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February 18, 2011

No tax on LG Cables for the offshore component of turnkey project: Ishikawajma's ruling echoed

In a recent ruling, the Delhi High Court (“High Court”) reaffirmed the principle laid down by the Supreme Court in Ishikawajma-Harima Heavy Industries Co. Ltd.1 While dealing with the question as to the levy of tax on the profits earned by LG Cable Ltd. (“LGCL” or “Tax Payer”) in relation to the offshore supply of equipment, the High Court ruled that such profits were not taxable in India even though the equipment was supplied for implementing a turnkey project situated in India.

Facts

The Tax Payer, a Korean company, entered into two contracts with Power Grid Corporation of India Limited (“PGCIL”) in connection with the supply and installation of “fibre optic cables” in India. One contract was for onshore execution, installation and erection of the cables (“Onshore Supply”) and the second contract was for offshore supply of equipment and related services (“Offshore Supply”). In order to facilitate the Onshore Supply, the Tax Payer set up a project office in India.

The Tax Payer offered its profits earned in connection with the Onshore Supply to tax in India under Articles 5 and 7 of the India Korea Double Tax Avoidance Agreement (“DTAA”). As regards the income from Offshore Supply, it was the Tax Payer’s claim that the same was not subject to tax in India as the entire contract was carried out in Korea. However, during the assessment proceedings, the Tax Officer (“Tax Department”) held that the profits accruing to the Tax Payer as a result of the Offshore Supply were also taxable in India having regard to the fact that the Offshore Supply and Onshore Supply were inextricably linked and the two contracts formed a composite contract for supply of equipment and its installation in India. Pursuant to the Commissioner of Income Tax (Appeals) dismissing the Tax Payer’s appeal, the Tax Payer filed a second appeal before the Income Tax Appellate Tribunal (“Tax Tribunal”). Much to the Tax Payer’s relief, the Tax Tribunal ruled in favour of the Tax Payer and held that the profits attributable to the Offshore Supply were not taxable in India. Aggrieved by the Tax Tribunal’s decision, the Tax Department filed an appeal before the High Court.

The Ruling

The entire dispute before the High Court boiled down to one single issue, namely, whether the two contracts (Offshore Supply and Onshore Supply) could have been regarded as a single composite contract, the consideration for which was attributable to India. The Tax Department argued that the two contracts were inextricably linked and performance of one was dependant on the successful performance of the other. Thus, they claimed that the Tax Payer’s income from the entire project was deemed to accrue or arise in India and was therefore taxable in India to the extent it was attributable to India.

The High Court rejected the Tax Department’s arguments and dismissed the appeal. In order to arrive at its decision, it thoroughly examined the provisions of both contracts and inferred that, contrary to what the Tax Department had claimed, the performance of one contract was not dependant on the successful performance of the other. The High Court observed that the contract for Offshore Supply was successfully performed as soon as the property in the goods / equipment was transferred to PGCIL, which performance had taken place outside India. The High Court also observed that “the fact situation in the instant case is almost identical to that in the case of Ishikawajma and the law as enunciated by the Supreme Court in the said case will squarely apply to the facts of the present case.” Thus, the High Court relied on the law laid down by the Supreme Court in Ishikawajma and held that-

  • The Offshore Supply consideration was taxable in India only to the extent that it could be attributed to the Tax Payer’s Permanent Establishment in India.
  • No activity relating to the Offshore Supply was carried out in India and the Tax Payer’s Permanent Establishment in India did not have any role to play in the Offshore Supply. Thus, no profits earned by the Tax Payer from the Offshore Supply could be attributable to the Tax Payer’s Permanent Establishment in India.
  • The present case would have to be distinguished from the ruling of the Chennai Income Tax Tribunal of Ansaldo Energia SPA2. Unlike the present case, the tax payer in Ansaldo’s case was not actually engaged in executing onshore contracts and it was one single contract that was split into four separate contracts. In the present case, there existed two separate contracts right from the inception. Moreover, in Ansaldo’s case, even after the goods were supplied from abroad, the manufacturing activities continued in India as a “continuous and ongoing process”, which was absent in the present case.

Conclusion

The law laid down by the Supreme Court in Ishikawajma has been echoed in this case. Income from the offshore supply of equipment and services by an entity outside India under a separate and distinct contract is not taxable in India merely because the equipment was supplied in relation to a turnkey project situated in India. Where the contract for such offshore supply of equipment and services is separate and distinct from the contract for onshore services, the profits earned as a result of offshore services cannot be taxed in India if it is not attributable to India.

Thus, in case of turnkey projects involving an offshore component, it is important to ensure that the offshore supply of goods and services is kept separate and distinct from the onshore services. Moreover, the manufacture and delivery of goods must take place outside India and the title in the goods should pass on to the buyer outside India itself.


Mansi Seth & Mihir Shedde

You can direct your queries or comments to the authors


1271 ITR 193

2Ansaldo Energia SPA represented by its Authorised Signatory Mr. Lorenzo Pesenti v. The Income Tax Appellate Tribunal Chennai Bench (2009) 310 ITR 237

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