TaxTMI 
TaxTMI 
2005 (8) TMI 670
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....he Government of Republic of India and the Government of Japan concluded a convention for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income, which was notified on March 1, 1990 (hereinafter referred to as "Treaty II"). 2. On May 18, 2001, the applicants and Mitsubishi Electric Corporation, Japan, formed a consortium of which Mitsubishi Corporation is the consortium leader. Pursuant to the international tender for the design, manufacture, supply, testing and commissioning of passenger rolling stock for the Delhi Metro issued by the Delhi Metro Rail Corporation (for short the "DMRC"), in the year 1999, the consortium offered a tender, which was accepted. The consortium and the DMRC entered into a contract in respect of the said work on May 22, 2001 (hereinafter referred to as "RS1"). The consideration for the entire work to be carried out by the consortium is a fixed lump sum price of INR 3,110,439,836 and US $ 260,997,269, which is apportioned amongst various cost centres (A to J see para. 12 of annexure III of the applications), and further apportioned amongst various milestones (sub-clause 13.3 of General Conditions of Contrac....
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....ss profits under article 7 of the DTAA between India and Korea? (5) Whether, on the facts and in the circumstances of the case, the expenditure incurred in India would be allowed deduction against business profits? In AAR/613/2003 (1) Whether in terms of contract RS 1 between DMRC and the consortium, the lump sum price for the works of design, manufacture, supply, testing and commissioning of passenger rolling stock of the Mass Rapid Transport System included any element of fee for technical services as defined in article 12 of the Double Taxation Avoidance Agreement between India and Japan? Or as a corollary to the above question, based on the contract "RS 1" of composite nature in its totality, whether it would be correct to disintegrate the contract and view and tax each of its components individually? (2) If the answer to question No. 1 is in the affirmative, what proportion of lump sum price payable by the DMRC under contract RS-1 can be regarded as fees for technical services (FTS)? (3) Whether, on the facts and in the circumstances of the case, fee for technical services, if any, arises through permanent establishment in India and as such is taxable as busi....
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....ice. RS 1 and related documents make it clear that the contract is essentially for providing technical services as also for supply of trains and these two elements are equally important. The preparation of plans and designs, supervision of maintenance and training are clearly in the nature of technical services and the payments attributable for that purpose cannot but be fee for technical services. The contract is separable into fee for technical services and the manufacture and supply of trains. It is added, "milestones payments for preparing the various management plans and designs, etc., which have been culled out from the Schedule of 'cost centres' have been made in respect of technical services including provision of personnel of which the description is given in the following Tables:- Cost Centre No. A -Preliminary and General Requirement for Rail and Metro Corridor (P.203-220 MC/PB) A1 Project Management Plan 5,284,743 A2 Interface Management Plan and Detailed Interface Documents 3,170,846 A3 Works Programme 3,170,846 A4 Design Submission Programme 3,170,846 A5 Quality Assurance....
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....ominant or underlying activities of manufacture and sale of products, therefore, the price of the contract cannot be segregated between the value of the service and the value of the material for the purpose of arriving at the incidence of income-tax. In the post hearing written submissions, it is stated that clause 1.10 clarifies the factual position that the transfer of drawings/designs was for the limited purpose of use by the DMRC in relation to the works which is defined in clause 1.1.6.11. RS 1 does not give any rights to the DMRC or to any other third party for the purpose of manufacture of train sets ; designs/drawings are provided to the DMRC for its own use in relation to the works. 7. Mr. S. D. Kapila, learned counsel appearing for the Commissioner, argued that after supply of 60 trains designs/drawings, etc., were to be used for indigenous trains and relied on pages 28, 77 of paper book II and pages 129-133 and 173 of paper book III. He strenuously contended that the apportionment of the fixed lump sum price was provided in RS 1 itself ; various elements of RS 1, having regard to major items of work, were segregated in RS 1 itself as would be evident from different co....
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....in order to arrive at milestone payments, the fixed lump sum price had merely been broken down into cost centres ; (5) the general conditions of the contract forming part of RS 1 provide that the "defects liability" period vis-a-vis the contractors would be calculated from the date of taking over of the whole of the works and not for any section or part of the clause. 11. Factors 1 and 5 may appropriately be dealt with jointly. It will be useful to refer to various clauses of RS 1 relied upon by the parties. Clause 1 of RS1, which is the subject-matter of the first factor urged by the applicants, reads as follows : Clause 1 DMRC agrees to hire and the contractor agrees to be hired to implement the design, manufacture, supply and commissioning of passenger rolling stock of contract RS 1 of the Mass Rapid Transport System-phase one project under the terms and conditions specified in this contract agreement and the other contract documents attached hereto as follows : . . . 12. We have carefully gone through clause 1 of the contract. It contains neutral facts. It merely states that the DMRC has agreed to hire and the contractor has agreed to be hired to implement the de....
