The Hindu Business Line : Double whammy for infrastructure

A recent decision of the Madras High Court in the Ansaldo Energia SPA case has disturbed the position on taxability of turnkey contracts laid down by the Supreme Court.

Need to rethink structuring of turnkey projects.

Arvind Singhal

India is one of the fastest growing economies in the world. Despite the global financial crisis impacting most emerging market economies, India has been able to attain 7.1 per cent GDP growth in the current year making it the second fastest growing economy in the world.

The infrastructure sector has contributed significantly to sustain this high economic growth rate. Its share in GDP has grown from 3.5 per cent in 1996-97 to 8.5 per cent in 2006-07. To counter the fallout of the global slowdown on the Indian economy, the Government has till date announced several ‘multidimensional’ fiscal stimulus packages to fuel industrial growth and boost output across various sectors, including infrastructure.

Besides, in the Interim Budget presented on February 16, the Finance Minister emphasised on various measures relating to the growth of the infrastructure sector.

As if the global economic slowdown was not enough to impact the growth of the infrastructure sector, a recent decision of the Madras High Court in the Ansaldo Energia SPA case has disturbed the position on taxability of turnkey contracts laid down by the Supreme Court in the Ishikawajima-Harima Heavy Industries Ltd (IHHI) case.

As per the facts of the case, the taxpayer, a foreign company, was engaged in the business of selling and setting of power plants. The taxpayer had a company in India called Ansaldo Services Private Ltd (ASPL). The taxpayer, as a single bidder, was awarded a turnkey contract by Neyveli Lignite Corporation (NLC) for setting up two thermal plants at Neyveli.

The project was divided into four contracts dealing with (i) offshore supply of equipment, (ii) offshore supervisory services, (iii) onshore supply and (iv) onshore services. The taxpayer claimed substantial amount of income under contract 1 as tax-exempt. Further, the balance income from designing and engineering services and the income on contract (ii) was offered to tax at 20 per cent.

Contract split

The tax officer held that the entire receipts were fees for technical services (FTS). The Commissioner of Income-tax (Appeals) held that the taxpayer had a permanent establishment (PE) in India and that the contract was split up only for tax purposes.

The CIT(A) further held that the price of contracts (i) and (ii) were loaded higher on account of the responsibilities and risks with respect to contracts (iii) and (iv) due to the taxpayer being the single bidder. The CIT(A) estimated the profits on the entire project taking into consideration the losses of contracts (iii) and (iv) and also profit attributable to PE. The tax tribunal upheld the order.

The High Court held that in the IHHI case the Supreme Court had ruled that offshore supply could not have been taxed in India, only after analysing the terms of the contract, all parts of the transaction took place offshore, involvement of the PE in the offshore supply and composite nature of the contract.

SC ruling distinguished

The High Court distinguished the Supreme Court decision on the basis of various facts and upheld the order of the Tribunal with regard to the taxability of offshore supply of equipment on the following basis:

Activities rendered by the taxpayer under various contracts were inextricably linked. It was a composite contract and there was involvement of the PE.

Consortium formed by the taxpayer was not of equal players and responsibility for the execution of the contract was on the taxpayer. Further, there was existence of an intimate, real and continuous relationship with ASPL.

There was price imbalance between contract values with more value loaded on to contract (i) which was claimed exempt.

Clause relating to passing of title in the IHHI case, where the words ‘care and custody of the goods supplied’ were used, is different from the words ‘loss, risk and damage’ used in the contract of the taxpayer.

It appears that the Madras High Court has given an adverse finding based on particular facts of that case and the evidence collated by the tax authorities.

This decision cannot be said to unsettle the legal position laid down by the Supreme Court in the IHHI case. At the same time, this decision has thrown open certain issues which need to be considered by corporates while structuring turnkey projects in consultation with tax experts.

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(The author is a Delhi-based chartered accountant.)

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