ITAT: If Control Over Ship Remains with Owner, Hire Charges received under Time Charter Agreement cannot be Taxable as Royalty

ITAT: If Control Over Ship Remains with Owner, Hire Charges received under Time Charter Agreement cannot be Taxable as Royalty

The Income Tax Appellate Tribunal, Mumbai Bench (in short ITAT) by its division bench comprising of Amit Shukla (Judicial Member) and Gagan Goyal (Accountant Member) ruled that hire charges received by the owner of a ship for chartering its vessel under a 'Time Charter Agreement', is not taxable as 'royalty' under Section 9(1)(vi) of the Income Tax Act, 1961, if control and dominance over the ship remained with the assessee/owner and not with the charterer.

The assessee, Nan Lian Ship Management LLC, is a tax resident of UAE and engaged in the business of shipping operation. The assessee entered into a Time Charter contract with M/s Poompuhar Shipping Corp. Ltd. (in short 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 (in short AO) found 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, observing that 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 (in short DRP). The assessee challenged the assessment order by filing an appeal before the ITAT.

The main issue involved was, whether the income earned by the assessee is to be taxed under section 44B of the Act on the presumption basis as claimed by the assessee in the return of income or whether the receipt should be taxed as 'royalty' for use of an equipment in terms of clause (iva) to Explanation 2 to section 9(1)(vi).

The Tribunal stated, 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 comprehensively examined and interpreted the clauses mentioned in Time Charter Agreement and observed firstly, the compensation was based on freight as per the loading per voyage; secondly, the vessel owner was responsible for the entire maintenance and keep of the vessel; thirdly, the hire charges were liable to be reduced pro-rata if the load on the vessel leads to lesser loading capacity for the charterer or if the vessel is out of service, then the charges are accordingly reduced and if there was any action, the vessel was not hired for a period of 24 hours to 6 days, then all those charges will be on owners account; and lastly, any compensation for non-adherence to loading or breakdown of the vessel loss/ damage, the compensation is calculated on the basis of ocean freight charges.

Thus, the Tribunal opined that 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.

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".

The ITAT denied to apply the observation passed by the High Court in the case of Poompuhar Shipping Corporation (2013) as in the present case, 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 Case.

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.