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....e executed by the contractor at his own cost, if the necessity for such work is due to : (a) the design of the works ; (b) plant, rolling stock, materials or workmanship not being in accordance with the contract ; or (c) failure by the contractor to comply with any of his other obligations. If in the opinion of the employer's representative, such necessity is due to any other cause, he shall determine an adjustment to the contract price, with the approval of the employer, and shall notify the contractor accordingly. In this event, sub-clause 14.3 shall apply to such work." 14. Having defined "defects liability period" in para. 12.1, the next para. (12.2) goes on to provide that all the works referred to in sub-clause 12.1(b) shall be executed by the contractor at its own cost if the necessity for such work arises due to the design of the work, plant, rolling stock, materials or workmanship not being in accordance with the contract or due to failure of the contractor to comply with any of his other obligations. It also deals with other connected issues. It is obvious that having regard to the obligations of the contractor, the starting point of the limitation for the ....
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....rising 43 No. of 25 KV AC trains for rail corridor and 17 No. 1500 VJc trains for metro corridor. Out of these 60 trains, 14 rail corridor trains and 1 metro corridor train shall be completely manufactured off-shore. The balance 45 trains will be progressively indigenised with the essential condition that car body shells of at least 18 rail corridor trains and 7 metro corridor trains shall be manufactured in India with mostly indigenous materials. The price to be quoted shall be inclusive of all taxes, levies, duties and any other charges leviable, including tax deducted at source, except that : . . ." 17. In the instructions for completing the pricing document, caption "A" deals with 'apportionment' of fixed lump sum price to costs centre and milestone under each cost centre. Para. 1.1, referred to above, is under the heading "General Requirements". Heading 'B' deals with "Customs clearance" ; heading 'C' deals with "Milestones achievement periods" ; heading 'D' deals with "milestone payment schedule" ; heading 'F' deals with "Cost centres" ; headings "G" & "H" dealing with "Currency" and "Gauge option" with which we are not concerned here. Paras. (2), (3) and(4) of the instruc....
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....he instructions to the tenderer contain the description of cost centres in the statement which is as under : Apportionment of fixed lump sum price among cost centres Total apportioned amounts of cost centre items A. Preliminaries and general requirements for rolling stock for rail and metro corridors 52,843,413 34,088,557 B. Design of rolling stock for rail and metro rolling 8,707,930 8,114,758 C. Off-shore manufacture, factory, testing, inspection, marine insurance and shipping to port in India and transit insurance from port in India to depot site of 14 No. 25 KV AC trains for rail corridor and one 1500 VDC for metro corridor 46,437,149 151,458,794 D. Indigenous manufacture, factory testing, inspection and despatch, transit insurance from factory to depot of 29 No. 25 KV AC trains for rail corridor and 16 No. 1500 VDC trains for metro corridor 105,546,593 2,795,448,312 E. Inland transportation of trains which India including handling charges at port in India, depot or at any other place, and all other incidental costs, receipt of cars in depot, formation of t....
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....t and include plant, rolling stock and materials and their accessories." 22. A plain reading of the definition of "works" quoted above, would show that services to be carried out are included within the meaning of that term. Among major items of works (A to J), it is pleaded by the Commissioner, items "A", "B", "G" and "J" involve services to be carried out by the contractor. Even assuming that the cost centres and milestones are prescribed to facilitate periodic payments to the contractor, as contended by Mr. Mitra, is correct, the fact that on functional basis services are allotted separate cost centres as major items of works and divided into milestones and thus there is segregation of services as major items of works which are paid separately under RS 1, is not mitigated. We shall advert to this aspect further presently. 23. However, relying upon letter No. DMRC/134/98/XVOO-Payment-582 dated November 7, 2002, of the DMRC (at pages 145-146 of paper book II) it is contended by Mr. Mitra that under RS 1 no technical services were rendered by the consortium-a fact which is vouched by the DMRC. Mr.Kapila strongly objects to placing reliance on this letter on the ground that it....
