TDS Implication on Supply of Equipment & Installation Services

Background:

xxxxxxxxxxxxxxxxxxxx has invited tender for supply, installation, testing and commissioning along with comprehensive AMC of xxxxxxxxxxxxxxx (“DFMD” or “the Equipment”) and Test Kit at various xxxxxxx in India. Amongst various bidders, the tender of xxxxxxxxxxxxxxxx was accepted.
As per the work order issued by xxx, the following are the components of works:

• Supply of DFMD and Test Kit
• Cost of Installation, Maintenance, System administration and training
• Comprehensive AMC Cost

We understand that xxxx is a tax resident of xxxx and has obtained a PAN in India. Further, it does not have a Permanent Establishment or a place of business in India.

In light of the above facts, xxxx has approached KL Aggarwal & Associates to seek an opinion whether consideration payable by xxx to xxxx towards supply, installation, testing and commissioning (other than comprehensive AMC) of xxxxxxxxx (DFMD) and Test Kit at various Airports in India would be subject to tax in India and whether xxx is required to deduct any withholding tax on payment made to xxxx?

Our Opinion:

Withholding tax liability on payment made by an Indian Company to a non resident company is governed by provisions of Section 195 of the Income Tax Act, 1961 (“the Act”).

Section 195 of the Income Tax Act contains provision for deduction of tax at source from payment to non resident. It provides that any person responsible for paying to a non-resident any sum chargeable under the Act shall at the time of credit of such income deduct income-tax thereon at the rates in force. The relevant provisions of the section are given as under:

“Any person responsible for paying to a non-resident, not being a company, or to a foreign company, any interest (not being interest referred to in Section 194LB or Section 194LC or Section 194LD) or any other sum chargeable under the provisions of this Act (not being income chargeable under the head “Salaries”) shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rates in force..”

Therefore, for application of Section 195, it is sine qua non that the payment to non resident must have an element of income liable to be taxed under the Indian Income-tax Act, 1961. In other words, when no part of payment to non resident constitutes an income taxable under the Act, tax withholding obligations under section 195 do not come into play at all.

So, in the instant case, we need to examine whether proposed payment by xxxx to xxxxx towards supply and installation of equipment is chargeable to tax under Indian Income Tax Act or Double Taxation Avoidance Agreement between India and Singapore. If it is chargeable, there is an obligation on payer to withhold tax on payment made to non resident.

The chargeability under Indian Income Tax Act is governed by Section 5 of Income Tax. The scope of total income of Non resident is defined under section 5(2) of the Act as under:

“Subject to the provisions of this Act, the total income of any previous year of a person who is a non-resident includes all income from whatever source derived which —

(a) is received or is deemed to be received in India in such year by or on behalf of such person ; or
(b) accrues or arises or is deemed to accrue or arise to him in India during such year.”

Section 9 of the Act provides nature of incomes which are deemed to accrue or arise in India determined the chargeability of payment to non resident, we need to determine beneficial provision available to non resident as contained in Section 90(2) of the Income Tax Act as under:

“Where the Central Government has entered into an Agreement with the Government of any country outside India under sub section (1) for granting relief of tax, or as the case may be for avoidance of double taxation, then, in relation to the assessee to whom such agreement applies, the provision of this Act shall apply to the extent they are more beneficial to the assessee”

Hence in order to determine whether tax is required to be deducted from any payment to non resident, we have to first determine whether such payment are chargeable to tax in India or not under provisions of Income Tax Act or Double Taxation Avoidance Agreement. In case, payment is not chargeable to tax in India under Indian Income Tax, no tax shall be required to be deducted at source in terms of section 195 of the Act. Further, in case the payment is chargeable to tax in India, but not chargeable to tax as per provision of DTAA, even then no tax is required to be deducted under section 195 notwithstanding that such payment may be liable to tax under the Indian Income Tax Act.

Taxability of Supply of xxxxxxxxxx (“DFMD” or “the Equipment”) and Test Kit

Taxability under India-Singapore DTAA:

From the tax treaty perspective, the income earned by xxxxx from the sale of equipment will be construed as business income and accordingly will be governed by Article 7 of the India Singapore tax treaty which reads as under:

“…The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as it directly or indirectly attributable to that permanent establishment…”

In the present case, we have been given to understand that xxxx is a tax resident in Singapore and does not have a Permanent Establishment (“PE”) in India. Hence, in absence of PE of xxxx in India, the profits arising from sale of equipment by xxxx can only be taxed in Singapore and no income will be taxable in India.

