2009 (3) TMI 41 - AAR - Income Tax

Agreement between applicant (Foreign Co.) & Reliance industry for providing services got terminated in mid-way - Held that Engineering and Procurement services rendered fall within scope of royalties as defined in the DTAA and receipts are taxable in India by virtue of Art. XII(2). Under the Act too, they are taxable - However, receipts from Project & Management Services, shall be treated as business income & be taxable only to the extent they are attributable to the operations of PE in India

Issues Involved:
1. Permanent Establishment (PE) in India.
2. Nature of services as 'royalty'.
3. Taxability of receipts under the Double Taxation Avoidance Agreement (DTAA) between India and Australia.
4. Rate of tax applicable to the receipts.

Issue-wise Detailed Analysis:

1. Permanent Establishment (PE) in India:
The applicant, an Australian company, had a fixed place of business in Mumbai at the office of Jacobs Engineering Works, where several technical personnel stayed and worked for substantial periods. The existence of a PE was not disputed, but the effective connection between the PE and the services rendered under the Basic Engineering and Procurement (BE&P) Agreement was in question. The ruling concluded that although the applicant had a PE in India, the services under the BE&P Agreement were primarily performed in Perth, Australia, with no substantial role played by the PE in India. Therefore, the effective connection between the services and the PE was not established.

2. Nature of Services as 'Royalty':
The services provided under the BE&P Agreement, including basic engineering and procurement services, were considered to fall within the definition of 'royalty' under Article XII(3) of the DTAA and section 9(1)(vi) of the Income-tax Act, 1961. Both parties agreed that the receipts constituted 'royalty' income. The ruling emphasized that the services were in the nature of consultancy and technical services ancillary to the supply of scientific and technical knowledge, thus fitting the definition of 'royalty'.

3. Taxability of Receipts under DTAA:
The ruling analyzed Article XII of the DTAA, which allows the State of residence to tax the royalty income but also permits the source State to tax it subject to certain limits. Article XII(4) excludes the application of paragraphs (1) and (2) if the royalties are effectively connected with a PE in the source State, in which case Article VII applies. However, the ruling concluded that the effective connection between the services under the BE&P Agreement and the PE in India was not established. Therefore, the exclusion clause in Article XII(4) did not apply, and the royalty income was taxable under Article XII(2).

4. Rate of Tax:
The ruling determined that the entire receipts under the BE&P Agreement were taxable as royalty income on a gross basis at the rate of 15 percent, as specified in Article XII(2)(b) of the DTAA, which was more beneficial than the rate under section 115A of the Income-tax Act. For the Project Management Services (PMS) Agreement, the receipts were treated as business income attributable to the PE in India and taxable on a net basis at the appropriate rate applicable to business income.

Conclusion:
- The services under the BE&P Agreement were classified as 'royalty' and taxable in India under Article XII(2) of the DTAA at a rate of 15 percent.
- The effective connection between the PE and the services under the BE&P Agreement was not established, so Article XII(4) did not apply.
- The receipts from the PMS Agreement were treated as business income, taxable to the extent attributable to the PE in India, with permissible deductions and the applicable rate for business income.

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