Taxation of International Transactions V. Vikram, Advocate M/s Subbaraya Aiyar, Padmanabhan &...

Taxation of International Transactions

V. Vikram, AdvocateM/s Subbaraya Aiyar, Padmanabhan & Ramamani (S.A.P.R) Advocates

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http://www.saprlaw.com/

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Agenda

Part I : Introduction to International TaxationPart II : Two spheres of International taxationPart III: Indian Income Tax Act vs. DTAAPart IV: Business connection / PE

Section 9(1)(i) and Article 7 r.w. Article 5Part V : Royalty

Section 9(1)(vi) and Article 12

Agenda…..

Part VI : FTS Section 9(1)(vii) and Article 12/13Part VII : TDS provisions S.40(a)(i), S.201(1) Part VIII : Transfer Pricing (TP)

Introduction to TP & CHAPTER X

Part I. Introduction to Part I. Introduction to International TaxationInternational Taxation

Introduction to International Taxation

• Money flow between India and abroad is enormous

• Key question to always keep in mind:– “How is the taxation pie shared?” (between the

countries)– Each country will naturally want their share

enhanced and there in lies the rub….

• Treaties are negotiated to arrive at sharing of rights

Part II. Two Spheres of Part II. Two Spheres of International TaxationInternational Taxation

Two spheres of International Taxation

• Indian Income Tax Act – Section 5 – scope of total income– Section 9 – deeming provision

• Double Tax Avoidance Agreements– Notified Treaties of India with various Countries– Based on OECD/UN/US Model conventions,

mutually negotiated between Countries– Source vs. Residence country taxation rights

International Taxationunder Indian IT Act

• Section 5, both for residents in sub-section (1) and for non-residents in sub-section (2),brings within the fold of chargeable total income, all income which is – Received or is deemed to be Received in India or– Accrues or Arises or is deemed to Accrue or Arise

in India to the assessee in particular previous year

International Taxation under Indian IT Act(Section 9 – an Introduction)

• Section 9 of the Act defines the term "Income deemed to accrue or arise in India". – There are certain income, which generally remains

outside the scope of taxable income, by virtue of section 9 comes within the ambit of taxation. Classic example of “deeming provision”

– CIT v R.D.Aggarwal & Co. and others 56 ITR 20 (SC) - it must in all cases be remembered that the fiction embodied in section 9 does not apply to the income which actually accrues or arises to the assessee in India.

Section 9 – An Introduction

• Similar views has been expressed in case of• Sakalchand Babulal v ITO 47 ITR 673 (Mad)• Annamalais Timber Trust & Co. v CIT 41 ITR 781 (Mad),• Turner Morrison & Co. Ltd. v CIT 23 ITR 152 (SC)• Hira Mills Ltd. v ITO 14 ITR 417 (All) and • Anglo-French Textile Company Ltd. v CIT 25 ITR 27 (SC).

– The income which has been included in the total income of a person on the basis that it has accrued or arisen or deemed to have accrued or arisen shall not again be included on the basis that it is received or deemed to be received by him in India.

Section 9 – An Introduction

• Section 9 enumerates various categories of income which shall be deemed to accrue or arise in India under certain circumstances. – The income dealt with in each clause is distinct and

independent of the other. – In case of specific class of income one must look at

the specific clause and not to general provisions of clause (i).

– Meteor Satellite Ltd. v ITO 121 ITR 311 (Guj) – CIT v Copes Vulcan Inc. 167 ITR 884 (Mad)

International Taxationunder the DTAA’s

• The genesis of individual DTAA’s or Treaties are from the Model Conventions (MCs)– The OECD Model Convention, the US Model

Convention and the UN Model Convention– All Model Conventions, and hence DTAA’s,

consists of a number of Articles with each Article

• In this talk we are concerned with Article 12 (Royalties & FTS) and also Article 7 (Business Profits) r.w. Article 5 (PE)

Articles of Model ConventionChapter Article Topic covered

Chapter I : Scope of Convention

Article 1 Persons covered

Article 2 Taxes covered

Chapter II : Definitions Article 3 Definitions

Article 4 Residence

Article 5 Permanent Establishment

Chapter III : Taxation of Income

Article 6

Article 7 Business Profits

Article 8 Shipping & air transport

Article 9 Associated Enterprises

Article 10 Dividends


Chapter III: Taxation of Income (contd.)

Article 11 Interest

Article 12 Royalties & Fees for Technical Services

Article 13 Capital Gains

Article 14 Independent Personal Services

Article 15 Dependent Personal Services

Article 16 Director’s Fees

Article 17 Artistes and sportsmen

Article 18 Pensions

Article 19 Government service

Article 20 Students

Article 21 Other Income


Chapter III: Taxation of Income (contd.)

Article 22 Capital

Chapter IV: Methods for the elimination of double taxation

Article 23 Method for elimination of double taxation (tax credit / exemption)

Chapter V : Special Provisions

Article 24 Non-discrimination

Article 25 Mutual Agreement Procedure

Article 26 Exchange of Information

Article 27 Assistance in collection of taxes

Article 28 Diplomatic mission

Chapter VI: Final Provisions Article 29 Entry into force

Article 30 Termination


• Typically income of non-resident is its business income i.e., Article 7 – If it is rendered through a P.E in India then Article 7 r.w. Article

5 applies• However, if income of non-resident has specific character such

as Royalty or FTS etc. , then those specific Articles apply and not Article 7– This is enshrined in Article 7 itself i.e., Article 7(4) which states“Where profits include items of income which are dealt with

separately in other Articles of this Convention, then the provisions of those Articles shall not be affected by the provisions of this Article”


• Similarly we jump out of Article 12 into Article 7 r.w. Article 5 if there is a P.E involved in providing the Royalties or Fees for Technical Services.

– This is enshrined in Article 12 itself i.e., Article 12(3) which states

“The provisions of paragraph 1 shall not apply if the beneficial owner of the royalties, being a resident of a Contracting State, carries on business in the other Contracting State in which the royalties arise through a permanent establishment situated therein and the right or property in respect of which the royalties are paid is effectively connected with such permanent establishment. In such case the provisions of Article 7 shall apply”

Part III. Indian Income Tax vs. DTAAPart III. Indian Income Tax vs. DTAA

Indian Income Tax Act vsDTAA

• Section 90(2)“(2) Where the Central Government has entered into an

agreement with the Government of any country outside India or specified territory outside India, as the case may be, under sub-section (1) for granting relief of tax, or as the case may be, avoidance of double taxation, then, in relation to the assessee to whom such agreement applies, the provisions of this Act shall apply to the extent they are more beneficial to that assessee”

Income Tax Act vs. DTAA

• In case of conflicting provisions between DTAA and Act, the more beneficial to the assessee can be taken– Confirmed by numerous judgments including

• UoI vs. Azadi Bachao Andolan [263 ITR 706 SC]• CIT vs. Davy Ashmore India Ltd. [190 ITR 626 Cal.]• CIT v. Visakhapatnam Port Trust [144 ITR 146 (AP)]

– Also refer CBDT Circular 333 dated 1982

Part IV. Business connection / PEPart IV. Business connection / PESection 9(1)(i)Section 9(1)(i)

Section 9(1)(i)

Income deemed to accrue or arise in India.9. (1) The following incomes shall be deemed to accrue or arise in India :—

(i) all income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India.

