POSCO ENGINEERING AND CONSTRUCTION COMPANY LTD.,NEW DELHI vs. ADDL. CIT, INTERNATIONAL TAXATION , CHANDIGARH

The above two appeals filed by the assessee are directed against the separate orders passed u/s 143(3) r.w.s. 144C(5) and 144C(13) of the IT Act, 1961 for assessment years 2008-09 and 2009-10, respectively.

Since common issues are involved in both these appeals, therefore, these were heard together and are being disposed of by this common order.

This is the second round of litigation before the Tribunal. Facts of the case, in brief, are that the assessee is a company incorporated under the laws of Korea and is engaged in the business of construction, design and engineering of steel mill facilities. It filed its return of income on 29th August, 2008 declaring nil income. This return was revised by the assessee a number of times and finally the same was revised on 21.05.2009 declaring a loss of Rs.84,04,207/- and value of fringe benefit of Rs.2,35,261/-. In the original draft assessment order passed u/s 144C(1) of the Act the AO proposed to attribute reveneues earned from offshore supply of equipment made by the assessee from Korea to the PE of the assessee in India. The tax payer filed objections before the DRP and after receipt of directions from the DRP, the final assessment order was passed by the AO on 27th September, 2013 determining the total income at Rs.24,48,85,181/-. The income of the tax payer was assessed as under:-

The tax payer filed appeal before the Tribunal and the Tribunal, vide order dated 26th February, 2014 in set aside certain issues to be decided afresh by the AO. The Tribunal has deleted the other additions except the set aside issues for which the Revenue is in appeal before the Hon’ble High Court and we are not concerned with the same.

Similarly, for A.Y. 2009-10, after receipt of the directions from the DRP, the final assessment order was passed by the AO on 21.01.2014 by determining the income of the assessee as under:-

The assessee filed appeal before the Tribunal and the Tribunal, vide order dated 2nd April, 2014 in set aside certain issues to be decided afresh by the AO. While doing so, the Tribunal followed its earlier order for A.Y. 2008-09.

So far as assessment year 2008-09 is concerned, the Tribunal, while restoring the issue to the file of the AO, held that the title of goods in respect of the offshore supply of equipments was transferred outside India against which the Revenue is in appeal before the Hon’ble High Court. The Tribunal also examined 3 in detail the issue as to whether the sale price of the offshore supply of equipment includes some consideration for services rendered or to be rendered by the assessee in India. In so far as training charges are concerned, the Tribunal held that these are surely included in the sale price but the question of consideration for other factors such as tests and inspection, liquidated damages and defect liability requires examination at the level of the AO. The relevant observations of the Tribunal read as under:- “2. Whether sale price includes any consideration for services rendered or to be rendered in India ? 2.a. Having held that supply of such equipments was offshore, now we espouse the next argument of the ld. DR that the sale price also includes some consideration for services rendered or to be rendered in India. The ld. DR vehemently argued that certain costs for doing of some activities in India in relation to offshore supply of equipments were not specifically charged and hence were inbuilt in the price so charged. This was contradicted by the ld. AR by stating that consideration for the supply of equipments and refractory was exclusively towards the price of goods and no part of it was towards rendering of any services in India. It was shown that there was a distinct charge of `Foreign Supervision charges’ in the Summary of prices at Euro 4440000, which the assessee also considered as chargeable to tax in India. This amount was claimed to be towards rendering of all services in India in connection with the supply of offshore equipments. 2.b. We find from Table 1B, whose copy is available on page 1023 of the Paper book, which is an integral part of the Contract agreement and has been captioned as `Summary of Prices’ that there is a charge for supply of offshore equipment and also there is a separate charge towards `Foreign supervision charges’ to the tune of Euro 444000. The description of such foreign supervision charges has been given in Table 13B, a copy of which is available on page 1036 of the paper book. When we turn to such Table, the description of `Foreign supervision charges’ is found as : “Foreign supervision charges in India during Erection, Start up, Commissioning and Performance Guarantee tests.” Getting a separate charge for foreign supervision charges for the setting up of plant makes it clear that such supervision charges are not part and parcel of the price of equipment as referred to in columns 3, 5 and 7 of Table 1B. It implies that there was distinct charge for foreign supervision charges which has been construed by the assessee itself as onshore services chargeable to tax 4

So far as the issue regarding the taxability of the price of offshore supply of equipment and compensation for the services rendered in India, the Tribunal held that the price shown towards offshore supply of equipments has two components viz., one is the price for offshore supply of equipments simplicitor and second is the consideration for some services rendered in India. The relevant observations of the Tribunal is as under:- “…it is palpable that that the second component of the sale price of offshore equipments, which is quid pro quo for services rendered in India is chargeable to tax in India.”

