2025 (5) TMI 197 - AT - Income Tax

Applicability of Section 44BB - Transactions pertains to the provision of services and facilities related to the exploration and exploitation of mineral oils and natural gas rather than payments classified as royalties or fees for technical services - applicability of the beneficial treaty provisions - whether such a classification disregards the nature of the transactions and the specific provisions u/s 44BB of the Act which should govern the assessment of business income in this case? HELD THAT - We note that the assessee is in the business of drilling extraction and exploration of mineral oil and natural gas. The Assessee made payments to non-residents/ foreign companies with respect to rig s/equipment s hiring/renting charges and professional/ consultancy/ support / maintenance services utilised for the activity of drilling extraction and exploration of mineral oil and natural gas which is covered u/s. 44BB of the Act. The Section 44BB i.e. Special provision for computing profits and gains in connection with the business of exploration etc. of mineral oils (presumptive taxation scheme) in the case of a non-resident engaged in the business of providing services or facilities in connection with or supplying plant and machinery on hire used or to be used in the prospecting for or extraction or production of mineral oils a sum equal to ten per cent of the aggregate of the amounts specified in sub-section (2) shall be deemed to be the profits and gains of such business chargeable to tax under the head Profits and gains of business or profession . Therefore the consideration paid for these transactions pertains to the provision of services and facilities related to the exploration and exploitation of mineral oils and natural gas rather than payments classified as royalties or fees for technical services. We note that such a classification disregards the nature of the transactions and the specific provisions under Section 44BB of the Act which should govern the assessment of business income in this case. Therefore we cannot accept the view of the AO and that of the CIT(A) as it is inappropriate and contrary to the principles of natural justice. These payments made by the assessee to non-residents do not fall into the ambit of either royalty or technical fees as these payments relating to the nature of business covered u/s. 44BB of the Act. CBDT vide Instruction No. 1862 dated 22-10-1990 has clearly clarified the fact that payments to a foreign company for services in relation to prospecting for or extraction or production of mineral oil will be income chargeable to tax under the provisions of Sec. 44BB of the Income-tax Act 1961 and not under the special provision for the taxation contained in section 115A read with section 44D of the Income-tax Act 1961. We are of the view that the assessee was right in effecting deduction of tax at source considering section 44BB of the Act. Therefore we are of the considered view that the order of the CIT(A) is erroneous and hence we set aside the same by allowing the grounds of appeal raised by the assessee.

Summary

Issues Presented and Considered

The core legal questions considered in this appeal are:

1. Whether the payments made by the assessee to non-resident foreign companies for services related to offshore drilling, extraction, and exploration of mineral oil and natural gas should be classified as business income governed under Section 44BB of the Income Tax Act, 1961, or as royalty and fees for technical services (FTS) taxable under Sections 115A read with 44D/44DA.

2. Whether the Assessing Officer (AO) and Commissioner of Income Tax (Appeals) [CIT(A)] erred in treating the payments as royalty and FTS and applying tax rates accordingly, ignoring the special provisions of Section 44BB.

3. Whether the assessee was justified in deducting tax at source (TDS) under Section 195 read with Section 44BB on payments to non-residents.

4. Whether the provisions of the Double Tax Avoidance Agreement (DTAA) apply and if so, whether Article 7 (business profits) governs the taxation rather than Articles 12/13 (royalty/FTS).

5. Whether the payments made to non-residents without permanent establishment (PE) in India are taxable in India, and if withholding tax is required in such cases.

6. Whether the AO and CIT(A) violated principles of natural justice by not giving reasonable opportunity to the assessee and by misapplying the tax provisions.

7. The applicability and interpretation of the Explanation to Section 9(1) defining "royalty" and "fees for technical services" and the exclusion of payments covered under Section 44BB from these categories.

Issue-wise Detailed Analysis

Issue 1 & 2: Classification of Payments under Section 44BB vs. Royalty/FTS

Legal Framework and Precedents: Section 44BB provides a special presumptive taxation scheme for non-residents engaged in providing services or facilities in connection with prospecting, extraction, or production of mineral oils, deeming 10% of aggregate receipts as taxable business income. Sections 115A, 44D, and 44DA govern taxation of royalty and fees for technical services.

The Explanation to Section 9(1) clarifies definitions of "royalty" and "fees for technical services," explicitly excluding amounts referred to in Section 44BB from the definition of royalty and excluding mining or like projects from fees for technical services.

