Agreements to pass through test of pith and substance to determine its dominant purpose and consequent tax chargeability #Indianlaws

The question before the Supreme Court was “whether the amounts paid by  ONGC to the non-resident assessees /foreign companies for providing various services in connection with prospecting, extraction or production of mineral oil is chargeable to tax as “fees for technical services”. It was held that to determine tax liability under an Agreement, dominant purpose of the Agreement is to be seen.

The common issue for consideration in the present group of appeals was “whether the amounts paid by the ONGC to the non-resident assessees /foreign companies for providing various services in connection with prospecting, extraction or production of mineral oil is chargeable to tax as “fees for technical services” under Section 44D read with Explanation 2 to Section 9(1)(vii) of the Income Tax Act (Act) or will such payments be taxable on a presumptive basis under Section 44BB of the Act”?

ONGC was assessed in a representative capacity on behalf of the different foreign companies with whom it had executed separate agreements for services to be rendered by such companies in connection with prospecting, extraction or production of mineral oils by ONGC.

The primary/assessing authority took the view that the assessments should be made under Section 44D of the Act and not Section 44BB of the Act. After the subsequent fora disagreed with the views of the assessing authorities, High Court upsetting the view, held, the payments made were liable for assessment under Section 44D of the Act.

Under Section 44BB(1) in case of a non-resident providing services or facilities in connection with or supplying plant and machinery used or to be used in prospecting, extraction or production of mineral oils, the profit and gains from such business chargeable to tax is to be calculated at a sum equal to 10% of the aggregate of the amounts paid or payable to such non-resident assessee.

Section 44D on the other hand contemplates that if the income of a foreign company with which the government or an Indian concern had an agreement executed before 1.4.1976 or on any date thereafter the computation of income would be made as contemplated under the aforesaid Section 44D. Explanation (a) to Section 44D however specifies that “fees for technical services” as mentioned in Section 44D would have the same meaning as in Explanation 2 to Clause (vii) of Section 9(1). The said explanation defines “fees for technical services” to mean consideration for rendering of any managerial, technical or consultancy services. However, the later part of the explanation excludes from consideration for the purposes of the expression i.e. “fees for technical services” any payment received for construction, assembly, mining or like project undertaken by the recipient or consideration which would be chargeable under the head “salaries”.

Fees for technical services will not include payments made in connection with a mining project. There was also a mention of Circular No. 1862 dated 22.10.1990 having a bearing on the subject.

It was held that the Income Tax Act does not define the expressions “mines” or “minerals”, which though are defined and explained in the Mines Act, 1952 and the Oil Fields (Development and Regulation) Act 1948. While construing the somewhat pari materia expressions appearing in the Mines and Minerals (Development and Regulation) Act 1957, regard must be had to the provisions of Entries 53 and 54 of List I and Entry 22 of List II of the 7th Schedule to the Constitution to understand the exclusion of mineral oils from the definition of minerals in Section 3(a) of the 1957 Act. Regard must also be had to the fact that mineral oils is separately defined in Section 3(b) of the 1957 Act to include natural gas and petroleum in respect of which Parliament has exclusive jurisdiction under Entry 53 of List I of the 7th Schedule and had enacted an earlier legislation i.e. Oil Fields (Regulation and Development) Act, 1948. Reading Section 2(j) and 2(jj) of the Mines Act, 1952 which define mines and minerals and the provisions of the Oil Fields (Regulation and Development) Act, 1948 specifically relating to prospecting and exploration of mineral oils, exhaustively referred to earlier, it is abundantly clear that drilling operations for the purpose of production of petroleum would clearly amount to a mining activity or a mining operation.

It is the proximity of the works contemplated under an agreement, executed with a non-resident assessee or a foreign company, with mining activity or mining operations that would be crucial for the determination of the question whether the payments made under such an agreement to the non-resident assessee or the foreign company is to be assessed under Section 44BB or Section 44D of the Act. The test of pith and substance of the agreement was held to be reasonable for acceptance. The CBDT accepting the said test had issued a circular on 22.10.1990 to the effect that mining operations and the expressions “mining projects” or “like projects” occurring in Explanation 2 to Section 9(1) of the Act would cover rendering of service like imparting of training and carrying out drilling operations for exploration of and extraction of oil and natural gas and hence payments made under such agreement to a non-resident/foreign company would be chargeable to tax under the provisions of Section 44BB and not Section 44D of the Act, and the said view was held as correct.

The contracts for the purposes of present appeals and question involved indicated that the pith and substance of each of the contracts/agreements is inextricably connected with prospecting, extraction or production of mineral oil. The dominant purpose of each of such agreement was for prospecting, extraction or production of mineral oils though there may be certain ancillary works contemplated thereunder. The payments made by ONGC and received by the non-resident assessees or foreign companies under the said contracts were held to be more appropriately assessable under the provisions of Section 44BB and not Section 44D of the Act.

The Appeals were accordingly allowed and thereby the view taken by the primary authority was reversed.

[Oil & Natural Gas Corporation Limited vs. CIT & Anr.]

(SC, 01.07.2015)

Civil Appeal No. 731 OF 2007 and other connected appeals