So far as the issue regarding attribution of income to the services rendered in India (from the sale price of offshore equipments), the Tribunal, vide para 4d. and 4e. of its order has held as under:-

The AO during set aside proceedings after the order of the Tribunal asked the assessee to make its arguments/submissions to which the assessee complied with. So far as the issue relating to training charges is concerned, it was submitted inter alia by the assessee that : a) it did not provide any training to the employees of SAIL in India, since such training was to be provided to the employees of SAIL outside India, and that too, free of cost, no income could be said to have accrued to the assessee in India b) Clause 7.8 of the GCC read with Clause 6 of the SCC shows that no training is envisaged in India under the terms of contract. c) it is under obligation to provide training to SAIL staff in Korea or in any other Country but not in India. d) training is inextricably linked to the offshore supply and therefore not taxable in India. e) certificate issued by SAIL was produced wherein it has been certified that no training is to be conducted in India under the terms of the contract, and if at all, some training needs arises in India, that would be free of cost.

So far as the issue relating to liquidated damages and defect liability is concerned, it was submitted by the assessee that:

As regards the revenue received for design and engineering services is concerned, it was submitted that: a) Design and Engineering sold by the Assessee to SAIL have been designed largely on the basis of standard technologies available with it. b) Consideration received by the assessee was for the sale of a product which is indispensable part of offshore supply, hence not taxable. c) Primarily the work relating to the sale of designs and engineering was done outside the territory of India and the sale was also affected outside India. d) Even if the consideration for off-shore designs is treated as for services, then too both under the Act as well as under Double

However, the AO was not satisfied with the arguments advanced by the assessee. So far as the training charges is concerned, he held that training has been provided in India and the consideration for the same is included in the revenue received by the assessee for offshore supply of equipment. As regards liquidated damages and defect liability is concerned, the AO attributed 2% of the consideration for offshore supply as the price for liquidated damages and defect liability and accordingly assumed ad hoc profit rate of 50%. As regards the revenue received for design and engineering services is concerned, the AO held that design and engineering are chargeable to tax u/s 9(1)(vii) of the Act as well as Article 13 of the India-Korea DTAA. The DRP upheld the action of the AO. However, in the case of liquidated damages and defect liability, the DRP directed the AO to consider the profit rates in the global financials while computing profit rate on such charges. The AO, in the final order, determined the taxable income of the assessee at Rs.4,68,85,264/-.

Aggrieved with such order of the AO/DRP, the assessee is in appeal before the Tribunal by raising the following grounds:- “1. That the Assessment Order passed in pursuance to the directions issued by the Learned Dispute Resolution Panel (‘DRP’) is a vitiated order as the Ld. 11 DRP has erred both on facts and in law in confirming the addition made by the Learned Deputy Commissioner of Income-tax (‘Ld. AO’) to the appellant’s income.

The assessee has also raised the following additional grounds:-

The ld. Counsel for the assessee, referring to the additional grounds, submitted that these are purely legal in nature and no fresh facts are required to be investigated. Referring to the decision of the Hon’ble Supreme Court in the case of Jute Corporation of India Ltd. vs. CIT, reported in 187 ITR 688 and various other decisions, he submitted that the additional ground raised by the assessee may kindly be admitted and necessary relief be granted to the assessee.

The ld. DR, on the other hand, opposed the additional grounds.

After hearing both the sides, we find that the additional ground raised by the assessee are purely legal in nature. Therefore, relying on the decisions of the Hon’ble Supreme Court in the case of NTPC Ltd. vs. CIT, 229 ITR 383 and the decision in the case of Jute Corporation of India cited (supra), we admit the additional grounds raised by the assessee for adjudication.

