Computation of income of non-resident shipping entities posed many challenges and to ease the same Section 44B was enacted vide Finance Act, 1975 w.e.f. 1 April 1976. It provided that income of a non-resident assessee engaged in the business of operation of ships, 7.5% of the gross freight will be deemed to be profits and gains chargeable to tax under the head "Profits and gains of business or profession". Section 172 of the Income Tax Act, 1961 ('the Act') overriding all other provisions of the Act provides for procedure of levy and recovery of tax in case of any ship belonging to or chartered by a non-resident which carries passengers, livestock, mail or goods shipped at any port in India.
Hon'ble Chennai Bench of Income Tax Appellate Tribunal (ITAT) in a recent decision in the case of Sical Logistics [see end note 1] dealt with the issue of interpretation of Section 172 vis-Ã -vis income from time charter. The tax authorities had treated the Indian payer of income as representative assessee with respect to the shipping income of its service providers being Foreign Shipping Companies ('FSCs').
Before the ITAT the tax authorities placed reliance on the decision of Hon'ble Madras High Court in the case of Poompuhar Shipping Corporation Limited [see end note 2] contending that the payment to shipping company for time charter is in the nature of royalty.
The issue of taxability of time charter payments had come up before Hon'ble Supreme Court in the case of Gosalia Shipping [see end note 3] wherein the Court had held as under:
- The case is of a time charter i.e. when the owner of the ship is entitled to payment for hire of ship irrespective of its usage
- The payment to shipping company is based on deadweight carrying capacity as against based on volume of goods carried
- Charterers were liable to pay the agreed hire amount, as above, irrespective of whether they carried goods or not
- While the form of agreement and labels used therein are not decisive yet there is no evidence to arrive at a conclusion that real intent differs from words used therein
- Payer of income had the liberty to sub-let the ship
- Captain of the ship was under orders and directions of the payer of income
In the case of Poompuhar Shipping (Supra) the court held that the payment to FSCs is in the nature of royalty because:
- Payer of income had the right of deciding the route and selecting the time as per its requirement
- Possession and control over ship was not a relevant criterion especially after amendments made vide Finance Act, 2012 inserting Explanation 4 & 5
- The expression 'use or right to use' does not have a precise meaning and its meaning varies depending on the context. The test of use has been met in the present case
The cumulative effect of the decisions of Apex Court and Madras High Court cited above is that payment for time charter is royalty under the Act and warrants tax deduction at source accordingly [see end note 4].
The Chennai Bench of ITAT in the case of Sical Logistics (supra) however has distinguished the decision of Madras High Court by holding that in that case the taxpayer had a facility of berthing at an Indian port. Regarding Sical it further observed as under:
- Payer of income has hired vessels from FSCs for transportation of coal
- Vessels were hired admittedly on time charter basis and time charter hire charges have been paid as agreed
- Payer of income would intimate the FSC about availability of cargo and its origin and destination
- The Captain/Master of vessel, crew and other staff are controlled by ship owner
- Vessel is insured by the ship owner
Based on the above mentioned facts the ITAT held that the payment does not constitute royalty because:
- The payer of income did not have any control or possession over the vessel
- Every one cannot operate a vessel as it requires approval from Maritime Authorities which the payer of income did not have
- There is a difference between 'letting the asset' and 'use of the asset by the owner for providing services'; the former results in royalty but latter doesn't
- Taxability of income in the present case is to be governed by Section 172 which is a complete code in itself
The position regarding applicability of TDS in cases governed by Section 172 can be treated to have been settled by the decision of Full Bench of Hon'ble Bombay High Court in the case of Dempo [see end note 5] & [see end note 6]. The Court held that Section 172 is a special provision for collection of tax and overrides the regular collection machinery embodied in TDS provisions. The question is about correct application of Section 172 to facts of a particular case which cannot be determined merely by reference to nomenclatures used by parties in their agreements [see end note 7].
To conclude, the agreement may use term 'time charter' as happened in the case of Sical Logistics however if the terms of the agreement demonstrate that the vessel is in control of and used by service provider and not let to the payer of income, the payment will not be treated as royalty in view of the decision of ITAT in that case. It is possible to agree with the conclusion of the ITAT that absent control and possession the payment will not be royalty [see end note 8]. However, it is not clear as to how the ITAT could apply the test of control and possession relying on the decision of Delhi High Court in the case of Asia Satellite [see end note 9] rendered in the context pre-amended law while that test has been considered irrelevant by the Hon'ble Madras High Court after referring to amendments made vide Finance Act, 2012.