Income from time charter of ship from operations between Indian ports is taxable as royalty
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Income from time charter of ship from operations between Indian ports is taxable as royalty

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Recently, the Madras High Court (the High Court) in the case of Poompuhar Shipping Corporation Ltd. and West Asia Maritime Limited held that the income from time chartering or ‘use of ship’ ...

Recently, the Madras High Court (the High Court) in the case of Poompuhar Shipping Corporation Ltd. and West Asia Maritime Limited held that the income from time chartering or ‘use of ship’ between the ports in India, constitutes royalty under Section 9(1)(vi) of the Income-tax Act, 1961 (the Act) and the relevant tax treaties. The High Court held that as per the inclusive definition in Section 43(3) of the Act, the word 'plant' is widely defined to include a ship and therefore, a ship is equipment of the business of a ship owner.

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     Income from time charter of ship from operations between Indian ports is taxable as royalty Income from time charter of ship from operations between Indian ports is taxable as royalty Document Transcript

    • KPMG FLASH NEWS KPMG IN INDIA Income from time charter of ship from operations between Indian ports is taxable as royalty 11 November 2013 Background Recently, the Madras High Court (the High Court) in the case of Poompuhar Shipping Corporation Ltd. and West 1 Asia Maritime Limited (the taxpayer) held that the income from time chartering or ‘use of ship’ between the ports in India, constitutes royalty under Section 9(1)(vi) of the Income-tax Act, 1961 (the Act) and the relevant tax treaties (tax treaties). The High Court held that as per the inclusive definition in Section 43(3) of the Act, the word 'plant' is widely defined to include a ship and therefore, a ship is equipment of the business of a ship owner. Facts of the case Poompuhar Shipping Corporation Ltd.  The taxpayer was a company owned by Government of Tamil Nadu. The taxpayer was engaged in the business of moving coal from various ports in India to Chennai, Tamil Nadu. Accordingly, the taxpayer entered into time charter agreement (TCA) with the foreign shipping companies (FSCs) having their vessels registered in different countries. ________________ 1  The taxpayer did not deduct tax at source while remitting charter payments (hire charges) to the FSCs.  However, the Assessing Officer (AO) held that the charges paid by the taxpayer was on account of the use and hire of the ship and hence, it was royalty within the meaning of Section 9(1)(vi) of the Income-tax Act, 1961(the Act) and Article 12 of the respective tax treaties (tax treaties). Accordingly, the AO treated the taxpayer as ‘assessee-in-default’ for non-deduction of tax at source while remitting such charges.  Also, the AO held the FSCs were the owners of the ship hired by the taxpayer and there was an element of continuity of activity hence there was business connection between the FSCs and the taxpayer. Poompuhar Shipping Corporation Ltd v. ITO (T.C.(A)Nos.2206 to 2208 of 2006) (Mad HC), West Asia Maritime Limited v. ITO (T.C.(A)Nos.2629 & 2630 of 2006) (Mad HC) © 2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
    •  Further, relying on the case of Gosalia Shipping Pvt. 2 Ltd. the AO held that the payments were assessable as royalty.  The Commissioner of Income Tax (Appeals) [CIT(A)] upheld the AO’s order.  Relying on the various case laws , the Madras Bench of Income-tax Appellate Tribunal (the tribunal) upheld the order of the AO. Further, the Tribunal held that although the taxpayer could not be treated as a ‘representative assessee’ under Section 160 of the Act, it was liable to deduct tax on such payments made, as per Section 195 of the Act.  Whether transporting goods between Indian ports amounts to operation of ships in international traffic and therefore eligible to benefit under Article 8 of the tax treaty?  Whether PE existed for the FSCs in India to whom PSC made payments for the hire charges? 3 West Asia Maritime Ltd.  West Asia Maritime Ltd. (WAM), a public limited company was engaged in shipping business and during the relevant year made payments to Dolphin Maritime Co. Ltd. (DMCL), an associated enterprise based in Cyprus, towards hire charges under a bare boat chartercum-demise (BBCD) for use of its ship.  