Thursday 20 December 2012

Income of non-residents engaged in providing geophysical services to oil and gas exploration industry is entitled to taxation on a deemed profit basis under section 44BB of the Income-tax Act


The Delhi High Court has affirmed that the income of non-residents engaged in the business of providing geophysical services to oil and gas exploration industry is taxable as per the provisions of section 44BB of the Income-tax Act, 1961 (“Act”).  Thereupon, the Delhi High Court has dismissed the writ petition filed by the Revenue Authorities.  The Revenue Authorities had filed a writ against the ruling of the Authority for Advance Rulings (“AAR”) in the case of DIT-II vs OHM Limited.

Framework for taxation of non-resident oilfield service providers in India and related controversy

Section 44BB of the Act provides for taxation of non-residents engaged, inter alia, in the business of providing services or facilities in connection with prospecting for, extraction and production of mineral oil, on a deemed profit basis of 10 percent on the gross revenues.  Therefore, based on the prevailing corporate tax rate of 40 percent for non-residents, the effective rate for taxation under the provisions of section 44BB is 4 percent (plus applicable surcharge and education cess) on the gross revenues.  Section 44BB carves an exception that where the consideration is chargeable to tax as fee for technical services (“FTS”) (under section 115A or section 44DA of the Act), the provisions of section 44BB will not apply.
 
Section 115A prescribes the computation mechanism for taxing income as FTS at the rate of 10 percent (plus applicable surcharge and education cess) on a gross basis in the absence of a Permanent Establishment (“PE”) of the assessee in India.  In case the FTS is effectively connected to a PE of the assessee in India, such income is taxable on a net basis (ie, revenues less expense) at the rate of 40 percent (plus applicable surcharge and education cess).  Section 44DA was inserted as exclusion to section 44BB from April 1, 2010 onwards with a corresponding amendment in section 44DA as well.  This basically implied that provisions of section 44BB and section 44DA are mutually exclusive. 

The term ‘FTS’ is defined under Explanation 2 to section 9(1)(vii) of the Act and it specifically excludes from its scope ‘the consideration payable for any construction, assembly, mining or like project.
   
For two decades from 1987, the Revenue Authorities as well as the judiciary in India have accepted the position that drilling and oilfield services such as seismic and geological surveys, drilling, well completion, well logging, formation testing, cementing, fracturing etc would fall within the purview of section 44BB of the Act.  Over the last few years (from 2007 onwards), the Revenue Authorities have deviated from the above settled position and sought to deny taxation on deemed profit basis to the oilfield service providers by holding the income earned by them to be in the nature of FTS. 

Relevant facts

·                OHM Limited (“taxpayer”), a company incorporated under the laws of United Kingdom was engaged in the business of providing geophysical services to oil and gas exploration industry.  It conducted electromagnetic survey, processing and interpretation of data and such data was used in offshore oil industry. 

·                The taxpayer was awarded contracts by two companies namely Petro Gas E&P LLC and CGGVeritas Services SA for procuring data, processing and interpreting the data in respect of offshore exploration in India.  The taxpayer was also paid for mobilization and demobilization of its vessels from the site area and for providing services in connection with the prospecting for extraction or production of mineral oils.

·                The taxpayer sought lower withholding tax order from the concerned tax officer under the provisions of section 44BB of the Act (at the effective tax rate of 4.223 percent).  The claim of the taxpayer was rejected, and the order was issued determining the tax withholding at the rate of 10 percent (plus applicable surcharge and cess) on a gross basis.

·                Aggrieved by the said order, the taxpayer applied to the AAR for determining its entitlement under section 44BB of the Act.  The AAR held that the income received by the taxpayer under the contracts would be taxable on a deemed profit basis under section 44BB of the Act.

·                The Revenue Authorities, challenged the ruling of the AAR by filing a writ petition before the Delhi High Court.

Revenue’s contentions

The AAR had erred in holding that the income earned by the taxpayer from providing geophysical services is taxable on a deemed profit basis under section 44BB of the Act without appreciating that such income qualifies as FTS and is to be taxed on a net income basis (under the provisions of section 44DA of the Act). 

Taxpayer’s contentions

·                Geophysical services are directly related to and are part of the exploration / processing activities of mineral oil.  Therefore, the income from such services, being rendered in connection with exploration, extraction and production of mineral oil would be taxable on a deemed profit basis as per section 44BB of the Act. 

·                Provisions of section 44BB (‘special provisions for computing the profits and gains in connection with business of exploration etc of mineral oils’) being more specific vis-à-vis section 44DA of the Act (‘special provisions for computing income by way of royalty etc in case of non-residents’) would be applicable. 

