Recently, the Pune tribunal has held that installation/erection and related service charges formed an integral part of the purchase price of machinery and the situation would remain unaffected, whether the charges were embedded in the cost of purchase price or, were charged separately. Thus, there was no obligation on the payer to withhold tax on entire payment.
The case was like this. During 2007-08, Mahindra Forgings Ltd (tax payer), which makes forgings for the automotive industry, bought forge and similar machines from various parties outside India for setting up a forging industry in Pune.
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The assessing officer (AO) held that these payments (other than payments for purchase of machinery) were taxable as fees for technical services (FTS) under the Income-tax Act, 1961 (ITA) and also under Article 12 of the India?s tax treaties with the respective countries, and considered the tax payer as an ?assessee-in-default? for not deducting tax at source.
On appeals by the tax payer, the commissioner of income-tax (appeals) [CIT(A)] confirmed the AO?s view in respect of payments made to Russian, German and Czech Republic companies on the basis that there were separate agreements (i.e. purchase orders) for purchase of machinery and separate for installation/ erection and related service charges.
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However, CIT (A) did not agree with the position taken by the AO in respect of payment made to A Japanese company (to which no separate PO was issued) for supply of designs and drawings on the basis that the transaction was a purchase transaction as no technology know-how relating to the machinery was made available.
The tax payer and the AO filed appeals before the Pune tribunal. The key issue before the tribunal was, whether the tax payer was required to withhold tax on payment towards installation/erection and related service charges and on supply of designs and drawings.
The tribunal held that:
o The supervision of installation /erection of machinery was an activity which related to sale of machinery and the installation charges formed an integral part of the purchase price of the machinery. The situation would remain unaffected, whether the charges were embedded in the cost of purchase price or, were charged separately.
o The machines purchased were complex equipment and, hence, could not be installed by any ordinary technical person. That was the reason why machinery seller was given the contract of erection and installation and services thereof.
o The principle of ?inextricable nexus? did not change merely because two separate agreements were reached, one for purchase-sale transaction and another for installation/erection and other related services.
Further, regarding payments for acquiring designs and drawings, the tribunal upheld the order of CIT (A) as the designs and drawings were acquired by tax payer for ensuring the smooth functioning of the plant and machinery and the tax payer neither used these drawings in manufacturing of the machinery nor did exploit it for any other commercial purpose. Accordingly, it was not an obligation on the part of the tax payer to withhold tax at source on the entire payment.
Based on this, tax payers could consider reviewing their agreement to evaluate whether installation/erection and related services form an integral part of purchase price of machinery and accordingly determine the applicability of withholding tax on the payments.
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