23 October 2013

2013mber 2012

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

Executive summary
This tax alert summarises a recent ruling of the Madras High Court (HC) in the
Tax Alerts cover case of Poompuhar Shipping Corporation Ltd. (PSCL) and West Asia Maritime
significant tax news, Ltd. (WAML) [1] on the issue of whether hire charge for chartering Indian coastal
developments and shipping vessels (ships) for plying within Indian ports under time-charter
changes in legislation arrangement (TCA) and bare-boat charter-cum-demise (BBCD) arrangement,
that affect Indian with various foreign shipping companies (FSCs), is taxable in India as “royalty”,
businesses. They act
under the Indian Tax Laws (ITL) as well as under the Double Taxation Avoidance
as technical summaries
Agreement (DTAA). While determining taxability under TCA and BBCD, the HC
to keep you on top of
the latest tax issues. dealt with a number of issues, viz., (a) whether a ship qualifies as equipment, (b)
For more information, whether charges under TCA and BBCD are for the “use” or “right to use” such
please contact your EY equipment and, consequently, taxable as royalty, (c) availability of benefit of
advisor. 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.

[1]
ITA Nos. 2841,1191&2842/Mds/05; ITA Nos. 2376&2377/Mds/2005; ITA Nos. 145 to 153/Mds/2012; ITA
Nos. 145 to 148/Mds/2012
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.
Background and facts of
PSCL and WAML:
► PSCL, a Government undertaking, was
engaged in the business of moving coal
from various ports in India to a particular
location within India. For this purpose,
PSCL entered into TCA with various FSCs
for chartering ships. PSCL did not
withhold taxes on payments to FSCs as it
was of the view that the payment was in
the nature of service and was
accordingly, not taxable in India under
the ITL as well as the DTAA. Further,
WAML, a public limited company, was
engaged in the business of shipping, had
hired a ship from a Cyprus company
(CyprusCo) under BBCD arrangement.
WAML claimed that the payments under
BBCD were towards option to purchase
ship and hence, not taxable.
► The Tax Authority scrutinized TCA and
observed that PSCL was required to pay
a fixed sum irrespective of the quantum
of freight carried or the number of
journeys undertaken by the ships.
Accordingly, the Tax Authority held that
the arrangement was not a service but
constituted “royalty” as the same was for
the “use” or “right to use” industrial,
commercial or scientific equipment
(equipment royalty). Accordingly, PSCL
was treated as a payer-in-default for not
withholding taxes. Additionally, PSCL
was also treated as a representative
agent (Agent) of FSCs under the ITL. In
the case of WAML, the Tax Authority
observed that WAML had an option to
exercise purchase of the ship at the end
of each year, which however, was not
exercised. As the ship was deployed on
the coastal line between ports in India,
benefit of the DTAA was not available.
► Aggrieved, PSCL and WAML appealed
before the First Appellate Authority
(FAA). The FAA upheld the findings of the
Tax Authority and ruled that:
► Payment to FSCs was not for
rendering services but for hiring
ships. As PSCL had control over the
captain of the ships and FSCs acted
as agents of PSCL, the payment for
the ships was for the “use” or “right
to use” of equipment and
accordingly, taxable as “equipment
royalty”.
► In the case of WAML, WAML was not
the owner of the ship until the last
month’s hire instalment was paid to
CyprusCo. Thus, till the option to
purchase was not exercised, WAML
was not to be treated as the owner
but only as a hirer of the ship. Thus,
the consideration paid periodically
was in the nature of hire charges for
the use of the ship and not deferred
payment of consideration.
Accordingly, the payment
constituted royalty.
► FSCs (including CyprusCo) cannot
rely on Article 8 of the DTAA
(shipping income), as the DTAA
benefit was restricted only to
incomes earned by FSCs from
transportation of passengers, goods
etc. in “international traffic”. In the
present case, the ships are engaged
in carrying goods between ports in
India and not outside, and the
requirement of plying in
“international traffic” (between
different countries) is not satisfied.