Taxability under provisions of the Income Tax Act:

In the present case, we have been given to understand that the equipments will be exported by xxxx to xxx from outside India. Equipment shall be imported in the name of xxxxxxxx and Bill of Lading will also be in the name of xxxx. Further, insurance policy shall be in the name of xxx. Also, the Custom duty shall also be paid by xxx in India. Moreover, the consideration is proposed to be received by xxxx outside India in foreign currency.

Hence, a view may be taken that the title of the equipments is transferred outside India. Merely because xxxx is expected to take responsibility for transportation, freight and other expenses is not sufficient ground to hold that the title is passed in India at the jobsite. The transit risk borne by xxxx till the goods reach the site in India is not necessarily inconsistent with the sale of goods taking place outside India. Also, clause relating to part value of equipment payable on successful completion of various tests in India appears to be only a commercial arrangement; it could not be construed that, for such clause, the sale took place in India. Such clause is in the nature of warranty provisions. This balance payment is merely a deferred payment that did not have any impact on the sale of goods.

Since, the sale of equipment may be construed to take place outside India, no income could be considered to accrue or arise in India in terms of provisions of Income Tax in India.

Reliance in this regard is placed on the decision of the Supreme Court (SC) in the case of Ishikawajima-Harima Heavy Industries Limited v DIT 288 ITR 408 (SC). In the said case, the Hon’ble Apex Court has held that revenue from offshore supply of equipment forming part of composite contract shall not be taxable in India. The relevant observations of the Court are as under:

“… Only such part of income, as is attributable to the operations carried out in India can be taxed in India as contemplated in Explanation 1(a) of section 9(1)(i ); (2)Since all parts of the transaction in question, i.e. the transfer of property in goods as well as the payment, were carried out outside the Indian soil, the transaction could not have been taxed in India; (3) The principle of apportionment, wherein the territorial jurisdiction of a particular State determines its capacity to tax an event, has to be followed; (4) The fact that the contract was signed in India is of no material consequence, since all activities in connection with the offshore supply are carried outside India, and therefore cannot be deemed to accrue or arise in India..”

Reliance in this regard is placed on the decision of Supreme Court in the case of Mahabir Commercial Co. Ltd 1976 86 ITR 417(SC).

Reliance is further placed on the decision of Delhi Tribunal in the case of Technip Italy Spa v ACIT– 2010-TII-133-ITAT-DEL-INTL. In this case, the Hon’ble ITAT after applying the decision of Supreme Court in case of Ishikawajima Harima (mentioned supra) held that the income from offshore supply of equipment on a Cost Insurance Freight basis under a composite contracts is not taxable in India.

Reliance is also placed on the decision of Delhi High Court in the case of DIT v LG Cable Ltd 237 CTR 438 (Del HC) wherein the Hon’ble Court has held that income from offshore supply of equipment cannot be taxed in India merely because it is interlinked with the satisfactory performance of onshore contract. In this case, the assessee, a Korean company, entered into three contracts with Delhi Transco Ltd for (i) offshore supply contract on CIF basis, (ii) onshore supply contract and (iii) onshore service contract. The applicant claimed that the income arising from the offshore supply contract was not taxable in India. The revenue claimed that the profits from the off-shore supply was taxable in India on the basis that (a) though the supply contract was awarded separately, any breach under one contract was deemed breach of the other contracts, (b) the award of separate contracts did not dilute the responsibility of the applicant for successful completion of the facility as per specifications, (c) the three contracts were composite contracts and one could not exist without the other, (d) the offshore supplies were on CIF basis and the contracts for offshore supply and onshore contracts were signed on the same date, (e) the insurance requirement of the offshore supplies contract require that the applicant will take out and maintain insurance of cargo, installation, worker compensation, etc, (f) the case is not a case of a sale simpliciter but is for full package involving onshore services. It could not have made a difference had the contract been one instead of three divisible contracts. The Hon’ble Delhi High Court rejecting the contentions of the department, held as under:

“…The clauses in the offshore supply contract agreement regarding the transfer of ownership, the payment mechanism in the form of letter of credit which ensures the credit of the amount in foreign currency to the applicant’s foreign bank account on receipt of shipment advice and insurance clause establish that the transaction of sale and the title took place outside Indian Territory. The ownership and property in goods passed outside India. The transit risk borne by the applicant till the goods reach the site in India is not necessarily inconsistent with the sale of goods taking place outside India. The parties may decide between them as to when the title of the goods should pass…”

Similar reliance is also placed on the decision of Delhi High Court in the case of Nokia Networks OYE 358 ITR 259 (Delhi HC).

