Madras HC rules income under time charter arrangement for ships as “royalty”

 

This tax alert summarises a recent ruling of the Madras High Court in the case of Poompuhar Shipping Corporation Ltd. (PSCL) and West Asia Maritime Ltd. (WAML) on the issue of whether hire charge for chartering Indian coastal shipping vessels (ships) for plying within Indian ports under time-charter arrangement (TCA) and bare-boat charter-cum-demise (BBCD) arrangement, with various foreign shipping companies (FSCs), is taxable in India as“royalty”, under the Indian Tax Laws (ITL) as well as under the Double Taxation Avoidance Agreement (DTAA). While determining taxability under TCA and BBCD, the HC dealt with a number of issues, viz., (a) whether a ship qualifies as equipment, (b) whether charges under TCA and BBCD are for the “use” or “right to use” such equipment and, consequently, taxable as royalty, (c) availability of benefit of Article 8 of the DTAA dealing with shipping income, (d) trigger of permanent establishment (PE) for FSCs by virtue of presence of ships in India, (e) whether parallel proceedings, as payer-in-default and representative agent (Agent) against the payer, is permissible under the ITL.

While ruling in favor of the Tax Authority, the HC held that payments under TCA are for the “use” and hire of ships and not for rendition of any service. Further, the ship qualifies as “equipment” for the purposes of “equipment royalty” under the ITL as well as the DTAA and thus, taxable as royalty. FSCs cannot avail the benefit of Article 8 of the DTAA as the ships are not plying in “international traffic” but between two ports in India. Furthermore, operating through FSCs, ships constitute PE and, the income from letting out ships is not effectively connected/attributable to the said PE and could be taxable as royalty on gross basis. The Tax Authority is permitted to initiate parallel proceedings against the payer (a) as a payer-in-default for failure to withhold tax and (b) as an Agent for assessment of FSCs’ taxable income in India as both the proceedings operate in different streams.

Taxability under a time-charter arrangement has been a contentious issue. In a recent decision of the Chennai Tribunal in the case of Poompuhar Shipping Corporation Ltd. (ITA No. 145 to 148/ 2012), it was held that hire charges paid to FSCs, under a time- charter arrangement are towards service and may not be considered as payment for use of equipment and hence, not “royalty”. The HC however, has rejected this ruling and has taken a divergent view on the matter. By observing that the features of the time-charter arrangement were comparable to the arrangement before the SC in the case of Gosalia Shipping P. Ltd., the HC held that the consideration was for the hire of the ship and since a ship is an equipment, TCA charges constitute royalty.

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 DTAA was not available.

The observations of the HC on initiation of parallel proceedings on the Indian payers as (a) payer-in-default, and (b) an Agent, may also merit special attention. In fact, the Chennai Tribunal in the case of Poompuhar Shipping Corporation Ltd, had restored the matter back to the Tax Authority with an instruction to initiate proceedings either as a payer-in-default or as an Agent, but not under both. Such initiation of proceedings would certainly be severe and harsh on the Indian payer. It is therefore, advisable to obtain clarity on withholding requirement before discharging the payments to NRs.