Hire Charges Received Under ‘Time Charter Agreement’ Not Taxable As Royalty, If Control Over Ship Remained With Owner: ITAT

The bench of Amit Shukla (Judicial Member) and Gagan Goyal (Accountant Member) held that to fall within the ambit of “use or right to use” an equipment under Clause (iva) to Explanation 2 of Section 9(1)(vi), it is sine qua non that the hirer or the charterer has complete control and ownership of the equipment (ship) for the period of lease and the owner/ assessee is only earning passive income by simply letting out the equipment.

The assessee, Nan Lian Ship Management LLC, is a tax resident of UAE and is engaged in the business of shipping operation. The assessee entered into a Time Charter contract with M/s Poompuhar Shipping Corp. Ltd. (PSCL) for transporting coal from one port to another through its ship.

The assessee showed the receipts received from PSCL as income from shipping business and offered the same to tax under Section 44B of the Income Tax Act.

The Assessing Officer (AO) opined that the assessee simply let out its vessel and PSCL hired the same for the period of 13 months. The AO held that PSCL paid the assessee for the use/right to use the vessel in form of leasing or letting out, and, therefore, the receipts were taxable as ‘royalty’ under Section 9(1)(vi) of the Income Tax Act.

The AO concluded that the assessee was paid a fixed amount irrespective of whether the vessel was being used by the charterer or not. He held that the assessee was not paid for transporting coal from one port to another and, therefore, the income cannot be taxed under Section 44B.

The AO thus passed an assessment order, holding the receipts received by the assessee on account of Time Charter of its ship as ‘royalty’, and taxing the same under Section 9(1)(vi). The said order was confirmed by the Dispute Resolution Panel (DRP). The assessee challenged the assessment order by filing an appeal before the Income Tax Appellate Tribunal (ITAT).

The assessee, Nan Lian Ship, argued that it is a non-resident company and the income derived from the business of operation of ships has to be taxed under the special provision, i.e., Section 44B. Referring to the time charter agreement, the assessee contended that PSCL had only taken the ship on a time charter basis for transporting coal from one port to another. It reiterated that at all time, the possession, control and ownership of the ship was with the assessee company and PSCL was only using the ship on a time charter basis.

Relying on the decision of the Madras High Court in Poompuhar Shipping Corporation Ltd. v. ITO (2013), the revenue department contended that the Madras High Court has clearly held that payment made to a non-resident company who has given its ship on time charter basis, is ‘royalty’ within the meaning of Section 9(1)(vi). The department argued that the ship is an ‘equipment’ which was let out by the assessee and hired by the charterer. The receipts were in the nature of hire charges, which arose from ‘use of the equipment’, the department said. Accordingly, the receipts must be taxed as ‘royalty’, in terms of clause (iva) to Explanation 2 to Section 9(1)(vi), it pleaded.

The ITAT took note that as per Clause (iva) to Explanation 2 of Section 9(1)(vi), the term ‘royalty’ includes payments received for “use or right to use any industrial, commercial or scientific equipment but not including the amounts referred to in section 44B”.

Referring to the Time Charter Agreement, the ITAT concluded that the vessel was charted and used by the charterer for a specific purpose of transporting the coal. Further, the charterer had to pay for the use and hire of the vessel per running day of the calendar month. Also, the remunerating payable to the assessee was calculated purely on the basis of the load to be carried by the charterer/PSCL. Further, the charterer had no control of the ship except for carrying the coal as per its requirement, and at all time the ownership and control of the ship remained with the owner/ assessee, the ITAT observed.

The ITAT added: “To fall within the ambit of use or right to use equipment, it is sine qua non that the hirer or the charterer has complete control and ownership of the equipment for the period of lease and the owner is only earning passive income by simply letting out the equipment.”

The Tribunal concluded: “…the hire charges are not independent of the loading capacity and therefore, it cannot be inferred that payment of hire is for letting out of equipment as assumed by the AO. Thus, it is not a case of leasing out of an equipment and use or right to use of equipment is for the carriage in the vessel owned and operated by the owner and it is not a case of simply by letting out the ship for certain time period.”

Referring to the decision of the Madras High Court in Poompuhar Shipping Corporation (2013), the Tribunal reckoned that in that case the High Court had concluded that the hire charges were payable to the owner for the use of the ship for a specific period of time, irrespective of whether or not the charterer choose to use it for carrying cargo. Further, the High Court had held that to fall in the realm of ‘royalty’, ownership and possession of the vessel, which remain with the owner, must be separated from the use of the ship, which must be granted to the charterer.

The ITAT ruled that the decision of the Madras High Court in Poompuhar Shipping Corporation (2013) was not applicable to the facts of the present case since the control over the working and navigation of the ship was never transferred to the charterer by the assessee and there was never a transfer of the ship, which was one of the conditions laid down in Poompuhar Shipping Corporation (2013).

Thus, the ITAT held that the payment received by the assessee from the charterer/PSCL was not in the nature of ‘royalty’ and thus, the same was not taxable under Section 9(1)(vi) of the Income Tax Act.

“The agreement and the payment received by the assessee is for carriage of goods and for operating the ships, therefore the income of the assessee has rightly been offered to tax u/s 44B of the Act,” the ITAT said.

The Tribunal thus allowed the appeal.

Case Title: Nan Lian Ship Management LLC versus ACIT (Int. Tax)

Dated: 30.12.2022

Representative for the Appellant: Mr. Nishit Gandhi /Dhanlaxmi Iyer, Ld. ARs

Representative for the Respondent: Mr. Soumendu Kumar Das, Ld. DR

Click Here To Read/Download the Order