[Explanation 1].—For the purposes of this clause—(a) in the case of a business of which all the operations are not

carried out in India, the income of the business deemed under this clause to accrue or arise in India shall be only such part of the income as is reasonably attributable to the operations carried out in India;

b) in the case of a non-resident, no income shall be deemed to accrue or arise in India to him through or from operations which are confined to the purchase of goods in India for the purpose of export ;

The Vodafone case• Issues:

– Taxability over Capital Gains on an overseas transaction between 2 foreign companies (having non residential status in India) of sale of investments comprising of shares of an Indian Company;

– Withholding Tax obligations of the Non Resident Buyer while making payment of lump sum consideration to Non Resident Seller

• Facts of the Case – Vodafone International Holdings BV, Netherlands (“VIH“) entered into a Share

Purchase Agreement with Hutchison Telecom, Cayman Islands for purchasing equity shares of its subsidiaries CGP, Cayman Islands

– CGP in turn, directly and indirectly, owned ~52% share capital of Indian Company named as Hutchison Essar Limited (“HEL"). The acquisition meant VIH acquired control over CGP and subsidiaries, including HEL

– The Revenue Authorities held that the gains were taxable in India as there was transfer of controlling stake / business situated in India and accordingly alleged failure on part of VIH to withhold tax on gains arising to HTIL on the transfer of shares of CGP

Vodafone judgment synopsis• The transaction for transfer of shares of a Foreign Company (though directly

or indirectly holds shares of an Indian Company) between two non-residents on principal to principal basis abroad cannot be deemed as “Transfer of Capital Asset” situated in India and accordingly, cannot result into levy of capital gains tax in India.

• The provisions of Section 9 of Act will be attracted only when capital asset• is located / situated in India.• The transaction should not be structured in a manner for avoidance of income

tax. The investment structure should be examined and seen in a holistic manner.

• The lumpsum consideration for purchase of an entire investment cannot be allocated or dissected in order to calculate the value of specific rights and entitlements.

• The withholding tax obligations in India would arise only when such income is taxable in India

Vodafone judgment – Retrospective Amendments in Finance Act 2012

• Explanation 4 has been inserted in section 9(1) (i), w.e.f. A.Y. 1962-63 to clarify that the expression ‘through’ (used in section 9(1) (i) in relation to any asset or source of income in India) shall mean and include and shall be deemed to have always meant and included “by means of”, “in consequence of” or “by reason of”

• Explanation 5 has been inserted in section 9(1)(i), w.r.e.f. A. Y. 1962-63 to clarify that an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be and shall always be deemed to have been situated in India if the share or interest derives, directly or indirectly, its value substantially from the assets located in India.

• Consequent to insertion of above explanations, the following explanations have also been added to clarify the meaning of (a) “capital asset” given in section 2(14), (b) “transfer” given in section 2(47) and (c) to widen the scope of section 195(1).

Sanofi Pasteur Holdings SA vs. Dept. of Revenue, GOI(WP 1421 of 2010 dated 15-02-2013, Andhra HC)

• Two French companies named “Murieux Alliance” (‘MA’) and “Groupe Industrial Marcel Dassault” (“GIMD”) held shares in another French company named “ShanH”.

• MA & GIMD acquired shares in an Indian company named “Shantha Biotechnics Ltd” (“Shantha”). The shares in Shantha were transferred to ShanH.

• MA and GIMD subsequently sold the shares in ShanH to another French company named “Sanofi Pasteur Holding”.

• The assessees filed an application for advance ruling claiming that as the two French companies had sold the shares of another French company to a third French company, the gains were not chargeable to tax in India.

• AAR upheld Dept.’s plea and on appeal AP High Court held in favour of assessee that no capital gains was chargeable to tax in India under India-France Treaty, even after Amendments to S.9(1)

Sanofi Pasteur Holdings SA vs. Dept. of Revenue, GOI

• Article 14(5) of the India-France DTAA which exempts capital gains from shares representing more than 10% holding from tax in India does not permit a see through on whether the alienation of shares by ShanH is an alienation of the control, management or assets of the Indian company. It cannot be said that an actual alienation of the ShanH shares amounts to a deemed alienation of the Indian company’s shares.

• The fact that the value of the shares of ShanH was because of the value of the Indian company’s assets is irrelevant;

• The retrospective amendment to s. 9(1) so as to supersede the verdict in Vodafone International and to tax off-shore transfers does not impact the provisions of the India-France DTAA because the DTAA overrides the Act

• Hence no capital gains chargeable to tax in India and hence no withholding required

Payments to Foreign Commission Agents(u/S.9(1)(i))

CBDT Circular No.23 of 1969 dt 23.07.1969 – A foreign agent of Indian exporter operates in his own country and no

part of his income arises in India.– His commission is usually remitted directly to him and is, therefore,

not received by him or on his behalf in India.– Such an agent is not liable for income tax on this commission.

CBDT Circular No.786 dated 07.02.2000 The deduction of tax at source under s.195 would arise if the payment

of commission to the non-resident agent is chargeable to tax in India– In this regard attention to CBDT Circular No. 23, dated 23rd July, 1969

is drawn. It had been clarified then that where the non-resident agent operates outside the country no part of his income arises in India.

Such payments were therefore, held to be not taxable in India.

Payments to Foreign Commission Agents

CIRCULAR NO. 7 OF 2009, DT. 22ND OCT., 2009 Withdrawal of Circular No. 23 dated 23rd July, 1969, No. 163

dated 29th May, 1975 and No. 786 dated 7th February, 2000 Withdrawal of Circular does not change the statute!

Assuming there is ‘business connection’ between principal and foreign agent, there can be no “attribution of income to operations carried out in India” as per Explanation 1 to S.9(1)(i) . In other words there is no PE of foreign agent in India

Income not taxable in India and is business profits under Article 7. Hence no TDS ought to be necessary

Payments to Foreign Commission AgentsCase Laws

• CIT v Toshoku Ltd (125 ITR 525, SC) the Hon’ble Supreme Court held that when a non-resident, with no operation of business in India, rendered services outside India to an Indian concern , then provisions of Section 9 of the I.T Act 1961 are not attracted.

• CIT vs. Eon Technology (P) Ltd – 343 ITR 366 wherein the Hon’ble Delhi High Court has held that foreign commission agent payments do not require tax withholding

• CIT vs. Sheraton International Inc ((2009) 313 ITR 267) where the Delhi High Court has reversed the order of Tribunal by holding that the main service rendered by the U.S Company to Indian company was advertisement, publicity and sales promotion and these would neither fall under the category of ‘Royalty’ nor ‘Fees for Technical Service’


• CIT vs Indopel Garments (P) Ltd. Vs DCIT (2001 72 TTJ Mad 702) where ITAT Chennai held no disallowance under s. 40(a)(i) could be made for commission payment to foreign concern without acting as a selling agent of assessee for canvassing orders outside India

• DCIT vs. Ardeshi B. Cursetjee & Sons Ltd (2008 115 TTJ Mumbai 916) where ITAT Mumbai held commission payment made to non-resident for services rendered outside India not being chargeable to tax in India could not be disallowed under Section 40(a)(i)

• JCIT vs. George Williamson (Assam) Ltd. (2009 116 ITD 328) where in the ITAT Guwahati Bench held that with respect to payment of selling commission, brokerage and other related charges to non-resident agents in respect of sale of tea outside India, no income had accrued or arisen in India either under Section 5(2) or under Section 9 and therefore no tax was deductible under Section 195.


• TVS Motor Company vs. ACIT (ITA Nos.697 &757/Mds/2009) where the ITAT Chennai in an order dated 22nd December 2010, amongst other issues, has affirmed that export commission payments made to non-resident agents will not be liable to tax deduction at source and disallowance u/s 40(a)(i) is to be deleted

• DCIT vs. Sanjiv Gupta (2011 135 TTJ Lucknow 641) where the ITAT Lucknow had held that disallowance under Section 40(a)(i) for the A.Y 2007-08 on the commission payments made to non-residents was not called for as the withdrawal of Circulars 23 of 1969 and 786 of 2000 by Circular 7 of 2009 dated 22-10-2009 was only operative from the date of issue of Circular 7 and did not have retrospective effect

PE under the Act(u/S.9(1)(i))

• Concept of “business connection” was explained in CIT vs. R.D.Agarwal (56 ITR 120)“The expression ‘business connection’ undoubtedly means something more than ‘business’. The expression ‘business connection’ postulates a real and intimate relation between the trading activity carried on outside the taxable territories and the trading activity within the territories, the relation between the two contributing to the earning of income by the non-resident in the trading activity”

• “Reasonably attributable to operations in India” means attributable to Permanent Establishment (PE) in India–PE defined in Act u/s S. 92F(iiia) as "permanent establishment", referred to in clause (iii), includes a fixed place of business through which the business of the enterprise is wholly or partly carried on”

PE under the DTAA(Article 5)

• Article 5 of MC’s and India’s Treaties deals with Permanent Establishment• Article 5(1) “For the purposes of this Convention, the term “permanent

establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on.”

