Tax trouble in sales from turnkey projects

Many Indian enterprises are entering into agreements with foreign enterprises for execution of turnkey projects in India which involve designing, manufacturing, sale or supply of the goods and installation, testing, commissioning of the goods so supplied.

The enterprise may enter into separate contracts for the sale and supply of equipment and for installation, commissioning and so on. Or it might sign a composite contract and fix a lump sum price for all the activities.

In the first situation, where separate contracts are entered into ""one contract for designing, manufacturing, sale and other for installation, testing, commissioning or training of employees in India""profit from the contract for sale and supply will not accrue in India if sale of goods takes place outside India.

It should, however, be noted that the sale of goods will be treated as completed outside India only if the risk and property in the goods passes from the seller to the buyer outside India.

If, however, for the offshore supply, consideration is received in India or property in the goods passes in India, a part of the profit as are reasonably attributable to the operations carried out in India will accrue in India and will therefore be taxable in India (Ishikawafima 271 ITR 193 AAR).

As far as the contract for the services in India (for example, installation, commissioning, etc) is concerned, the income from such contract will be deemed to accrue or arise in India, unless the services relating to installation and commissioning are inextricably linked with the sale and supply of the goods.

In situations where a lump-sum price is fixed for all activities, the tax authorities normally contend that the entire profits arising from the contract should be taxed in India because the sale and supply of the equipment as well as its installation is completed in India.

The above issues came up for consideration before the Authority for Advance Rulings in a recent case of Rotem Company, (2005) 279 ITR 165 (AAR). In the case, a consortium of foreign companies entered into an agreement with the Delhi Metro Rail Corporation (DMRC) for the design, manufacture, supply, testing and commissioning of passenger rolling stock, supervision of maintenance and the training of operation and maintenance personnel for corridors.

The issues raised before the authority included whether in terms of contract between DMRC and the consortium, the lumpsum 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.

Or as a corollary to the above question, based on the contract of composite nature in its totality, whether it would be correct to disintegrate the contract and view and tax each of its components individually.

The authority ruled that in a contract for manufacture, installation, sale or supply of goods the element of services will always be present.

Where services are inextricably linked with manufacture, installation, sale or supply, they cannot be evaluated for the purposes of fees for technical services. It is only where services are separable and independent that fees for technical services will be liable for tax.

The authority also observed that following the Supreme Court (Continental Construction Ltd 195 ITR 81) ruling even in composite turn-key contracts apportionment of lump-sum price between the activities relating to sale and those relating to provision of technical services should be made.

agar@nda.vsnl.net.in