In recent years, the phenomenon of engineering, procurement, commissioning contracts (EPC contracts) has gained momentum with the import of technology, requirement in infrastructure and in sectors that require a high degree of expertise and technical skill.

The usual terms of an EPC contract stipulates that besides designing and supplying machinery etc, the contractor is also required to perform other activities which are incidental to the scope of work. Over and above the foregoing, the salient feature of an EPC contract is the provision of comprehensive guarantee by the contractor with regard to the performance of the project for an agreed period of time.

The income tax incidence arising in the hands of non-residents who had entered into contracts with resident organizations/public sector companies for the execution of power projects on turn key basis involving activities to be carried out in India as well as outside India had been dealt with by the Central Board of Direct Taxes (CBDT) in its Instruction No. 1829/1989 dated September 21, 1989.

Although the 1989-instruction was specifically for power plants, it had a persuasive application for similar infrastructure projects executed on a turnkey basis, such as oil refineries, LPG contracts and fertiliser plants etc.

The Instruction provides the taxation mechanism of certain activities of consortium of foreign companies listed therein. Wherein, equipments and materials were sold on FOB basis, delivered at port outside India, payments are also made outside India, it instructs that no part of the income will be deemed to accrue or arise in India.

Further, planning, design and engineering services are taxable as fees for technical services and civil works contracts executed in India and contracts for erecting testing or commissioning of plant or machinery are also taxable under the scheme of the Income Tax Act, 1961 on a presumptive basis.

Very recently, CBDT vide its Instruction No. 5/2009 dated July 20, 2009 has withdrawn its earlier Instruction No. 1829 dated September 21, 1989 which may have a serious setback on the Indian infrastructure sector. The grounds on which CBDT wishes to validate such withdrawal is the exploitation of the Instruction by unscrupulous taxpayers as all other sectors, apart from the power sector were also taking advantage, leading to a loss of revenue for the exchequer and there have been instances when a consortium has been created only to take advantage of the instruction. According to the Revenue Administration, the said Instruction was being leveraged as an instrument to align business operations in a manner to avoid payment of taxes in India, which rendered the very purpose of issuance of this Instruction as infructuous.

However, after the withdrawal of the Instruction, it is likely that income of the foreign consortium would be taxed as a composite activity at an effective rate of 42.23%, and a domestic company at an effective rate of 33.99%.

In the given scenario when the challenge before the policy makers is simplifying tax laws more particularly in case of non-residents, aptly highlighted also by the Finance Minister in his budget speech, such a withdrawal is certainly a hasty step in the wrong direction.