• Article 5(2). “The term “permanent establishment” includes especially: • (a)A place of management;• (b)A branch;• (c)An office;• (d)A factory;• (e)A workshop;• (f)A mine, an oil or gas well, a quarry or any other place of extraction of

natural resources.”


• Article 5(3) “3.The term “permanent establishment” also encompasses:

(a) A building site, a construction, assembly or installation project or supervisory activities in connection therewith, but only if such site, project or activities last more than six months;

(b) The furnishing of services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose, but only if activities of that nature continue (for the same or a connected project) within a Contracting State for a period or periods aggregating more than 183 days in any 12-month period commencing or ending in the fiscal year concerned”

• Certain Treaties also define “Service” PE’s , Dependent Agent PE’s (DAPE’s) , “force of attraction” clauses etc. - highly litigated area!


• Note that for a PE, the income minus expenses i.e., net income is taxable (as opposed to say Royalty or FTS where withholding is on gross receipts)

• The Andhra Pradesh High Court, in CIT v. Visakhapatnam Port Trust(144 ITR 146), held that:"The words "permanent establishment" postulate the existence of a substantial element of an enduring or permanent nature of a foreign enterprise in another country which can be attributed to a fixed place of business in that country. It should be of such a nature that it would amount to a virtual projection of the foreign enterprise of one country into the soil of another country.“

Part V. RoyaltyPart V. Royalty

Royalty under the Act

Section 9(1)(vi) – Royalty under IT Act

• The key part of the Royalty sub-section is

the Explanation 2 which defines Royalty

• Similar, not identical, to the Model

Convention definition found in Article 12(2)

and the definition in various Treaties

• Bottomline: Every word matters (!!) in the

Royalty definition as we will find out…..

Explanation 2 – Definition of Royalty“”“Explanation 2.—For the purposes of this clause, "royalty" means

consideration (including any lump sum consideration but excluding any

consideration which would be the income of the recipient chargeable

under the head "Capital gains") for—

(i) the transfer of all or any rights (including the granting of a licence) in

respect of a patent, invention, model, design, secret formula or process or

trade mark or similar property ;

(ii) the imparting of any information concerning the working of, or the

use of, a patent, invention, model, design, secret formula or process or

trade mark or similar property ;

Explanation 2 (contd..)(iii) the use of any patent, invention, model, design, secret formula or process or trade

mark or similar property ;

(iv) the imparting of any information concerning technical, industrial, commercial or

scientific knowledge, experience or skill ;

(iva) the use or right to use any industrial, commercial or scientific equipment but not

including the amounts referred to in section 44BB;

(v) the transfer of all or any rights (including the granting of a licence) in respect of any

copyright, literary, artistic or scientific work including films or video tapes for use in

connection with television or tapes for use in connection with radio broadcasting, but not

including consideration for the sale, distribution or exhibition of cinematographic films ; or

(vi) the rendering of any services in connection with the activities referred to in sub-clauses

(i) to (iv), (iva) and (v)

Royalty CasesTOPIC – (AREA OF DISPUTE) ROYALTY CLAUSE

Payments for off-the-shelf software Explanation 2, clause (i)

Payments for online access to databases (journal subscriptions, magazines etc.)

Explanation 2, clause (i)

Fees for use of Satellite Explanation 2, clause (iii), (iv), (iva)

Payment for leased line / internet connectivity Explanation 2, clause (iii), (iv), (iva)

Payment for know-how, designs, drawings Explanation 2, clause (i), (iv), (vi)

Divisibility of contracts, Composite Agreements Explanation 2

Payment for off-the-shelf software• A highly controversial and litigated issue in recent

times!!• The Department takes view that “the transfer of all or any

rights (including the granting of a licence)” includes the right to use by the purchaser and hence these are Royalty payments and not business profits

• The taxpayers argue that purchase of such software is like buying a book off the shelf and is akin to a sale. When one buys a book, one buys a copyrighted article (i.e., the copyright is embedded in the article which has been bought) and there is no transfer of copyright itself.

Payment for off-the-shelf software• In other words, one buys a book (or software) and reads it

(or uses it) and has no permission to re-print or reproduce it further for commercial use and hence the payment for such book (or software) cannot be termed as Royalty but merely a payment for buying the book (or software).

• The fact that software tends to have End-User License Agreements (EULA) which are boilerplate contracts does not change the substance of the issue in question that the transfer is of the copyrighted article and not the transfer of copyright itself.

• That a backup copy of the software can be made to use in case of emergencies comes under fair use

Payment for off-the-shelf software• SECTION 14 of the COPYRIGHT ACT, 1957 states:

“14. Meaning of copyright.— For the purposes of this Act, “copyright” means the exclusive right subject to the provisions of this Act, to do or authorize the doing of any of the following acts in respect of a work or any substantial part thereof, namely:—

(a) in the case of a literary, dramatic or musical work, not being a computer programme,—

(i) to reproduce the work in any material form including the storing of it in any medium by electronic means; (ii) to issue copies of the work to the public not being copies already in circulation;(b) in the case of a computer programme,— (i) to do any of the acts specified in clause (a); (ii) to sell or give on commercial rental or offer for sale or for commercial rental any copy of the computer programme:Provided that such commercial rental does not apply in respect of computer programmes

where the programme itself is not the essential object of the rental”

Payment for off-the-shelf software• Tata Consultancy Services Vs. State of AP (271 ITR 401 SC)

• Issue was whether branded software amounts to “goods” (for sales tax). The court held that the moment copies are made and marketed, it becomes goods, which are susceptible to sales tax

• Motorola Vs. DCIT (2005) 96 TTJ Delhi 1 (SB)• An important decision where software supplied was a copyrighted article and not

a copyright right the payment received by the assessee in respect of the software cannot be considered as royalty either under the Income tax Act or the DTAA. ‐

• Lucent Technologies Hindustan Ltd. Vs. ITO (120 TTJ (Del.) 929)• Software was such that it was customized for each of the machines imported and

could not have been duplicated for commercial purpose. The contract also forbids the assessee from copying the software. No copyright in the software could be said to have accrued to assessee

Payment for off-the-shelf software IMPORTANT decision in CIT Vs. Samsung Electronics Co. Ltd. & Others

(245 CTR (Kar) 481) where in Karnataka HC has upheld the view of the

Revenue Department that the payments for off- the-shelf software to

non-residents is Royalty and hence liable to withholding of taxes in India.

Samsung(supra) is a controversial decision for both S.195(2) as well as

Royalty for payment to acquire software

Overturned multiple decisions wherein the Tribunals and Courts have

upheld the distinction between ‘copyright’ and ‘copyrighted article’

and decided in favour of the assessee saying payments made for

shrink-wrapped licensed software not to be characterized as Royalty

Payment for off-the-shelf software(Samsung decision - Karnataka HC)

“Accordingly, we hold that right to make a copy of the software and

use it for internal business by making copy of the same and storing the

same in the hard disk of the designated computer and taking back up

copy would itself amount to copyright work under s. 14(1) of the Act

and licence is granted to use the software by making copies, which

work, but for the licence granted would have constituted infringement

of copyright and licencee is in possession of the legal copy of the

software under the licence. Therefore, the contention of the learned

senior counsel appearing for the respondents that there is no transfer

of any part of copyright or copyright and transaction only involves sale

of copy of the copyright software cannot be accepted……”

Payment for off-the-shelf software The Delhi Tribunal in Gracemac Vs. ADIT 134 TTJ (Del) 257 held that :

The term ‘copyrighted article’ is not defined anywhere OECD Commentary

and would not be a correct guide for interpreting domestic provisions

TCS case (supra) was in context of sales tax

The amended definition of Royalty in the domestic provisions of the Act

will override any Treaty definition (relied on Gramophone Company Vs.