The AO held that hire payments by the taxpayer therein was 'royalty' for the use of equipment (i.e. ship) without deducting TDS under Section 195 of the Act. WAM could exercise its option to purchase the ship at the end of each year however it had not done so. Accordingly, the payment made for the years under consideration was to be taken as for hire charges, taxable under Article 12 of the tax treaty. These payments were in the nature of hire charges and not towards a purchase transaction, therefore, it was consideration for use of equipment amounting to royalty.  The AO also held that as the ship was put to use on the coastal line between Ports in India by the hirer, namely, PSC, Article 8 of the tax treaty would not be of any application.  The CIT(A) held that payments made to DMCL for hire charges being royalty would be covered by Article 12 of the India-Cyprus tax treaty. The Tribunal confirmed the order of the CIT(A). Issues before the High Court  Whether simultaneous proceeding could be initiated to make assessment on taxpayer in the capacity of a ‘representative assessee’ and also treat him as ‘assessee-in-default’? West Asia Maritime Ltd.  Whether ‘use of ship’ constitutes ‘use of equipment’ for determining royalty under the Act and the tax treaty?  Whether payments made by WAM under the BBCD constituted capital expenditure since the BBCD was an approved method of acquiring ships? Taxpayer’s contentions Poompuhar Shipping Corporation  There is no definition on the expression 'equipment' under the Merchant Shipping Act hence the expression 'equipment' cannot be strained to include ship. Placing reliance on the case of Essar 4 Shipping Ltd. , PSC contended that there being no possession transferred to the hirer, the payments under the time charter cannot be treated for the use or right to use the ship as equipment.  Referring to the commentaries on the UN and OECD model, the taxpayer submitted that payment under time charter party or voyage charter party or for liner services is more in the nature of a payment for services and hence, cannot be construed as royalties.  When the payment is not royalty, then it could, be only 'business profits' falling under Article 7 of the tax treaty and unless the taxpayer has a PE linked to the earning of profit, such income cannot be taxed in India. Poompuhar Shipping Corporation  Whether payments to FSCs are for ‘use of equipment (i.e. ship)’ and therefore royalty under the Act and the tax treaties? ________________ 2 Union of India v. Gosalia Shipping Pvt. Ltd. [1978] 113 ITR 307 (SC) 3 West Asia Maritime Ltd., v. ITO (ITA Nos. 2376 and 2377/Mds/2005 dated 19 May 2006), Transmission Corporation of A.P. Ltd. and another v. CIT [1991] 105 Taxman 742 (SC) ______________ 4 State of Tamil Nadu v. Essar Shipping Ltd. [2012] 47 VST 209 (Mad) © 2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
    • West Asia Maritime Ltd  'Equipment' referred to in clause (iva) to Explanation 2 of Section 9(1)(vi) of the Act, read in the context of other clauses in the said Explanation, must be read as having relevance to those special equipment relating to intellectual property rights, which are of industrial, commercial and scientific nature. Accordingly, not every kind of transaction, 'equipment', for use or right to use, is covered by clause (iva) of Explanation 2.  The case of the taxpayer falls under Article 8 of the tax treaty and not under Article 12 of the tax treaty relating to royalty, since 'royalty', even as per Clause (iva) of Explanation 2, applies to use or right to use of scientific, commercial or industrial equipment.  The policies of Ministry of Finance and Ministry of Surface Transport govern the purchase of a ship under BBCD and the agreement was a means for acquiring the ship and not for hiring the ship simpliciter. Tax department’s contentions Poompuhar Shipping Corporation Ltd  As per the Act, the income from the traffic within India is taxable even though the effective management may be outside. When the ships are operated between the places in India, the transaction does not fall within the meaning of 'international traffic' to be covered under Article 8 of the tax treaty.  As per Article 12 of the tax treaty, the definition of 'royalty' included receipts arising from use or right to use of industrial, commercial and scientific equipment. Thus, lease income receipts were included under royalty.  Referring to the text by Klaus Vogel, tax department submitted that wherever the term 'equipment' is used, payment is treated as 'royalty' only and there is no difference between the tax treaty and the Act for treatment on royalty.  Time charter being one for usage of ship and the consideration is for the right to use the ship, the transaction would fall within the ambit of 'use' under Clause (iva) of Explanation 2 to Section 9(1)(vi) of the Act, and similar language is also found in Article 12 of the tax treaty.  