Energy and Infrastructure sectors are the backbones of the Indian economy. EPC contracts are the soul of most infrastructure and energy-related projects in India. Such contracts involve issues of international taxation as they are mostly carried out by the foreign contractors in India. The write-up seeks to analyse the issues of taxation under the domestic law and international tax treaties. The concepts of permanent establishment, business connection, base erosion and profit shifting and force of attraction are covered to understand the tax considerations arising out of EPC contracts. Further, some of the tax benefits available for the energy and infrastructure companies and the challenges faced to avail the same are also analysed in brief. In conclusion, the write-up provides an overview and brief snapshot of the major aspects and considerations related to the energy and infrastructure sector along with their tax implications.
India, the 7th largest country by area, the 2nd most populous country, and the most populous democracy in the world, offers a wide range of business opportunities. Among the business opportunities, the sector of Projects, Energy and Infrastructure is predominant. The Energy sector is majorly comprised of companies engaged in thermal and renewable energy projects including solar, hydro, wind, oil & gas projects. The infrastructure sector includes companies engaged in the construction, operation of roads, railways, ports, airports, logistics, waste management and water projects. The 10 ‘Maharatna’ Central Public Sector Enterprises (BHEL, BPCL, CIL, GAIL, HPCL, IOCL, NTPC, ONGC, PGCIL, SAIL) are majorly involved in Energy and Infrastructure sector. The aforesaid shows the impact and significance of the sector in the growth of the country.
As per theEconomic Survey of India (2020-21), the Indian economy encountered a “once in a century” crisis due to the COVID-19 pandemic that affected economic activities and consequently impacted the livelihood of billions of people.” The industrial sector also faced an intense recession during the lockdown period. However, over the time, the economy started to recover gradually. A V-shaped economic recovery was spotted in many sectors with consistent shift towards the pre-pandemic levels. The broad-based quick revival of the industrial activity stemmed from remedial measures, reforms, and the sizable stimulus package announced by the Government of India under the Atmanirbhar Bharat package. Further improvement and firming up in industrial activities are foreseen with the Government enhancing capital expenditure, the vaccination drive and the resolute push forward on long-pending reform measures.
Being a capital-intensive sector, the energy and infrastructure companies involve the aspects of EPC, i.e., Engineering, Procurement and Construction Contracts (‘EPC’). The EPC contracts are in the form of turnkey contracts and are generally used to take up complex infrastructure and construction projects on a large-scale. The EPC sector involves various considerations. One such consideration is Taxation.
Taxation in India
India and Taxes have a prolonged tryst. Taxes are levied by the Government to meet the common welfare expenditure of the society. “Article 265 of the Constitution of India lays down that tax can be levied or collected, only by the authority of law.” Further, the Constitution of India gives the power to levy and collect taxes, to the Central and State Governments. “The empowerment to make laws are as per theArticle 246 and the 7th Schedule of the Constitution of India. Entry 82 of the Union List, i.e. List 1 of the 7th Schedule to Article 246 of the Constitution of India gives the power to the Parliament to make laws on taxes.” And hence, the Income-tax Act, 1961 (‘Act’) came into existence which governs the direct tax laws of the country. In addition to the domestic tax laws in India, there are numerous agreements signed by the Government of India with other countries, which are commonly known as the Double Taxation Avoidance Agreements (‘DTAA’) or tax treaties.
A number of infrastructure and energy-related projects are carried out by foreign companies because it requires highly sophisticated technology and expertise. And, when it comes to tax, the greatest daunting issue for any foreign company in India is constituting a Permanent Establishment (‘PE’) in India, leading to further tax considerations.
Under the DTAA, PE is generally of 3 to 4 types, i.e. a fixed place PE, wherein a foreign enterprise has an office or branch or a factory, etc., an installation or supervisory PE, an agency PE, a service PE, etc. For a foreign company engaged in an EPC contract in India, PE related considerations arise as foreign companies may procure goods or services either from their own country or from India. The aforesaid division in procuring goods, supplies and services from different geographical locations create a complicated scenario wherein there may be a higher chance of an income being doubly taxed. For instance, the foreign enterprises may procure goods from outside India and supply the same to an Indian resident and further, foreign enterprise’s professionals may visit India to provide supervisory or installation or construction services. In such cases, the issue of taxability may arise as there are offshore as well as onshore supplies of goods and services which are being utilized in India.
Further, there are various other considerations as well. For example, to constitute a service PE or a supervisory PE in India, various thresholds in the form of the number of days present in India is prescribed. In addition, under an agency PE, the form and structure of agency contracts become significant which in turn would become a determining factor for constituting an Agency PE in India. However, due to certain gaps in the aforesaid provisions related to PE, many multinational enterprises, in the past, have avoided taxes.