V.B. Pandey (AIR 1984 SC 667))

The Mumbai Tribunal in ADIT Vs. TII Team Telecom International (60 DTR

177) considered the Gracemac decision (supra) in detail and arrived at a

contrary conclusion stating that the software payments were not Royalty

PAYMENTS FOR ONLINE ACCESS TO DATABASE (SUBSCRIPTIONS)

• The key issue here is whether the payments received for the subscription access to an online database, reports, journal, e-zine etc. came under the ambit of Royalty and hence deemed to be taxable in India.

• This issue has been consistently litigated in various Tribunals and Courts with disparate results. Few decisions below:

CIT Vs. HEG Ltd. (263 ITR 230 MP High Court) :

• Payment for a compilation of technical information (“Carbon databank”) to a US company cannot be construed as Royalty.

• In order to withhold tax on payments for information received, the information should have some special features and should not merely be of a pure commercial nature.

Payment for online access to database (subscriptions, journals etc.)


• Similar view was taken by Tribunal in :

• Gartner Ireland Ltd v. DDIT (ITA No. 452/Mum/08 )

• TIS Two Administration(Sing.) Pte Ltd. vs. DDIT (Mumbai ITAT)

• Hughes Escort Communications Ltd. (HECL) vs. DCIT (21

taxmann.com 171)

• Another well-considered decision was Wipro Ltd. Vs. ITO [2004]

278 ITR 57 (Bang. ITAT) which held that annual subscription for

providing access to database through the web by US company is

not information or advice given individually and cannot be

considered as Royalty.



• However post-Samsung decision, the Karnataka High Court in

Wipro’s case (203 Taxmann 621) reversed decision of ITAT and

held:• Though subscription access to journal may seem different from

software licence, it is in fact nothing but a licence to use ('right to use') the journal and it will come under S.9(1)(vi) of Act!

• Note also decision of the AAR in Cargo Community Network Pte

Ltd (289 ITR 355 AAR) held that payments for online access to

travel portal is Royalty


• The key issue is whether the payments received for the use of

satellite were taxable as royalty under Section 9(1)(vi) .

• Explanation 2 Clauses (iii), (iv) and (iva) have all been

variously used to fight over this issue;

• The main questions to be answered are:

• Whether the use of the satellite is a “process”?

• Whether the use of a satellite transponder for uplinking

and downlinking is a use of (or right to use of) commercial,

industrial or scientific equipment.

Fees for use of satellite – Whether royalty?

• Asia Satellite (85 ITD 478 Delhi ITAT) :

• Receipts were taxable as Royalty having been paid in respect of

a “process” as envisaged in Section 9(1)(vi)(iii).

• This decision was also applied in ACIT Vs. Sanskar Info. TVP

Ltd. (24 SOT 87 Mumbai ITAT)

• However, in DCIT Vs. PanAmSat International Systems Inc. (9 SOT 100) it was held that :

• The term “royalty” in Art. 12 of the India-USA DTAA has a ‘comma’ after the words “secret formula or process”!

• it was only a ‘secret process’ which would qualify as royalty and not what was provided by the assessee.


• The Delhi Special Bench in New Skies Satellite N.V. Vs. ADIT (319 ITR

269) was constituted to resolve the conflict and held reversing the

PanAmSat decision (supra) that :

• The transponder provision through which uplink and downlink

happens in the desired area is a “process”

• To constitute “royalty”, it is not necessary that the process should

be a “secret process”.

• The fact there is a ‘comma’ after the words “secret formula or

process” in the DTAA does not mean that a different interpretation

has to be given to the DTAA as compared to Act

• To be Royalty it is not necessary that the instruments through which

the process is carried on should be in the possession of the payer.


Subsequently, the Delhi High Court in Asia Satellite

Telecommunications

Co. Vs. DIT (332 ITR 340) has held that :

• NO income is deemed to accrue in India from use of satellite

outside

India to beam TV signals into India even if bulk of revenue

arises due to

viewers in India

• The satellite was used by the assessee for providing services to

its

customers

•There is a well known distinction between “lease of equipment”

and

“use of equipment” (ISRO Satellite Centre vs. DIT (307 ITR

59 (AAR))

• The transponder was in orbit and merely because its footprint

was on

India did not mean that the “process” had taken place in India

• OECD and Klaus Vogel commentaries stating that the use of a

satellite

is a service and not a rental cannot be discarded because the

technical

terms in the DTAA are the same as that in s. 9(1)(vi)


• The key issue here is regarding the payment for dedicated internet

connectivity typically via ‘leased line’ or dedicated circuits or VSAT

(via uplink/downlink) by a non-resident telecom provider.

• Similar to the issue surrounding lease of transponder as the question is

whether there is a use of process and/or use of scientific, commercial or

industrial equipment.

Moreover, in this issue there is significant overlap between the FTS and

Royalty issues because the Revenue’s contention has been two-fold –

That there is a technical service provided by the telecom provider to the

assessee (AND)

That payment is for a process and the payment is for the use of industrial,

commercial or scientific equipment.

Payment for leased line/ connectivity charges

• Infosys Technologies Ltd. Vs. DCIT (139 TTJ (Bang.)(UO) 18) :

• Payment towards bandwidth charges is not use of or right to use

of industrial, commercial or scientific equipment.

• Wipro Ltd. Vs. ITO (80 TTJ (Bang.) 191) :

• Held that payment for transmission of data and software through

uplink and downlink services is not Royalty as no process has

been made available to the assessee and Explanation 2 clause (iii)

cannot apply.

• Dell International Services India (P) Ltd., In Re (305 ITR 37

AAR) hed that providing telecom bandwidth by US company does not

mean “the use or right to use any industrial, commercial or

scientific equipment” and under the DTAA the term ‘secret’ covers

both formula and process and there is no secret process here used by

the applicant.


• However in Verizon Communications Singapore Pte Ltd. Vs. ITO

(45 SOT 263 ITAT Chennai),

• The Tribunal in a very elaborate decision came to the conclusion that

the payment for providing international connectivity services is

Royalty under both Act and DTAA as it is for the use of ‘process’.

• The same has been approved by the Madras High Court in Verizon’s case on

7th Nov, 2013 and the Court has held that:

“In the circumstances, we affirm the order of the Tribunal holding that the

consideration paid by the customer to the assessee is ‘royalty’ within the

meaning of Explanation 2(iva) or in the alternative under Explanation 2(iii) of

Section 9(1)(vi) of the Income Tax Act and Article 12(3) of the DTAA between

India and Singapore.”


• The difference between Sale and Royalty transaction is based on

whether the sellor/licensor retains the ownership rights in the

property being sold/licensed i.e., is it an outright sale or does it fall

under one of the Royalty clauses in Explanation 2 ?

• CIT Vs. Davy Ashmore India (190 ITR 626) : Sale of know-how cannot

be taxed as royalty

• Pro-Quip Incorporation Vs. CIT (255 ITR 354) : Royalty payment must

be in respect of a right to use designs and drawings, and not for the

purchase thereof.

Payment for know-how, designs, engg. drawings etc.

• CIT Vs. Klayman Porcelains Ltd. (229 ITR 735 AP HC) : Amount paid by

Indian company to the non-resident company as payment for technical

drawings towards engineering for a kiln would not amount to

imparting any information concurring the working of, or the use of

patent, invention, model, design, secret formula or process and hence

will not constitute Royalty under Section 9(1)(vi) of the Act

• CIT Vs. Magronic Devices (P) Ltd., 329 ITR 442 HP HC : The foreign

company was to supply plant know-how and product know-how.