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....cates that no technical consultancy or advisory services were rendered by the contractor and the DMRC did not acquire the expertise to manufacture these coaches indigenously as a result of these discussions and there has not been exchange of technical expertise or know-how or skill between the parties. Apart from the fact that this letter of the DMRC cannot be taken as having any binding force on the Commissioner in regard to the interpretation of RS 1, we are of the view that it is of no consequence because in RS 1-a carefully worded contract- specific services are assigned costs centres for which defined milestones are prescribed for payment and it would, prima facie, be too premature to say within one and a half years of RS 1 that no such services are provided. Further having regard to the definition of the expression "fees for technical services" in Treaties I and II, the provision of services of technical or other personnel, would also be within the meaning of FTS and this aspect is not covered by the letter. Inasmuch as articles 13(4) and 12(4) of Treaties I and II respectively which embody the definition of and the expression "Fees for Technical Services" (FTS) are substanti....
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....at a close reading of the type of work as well as other items of the memorandum of agreement between the parties showed that the consideration was paid for construction/installation of the kiln and the services rendered in India were only that of supervision by an expert deputed by the foreign company and that the payment made to the foreign company was not for imparting any information concerning the working of, or the use of, a patent, invention, model, design, secret formula or process or trade mark or similar property falling under clause (ii) of Explanation 2 to section 9(1)(vi) or for imparting of any information concerning technical, industrial, commercial or scientific knowledge, experience or skill within the meaning of clause (iv) of Explanation 2. Consequently, the payments made to the non-resident company did not constitute income by way of royalty within the meaning of section 9(1)(vi) of the Act. It is obvious that this case is not an authority for the proposition whether a composite contract can be segregated into its elements nor can it be of any assistance to ascertain whether the contract-RS 1-contains the element of fees for technical services. 29. In CIT v. S....
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....on Ltd. [2000] 243 ITR 459 (Mad), the assessee was engaged in the mining of lignite. It entered into an agreement with a Hungarian company for acquiring steam generating plants with auxiliaries for more efficient running of its business. The Income-tax Officer held that the amounts payable under the contracts for design and engineering were income of the foreign contractor in India and, therefore, the assessee was required to deduct the income-tax before payment of the amounts to the foreign contractor. The Tribunal held that the amounts could not be regarded as royalty and therefore it would not be income accruing to the foreign contractor in India. On a reference, a Division Bench of the Madras High Court observed that there was no transfer or licence of any patent invention, model or design ; the design referred to in the contract was only the design of the equipment required to be manufactured by the foreign supplier to the Indian purchaser ; the information concerning the working of the machine was incidental to the supply as the machinery was tailor-made for the buyer ; therefore, the price paid by the assessee to the foreign contractor was a total contract price which covere....
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....he High Court, inter alia, opined that the execution of the work by the appellant fell under section 80HHB and not under section 80-O and that it was open to the Assessing Officer to satisfy himself as to whether the conditions laid down in section 80-O were fulfilled. On appeal to the hon'ble Supreme Court, it was held that the mere fact that the appellant was carrying on business as engineers and contractors and its receipts flowed in the course of its business as such did not necessarily preclude relief under section 80-O if they could be brought within the categories of receipts mentioned in the section and that the mere fact that the contract did not specifically assign the nomenclature mentioned under section 80-O to the payments made to the appellant could not be conclusive of its claim for exemption. It was, further, held that there was complete identity of the matters governed by section 80HHB and section 80-O and, therefore, the appellant would be entitled, in view of section 80HHB(5), only to one and not both the reliefs and that the approval of the Board would not help the appellant to overcome the mandate of section 80HHB(5) and, therefore, the appellant was entitled t....
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....d the second limb includes the provision of services of technical or other personnel. With reference to the Table containing apportionment of the fixed lump sum price among various cost centres and milestones, it is pleaded by the Commissioner that cost centres "A", "B", "G" and "J" involve services to be rendered by the contractor. 38. In the light of the above discussions, we shall now examine whether in cost centres "A", "B", "G" and "J" the services are inextricably connected with the sale/supply of metro trains or are separate and independent of such sale/supply so as to be within the meaning of FTS under the said treaties. This necessitates an analysis of relevant milestones activities of cost centres "A", "B", "G" and "J", keeping in view the scope of works under RS 1. Clause 1.1.4 of Chapter I "RS 1 employer's requirements : General specification" which specifies the scope of the works runs thus : "The scope of works under this contract covers design, manufacture, supply, testing and commissioning of passenger rolling stock, supervision of maintenance and the training of operation and maintenance personnel for metro and rail corridors. The scope also covers supply of ....
