Loss-making comparables upheld in FAR analysis; 2% profit attribution on offshore supplies sustained, Revenue's cross-appeal dismissed

ITAT allowed the assessee's appeal, holding that the six comparables selected by the assessee satisfied the FAR analysis and could not be discarded merely for having losses or low margins. Upon inclusion of all comparables, the weighted average margin was 1.69%, below the 2% profit already attributed by the assessee to its Indian operations from offshore supply of goods; hence, no further profit attribution was warranted, and the AO was directed to accept the 2% attribution. Applying judicial consistency with earlier years, ITAT rejected the Revenue's grounds on characterization of receipts from core/fluid analysis and software maintenance contracts, and dismissed the Revenue's cross-appeal.

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1. ISSUES PRESENTED AND CONSIDERED

1.1 Attribution of profit to the permanent establishment in India in respect of offshore supply of equipment and determination of appropriate profit rate (2% vs. higher rate such as 3.13% / 3.98%) based on comparables and profit attribution report.

1.2 Characterisation and taxation of receipts from core/fluid analysis services and software maintenance contracts as income taxable under section 44BB versus as "royalty" / "fees for technical services" taxable under sections 9(1)(vi)/(vii) read with sections 44DA / 115A.

1.3 Inclusion or exclusion of service tax collected/reimbursed from gross revenue for the purposes of computing presumptive income under section 44BB (and 44DA).

1.4 Taxability, character and mode of taxation of interest on income-tax refund received by a tax resident of UAE having a permanent establishment in India, i.e., whether taxable on gross basis under Article 11 of the India-UAE DTAA or as business profits attributable to PE under the domestic law and DTAA, in light of jurisdictional High Court decisions.

1.5 Application of judicial consistency for subsequent assessment years where facts and legal position are identical to earlier years already decided by the Tribunal and/or jurisdictional High Court.

2. ISSUE-WISE DETAILED ANALYSIS

2.1 Attribution of profit to PE for offshore supply of equipment (rate of 2% vs. higher rate)

(a) Legal framework (as discussed)

2.1.1 The Tribunal considered profit attribution to Indian operations in the context of offshore sale of equipment by a non-resident having a permanent establishment in India. The assessee had prepared a Profit Attribution Report in accordance with section 92D read with Rule 10D, using comparables and FAR (Functions, Assets, Risks) analysis to support attribution of profit at 2% of gross sales related to offshore supplies.

2.1.2 Reference was made to earlier Tribunal order in the assessee's own case for a prior year, where the dispute was whether profit attribution should be at 2% offered by the assessee or at 3.13% determined by the Commissioner (Appeals) on the basis of selected comparables. The Tribunal in that earlier year relied on transfer pricing principles, Rule 10B(2), FAR analysis, and the Special Bench ruling in Quark Systems Pvt. Ltd. on treatment of loss-making/low-margin comparables.

(b) Interpretation and reasoning

2.1.3 In the earlier year referred to (A.Y. 2012-13), the Commissioner (Appeals) had derived a mean margin of 3.13% by using only three comparables and by excluding entities with negative margins or margins below 1%. The assessee had, however, used six comparables (including those with low or negative margins) and derived a weighted average margin of 1.69%, while itself attributing 2% profit to Indian operations.

2.1.4 The Tribunal in that year held that:

* All six comparables chosen by the assessee satisfied the FAR and comparability criteria.

* The Commissioner (Appeals) did not dispute FAR comparability, but had excluded comparables merely because they had losses or margins below 1%.

* As per the Special Bench in Quark Systems Pvt. Ltd. and other Tribunal precedents, a comparable cannot be rejected solely due to loss/low margin if it is otherwise functionally comparable.

2.1.5 On inclusion of all six comparables, the weighted average margin was 1.69%, while the assessee's self-attribution at 2% was higher than this arm's length benchmark. Therefore, no further upward adjustment or higher attribution was justified.

2.1.6 For the years under appeal (A.Ys. 2013-14, 2014-15, 2015-16), the facts and method of attribution, nature of offshore supplies, and functional profile of the permanent establishment were found to be the same as in the earlier year already adjudicated. The Commissioner (Appeals), however, had applied a higher profit rate of 3.98% by following his approach for A.Y. 2012-13.

(c) Conclusions

2.1.7 The Tribunal adopted judicial consistency and followed its own decision for the earlier year, holding that:

* Profit attribution for offshore sale of equipment to the Indian permanent establishment should be accepted at 2% of gross sales as offered by the assessee.

* Any higher attribution (such as 3.13% or 3.98%) based on exclusion of low-margin or loss-making comparables is unwarranted.

