Oil and gas service receipts held taxable under Section 44BB, not FTS under Section 9(1)(vii) r.w.s. 44DA

ITAT Delhi held that the assessee's receipts from oil and gas services are taxable under Section 44BB, rejecting the AO's treatment of certain receipts as FTS under Section 9(1)(vii) r.w.s. 44DA, following judicial consistency with earlier years in the assessee's own case. On offshore sale of equipment, the Tribunal accepted the assessee's 2% profit attribution for Indian operations, endorsing the FAR-based comparability analysis and inclusion of additional comparable companies, which yielded a lower weighted average margin of 1.69%. Consequently, no further profit attribution was warranted, and the Revenue's appeals were dismissed in entirety.

---

---

1. ISSUES PRESENTED AND CONSIDERED

1.1 Whether receipts from various service and software maintenance contracts are taxable under the presumptive provisions of Section 44BB of the Income-tax Act, 1961, or as "royalty" / "fees for technical services" under Sections 9(1)(vi)/(vii) read with Sections 44DA / 115A.

1.2 Whether income on account of offshore sale of equipment (including from composite and pure supply/standalone contracts) is to be taxed on the basis of profit attribution at 2% of gross revenues as offered by the assessee, or at higher rates as estimated by the Assessing Officer.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1 - Characterisation of receipts from services and software contracts: Section 44BB vs Sections 9(1)(vi)/(vii) r.w.s. 44DA / 115A

Interpretation and reasoning

2.1 The Tribunal noted that the Assessing Officer had bifurcated receipts, treating most contract receipts as covered under Section 44BB, but classifying certain contracts (including inspection/servicing of drilling tools, provision of specialist technical services, software, software maintenance and AMCs) as "royalty" / "fees for technical services" (FTS) under Sections 9(1)(vi)/(vii) read with Section 44DA / 115A, inter alia on the basis that they were managerial/technical/consultancy services not amounting to "mining or like project".

2.2 The Department relied on: (i) Explanation 2 to Section 9(1)(vii) defining FTS; (ii) Explanations 3-6 to Section 9(1)(vi) defining and expanding "royalty"; (iii) the Finance Act, 2010 amendments to Sections 44BB and 44DA; and (iv) a High Court judgment (Paradigm Geophysical) to argue that where income assumes the character of royalty/FTS, Section 44DA and not Section 44BB must apply post-amendment, and that reliance on the Supreme Court decision in ONGC was misplaced for post-2011 years.

2.3 The Tribunal observed that the same controversy regarding characterisation of receipts from similar service/software contracts in the context of oil and gas exploration activities had repeatedly arisen in the assessee's own cases from earlier assessment years, and that a Coordinate Bench had already held, for Assessment Years 2007-08, 2008-09, 2009-10, 2010-11, 2011-12 and 2012-13, that such receipts were taxable under Section 44BB.

2.4 In particular, the Tribunal referred to its earlier orders (including for Assessment Year 2011-12 and for Assessment Years 2013-14 to 2015-16), where it had followed the principle that income on account of provision of equipment and services in connection with exploration/prospecting/extraction of mineral oil is to be taxed under Section 44BB, and noted that these orders had been upheld by the jurisdictional High Court. The Tribunal emphasised the need to maintain judicial consistency where there was no material distinction in facts or law.

2.5 The Tribunal found no change in the nature of activities, contracts, or factual matrix for the years under appeal vis-à-vis the earlier years. It noted that the Commissioner (Appeals) had followed the existing binding precedent which applied the ratio of the Supreme Court decision in ONGC holding that services in connection with exploration and production of mineral oils fell within Section 44BB and outside the ambit of FTS as defined in Section 9(1)(vii).

2.6 The Tribunal did not accept the Revenue's contention that the post-2011 amendments to Sections 44BB/44DA or the High Court ruling in Paradigm Geophysical altered the position as already settled inter se the parties by earlier binding orders for overlapping and immediately preceding assessment years, in the absence of any shown factual or legal distinction.

Conclusions

2.7 The Tribunal held that the receipts from the impugned service and software contracts, being in connection with exploration/prospecting/extraction/production of mineral oils, are taxable under Section 44BB and not as "royalty" or "fees for technical services" under Sections 9(1)(vi)/(vii) read with Sections 44DA / 115A.

2.8 The detailed reasoning and directions of the Commissioner (Appeals) directing assessment under Section 44BB were affirmed, and the Revenue's grounds on this issue (Grounds 1 to 5) were dismissed as devoid of merit.

Issue 2 - Taxability and profit attribution on offshore sale of equipment (composite and pure supply contracts)

Interpretation and reasoning

2.9 The Assessing Officer had distinguished between: (i) composite contracts involving both supply of material/equipment and services, wherein receipts were brought under Section 44BB; and (ii) standalone/pure supply contracts involving independent sale of imported material without associated services, for which Section 44BB was held inapplicable and profits were estimated at higher margins (35% in one year, 10% in subsequent years) with 50% of such profits attributed to India.

2.10 The assessee, based on a Profit Attribution Report (PAR) and comparable companies' margins (including Aseem Global Ltd., Hazel Mercantile Ltd., Veritas India Ltd.), had offered income from offshore sale of equipment-both from composite contracts and from pure supply/standalone contracts-at 2% of gross revenues as profit attributable to Indian operations. The Assessing Officer rejected the comparables and the PAR on the ground of alleged functional dissimilarity.

2.11 The Tribunal noted that an identical issue regarding attribution of profit on overseas/offshore sale of tools and equipment in the context of similar contracts had already been considered in the assessee's own case for Assessment Year 2012-13, and again for Assessment Years 2013-14 to 2015-16. In those earlier orders, the Tribunal had:

(a) Accepted that the attribution of 2% profit to Indian operations was based on a comparability analysis satisfying the FAR (Functions performed, Assets employed, Risks assumed) test.

(b) Held that the Commissioner (Appeals) was not justified in excluding comparables merely because they had negative margins or margins less than 1%, in view of the Special Bench decision in Quark Systems Pvt. Ltd. and other coordinate bench rulings which held that a functionally comparable company cannot be rejected solely due to loss or low margin in a particular year.

(c) Held that, upon including all comparables (including those with negative or sub-1% margins), the weighted average margin worked out to 1.69%, and therefore the assessee's attribution at 2% was reasonable and required no further enhancement.

2.12 For the present assessment years, the Tribunal recorded that the facts, contractual structure, type of supply contracts, and transfer-pricing / attribution methodology were the same as in the earlier years, and that the Commissioner (Appeals) had followed the binding earlier orders.

2.13 The Tribunal again emphasised judicial consistency, noting that in the absence of any shown change in factual profile or legal position, the view taken in the immediately preceding years on an identical issue between the same parties should be followed.

Conclusions

2.14 The Tribunal held that the entire revenue from offshore sale of equipment-whether arising from composite contracts or pure supply/standalone contracts-is to be taxed by attributing profit at 2% of gross revenues as offered by the assessee, and that higher estimations made by the Assessing Officer are unsustainable.

2.15 The directions of the Commissioner (Appeals) in line with the earlier years' orders were upheld, and the Revenue's grounds on this issue (Grounds 6 to 8) were dismissed as devoid of merit.

2.16 Consequently, all the Revenue's appeals for the assessment years under consideration were dismissed.

---