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.... Provide and erect, offices for the con tractor and for the employers representative, including secondary and integrated testing and commissioning plan 17,968,108 17,044,279 A11 Provide transport for the use of the employers representative 17,044,278 A12 Any other item considered necessary by the contractor to comply with the scope of work. & Cost Centre Total Carried to Tender Total 52,847,413 34,088,557 Cost Centre No. B-Design of Rail and Metro Corridor Rolling Stock B1 Obtain the Notice of no objection or Notice of no objection subject to from the employers representative for Preliminary Design submission 609,555 B2 Obtain the Notice of no objection or Notice of no objection Subject to from the employers representative for Pre-Final Design Submission 609,555 B3 Obtain the Notice of no objection or Notice of no objection subject to from the employers representative for Final Design Submission 609,555 B4 Obtain the Notice of no objection or Notice of no objection Subject to from the employers representative for Final Design Document Delivery 609,555....
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....RS 1 of the Mass Rapid Transport System. Those activities involve various types of services including co-ordination and liaison with designated contractors and civil engineer which are necessary for a proper and safe designing and manufacture of metro trains vis-a-vis construction of metro corridor or other related works. They are, therefore, services inextricably linked with the primary object of RS 1. 40. A little explanation would make the point clear. Chapter 2 of RS 1 Employer's Requirements : General Specification speaks of management plans. Para. 2.1.1 of Chapter 2 refers to development and submission of the following plans for employer's representative's review : (i) Project management plan-which is referred to in Milestone A1. (ii) Interface management plan-which is referred to in Milestone A2. (iii) Work plan (work programme and design submission programme)-which is referred to in Milestones A3 and A4 Safety assurance plan-which is referred to in Milestone A6 (iv) Quality assurance plan-which is referred to in Milestone A5 Software quality assurance plan-which is referred to in Milestone A8 (v) Environmental plan-which is referred to in Milestone A7 (....
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....n site in New Delhi and devote himself full time to the project, commencing not later than thirty (30) calendar days from the date of the notice to proceed and shall continue up to the end of defects liability period. 2.2.3 The contractor will submit a project management plan within 15 days of the date of notice to proceed. The employer's representative will review the contractor's project management plan and shall have the right to require the contractor to make amendments as deemed necessary by the employer's representative. The contractor shall submit a detailed revised plan within 10 days of the review of the employer's representative. 42. From a perusal of cost centre "A" and milestones specified thereunder, a misleading impression is created by milestones A1 and A2 which are in respect of project management plan and interface management plan, respectively, that services of liaison and co-ordination relate to the project of the DMRC, as such they involve FTS. We shall, therefore, deal with milestones A1 and A2 elaborately. A meticulous reading of the above paras. makes it clear that the project management plan refers to the contractor's organization, the management syste....
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....s' general specification. Chapter 3 is concerned with "Co-ordination with designated and other contractors". Clause 3.1.1 in the following terms :- "The contractor is responsible for detailed co-ordination of his design and manufacturing activities with those of the system-wide contractors, civil contractors, consultants and other contractors whether or not specifically mentioned in the contract, who may be working on or adjacent to the site for the purpose of the project." 45. It imposes an obligation on the contractor for detailed co-ordination of his design and manufacturing activities with those of the system-wide contractors, civil contractors, consultants and other contractors whether or not specifically mentioned in the contract who may be working on or adjacent to the site for the purpose of the project. Indeed it is incomprehensible that RS 1 which is for a limited purpose of sale/supply of metro trains, should be dealing with services of extensive project of the DMRC. It is worthwhile emphasizing that the services, liaison, co-ordination of the contractor with designated and other contractors are so inextricably connected with design, manufacturing activities ....
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....lestone J1 speak of "Supervision of maintenance". The milestones activities of these cost centres are services which are separate and independent of design, manufacture-sale and supply of metro trains. They may be because of but are not intrinsic part of the sale/supply of metro trains. It is worth noticing that the footnote appended to milestone No. J1, specifically mentions, "This excludes contractor's obligations and responsibilities during the defects liability period". This brings out the distinction clearly because the nature of the work delineated in 12.1(b), noted above, which the contractor has to execute at his costs, is the work inextricably connected with supply of metro trains, whereas services of cost centre'J' are independent services for which separate payment is made by the DMRC. 50. From the above discussion it follows that the contract-RS 1-comprises element of fee for technical services in cost centres "G" and "J" within the meaning of article 13(4)/12(4) of Treaties I and II and it can be separated for purposes of levying income-tax. 51. In regard to question No. 2 which is a consequential question, it will suffice to mention that the proportion of the lu....