SKP Tax Alert
| Volume 8 Issue 27
Project Office, acting as communication channel, not to be treated as PE, such activity being preparatory and auxiliary in nature
 

Recently, the Delhi High Court in the case of National Petroleum Construction Company vs Director of Income tax (International Taxation) (ITA 143/2013 ITA 533/2013 ITA 144/2013) held that Project Office (PO) does not constitute a fixed place permanent establishment (PE) if the activities carried out by the PO, acting as a communication channel, are auxiliary and ancillary in nature. Further, it has also been held that while computing the threshold of nine months for determining installation PE, the period for which an enterprise has not been granted access to the site and carries on no activity at site, should not be considered for counting.

Facts of the case
  • National Petroleum Construction Company (taxpayer), a company incorporated and tax resident of UAE was engaged in the fabrication of petroleum platforms, pipelines and other equipment. In addition, it also undertook contracts for installation of petroleum platforms, submarine pipelines and pipeline coating at various sites.
  • During the previous year 2005-06, the taxpayer had tendered and won a contract with ONGC. The contract entailed designing, engineering, procurement, fabrication of loaded offshore platform and its installation, testing and commissioning at an offshore facility of ONGC. Whilst the activities relating to survey, installation and commissioning were conducted entirely in India, the platforms were designed, engineered and fabricated overseas - at Abu Dhabi. It also established a project office in India by obtaining permission from Reserve Bank of India.
  • The taxpayer had engaged a third party, M/s Fugro Geonics Pvt Ltd, for conducting the pre-engineering and pre-construction surveys. The taxpayer had also appointed Arcadia Shipping Ltd (ASL) for technical and marketing support. Such activities were carried out for a period of 9 days and 27 days respectively during the financial year 2005-06 and 2006-07 (from 27 February 2006 to 7 March 2006 and from 25 April 2006 to 21 May 2006).
  • The taxpayer filed its return of income under the Act on a presumptive basis by taxing the gross receipts pertaining to the activities in India less verifiable expenses at the rate of 10% and the receipts pertaining to activities outside India at the rate of 1%.
  • The taxpayer commenced its activities at site when the barges entered Indian territory on 19 November 2006 and such activities relating to the installation, testing and commissioning of the platforms continued till 27  April 2007 (for a period of six months).
  • The tax officer contended that the taxpayer had a Fixed Place PE in India in the form of a Project Office at Mumbai. It was also held that ASL constituted a Dependent Agent PE (DAPE) of the taxpayer in India. In addition, the AO also contended that the National Projects Construction and Corporation Ltd (NPCC) even had an installation/construction PE in India.
  • The tax officer had also held that the entire contract was a turnkey contract and was not divisible as claimed by the taxpayer. Accordingly, he held that the entire contract receipt including the sale of fabricated material was taxable in India. Since the taxpayer did not maintain  separate books pertaining to the contract, the taxofficer estimated the taxpayer’s profit to be 25% of the consideration received from ONGC.
  • When the taxpayer appealed to the Dispute Resolution Panel (DRP), the DRP observed that the taxpayer had shown the Project Office as its PE in the earlier years as well as in the assessing year (AY) 2007-08 and cannot change its stand subsequently on the basis of the ITAT’s judgment in the case of DCIT vs Hyundai Heavy Industries Limited (2009) 31 SOT 482 (Del). It concurred with the view of the tax officer that the taxpayer had a PE in India.
  • The DRP further held that pre-engineering and pre-design survey, which was conducted by the sub-contractor was an integral part of the contract and the time spent by the sub-contractor would also constitute time spent by the taxpayer for computing the duration of installation PE.
  • The ITAT confirmed the view of the tax officer and the DRP on almost all aspects, except on profit attribution for which the ITAT has held that the contract in question could be segregated into offshore and onshore activities and that the taxpayer’s income attributable to the activities carried out outside India would not be taxable in India.
  • Both the taxpayer and the tax department were aggrieved by the decision of the ITAT and presented the matter before the Delhi High Court.

