BEFORE THE AUTHORITY FOR ADVANCE RULINGS (INCOME

TAX)
NEW DELHI

16th Day of May, 2011

A.A.R. No.874 of 2010

PRESENT
Mr. Justice P.K.Balasubramanyan (Chairman)
Mr. J. Khosla (Member)
Mr. V.K. Shridhar (Member)

Name & address of the applicant Lanka Hydraulic Institute Limited

177, John Rodrige Mawatha
Katubedda
Moratuwa
Sri Lanka

Commissioner concerned The Director of Income-tax

(International Taxation), Kolkata

Present for the applicant Mr.Rajan Vora, C.A.

Mr.Mithun D‟Souza, C.A.

Present for the Department Mr.Shahi Sanjay Kumar,

Addl.DIT(Intl.Taxn.)-I, Kolkata
Mr.V.K.Agarwal,DDIT(Intl.Taxn.)-I(1)
Kolkata

RULING
(By Mr. V.K. Shridhar)

The applicant, Lanka Hydraulic Institute Limited (LHI), is a company

incorporated under the laws of Sri Lanka and is a tax resident of Sri Lanka. It

provides technical feasibility studies, preparation of coastal zone management

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plan, port and other water related engineering projects, etc. The applicant submits

that it does not have any office or place of business in India.

2. The Kolkata Port Trust awarded a contract to Water and Power Consultant

Limited (WAPCOS), a Public Sector Undertaking under the Union Ministry of

Water Resources. WAPCOS further sub-contracted the work to the applicant

through an agreement dated 10.2.2009. The applicant submits that the services

under the contract are to be performed within a period of 42 weeks from the

commencement of the contract. On the basis of man hours, substantial part of the

services has been performed in Sri Lanka and only about 20% of the services are

rendered in India. For rendering services in India, engineers are deputed at short

intervals on the project site at Hoogly river basin. The applicant also outsourced

part of the services relating to investigative assessment to another independent

contractor, Indomer Coastal Hydraulic (P) Ltd (ICHPL).

3. For the services, WAPCOS will pay a fee of US$ 13,33,500 in a phased

manner to the applicant on a milestone basis as specified in the contract. Out of the

above fee, the applicant is to pay US$ 2,95,000 to ICHPL for the services

outsourced and another 5% of the contract price by way of representative fees to

an Indian company Mantec Consultants (P) Ltd. (Mantec).

4. WAPCOS remitted a sum of US$ 6,66,750 to the applicant and withheld

taxes under section 195 of the Income Tax Act,1961 (Act) by treating the receipts

as under section 9(1)(vii) of the Act. The applicant had approached the assessing

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officer for a „nil‟ withholding tax certificate under section 197 of the Act, but

decided to withdraw it.

5. On these facts, the applicant desires to know whether the payments

received from WAPCOS are liable to tax in India as per provisions of India and

Sri Lanka Tax Treaty (Treaty) and has raised the following questions for ruling by

this Authority:-

(1) On the facts and circumstances of the case, given that the
„Convention between the Government of the Republic of India
and the Government of the Democratic Socialist Republic of Sri
Lanka for the avoidance of double taxation and the prevention of
fiscal evasion with respect to taxes on income and on capital
(„Tax Treaty‟) does not contain a specific Article for the taxation
of Fees for Technical Services (FTS) would the liability to tax, if
any, of the consideration received by the Applicant from Water
and Power Consultants Ltd. („WAPCOS‟) under the Contract be
governed by Article 7 of the Tax Treaty, which deals with
taxation of business profits?

(2) If the answer to the Question 1 is in the affirmative, whether

based on the facts and circumstances of the case, the specific
nature of activities performed by the Applicant under the
contract with WAPCOS results in the constitution of permanent
establishment („PE”) of the Applicant in India, within the
meaning of the term as defined in Article 5 read along with the
protocol of the tax Treaty?

(3) If the answer to Question 2 is in the negative, whether the

consideration received by the Applicant under the contract with
WAPCOS is liable to tax in India under Article 7 of the Tax
Treaty?

