TMI Blog2005 (8) TMI 670X X X X Extracts X X X X X X X X Extracts X X X X ..... tem includes element of fee for technical services as defined in article 12(4) of the Treaty between India and Japan. Whether it would not be incorrect to disintegrate the contract for purposes of taxation of each of the component? Whether the proportion of the lump sum price payable by the DMRC under contract-RS-1-as mentioned against costs centre, ‘G’ and ‘J’ can be regarded as fee for technical services? Whether Fee for technical services cannot be taxed as business profits under article 7 in view of the fact that the FTS is specifically dealt with in article 12(4) of the Treaty. - A. A. R. Nos 612 and 613 of 2003 - - - Dated:- 26-8-2005 - SYED SHAH MOHAMMED QUADRI AND A. S. NARANG, JJ. S. D. Kapila, for the Department Rahul Krishna Mitra, for the applicant RULING Syed Shah Mohammed Quadri J. (Chairman).- These two applications are filed under section 245Q(1) of the Income-tax Act, 1961 (for short the Act ). M/s. Rotem Company (for short Rotem ) incorporated and registered in and a tax resident of Korea, is the applicant in AAR/612/2003 and M/s. Mitsubishi Corporation (for short Mitsubishi ) incorporated and registered in and a tax resident o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... endering services and that no part of the fixed lump sum price under RS 1 can be regarded as fee for technical services (FTS) within the meaning of articles 13 and 12 of Treaties I and II, respectively. On these facts the applicants sought advance rulings of the Authority on the questions set forth as follows : In AAR/612/2003 (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 13 of the Double Taxation Avoidance Agreement between India and Korea? Or as a corollary to the above question, based on the contract RS1 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... there is no separate contract between the DMRC and the members of the consortium. The implementation of RS 1 is under the control of a unified and dedicated project management team drawn from three member companies. All payments are received from the DMRC in the bank account of the applicant in AAR/613/2003, which has the authority to act on behalf of the other members. The members then divide the amounts among themselves. It is stated that RS 1 is not an ordinary contract for supply of rolling stock as per the specifications of the DMRC. Though the contract is a composite contract under which a fixed lump sum price is payable, the pricing schedule has itself disintegrated the fixed lump sum price into various cost centres which laid down milestone activities for payments. Some of those payments are in respect of technical services including provision of personnel as would be evidenced from the schedule of cost centres. It is also important to point out that the entire payment to the leader of the consortium is on account of its managerial services by way of coordinating the entire programme for execution of the contract. Only 16 trains were manufactured offshore and imported into ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Preliminary design submission 6,09,555 B2 Pre-final design submission 6,09,555 B3 Final design submission 6,09,555 B4 Final design document delivery 6,09,555 B5 As built drawings delivery 24,38,221 B6 Mock-up at contractor off-shore factory 24,87,980 Cost Centre G (P. 217 MC/PB) Milestones for providing training including provision of instructors in India 15,58,410 Milestone J1 (P. 220 MC/ PB) Supervision of maintenance 24,54,936 Total 46,257,072 It may be noted that in the above table in para. 10 (sic) the payments in relation to operation and maintenance manuals, integrated testing and commissioni ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gard to major items of work, were segregated in RS 1 itself as would be evident from different cost centres mentioned in it ; he referred to the definitions of terms, tender , contract and contractor in RS 1 (pp. 128-129 of paper book II) to show that one of the elements of the work is supplying of services as contained in cost centres A , B , G and J ; various cost centres and milestones specified thereunder would show that RS 1 was separable on the basis of the supply of material and providing of services which fell within the meaning of FTS under article 13/12 of Treaty I and Treaty II respectively. 8. On the above contentions, the germane issues that arise for consideration are whether RS 1-a composite contract-is separable into its elements and whether it contains an element of FTS. These are essentially issues of fact which have to be resolved on a holistic consideration of RS 1 along with all other connected documents. 9. It is common ground that RS 1 is a composite contract. The term contract is defined in clause 1.1.1.3 of the General Conditions of Contract in the following terms:- General Conditions of Contract. 1. Definitions and interpretation ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... states that the DMRC has agreed to hire and the contractor has agreed to be hired to implement the design, manufacture, supply and commissioning of passenger rolling stock of the contract-RS 1 of the Mass Rapid Transport System under the terms and conditions specified in the contract and the other contract documents attached thereto. It also enumerates the documents referred to in RS 1 as the contract documents. We have also perused the definitions of tender and Contractor . None of these support the contention of inseparability of RS1. 