Taxpayer’s  contention
  • The Project Office was established only to comply with the contractual requirements and the applicable exchange control regulations. It merely acted as a communication channel between the taxpayer and ONGC. Hence, the activities carried out by the PO were preparatory and auxiliary in nature.
  • Activities of independent sub-contractor should not be included for calculating the period of nine months under Article 5(2)(h) of the tax treaty between India and UAE.
  • The taxpayer also contended that ASL was an independent entity carrying out substantial business activities other than those with the taxpayer. In this regard, the taxpayer had filed the Annual Report of ASL substantiating the various business contracts entered by ASL with entities other than the taxpayer.
  • Thus, there was no PE in terms of fixed place, DAPE or installation PE and hence no income was taxable in India.

Tax Authorities contention
  • Relying on the decision of Supreme Court in the case of Goetze (India) Ltd vs CIT (2006) 284 ITR 323, the tax authorities contended that if the taxpayer had once filed a return of income admitting that it had a PE in India, a contrary claim could not be made at the time of assessment. It was contended that the taxpayer cannot be permitted to depart from its consistent stand that had been sustained over the past several years.
  • The tax authorities also contended that the contracts with ONGC were composite contracts and all the activities were closely linked. Thus, the contract could not be split between the activities carried out overseas and activities carried out in India. It distinguished the decisions of the Supreme Court in the cases of Ishikawajima-Harima Heavy Industries Ltd vs DIT: (2007) 288 ITR 408 (SC) and Hyundai Heavy Industries (supra) by contending that while the situs of transfer of properties in those cases was outside India; in the present case, possession of the platforms was handed over to ONGC in India.
  • The tax authorities contented that the activities carried out by the PO in India cannot be treated as ancillary and auxiliary in nature.
  • It also contended that the duration for installation PE would commence from the commencement of contract and does not relate to the actual performance of activities on site.
  • In addition to the above contentions, ASL was treated as a DAPE of the taxpayer. This was on the basis of the terms of the consultancy agreement whereby it was agreed that the ASL would not represent a competitor of the taxpayer or act in a manner detrimental to the interest of the taxpayer.

High Court’s Ruling
  • The decision in case of Goetze (India) Ltd does not restrict the appellate authority from considering the claim of the taxpayer. Such a limitation is only with regards to the tax officer.
  • Since the main business of the taxpayer was fabrication and installation of platforms, the function of acting as a communication channel between ONGC and the head office would clearly qualify as an activity of an auxiliary nature – an activity which aids and supports the main business.
  • Activities at site carried on by any contractor through a sub-contractor would not be counted towards the duration of the contractor’s PE unless the contractor's office or establishment in India is also involved along with the sub-contractor.
  • An interruption in the normal course of activities such as weekly day off would undoubtedly be included in the duration of the installation PE but in cases where the interruption exceeds substantial periods which represent cessation of the activities at site, it would be difficult to accept that the building/project site continues to represent the fixed place of business of an enterprise.
  • With respect to the Agency PE, the High Court observed that the final accounts of ASL showed that it carries on substantial business other than the services provided to the taxpayer. Further, the agreement between the ASL and the taxpayer is on a principal to principal basis.
  • Based on all of the above, it held that the taxpayer did not have a permanent establishment in India. Further, the High Court also commented that even if the taxpayer had a PE in India, consideration for the activities carried on overseas, which is separately specified in the contracts, cannot be attributed to such a PE in India
SKP's comments
  • The above decision is a welcome decision for differentiating between the offshore and onshore activities and its taxability in India. It clarifies that if the considerations for each of the activities in a turnkey contract are identifiable, then such a contract should be considered divisible and activities performed outside India should not be brought to tax in India.
  • It also clarifies that for the purpose of counting the number of days spent on the project, long interruptions leading to suspension of the work should not be considered. Also, if the subcontractor has worked independently on the site without any support of the contractor, then the time spent by the sub-contractor should be excluded while determining the duration of the PE of the contractor.
  • It further reinforces the principle laid down in earlier rulings that the commencement of contract date would be reckoned from the preparatory activities letting to the performance of the contract of the core business activity and not from the date of signing of the contract.
  • Most significantly, the PO could act for providing auxiliary and ancillary activities and hence would not be regarded as PE. 

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