(4) If the answer to Question 1 is in the negative, whether based on

facts and circumstances of the case, the consideration received
by the Applicant under its Contract with WAPCOS is taxable in
India, under any other Article of Tax Treaty and the taxability
thereof?

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6. The contention of the Revenue is that as FTS has not been specifically dealt

with under the Treaty, taxing FTS under any Article of the Treaty other than under

Section 9(1) (vii) of the Act would mean changing the character of the income.

The OECD convention serves as a guideline to tax the payment under contract for

services under Article 7 of the Treaty. In the absence of the breakup of the

consideration it cannot be concluded whether the supply of software is incidental

to the provision of services or the provision of services was incidental to the

supply of software. Even if the consideration received was incidental to the

provision of services, the services provided are FTS and taxable u/s 9(1)(vii) of the

Act. The second contention of the Revenue is that the software is not sold. It is

only licenced. The licence is to use the copyright. Therefore the nature of the

consideration is Royalty under section 9(1)(vi) of the Act.

Regarding the applicant‟s stand that the consideration for provision of service

is business receipt and cannot be taxed in India in the absence of a PE, the revenue

contended that the presence of applicant‟s employees for less than 183 days is not

ascertainable. On that basis, it cannot be determined whether the applicant has a

PE or not. Further, as a portion of the work was contracted out to two Indian

entities ICHPL and Mantec, it cannot be denied that instructions were given by the

applicant to ICHPL and Mantec. Once the instructions were given by the

applicant to ICHPL the services rendered are controlled and then ICHPL and

Mantec constitute dependent agency of the applicant. It is also not substantiated

that the ICHPL and Mantec do not provide similar services to other concerns and

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hence it cannot be concluded that these two concerns are independent agencies and

do not constitute dependent agent. The applicant therefore has a PE in India and

the services rendered are taxable under Article 7 of the Treaty. Thus the case of

the revenue is that the consideration should be chargeable under section 9(1)(vii)

of the Act or under Royalties and not as business receipts under Article 7 of the

Treaty.

7. In response, the applicant stated that the receipts for supply of software

should be treated as business receipts under Article 7 of the treaty and not as

Royalty. The supply of software is incidental to the contract and the predominant

purpose of the contract is service. The receipt cannot be considered as Royalty as

the payment is for obtaining rights limited to enabling effective operation of the

software and not for the end user to commercially exploit the underlying rights in

the software. Without prejudice, it is stated that the receipts would not constitute

Royalty as perpetual rights in software are given to WAPCOS by the applicant

The applicant states that the consideration for provision of service is business

receipt. It does not have any fixed place of business or place of management,

branch office in India. As per clause (i) of Article 5(2) of the Treaty, it can have a

PE only if the furnishing of services is for a period exceeding 183 days in any 12

months period. Further, since most favoured nation clause has been inserted in the

Treaty, the period gets relaxed to any period of longer duration in any of the

DTAAs entered into by Sri Lanka. Since in the Treaty between Sri Lanka and

Yugoslavia the period is 275 days, the period in Article 5 should be read as 275

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days in any 12 months. As only 20% of the work is rendered in India, the

cumulative presence of employees in India from 26.1.2009 to 22.2.2010 was 193

days. Further deputation of employees would not exceed 10 days up to the

completion of the contract.

8. On the other hand, the learned DIT raised an objection that as per section 190

to 194 of the Indian Contract Act, 1872, ICHPL would constitute a sub-agent of

LHI in India for the reason that under the contract between LHI and WAPCOS,

LHI will not outsource any part of the work relating to surveys and investigation

and modeling. Under Section 193 of Indian Contract Act, where an agent has no

authority to delegate work to another/ appoint a sub-agent, he becomes responsible

for the acts of such sub-agent. As the services have been partially sub-contracted

to ICHPL, the duration of time spent by ICHPL employees should also be taken

into account in determining the creation of service PE of LHI in India.