Hence, in light of the above decisions, it appears that the Courts have admitted this position that even in case of offshore supply of equipments under CIF contracts, where the responsibility to bear cost, Insurance and Freight up-to the destination of buyer is on the seller, the title of goods may be considered as transferred outside India. In that view of the matter, it may be construed that in the instant case, the income from transfer of equipment would not accrue or arise in India. However, it may be noted the tax authorities may take a contrary view that the title of the goods has been transferred in India and hence the income is subject to tax in India. However, even in that case, since the foreign entity does not have permanent establishment in India, in our view, there should not be any tax liability in light of beneficial provisions of India Singapore DTAA.

In light of the above, in our view, the income earned by xxxx from supply of xxxx(“DFMD” or “the Equipment”) and Test Kit will not be subject to tax in India both in terms of DTAA between India and Singapore and provisions of Income Tax Act and DTAA, hence there is no requirement to withhold any tax on such payment.

Taxability of Auxiliary services viz. installation, commissioning and assembly of Equipment in India:

As per terms of Work Order, in addition to supply of equipment, xxxx is also required to provide ancillary services viz. installation, commissioning and assembly of equipments in India. We understand that such services are intrinsically connected to the sale of equipments and will be provided by xxxx personnel in India.

Taxability of such services would be governed by provision of Section 9(1)(vii) of the Income Tax Act. In terms of said provisions, such services would be construed as Fees for Technical Services as per the provisions of the Act. Such income accrues and arises in India, since the related economic activity was performed in India.

Now, we will examine the taxability of such services as per provisions of DTAA between India and Singapore. Article 5 of the DTAA inter alia provides that a Company constitutes a PE in India if:

“..A building site or construction, installation or assembly project constitutes a permanent establishment only if it continues for a period of more than 183 days in any fiscal year…”

In the instant case, we have been given to understand that the installation and commissioning of the Equipments by xxxxx employees in India will not continue for a period of more than 183 days in a financial year, hence a view may be taken that Installation PE of xxxx will not be constituted in India.

It may further be noted that Installation and commissioning services provided by a foreign enterprise since being inextricably connected to the sale of Equipments will not be assessable as Fees for technical services (“FTS”) as defined in Article 12 of India Singapore Treaty. This is due to the fact that DTAA between India and Singapore has provided for a specific Permanent Establishment (PE) Clause (as referred in above paragraph) with respect to installation and supervision activity, it would override the general clause of FTS in the treaty.

The services in the nature of installation and commissioning would, de facto, amount to ‘technical services’. There is an overlapping effect, such that, there is a general provision of Fees for Technical Services (FTS) for taxability of technical services and a specific provision (of installation PE) for taxability of technical services in the nature of construction, installation and supervision activities. If there is an apparent conflict between two independent provisions, a specific provision must prevail over the general provision. Reliance in this regard is placed on the Supreme Court’s rulings in the cases of Union of India v. India Fisheries (P) Ltd. [1965] 57 ITR 331 1965 (SC) and ITO v. Titagarh Steels Ltd. [2001] 79 ITD 532 (SC)

If one were to proceed on the basis that, even if the PE test fails, taxability can be held under the FTS provisions, such an approach would render the PE provisions meaningless. In a case where there is a specific PE clause for a specific type of service and such services are also covered by the scope of FTS provision, the taxability of consideration for such services must remain confined to the relevant specific PE clause. The provisions of taxability as FTS will not come into play in such cases.

Thus, consideration attributable to installation, commissioning and assembly of equipments would be treated as business income and taxable in accordance with Article 7 read with Article 5 of India Singapore Treaty and Article 12 of DTAA dealing with FTS would have no role to play in such cases. Hence, in absence of PE of xxxx in India, income arising from provision of installation, commissioning and assembly services would not be subject to tax in India.

