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Facts
The assessee, J.M. Voith SE & Co. KG, a German tax resident, is engaged in the design and manufacture of paper machines and entered into four contracts with Indian entities for design, manufacture, supply, installation, and commissioning. The Assessing Officer sought to tax income from offshore supplies, treating the contracts as composite projects and asserting the existence of a Permanent Establishment (PE) in India. The assessee contended that the contracts were divisible, activities occurred outside India, and income from offshore supplies was not taxable, denying the existence of a PE for such supplies.
Held
The tribunal noted that the departmental authorities had not adequately examined all four contracts, particularly regarding their divisibility, and found the profit attribution rates to the PE (10% by AO, 5% by CIT(A)) to be ad-hoc and without proper rationale. The tribunal also found that the assessee's contentions regarding the existence of PE and the applicability of Article 7 of the India-Germany DTAA Protocol were not properly considered. Therefore, the tribunal restored the entire issue to the Assessing Officer for de novo adjudication, requiring a thorough re-examination of all contracts and relevant DTAA provisions.
Key Issues
Taxability of income from offshore supplies; existence and nature of Permanent Establishment (PE) in India; and the appropriate attribution of profit to the PE, considering the divisibility of contracts and India-Germany DTAA provisions.
Sections Cited
section 9(1)(i), Rule 10, Article 5(2)(i) of the Tax Treaty, Article 7 of protocol to India-Germany DTAA
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Income Tax Appellate Tribunal, DELHI BENCH ‘D’ NEW DELHI
Before: SHRI G.S. PANNU, VICE- & SHRI SAKTIJIT DEY, VICE-
per clause 1(a) to Article 7, if the machinery or equipment is delivered from Head Office or another Permanent Establishment situated outside the other contracting State, no profit can be attributed to the profits of the building site or construction, assembly or installation projects. He submitted, even, clause 1(b) of Article 7 of protocol, income from planning, project, construction or research activities as well as income from technical services, if derived from the resident State in connection with a PE situated in other contracting State, it shall not be attributable to the PE. He submitted, though, the Article 7 of the protocol was specifically brought to the notice of the Assessing Officer, however, he failed to appreciate it correctly. He submitted, the decisions rendered in case of Sanghai Electric Group Co. Ltd. vs. DCIT, 84 taxmann.com 44, DDIT vs. Mitsui & Co. Ltd. (2020), 118 taxmann.com 379 and Ansaldo Energia SPA (2009), 178 Taxman 57 (Madras HC), though, relied upon by the Assessing Officer, however, they are not applicable to assessee’s case. Thus, he submitted, the profit attributed to the PE is improper.
Without prejudice, he submitted, while the Assessing Officer arbitrarily applied the profit rate of 10%, the first appellate authority has reduced it to 5%. However, neither of them has provided any basis for estimation of such profit. He submitted, as per the global profitability statement, the margin earned by global paper division is 2.28% of the sales. Therefore, when the assessee had provided a basis, the departmental authorities were not justified in applying profit rate purely on estimate basis.
Learned Departmental Representative strongly relied upon the observations of the Assessing Officer and learned Commissioner (Appeals). Further, he submitted, the contract with security paper mill at Hoshangabad is a single contract and the assessee was given integrated work of design, manufacturing, supply, installation, start-up, commissioning work of the entire 6000 MTs paper mill. He submitted that as per the terms of the contract, the assessee was required to hand over a complete paper mill at deliverable stage. He submitted, what the assessee had supplied from outside India are parts and components of the paper mill, which comes into shape once the installation and erection is complete and start-up and commissioning is done. Thus, he submitted, the contract with the assessee is to set up the paper mill and not supply of certain parts and equipments of the paper mill. He submitted, assessee’s liability and obligation in terms of contract does not end on completion of supply of materials, but still remains to be discharged till satisfactory commissioning of the paper plant. He submitted, for erection/installation and other related services, assessee’s personnel have visited India and were actively involved not only in the installation/erection process, but also the supervisory work.
He submitted, the contract, read as a whole, would demonstrate that the scope of work under the contract is a single integrated activity, i.e., setting up a state of art 6000 MTs per annum paper making machine.
He submitted, the assessee is not involved in supply of material on standalone basis. He submitted, even, the payment to be made towards supply of plants and equipments of the paper mill is linked to satisfactory test run, commissioning and performance. Thus, he submitted, the assessee’s claim that the revenue received from supply of plant and equipment made from outside India is not taxable in India, is unacceptable, as, such plant and machinery have been incorporated in India by the assessee itself in terms with the contracts.
Further, learned Departmental Representative submitted, the fact that the assessee had a PE in India is beyond doubt, as the Assessing Officer has established on record that the project office acted as a PE.
Further, assessee’s personnel have frequently visited India not only for work of installation, commissioning, start-up, but also supervisory work. Thus, it is proved on record that the assessee had both fixed place PE as well as the installation/supervisory PE in India.
As regards the issue of attribution of profit, learned Departmental Representative submitted, since, the assessee has been unable to substantiate any justifiable reason for acceptability of global profit rate, the decision of learned Commissioner (Appeals) in estimating the profit of the PE at 5% is reasonable.
