Construction contracts get relief: Work done by subcontractor in India not to result in a PE for German contractor
In an interesting case on construction and installation PE, the Authority for Advance Rulings (“AAR”) recently held that the work done by an Indian subcontractor in its factory/warehouse in its independent capacity should not result in constitution of a permanent establishment (“PE”) of the German construction company in India under Article 5(2)(i) of the India- German Tax treaty (“Tax Treaty”).
In November 2006, Pintsch Bamag a German construction company (the “Applicant”) was awarded a contract by M/S Tuticorin Port Trust (“TPT”) for designing, fabrication, supply, installation and maintenance of a navigational channel and fairway buoys in relation to the Sethu Samudram Ship Channel Project. The Applicant sub-contracted a major portion of its work to an Indian company, Asia Navigation Aids (“Indian Co”) and also entered into supply contracts with third party Indian suppliers.
As a consequence of these arrangements, the work performed by the Applicant was limited and included (a) study of technical requirements relating to execution of contract; (b) equipment design and supply of critical components to the sub-contractor; and (c) supervision of installation of equipment in India by two German engineers deputed for the purpose. Of these three, the first two tasks were carried out in Germany and the third in India.
Arguments and Analysis
The Applicant contended before the AAR that it had no PE in India under Article 5 and its business profits should not be subject to tax in India as per Article 7 of the Tax Treaty. The argument centered around the interpretation of the PE provision contained in Article 5(2)(i), which reads as follows:
(i) a building site or construction, installation or assembly project or supervisory activities in connection therewith, where such site, project or activities continue for a period exceeding six months.
The revenue contended that the computation of period of presence should take into consideration the activities of the Indian Co, which was involved in ”undertaking various activities which constituted the core of the contract work entrusted to the Applicant”. It was further argued that “the workshop or place of manufacture of the sub-contractor should be treated as part of the PE of the Applicant” and consequently, ”if the duration of work done by the sub-contractor at the workshop or the factory is taken into account, the duration will be much beyond six months which is the period stipulated in Clause (i) of Article 5(2) of the Treaty”.
It was held that the contention of the revenue could not be upheld, “unless the sub-contractor is treated as a dependent agent of the applicant as distinct from an independent agent”. The AAR noted that the relationship between the Applicant and the Indian Co was more akin to a relationship between principals than that of an agent and subcontractor. Therefore, to compute the period of presence, the number of days spent by the Indian Co at its factory or workshop should not be taken into account.
The revenue contended that “the Applicant’s effective presence in India will date back to the point of time when it had to undertake technical studies by intermittent site inspection”. In this regard, the AAR observed that the “activities which have taken place at the preliminary stages” do not require “regular and constant presence of the applicant’s staff. Occasional or brief visits by some of the employees of the applicant right from the beginning does not give rise to inference of the existence of PE.” On the basis of such observations, the Authority observed, “it appears the need for setting up the PE would arise sometime before the installation and commissioning operations begin”.
The AAR relied on the case of Cal Drive Marine Construction to discuss the interplay between the clauses of Article 5, and observed that the determination of PE in this case would be under Article 5(2)(i), thereby eliminating the application of general provisions under other clauses of Article 5(2). Relying on the case of Cal Drive, it held as follows: “Once clause (i) is attracted, the minimum period test will have to be necessarily applied. The fact that the applicant may have a project office or a workshop for the purpose of carrying out the contractual work does not bring the establishment of the applicant within the other clauses of para 2 to the exclusion of clause (i).”
The jurisprudence laid down by the AAR in this case is in line with the OECD Commentary, by virtue of the AAR applying the principles of Article 5(1) and reading the provisions of Article 5(1) conjointly with Article 5(2)(i). The AAR has also clarified that this is not akin to a situation where services rendered by the contactor and sub-contractor are inseparable. If that were so the time of the sub contractor could have been added on to determine whether the threshold period of six months has been breached. This ruling of the AAR will provide some clarity on taxation of income arising out of construction projects whereby part of the work is outsourced to Indian sub contractors.
It is important to note that rulings pronounced by the AAR are private in nature and are binding only on the Applicant and the tax authority with respect to the particular issue before it. Though such rulings do not have precedent value for other tax payers, they do have a persuasive value.