 
In support of the above contentions, reliance is placed on following decisions:
 

• (i) Andrew Yule & Co. vs CIT 207 ITR 899 (Calcutta HC) – In this case, the Hon’ble Calcutta High Court has dealt with the identical issue. In that matter a German Company had supplied certain machinery to the Indian assesee and had rendered certain services in setting up of the machinery. Considering those facts, the Hon’ble Court held that services rendered in setting up of machine could not be treated as personal service even if the agreement for rendering the services was embodied in a separate agreement, that the German Company had no PE in India, that in view of the Indo-German DTAA no income had accrued in India, that there was no liability to deduct tax source.

 

• (ii) Prasad Production Limited(125 ITD 263) – Chennai Special Bench In this case, the Assessee-company was awarded a contract by Tourism Department of State Government to establish IMAX theatre. Assessee entered into agreement with IMAX Ltd., Canada for purchase of equipment, maintenance and installation. As per terms of agreement, assessee was to make payment to IMAX Ltd. on account of purchase of system and also as technology transfer fee. During relevant assessment year, assessee made certain payment to IMAX Ltd. Assessing Officer was of view that amount remitted by assessee was for provision of technical services by IMAX Ltd., which would fall under section 9(1)(vii). On appeal, Commissioner (Appeals) set aside assessment order. On revenue’s appeal, it was seen that as per terms of agreement, IMAX Ltd., was to install equipment, test it and also provide training to four projectionists. The ITAT Special Bench held that Assessing Officer had mistaken in considering aforesaid services to be transfer of technology whereas they were auxiliary to sale of equipment, hence amount remitted by assessee was not chargeable to tax in India and, thus, Commissioner (Appeals) was justified in setting aside impugned assessment order.

 

• (iii) Gujarat Pipavav Port Limited vs ITO – ITA No.7878/Mum/2010 – Mumbai ITAT – In this case the Hon’ble ITAT has held that Installation services provided by a foreign enterprise which are inextricably connected to the sale of goods are not assessable as “fees for technical services” or as “business profits” under the DTAA. The ITAT has observed that though service of installation is covered by the FTS clause as well as Installation PE clause of the India China treaty and though the installation contract (including period of after sales service) exceeded 183 days, the income from installation activity was neither taxable as FTS nor as business income since:

   

  • the service of installation was inextricably connected to sale of goods, the same could not be treated as FIS or FTS
  • specific installation PE clause in India China Treaty will override General FTS clause
  • the aforesaid threshold limit of 183 days would have to be applied to the actual period of installation (which was less than 183 days) and not the contractual period.

 

• (iv) Birla Corporation Ltd vs ACIT ( I.T.A. No.: 251 and 252/JAB13 )- Jabalpur ITAT – In this case, the Jabalpur Tribunal (ITAT) has held that tax is not required to be withheld for payments made for purchase of plant and machinery which may also include charges for installing and commissioning of these machines. In arriving at this conclusion, the ITAT has disregarded this contention of the Tax Authorities, that the payments were made for composite contract of purchase of plant and machinery, including incidental services of installation and commissioning. The ITAT has also brushed aside the Tax Authorities’ contention that payment for installing and commissioning services constitute Fees for Technical Services (FTS) and hence tax was required to be withheld accordingly. The ITAT held that taxability of such payments have to be determined with respect to the Double Tax Avoidance Agreement (DTAA) entered into by India with various countries, and since in the case under consideration, each of the DTAA has provided for a specific Permanent Establishment Clause (PE) with respect to installation and supervision activity, it would override the general clause of FTS in the treaty. Thus, it was concluded by the ITAT that purchase consideration attributable to installation and commissioning, if any, would be treated as business income and taxable in accordance with Article 7 read with Article 5 of the respective Treaty and Article 12 or 13 of DTAA dealing with FTS would have no role to play in such cases.

Alternatively, even if for argument sake, the FTS article (Article 12) is to be applied to the instant case, the payment might not qualify as FTS under the India-Singapore tax treaty because of ‘make available’ clause under the said Treaty. Article 12 of India Singapore DTAA provides that:

“..The term “fees for technical services” as used in this Article means payments of any kind to any person in consideration for services of a managerial, technical or consultancy nature (including the provision of such services through technical or other personnel) if such services :

……
make available technical knowledge, experience, skill, know-how or processes, which enables the person acquiring the services to apply the technology contained therein ; or
…..”

