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TMI Blog2005 (8) TMI 670X X X X Extracts X X X X X X X X Extracts X X X X ..... e Government of Japan concluded a convention for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income, which was notified on March 1, 1990 (hereinafter referred to as "Treaty II"). 2. On May 18, 2001, the applicants and Mitsubishi Electric Corporation, Japan, formed a consortium of which Mitsubishi Corporation is the consortium leader. Pursuant to the international tender for the design, manufacture, supply, testing and commissioning of passenger rolling stock for the Delhi Metro issued by the Delhi Metro Rail Corporation (for short the "DMRC"), in the year 1999, the consortium offered a tender, which was accepted. The consortium and the DMRC entered into a contract in respect of the said work on May 22, 2001 (hereinafter referred to as "RS1"). The consideration for the entire work to be carried out by the consortium is a fixed lump sum price of INR 3,110,439,836 and US $ 260,997,269, which is apportioned amongst various cost centres (A to J see para. 12 of annexure III of the applications), and further apportioned amongst various milestones (sub-clause 13.3 of General Conditions of Contract). Heading "A" of "instructions to the ten ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd Korea? (5) Whether, on the facts and in the circumstances of the case, the expenditure incurred in India would be allowed deduction against business profits? In AAR/613/2003 (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 12 of the Double Taxation Avoidance Agreement between India and Japan? Or as a corollary to the above question, based on the contract "RS 1" 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 services, if any, arises through permanent establishment in India and as such is taxable as business profits under article 7 read with article 12(5) of the DTAA ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lly for providing technical services as also for supply of trains and these two elements are equally important. The preparation of plans and designs, supervision of maintenance and training are clearly in the nature of technical services and the payments attributable for that purpose cannot but be fee for technical services. The contract is separable into fee for technical services and the manufacture and supply of trains. It is added, "milestones payments for preparing the various management plans and designs, etc., which have been culled out from the Schedule of 'cost centres' have been made in respect of technical services including provision of personnel of which the description is given in the following Tables:- Cost Centre No. A -Preliminary and General Requirement for Rail and Metro Corridor (P.203-220 MC/PB) A1 Project Management Plan 5,284,743 A2 Interface Management Plan and Detailed Interface Documents 3,170,846 A3 Works Programme 3,170,846 A4 Design Submission Programme 3,170,846 A5 Quality Assurance Plan 3,170,846 A6 Safety Assurance Plan and Site Safety Plan 3,170,846 A7 Environmental Plan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... idence of income-tax. In the post hearing written submissions, it is stated that clause 1.10 clarifies the factual position that the transfer of drawings/designs was for the limited purpose of use by the DMRC in relation to the works which is defined in clause 1.1.6.11. RS 1 does not give any rights to the DMRC or to any other third party for the purpose of manufacture of train sets ; designs/drawings are provided to the DMRC for its own use in relation to the works. 7. Mr. S. D. Kapila, learned counsel appearing for the Commissioner, argued that after supply of 60 trains designs/drawings, etc., were to be used for indigenous trains and relied on pages 28, 77 of paper book II and pages 129-133 and 173 of paper book III. He strenuously contended that the apportionment of the fixed lump sum price was provided in RS 1 itself ; various elements of RS 1, having regard 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 i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ould be calculated from the date of taking over of the whole of the works and not for any section or part of the clause. 11. Factors 1 and 5 may appropriately be dealt with jointly. It will be useful to refer to various clauses of RS 1 relied upon by the parties. Clause 1 of RS1, which is the subject-matter of the first factor urged by the applicants, reads as follows : Clause 1 DMRC agrees to hire and the contractor agrees to be hired to implement the design, manufacture, supply and commissioning of passenger rolling stock of contract RS 1 of the Mass Rapid Transport System-phase one project under the terms and conditions specified in this contract agreement and the other contract documents attached hereto as follows : . . . 12. We have carefully gone through clause 1 of the contract. It contains neutral facts. It merely 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 doc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... other obligations. If in the opinion of the employer's representative, such necessity is due to any other cause, he shall determine an adjustment to the contract price, with the approval of the employer, and shall notify the contractor accordingly. In this event, sub-clause 14.3 shall apply to such work." 14. Having defined "defects liability period" in para. 12.1, the next para. (12.2) goes on to provide that all the works referred to in sub-clause 12.1(b) shall be executed by the contractor at its own cost if the necessity for such work arises due to the design of the work, plant, rolling stock, materials or workmanship not being in accordance with the contract or due to failure of the contractor to comply with any of his other obligations. It also deals with other connected issues. It is obvious that 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 un ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on that car body shells of at least 18 rail corridor trains and 7 metro corridor trains shall be manufactured in India with mostly indigenous materials. The price to be quoted shall be inclusive of all taxes, levies, duties and any other charges leviable, including tax deducted at source, except that : . . ." 