Supreme Court Clarifies Tax on Mobilization Fees for Mineral Oil Exploration: Sedco Forex International Inc. vs. Commissioner of Income Tax (2017)

Date of the Judgment: 30 October 2017

Citation: (2017) INSC 942

Judges: A.K. Sikri, J., Ashok Bhushan, J.

Are mobilization fees paid to foreign companies for bringing their drilling rigs to India taxable under Indian Income Tax Law? This was the core question before the Supreme Court in a batch of appeals concerning non-resident entities engaged in mineral oil exploration. The court had to determine whether these fees, often claimed as reimbursements, should be included in the computation of taxable income under Section 44BB of the Income Tax Act, 1961. The bench, comprising Justices A.K. Sikri and Ashok Bhushan, delivered a unanimous judgment, clarifying the scope of this provision.

Case Background

The case involves multiple appeals filed by various non-resident companies, primarily engaged in providing services and facilities for mineral oil exploration. These companies had contracts with Oil and Natural Gas Corporation (ONGC) and other entities to provide drilling rigs and related services. A key aspect of these contracts was the payment of mobilization fees, which covered the cost of transporting the drilling rigs from their overseas locations to the designated sites in India. The assessees, the non-resident companies, argued that these fees were reimbursements of actual expenses, not income, and thus should not be taxed. The Income Tax Department, however, contended that these fees were part of the overall consideration for services rendered and were taxable under Section 44BB of the Income Tax Act, 1961.

The specific dispute arose because the assessees did not include the mobilization charges in their gross revenue when computing their income under Section 44BB. Some assessees included only 1% of the mobilization fees, based on a Central Board of Direct Taxes (CBDT) instruction. The Assessing Officer (AO) included the full mobilization fees in the gross revenue, which was upheld by the Commissioner of Income Tax (Appeals) [CIT(A)]. However, the Income Tax Appellate Tribunal (ITAT) had differing views, with some upholding the AO’s decision and others directing assessment at 1% of the mobilization charges. The High Court eventually ruled in favor of the Income Tax Department, stating that the mobilization charges were taxable under Section 44BB.

Timeline

Course of Proceedings

The Assessing Officer (AO) initially included the mobilization/demobilization amounts in the gross revenue to compute profits and gains under Section 44BB of the Income Tax Act, 1961. The Commissioner of Income Tax (Appeals) [CIT(A)] upheld the AO’s decision. The Income Tax Appellate Tribunal (ITAT) had differing views. In the case of Sedco Forex International Inc., the ITAT dismissed the appeal and upheld the AO’s decision. However, in the case of Transocean Offshore Inc., the ITAT upheld the assessee’s view and directed the AO to assess profits on mobilization charges at 1% of the amount received, following a CBDT circular and a third member decision. The High Court, in its judgments, held that mobilization charges, including those for services rendered outside India, were taxable under Section 44BB, as this section was not governed by the charging provisions of Sections 5 and 9 of the Income Tax Act, 1961. The High Court also held that reimbursements of expenses incurred by the assessee were to be included in gross receipts and were taxable under Section 44BB.

Legal Framework

The core of this case revolves around Section 44BB of the Income Tax Act, 1961, which provides a special mechanism for computing profits and gains for non-resident entities engaged in the business of exploration, etc., of mineral oils. This section states that a sum equal to 10% of the aggregate amounts specified in sub-section (2) shall be deemed to be the profits and gains of such business, chargeable to tax. The relevant parts of Section 44BB are as follows:

“44BB. Special provision for computing profits and gains in connection with the business of exploration, etc., of mineral oils.
(1) Notwithstanding anything to the contrary contained in sections 28 to 41 and sections 43 and 43A, in the case of an assessee, being a non-resident, engaged in the business of providing services or facilities in connection with, or supplying plant and machinery on hire used, or to be used, in the prospecting for, or extraction or production of, mineral oils, a sum equal to ten per cent of the aggregate of the amounts specified in sub-section (2) shall be deemed to be the profits and gains of such business chargeable to tax under the head “Profits and gains of business or profession” :
Provided that this sub-section shall not apply in a case where the provisions of section 42 or section 44D or section 44DA or section 115A or section 293A apply for the purposes of computing profits or gains or any other income referred to in those sections.
(2) The amounts referred to in sub-section (1) shall be the following, namely :—
(a) the amount paid or payable (whether in or out of India) to the assessee or to any person on his behalf on account of the provision of services and facilities in connection with, or supply of plant and machinery on hire used, or to be used, in the prospecting for, or extraction or production of, mineral oils in India; and
(b) the amount received or deemed to be received in India by or on behalf of the assessee on account of the provision of services and facilities in connection with, or supply of plant and machinery on hire used, or to be used, in the prospecting for, or extraction or production of, mineral oils outside India.”