13. In this connection, it is apposite to refer to the fifth factor, which relates to clause 12.1 (page 43 of the PB-II), the General Conditions of Contract dealing with the defects liability period. What is sought to be contended by Mr. Mitra on the basis of the fifth factor, is that for the purpose of defects liability period the date of taking over of the whole of the works and not any section or part thereof, is the criteria, therefore the works covered by RS-1 are not segregable. The contention though attractive at the first sight, is found to be lacking in substance on examination. The expression defects liability period , is defined ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hat having regard to the obligations of the contractor, the starting point of the limitation for the defects liability period has to be from the date of taking over of the whole of the works and not any section or part thereof because RS 1 postulates taking over of the whole works and not piecemeal. Further taking any section or part of works, would lead to a chaotic situation and unending process. As far as we could see these factors are not suggestive of the contract being inseparable into different elements. 15. Factors 2, 3 and 4 highlighted by Mr. Mitra, can be conveniently considered together. These factors deal with the fixed lump sum price payable to the contractor under RS 1. Clause 4 of RS 1 (pp. 22-23 of PB 1) which incorporates the value of work and completion time reads as under :) The employer agrees to pay for the total cost of the works and the contractor agrees to accept the sums mentioned below in the following currencies to be the total cost of the work carried out by him as part of its obligations, responsibilities and liabilities under and according to the provisions and obligations imposed on him by the contract. Fixed lump sum price (i) Rupees th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Currency and Gauge option with which we are not concerned here. Paras. (2), (3) and(4) of the instruction (page 124 of paper book II) under Caption A of the same document, clearly show that the fixed lump sum price is apportioned to cost centres and milestones under each cost centre. It would be necessary to read these instructions to the tenderers, which are as follows : Para.-2 The whole of works including design is divided into cost centres. Each of these cost centres represents a major item associated with the works. Cost centres are named according to their general scope of work. Para.-3 The fixed lump sum price for the whole of works (60 trains) shall be apportioned by the tenderer among the various cost centres. The apportioned amount of each cost centre will be further distributed among various milestones included in that cost centre, separately for foreign currency and for the rupee portion. Para.-4 The sum of amounts shown against milestones in a cost centre is the cost centre amount that is to be carried forward to the tender total. For cost centres that involve payment in foreign currency, the division of the respective cost centre amounts betwe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 trains, satisfactory completion of tests and running of train in the depot 12,121,020 71,017,860 F. Integrated testing and commissioning of trains on the section and service trials 19,054,140 G. Training 1,558,410 1,420,358 H. Operation and maintenance manuals 1,731,563 I. Unit exchange spares, consumable spares for a period of three years, special tools, testing and diagnostic equipment 10,538,115 34,569,358 J. Supervision o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 is the handy work of some officers and those who are responsible for the letter are being dealt with administratively by the concerned authorities. 24. The portion relied upon by the applicants reads as under : It is an accepted fact that industry practice in project procurement is to start fabrication after securing the order. It may be appreciated that rolling stock (trains) are based on standard technolo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rd 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 substantially the same, we would refer to article 13(4) of Treaty I which is as under (see [1987] 165 ITR (St.) 199 ) : Article 13 : Royalties and fees for technical services . . . . . 4. The term fees for technical services as used in this Article means payments of any kind to any person, other than payments to an employee of the person making the payments and to any individual for independent personal services mentione ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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. Sundwiger EMFG Co. [2003] 262 ITR 110, a Division Bench of the Andhra Pradesh High Court considered the question whether payments received by a non-resident company from an Indian company, were assessable in India as fees for technical services within the meaning of Explanation 2 to section 9(1)(vii) of the Income-tax Act. There the Indian company placed orders with non-resident companies for supply of different types o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed 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 covered all the stages involved in the supply of machinery (from the stage of design to the stage of commissioning) and that the design supply was not to enable the assessee to commence manufacture of the machinery itself with the aid of such design. In that case the Madras High Court considered whether the payments made by the Indian company to the foreign contractor fell within the meaning of royalty. In this case we are not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ceipts 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 to the relief under section 80-O for the assessment year earlier to 1983-84 and the approval granted by the Board under that section was right and proper. Further for the assessment year 1983-84, the assessee did not qualify for deductions on the terms of that section as contract receipts were fully covered by the provisions of section 80HHB and the deductions under that section would prevail over the relief that might ha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s 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 spares, special tools, testing and diagnostics equipment, jigs and fixture etc. for maintenance, repair and overhaul of cars. The cars required for the corridors shall be of modern design, lightweight made of stainless steel, with 3 phase AC drive having V.V.V.F control, regenerative braking and suitable for ATP, ATC etc. provided by other designated contractors. The cars for Metro corridor and rail corridor shall operat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 84,743 A10 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 609,5 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssion of Training Manuals (Original plus five hard copies) and in Electronic format. 