Force of Attraction
To avoid treaty abuse or tax evasion, various international concepts under the ambit of tax treaties, have been developed over the period of time. One such concept is the ‘Force Of Attraction’ or FOA. While there is a general consensus that only those profits ‘directly attributed’ to the PE may be taxed in India, the rule of FOA indicates that the profits that arise from ‘same or similar kind of activities’ conducted by the foreign enterprise with or without the involvement of PE would also be considered for taxability in India. Hence, there may be a scenario wherein the profits that are both ‘directly’ and ‘indirectly’ attributable to the PE, may become taxable in India. From time to time, various courts in India and foreign jurisdictions have analysed the FOA such as in the case ofLinklaters LLP v. Income Tax Officer. Further, other cases such asShanghai Electric Group Co. Ltd. v. DCIT andDeputy Commissioner Of Income Tax v. Roxon Oy also analysed and reiterated the principles similar to the case of Linklaters (supra).
Base Erosion and Profit Shifting (BEPS)
Over the past few decades, taxpayers across the globe had developed numerous ways to manage high taxes and avoid payment of taxes through artificial measures. The Organisation for Economic Co-operation and Development (‘OECD’), an intergovernmental economic organisation has come up with the BEPS project. BEPS aims to streamline and consolidate the tax treaties globally in consideration of the time-to-time developments across the globe. The BEPS project consists of 15 Action Plans.Action 6 provides for Treaty Abuse, wherein suggestions are provided for creating provisions to combat treaty shopping and incorporate specific anti-abuse rules. Further,Action 7 related to ‘PE Status’, expands the definition of a PE to counter the strategies adopted by the taxpayers to avoid having a taxable presence in a country. In addition,Action 15 provides for Multilateral Instrument which may allow various countries to modify their bilateral DTAAs swiftly and efficiently.
Indian Domestic Law
While a lot has been discussed with respect to the international concepts, it is pertinent to consider and analyse the provisions of the Indian domestic tax laws as well. Under the provisions of the Act, the concept of residence and scope of total income is significant. Especially when it comes to analysing the position for foreign companies engaged in EPC contracts and infrastructure developments.
Under the Indian domestic tax statute, the liability to pay tax on any taxpayer depends upon his residential status under the Act. A company would be resident in India only if it is an Indian Company or its Place of Effective Management (‘POEM’) in the year, is in India. POEM is defined as a place where the important administrative, management and commercial decisions which are required for the smooth conduct of the business of an enterprise are made. At the same time, the Taxpayers are liable to pay tax on the income received or deemed to be received by them in India irrespective of their residential status and the place of its accrual. While analysing the aforesaid provisions, the concepts of ‘significant economic presence’ and ‘business connection’ also become relevant.
In the caseIshikawajima-Harima Heavy Industries Ltd. v. Director of Income-tax, while analysing the domestic tax laws and India-Japan DTAA, the Apex Court of the country held that the mere existence of ‘business connection’ may not cause the income from the business activity with such a business connection, to accrue or arise in India. The court held that it would be incorrect to equate a PE and a business connection. The purpose of PE is to assess the income of a non-resident under a tax treaty, and the purpose of ‘business connection’ is for the application of Section 9 of the Act. Section 9 of the Act contains provisions related to ‘Income deemed to accrue or arise in India’. In order to attract tax liability under the taxing statute, the business activity has to be conducted through a PE. If income arises without any activity of PE, then, even under the tax treaty, taxation liability in respect of overseas services would not arise in India. The location of source of income within India would not render sufficient nexus to tax income from that source. Therefore, under section 9 of the Act, it is necessary that services provided by a non-resident foreign entity be both utilized and rendered within India.
Similarly, in the case ofCommissioner of Income-tax, Meerut v. Hyundai Heavy Industries Co. Ltd, the Supreme Court of India held that when an income accrues or arises to a foreign enterprise in India then, only such part of the income would be taxable which accrues or arises through such enterprise’s activities carried out in India. Further, in order to compute profits accruing in India, profits attributable to the Indian PE of the non-resident enterprise are required to be computed under the normal accounting principles and in accordance with the provisions of the Act. Ascertaining taxable income of a foreign enterprise in India involves an artificial division between income earned in India and the income earned outside India by the foreign enterprise. Also, the computation of profits in each PE decides the quantum of income on which source country can levy tax. Hence, it is important that profits of PE are computed as independent units. In addition, the question of taxability does not arise, if the PE is not established in the source state, irrespective of whether the business activities are direct or they are through PE.
While much guidance and interpretation of laws have been provided by the Indian courts, but still the issues revolving around the concept of PE and further attribution of profits to such PE are vexed and not free from multiple aspects. Each scenario requires an independent analysis based on the facts and circumstances of the case.
Other Direct Tax Aspects
To promote foreign direct investments and to encourage growth in the infrastructure industry, the income tax laws in India provide various benefits.
Reduction in corporate tax rates: The corporate tax rate on the taxable income of the new manufacturing domestic companies has been reduced to 15%. However, to avail of the aforesaid reduced rate, the company should have been set up and registered on or after the 1 October 2019 and should have commenced manufacturing or production of any article or thing on or before 31 March 2023. Also, the aforesaid provisions are available for companies engaged in the business of the generation of electricity. The motive behind this move is to increase investments in the country and boost the ‘Make in India’ initiative of the Government of India for establishing an ‘Atmanirbhar Bharat’.