The court also considered Sections 4, 5, and 9 of the Income Tax Act, 1961, which deal with the charging of income tax, the scope of total income, and income deemed to accrue or arise in India, respectively. Section 5(2) specifies that the total income of a non-resident includes income received or deemed to be received in India, or income that accrues or arises in India. Section 9(1)(i) states that income accruing directly or indirectly through any business connection in India is deemed to accrue or arise in India.

Arguments

Arguments of the Assessees:

• The assessees argued that the mobilization fees were reimbursements of actual expenses incurred for transporting drilling rigs from foreign locations to India. They contended that these were not income, as they did not have any profit element.
• They submitted that India follows a territorial system of taxation, and only income attributable to operations within India is taxable for non-residents. They argued that the mobilization fees were for services rendered outside India and, therefore, did not accrue or arise in India.
• The assessees asserted that Section 44BB of the Income Tax Act, 1961 is only a computation provision and does not override the charging sections (Sections 4, 5, and 9) of the Act. They relied on the judgment of the Supreme Court in Union of India & Anr. v. A. Sanyasi Rao & Ors. [(1996) 3 SCC 465], arguing that Section 44AC of the Act is a machinery provision and not a charging section.
• They contended that since the actual expenditure incurred for mobilization was higher than the amount reimbursed in some cases, there was no income to be taxed.
• They also relied on the CBDT Circular No. 495 dated September 22, 1987, which stated that Section 44BB was introduced to simplify the computation of income for non-residents engaged in mineral oil exploration and that the amounts received or due to be received in India on account of such services or facilities or supply of plant and machinery would be included.
• They argued that there should be a sufficient territorial nexus between the rendering of services and the territorial limits of the Income Tax Act, 1961 to make the income taxable.
• They also argued that the mobilization fee was in respect of activities carried out outside India prior to the establishment of a Permanent Establishment (PE) in India and, therefore, was not taxable under the Double Taxation Avoidance Agreement (DTAA) between India and France.

Arguments of the Revenue:

• The revenue argued that the contracts between ONGC and the assessees were indivisible, and the mobilization fees were part of the overall consideration for providing drilling units and related services.
• They contended that the mobilization fees were not reimbursements but payments for the supply of drilling units, operating the rigs, and providing experts.
• The revenue relied on Sections 2(24) and 2(45) of the Income Tax Act, 1961, which define “income” and “total income,” respectively, and argued that the mobilization fees were income chargeable to tax.
• They argued that the assessees had a business connection in India through the equipment they owned and operated in India and their employees working in India, thus fulfilling the requirements of Section 9(1)(i) of the Income Tax Act, 1961.
• The revenue submitted that Section 44BB of the Income Tax Act, 1961 is a complete code for determining taxable income for non-resident assessees engaged in mineral oil exploration, replacing the normal computation mechanism.
• They argued that Section 44BB provides for “presumptive income determination,” where 10% of the aggregate receipts are considered income, and the remaining 90% is treated as expenditure.
• They submitted that the mobilization fees were paid for the business operations in India and that the source of income was in India, thus negating any argument for apportionment.

Issues Framed by the Supreme Court

The Supreme Court framed the following key issue for consideration:

1. Whether the mobilization fees paid to non-resident companies for transporting drilling rigs to India are to be included in the aggregate of amounts specified in sub-section (2) of Section 44BB of the Income Tax Act, 1961, for computation of deemed profits and gains of business, chargeable to tax under the said provision.

Treatment of the Issue by the Court

Authorities

The Supreme Court considered the following authorities:

The Court also considered the following legal provisions:

• Section 44BB of the Income Tax Act, 1961: Special provision for computing profits and gains in connection with the business of exploration, etc., of mineral oils.
• Section 4 of the Income Tax Act, 1961: Charging section for levying tax on income.
• Section 5 of the Income Tax Act, 1961: Scope of total income.
• Section 9 of the Income Tax Act, 1961: Income deemed to accrue or arise in India.
• Section 2(24) of the Income Tax Act, 1961: Definition of “income.”
• Section 2(45) of the Income Tax Act, 1961: Definition of “total income.”