The d. counsel for the assessee submitted that the AO was supposed to pass the draft assessment order. However, at para 11 of the order dated 26th December, 2016, the AO has given a direction for issue of demand notice, show cause notice for penalty and challan. This shows that this is the final order. He submitted that as per the provisions of section 144C(1) of the Act, the AO must forward a draft of the proposed order of assessment to the eligible assessee if he proposes to make on or after the first day of October, 2009 any variation which is prejudicial to the interests of such assessee. Therefore, as per the provisions of the Act, where the AO proposes to vary the income in the hands of the assessee, there was a requirement to issue show cause notice to the assessee to the said additions by way of draft assessment order. Since, in the instant case, the AO has passed the order along with which he also directed to issue demand notice and show cause notice for levy of penalty, therefore, such action of the AO results in finalization of the assessment. Since the AO has not followed the correct procedure as provided in the statute and has passed the final assessment order, therefore, in view of the decision of the Chennai Bench of the Tribunal in the case Shri Chandanmal Nagaraj vs. ACIT, and the decision of the Pune Bench of the Tribunal in the case of Eaton Industrial Systems (P) Ltd., ITA No.536/Pune/2014, order dated 12th April, 2018, the order passed by the AO is null and void.

The ld. DR, on the other hand, submitted that it is only a typographical error and no such notice of demand has been issued to the assessee. Referring to the provisions of section 292B and 292BB of the Act, he submitted that since no notice has been issued to the assessee and this is not the final assessment order and it is only a typographical error, therefore, the arguments advanced by the ld. Counsel for the assessee are not tenable in law. Further, final order has been passed subsequently. He accordingly submitted that the additional grounds raised by the assessee should be dismissed.

We have heard the rival arguments advanced by both the sides and perused the record. On a pointed query raised by the Bench as to whether the assessee has received any such demand notice, the ld. Counsel fairly conceded that no such demand notice or show cause notice for levy of penalty has been received. Further, after receipt of the order, the assessee has approached the DRP and the DRP has passed the order on 18th September, 2017 and, thereafter, the AO has passed the final order on 30th October, 2017. Since the ld. Counsel for the assessee could not substantiate with evidence to the satisfaction of the Bench that the AO has issued the demand notice and challan along with the draft assessment order, therefore, the additional ground raised by the assessee are dismissed.

The ld. Counsel for the assessee strongly challenged the order of the AO. He submitted that the Tribunal in the original proceedings has held that the sale price of offshore supply of equipment also includes some consideration towards training activities and it directed the AO to verify the date of actual rendition of training and determine the value of training as per man day rate. He submitted that the Assessee in the remand proceedings before the AO had submitted that the training would be provided to SAIL staff post installation and commissioning for the purpose of operation and maintenance of the plant. Since, no training had been provided in the years under consideration, the question of attributing an amount towards training in the year under consideration, does not arise at all. Referring to the certificate issued by SAIL (copy placed at Page 78 of the Convenience Compilation), he submitted that it has been certified that no training has been conducted in India and that the consideration for training services is included in the amount being received by the company for foreign supervision services.

He submitted that the AO ignored the above submissions as well as the certificate and proceeded to attribute Rs.2,23,41,600 (AY 2008-09) and Rs. 2,40,12,000 (AY 2009-10) towards training services. The ld. Counsel for the assessee submitted that the AO cannot attribute any amount on account of training services specifically when the same have not been imparted in the year under consideration. He submitted that since the consideration of these services has already been included in the amount received for Foreign Supervisory Activity and the revenue from the aforesaid activities have already been offered to tax, therefore, no further attribution can be made by the AO. He accordingly submitted that the addition made by the AO on account of training services should be deleted.

So far as addition on account of Liquidated Damages and Defect Liability is concerned, the ld. Counsel for the assessee submitted that the consideration for the offshore supplies does not include any consideration towards Defect Liability and Liquidated Damages. He submitted that the Tribunal in the original round of proceedings had asked the AO to determine if consideration for defect liability and liquidated damages was included in the amount received for offshore supply of equipment.