Decision of the Delhi High Court

The Delhi High Court affirmed the ruling of the AAR and held that the income of the taxpayer from providing geophysical services to oil and gas exploration industry should be taxed on a deemed profit basis under section 44BB of the Act.  It further held that section 44BB is a specific section governing the taxability of non-residents engaged in the providing services / facilities in connection with prospecting for, extraction and production of mineral oil and would continue to apply even after exclusion of section 44DA from section 44BB of the Act.

The relevant observations of the High Court are as under:

·                The rule that specific provisions would exclude general provisions as expressed by the maxim Generallia specialibus non derogant’ should be applied in the present fact pattern.  Basis this rule, the provisions of section 44BB being more specific and special to the case of taxpayer and covering the activities rendered by it would prevail over provisions of section 44DA, which is broader and more general in nature and provides for assessment of income of the
non-residents by way of royalty or FTS where such non-resident carry on business in India through a PE. 

·                When in an enactment, two provisions exist, which cannot be reconciled with each other, these should be so interpreted, that if possible, effect should be given to both.  Accordingly, if it was held that section 44DA of the Act covers all types of services rendered by the non-resident, then it would reduce section 44BB to a dead letter and such a result would be opposed to the very essence of the rule of harmonious construction.

·                The careful reading of both the provisions of section 44BB and 44DA of the Act indicates that these refer only to different modes / methods of the computation of profits.  It provides that as per the proviso to section 44BB of the Act, the deemed profit basis of 10 percent would be available only on specific services covered therein and not on the services which are general in nature so as to fall under section 44DA.  Similarly, where the services are general in nature and fall under provisions of section 44DA, the provisions of section 44BB would not be applicable.  

·                The amendments made by the Finance Act, 2010 applicable from the financial year beginning April 1, 2010 in both the sections have been made only to clarify the above position and such amendment would not have the effect of altering or effacing the fundamental nature of either of the provisions or their respective spheres of operation or to take away the separate identity of section 44BB.

In arriving at the said conclusion, the Delhi High Court relied on the principles emerging from the decision of its Coordinate Bench in the case of Jindal Drilling and Industries Limited[1] and the ruling of the AAR in the case of Geofizyka Torun Sp Zo.o[2] . 

In the case of Geofizyka Torun Sp Zo.o, the applicant, a foreign company was engaged in the business of providing geophysical services to international oil and gas industry.  It conducted seismic surveys and provided on-shore seismic data acquisition and other associated services such as processing and interpretation of such data to global and oil companies.  It sought a ruling from AAR on whether the income earned by it from rendering the said services was covered under the provisions of section 44BB of the Act.  The AAR appreciated the specific application of section 44BB of the Act in the case of applicant and observed as under:

·                Section 44BB is a special, specific and exclusive provision dealing with the computation of profits of the non-residents engaged in the business of providing services in connection with or supplying plant and machinery on hire to be used ‘in the prospecting for, or extraction or production of mineral oils’.

·                Profits arising from the business specified in section 44BB may also fall within the ambit of FTS [as per section 9(1)(vii) of the Act read with section 44DA of the Act].  However, section 44BB being a more specific provision should prevail for the purposes of computation.

·                The rendering of technical services through a PE in India may be the common feature under section 44DA as well as section 44BB, however, the application of relevant section must be determined based on the nature of business of the non-resident assessee.  Thus, if the income received by a non-resident is for the technical services provided in relation to prospecting and extraction of mineral oil, the same should be governed by section 44BB of the Act.

·                Adoption of an interpretation that all the services, being in the nature of technical services within the meaning of Explanation 2 to section 9(1)(vii) of the Act, are to be computed in accordance with section 44DA of the Act would unduly curtail the scope and content of special provision in section 44BB for computing the profits in relation to the services connected with exploration and extraction of mineral oils. 

In the case of Jindal Drilling and Industries Limited, the question was whether the income earned by a non-resident from the services of transportation and jacking up of rigs, review of design and issuance of suitability certificate to a resident company, would be subject to tax withholding as FTS or on a deemed profit basis under section 44BB of the Act.  The Revenue Authorities treated the income as FTS, while the assessee claimed the application of provisions of section 44BB of the Act on the payments. 

The Coordinate Bench of the Delhi High Court, affirming the decision of the Income tax Appellate Tribunal (“Tribunal”), observed as under:

·                The nature of services rendered by the non-resident at the off-shore rigs of the assessee were part and parcel of the activities engaged in by the assessee itself for exploration, prospecting and production of mineral oil from the sea bed.

·                These services, specifically the movement of rigs from one place to another was a very cumbersome exercise requiring technical expertise and involved various processes and therefore, were provided in connection with the exploration or prospecting or production of mineral oil. 

·                Further, such services are specifically excluded from the definition of FTS, as being in nature of ‘consideration for any construction, assembly, mining or like project undertaken by the recipient’.  Accordingly, the income received by the non-resident would be covered within the ambit of provisions of section 44BB of the Act. 

DIT - II vs OHM Limited (Writ petition 6830/2011)

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