case. According to the ld. DRP in the case of apportionment of revenue between PO and HO which is based on examination of functions, asset and risk undertaken by PO and HO and such examination of the functions have been undertaken by the ld. AO which is based on principle reasonableness and fair.

Thus, the aforesaid para of Article 7 clearly requires that PE is deemed as distinct and separate enterprise for the purpose of PE attribution and profits attributable to PE need to be determined in line with the ALP principle. This view is now well supported by the judgment of ITAT Special Bench, Ahmedabad in the case of BEA Shenyang Transformer Group Company Ltd. [2024] 169 taxmann.com 145, wherein the question referred to the Special Bench of the ITAT was:-

Thus, we hold that attribution of revenue between PO and HO is an international transaction which is subject to TP regulations which here in this case has been duly complied with the assessee and ld. AO has failed to carry out such analysis and adhoc adjustment cannot be sustained or upheld. Accordingly, such ground raised

In the result, appeal of the assessee is allowed. Order pronounced on 28th March,2025.