► Aggrieved, PSCL and WAML appealed
before the Second Appellate Authority
(Tribunal). The Tribunal however,
dismissed the appeals filed by PSCL and
WAML and upheld the order of FAA.
 Aggrieved, PSCL and WAML filed an
appeal with the HC.
HC’s ruling
Whether TCA is for “rendition of a
service” or for “use and hire of ships”?
► TCA between FSCs and PSCL provides
that (a) PSCL has the liberty to sub-let
the vessel for all or any part of the time
covered by TCA; (b) PSCL shall pay for
the use and hire of the ships for each
day, commencing from the date of
delivery; (c) the usual places of loading
shall be at PSCLs disposal; (d) the place
of re-delivery of ships is at PSCLs option;
(e) the masters/captains and others
working in the ships are at the disposal
of PSCL; and (f) PSCL is to provide for all
operating expenses such as fuel, port
charges, pilotages, agencies,
commissions, consular charges etc.
► The Supreme Court (SC) in Gosalia
Shipping P. Ltd.[2] considered similar
clauses in TCA and ruled that the
payment by hirers was not on account of
carriage of service, but was payable on
account of use and hire of ships. The SC,
thus, ruled that a TCA is essentially for
the use and hire of ships and the amount
payable to FSCs is irrespective of what
use the ship is put to, by the hirers.
Accordingly, payments under TCA are for
the “use” and hire of ships and not for
rendition of any service.
Whether payments to FSCs are for “use”
or “right to use” and consequently,
royalty?
► Under the ITL as well as the DTAA,
“royalty” means the consideration paid
for the “use” or the “right to use”.
Consideration paid for use or right to use
“simplicitor” is sufficient for
characterization as “royalty”.
[2]
[113 ITR 307]
► The SC in Rashtriya Ispat Nigam Ltd.[3]
observed that by giving possession to the
hirer who has control and custody, the
condition of “use or right to use” is
satisfied. Thus, so long as the hirer is
given the right to use (with a right to put
the equipment to beneficial use for itself,
or to keep it idle, or the right to sublet)
and accesses the ships to its advantage
economically then, the requirement of
“use or right to use” is met.
► The term “use” or “right to use” is
intended to take its ordinary meaning
and needs to be applied in the broader
sense, i.e., “employing for any purpose”.
Thus, presence or absence of possession,
effective or general control, and custody
with the payer may not be relevant while
evaluating the character of a payment.
► PSCL, as per TCA, had right to use ship,
select the time and decide route as per
its requirement. Though PSCL did not
have physical possession of the ship, the
payment is for the use or right to use the
ship. Accordingly, where PSCL derives an
economic benefit from the ships,
consideration paid thereof constitutes
“royalty”. In the case of WAML, under
BBCD, WAML was not the owner of the
ship and the consideration was,
therefore, in the nature of hire charges
for the use of the ship.
Whether ship qualifies as “equipment”
for royalty purposes?
► The term “equipment” has not been
defined under the ITL or the DTAA.
However, the term “plant” has been
defined in the ITL for depreciation
purposes while computing income under
the head “business or profession”, in an
inclusive manner. This inclusive definition
embraces within its fold a ship, book,
medical equipment, apparatus etc.
[3]
[77 STC 182]
► The term “plant” is judicially understood
Whether a PE exists for FSC in India?
as an apparatus used by a businessman
for carrying on his business, including
► As per Article 5 of the DTAA, a PE is a
goods and chattels (movable or
fixed place of business through which the
immovable), which is meant for
business of FSC, i.e., the FSC based out
permanent employment in such
of Cyprus, is wholly or partly carried on
business. Thus, plant includes every tool,
in India.
apparatus, equipment or machinery, not
limited to machinery used in tool.