9. The learned Advocate clarified that the constitution of a Service PE of a Sri

Lankan entity in India is covered by Article 5(2)(i) of the Tax Treaty, which reads

as follows:-

“The term “permanent establishment” shall include especially:

(i) The furnishing of services, including consultancy services, by an

enterprise through employees or other personnel, where

activities of that nature continue within the country for a period

aggregating more than 183 days within any twelve month

period.”

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 It is stated that in the present case, the services to LHI were provided by

ICHPL in its independent capacity as a service provider. ICHPL has the expertise

and has performed similar engagements for governmental and other entities.

ICHPL services are rendered by it through its employees to work under its own

direction, supervision and control. The employees of ICHPL cannot be considered

to be “other personnel” within the meaning of Article 5(2)(i) of the Treaty. Hence

the duration of time spent by such personnel is not to be considered in determining

the creation of a PE of the applicant in India.

10. Under the Act income by way of fees for technical services payable by a

person who is a resident shall be included in the total income of the non-resident

whether or not the non-resident has a residence or a place of business or business

connection in India. In other words existence of a PE is not a condition to tax the

income arising from technical services. Consultancy services come within the

meaning of FTS under the Act. If we go by the Treaty, consultancy services would

come under the term “permanent establishment” only where the activities of that

nature continue for a period aggregating to more than 183 or 275 days within any

12 months as averred by the applicant. Even if a payment to the applicant is not

within the scope of section 9(1)(vii) of the Act, it makes no difference as the treaty

would prevail over the Act. There is no incompatibility between recognizing the

receipts as FTS and also looking upon it as the profit of the business. To that

extent we agree with the contention put forth by the Learned Advocate.

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11. Let us place the facts in a more comprehensive manner to answer the

questions raised in the application. For the survival of Haldia Port, the channel

depth is required to be improved and the quantity of dredging is required to be

restricted. Model studies are proposed to evolve River Regulatory Measures

(RRM) to improve the channel. WAPCOS expressed the necessity to bring global

expertise to participate in the proposed study and to adopt technical collaboration

of CWPRS with foreign consultancy having required software and experience in

the field under its logistical support. The scope of the work for foreign consultant

was divided into 3 parts:

i) Field data collection.

ii) Desk study & Mathematical Model study to arrive at suitable

solution.

iii) Technology transfer.

The technology transfer component involved transfer of software procurement

and installation of software at CWPRS with perpetual licence and support and

maintenance for at least two years and training of KoPT/CWPRS/WAPCOS

personnel. The facts stated in the application are that a tender was floated by

WAPCOS for “Mathematical Model Studies For River Regulatory Measures For

Improvement of Drafts in Hugli Estuary”. Quotations were invited for the work of

software supplies, installations, modeling, field data collection, transfer of on-job

training/technology, maintenance, monitoring, handover of software, designs and

submissions of reports, etc. LHI appointed Mantec as its representative in India

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and utilized its services to win the tender for an agreed representative fee of 5% of

the contract price. WAPCOS communicated the award of the said project to LHI

for an amount of US$ 14,98,321 inclusive of all taxes and duties. LHI was

informed to make preliminary arrangements to commence work and to sign the

agreement. It may be stated that in the letter of award, it was made clear to LHI

that the:

“award of the project is considered based on your quote and

confirmations about utilization of Mike software packages developed by DHI

Water Environment Health, Denmark and making available all necessary

support of DHI in various processes to achieve the project study requirements

and schedules agreed for the studies under consideration. ….”