Agreement was concluded & data was delivered abroad. High Court

held that the transaction was that of a sale, hence, no income could be

deemed to accrue or arise to non-resident.


• ADIT Vs. Zimmer AG (2008 22 SOT 97 Kol) :

• Engineering documents were handed to the Indian

purchaser company SAPL by the German assessee

company outside India under a ‘Know-how and

Engineering Agreement’

• These documents were an integral part of plant and

machinery and the transfer of engineering was complete

with the handover of the documents

• The payment for these documents could not constitute

Royalty under the Act or the DTAA as the German

assessee sold and transferred ownership, title and risk in

the engineering documents to SAPL at Germany for

consideration paid outside India


• However, the Chandigarh ITAT in DCIT Vs. Majestic Auto Ltd.

(51 ITD 313 (CHD)) took a contrary view and held that

payment for supply of drawings, designs etc. was taxable as

Royalty.

• ITAT Calcutta Bench in Union Carbide Corporation Vs.

Inspecting ACIT (50 TTJ (Cal) 535) held that :

• The words “similar property” in clauses (ii), (iii) and (iv) of

Explanation 2 to Section 9(1)(vi) do not require, to

constitute ‘royalty’, that there should be any legally

protected right and these words include specialized

information and knowledge

• In other words, the absence of copyright or patent or one-

time parting with information does not mean the payment

cannot be Royalty under Explanation 2 to Section 9(1)(vi).


• In many cases contracts between parties are such that a number of

activities are carried both offshore and onsite and are essentially

turnkey or EPC contracts.

• The issues relating to Royalty might be with respect to only one or

few components of the overall contract. The agreements and facts of

each contract are important

• The key takeaway is that if it is a composite, indivisible contract the

entirety of the transaction ought to be taken. If there are divisible,

identifiable parts, it is likely for the Revenue and the Courts thereafter

to call for the contract parts to be split and taxed independently on

their individual merits.

Divisibility of Contracts, Composite Agreements and Royalty

• CIT Vs. Neyveli Lignite Corporation Ltd. (243 ITR 459

Mad HC) :

• The Court held amount paid by assessee to foreign

company under a comprehensive contract for design,

manufacture, supply, erection and commissioning of

machinery not involving a transfer of any licence or patent,

invention, model or design could not be regarded as

Royalty under the Act

• CIT Vs. DCM Ltd. 336 ITR 599 :

• Delhi High Court held that payment to UK non-resident for

comprehensive technical know-how on non-exclusive basis

and

supply of equipments with a right to sub- license the

technology

and know-how subject to the approval of the non-resident

is not

Royalty under Explanation 2 to Section 9(1)(vi).


• DIT Vs. Ericsson A.B (204 Taxman 192 Delhi HC) :• The supply contract of a non-resident to an Indian company

of a “GSM system” including hardware and software is not divisible separately so as to tax the software component as Royalty

• The definition of Royalty in the India-Sweden DTAA (Article 13(3)) is narrower than the Act and has to be considered. No part of the payment can be classified as Royalty.

• It affirmed the decision of Special Bench in Motorola Inc. Vs. DCIT (96 TTJ Del(SB) 1)

• Roxair Maximum Reservoir Performance WLL (AAR 977/2010) :

• The contract should be looked at as a whole and not “looked through” following the Vodafone International Holdings BV case (345 ITR 1 SC).


• Raytheon Company Vs. DCIT 142 TTJ (Del) 137 :

• In a turnkey project for supply and installation of equipment, composite contract could be conveniently segregated into different components (milestones)

• Supply of equipment and software were taxable in the year prior to relevant year as it was earlier milestone but installation contract/services milestone profits were taxable in current year

• Ansaldo Energia Spa Vs. IT (2009-TIOL-62-HC-MAD-IT) :

• The Madras HC held that the four contracts which the assessee entered into with Indian JV company under single-bid system were to be consolidated and read as single composite contract and the divisibility into 4 contracts for tax was incorrect!

Divisibility of Contracts, Composite Agreements & Royalty

Amendments made to S.9(1)(vi)• Important amendments made to Section 9(1)(vi) over time starting with Finance Act

2001 up to current Finance Act 2012

• Finance Act 2001 amendment

– W.e.f. 1-4-2002, clause (iva) was added to Explanation 2 to read as follows: “(iva)

the use or right to use any industrial, commercial or scientific equipment but not

including the amounts referred to in section 44BB”

– Use or right to use any equipment is not found in the UN and US MC and the OECD

MC also deleted the same in the early 1990’s.

– However India’s treaties do have this clause present though the India-US, India-UK

and India-Singapore treaties provides exclusion clauses for Article 8 related

transactions.

Amendments made to S.9(1)(vi)Finance Act 2010

• In Finance Act 2010, w.e.f 1-6-1976, an Explanation was added which applied to

both Royalties and Fees for Technical Services which read:

“Explanation.—For the removal of doubts, it is hereby declared that for the

purposes of this section, income of a non-resident shall be deemed to accrue or

arise in India under clause (v) or clause (vi) or clause (vii) of sub-section (1) and

shall be included in the total income of the non-resident, whether or not,—

(i) the non-resident has a residence or place of business or business

connection in India; or

(ii) the non-resident has rendered services in India.”


• Finance Act 2012, w.e.f 1-6-1976

Explanation 4.— For the removal of doubts, it is hereby clarified

that the transfer of all or any rights in respect of any right,

property or information includes and has always included transfer

of all or any right for use or right to use a computer software

(including granting of a licence) irrespective of the medium

through which such right is transferred


• Finance Act 2012, w.e.f 1-6-1976

Explanation 5.—For the removal of doubts, it is hereby clarified that

the

royalty includes and has always included consideration in respect of any

right, property or information, whether or not—

(a) the possession or control of such right, property or information

is with the payer;

(b) such right, property or information is used directly by the payer;

(c) the location of such right, property or information is in India.


• Finance Act 2012, w.e.f 1-6-1976

Explanation 6.—For the removal of doubts, it is hereby clarified that the

expression "process" includes and shall be deemed to have always included

transmission by satellite (including up-linking, amplification, conversion

for down-linking of any signal), cable, optic fibre or by any other similar

technology, whether or not such process is secret;

These retrospective amendments have been introduced in the Finance

Act 2012 w.e.f 1-6-1976 i.e., the start of the Royalty chapter.


• These amendments came after a number of decisions (we have

seen already!) to nullify their effect

• With these amendments, the definition of Royalty under OECD MC

and Prof.Klaus Vogel’s treatise differs from India’s stance on Royalty

• OECD TAG Report specifically sets down criteria which have been

addressed by Explanation 5

• India is the only country which has reservations against so many of

the updated Model Commentary paragraphs under Article 12

Responding to the outcry from the industry, the CBDT has issued a

Circular F. No. 500/111 12009-FTD-l (Pt.) dated 29th May 2012:

“The Finance Act 2012 has introduced certain clarificatory amendments

in Section 2 clause (14), Section 2 clause (47), Section 9 and Section 195,

of the Income Tax Act, 1961 (“Act”), with retrospective effect from

01.04.1962 or 01.04.1976, whereby meaning of various terms used in

these sections have been clarified in order to remove any doubt regarding

their interpretations.

2. These amendments have been introduced retrospectively in order to

clarify the legislative intent and state the position of law from the date of

coming into effect of these sections in the Act


…

4. The Board, after due consideration, hereby directs that in case

where assessment proceedings have been completed under section

143(3) of the Act, before the first day of April, 2012, and no notice for

reassessment has been issued prior to that date; then such cases shall

not be reopened under Section 147/148 of the Act on account of the

abovementioned clarificatory amendments introduced by the Finance

Act, 2012. However, assessment or any other order which stand

validated due to the said clarificatory amendments in the Finance Act

2012 would of course be enforced…”

Royalty under DTAA’s

OECD MC US MC UN MC1. Royalties arising in a Contracting State and beneficially owned by a resident of the other Contracting State shall be taxable only in that other State.

