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GLOBAL SERVICE/ INDUSTRY TAX EPC Contracts – Evolution of judicial interpretations Sudhir Kapadia, Executive Director & Head of Tax November 19, 2007

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Page 1: Epc Contracts

GLOBAL SERVICE/ INDUSTRY

TAX

EPC Contracts – Evolution of judicial interpretations

Sudhir Kapadia, Executive Director & Head of TaxNovember 19, 2007

Page 2: Epc Contracts

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OverviewOverview

Features of EPC contracts

Key tax rulings

Way Ahead

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Features of EPC contracts

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EPC – Key AspectsEPC – Key Aspects

Activities envisaged under Activities envisaged under a typical EPC contracta typical EPC contract

Classification of Classification of revenue streamsrevenue streams

Onshore installation Onshore installation Services - skilledServices - skilled

Onshore installation Onshore installation Services - unskilledServices - unskilled

Onshore supplyOnshore supply

Offshore design, project Offshore design, project management and controlmanagement and control

Offshore suppliesOffshore supplies Offshore suppliesOffshore supplies

Offshore servicesOffshore services

Onshore suppliesOnshore supplies

Local servicesLocal services

Onshore technicalOnshore technical servicesservices

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EPC – Key Parameters Impacting TaxabilityEPC – Key Parameters Impacting Taxability

Income Tax

Divisibility & allocation of consideration Tax residential status

Nature & categorization of scope of workDuration of services

Situs of services

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CommercialCommercial imperatives imperatives

not to be not to be compromisedcompromised

Objectives of Contract StructuringObjectives of Contract Structuring

Efficient contract structuring options need to be analysed to optimize taxes in light of the significant tax inefficiencies arising from a single consolidated contract for the entire work and lump sum price.

Ease of Ease of implementationimplementation• minimizing minimizing exposuresexposures• avoiding avoiding litigationlitigation

Certainty in Certainty in tax impacttax impact• definite taxabledefinite taxable basebase• responsibility to responsibility to pay tax pay tax • factor factor ‘ ‘change in law’change in law’

Optimization of Optimization of taxestaxes• minimization minimization of taxesof taxes• ensure ensure availability availability of all of all concessions/ concessions/ exemptionsexemptions

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EPC – Contract StructuresEPC – Contract Structures

Contract structures

Single Contract- Exposes entire

contract revenues to tax

Sub-Contracts- All parties are taxable

Multiple Contracts- Optimizes taxes

and facilitates planning avenues

Consortium Contracts

- Exposure to AOP if not

structured appropriately

- CBDT instruction 1829

supports non-AOP view

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CBDT I No 1829 - Taxability of non-residents engaged in CBDT I No 1829 - Taxability of non-residents engaged in the execution of power projects on turnkey basisthe execution of power projects on turnkey basis

Consortium of foreign companies (‘FCos’) - Separate agreements for:

Sale of equipments/materials on FOB outside India – not deemed to accrue or arise in India

Planning, design, engineering services – taxable as FTS

Civil works contracts executed in India – taxable under Section 44BBB

Status of FCos – Association of persons (‘AOP’) not constituted if:

Overall performance agreement (‘OPA’) for ensuring guaranteed performance

No payment made under the OPA

All entities of FCos treated as separate entity

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Key Tax Rulings

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AAR - (228 ITR 487) Aug 1995AAR - (228 ITR 487) Aug 1995

Agreement Activities

Umbrella Services Agreement (USA)Umbrella Services Agreement (USA) -*-*

License and Basic Engineering Agreement (LBEA)License and Basic Engineering Agreement (LBEA) OffshoreOffshore

Engineering Services Agreement (ESA)Engineering Services Agreement (ESA) Onshore/ OffshoreOnshore/ Offshore

Equipment Supply Agreement (SA)Equipment Supply Agreement (SA) OffshoreOffshore

Buying Services Agreement (BSA)Buying Services Agreement (BSA) Onshore/ offshoreOnshore/ offshore

Site Services and Assistance Agreement (SSA)Site Services and Assistance Agreement (SSA) OnshoreOnshore

Project Management Services Agreement (MSA)Project Management Services Agreement (MSA) Onshore/ OffshoreOnshore/ Offshore

*No consideration provided

Facts

French Co to provide complete project services on a single point under an Umbrella Agreement (ie separate onshore and offshore agreement for each scope of work)

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Held - Offshore Services - Not taxable

PE in India has an ‘undoubted voice’ over the offshore activities and hence effectively connected with the PE - Not taxable as Royalty/FTS

Not taxable as business profits as per Para 3 of the Protocol - activities effectively connected with the business of the PE in India carried outside India are not liable to tax in India

Taxability of Onshore Services

Effectively connected to the PE in India – taxable as business income

AAR - (228 ITR 487) Aug 1995 (contd…)AAR - (228 ITR 487) Aug 1995 (contd…)

Key Observation-Multiple contract not artificial - required due to complexity of large infrastructure projects

- Even if regarded as a single contract - only profits attributable to the operations carried out in India would be taxable.