Judgment

The Supreme Court held that the mobilization fees paid to the assessees were to be included in the aggregate of amounts specified in sub-section (2) of Section 44BB of the Income Tax Act, 1961. The court clarified that Section 44BB is a special provision for computing profits and gains in connection with the business of exploration of mineral oils, and it has to be read in conjunction with Sections 5 and 9 of the Income Tax Act, 1961. The court emphasized that the mobilization fees were not merely reimbursements of expenses but were part of the overall consideration for providing services and facilities related to mineral oil exploration in India. The court stated that these fees are deemed to be income under Section 44BB and are also considered to be earned in India, thereby satisfying the requirements of Section 9 of the Act.

How each authority was viewed by the Court?

• Union of India & Anr. v. A. Sanyasi Rao & Ors. [(1996) 3 SCC 465]: The court distinguished this case, stating that while it held that Section 44AC is a machinery provision, Section 44BB is a special provision for computation of income and deems certain amounts as income.
• Anglo-French Textile Company , Ltd., by Agents M/s Best & Company, Ltd., Madras v. Commissioner of Income Tax, Madras [(1954) 25 ITR 27 (SC)]: The Court did not find the principle of apportionment as applicable in the present case.
• Ishikawajma-Harima Heavy Industries Ltd. v. Director of Income Tax, Mumbai [(2007) 288 ITR 408 (SC) = (2007) 3 SCC 481]: The court distinguished this case, stating that it dealt with Sections 5 and 9 of the Income Tax Act, 1961, while the present case was governed by Section 44BB.
• Carborandum & Co. v. CIT, Madras [(1977) 108 ITR 335 (SC)]: The court did not find the principle that reimbursement of actual expenses does not represent income as applicable in the present case.
• Commissioner of Income Tax, Madras v. Best and Company (Private) Ltd., Madras [(1966) 60 ITR 11 (SC)]: The Court did not find the principle of apportionment as applicable in the present case.
• Commissioner of Income Tax v. F.Y. Khambaty [(1986) 159 ITR 203]: The court did not find the principle that computation provision cannot override charging section as applicable in the present case.
• Commissioner of Income Tax and Anr. v. Hyundai Heavy Industries Co. Ltd. [(2007) 7 SCC 422]: The Court did not find the principle of apportionment as applicable in the present case.
• State Bank of Travancore v. Commissioner of Income Tax, Kerala [(1986) 158 ITR 102 (SC)]: The Court did not find the principle of apportionment as applicable in the present case.
• Avasarala Technologies Limited v. Joint Commissioner of Income Tax, Special Range 1, Bangalore [(2015) 14 SCC 732]: The court relied on this case to uphold the concurrent findings of fact by the lower authorities.
• Commissioner of Income Tax Bihar and Orissa, Patna v. Ashoka Marketing Co. [(1972) 4 SCC 426]: The court relied on this case to uphold the concurrent findings of fact by the lower authorities.

The court emphasized that the mobilization fee was a fixed amount, not tied to actual expenses, and was part of the consideration for services related to mineral oil exploration in India. The court also noted that the contracts were indivisible, and the mobilization fees were an integral part of the overall agreement.

The court quoted the following from the judgment:

“It is stated at the cost of repetition that, in the instant case, the amount which is paid to the assessees is towards mobilisation fee. It does not mention that the same is for reimbursement of expenses. In fact, it is a fixed amount paid which may be less or more than the expenses incurred. Incurring of expenses, therefore, would be immaterial.”

“From the bare reading of the clauses, amount paid under the aforesaid contracts as mobilisation fee on account of provision of services and facilities in connection with the extraction etc. of mineral oil in India and against the supply of plant and machinery on hire used for such extraction, clause (a) stands attracted. Thus, this provision contained in Section 44BB has to be read in conjunction with Sections 5 and 9 of the Act and Sections 5 and 9 of the Act cannot be read in isolation.”