He submitted that AO after merely referring to the findings of the Tribunal proceeded to unreasonably attribute 2% of the consideration for offshore supply as the price for liquidated damages and defect liability. An ad-hoc profit rate of 50% was assumed and additions of Rs. 2,35,83,017 (AY 2008-09) and Rs. 2,78,33,443 (AY 2009-10) were made. He submitted that the AO failed to consider the various clauses of the contract and certificates brought on record by the assessee and proceeded to attribute part of revenue earned from offshore supply equipment towards defect liability and liquidated damages which is not correct.

The ld. Counsel for the assessee referring to page 139 of the paper book submitted that Table 13B in the contract clearly shows that revenue for Performance Guarantee Tests was included in the Foreign Supervisory Charges. Hence, the finding of the AO that price for rectifying any defect in the equipment is included in revenue earned from offshore supply is incorrect. He submitted that as far as liquidated damages are concerned, the same may arise due to delay in completion of facilities. For the above, he drew the attention of the Bench to Clause 29.2 of the agreement copy of which is placed at page 246 of the paper book. Referring to Clause 29.2.1 of the contract (Page 246 of the Convenience Compilation) he submitted that the said clause clearly quantify the same as 0.5% of contract value per week of delay with a cap of 5%. The said damages are penal in nature and exist only to protect the interest of the buyer. These damages have to be paid by the assessee in case of delay i.e. a contingent event. The said liquidated damages under no circumstance can be concluded to be a part of the consideration. Hence, the AO’s conclusion that the same forms part of the revenue earned from offshore supply is incorrect and against the settled principles of contract law.

He submitted that the clauses pertaining to defect liability also provide that in case the product is defective the same will have to be replaced or repaired (Clause 30.1 and 30.2 at Page 242 of the convenience compilation). The same are again contingent in nature and can arise only on the happening of certain specific events as mentioned in clause 30 of the General Conditions to the Contract (‘GCC’). He submitted that since, the years under consideration were the first years of the project, none of the above- mentioned events had occurred to trigger such liability. Referring to the certificate issued by SAIL (Page 80 of the Convenience Compilation), he submitted that it has been certified that no liability has arisen in the subject years. Referring to clause 30 of General Conditions of the Contract (page 133), the ld. Counsel for the assessee submitted that the defect liability period has been specified and the liability on this account would arise only if any defect is found in the design and engineering, materials etc. during such defect liability period. It is certified that no liability on this account has arisen during the Financial Year 2008-09.

Referring to the decision of Kolkata Bench of the Tribunal in the case of Outotec GmbH v. DDIT [172 TTJ 337], the ld. Counsel for the assessee submitted that the Tribunal in the aforesaid case has held that clauses like liquidated damages, performance guarantee and defect liability are part of normal commercial arrangements generally agreed in common trade parlance and cannot form the basis for attributing revenue earned from offshore supply of equipment to India. He accordingly submitted that in view of the decision cited (supra) no portion of the revenue earned from the sale of equipment can be taxed in India by virtue of the commercial clauses like performance guarantee, defect liability and liquidated damages.

Ld. Counsel for the assessee submitted that despite the aforesaid clauses, the AO attributed 2% of the consideration for offshore supply on ad-hoc basis and estimated a profit rate of 50%. He submitted that the action of the AO runs contrary to the clauses of the contract and the certificate of SAIL and, therefore, the addition made on account of liquidated damages and defect liability should be deleted.

Without prejudice to the above submissions, the ld. Counsel for the assessee submitted that the AO has incorrectly assumed a profit rate of 50% and disregarded the global profit rates of the company submitted during the assessment proceedings. Referring to the paper book page 106 to 110, he submitted that the assessee’s global profit rate during the calendar year 2007 and 2008 was 9.7% and 5.3% respectively. However, the AO completely disregarded the financials and applied 50% as profit rate without any cogent reason or explanation. He submitted that the DRP in its directions also directed the AO to compute the profit rate as per the global financials of the assessee but the AO failed to follow the said direction of the DRP as well. He accordingly submitted that the AO should be directed to follow the aforesaid directions of the Ld. DRP and compute profit rate in line with the global profit rate of the assessee during the calendar year 2007 and 2008 i.e. 9.7% and 5.3% respectively.

