A typical maintenance, repair and overhaul (MRO) contract would involve replacing unserviceable parts with functioning parts so as to keep the equipment functioning.
There are some unique features that relate to a typical MRO contract for the airline industry. An MRO contract, which is also recognised by the term "parts by the hour" (PBH) contracts, envisages a list of specified parts/components of the aircrafts which are contracted for replacement with an assurance that such parts/components would be exchanged within a specified TAT (turn-around time) when such part/components become defective/unserviceable on the aircraft.
A PBH contract is usually entered into with the customer of the aircraft at the time of the sale of a new aircraft. The contract envisages a pre-contracted hourly rate for all the parts/components covered in the PBH contract. The consideration is paid by the customer based on number of hours flown by the aircraft i.e. number of flight hours flown during the period contracted multiplied by price per hour. The periodicity of payment of consideration could be monthly or quarterly. Based on the periodical details of flying hours of the aircraft reported by the customer, the PBH invoice is raised. The invoice is raised regardless of whether or not any component has been replaced.
From the perspective of both the customer and the PBH contractor the vital part of the agreement is to ensure the uninterrupted operations and reduce the time for which the plane is grounded. The spare which though could have been serviced/refurbished, just to adhere to the assured TAT, the component is replaced with a new one instead of repairing it then and there. Accordingly, the supply of material and spares though could be of material value, is only incidental to the main service. However, this transaction would be viewed quite differently from a legal perspective. Even though the transaction appears to be one of a service, under Indian law, a transaction that involves transfer of either title or possession of goods for a consideration is considered to be a sale of goods liable to VAT. The PBH transaction in its entirety appears to be a sale transaction as the essence is to transfer the property in the serviceable parts/components which is contingent on occurrence of an event, i.e. when parts/components fall unserviceable.
This, however, in not as simple as it may sound. The unique features of PBH contracts bring more complexity to this aspect. In actual practice, a PBH contractor could be handling a fleet of aircrafts which would operate all over India. PBH contractor could also be maintaining multiple warehouses all over India to maintain stock of contracted spares. The replaced serviceable part would be a similar repaired/second hand part and could in case of non availability of repaired/second hand part, a new part. This part becomes the customer's property. On receipt of replaced serviceable parts, customer would dispatch and return the unserviceable parts/components to PBH contractor. The property in the unserviceable parts would get transferred from the customer to the PBH contractor. The unserviceable parts transferred to contractor have significant value and in the absence of such an exchange the fee rate applicable to the contract would go up considerably.
This effectively means that the PBH contractor would receive consideration in two components, i.e. cash consideration on hourly charge rate and the value of unserviceable components. While the VAT is paid on the sale value of the goods, the sale value as per legal provisions includes cash, deferred payments or any other valuable consideration received by the seller of the goods. As per the legal precedents the other valuable consideration could only be something which should be readily convertible in cash. It is worth mentioning here the apex court ruling in Devi Dass Gopal Krishnan and Others v state of Punjab and others [1967 (20) STC 430 (SC)], where the court held that the expression valuable consideration can only mean some other monetary payment in the nature of cash or deferred payment. Since there is no mechanism to assign a monetary value to the unserviceable part, the value of the same could not be included in the consideration for such sale. Having said that it is still possible that the service tax authorities might treat it as a service contract wherein the PBH contractor is providing an assurance 24x7 for maintaining the stock of contracted components, the overall essence of which is to reduce the down-time of an aircraft and the consideration is paid whether or not the component is replaced during the period contracted/billed for. Keeping in with this, it is vital on the part of the contracting parties to give special attention to the documentation aspect of such contracts to give an unambiguous framework to the transaction and to better plan the applicable taxes thereon.
There are some unique features that relate to a typical MRO contract for the airline industry. An MRO contract, which is also recognised by the term "parts by the hour" (PBH) contracts, envisages a list of specified parts/components of the aircrafts which are contracted for replacement with an assurance that such parts/components would be exchanged within a specified TAT (turn-around time) when such part/components become defective/unserviceable on the aircraft.
A PBH contract is usually entered into with the customer of the aircraft at the time of the sale of a new aircraft. The contract envisages a pre-contracted hourly rate for all the parts/components covered in the PBH contract. The consideration is paid by the customer based on number of hours flown by the aircraft i.e. number of flight hours flown during the period contracted multiplied by price per hour. The periodicity of payment of consideration could be monthly or quarterly. Based on the periodical details of flying hours of the aircraft reported by the customer, the PBH invoice is raised. The invoice is raised regardless of whether or not any component has been replaced.
From the perspective of both the customer and the PBH contractor the vital part of the agreement is to ensure the uninterrupted operations and reduce the time for which the plane is grounded. The spare which though could have been serviced/refurbished, just to adhere to the assured TAT, the component is replaced with a new one instead of repairing it then and there. Accordingly, the supply of material and spares though could be of material value, is only incidental to the main service. However, this transaction would be viewed quite differently from a legal perspective. Even though the transaction appears to be one of a service, under Indian law, a transaction that involves transfer of either title or possession of goods for a consideration is considered to be a sale of goods liable to VAT. The PBH transaction in its entirety appears to be a sale transaction as the essence is to transfer the property in the serviceable parts/components which is contingent on occurrence of an event, i.e. when parts/components fall unserviceable.
This, however, in not as simple as it may sound. The unique features of PBH contracts bring more complexity to this aspect. In actual practice, a PBH contractor could be handling a fleet of aircrafts which would operate all over India. PBH contractor could also be maintaining multiple warehouses all over India to maintain stock of contracted spares. The replaced serviceable part would be a similar repaired/second hand part and could in case of non availability of repaired/second hand part, a new part. This part becomes the customer's property. On receipt of replaced serviceable parts, customer would dispatch and return the unserviceable parts/components to PBH contractor. The property in the unserviceable parts would get transferred from the customer to the PBH contractor. The unserviceable parts transferred to contractor have significant value and in the absence of such an exchange the fee rate applicable to the contract would go up considerably.
This effectively means that the PBH contractor would receive consideration in two components, i.e. cash consideration on hourly charge rate and the value of unserviceable components. While the VAT is paid on the sale value of the goods, the sale value as per legal provisions includes cash, deferred payments or any other valuable consideration received by the seller of the goods. As per the legal precedents the other valuable consideration could only be something which should be readily convertible in cash. It is worth mentioning here the apex court ruling in Devi Dass Gopal Krishnan and Others v state of Punjab and others [1967 (20) STC 430 (SC)], where the court held that the expression valuable consideration can only mean some other monetary payment in the nature of cash or deferred payment. Since there is no mechanism to assign a monetary value to the unserviceable part, the value of the same could not be included in the consideration for such sale. Having said that it is still possible that the service tax authorities might treat it as a service contract wherein the PBH contractor is providing an assurance 24x7 for maintaining the stock of contracted components, the overall essence of which is to reduce the down-time of an aircraft and the consideration is paid whether or not the component is replaced during the period contracted/billed for. Keeping in with this, it is vital on the part of the contracting parties to give special attention to the documentation aspect of such contracts to give an unambiguous framework to the transaction and to better plan the applicable taxes thereon.
The author is Leader, Indirect Tax Practice, PwC India pwctls.nd@in.pwc.com
Supported by Tajinder Singh
Supported by Tajinder Singh