2.1.8 Accordingly, additions made by applying 3.98% were deleted and the Assessing Officer was directed to accept the 2% attribution for A.Ys. 2013-14, 2014-15 and 2015-16.

2.2 Characterisation of income: section 44BB vs. royalty/FTS under sections 9(1)(vi)/(vii), 44DA, 115A

(a) Legal framework (as discussed)

2.2.1 The Revenue contended that receipts from core/fluid analysis services and software-related contracts constituted "royalty" or "fees for technical services" within sections 9(1)(vi) and 9(1)(vii), so as to be taxed under sections 44DA / 115A rather than under section 44BB.

2.2.2 The Tribunal noted the long-standing controversy between the parties on this characterisation issue from earlier assessment years (starting at least from A.Y. 2007-08), and referred to:

* Coordinate bench decisions in the assessee's own case for prior years (including A.Y. 2011-12 and earlier years 2007-08 to 2010-11), consistently holding that income from provision of equipment and services in connection with exploration, prospecting or extraction of mineral oil is taxable under section 44BB, not as royalty/FTS.

* The jurisdictional High Court's dismissal of the Revenue's appeals against such Tribunal orders.

* The Supreme Court decision in ONGC v. CIT (376 ITR 306), which held that services in connection with exploration and production of mineral oil fall within section 44BB and outside fees for technical services as defined in section 9(1)(vii).

(b) Interpretation and reasoning

2.2.3 For A.Y. 2011-12, a coordinate bench had already held, in the assessee's own case, that:

* Income arising from provision of equipment and services related to exploration/prospecting/extraction of mineral oil (including rental, service charges, and related receipts) is to be taxed u/s 44BB.

* This conclusion was supported by an earlier comprehensive Tribunal order for A.Ys. 2007-08 to 2009-10, and affirmed by the jurisdictional High Court.

2.2.4 In the present appeals, the Revenue argued that post-amendment provisions of sections 9(1)(vi), 9(1)(vii), 44AB, 44DA and the Memorandum to Finance Bill 2010 required that any income falling within section 44DA be assessed under that provision, even if related to oil exploration activities.

2.2.5 The Tribunal, however, emphasised:

* The identical nature of contracts and receipts now in dispute with those previously adjudicated in favour of the assessee.

* The binding nature of the jurisdictional High Court and Supreme Court rulings which had already interpreted the interaction of section 44BB vis-à-vis sections dealing with royalty/FTS in the context of oil exploration services.

* That earlier decisions had specifically considered the same class of services and had held them to be covered under section 44BB.

(c) Conclusions

2.2.6 The Tribunal held that the Commissioner (Appeals)'s direction to assess the receipts under section 44BB did not warrant interference.

2.2.7 The Revenue's grounds seeking assessment as "royalty" / "fees for technical services" under sections 9(1)(vi) / 9(1)(vii) read with sections 44DA / 115A were rejected for A.Ys. 2013-14, 2014-15 and 2015-16, maintaining the section 44BB regime.

2.3 Inclusion of service tax in "gross receipts" under section 44BB / 44DA

(a) Legal framework (as discussed)

2.3.1 The issue was whether service tax collected/reimbursed by the assessee formed part of "gross receipts" for computing presumptive income u/s 44BB (and, as argued by Revenue, under 44DA).

2.3.2 The Tribunal referred to:

* The coordinate bench decision in the assessee's own case for A.Y. 2011-12 and A.Y. 2012-13, wherein it had been held, relying on jurisdictional High Court in CIT v. Mitchell Drilling International P. Ltd. (380 ITR 130) and on another Tribunal decision in Sundowner Offshore International (Bermuda) Ltd., that service tax does not form part of gross receipts under section 44BB.

* The Uttarakhand High Court decision in DIT v. Schlumberger Asia Services (414 ITR 1), confirming that service tax does not partake the character of income and is not to be included in gross receipts for section 44BB computation.

(b) Interpretation and reasoning

2.3.3 Earlier coordinate bench in the assessee's case had reasoned that:

* Section 44BB is a self-contained code prescribing presumptive taxation on the "amount paid or payable" for the services; however, statutory levies like service tax, collected on behalf of the government, are not income of the assessee.

* Jurisdictional High Court authority has specifically held that service tax is excludible from the computation base under section 44BB.

2.3.4 In the present years, the Revenue relied, inter alia, on the Supreme Court decision in Chowringhee Sales Bureau (P) Ltd. (82 ITR 542), contending that sales tax collected is part of business receipts and, by analogy, service tax should be part of gross receipts under section 44BB, and that section 44BB being a complete code does not permit exclusions.