17. In the instructions for completing the pricing document, caption "A" deals with 'apportionment' of fixed lump sum price to costs centre and milestone under each cost centre. Para. 1.1, referred to above, is under the heading "General Requirements". Heading 'B' deals with "Customs clearance" ; heading 'C' deals with "Milestones achievement periods" ; heading 'D' deals with "milestone payment schedule" ; heading 'F' deals with "Cost centres" ; headings "G" & "H" dealing with "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 w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ling stock for rail and metro corridors 52,843,413 34,088,557 B. Design of rolling stock for rail and metro rolling 8,707,930 8,114,758 C. Off-shore manufacture, factory, testing, inspection, marine insurance and shipping to port in India and transit insurance from port in India to depot site of 14 No. 25 KV AC trains for rail corridor and one 1500 VDC for metro corridor 46,437,149 151,458,794 D. Indigenous manufacture, factory testing, inspection and 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 year ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... escribed 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 technologies available with differ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 mentioned in Article 15, in consideratio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sign, 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 of capital equipment in connection with s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 faced with the problem of scope of defini ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 have been otherwise available in view of section ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ected 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 operate on 1500 V DC overhead rigid current collection system and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 609,555 B3 Obtain the Notice of no objection or Notice of no objection subject to from the employers representative for Final Design Submission 609,555 B4 Obtain the Notice of no objection or Notice of no objection Subject to from the employers representative for Final Design Document Delivery 609,555 B5 Obtain the Notice of no objection or Notice of no objection subject to from the employers representative for As-Built Drawings delivery 2,438,221 B6 Obtain the Notice of no objection or Notice of no objection subject to from the employers representative for Mock-up at Contractors Off-shore Factory 2,487,980 A7 to A12 and B7 and B8 are not relevant for the present discussion. Cost Centre No. G-Training Col. A Col. B Obtain the Notice of no objection or Notice of no objection subject to from the employers representative for completion of all training ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... stone A1. (ii) Interface management plan-which is referred to in Milestone A2. (iii) Work plan (work programme and design submission programme)-which is referred to in Milestones A3 and A4 Safety assurance plan-which is referred to in Milestone A6 (iv) Quality assurance plan-which is referred to in Milestone A5 Software quality assurance plan-which is referred to in Milestone A8 (v) Environmental plan-which is referred to in Milestone A7 (vi) Inspection, test and commissioning plan-which is referred to in Milestone A9 41. The import of project management plan is contained in para. 2.2 of the same chapter. It reads as follows: 2.2 Project management plan 2.2.1 The project management plan shall provide a clear overview of the contractor's organization, the management system and methods to be used for completion of the works. The organization resources for the design, procurement, manufacture, installation, testing and commissioning, and setting to work, shall be clearly defined. 2.2.2 The tenderer shall submit a project management plan as a part of the tender, which shall provide the following information : (i) A diagram showing the organizational structure for the manageme ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... A1 and A2 which are in respect of project management plan and interface management plan, respectively, that services of liaison and co-ordination relate to the project of the DMRC, as such they involve FTS. We shall, therefore, deal with milestones A1 and A2 elaborately. A meticulous reading of the above paras. makes it clear that the project management plan refers to the contractor's organization, the management system and the methods to be used for completion of the works and not to the project of the DMRC. It requires organization resources for the design, procurement, manufacture, installation, testing and commissioning, and setting to work to be clearly defined. The project management plan has to provide the information contained in clauses (i) to (vii) of para. 2.2.2. All these information relate to the design, manufacture, installation, testing etc. of the works by the contractor. We have also perused the organizational chart drawn on page 122 of the paper book-II (filed by the Revenue) which relates to the organization of the contractor and not of the DMRC. 43. In regard to milestone activity A2, para. 2.3 of Chapter 2 is material and reads as follows : 2.3 Interface Mana ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the purpose of the project. Indeed it is incomprehensible that RS 1 which is for a limited purpose of sale/supply of metro trains, should be dealing with services of extensive project of the DMRC. It is worthwhile emphasizing that the services, liaison, co-ordination of the contractor with designated and other contractors are so inextricably connected with design, manufacturing activities of metro trains that the element of services cannot be separated for purposes of taxation of FTS. 46. We consider it unnecessary to burden this ruling by a discussion of each of the milestones. Suffice it to mention that we have gone through Chapters 2 and 3 of the "RS1 Employer's Requirements : General Specification" and examined milestone activities of A1 to A9 and we are satisfied that those milestone activities do not involve element of FTS. 47. Yet another submission of Mr. Kapila needs to be noticed. It was argued that Mitsubishi Corporation-leader of the consortium-was not involved in supply of material but was rendering management services as per consortium agreement. Therefore, FTS is attracted. We are unable to accede to this submission. We have perused consortium agreement dated May ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... om the above discussion it follows that the contract-RS 1-comprises element of fee for technical services in cost centres "G" and "J" within the meaning of article 13(4)/12(4) of Treaties I and II and it can be separated for purposes of levying income-tax. 51. In regard to question No. 2 which is a consequential question, it will suffice to mention that the proportion of the lump sum price which is noted against each of the above-mentioned items ("G" and "J") relating to providing of services could only be regarded as fee for technical services. 52. In regard to question No. 3 ; it may be pointed out that in view of para. 7 of article 7 of the Treaty when an item of income is dealt with separately in another articles of the Treaty, the provisions of the other article shall not be affected by article 7. It is obvious that fee for technical services is specifically dealt with in article 13/12 of the Treaties, therefore, it gets excluded from the scope of article 7 of the treaties. It would be apt to note that the same view is taken by the Authority in its ruling in Ishikawajima-Harima Heavy Industries Co. Ltd., In re [2004] 271 ITR 193 (AAR). 53. While concluding we would note th ..... X X X X Extracts X X X X X X X X Extracts X X X X
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