We have considered rival submissions in the light of decisions relied upon and perused materials on record. The issue arising for consideration is the taxability of income received from supply of plants, equipments, spares etc. It is the case of the assessee that plants, equipments and spares have been manufactured and supplied from outside India, hence, they are not taxable in India. The assessee has also claimed that it does not have any PE in India.
As can be seen from the facts on record, the assessee had four ongoing contracts in India. In so far as the contract with Security Paper Mill (SPMCIL), otherwise known as project Hoshangabad is concerned, in response to a global tender issued by SPMCIL, the assessee participated in the bid and was successful. As per the terms of the bid, the assessee agreed to design, supply, erect, install, and commission 6000 MTs per annum capacity of state of art CWBN paper making machine compatible with slitter, sheet cutter, inspection packaging line, mould cover plant, facilities to incorporate security features like water mark, windowed security thread, security fibres etc. and other allied items.
Accordingly, an agreement was executed between the assessee and the General Manager, Security Paper Mill on 24.06.2010. As per the object clause of the agreement, scope of work of the assessee is for design, supply, erection, commissioning and performance run of 6000 MTs per annum capacity of state of art CWBN paper making machine compatible along with slitter, sheet cutter, inspection, packaging line, mould cover plant. The expression ‘Mill’, as per agreement, is defined as the paper mill at Hoshangabad. The ‘project’ means the implementation of the project proposed by the seller as contained in the agreement. The term ‘supply’ means one line CWBN paper making machine which shall be supplied by the seller (assessee) to SPMCIL. The definition of ‘plant’ as per agreement is – design, supply, installation, commissioning of one CWBN paper machine along with compatible slitter, sheet cutter, inspection, packaging line and mould cover making plant with state of art technology dedicated for production of currency/security papers on turnkey basis.
Further, as per the object clause, with a view to attaining the objects, the assessee shall provide machinery and equipments, engineering services, specialist staff and training. The agreement further provides that the assessee shall carry out plant engineering, planning, execution, monitoring, coordinating of not only items within the scope of supply, but also for items supplied by the contractee by using scientific technique, i.e., project management software and tools for timely completion of the project. It also provides that the assessee shall provide technical assistance by way of coordination of erection and technical erection check, final check with SPMCIL during taking over. The terms of the agreement further provide that only after satisfying its obligations under the contract, the assessee shall be entitled to withdraw all its personnel remaining in the mill after commissioning of the new plant has taken place. The agreement also provides that the contractee shall store all received equipments and parts of the new plant at the site at its risk and expenses. The agreement provides that the contractee shall provide well equipped office with tables and chairs for assessee and its staff in charge of the project on site. The contractee is also required to provide lodging and boarding facilities at Hoshangabad for the personnel of the assessee for the entire period of stay.
As per the obligations of the assessee, the equipments and spares to be sold are on FOB European port basis and the seller has to guarantee that the plant and machinery, being supplied, are of state of the art technology. The seller shall also guarantee availability of spares for 15 years and there should not be any major fault in the new plant for at least five years of its installation and commissioning. The seller is also required to provide a certificate that technology, being supplied and the plant being installed, shall not be out of market for at least fifteen years and spares shall be available during that period.
Clause-9 of the agreement provides that the seller shall arrange shipment of the new plant within a period of 18 months and the seller shall be responsible for starting and commissioning of the equipment supplied. It also provides that technical supervisors/engineers of the seller will be in charge of the installation, starting and commissioning of the new plant. It also provides that the erection of the new plant shall be completed within the project time schedule. The terms of the agreement provide that when the seller is of the opinion that different sections of the new plant, i.e., paper machines, slitter re-winders, cutter, inspection packaging line and mould cover plant are ready for start-up, it shall have to notify purchaser/contractor in writing of its intention to begin the start up and indicate the date, on which it can commence. During the start-up, the seller shall be responsible for technical operators of the processing line and will operate the technical process with its supervisory personnel together with purchaser’s personnel.
The agreement provides that when the seller is of the opinion that the machinery and equipments are ready for performance testing, it shall notify in writing the purchaser to start the performance testing. If the test reveals that each unit does not meet the guaranteed performance, the seller have to take necessary steps to correct such deviation without any delay. The agreement provides that the new plant shall be regarded as commissioned and accepted when the conditions specified in Annexure-6 are fulfilled. The agreement also provides that the seller shall provide training to authorised persons of the purchaser in the technique and skills required to operate and to repair the new plant. Training can be on the job training or classroom training. The seller is also required to keep training to the mould cover making plant personnel and maintenance personnel. The training to be given by the assessee is both at its site and also at the installation site.