Agreement between WAPCOS and LHI took place on 10.2.2009. As

per clause 2 of the agreement, all the softwares/modules shall be installed at

CWPRS by LHI with perpetual license and version, which would be followed by

all exclusive training to the officers of KoPT/CWPRS/WAPCOS by LHI. LHI

would also indemnify WAPCOS against intellectual property rights. As an all-

important aspect of the project study required utilization of Mike software

packages developed by DHI, LHI ensured its procurement from DHI through a

letter dt. 31.12.2008. The letter especially states that DHI on behalf of LHI will

supply through DHI India the software for the Mathematical Model studies on

RRM in the Hoogly Estuary for the work awarded to WAPCOS. The total cost of

the software packages and modules with license to use along with annual service

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maintenance agreement is also mentioned in the offer. It is made clear that LHI is

not entitled to any commission as the end client is based in India. The DHI

software licence agreement is not an agreement for sale of software. It has given

only limited rights to use the proprietary DHI software in object code form. The

rights granted are non-transferable and non-exclusive right to use one or more

copies of the software. For field data collection, LHI outsourced the work to

ICHPL, Chennai, for a consideration of US$ 2,95.000. The scope of work

involved measurement programmes on tides, currents, sediment load etc. in the

channel area from Sagar Island to Hoogly point at a stretch of about 100 km

upstream. A report is required to be submitted by ICHPL.

12. The term „royalties‟ as used in Article 12 of the Treaty with Sri Lanka is

extracted below:

Article 12
Royalties

3. The term “royalties” as used in this Article means payments of

any kind received as a consideration for the use of or the right to the

any copyright of literary, artistic or scientific work including

cinematograph films, or tapes for television or broadcasting, any

patent, trade mark, design or model, plan, secret formula or process,

or for the use of, or the right to use, industrial, commercial or scientific

equipment, or for information concerning industrial, commercial or

scientific experience.”

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13. The objective for which the tender is invited is to obtain best possible studies

to improve the channel depth and restrict the quantity of dredging. The studies

would result in providing know-how to WAPCOS on long term basis. The

scientific experience in hydrology possessed by LHI to study and adopt the

required model is what is intended in the tender. The ancillary activities carried

out by Indomer in collecting the data is a part of the exercise of the model studies.

Therefore, what has been provided to WAPCOS is not an off-the-shelf product

which is sold to it but scientific equipment for its perpetual use. The ownership in

the core of the product, that is to say, the software, is not sold. It is thus the use of

the equipment or of such a product which in essence is the technology transfer that

is envisaged in the tender document. The nature and form of technology is

transferred by means of field data collection and by desk study of the data

available to arrive at the best mathematical model by making use of the software.

The software is the heart and soul of the technology transferred by LHI. The

intellectual property rights in the software are not transferred. The accumulated

fund of knowledge acquired by years of observation, search, experimentation and

experience possessed by LHI is transferred through the above means as intended

in the tender by WAPCOS, without incurring any liability for violation of

intellectual property rights or copyrights embedded in the technology transfer. The

consideration received is for the use of scientific work, model, plan, and for the

use of scientific equipment and scientific experience. The payment falls under the

term royalties as per Art 12 of the Treaty.

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14. It is true that the treaty does not contain a specific article for the taxation of

fees for technical services. In that event reference is to be made to Article 22 of

the Tax Treaty which reads as follows:

“Item of income of a resident of a Contracting State which are not

expressly mentioned in the foregoing Article of this Agreement in respect of

which he is subject to tax in that state shall be taxable only in that state.”

Accordingly, Question No.1 is answered by holding that the fees for technical

services shall be governed by Article 22 of the Tax Treaty and not as per Article 7

of the Tax Treaty which deals with taxation of business profits.

14.1 In the view that the nature of the activities performed by the applicant

constitute „Royalties‟ under Article 12 of the Tax Treaty, the answer to Question

No.2 is academic.

14.2 The consideration received by the applicant is liable to tax under Article 12

of the Tax Treaty and not under Article 7 of the Tax Treaty. Accordingly,

Question No. 3 is answered in the negative.

14.3 The taxability of the entire consideration received by the applicant under

contract with WAPCOS is in the nature of “Royalties” to be taxed under Article

12 of the Tax Treaty. Question No.4 is answered accordingly.

Accordingly, ruling is given and pronounced on 16th day of May, 2011.

(J. Khosla) (P.K.Balasubramanyan) (V.K.Shridhar)

Member Chairman Member

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