Based on the provisions of Tamil Nadu General Sales Tax Act and Service Tax under the Finance Act, 1996, the tax department contended that transfer of right to use and supply of tangible goods for use without transferring the right of possession and effective control respectively could be treated as royalty.  Based on various decisions dealing with cases under Section 172 (Shipping business of non-residents) of the Act, the tax department contended that where the facts are covered by charter agreements, the payment are not for freight but for the use of the ship, the receipts would fall under the scope of royalty. 5  The mechanism on TDS is a facility for recovery and at that stage the question of that person being treated as an agent of the recipient does not arise. The question as to whether a person could be assessed in a representative capacity is a stage arising after the deduction stage contemplated under Section 195 of the Act. Thus, the provisions in relation to assessment in representative capacity and withholding tax operate on different fields and they are not in conflict.  The relationship is not of an occasional one but of a continuous nature, the regularity of the activity and the intimate connection between the non-resident and Indian business for earning global income resulting in profit in India by the existence of the time charter agreement results in a business connection in India.  Referring to Article 5 in OECD commentary and IndiaAustralia tax treaty, as given under a PE, a place of business includes facilities. Accordingly, a Port used by every person is also a place of business, there need not be any exclusive usage of the space by the foreign enterprise to constitute a PE. West Asia Maritime Ltd  The deferred payments made were in the nature of lease rentals and not towards deferred consideration. Further, similar contentions were made in the present case by the tax department as made in the case of PSC. High Court’s ruling  TCA shows that the charterers have the liberty to sublet the vessel for all or any part of the time covered by the charter. The charterers shall pay for the use and hire of the vessel at the rate of US Dollars per day.  According to the TCA, the whole reach of the Vessel's hold, docks and usual places of loading shall be at the charterer's disposal. Also, the Captain shall be under the direction of the charterer as regards the employment and agency. ________________ 5 Union of India v. Gosalia Shipping Pvt. Ltd. [1978] 113 ITR 307 (SC), CIT v. Hongkong Oceans Shipping [1999] 238 ITR 955 (Mad), CIT v. Taiyo Gyogyo Kabushiki Kaisha [2000] 244 ITR 177 (Ker) © 2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
    •  In the case of Gosalia Shipping P. Ltd., the Supreme Court based on the similar type of TCA held that the payment by time charterers to the owners of the ship was not one payable on account of the carriage of goods, but was payable on account of the use and hire of the ship. Ship is equipment  Section 43(3) of the Act defines ‘plant’ to include ships, vehicles, books, scientific apparatus and surgical equipment used for the purposes of the business or profession. Based on the inclusive definition in Section 43(3) of the Act, the word 'plant' is widely defined to include a ship.  In the context of Section 9(1)(vi) of the Act, the presence of the word 'any' preceding an equipment, clearly points out the need for construing 'equipment' widely, so as to embrace every article employed by the employer for the purposes of his business. 'Equipment', so long as they are employed for the purposes of one's income, the same shall stand covered by Clause (iva) to that Section. Accordingly, a ship is equipment of the business of a ship owner.  The ship was sold in January 2005 and till that time, it was a bare boat charter which as per Section 115V(a) of the Act means hiring of ship for a stipulated period on terms which give the charterer the possession and control of the ship, including the right to appoint the master and crew.  Accordingly, with possession and custody with the hirer, the consideration paid for the use of the same is liable to be treated as 'royalty'. Operations were not carried out in international traffic  According to Article 8 of the tax treaty, profits from the operation of ship engaged in international traffic shall be taxable only in the Contracting State, in which, the place of effective management of the enterprise is situated except when the ship is operated solely between places in the other Contracting State.  Based on the model tax commentary, the definition on international traffic in the tax treaty and the BBCD, the taxpayer fails in the test on international traffic and therefore, the receipt are taxable in India. Hire charges under TCA amounted to royalty FSCs had a PE in India  Under the Act and the tax treaties, royalty means consideration that is paid for ‘use’ or ‘right to use’.  