The Hindu Business Line : All about telecom and tax

MOTOROLA, Ericsson and Nokia were on one side, and the taxman was on the other, in a case that a Special Bench of the Delhi ITAT (Income Tax Appellate Tribunal) decided recently.

The question before Vimal Gandhi, R.V. Easwar, and Pradeep Parikh of the Bench was whether the revenues earned by the companies from the supply of equipment and software to Indian telecom operators were taxable in India?

The Department's counsel G.C. Sharma submitted that what the cellular operators wanted under the agreements was to set up GSM Cellular Exchange in the site approved by the Department of Telecommunications (DOT).

"The cellular operator is not interested in the hardware alone or in the software alone. He is interested in the system as a whole and not merely the system in the abstract, but a system that is properly installed by the installation contractor," he said.

Looking at agreements entered into by the mobile biggies, Sharma said the supply contract, installation contract and business promotion agreement have all to be read together. "If so read, the conclusion would be inescapable that all of them are inseparable, intertwined and impinge on each other, with the result that they have to be viewed as one integrated whole, which in turn would mean that the whole object of the parties is to execute a works contract and it is not a case of a mere sale of goods," informs the text of Tribunal's ruling, citing the argument of the Department.

Sharma argued that by disintegrating the entire works contract into three separate agreements, the parties have attempted to evade tax, which then allows the Department to `lift the veil of the transaction' using the McDowell precedent and "thwart the object of the parties in splitting a single transaction into three parts".

He pointed out that the overall agreement was a tripartite agreement entered into on the same day as the other three agreements between the assessee, the cellular operators and the installation contractor, as if to prove the point that all the transactions constituted a single integrated transaction.

Another point contended by the Department was that the connection between Indian cellular operators and the mobile phone companies constituted a business connection, and that the link was the purchase of GSM Cellular system.

If the activity that produces income is located in India, and the source of income is also in India, then income for the non-resident assessees accrues or arises also in India, "where the contract was signed on July 2, 1996", said Sharma.

The order cites interesting discussions of `permanent establishment' and DTAA, i.e. double taxation avoidance agreement, though many may find it too taxing to wade through a text that runs to almost 98,000 words in about a thousand paragraphs, all making up a chunky 5.6 lakh bytes.

Speaking for Ericsson Radio Systems, Sohrab E. Dastur said that it was factually incorrect to say that there was a contract between the company and the Indian cellular operators for installation. There was no agreement at all between Ericsson and the cellular operator for installation, he said. "The agreement with the cellular operator was only for the supply of the system."

He clarified that the Ericsson Radio Systems AB (or ERA) is a subsidiary of a Swedish Company called LME, and that another subsidiary of LME, viz. Ericsson Telephone Corpn India AB (EFC) had a branch in India till June 1996, with which ERA had marketing agreements for three months. "There is another Indian company known as Ericsson Communications Ltd (ECI for short) which acted as marketing and installation contractor for nine months. This company is also stated to be a subsidiary of LME."

Dastur said that the installation contract was between ECI and the cellular operators, and both EFC and ECI were assessed to tax in India for the income earned by them, respectively, from the marketing and installation contracts.

He said that ERA had entered into supply contracts with cellular operators in India, for the sale of hardware and software. For instance, as per the contract with JT Mobiles (cellular operator), ERA was to supply hardware and software for a total consideration of $15.5 million.

Among the various clauses of the supply contract, Dastur drew the Tribunal's attention to Clause 13. It showed that the title and risk in the GSM system was to pass outside India at Sweden when they were delivered to the carrier at Swedish Port. Dastur also explained that the Project Manager referred to in the supply contract was situated outside India and the Project Manager referred to in the installation contract was to be at the site in India.

Citing other clauses such as those about financing of the software, warranties, additional orders, termination of the contract and notices to be issued, Dastur contended that the supply contract was a complete and self-functioning contract of sale. The `overall agreement' that coordinated the supply and installation contracts was only a sort of memorandum of understanding with no consideration payable thereunder; and so the ultimate and enforceable effective contract was only the supply contract, he said.

To help the Tribunal determine whether there was any business connection, Dastur outlined ERA's operations in India through a serious of negatives: No manufacture of any equipment in India; no sale of any equipment in India; no research activity carried out in India; and installation of the equipment, though in India, is not carried out by the assessee (and the income from the installation contract has been taken into account in the case of the installation contractor and assessed in its hands).

The marketing and business promotion activity carried on in India is not carried out by the assessee but is carried out either by the branch (EFC) or by ECI, the Indian company, which are entities separate from the assessee, and income from this activity has been assessed in their respective hands. Since no operations were carried out in India by ERA, no income accrued to it either, nor any income was deemed to accrue, said Dastur. Opposing Sharma's works contract theory, Dastur submitted that the result of accepting that new argument would be to assess the entire profits in the hands of ERA, amounting to double taxation, because installation profits and business promotion profits had already been assessed in the hands of the separate entities.

But Sharma was not willing to let go of his arguments. For, many pages later, you'd find him pointing out that the word used in the supply contract was `contractor', not `supplier' as in the normal course. He further pointed out that in all the contracts, the common word used was `system' which means both the hardware and the software, and that there were cross-references between the supply contract and the installation contract, so one had to be necessarily read with the other. And, as in a turnkey contract, payment was linked with the progress of the work, he mentioned. What a pity that I have only progressed to page 119 out of 267, in what appears to be a long haul.

An interesting case for the too avid who won't mind working through the cell theory of works contract that ultimately didn't sell.

Picture by T. Singaravelou

Cases@TheHindu.co.in

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