1. Royalties arising in a Contracting State and beneficially owned by a resident of the other Contracting State may be taxed only in that other State.

1. Royalties arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that Other State. However, such royalties may also be taxed in the ContractingState in which they arise and according to the laws of that State, but if the beneficial owner of the royalties is a resident of the other Contracting State, the tax so charged shall not exceed ___ per cent (the percentage is to be established through bilateral negotiations) of the gross amount of the royalties

Royalty (Article 12) of Model Conventions

• The OECD and US MCs are much the same in substance .

• Both exclude the Source State’s right to tax. Under these models, the

Licensor’s State of Residence alone is entitled to tax Royalties

• On the other hand, the UN MC allows the Source State to impose tax well

while restricting its rate of tax

• In fact, nearly all DTAA’s with developing countries allow some sort of

restricted taxation at source

• It is because of this dichotomy between the Model Conventions on the

source vs. residence taxation that the OECD Model has been held to favour

the developed countries and the UN Model to favour the developing

countries.

Royalty (Article 12) of Model ConventionsSource vs. Residence tax rights

OECD MC US MC UN MC2. The term ‘royalties’ as used in this Article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience

2. The term ‘royalties’ as used in this Article means:a) payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific or other work (including cinematograph films), any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experienceb) gain derived from the alienation of any property described in subparagraph a), to the extent that such gain is contingent on the productivity, use, or disposition of the property.

3. The term “royalties” as used in this article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematographfilms, or films or tapes used for radio or television broadcasting,any patent, trademark, design or model, plan, secret formulaor process, or for the use of, or the right to use, industrial, commercial or scientific equipment or for information concerning industrial,commercial or scientific experience.

Royalty definition under Model Conventions(Article 12(2) )

A note on the updated OECD Model Commentary

• The OECD Model Commentary (OECD MC) provides a detailed explanation

of the clauses of the Model Convention. The MC was updated recently in

July 2010

• India has been one of the countries which have expressed a number of

“reservations” over the updates to Article 12 (Royalties).

• India has expressed a reservation on the interpretation relating to

• Satellite and transponder leasing, roaming cell network and

• Spectrum licences

• The right to use licensed computer software

• Mere purchase of a software license and using the purchased

software will not constitute royalty

• The transfer of full ownership of rights

• Exclusive rights in a geographical region, usage consideration etc

• India has basically adopted the UN Model Convention wherein it

provides restricted taxation for the source country i.e., India

• The main reason for this being that India is a developing country and

consumes a huge amount of know-how, technical information, designs

& drawings etc. from developed countries as it emerges a world leader.

• It is dealt with in Article 12 of India’s treaties, except in some cases like

the India – UK DTAA, where it is Article 13.

• Most of the Royalty Articles are combined with the Fees for Technical

Services (FTS) and are similar to each other

• Certain exceptions are found in India-Singapore, India-USA and India-UK

treaty relating to additional clauses, definitions/exceptions

Royalty in India’s DTAAs

Effect of Amendments to S.9(1)(vi)(Act vs. DTAA)

• Payment for leased line / connectivity:• In B4U International Holdings Ltd. vs. DCIT (ITA

No.3326/Mum/2006 dated 28th May 2012) it was held that:• “17. Coming to the argument of learned Departmental

Representative that the amendment to the Finance Act, 2012 changes the position, we find that there is no change in the DTAA between India and USA. Thus, the amendments have no affect on our decision”

• Payment for off-the-shelf software• ADIT vs. Siemens Aktiengesellschaft 142 ITD 614 (Mumbai HC)

• Assessee engaged in the business of sale of equipment supplied software embedded in the hardware. Software cannot function independent of the corresponding hardware.

• Equipment along with the embedded software was sold at a place which is outside India. Did not amount to royalty either under Income-tax Act or DTAA


• DIT Vs Infrasoft Ltd ITA 1034/2009 dt 22nd Nov 2013 (Delhi HC)

• Clear distinction between royalty paid on transfer of copyright rights and consideration for transfer of copyrighted articles.

• A non-exclusive and non-transferable licence enabling the use of a copyrighted product cannot be construed as an authority to enjoy any or all of the enumerated rights ingrained in Article 12 of DTAA.

• Convergys Customer Management Group Inc Vs ADIT dt 10-05-2013

• As regards the taxability of software license fees, the retrospective amendment to s. 9(1)(vi) by the Finance Act, 2012 widens the scope of the term “royalty” but does not impact the provisions of the DTAA in any manner.

• Consequently, the purchase of software falls within the category of copyrighted article and not towards acquisition of any copyright in software and hence the consideration is not assessable as Royalty


• DIT vs. Nokia Networks OY (ITA 512 of 2007 dated 7.9.2012, Delhi HC)

• Ishikawajima-Harima still good law!

• Amendments cannot be read into the Treaty (DTAA)

• Distinction between supply of “copyright” and supply of “copyrighted article”

• Poompuhar Shipping Corporation Ltd Vs ITO dt 9/10/2013 :

• Foreign ship hired for transporting coal between Indian ports; usage of ship held as use of equipment. HC held such equipment rental is taxable as “royalty” even if payer does not have control.

• The retrospective insertion of Explanation 5 to s. 9(1)(vi) is purely clarificatory!!

• Bottomline: Most judicial forums have held that the retrospective amendments of Finance Act 2012 made to Royalty definition in Act cannot override Treaty!

FTS under the Income Tax Act(Explanation 2 of Section 9(1)(vii))

Explanation 2:For the purposes of this clause, "fees for technical services" means any consideration (including any lump sum consideration) for the rendering of any managerial, technical or consultancy services (including the provision of services of technical or other personnel) but does not include consideration for any construction, assembly, mining or like project undertaken by the recipient or consideration which would be income of the recipient chargeable under the head "Salaries".

Explanation 2:For the purposes of this clause, "fees for technical services" means any consideration (including any lump sum consideration) for the rendering of any managerial, technical or consultancy services (including the provision of services of technical or other personnel) but does not include consideration for any construction, assembly, mining or like project undertaken by the recipient or consideration which would be income of the recipient chargeable under the head "Salaries".

Evolution of FTS under the Act(The Ishikawajima-Harima case)

Ishikawajima-Harima Heavy Industries Ltd. Vs DIT [(2007) 288 ITR 408 (SC)]

• The notion of “Territorial Nexus” was expounded by the SC.• It ruled that Section 9(1)(vii) envisaged dual condition

which need to be met simultaneously namely: 1. Services had to be rendered in India.2. And the said services should be utilized in India

• It held that mere “source” of income would not be sufficient to tax an income.

• The Apex Court held that there should be Direct Link between the services rendered and India.

Evolution of FTS under the Act(Amendment in Finance Bill 2007)

• In response to the decision of SC in Ishikawajima-Harima Heavy Industries Ltd. Vs DIT which is as follows

Explanation.—For the removal of doubts, it is hereby declared that for the purposes of this section, where income is deemed to accrue or arise in India under clauses (v), (vi) and (vii) of sub-section (1), such income shall be included in the total income of the non-resident, whether or not the non-resident has a residence or place of business or business connection in India

Explanation.—For the removal of doubts, it is hereby declared that for the purposes of this section, where income is deemed to accrue or arise in India under clauses (v), (vi) and (vii) of sub-section (1), such income shall be included in the total income of the non-resident, whether or not the non-resident has a residence or place of business or business connection in India

Evolution of FTS under the Act(Post-2007 Amendment)

• Not surprisingly, there were many conflicting decisions in the wake of Ishikawajima case and the amendment made thereafter.

– However at least two High Courts held that twin condition of rendering & utilization still held sway and hence Ishikwajima-Harima holds good even after 2007 amendment

• Jindal Thermal Power Company Ltd. Vs. DCIT [182 Taxman 252 Karnataka HC] The Karnataka High Court had to decide whether the technical services carried off-shore were FTS even after the amendment to Section 9(1)(vii) by Finance Act, 2007.

