The Assessee, a Chinese company, had entered into contracts with Indian entities for setting up of turnkey thermal power projects. Each of these contracts were divided into two parts – one for supply of equipment and materials of thermal power plant and second for erection and services of units of main plant along with some common facilities.The Assessee had a project office in India which constituted a permanent establishment (PE) for the assessee in India under the India-China DTAA.
The consideration receivable by the assessee was separately provided in respect of
(i) offshore supply of equipment, spare parts and tools outside India (offshore supply) and
(ii) for local supply, design, engineering, construction, erection, installation, testing and commissioning of thermal power units (onshore activities).
While the scope of work and consideration were part of separate agreements, such agreements contained a ‘cross-fall breach clause’ ensuring that performance of entire project was treated as single point responsibility and non-performance of any part would be treated as a breach of whole contract.
Tax Authorities’ arguments
- The contract was manipulated and artificially split up at the convenience of the foreign contractor i.e. assessee in such way that its onshore activities in India will always result in losses.
- The assessee’s PE in India had some role to play in overall execution of the contract (including offshore supply which was a continuous process). Accordingly, income in India should be computed by attributing profits to the PE under the provisions of the DTAA as well as transfer pricing provisions.
- Accordingly, on a reference to the TPO, profits were attributed to the PE in India in connection with both offshore and onshore components and adjustments were made resulting in taxable income of the assessee in India.
- The AAR, in a ruling in the case of Alstom Transport SA held that a composite contract for installation and commissioning cannot be split up into separate parts and the contract has to be read as a whole having regard to its object and the purpose it sought to be achieved. This was held by applying the ‘look at’ principle adopted by the Supreme Court in the case of Vodafone International Holdings (341 ITR 1).
- The observations of the AAR are certainly applicable in the cases in which the values assigned to the onshore services are prima facie unreasonable vis-à-vis values assigned to the offshore supplies, which make no economic sense when viewed in isolation with offshore supplies contract.
- The views of the AAR are accepted for the limited extent where the transactions are to be essentially looked at as a whole, and not on a standalone basis, when the overall transaction is split in an unfair and unreasonable manner with a view to evade taxes.
- Presence of ‘cross-fall breach clause’ indicates that the contract could be viewed as an integrated one.
- In the assessee’s case, as per the audited financial statements, losses were incurred not only in respect of onshore activities, but also on offshore supplies executed from China. If losses are incurred on the entire project, the mere fact that losses were incurred on onshore activities cannot be a sufficient reason to show or indicate that this was done to avoid taxes.
- Even if the contracts are taken together as an integrated whole and if there are no profits earned under the contracts, there can be no occasion to tax income from such contracts in India. The workings of the overall losses given by the assessee must be examined by the Revenue and if the Revenue does not have any issue regarding these workings, the very foundation of the actions of the Revenue ceases to be good in law.