In the present case, Installation or commissioning of Equipments by xxxx does not transfer technology, in the sense that the recipient of these services cannot perform such services on its own, without recourse to the service provider. Therefore, make available condition is not being satisfied in the instant case. In view of the same, payment made by xxx to xxxx cannot be treated as FIS. Article 12(5)(a) of the India-Singapore tax treaty specifically excludes services which are ancillary and subsidiary, as well as inextricably and essentially linked, to the sale of a property from taxation i.e. plant, equipment or machinery. Accordingly, even if there be any income embedded in the payments, in respect of installation, commissioning or assembly activities, or supervisory activities connected therewith, the same cannot be brought to tax. The receipts in the hands of the parties were in the nature of business income and the same were not taxable in India in the absence of a PE under the relevant tax treaties.

In light of the above discussions, in our opinion, a view may be taken that since that since the installation, commissioning and assembly services are inextricably linked with the sale of DFMD and Test Kit Equipments, the same would be taxable as Business Profits and in absence of PE of xxxxx in India, the said income would not be subject to tax in India. Hence, there is no requirement to withhold tax at source on such payments in India.

Requirement to obtain Certificate under Section 195(2) of the Income Tax Act:

At this point, it may also be worthwhile to discuss the provisions of Section 195(2) of the Act which provides as under:

“..Where the person responsible for paying any such sum chargeable under this Act (other than salary) to a non-resident considers that the whole of such sum would not be income chargeable in the case of the recipient, he may make an application to the Assessing Officer to determine, [by general or special order], the appropriate proportion of such sum so chargeable, and upon such determination, tax shall be deducted under sub-section (1) only on that proportion of the sum which is so chargeable…”

In light of the above provisions, a question may arise whether it is not permissible for the assessee to determine on its as to whether the income of non-resident would be taxable in India or not and, therefore, on its own decide not to deduct TDS?

The said controversy has been put to rest by the decisions of the Hon’ble Supreme Court in the cases of CIT v. Elililly and Company (India) Pvt. Ltd., 312 ITR 225 (SC) and G.E. India Technology Centre (P) Ltd. v. CIT, 327 ITR 456 (SC) wherein it has been held that tax is deductible at source only where payment is chargeable to tax in India. The Hon’ble Delhi High Court has also considered the issue after discussing above mentioned decisions of Hon’ble Supreme Court in the case of CIT v. Eon Technology P. Ltd. (2012) 343 ITR 366 (Del.) and now it is a settled legal position that tax is deductible only if the amount is chargeable to tax in India.

The Application of Section 195(2) pre-supposes that the person responsible for making the payment to the non resident is in no doubt that tax is payable in respect of some part of the amount to be remitted to a non-resident but is no sure as to what should be the portion so taxable or is not sure as to the amount of tax to be deducted. In such a situation, he is required to make an application to the Assessing Officer for determining the amount. It is only when these conditions are satisfied an application is made to the Assessing Officer that the question of making an order under Section 195(2) will arise. On the other hand, where a person responsible for deduction is fairly certain then he can make his own determination as to whether the tax was deductible or not.

In the present case, in light of the discussions given in Para 3 and 4 of this note, it is reasonably certain that income arising from supply of equipment and anciliary services to xxx would not be subject to tax in India, hence a view may be taken that xxxxx is not required to approach Assessing Officer for determining whether such income is subject to tax in India or not.

Conclusion:

• (a) The income earned by xxxx from supply of xxxx (“DFMD” or “the Equipment”) and Test Kit will not be subject to tax in India both in terms of provisions of Income Tax Act and DTAA between India and Singapore, hence there is no requirement to withhold any tax on such payment.

• (b) Since the installation, commissioning and assembly services are inextricably linked with the sale of DFMD and Test Kit Equipments, the same would be taxable as Business Profits and in absence of PE of xxxxx in India, the said income would not be subject to tax in India. Hence, there is no requirement to withhold tax at source on such payments in India.,/p>

• (c) Since the income arising from supply of equipment and anciliary services to xxxx would not be subject to tax in India, xxxxxx might not be required to approach Assessing Officer for seeking a tax order for determining whether such income is subject to tax in India or not.

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