Taxability of income of non resident contractors engaged by resident organisations. - Income Tax - 1767/CBDT

INSTRUCTION NO. 1767/CBDT Dated: July 1, 1987 The question of taxability of the income of non-resident contractors engaged by resident organisations like ONGC carrying on the business of Oil exploration and production in India, for the execution of turnkey projects involving work to be carried out in India as well as outside India, for a lump sum consideration, has been examined by the CBDT in consultation with the Ministry of Law. 2. It has been seen that most of the agreements entered into by these non-resident contractors relate to fabrication and installation of various facilities like off-shore platforms and pipelines, terminals, treatment plants on-shore, rigs, etc. for exploration and production of Oil and/or Natural Gas. In these contracts the equipment by way of platform, rig or any other facility is fabricated by the foreign contractor as per specific requirement of the Indian company organisation engaged in such exploration or production. The major part of the work, namely design, engineering, procurement and fabrication is performed abroad by the foreign contractor. In certain cases, ownership in the facilities is also seen to have been transferred abroad. Because of the size and complicated nature of the platform etc., it is fabricated and transported in modules for example jacket, piles, deck, topside equipment modules etc., to the actual off-shore site where these are then installed. The transport and installation of the facilities is at times undertaken by the same contractor who had done the engineering, procurement and fabrication and in certain cases by another enterprises. After installation, the work on hook-up and commissioning is generally done by the fabrication contractor himself because that is invariably an essential part of the satisfactory completion of the contract itself. 3. On these facts, it is clear that income accruing or arising to the non-resident contractor should be apportioned between the various activities carried on by it, some of which would be within India and some outside. Where the ownership in the platform, terminal, treatment plant or other facilities passes outside India, the non-resident will be taxable only in respect of the activities performed in India by way of installation, hook-up and commissioning etc., of the facilities acquired by the Indian enterprises engaged in oil exploration or production. Where, however, the sale has taken place in India, there will be two elements of income that should be brought to tax. One would relate to the proportion of the profits on the entire value of the contract which can be said to be attributable to the activity of the sale itself and the other would be in respect of the activities like installation, hook-up, commissioning etc., actually performed in India as part of the total work contract. 4. The question of determining a reasonable percentage of gross receipts as profits/income was discussed, inter alia, with the Ministry of Petroleum, in the light of the importance of the oil sector to the Indian economy and taking into account the fact that oil industry is now passing through a very difficult period, resulting in idle capacity all round. Taking all these factors into account, it has been decided to adopt 10 per cent of the gross receipts from the contract as the net income of the contractor. It has also been decided that out of the income so computed, 10 per cent (i.e 1% of the gross receipt) would be attributable to the activity of sale itself and that the balance would be attributable to the other manufacturing etc., (i.e. other than sales) activities. 5. On this basis, where the sale takes place outside India, only 10 per cent of the gross receipts in respect of the activities of installation, hook-up, commissioning etc., performed in India will be taxable here. Where, however, the sale takes place within the country, apart from the 10 per cent in respect of gross receipts for activities by way of ;installation etc. performed in India, the income arising from the activity of sale itself will have to be brought to tax. This will be done by estimating the income from such sale at one percent (10% of 10%) of the gross receipts in respect of all activities performed outside India. The activities performed in India are excluded for this purpose because, the entire income from such activities would already have been included as indicated in the preceding sentence. 6. A hypothetical example is given below to clarify the matter. For this purpose it is assumed that the gross payment for fabrication and including installation, commissioning etc. is awarded to a non-resident for a total consideration of $10M. It is further assumed that $ 8 M relates to fabrication etc., done abroad and $ 2 M to work done in India (on or off-shore). In such a case, if the sale is in India, Taxable income will be calculated as under:- I. Income in respect of work done in India-10% of $ 2 M. : $2,00,000 II. Total consideration for work done abroad : $ 8 M Therefore, profit on that at 10 per cent : $0.8 M ($8,00,000) Income attributable to activity of sale in India at 10% of above. : $ 80,000 III. Income assessable in India (I+II) : $2,80,000 If, in this example, the sale is also outside India, only $ 2,00,000 would be taxable in India. 7. Hook-up, commissioning etc. would not amount to rendering of technical services as defined in Explanation 2 to Section 9(1)(vii) of the Income-tax Act 1961. Assessing Officers may, however, examine the contracts and see whether the non-resident contractors have been paid fees for technical services. Fees for technical services, if any, paid under above mentioned contracts will not be covered by the above guidelines. Such fees will be taxable as per the rates specified in the relevant D.T.S. Agreement or in the Income-tax Act. 8. The above guidelines will be applicable to all such contracts for a period of 3 years, beginning from Assessment Year 1987-88 and for earlier assessment years where proceedings are "open" at any stage. 9. These guidelines will be applicable only if the non-resident company agrees to taxation on this basis and does not dispute it in any manner whatsoever. In cases where tax has already been deducted on a different basis, the non-resident company may file a return of income disclosing income calculated on the basis of the guidelines discussed above. In such cases assessment may be completed expeditiously and refund granted. 10. This may be brought to the notice of all officers working in your charge, particularly assessing and appellate authorities dealing with cases of non-residents.