311,682 G7 Any other item considered necessary by the contractor to comply with the scope of works Cost Centre Total Carried to Tender total 1,558,410 1,420,358 Cost Centre Total Carried to Tender Total 2,454,936 14,321,929 39. A close reading of the definitions, quoted above, as well as captions of cost centers A , B and milestone activities A1 to A9 ; B1 to B6 (relied upon by the Commissioner), would show that none of these milestone activities would fit in the meaning of FTS. Cost centre A- Preliminary and General Requirements for Rail and Metro Corridor and milestone activities A1 to A9 would show that those milestone activities have a direct nexus to implementation of design, manufacture, supply and commissioning of passenger rolling stock of contract RS 1 of the Mass Rapid Transport System. Those activities involve various types ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s, separately for principals and sub-contractors. (iii) A narrative describing the sequence, nature and interrelationship of the main contract activities including timing for exchange of information. (iv) Procedure for documentation control. (v) The tenderer shall nominate a suitably qualified and experienced English speaking engineer from his staff to be project manager. The nominee shall be subject to acceptance of the employer s representative, who shall have the right to demand his replacement at any time after the work commences, should the employer s representative consider this to be in the best interest of the project. (vi) The tenderer shall also nominate a senior engineer to coordinate activities of the design offices and manufacturing works. The engineer shall be responsible to the project manager for all works executed outside India and in India for ensuring that effective coordination is maintained with the various manufacturing units of the contractor, sub-contractors and suppliers and that contract delivery schedules are met. (vii) The project manager shall be continuously on site in New Delhi and devote himself full time to the project, commencing not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ted contractors. The interface management plan shall : (i) identify the sub-systems as well as the civil works and facilities with interfacing requirements. (ii) define the authority and responsibility of the contractor s and designated contractors (and any relevant sub-contractors ) staff involved in interface management and development ; (iii) identify the information to be exchanged, precise division of responsibility between the contractor and designated contractors and integrated tests to be performed at each phase of the contractor s and designated contractors works. (iv) Address the works programme of the contract to meet the key dates of each contractor and highlight any programme risks requiring management s attention. 2.3.3 After the review of interface management plan with no objections by employer s representatives, the contractor shall execute the works in accordance with the plan. 44. Clause 2.3.1 requires that the contractor shall interface and liaise with the designated and other contractors in accordance with the requirements of Chapter 3 of the employer s requirements general specification. Chapter 3 is concerned with Co-ordination with desig ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o rail and metro corridor milestone B1 to B5 (B6 is specifically excluded by the Commissioner himself). From a plain reading of milestone activities-B1 to B5-and contents of chapter 5 (design submission requirement) of RS1-Employer s Requirements : General Specification , it is evident and needs no elaboration to conclude that these milestone activities have direct nexus to the design submission programme for manufacture, sale and supply of metro trains. The services postulated by the milestone activities are also inextricably connected with the designing, sale and supply of metro trains and, therefore, the payment for these activities does not fall within the meaning of FTS. 49. Having examined the description and the nature of milestone activities of A1 to A8 and B1 to B5, we are of the considered view that they do not satisfy the requirements of definition of FTS. However, we hasten to add that the same cannot be said about cost centres Nos. G and J . Cost centre G and milestones thereunder are concerned with training of employer s driving instructors and drivers. Cost centre J and milestone J1 speak of Supervision of maintenance . The milestones activities of these ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... m price for the works of design, manufacture, supply, testing and commissioning of passenger rolling stock of the Mass Rapid Transport System includes element of fee for technical services as defined in article 13(4) of the Treaty between India and Korea. It follows that it would not be incorrect to disintegrate the contract for purposes of taxation of each of the components. Question No. 2-The proportion of the lump sum price payable by the DMRC under contract-RS-1-as mentioned against costs centre, G and J can be regarded as fee for technical services. Question No. 3-Fee for technical services cannot be taxed as business profits under article 7 in view of the fact that the FTS is specifically dealt with in article 13(4) of the Treaty. In AAR/613/2003 on Question No. 1-That in terms of contract-RS-1-between the 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 includes element of fee for technical services as defined in article 12(4) of the Treaty between India and Japan. It follows that it would not be incorrect to disintegrate the contra ..... X X X X Extracts X X X X X X X X Extracts X X X X
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