Depreciation Deduction: In the case of assets of an undertaking engaged in generation or generation and distribution of power, depreciation is available on a straight-line basis which provides for higher deduction.
Preliminary Expenses: Infrastructure and Energy companies are capital intensive entities and therefore, require a huge amount of expenditure along with certain preliminary expenses. The Act (Section 35D) provides for the amortisation of preliminary expenses incurred by the Indian companies for the establishment of business concerns or the expansion of the business of existing concerns. One-fifth of such preliminary expenditure is allowable as a deduction for each of the 5 successive years beginning with the year in which the business commences or, the year in which the extension of the undertaking is completed or the new unit commences production or operation, as the case maybe. The expenditure eligible for amortisation includes expenditure in connection with the preparation of feasibility report, project report, conducting a market survey, engineering services relating to the taxpayer’s business etc.
Challenges: The companies availing of the reduced corporate tax rate of 15% as mentioned above, may not be eligible to claim various exemptions and deductions, including the deductions for donations. Another important aspect that warrants attention is that the companies may be able to avail the reduced corporate tax rates only if they are solely engaged in the business of manufacturing or production.
Another major challenge that may be faced by power and energy sector companies is meeting the sunset clause of commencing the business before March 2023. This sunset clause poses much difficulty in availing the benefit specifically due to the COVID-19 pandemic which has made it difficult for the companies to commence their business on time. Considering the huge demand for power and energy in the country and the loss suffered by companies due to the COVID-19 pandemic, the government may explore the possibilities of extending the sunset clause.
Additionally, the Government of India may introduce provisions similar to the section 80-IA of the Act, related to deductions in respect of profits and gains from industrial undertakings or enterprises engaged in infrastructure development, etc.
As per theEconomic Survey of India (2020-21), the COVID-19 pandemic led to a unique recession where 90% of countries were expected to experience a contraction in its GDP per capita. Faced with unprecedented uncertainty at the onset of the pandemic, India chose to focus on saving livelihoods. India’s response stemmed from the humane principle advocated eloquently in the Mahabharata that “Saving a life that is in jeopardy is the origin of dharma.” Therefore, India recognised that while GDP growth will recover from the temporary shock but the human lives that are lost cannot be brought back. The response drew on epidemiological and economic research, which highlighted that an early, intense lockdown provided a win-win strategy to save lives and preserve livelihoods via economic recovery in the medium to long term. This strategy was also tailored to India’s unique vulnerabilities to the pandemic.
Now, since, people are prepared to battle the waves of pandemic looming ahead, India is focusing on devising ways to recover its economy. The GDP contraction in Q1 was 23.9% and a 7.5% in the Q2. Hence, the recovery across most sectors has been a V-shaped. A bouquet of measures equivalent to INR 29.87 lakh crores or 15% of India’s GDP was introduced as a measure of relief and support to the economy. These were subsequently backed by initiatives to further strengthen the economy.
At the same time, India actively participated in the 2021 United Nations Climate Change Conference, the 26th United Nations Climate Change conference where the Indian Prime Minister Shri Narendra Modi presentedfive nectar elements, Panchamrit to deal with the challenge of climate change. This included achieving 500GW of non-fossil fuel energy capacity, satisfying 50% of India’s energy needs from renewable energy sources, reducing carbon emissions by 1 billion tonnes and also reducing the carbon intensity of the economy by 45%. All this has been proposed to be achieved by 2030. The fifth and final element is to achieve the target of net zero emissions by 2070.
India is a front-runner when it comes to introducing public or economic policies for the benefit of society and general welfare. India was quick to take cues from the global tax developments and introduce provisions such as equalisation levy, withholding tax on e-commerce operators, significant economic presence, etc. The future promises a robust but simpler tax regime where both foreign companies and Indian domestic companies are treated at par to avoid discrimination. The law of the country evolves with the evolvement of its companies and industries. Infrastructure growth and energy sector developments would provide a better future with free flow of tax revenue to the Government of India to make India not only incredible but ‘Atmanirbhar’ as well.
About the Authors
Mr. Devashish Poddar is a Direct Tax Professional at a multinational professional services network of firms (big four accounting firm). He is also a Chartered Accountant, active with many clients, principally in the industry of telecommunications, technology, media and entertainment. He specializes in Corporate Tax Litigation specifically related to the Indian Income Tax Act, 1961 and has worked with large Indian groups, advising them on long-term value creation, tax and structuring issues.
Kopal Kesarwani is a third-year law student at the Jindal Global Law School, NCR, and an Associate Editor at IJPIEL.
Managing Editor: Naman Anand
Editors-in-Chief: Jhalak Srivastav and Aakaansha Arya
Senior Editor: Muskaan Singh
Associate Editor: Kopal Kesarwani
Junior Editor: Tisa Padhy
Preferred Method of Citation
Devashish Poddar and Kopal Kesarwani, “A Tryst with Taxation for the Indian Infrastructure Sector” (IJPIEL, 26 January 2022)
Amazing! Thanks for this.
Very well researched blog
Very well written