2016 (9) TMI 348 - AAR - Income Tax

Court allows deduction of proposal costs in India, exempts payments under India-UK DTAA, and permits liquidated damages.

The court ruled in favor of Foster Wheeler (GB) Limited regarding the deductibility of proposal costs incurred by Foster Wheeler Energy Limited for its ... Deduction as business expenditure under section 37 of the Income-tax Act - 'Fees for technical services' and the 'make available' clause under the India-UK DTAA - Withholding tax obligation on payments to non-residents under the India-UK DTAA - Deductibility of contractually agreed price reduction/liquidated damages as business expense in the year of accrualDeduction as business expenditure under section 37 of the Income-tax Act - Allowability of proposal/bid costs incurred by a group company (FWEL) and charged to the Project Office (FWGB) as a deduction under section 37. - HELD THAT: - The Authority found that FWEL incurred the proposal costs and charged FWGB, and the Revenue's verification confirmed that FWGB bore and paid its share to FWEL. Such expenditures were incurred wholly and exclusively for the purposes of the applicant's business. Consequently, these proposal expenses qualify as business expenditure allowable under section 37 and should be allowed in the year in which they were incurred. [Paras 5, 6, 15]Proposal costs charged by FWEL to FWGB are allowable under section 37 in the year of incurrence.'Fees for technical services' and the 'make available' clause under the India-UK DTAA - Withholding tax obligation on payments to non-residents under the India-UK DTAA - Whether payments to FWEL and to non-resident third-party service providers constitute 'fees for technical services' subject to tax/withholding in India under the India-UK DTAA. - HELD THAT: - The Authority examined invoices, timesheets and an affidavit describing the nature of services. The affidavit explained that the services provided by FWEL and by third parties were administrative/back-office and managerial support rendered from abroad, and that references to engineers or to 'consulting engineering services' on invoices identified the project or the basis of time allocation rather than transfer of technical know how. The Authority held that these services do not satisfy the DTAA 'make available' requirement and therefore are not fees for technical services; accordingly, they are not subject to withholding as FTS under the India-UK DTAA. [Paras 11, 12, 15]Payments to FWEL and to non-resident third-party service providers are not in the nature of 'fees for technical services' and do not attract withholding as FTS under the India-UK DTAA.Deductibility of contractually agreed price reduction/liquidated damages as business expense in the year of accrual - Deductibility of provisions for payment of liquidated damages/price reduction to IOCL under the contract while computing profits. - HELD THAT: - Clause 8.9 of the contract obliged FWGB to a price reduction for delay. The Revenue conceded the payment is not a penalty and may be allowed, subject to allowance in the year the invoices actually arose. The invoices and year-wise statement furnished showed amounts attributable to price reduction; the Authority ruled that such reductions, being agreed contractual adjustments, are deductible in computing profits in the year in which they actually accrued and were invoiced, subject to verification by the Income tax Authorities. [Paras 13, 14, 15]Contractual price reductions (delay penalties) are deductible in the year in which they accrue as evidenced by the invoices; the Income tax Authorities will allow them after verification.Final Conclusion: The Authority ruled that (i) proposal costs charged by FWEL to FWGB are allowable under section 37 in the year of incurrence; (ii) payments to FWEL and to non resident third parties are not 'fees for technical services' under the India-UK DTAA and thus are not subject to withholding as FTS; and (iii) contractually agreed price reductions/liquidated damages are deductible in the year they accrue, subject to verification by the Income tax Authorities. Issues Involved:1. Deductibility of proposal costs incurred by Foster Wheeler Energy Limited (FWEL) in computing the taxable income of the Project Office (PO).2. Withholding tax obligations on payments made to non-resident third-party service providers and FWEL under the Inter Company Agreement.3. Deductibility of provisions made for payment of liquidated damages to Indian Oil Corporation Limited (IOCL) under the contract.Issue-wise Detailed Analysis:1. Deductibility of Proposal Costs (Question No.1):The applicant, Foster Wheeler (GB) Limited (FWGB), sought to deduct proposal costs incurred by FWEL, a group company, in computing the taxable income of its PO in India under Section 37 of the Income-tax Act. These costs included time charges of UK staff, travel expenses, and miscellaneous expenses. The Department of Revenue initially contended that these expenses, incurred by a third party (FWEL), should not be allowed as deductions. However, after verification, the Department conceded that FWGB had indeed paid Rs. 4,79,33,690 to FWEL for these expenses. The ruling concluded that since these expenditures were incurred for business purposes, they should be allowed as deductions in the year they were incurred.2. Withholding Tax Obligations (Question No.5):FWGB made payments to third-party service providers and FWEL for services related to the PO. FWGB argued that these payments did not constitute 'fees for technical services' under Article 13(4) of the India-UK DTAA, as they did not make available technical knowledge, experience, skill, or know-how. The Department of Revenue argued that the payments to FWEL were for consulting engineering services, thus qualifying as fees for technical services. However, an affidavit provided by FWGB clarified that the services rendered by FWEL were administrative and managerial support services, not technical services. The ruling accepted this explanation, determining that the payments were not for technical services and thus not subject to withholding tax under the DTAA.3. Deductibility of Liquidated Damages (Question No.6):FWGB sought to deduct provisions made for liquidated damages (delay penalty) payable to IOCL under their contract. Initially, the Department of Revenue considered these expenses as penal and non-deductible. However, during the hearing, the Department agreed that these were not penalties but should be allowed as deductions in the year they were actually invoiced. The ruling confirmed that these deductions should be allowed based on actual invoices and amounts earned, subject to verification by the Income Tax Authorities.Rulings Pronounced:1. Proposal costs incurred by FWEL and charged to FWGB are allowable under Section 37 of the Income-tax Act in the year they were incurred.2. Payments made to non-resident third-party service providers and FWEL are not considered fees for technical services and thus are not subject to withholding tax under the India-UK DTAA.3. Provisions for liquidated damages (price reduction) are deductible while computing profits based on actual invoices, amounts earned, and the difference attributable to price reduction on a year-to-year basis.The ruling was pronounced on August 10, 2016.