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When supply and erection are codified in separate contracts but the overall reading of the two contracts point to they being essentially one, then the profit or loss from the two also must be computed in an integrated fashion, observed the Kolkata bench of the Income-tax Appellate Tribunal recently in Dongfang Electric Corporation v. Deputy Director of Income-Tax.
The appellant Chinese company was executing power projects in West Bengal, with site offices there performing the erection function in terms of a separate contract governing it. The supply from China was governed by another contract.
Settled law
The department found something fishy in the separation of the two functions.
It suspected that bulk of the profits was shifted to the supply contract with a view to benefitting from exemption from Indian income-tax available to it. It is a settled law in India that a foreign company supplying goods to India pursuant to a contract signed abroad, performed abroad and payment received abroad, is not liable to tax in India.
The department’s suspicion was that the Chinese company loaded the profits emanating from the erection function into the supply contract since it was in any case tax-free and thus was able to show enormous losses in India from the erection function.
The Assessing Officer stepped in, invoked the transfer pricing rules and added some Rs 92 crore to the taxable income in India for the assessment year 2006-7, thus converting the ostensible loss from erection into profit.
The Tribunal, while remanding back the order of the assessing officer in view of the audited accounts of both the Indian and Chinese operations showing losses, agreed with the approach of the department in viewing the two contracts as integrated.
The clinchers were the cross-fall breach clause — annulment of both the contracts even when one is breached — and the turnkey feature of the two contracts read in conjunction.
The key feature of the agreement was concept to commissioning and thus the division into supply and erection was wholly for the purpose of convenience, possibly tax evasion.
Thus, the Tribunal effectively has endorsed the approach of the department in adding the results of off-shore supply with the Indian erection operations but has obviously found the cost-plus method adopted by the transfer pricing officer suspect in view of the losses reported in both the audited accounts.
(The author is a New Delhi-based chartered accountant)
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