Aircraft overhaul expenses continue to be “fees for technical services” but not taxable absent source in India

In DIT vs. M/s. Lufthansa Cargo India: TS- 299-HC-2015, the Delhi High Court held that payment made by assessee (an Indian company) to German company for carrying out overhaul repairs to aircrafts was fees for technical services (“FTS”) under section 9(1)(vii) of the Income Tax Act, 1961 (“the IT Act”) but was not taxable in India as it did not have its source in India in view of clause (b) thereto.

In this case, the assessee, engaged in the business of wet-leasing of aircrafts, had acquired four old Boeing aircrafts from a non-resident company outside India. The assessee was granted the license by the DGCA to operate these aircrafts on international routes only and was obliged to keep the aircraft in flying condition. The assessee’s Boeing aircrafts were not used by any other airline in India and there were no facilities in India for their overhaul repairs. According to DGCA directives, various components and the aircraft itself had to undergo periodic overhaul repairs before the expiry of the number of flying hours prescribed for such individual components. Such overhaul repairs were permissible only in workshops authorized for the purpose by the manufacturer as well as duly approved by the DGCA, therefore, assessee’s all four aircrafts were wetleased to a foreign company, Lufthansa Cargo AG, Germany (hereafter “LCAG”).

The assessee maintained a base at Sharjah where the aircrafts were normally kept and where its crew and engineering personnel were also stationed. The assessee’s engineering department tracked the flying hours of every component; and before the expiry of flying hours, the component needing overhaul/repairs or needing replacement was dismantled by the assessee’s engineers and flown to Lufthansa Technik’s (a German company, hereafter “Technik”) workshops in Germany. The parts were supplied by Technik under separate agreement of sale, loan or exchange. In due course, the overhauled component was dispatched by Technik along with airway bill for which the freight was paid by the assessee. The overhauled component were fitted into aircrafts by the assessee’s own personnel. Technik carried out maintenance repairs without providing technical assistance by way of advisory or managerial services. LCAG utilized the aircrafts wet-leased to it for transporting cargo.

The assessing officer held that payments were in the nature of “Fees for technical services” as defined in Explanation 2 to Section 9(1) (vii) (b) of the IT Act, and were, therefore, chargeable to tax on which tax should have been deducted at source under Section 195(1) of the IT Act. The assessing officer further rejected the assessee’s plea that the business of aircraft leasing was carried on outside India and the payments made to residents of USA, UK, Israel, Netherlands, Singapore and Thailand could be taxed as business profits only and not as fees for technical services keeping in view the relevant provisions of the Double Taxation Avoidance Agreements (”DTAAs”) with those countries.

On appeal, the CIT (A) rejected the assessee’s contention that the payments made to the various non-residents for carrying out overhaul repairs were not chargeable to tax. The payments made to Technik were treated as the model for considering the question of taxability of payments made to all other foreign companies. CIT (A) held that such repairs required knowledge of sophisticated technology and trained engineers which were employed by the non-residents for carrying out the overhaul repairs and therefore, constituted “fees for technical services”, liable to TDS. With reference to payments made to residents of UK and USA, the CIT (A) held that they were not in the nature of “fees for technical or included services? under Article 12 of the TAX & CORPORATE NEWS BULLETIN DTAA read with the Memorandum of Understanding with USA which equally applied to the UK Treaty, but business profits not chargeable to tax in the absence of any PE in India. The Revenue went in appeal against the order of the CIT (A) on that point; the assessee appealed against other findings adverse to it, to the Tribunal.

Upon consideration of the wet leasing activity of the assessee and the agreements it entered into with foreign companies, the Tribunal noted that:

a.The assessee had to maintain the crew and keep the aircrafts in airworthy state.

b. The assessee company earned rental income on block-hours basis.

c. The assessee could not wet-lease the aircrafts to a third party without a written permission from the LCAG

d. In case of non-utilisation of aircrafts by the LCAG, it had to pay minimum guaranteed rental 240 block-hours per month in accordance with the terms of the contract

e. The amount of leasing revenues depended on the number of flying hours utilised by LCAG and not on the value of freight earned by the LCAG

f. The assessee was also assured of minimum rental income in the event LCAG does not actually use the aircrafts.

Considering the aforesaid facts, the Tribunal concluded that the sources from which the assessee had earned income was outside India as the income earning activity was situated outside India. Since it was towards the income earning activity that the payments for repairs were made outside India, such payments therefore fell within the purview of the exclusionary clause of Section 9(1) (vii) (b) of the IT Act.The Tribunal thus held that even assuming that the payments for such maintenance repairs were in the nature of “fees for technical services”, the same were not chargeable to tax.

On further appeal at the instance of the Revenue, the High Court observed that since the level of technical expertise and ability required in aircraft maintenance and repairs was specific in nature, so much so that the aircraft supplied by manufacturer had to be serviced and its components maintained, serviced or overhauled by designated centres to ensure safe and airworthy aircrafts, therefore, such exclusive nature of services would be regarded as “technical services” falling within the purview of Section 9(1)(vii) of the IT Act.

In respect of the issue regarding taxability in India of payments made by the assessee (i.e., the payments made) towards its activities outside India, the High Court affirmed the view of the Tribunal that since the overwhelming or predominant nature of the assessee’s activity was to wet-lease the aircraft to LCAG, i.e., to earn income from operations abroad, the said payment did not have its source in India and was hence not taxable in India for that reason and no TDS was required therefrom.