► FSC is the owner of the ship which is let
out on hire to WAML. The ship is
► The word "equipment", when construed
designated as a coastal vessel, i.e., which
in light of the equipment royalty clause,
is exclusively employed for plying
extends the normal or ordinary meaning
between ports in India. The ship is used
of the word. Also, the equipment royalty
continuously, in excess of 90 days, in
clause uses the term “any” before the
India. The hiring of the ship is not
term “equipment”. This clearly points out
occasional but for a continuous period.
the need for construing the said term
widely, so as to embrace every article
► In order for a PE to exist, there must be a
employed by the taxpayer for the
fixed place for the business to be carried
purposes of its business. So long as the
on. In the case of equipment, a fixed
equipment is employed for the purposes
place can be found to exist even though
of one's income, they shall also fall within
the equipment, for a single customer
the ambit of “equipment royalty”, even if
under one integrated contract, may be
it is referred to as an apparatus or plant
relocated from one place to another. A
or machinery. Thus, a ship is an
movable place of business is thus,
“equipment” of the business of a ship
treated as fixed when most of the
owner on a natural and ordinary meaning
equipment is used at fixed points within a
of the word.
proximate area on a repetitive
continuous basis for sufficient period of
► Therefore, a ship, being a plant, with
time as required by the business. Thus,
which FSCs operate their business, and
when the business activities are
commercially exploit for earning income,
peripatetic and the equipment moves
qualifies as an “equipment” and
between neighbouring locations, a single
accordingly, user charges thereof are
place of business exists, which presents a
taxable as “equipment royalty” under the
coherence in commercial and
ITL.
geographical aspect with regard to the
conduct of business.
Whether income earned by FSCs is not
taxable in India by virtue of Article 8? ► The moving ship has a place of business
where the ship is docked and the fact
► Under Article 8 of the DTAA, payment to that the ship moved from one point to
FSCs which are operating only in another is the result of the nature of
“international traffic” is taxable in the business contract and such movement is
country in which FSCs have a “place of an integrated one having business and
effective management”. In the present geographical coherence. This leads to an
case, FSCs (including CyprusCo) had let inference that FSC has a PE in India.
out the ship for use for plying within However, the receipt of hire charges is
Indian coastal waters. As the ship not attributed as the income earned from
operated between the coastal lines of the PE but, for the use or right to use the
two ports in India and thus, the test of ship and consequently, is taxable as
“international traffic” is not met. “royalty” and not as business profits
Accordingly, the payer could not invoke since the income is not effectively
Article 8 for determining taxability of connected/attributed to the said PE.
payments to FSC for the purposes of tax
withholding.
Whether parallel proceedings can be arrangement were comparable to
initiated under the ITL? the arrangement before the SC in
the case of Gosalia Shipping P. Ltd.
► The ITL treats any person as an Agent (supra), the HC held that the
when such person has a business consideration was for the hire of the
connection with a nonresident (NR) in
ship and since a ship is an
India or when a NR earns income
directly/indirectly, through or from, such equipment, TCA charges constitute
person. In such circumstances, the royalty.
person is treated as an Agent of the NR
for recovery of taxes payable by the NR. This ruling would not apply to cases
Further, where the payer fails to withhold
where TCA is in respect of ships
tax or after withholding the tax, fails to
deposit the same then, the payer would plying in international traffic. Since
be treated as a payer-in-default. the ships, in the present case, were
plying along the Indian coastal line
► Proceedings as payer-in-default have no and not in international traffic, the
correlation with the status of PSCL as an
benefit of the shipping article of the
Agent. As long as the Tax Authority is
able to justify that the income falls within DTAA was not available.
the deeming fiction of the source rule
under the ITL, the proceedings as an The observations of the HC on
Agent stands attracted. initiation of parallel proceedings on
the Indian payers as (a) payer-in-
► The contention that both the
proceedings cannot be initiated together default, and (b) an Agent, may also
is incorrect as both operate in different merit special attention. In fact, the
spheres, i.e., payer-in-default proceeding Chennai Tribunal in the case of
is on account of failure to withhold taxes Poompuhar Shipping Corporation
and proceedings as an Agent is for the
Ltd. (supra) had restored the matter
purposes of assessment of income of
FSCs. 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
Comments initiation of proceedings would
certainly be severe and harsh on the
Taxability under a time-charter Indian payer. It is therefore,
arrangement has been a contentious advisable to obtain clarity on
issue. In a recent decision of the withholding requirement before
Chennai Tribunal in the case of discharging the payments to NRs.
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
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