Judicial precedents relied upon include:

• Oil & Natural Gas Corporation Ltd. v. CIT (Supreme Court) - held that payments for services connected with prospecting, extraction or production of mineral oil are taxable under Section 44BB, not Section 44D.
• International Technical Services LLC v. ADIT (ITAT Delhi) - affirmed that Section 44BB being a specific provision prevails over general provisions regarding royalty and FTS.
• Deputy Commissioner of Income-tax v. ABAN Offshore Ltd. (ITAT Chennai) - held that payments for rental and repairs of machinery and drilling services are covered under Section 44BB and TDS deduction at 10% on deemed income is appropriate.
• GE India Technology Centre (Supreme Court) - clarified that TDS under Section 195 applies only to sums chargeable to tax in India, and Section 44BB provides a special mechanism for computing income of non-residents.

Court's Interpretation and Reasoning: The Court found that the payments made by the assessee for rig/equipment hiring and professional/consultancy services are integrally connected with the business of offshore drilling, extraction, and exploration of mineral oils and natural gas. Hence, these payments fall squarely within the ambit of Section 44BB.

The AO and CIT(A) erred in classifying these payments as royalty and FTS, thereby applying higher TDS rates under Section 115A and ignoring the specific exclusion in Explanation 2 to Section 9(1) and the CBDT Instruction No. 1862 dated 22-10-1990 clarifying that such payments are chargeable under Section 44BB.

The Court emphasized that Section 44BB is a special provision that overrides general provisions relating to royalty and FTS in this context and that the nature of the services and payments must be examined in pith and substance, not merely on form.

Key Evidence and Findings: The assessee's business activities, nature of services rendered, and payments made were scrutinized. The assessee deducted TDS at 10% on deemed business income under Section 44BB. The AO's contrary classification was not supported by facts or law.

Application of Law to Facts: Applying Section 44BB to the facts, the Court held that the payments are business income of non-residents connected with mineral oil exploration and extraction, taxable under Section 44BB, not as royalty or FTS.

Treatment of Competing Arguments: The Revenue's argument that payments are royalty/FTS taxable under Section 115A was rejected based on statutory exclusions and judicial precedents. The Court also rejected the contention that Section 44BB applies only to non-resident's assessment and not to TDS deduction by the payer, holding that Section 44BB governs the quantum of income chargeable to tax and thus TDS deduction.

Conclusion: Payments to non-resident foreign companies for services related to offshore drilling and mineral oil exploration are business income under Section 44BB, not royalty or FTS. The AO and CIT(A) erred in their classification and tax treatment.

Issue 3: Deduction of Tax at Source under Section 195 read with Section 44BB

Legal Framework and Precedents: Section 195 mandates TDS on sums payable to non-residents if such sums are chargeable to tax in India. Section 44BB provides a special rule for computing income of non-residents in mineral oil services, deeming 10% of gross receipts as taxable income.

Supreme Court decisions in GE India Technology Centre and Transmission Corporation of A.P. Ltd. clarified that TDS obligation is limited to income chargeable under the Act.

Court's Interpretation and Reasoning: The Court held that the assessee was justified in deducting TDS at 10% on the deemed income under Section 44BB and depositing the same. The AO's demand for higher tax and interest under Section 201 treating the assessee as in default was unwarranted.

Key Evidence and Findings: The assessee deducted TDS as per Section 44BB on payments to non-residents and complied with statutory requirements. The AO's order treating the assessee as in default was based on incorrect classification of payments.

Application of Law to Facts: Since Section 44BB prescribes deemed income at 10%, TDS on this portion is appropriate. The assessee's compliance with TDS provisions under Section 195 read with Section 44BB negates any default.

Treatment of Competing Arguments: Revenue's contention that TDS should be deducted on entire payment or at higher rates was rejected based on the special provisions of Section 44BB and judicial precedents.

Conclusion: The assessee rightly deducted TDS under Section 195 read with Section 44BB, and no default under Section 201 is established.

Issue 4 & 5: Applicability of DTAA and Taxability of Non-Residents without Permanent Establishment

Legal Framework and Precedents: Section 90(2) of the Act allows the assessee to choose the more beneficial provisions between the Act and DTAA. Article 7 of DTAA governs taxation of business profits, providing that income is taxable in the country of residence unless the non-resident operates through a PE in the other country.

Articles 12/13 govern taxation of royalty and FTS. The Explanation to Section 9(1) excludes mining or like projects from the definition of FTS.

Supreme Court decisions in GE India Technology Centre, Sedco Forex International Inc., Transmission Corporation of A.P. Ltd., and High Court decisions emphasize that income of non-residents without PE in India is not taxable in India.

Court's Interpretation and Reasoning: The Court found that payments to non-resident companies without PE in India for services rendered outside India are not taxable in India under DTAA provisions. The nature of payments is business income under Article 7, not royalty or FTS under Articles 12/13.

Key Evidence and Findings: The assessee demonstrated that seven payments to non-residents in USA and Singapore were for services rendered outside India, with no PE in India, supported by contract terms and DTAA provisions.