• Clifford Chance Vs. DCIT [176 Taxmann 458 Mumbai HC] In this case, the Bombay HC discussed the SC decision in the case of Ishikawajima-Harima case and the amendment passed in the Finance Act, 2007.

• Both decisions were in favour of the assesse averring that, even after the 2007 amendment, only income from services rendered and utilized in India is taxable in India.

Evolution of FTS under the Act(Amendment in Finance Bill 2010)

• A new revised Amendment in Finance Bill, 2010 was passed. The Memorandum to finance Bill elaborately explained the intention of the legislature which is as follows: – The ‘Source Rule’ means the situs of rendering services is

irrelevant– The interpretation in the case of Ishikawajima was NOT

IN accordance with law as it expounded that there should be ‘Territorial Nexus’ to classify a payment as FTS.

– To clarify the position, an amendment was inserted below Section 9 vide the Finance Act, 2007.

– However, even after the amendment, the Karnataka HC in the case of Jindal Thermal Power Company Ltd. has held that the amendment does not do away the requirement of rendering services in India

Evolution of FTS(Amendment in Finance Bill 2010)

• The new retrospective Explanation which substituted the earlier explanation is as follows:

Explanation.—For the removal of doubts, it is hereby declared that for the purposes of this section, income of a non-resident shall be deemed to accrue or arise in India under clause (v) or clause (vi) or clause (vii) of sub-section (1) and shall be included in the total income of the non-resident, whether or not,—(i) the non-resident has a residence or place of business or business connection in India; or(ii) the non-resident has rendered services in India.

Explanation.—For the removal of doubts, it is hereby declared that for the purposes of this section, income of a non-resident shall be deemed to accrue or arise in India under clause (v) or clause (vi) or clause (vii) of sub-section (1) and shall be included in the total income of the non-resident, whether or not,—(i) the non-resident has a residence or place of business or business connection in India; or(ii) the non-resident has rendered services in India.

FTS In India’s DTAAs

DTAAs having FTS with broad Definition

Similar to the IT Act definition “The term “fees for technical services” means

payment of any kind in consideration for the rendering of any managerial, technical or consultancy services including the provision of services by technical or other personnel but does not include payments for services mentioned in Article 14 and Article 15 of this Agreement.”

Similar to the IT Act definition “The term “fees for technical services” means

payment of any kind in consideration for the rendering of any managerial, technical or consultancy services including the provision of services by technical or other personnel but does not include payments for services mentioned in Article 14 and Article 15 of this Agreement.”

DTAA’s having FTS/FIS with narrow definition(Article 12(4) - the “make available” clause)

“Article 12(4): For the purposes of this Article, ‘Fees for Included Services’ means payments of any kind to any person in consideration for the rendering of any technical or consultancy services (including through the provision of services of technical or other personnel) if such services:

a) are ancillary and subsidiary to the application or enjoyment of the right, property or information for which the payments described under paragraph 3 is received.

b) make available of technical knowledge, experience, skill, know-how or process or consist of the development and transfer of technical plan and design. “

“Article 12(4): For the purposes of this Article, ‘Fees for Included Services’ means payments of any kind to any person in consideration for the rendering of any technical or consultancy services (including through the provision of services of technical or other personnel) if such services:

a) are ancillary and subsidiary to the application or enjoyment of the right, property or information for which the payments described under paragraph 3 is received.

b) make available of technical knowledge, experience, skill, know-how or process or consist of the development and transfer of technical plan and design. “

Analysis of “make available” clause - India-USA MOU(Article 12(4))

Article 12(4)(b) – the ‘make available’ clause• The India – USA MoU concisely defines how to interpret

the much talked about and most important ‘make available’ clause.

• It narrows down the definition provided in Article12(4)(a) because it excludes the service which does not make available the technology to the person who acquires it.

• “made available” means the person who is acquiring the service should be able to use the service/ apply the technology.

• Provision of technical input or using a technology embodied product will not be considered as ‘make available’.

The “make available” clause(Article 12(4) & MOU of India-USA DTAA)

• In naive terms, the idea of not making available vs. make available can be equated with giving man a fish vs. teaching him to fish! Let us now proceed to the India-USA MoU’s examples:

Example 3: Facts:A U.S. wallboard manufacturer sends technicians to an Indian builder to show its engineers the process of manufacturing strong wall board. Are the payments to the U.S. manufacturer considered to be payments for included services?


AnalysisThe services are of technical nature and it makes available to the Indian company technical knowledge, skill and process.

Example 4: Facts:The Indian company hires and provides raw materials to the U.S. manufacturer to produce strong wall boards in its plant using advanced technology. Are the fees paid for these services can be considered as FIS?Analysis: No. Although the services are clearly technical in nature it did make the technology available to the Indian company to produce the wallboard on its own.


Example 5:Facts: An Indian retail outlet engages an U.S. firm to modify its inventory control software to suit its newly expanded business. Are these payments constitute FIS?Analysis: Yes. The U.S. firm clearly performs a technical service and it transfers the technical plan (i.e., computer program) also.

Example 6: Facts: An Indian oil manufacturing company engages an U.S. Company modify the formula so as to produce cholesterol free oil and also to train its employees for applying the formula. Whether the payments made for the above service constitutes FIS?Analysis: Yes. It is a technical service and technical knowledge is made available to the Indian company.


Example 7: Facts: The Indian cholesterol free vegetable oil manufacturer engages an U.S. firm to do a computer stimulation of the world market for such oil and advice it on marketing strategies.Analysis: No. Although the U.S. company performs an substantial amount of technical service it did not transfer the skill, technical knowledge or know-how but only the commercial information.

The Indian Judiciary on the ‘make available’ clause

Raymond Ltd. Vs. DCIT [(2003) 86 ITD 791 (Mum)]

• Commission payments were made to lead managers of a GDR issue and the Mumbai ITAT in its detailed order held that though the services are managerial and consultancy in nature cannot be held as FTS under India –UK DTAA.

• The term ‘managerial services’ was deliberately excluded from the ambit of technical services in the later DTAA (1993).

• No technical knowledge was made available to the assessee.

• MoU of India-USA can be used to understand the scope of FIS.


Diamond Services Intl. Ltd. Vs UOI (2007) 304 UTR 201 Bom. HC)

• Payments made to Gemological Institute for grading and certification of diamonds.

• Held that the payments cannot be treated as neither FIS (nor Royalty). because it does impart any technical knowledge, experience, skill, etc.

Mahindra & Mahindra Vs. DCIT (2009) 313 ITR 263 (Mum SB)• The Mumbai Special Bench held that the management

commission cannot be considered as FTS under India- UK DTAA since it did not make available the technical knowledge.


CESC Ltd Vs. DCIT (2003) 80 TTJ 806 (Kol)• An UK Company was engaged as a technical advisor to the Indian

financial institution who were to hold equity in the Indian company.

• Held that the UK company did not make available any technology as its role was limited to review and giving opinion rather that providing design and direct the project.

Similar type of judgements had been passed in • Anapharm Inc. (2008) 305 ITR 394 (AAR) • Intertek Testing Services Pvt. Ltd Vs (2008) 307 ITR 418 (AAR)• NQA Quality Systems Ltd. Vs. DCIT (2004) 92 TTJ 946 (Del)


DIT Vs Guy Carpenter & Co. Ltd. (2012) 346 ITR 504 (Del. HC)• Several Indian insurance company made commission payments to

the UK based reinsurance company for arranging rearranging contracts.

• Held that these payments did not fit in to ‘make available’ under Article 13(4)(c).

CIT v. De Beers India Minerals (P) Ltd. [2012] 346 ITR 467 (Kar HC).• Payments made to carry out geographical survey i.e., conduct air

borne survey for providing high quality, high resolution, geophysical data suitable for kimberlite targets was not FTS.

• The payments will be considered as FTS only if it satisfies the dual condition i.e., rendering technical service and making that technical available to the payee.