The ld. DR, on the other hand, heavily relied on the order of the AO. He submitted that in this case the Tribunal had set aside the matter to the file of the AO on specific points with a clear-cut finding that the services included in sale consideration for offshore sale are chargeable to tax as fee for technical services. The Tribunal has held that the sale price of offshore supply of equipment also includes some consideration for services rendered or to be rendered by the assessee in India. Accordingly, the Tribunal upheld the attribution of sale consideration of offshore supply to the extent of the services included in the sale price. The assessee has filed appeal before Hon'ble High Court against the set aside decision of the Tribunal which is pending for decision. Referring to the grounds of appeal filed by the assessee, he submitted that as per the said grounds the treatment of the following services have been challenged:- • Training Services • Defect liability and Liquidated Damages • Design and Engineering Services

The ld. DR submitted that the Tribunal could not confirm with facts on record that whether separate charges were made for the above services or not. He submitted that this finding has relevance because if the service charges are separately charged, then, in that case, there is no question, of attribution of sale consideration towards such service and in case the services are not separately charged, it implies that the same were included in the sale consideration.

So far as the training cost is concerned, the ld. DR submitted that the Tribunal has concluded that it was included in the sale consideration as per page 25 of the order of the Tribunal. So far as the training expenses is concerned, he submitted that these are surely included in the sale price. The Tribunal has set aside the case to the AO to compute the value of such training conducted during the period under consideration. The AO was asked by the Tribunal to verify as to whether pre-supply training etc., in this regard was given by the assessee to the personnel of SAIL in India during the year under consideration. So far as the certificate issued by SAIL stating that no training was to be conducted in India under the terms of the contract and if at all some training needs arises in India, that would be free of cost is concerned, he submitted that the said certificate does not depict the time period of actual conduct of training. It nowhere denies that training was not imparted. It only confirmed that training need in India would be provided free of cost. Referring to para 18.4 of the general conditions of contract, he submitted that while basic induction training for all categories of staff and for all job positions will be provided by the employer, the contractor shall identify from the manpower requirements as per sub-clause 18.6 thereof, the key positions and number of persons to be trained for efficient running of the plant. Employer will depute personnel with appropriate qualification and experience for training. He submitted that in the absence of specific time period of training in the year under consideration, the AO has referred to the technical specifications which mentions that the taxpayer will be providing 1200 man days of training to the staff of SAIL and for the training services, no separate charge has been made. He accordingly submitted that the AO was justified in computing the training cost of 1200 man days at the rate of 600 Euros per man day.

So far as liquidated damages are concerned, he submitted that the certificate submitted by the assessee that no such event of incurring defect liability took place in the concerned period cannot be accepted in absence of filing of any evidence where such services for defect resolution have been separately charged during the entire contract. He submitted that the contract does mean liability on the assessee in case of defect liability and liquidated damages may have taken place in the entire contract period. However, this fact is indeterminate at the time of bid and therefore, the commercial bid is bound to load such liability cost on estimation basis in the sale consideration. Therefore, once the assessee has not charged any defect liability or liquidated damages, the only conclusion that is coming out of the decision of the Tribunal is that the defect liability and liquidated damages are part of sale consideration. He accordingly submitted that the AO is fully justified in estimating the cost of defect liability and liquidated damages by attributing the part of sale consideration and charge it as fee for technical services.

We have considered the rival arguments made by both the sides, perused the orders of the AO and DRP and the paper book filed on behalf of the assessee. We have also considered the various decisions cited before us. We find, the AO, in the instant case, made addition on account of training charges, defect liabilities and design and engineering services which have been approved by the DRP. So far as the training charge is concerned, it is the case of the AO that training has been provided in India and the consideration for the same is included in the revenue received by the assessee for offshore supply of equipments. It is the submission of the ld. Counsel that no training has been conducted in the concerned assessment year. It is also his submission that POSCO shall not be entitled to any separate consideration because the same is included in amount paid for Foreign Supervision Services. It is also his submission that the training would be provided to SAIL staff post installation and commissioning for the purpose of operation and maintenance of plants. According to him, since no training had been provided in the year under consideration, the question of attributing the amount towards training in the year under consideration does not arise at all.