Application of Law to Facts: Applying DTAA Article 7, the income is taxable only in the country of residence of the non-resident as no PE exists in India. Hence, no withholding tax obligation arises.

Treatment of Competing Arguments: Revenue's argument that payments are taxable in India irrespective of PE was rejected, relying on DTAA and judicial precedents.

Conclusion: Payments to non-resident foreign companies without PE in India for services rendered outside India are not taxable in India and no TDS is required.

Issue 6: Alleged Violation of Natural Justice

Legal Framework: Principles of natural justice require reasonable opportunity of hearing before adverse orders are passed.

Court's Reasoning: The Court found no violation of natural justice as the assessee was given opportunity to respond to show-cause notices and appeals. The CIT(A) considered the submissions before dismissing the appeal.

Conclusion: No breach of natural justice occurred.

Issue 7: Interpretation of Explanation to Section 9(1) regarding Royalty and Fees for Technical Services

Legal Framework: Explanation 2 to Section 9(1)(vi) defines "royalty," excluding amounts referred to in Section 44BB. Explanation 2 to Section 9(1)(vii) defines "fees for technical services," excluding consideration for mining or like projects undertaken by the recipient.

Court's Reasoning: The Court emphasized that payments for services connected with prospecting, extraction or production of mineral oils are excluded from royalty and FTS definitions and fall under Section 44BB.

CBDT Instruction No. 1862 dated 22-10-1990 was cited to clarify that mining operations, including drilling for oil and gas, are mining projects and payments for such services are taxable under Section 44BB, not as FTS or royalty.

Conclusion: The payments in question are excluded from royalty and FTS definitions and properly taxable under Section 44BB.

Significant Holdings

"The test of pith and substance of the agreement commends to us as reasonable for acceptance. Equally important is the fact that the CBDT had accepted the said test and had in fact issued a circular as far back as 22.10.1990 to the effect that mining operations and the expressions 'mining projects' or 'like projects' occurring in Explanation 2 to Section 9(1) of the Act would cover rendering of service like imparting of training and carrying out drilling operations for exploration of and extraction of oil and natural gas and hence payments made under such agreement to a non-resident/foreign company would be chargeable to tax under the provisions of Section 44BB and not Section 44D of the Act."

"Section 44BB is a special provision to the exclusion of all the contrary provisions provided in sections 28 to 41 and 43 and 43A of the Act... The hon'ble Supreme Court while dealing with its own decision in the case of Transmission Corporation of A.P. Ltd. [1999] 239 ITR 587 (SC), has categorically explained that the tax was liable to be deducted by the payer of the gross amount if such payment included in it an amount which was exigible to tax in India. This is not so in the present case. Here on account of the special provisions of section 44BB, 10 per cent of the gross amount payable to the non-residents deemed as the income chargeable to tax in India."

"The obligation to deduct TDS is limited to the appropriate portion of income chargeable under the Act forming part of the gross sums of money payable to the non-resident."

"Payments to a foreign company for services in relation to prospecting for, or extraction or production of, mineral oil will be income chargeable to tax under the provisions of Sec. 44BB of the Income-tax Act, 1961 and not under the special provision for the taxation contained in section 115A, read with section 44D of the Income-tax Act, 1961."

Core Principles Established:

• Section 44BB is a special provision governing taxation of income from services connected with mineral oil exploration and extraction, overriding general provisions relating to royalty and fees for technical services.
• Payments for equipment hire, professional, consultancy, and support services related to offshore drilling and mineral oil exploration are business income under Section 44BB.
• TDS under Section 195 is required only on the income chargeable to tax; the special deeming provision of Section 44BB quantifies the taxable income at 10% of gross receipts.
• Payments to non-residents without permanent establishment in India for services rendered outside India are not taxable in India under DTAA provisions.
• The Explanation to Section 9(1) excludes mining-related payments from the definition of royalty and FTS, reinforcing the applicability of Section 44BB.
• Principles of natural justice require reasonable opportunity to be heard, which was complied with in the present case.

Final Determinations on Each Issue:

• The AO and CIT(A) erred in treating payments as royalty and FTS; such payments fall under Section 44BB.
• The assessee correctly deducted TDS at 10% on deemed income under Section 44BB; no default under Section 201 arises.
• The DTAA provisions apply, and payments to non-residents without PE in India for services rendered outside India are not taxable in India.
• The Explanation to Section 9(1) excludes these payments from royalty and FTS definitions, supporting their classification under Section 44BB.
• The assessee was given adequate opportunity to be heard; no violation of natural justice occurred.
• The appeal is allowed, setting aside the orders of the CIT(A) and AO on these points.