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Vol. 11 Issue 7.1 July 9, 2015
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The Apex Court approves taxation of income of non-resident oilfield
service providers on a 10 percent deemed profit basis as per section
44BB of the Income-tax Act, 1961
In a clear and concise decision of Oil and Natural Gas Corporation Limited
(“ONGC”) vs Commissioner of Income Tax[1], the Supreme Court (“SC”) has
held that the income of non-resident oilfield service providers from rendering of
works / services which are inextricably connected with prospecting for, or
extraction or production of, mineral oils would be taxed as per the provisions of
section 44BB of the Income-tax Act, 1961 (“Act”) on a deemed profit basis. The
decision has been delivered in the case of ONGC as the representative assessee
in a batch of appeals with leading matter being of M/s Foramer France
(hereinafter referred to as “taxpayer”).
The decision is welcome, as it reinforces taxation on deemed profit basis for non-
resident oilfield service providers in India.
Taxation framework and related controversy
Section 44BB of the Act provides for taxation of non-residents engaged inter-alia
in the business of providing services or facilities in connection with prospecting
for, or extraction or production of mineral oils, on a deemed profit basis of 10
percent on the gross receipts. The provisions inter-alia exclude income in the
nature of fees for technical services (“FTS”), which is taxable under section 115A
(ie gross basis of taxation in the absence of a Permanent Establishment in India),
section 44D / 44DA (ie taxation in case of a Permanent Establishment in India) of
the Act. The controversy is whether the services rendered by non-residents
oilfield service providers qualify as FTS?
The term ‘FTS’ is defined in Explanation 2 to section 9(1)(vii) of the Act and it
specifically excludes from its scope ‘the consideration payable for any
construction, assembly, mining or like project’.
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Gokul Chaudhri
For two decades from 1987, the Revenue Authorities as well as the judiciary in
India have accepted the position that drilling and oilfield services such as seismic
and geological surveys, drilling, well completion, well logging, formation testing,
cementing, fracturing etc would fall within the purview of section 44BB of the Act.
In the years from 2007 onwards, the Revenue Authorities deviated from the above
settled position and sought to deny taxation on deemed profit basis to the oilfield
service providers by holding several services as giving rise to income in the nature
of FTS.
Brief facts of the case
ONGC entered into an agreement with the taxpayer, a non-resident
company, for making available supervisory staff and personnel having
experience and expertise for operation and management of drilling rigs. The
income earned by the taxpayer from ONGC was offered to tax on deemed
profit basis under section 44BB of the Act.
During the assessment proceedings, the assessing officer (“AO”) sought to
tax the income of the taxpayer as FTS under section 44D by denying taxation
on deemed profit basis. On an appeal, the Appellate Commissioner
[“CIT(A)”] and the Income Tax Appellate Tribunal (“ITAT”) overturned the
order of the AO and allowed the claim of the taxpayer.
On further appeal by the Revenue Authorities, the Uttarakhand High Court
(“HC”) reinstated the view of the AO by observing that different clauses of the
agreement clearly contemplated rendering of technical services by the
personnel of the taxpayer and not carrying on work for drilling of wells,
therefore, the same should be taxed as FTS under section 44D of the Act.
Aggrieved by the decision of the HC, ONGC preferred group of appeals with
the SC on the question whether the amounts paid by it to the non-resident
companies for providing services in connection with prospecting for, or
extraction or production of, mineral oils would be taxed as FTS under section
44D read with Explanation 2 to section 9(1)(vii) of the Act or on deemed profit
basis under section 44BB of the Act?
Ruling of the SC
After perusal of all the relevant provisions, it is inferred that provisions of
section 44D of the Act would apply only in cases where the income earned by
the taxpayer qualifies as FTS in nature. The definition of FTS under the Act
specifically excludes any consideration received for ‘mining or like project’.
Mukesh Butani, New Delhi
+91 11 3066 3010
Rajeev Dimri, New Delhi +91 124 669 5050 [email protected]
Gokul Chaudhri, New Delhi
+91 124 669 5040
Bobby Parikh, Mumbai
+91 22 6135 7010
Sriram Seshadri, Chennai
+91 44 4298 7000
Amit Jain, Pune +91 20 668 19010 [email protected]
Shweta Aggarwal
Amit Bablani
Nikhil Sharma
SC concurred with the opinion of Attorney General of India, accepted by the
Central Board of Direct Taxes (“CBDT”) in the Instruction No 1862 dated
October 22, 1990, which expressed the view that ‘prospecting for, or
extraction or production of, mineral oil’ are mining operations and the
‘expressions ‘mining project’ or ‘like project’ occurring in Explanation 2 to
section 9(1)(vii) of the Income tax Act would cover rendering of services like
imparting of training and carrying out drilling operations for exploration or
exploitation of oil and natural gas’.