As per the terms of the agreement, the assessee is also required to furnish bank guarantee as security deposit and also performance guarantee. The payment schedule as per the terms of contract, reveals that they are on mile-stone basis and 10% out of total cost of goods supplied shall be released after receipt of all the goods and erection, commissioning, start-up and trial run with training and issue of acceptance certificate. Though, the agreement stipulates the cost of equipments and the cost of erection, commissioning, training charges etc. under distinct and separate heads, however, the payments are linked to completion of project. The agreement also provides that the seller has to pay liquidity damages at specified rate for its failure to have the new plant commissioned as per the time schedule under the agreement. The agreement also vests right upon the purchaser to terminate the contract in case of any default in carrying out any of the terms, conditions, covenants of the agreement, the supplier is not entitled to payment of any charges on any account or any portion thereof with respect to any part not completed by the supplier in accordance with the terms of agreement. Clause 38 of the contract provides that any dispute arising under the agreement shall be governed and interpreted in accordance of laws of India and subject to exclusive jurisdiction of the competent courts of New Delhi.
Thus, a reading of the agreement, as a whole, reveals that the assessee was given one integrated end to end activity of setting up a 6000 MTs capacity per annum state of art CWBN paper making machine compatible with slitter, sheet cutter, inspection packaging line and mould cover plant on turnkey basis, which is otherwise known as the mill. The end to end activity covers design, supply, erection, commissioning, performance run of the entire paper mill. Thus, the assessee has to complete a single integrated project in terms of the contract. The agreement further reveals that assessee’s obligation under the contract does not end with the supply of goods and equipments, but would only end with the satisfactory commissioning and performance run of the paper mill. Only after the satisfactory performance run, the assessee can receive full payment qua the supply of goods and equipments. Thus, supply of goods and equipment from outside India cannot be treated as a standalone activity. On the contrary, as per the scope of work under the agreement, the assessee has to deliver the project of the Security Paper Mill and hand over to the contractee at deliverable stage as a complete package. The contract between the assessee and the contractee is not for purchase of plant and equipments simpliciter, but a complete paper mill to be installed and commissioned at deliverable stage. That being the factual position emerging on record, assessee’s contention that the income received from supply of plants and equipments is not chargeable to tax in India, as the supplies were made from outside India, in our view, is not acceptable. Not only the assessee has entered into a single contract providing for purchase, installation, commissioning, performance –run of a single unit of 6000 MTs Security Paper Mill, but the assessee is required to ensure proper functioning of the paper mill after commissioning through start-up and test-run. Thus, these facts clearly indicate that the contract is a composite indivisible contract of setting up the paper mill in India. That being the case, it cannot be said that the receipts from offshore supplies of plant and equipments etc. are not taxable in India.
However, at this stage, we must hasten to add, on a careful scrutiny of assessment order and first appellate order, we observe that receipts from offshore supplies are in relation to four projects in India.
The departmental authorities have referred only to terms of agreement between the assessee and SPMCIL, Hoshangabad. Whereas, the terms of the agreement with other three parties, viz., J.K. Paper Ltd., Bank Note Paper Mill India Pvt. Ltd., Mysore and Tamil Nadu Newsprint and Papers Ltd., Tamilnadu, to whom the assessee has supplied plant and equipments, have not at all been examined. From the submissions of the assessee, prima facie, it appears that the terms of the contracts in different projects are not identical. In fact, in case of project at Tamil Nadu, the assessee has entered into two separate contracts, one for supply of material and other for onshore services.
Therefore, if offshore supplies of plant and material do not have any relation to onshore services, they cannot be brought to tax in India.
These facts have not been verified by going into the terms of the contract by the departmental authorities. Even, to what extent the PE of the assessee, if at all there is one in India, is involved in manufacture and supply of plant and equipments, has not been properly gone into by the departmental authorities. Thus, in our view, without properly analysing the role of PE in offshore activities, 25% of the receipts arising out of offshore supplies cannot be attributed to PE, as it is purely on adhoc basis.
Furthermore, the Assessing Officer has attributed profit rate of 10% to the receipts/income of the PE, which has been reduced to 5% by learned Commissioner (Appeals). In our view, the estimation of profit is purely on adhoc basis without any rationale. When the assessee has furnished evidence to show that the global profit rate in the paper division is at 3%, there is no justification for adopting the rate at 10% or 5%. The reasoning of departmental authorities in adopting the estimated profit rate is based on conjectures and surmises. If learned Commissioner (Appeals) was of the view that the activities and obligations of different contracts for different supplies would be different, he should have examined each of the contracts and accordingly decided the profit rate. As discussed earlier, the departmental authorities have examined only one of the contracts.
Whereas, they have not gone through the terms of other contracts. In the aforesaid circumstances, we cannot accept the estimation of profit at 5% by learned Commissioner (Appeals). It is further to be noted that assessee’s contention regarding existence or otherwise of PE in terms of paragraph 7, 1(a) and (b) of Protocol to India-Germany DTAA has not at all been considered by learned first appellate authority. Since, various claims and contentions of the assessee have not been considered by the departmental authorities, while attributing part of the receipts from offshore supplies as income of the PE, we are inclined to restore the issue to the Assessing Officer for de novo adjudication after providing reasonable opportunity of being heard to the assessee. Grounds are allowed for statistical purposes.
In the result, appeal is allowed for statistical purposes.
Order pronounced in the open court on 23rd April, 2024.