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DCIT v. Roxon 291 ITR 275 (Mumbai ITAT) DCIT v. Roxon 291 ITR 275 (Mumbai ITAT) Aug 2006Aug 2006

Facts

FCo supplied equipment under a composite contract for a turnkey project

Employees sent for erection, commission and training

PE of the FCo procured local equipment and rendered services in India

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DCIT v. Roxon 291 ITR 275 (Mumbai ITAT) DCIT v. Roxon 291 ITR 275 (Mumbai ITAT) Aug 2006 Aug 2006 (contd…) (contd…)

Held

Payment for supply of equipment not taxable in India

Installation PE comes into existence after the equipment was supplied

Even if found supplies integral to activities of the PE no attribution to PE unless supplies are not at arm’s length price

Force of attraction rule not applicable since same or similar activities not carried out through the PE

SNC Lavalin/Acres Inc. (Delhi ITAT) – On differing facts Force of Attraction applied based on provisions of the India- Canada treaty

- entire composite contract receipts to tax

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• Consortium with 5 other enterprises (composite contracts)• Role, responsibility and consideration of each specified

Japan

India

IHHI

Petronet LNG Ltd.

Ishikawajima Harima Heavy Industries Ltd. (IHHI) v. DIT 288 ITR 408 (SC) Jan 2007Ishikawajima Harima Heavy Industries Ltd. (IHHI) v. DIT 288 ITR 408 (SC) Jan 2007

Offshore supply & offshore services – not taxable

Contract signed in IndiaOnshore supply, onshore services

and construction and erection -- taxability not

in dispute

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Turnkey Project need not mean entire contract is integrated and taxable in India

Rotem (AAR) – Composite contracts can be segregated

Merely signing of contract in India - entire contract not taxable in India

Sutron (AAR) – signing of contract in India triggered taxability

Offshore supplies not taxable – not attributable to Indian operations

Services inextricably linked to offshore supplies – part of supply and not taxable in India

Rotem (AAR) and Sundwiger (AP HC) – similar principle applied

IHHI - Key ObservationsIHHI - Key Observations

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Offshore services not taxable under the Act and Treaty

Not FTS under 9(1)(vii) as services rendered outside India Doctrine of territorial nexus applied – services to be rendered and utilised in India under the Act

Not taxable as Royalty / FTS since a PE was constituted

Not attributable to the PE under the treaty – activities performed outside India - hence not taxable as business income

IHHI - Key ObservationsIHHI - Key Observations

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Amendment to section 9(1)(v)(vi)(vii) - concept of ‘live link’ or ‘territorial nexus’ overruled?

Ruling confined to Section 9(1)(vii)(c) of the Act or applies to payments made by a resident to a non-resident for services rendered outside India?

Other services – IHHI still good in law?

IHHI - Key Issues IHHI - Key Issues

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CIT(A) v. Hyundai Heavy Ind Co Ltd CIT(A) v. Hyundai Heavy Ind Co Ltd 291 ITR 482291 ITR 482 (SC) May 2007(SC) May 2007

Facts in brief

Single contract for lumpsum value - divisible into two parts

designing and fabrication of platform

installation and commissioning of platform

Installation and commissioning lasted for less than nine months

Fabricated platform handed over outside India prior to emergence of installation PE

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CIT(A) v. Hyundai Heavy Ind Co Ltd CIT(A) v. Hyundai Heavy Ind Co Ltd 291 ITR 482291 ITR 482 (SC) May 2007 (SC) May 2007 (contd…)(contd…)

Held

Profits to be ascertained by making an artificial division between profits earned in India and profits earned outside India

Payment for fabrication of equipments not taxable in India

Installation PE comes into existence only on installation of fabricated platforms

Even if found supplies integral to activities of the PE no attribution to PE unless supplies are not at arm’s length price

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Ansaldo Energia SPA v. ADIT (ITAT, Chennai) Ansaldo Energia SPA v. ADIT (ITAT, Chennai) July 2007July 2007

Facts Single bid offered by FCo in response to request for a single bid for setting up two thermal plants

Subsequently contract split between FCo and Indian subsidiary (‘ICo’) into –

Contract I & II - Off-shore supply and onshore services (FCo)

Contract III & IV - Onshore supply and services (contracted to ICo of FCo at its request)

ICo not equipped with requisite experience, manpower, finance

All the liabilities/ responsibilities with FCo

Common managers and premises used by FCo and sub

FCo gave discounts for Contracts III & IV

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HeldCorporate veil lifted in absence of substanceReliance placed by FCo on Circular 1829 and Ishikawajima SC disregarded Contracts I & IV treated as a composite contract and fully taxableOffshore supply of equipment to the extent carried out in India (fabrication) connected to the PE in India and taxable in India

Ansaldo Energia SPA v. ADIT (ITAT, Chennai) Ansaldo Energia SPA v. ADIT (ITAT, Chennai) July 2007 July 2007 (contd…) (contd…)

Form v. SubstanceTerms of the contract, Conduct of the parties and

Circumstances of the case are critical for building substance

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Way ahead…

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Way ahead – Structuring contracts Way ahead – Structuring contracts

Execute separate contracts

Project OwnerProject Owner

PerformancePerformance guarantee guarantee agreement agreement

BetweenBetween Project Owner Project Owner and Contractorand Contractor

Offshore supply Offshore supply

Offshore servicesOffshore services

Onshore supply Onshore supply

Onshore servicesOnshore services- unskilled - unskilled

Onshore services Onshore services – – skilledskilled

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Way ahead Way ahead (contd...) (contd...)

Scope of work to be clearly identified under each contract

Obligation for executing the contract specific to the scope of work under each contract

Supply of equipment from outside of India, no activities to be performed in India

Entities executing independent contracts to substantiate substance

Overall performance guarantee agreement be entered into with the Project Owner

Consortium agreements to regulate rights and obligations of each member

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Thank you!

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Presenter’s contact details

Name: Sudhir Kapadia

KPMG India Private Limited

Phone number: +91 (22) 3983 5700

Email: [email protected]

www.in.kpmg.com

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

© 2007 KPMG India Private Limited, an Indian private limited company and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.