So long as the taxpayer is given the right to its usage (with a right to put it into beneficial use for itself or to keep it idle, the right to sublet) and the lessee has access to the use of the Vessel to its advantage economically, the consideration paid would be 'royalty'.  In the present case, the hiring was not an occasional feature and the hiring was for a continuous period solely at the disposal of the taxpayer for the entire period of hire.  The taxpayer, as per the TCA, had the right to use the ship, selecting the time and the decided route as per its requirement, for which it paid the FSCs, the consideration and therefore the character of payment is royalty.  The moving ship has a place of business in the place where the ship is docked and the fact that the ship moved from one point to another is the result of the nature of business contract. Also, the ship movement is an integrated one having business and geographical coherence. Accordingly, the foreign enterprise has the place of PE in India.  The foreign enterprise thus satisfying the presence of a PE but the character of the receipt was not being attributed as the income earned from the PE. Accordingly, the receipts to be assessable as business profits earned by its participation in the economic benefit of India, the income could not be brought under Article 7 of the tax treaty to be assessed as business income.  Even though the berth is a PE of the foreign enterprise yet the royalties paid not being effectively connected with or attributed to such PE, the payment would fall for consideration only under Article 12 and not under Article 7 of the tax treaty. Hire charges under BBCD amounted to royalty  As per Section 115V(b) of the Act, ‘bare boat chartercum-demise’ means a bareboat charter where the ownership of the ship is intended to be transferred after a specified period to the company to whom it has been chartered.  In the present case, the parties agreed for payment for hire of the ship and the agreement reserved the right of the taxpayer to purchase the ship at the end of the contract period or even prior to that date subject to the ballooning payment, which gets reduced as the year roll. © 2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
    • Simultaneous proceedings can be initiated under 163 and 201 of the Act  Section 160 of the Act is a procedural and enabling Section for the determination of the quantum of income of the non-resident assessee and the tax to be demanded. As per Section 201 and 201A of the Act, the amount payable to the non-resident was exigible to tax and tax was not duly deducted on the same hence the taxpayer was an ‘assessee-indefault’.  The proceedings under Section 201 and 201A of the Act has nothing to do with the status of the taxpayer as an agent under Section 160 and 163 which would assume significance only for assessment purposes.  Section 195 of the Act casts an obligation on TDS on any person responsible for paying, whereas Section 163 of the Act is for assessment purposes. Accordingly, proceedings under Sections 163 and 201 of the Act can be simultaneously initiated since they operate on different spheres. Our comments Taxability of payment under a TCA has been a matter of debate before the Courts. In this decision, the High Court held that the features of the TCA (which is based on standard format approved by the New York Produce Exchange and referring to the term ‘use and hire of vessel’) were comparable to the arrangement before the Supreme Court in the case of Gosalia Shipping P. Ltd. The consideration was for the hire of the ship and since a ship is equipment, TCA charges constitute royalty. The decision would have similar implications in respect of the TCA drawn on the basis of aforesaid standard format. The courts have thus considered the terms of the TCA to interpret the actual arrangement with the parties though in substance a TCA could be purely a contract of service for transportation of goods. It is therefore essential to refer to the actual terms used in the agreement to indicate the real purport of the agreement based on the decision in this ruling. This ruling would not apply to cases where TCA is in respect of ships plying in international traffic. Since the ships, in the present case, were plying along the Indian coastal line and not in international traffic, the benefit of the shipping article of the tax treaty was not available. © 2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
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