“Thereafter, on such deemed profits and gains (treating the same as income), a concessional flat rate of 10% is charged to tax. In these circumstances, the AO is supposed to apply the provisions of Section 44BB of the Act, in order to find out as to whether a particular amount is deemed income or not. When it is found that the amount paid or payable (whether in or out of India), or amount received or deemed to be received in India is covered by sub-section (2) of Section 44BB of the Act, by fiction created under Section 44BB of the Act, it becomes ‘income’ under Sections 5 and 9 of the Act as well.”

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the interpretation of Section 44BB of the Income Tax Act, 1961, and its interplay with Sections 5 and 9. The court emphasized that Section 44BB is a special provision that deems certain amounts as income, and it cannot be read in isolation from the other charging provisions of the Act. The court’s reasoning highlighted the following points:

• Nature of Mobilization Fees: The court emphasized that the mobilization fees were not mere reimbursements but were a fixed amount paid as part of the overall consideration for the services provided. This was a key factor in determining that the fees were income.
• Indivisibility of Contracts: The court noted that the contracts between ONGC and the assessees were indivisible, and the mobilization fees were an integral part of the agreement. This supported the view that the fees were part of the overall consideration for the services.
• Special Provision of Section 44BB: The court highlighted that Section 44BB is a special provision for computing profits and gains and that it deems certain amounts as income. This provision was central to the court’s decision.
• Territorial Nexus: The court stated that the mobilization fees were for services related to mineral oil exploration in India, and thus, they had a territorial nexus with India, making them taxable under Section 9 of the Income Tax Act, 1961.
• Purpose of Section 44BB: The court noted that Section 44BB was introduced to simplify the computation of income for non-residents engaged in mineral oil exploration. This provision was meant to provide a simplified method for taxation.

Fact:Law Ratio

Logical Reasoning:

Final Verdict

The Supreme Court dismissed the appeals filed by the assessees and upheld the decision of the High Court. The court concluded that mobilization fees paid to non-resident companies for transporting drilling rigs to India are to be included in the aggregate of amounts specified in sub-section (2) of Section 44BB of the Income Tax Act, 1961. This decision clarified that these fees are part of the overall consideration for services related to mineral oil exploration and are taxable under the said provision. The court also emphasized that Section 44BB is a special provision that deems certain amounts as income and should be read in conjunction with Sections 5 and 9 of the Income Tax Act, 1961.

Impact and Implications

The Supreme Court’s judgment in Sedco Forex International Inc. vs. Commissioner of Income Tax (2017) has significant implications for non-resident companies engaged in mineral oil exploration in India. The key impacts and implications are:

• Taxability of Mobilization Fees: The judgment definitively establishes that mobilization fees, irrespective of whether they are termed as reimbursements, are part of the overall consideration for services and are taxable under Section 44BB of the Income Tax Act, 1961.
• Special Provision: The ruling emphasizes that Section 44BB is a special provision that deems certain amounts as income, and it cannot be read in isolation from the charging provisions of the Income Tax Act, 1961.
• Territorial Nexus: The decision clarifies that services related to mineral oil exploration in India have a territorial nexus, making them taxable under Indian tax laws, even if some activities are performed outside India.
• Simplified Tax Computation: The judgment reinforces the purpose of Section 44BB as a simplified method for computing income for non-resident entities engaged in mineral oil exploration, by treating 10% of the aggregate amounts as taxable income.
• Future Tax Planning: Non-resident companies need to factor in the taxability of mobilization fees when entering into contracts for mineral oil exploration in India. They cannot treat these fees as mere reimbursements and exclude them from their taxable income.
• Consistency in Tax Treatment: The judgment promotes consistency in the tax treatment of mobilization fees, ending the varying interpretations of Section 44BB by different authorities and tribunals.
• Impact on DTAA: The decision also implies that the taxability of mobilization fees under Section 44BB will be considered in the context of Double Taxation Avoidance Agreements (DTAA), and the specific provisions of the respective DTAA will need to be examined.

In conclusion, the Supreme Court’s judgment in Sedco Forex International Inc. vs. Commissioner of Income Tax (2017) provides a clear and definitive interpretation of Section 44BB of the Income Tax Act, 1961, and its application to mobilization fees. This decision has far-reaching implications for non-resident companies engaged in mineral oil exploration in India and underscores the importance of understanding the tax implications of such contracts.