The terms ‘mines’ or ‘minerals’ are not defined under the Act and therefore,
for interpretation of these terms the righteous reliance should be placed on
the provisions of Mines Act, 1952, Oil fields (Regulations and Development)
Act, 1948 and Petroleum and Natural Gas Rules, 1959. From an
examination of these provisions, it is abundantly clear that the drilling
operations for the purpose of production of petroleum would tantamount to
mining activity or a mining operation.
It is the proximity of the works contemplated under an agreement with the
mining activity or mining operations, which is crucial to establish the taxability
of payments on a deemed profit basis under section 44BB of the Act. Due
weightage and cognizance should be given to the CBDT Instruction, which
laid down that the income from works / services mentioned in the particular
agreement, which are directly associated or inextricably connected with
prospecting for, or extraction or production of, mineral oils should be taxed
under section 44BB of the Act.
Brief description of work under the agreements, as provided by ONGC, was
examined by the SC which included wide gamut of services such as:
Drilling of exploration wells and carrying out seismic surveys for
exploratory drilling
Furnishing supervisory staff with expertise in operation and management
of drilling unit
Capping including subduing of well, fire fighting
Analysis of data to prepare job design, procedure for execution and
details regarding monitoring
Assessment and processing of seismic data along with engineering and
technical support in implementation of cyclic steam stimulation
Conducting reservoir stimulation studies in association with personnel of
ONGC
Consultancy for optimal exploitation of hydrocarbon resources and for all
aspects of coal bed methane
Geological study of the area and analysis of seismic information reports
to design 2D seismic surveys
Engineering and technical support to ONGC in implementation of Cyclic
Steam Stimulation in heavy oil wells
Evaluation of ultimate resource potential and presentations outside India
in connection with promotional activities for Joint Venture Exploration
program
Inspection of existing control system and deputing engineer to attend to
any problem arising in the machines
Feasibility study of rig to assess its remaining useful life and to carry out
structural alterations and engineering analysis of rigs
Training on well control, on implementation of Six Sigma concepts, on
Drilling project management, and in Safety Rating System and
assistance in development and audit of Safety Management System
To develop technical specification for 3D Seismic API modules of work
and to prepare bid packages
Supply supervision and installation of software which is used for analysis
of flow rate of mineral oil to determine reservoir conditions
Supply, installation and familiarization of software for processing seismic
data
On the basis of the examination of description of work, the SC held that since
the pith and substance as well as the dominant purpose under each of the
agreement was inextricably connected with / was for prospecting, or
extraction or production of, mineral oils even though certain ancillary works
were also included, the income from rendering such services by the non-
resident oilfield service providers should be taxed on deemed profit basis
under section 44BB of the Act and not as FTS under section 44D of the Act.
BMR Comments and analysis
The SC decision clearly establishes that any service which is proximate
with prospecting for, or extraction or production of, mineral oils should be
taxed on deemed profit basis under section 44BB of the Act, and not as
FTS under section 44D of the Act. While the decision is in the context of
section 44D of the Act, the legal principle emerging therefrom on what
qualifies as ‘mining or like project’, should squarely be applicable for
interpretation of definition of FTS for subsequent years. Accordingly, for
such income, which is not FTS, the taxation principles of section 44D or
section 44DA should not be of any consequence.
The SC has primarily relied on the Instruction issued by CBDT. In 2012,
the Delhi Bench of ITAT[2] distinguished the said Instruction and
characterized the income as FTS. Further, it is pertinent to note that
while the Instruction dealt with only specific kind of services, the SC has
held that a wider gamut of services, as enumerated above, should be
taxed under section 44BB.
The Revenue Authorities, especially since 2007, have alleged that
income of the non-resident oilfield service providers is taxable as FTS.
The decision clears the cloud of uncertainty created in the minds of the
non-resident oilfield service providers by this approach of the Revenue
Authorities and plethora of Appellate Court decisions, ie, at HC and ITAT
level, both in favour and against. The SC has resolved the unwarranted
controversy on taxation of non-resident oilfield service providers on
deemed profit basis to align with the intent of legislature as has originally
been!
As per Article 141 of the Constitution of India, the decision of SC
becomes the law of the land and is binding on all Courts within India.
This could be instrumental in defining the way forward on the long-drawn
tax litigation.
The decision of the SC is likely to allay the concern of foreign
contractors. Further, with the next round of auction of oil and gas blocks
under the New Exploration Licensing Policy (“NELP”) being around the
corner, this could be positive development in the oil and gas sector.
Sceptics would worry that the decision could be rendered otiose through
an amendment of law or withdrawal of Instruction by CBDT, however,
considering the stated objectives of Modi Government of reducing
litigation, making the tax environment conducive to foreign investments,
this possibility could be less likely than previously feared.
[1]Civil appeal no 731 of 2007
[2]CGG Veritas Services SA (2012) (50 SOT 335) (Del)
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