Taxability of Offshore Supply of Equipment Under the IT Act and DTAA 

Shubhangi Jain

15 Mar, 2023

On 22 February 2023 , ITAT Delhi pronounced a judgement in the case titled Smiths Detection Asia Pacific Pte Ltd Vs. The Dy. C.I.T wherein the assessee filed the present appeal against the order dated 18 July 2022  framed u/s 143(3) r.w.s 144C(13) of IT Act, 1961^[1] pertaining to AY 2019-20. The assessee had raised as many as 7 grounds of appeal, but the sole substance of the assessee’s grievance was regarding the taxability of offshore supply of equipment under the IT Act and the taxability of the same under the India-Singapore Double Taxation Avoidance Agreement [DTAA]. The present article shall discuss the aspects covered in the judgment to provide a better understanding of the same.

Facts of the Case

• The assessee company is established under Singapore laws and is a tax resident of Singapore, as per the definition of Article 4 of the DTAA between India and Singapore. The aggrieved assessee is part of UK based business conglomerate – Smiths Group and has the business of manufacturing and trading security equipment.
• The ITR was filed by the assessee on November 30, 2020, wherein the total income was declared as Rs. 3,50,02,980/- at special rates and a loss of Rs. 1,11,62,442/- and claimed exempt income of Rs. 1,04,55,60,800 for the supply of offshore equipment followed by declaring the required receipt in the ITR.
• At the time of the scrutiny assessment proceedings, the assessee itself made a submission of having a Permanent Establishment [PE] in India pursuant to the contract with CIAL and accordingly, the AO  opined that once a PE has been established for a foreign entity, there isn’t any need of establishing the PE again.
• The AO further opined that the taxation of business income of the non-resident is determined in accordance with the source rules under the domestic provisions r.w. Relevant Article of the DTAA.
•  Placing reference to the financial statements furnished by the assessee for the relevant period, the AO noticed that the assessee company also conducts similar business in other countries. Therefore, the operating margin that the applicant company has disclosed from similar businesses across the world can be considered as the profit similar to the Arm’s length profit margin.
• On the lines of this ratio, the AO computed the total profit at Rs. 10 73, 79,094/-.
• Further, the Assessing Officer noticed that according to Form 26AS, there had been a receipt of interest income of Rs. 71, 51,535/- from Canara Bank by the assessee; however, it had declared interest of Rs. 62,94,461/-. Therefore the AO made the addition of Rs. 8,57,074/-  thereby concluding the assessment proceedings.
• Objections rose before the DRP were of no avail.

Issues

1.  Tax Treatment  of offshore supply of equipment under the IT  Act  and the taxability of the same under the India-Singapore Double Taxation Avoidance Agreement DTAA
2. Addition of interest on FD  amounting to Rs. 8,57,074/-

Contentions of the Assessee

The assessee’s counsel vehemently submitted that the assessee’s branch office doesn’t have any role to play in the execution of contracts regarding AAI and CIAL. As the role of the branch office was limited to the  maintaining CIAL

The assessee’s further stated that the assessee doesn’t have a PE in India for offshore supply of equipment. The assessee’s counsel brought to the notice that the transaction in the present case is one akin to the export of goods from outside of India pursuant to the contract for the supply of goods as entered outside of India,  along with the sale being affected outside the country and the equipment’s title in the property is passed outside the country.

He strongly relied on the Hon’ble Apex Court in the case titled Ishikawajima Harima Heavy Industries Ltd and Hyundai Heavy Industries Co. Ltd.

Contentions of the DR

 Ld DR was in support of the Assessing Officer/DRP findings. Referring to the remand report that the AO had submitted, the ld. DR pointed out that through the communication letter written by the applicant company to the CIAL dated 22 August 2018 and communication addressed to the AAI, the scope of work awarded was divided into 2 components by the assessee on its own accord, comprising of supply of equipment and the other being commissioning, installation, testing, and comprehensive annual maintenance.

The ld. DR vehemently stated that the aspect related to the supply of equipment was assigned by the assessee to itself, and the other component of work, i.e., testing, installation commissioning, AMC has been assigned to the subsidiary of the applicant in India, i.e. Smith Detection Systems Pvt Ltd.

The ld. DR further submitted that suo moto bifurcation by the assessee wouldn’t be changing the colour of the transaction, and the attribution of profit by the AO /DRP  can’t be faulted with.

Observations of the Tribunal

The tribunal observed that the core issue that must be dealt with in the present case was regarding the application and extent of the Force of Attraction Rule in case of offshore supply sales of goods/merchandise. The tribunal referred to the judgement of the Apex court that had been cited by the assessee wherein the apex court discussed the implication of such a rule, observing that.

“The attraction rule refers to a situation when an enterprise (GE)  establishes  a PE in another country, it  becomes a part of the fiscal jurisdiction of that other country to such a degree that such another country  has the authority to tax all profits that the GE derives from the sources country-whether through PE or otherwise  It is setting out a PE which is triggering the taxation of transactions in the source State. Therefore,  until and unless the PE is set up, the question of taxability doesn’t arise.”

The judgement also discussed the aspects of a Turnkey Project, whose facts were identical to the facts of the present case; therefore, the tribunal supported the observation of the apex court regarding the turnkey project as decided in the Harima Heavy Industries case.

“In cases such as this, wherein  different severable parts of the composite contract are performed in different places, the principle of apportionment  must be applied  for determining which fiscal jurisdiction can tax that particular part of the transaction. This principle helps  ascertain  the territorial jurisdiction of a particular state lies to ascertain  its capacity to tax  a transaction. Applying it to composite transactions having  some operations in one territory and some in others is  important to  ascertain  the taxability of various operations.”

Judgement  

The tribunal opined that the facts of the above decisions of the  Apex Court were squarely applicable to the facts of the case in hand as well. The turnkey project was split into two parts, and payments have also been made by 11 AAI and CIAL separately for offshore supply and installation and commissioning.

Therefore, the allegation of the ld. DR  regarding the suo moto bifurcation of the contract doesn’t hold any substance due to the other parties concurring to the same at the beginning itself and, therefore, making separate payments.

Thus the tribunal didn’t find any justification in the attribution of profit on the offshore sale of equipment and directed the AO  for the deletion of the impugned addition, thereby allowing the grievance along with all its sub-grounds and clarifying the taxability of offshore supply of equipment under the IT Act and the taxability of the same under the India-Singapore Double Taxation Avoidance Agreement. 

With regard to the addition of interest on fixed deposits amounting to Rs. 8,57,074/-The ld. Counsel for the assessee vehemently submitted that there had been a misplacement of FD  by the assessee, and,  as it is a capital asset,  it has been written off by the assessee. Therefore there isn’t any question of earning any interest income.

This contention of the assessee was considered illogical and unacceptable as The Canara Bank, in Form No. 26AS, has acknowledged the FDs with it and has credited interest by deducting TDS. Even in case of misplacement of FDs, the assessee could have approached the Canara Bank, requesting for duplicate FD.  The tribunal didn’t find any error or infirmity in addition made by the Assessing Officer, and the same was upheld. 

Conclusion

The judgement pronounced in the present case provides the much needed clarity on the concept of taxability of offshore supply of equipment under the IT Act and the taxability of the same under the India-Singapore Double Taxation Avoidance Agreement and the addition of interest on fixed deposits which can be beneficial for all the further matters involving similar issues.

Also Read:
Why start an offshore company in Canada?
Offshore Company Incorporation in Malaysia: A complete Procedure