2.3.5 The Tribunal, following its earlier orders and the jurisdictional High Court decisions, held that service tax has a distinct statutory character and does not represent consideration for services so as to form part of revenue receipts for presumptive computation.

(c) Conclusions

2.3.6 Service tax collected / reimbursed is to be excluded from gross receipts for the purposes of computing income under section 44BB (and consequentially under 44DA where applicable).

2.3.7 Revenue's grounds seeking inclusion of service tax in gross receipts were rejected for A.Ys. 2013-14, 2014-15 and 2015-16.

2.4 Taxability of interest on income-tax refund under India-UAE DTAA where assessee has a PE in India

(a) Legal framework (as discussed)

2.4.1 The assessee, a tax resident of UAE with a permanent establishment in India, received interest on income-tax refund and claimed it to be taxable in India on gross basis as "interest" under Article 11 of the India-UAE DTAA, relying on a Special Bench decision in Clough Engineering Ltd. which treated such interest under the "interest" article of the relevant DTAA.

2.4.2 The Commissioner (Appeals), however, relied upon the jurisdictional Uttarakhand High Court decisions in:

* Pride Foramer SAS (ITA No. 16 of 2009); and

* BJ Services Co. Middle East Ltd. v. ACIT (ITA No. 1 of 2010),

to hold that interest on income-tax refund, where there is a permanent establishment, cannot be taxed on a gross basis under the DTAA's interest article, but is to be taxed with reference to the PE.

(b) Interpretation and reasoning

2.4.3 The Commissioner (Appeals) held, and the Tribunal endorsed, that:

* Since the assessee had a permanent establishment in India, income from interest on tax refund is connected with and attributable to that PE.

* In such a case, as per the jurisdictional High Court, the interest is not to be treated under the DTAA's "interest" article on a gross basis but as part of business profits attributable to the PE, taxable under domestic law and relevant business profits article of the DTAA.

2.4.4 The assessee cited the Bombay High Court decision in DIT v. Credit Agricole Indosuez (377 ITR 102) in support of its contention for gross basis taxation under the interest article. The Tribunal rejected this reliance because:

* The Uttarakhand High Court, being the jurisdictional High Court, is binding on the Tribunal in this case.

* In the presence of conflicting non-jurisdictional authority, the Tribunal must follow the jurisdictional High Court decisions already cited by the Commissioner (Appeals).

(c) Conclusions

2.4.5 Interest on income-tax refund received by the UAE-resident assessee with a permanent establishment in India is not taxable on a gross basis under Article 11 of the India-UAE DTAA; instead, it is to be taxed in accordance with the jurisdictional High Court rulings treating such interest as taxable with reference to the permanent establishment.

2.4.6 The assessee's ground on this issue for A.Y. 2014-15 was rejected and the order of the Commissioner (Appeals) was upheld.

2.5 Judicial consistency across assessment years on identical facts

(a) Legal framework (as discussed)

2.5.1 The Tribunal repeatedly referred to earlier decisions in the assessee's own case for A.Ys. 2007-08 to 2012-13, as well as to jurisdictional High Court and Supreme Court rulings, to maintain consistency on issues where facts and law remained unchanged.

(b) Interpretation and reasoning

2.5.2 On profit attribution rate for offshore supplies, the Tribunal observed no distinction in facts or legal position between A.Y. 2012-13 (already decided) and the present years, and therefore followed the prior order permitting 2% attribution.

2.5.3 On characterisation of income (section 44BB vs. royalty/FTS), and on inclusion of service tax in gross receipts, the Tribunal noted that:

* The issues were identical to those previously decided by coordinate benches in the assessee's own case.

* The jurisdictional High Court had already dismissed Revenue appeals on these very determinations.

* For A.Y. 2014-15 and A.Y. 2015-16, the parties themselves conceded that the issues were covered by earlier years.

2.5.4 On interest on income-tax refund, the Tribunal upheld the Commissioner (Appeals) who had followed binding jurisdictional High Court decisions, giving precedence over contrary non-jurisdictional case law.

(c) Conclusions

2.5.5 Judicial consistency was applied to:

* Accept 2% profit attribution for offshore supplies for A.Ys. 2013-14, 2014-15 and 2015-16;

* Sustain taxation of oilfield-related receipts under section 44BB rather than as royalty/FTS for all years in appeal;

* Exclude service tax from gross receipts for section 44BB/44DA computations;

* Uphold the jurisdictional High Court's view on taxability of interest on income-tax refunds.

2.5.6 Consequently, the assessee's appeals for all three years were allowed in part or whole on the covered issues, and the Revenue's cross appeals for all three years were dismissed.

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