The Indian Judiciary on ‘make available’ clause

• Let us now look in to the decisions which are against the assesse:

Perfetti Van Melle Holding B.V. (204 Taxman 166 AAR)• Held that the support services relating heads of accounting,

budgeting and reporting, forex management, global credit facility, etc were in nature of technical services which were made available to the service recipient.

ITO Vs. Sinar Mas Pulp And Paper (India) (85 TTJ Delhi 794)• Payment for feasibility report under India-Singapore DTAA was FTS.

Maruti Suzuki Vs. ADIT (130 TTJ Del. 66)• Impact testing fees and fees for testing reports under India-France

DTAA was FTS and taxable in India.

Services which are not FTS(Article 12(5))

“Article 12(5): Notwithstanding paragraph 4, “fees for included services” does not include amounts paid :

(a) for services that are ancillary and subsidiary, as well as inextricably and essentially linked, to the sale of property other than a sale described in paragraph 3(a) ;

(b) for services that are ancillary and subsidiary to the rental of ships, aircraft, containers or other equipment used in connection with the operation of ships or aircraft in international traffic ;

(c) for teaching in or by educational institutions ; (d) for services for the personal use of the individual or individuals making

the payments ; or (e) to an employee of the person making the payments or to any

individual or firm of individuals (other than a company) for professional services as defined in Article 15 (Independent Personal Services).”

“Article 12(5): Notwithstanding paragraph 4, “fees for included services” does not include amounts paid :

(a) for services that are ancillary and subsidiary, as well as inextricably and essentially linked, to the sale of property other than a sale described in paragraph 3(a) ;

(b) for services that are ancillary and subsidiary to the rental of ships, aircraft, containers or other equipment used in connection with the operation of ships or aircraft in international traffic ;

(c) for teaching in or by educational institutions ; (d) for services for the personal use of the individual or individuals making

the payments ; or (e) to an employee of the person making the payments or to any

individual or firm of individuals (other than a company) for professional services as defined in Article 15 (Independent Personal Services).”


• And again, India-USA MoU provides excellent, self-explanatory examples to bring clarity to the clause.

Example 8 Facts: An Indian company purchases the computers from an U.S. Company and the U.S. company agrees to provide installation service such as setting up of the computers and install operating system in order to make the employees use computer and also agrees to provide updates for ten consecutive years as a part of the agreement.Analysis: Installation services cannot be considered as FIS because installing software is inextricably related to the sale of the computers without which computer cannot be used. However, provision for updates will amount to FIS because even without the updates the computers can perform.


Example 9 Facts: The U.S. Company agrees to do initial installation services as well as periodical services for the first two years to the Indian company on purchase of X-ray machines. Also, the U.S. Company agrees to do life-time service to the X-ray machine and also advising hospital new developments in the field for a separate consideration.Analysis: Initial installation services including the periodical services are not FIS but the life-time service and technical advice will be considered as FIS.

Example 10 Facts: An Indian helicopter manufacturer sends its engineers to MIT for two years to study aeronautical engineering.Analysis: Fee paid for teaching by an educational institution is not considered as an FIS under Article 12(5)(c).

Services which are not FTS (Article 12(5))

Example 11 Facts: An Indian university enters in to an agreement with MIT to send its professor of aeronautical engineering as a visiting faculty to the Indian institute.Analysis: No. The payments made for teaching in an educational institution as per Article 12(5)(c).

Example 12 Facts: An Indian hires an American company to design the necessary wiring system, adapt standard software and provide instruction for installation of computerised system in his home to control lightning, heating and air-conditioning, a stereo sound system and a burglar and fire alarm system.Analysis: Under normal conditions it would have an FIS. However, because the services are for personal use of the individual making payments, it is not taxable under Article 12(5)(d). i.e., Independent Personal Services.

Article 12(6) The provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the royalties or fees for included services, being a resident of a Contracting State, carries on business in the other Contracting State, in which the royalties or fees for included services arise, through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the royalties or fees for included services are attributable to such permanent establishment or fixed base. In such case the provisions of Article 7 (Business Profits) or Article 15 (Independent Personal Services), as the case may be shall apply.

Article 12(6) The provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the royalties or fees for included services, being a resident of a Contracting State, carries on business in the other Contracting State, in which the royalties or fees for included services arise, through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the royalties or fees for included services are attributable to such permanent establishment or fixed base. In such case the provisions of Article 7 (Business Profits) or Article 15 (Independent Personal Services), as the case may be shall apply.

FTS vs. PE(Article 12(6))

FTS case laws S.No TOPIC

1 Payments made for Commission Agents

2 Payments made for technical reports

3 Payments for use of ‘Standard Facility’

4 Payments for Satellite up linking charges, use of internet bandwidth, etc.

5 Payments for hosting websites abroad, subscribing to online portals, etc.

6 Payments made accreditation, certification, etc.

7 Payments made for mineral oil exploration and related activities

8 Payments towards reimbursement of expenses

9 Payments made for manpower supply outside India

10 Human Intervention Test

11 Re-opening u/s 147 based on FTS

12 Exception clause in Section 9(1)(vii) of the Act

Payments made for Commission Agents (advertising, promotion, publicity, management, referral, underwriting, etc.)

• Typically most of the payments paid to the foreign agents are for advertising, promotion and publicity activities of Indian companies abroad. The other type of payments are for management, selling, underwriting commission to financial entities abroad and payments made to foreign reinsurance brokers.

• Sheraton International Vs. DDIT (2007 107 ITD 120 Del.) In this case, the ITC Hotels had made commission payments to the assessee (foreign agent) for making room reservations from abroad. The ITAT held that the assessee did not make available the technical knowledge to the Indian hotel chains.

• Later the decision of ITAT was upheld by the Delhi High Court in DIT Vs. Sheraton International Inc. (313 ITR 267)


• Raymond International Vs. DCIT (2003 86 ITD 791 (Mum)) – In this case, the Mumbai ITAT elaborately discussed the concept of ‘make available’ and held that payments made to lead managers of a GDR issue cannot be called as FTS under make available clause of India-UK DTAA.

• Mahindra & Mahindra Ltd. Vs. DCIT (122 TTJ 577 (Mum. SB)) – Indian company paid management, selling and underwriting commission to the UK non-resident company for bringing out the FCCB issue. The ITAT held that though the services can be classified as technical service but did not make available the technical knowledge and hence, cannot be termed as FTS.

• CEAT International SA Vs. CIT (237 ITR 859) – The Bombay HC has held that the assessee did not do technical service u/s 9(1)(vii) of the Act by entering in to non-compete agreement with the Indian company.


• Cushman & Wakefield P. Ltd. In re (305 ITR 208) – referral fee received by the Singapore company for referring potential customers to the Indian company is not FTS as it did not make available the technical knowledge to the Indian company.

• Mckinsey A Co. Inc. (Philippines) Vs ACIT 248 ITR 227 (Mum) – In this case again, the Mumbai ITAT had held that payments are not FTS since there were no material evidence to prove that the technology was made available to the service recipient.

• Finally, when it comes to FTS and ‘make available’ we turn to CIT Vs. Guy Carpenter [(2012) 346 ITR 504 (Del.HC)] where the HC have held that the commission paid by the Indian insurance companies to the foreign reinsurance companies for arranging reinsurance contracts is not FTS asit did not make available the technology to the service recipient.

Payments made for technical reports (i.e., test reports, survey reports, data processing reports, etc.)

• The second most important aspect of FTS is whether the payments made for technical reports, whether surveys or analysis or detailed scientific or testing reports, constitutes FTS or not? Let us analyze this proposition.

• CIT Vs De Beers India Minerals P. Ltd. (346 ITR 467) – The Karnataka HC has held that the geophysical airborne conducted and the output provided to the service recipient by the Netherland Co. did not amount to FTS as the Netherland Co. did not make available the technology to the assessee.

• ACIT Vs Paradigm Geophysical Pty. Ltd (122 ITD 155) – In this case, the Australian Co. processed the seismic data collected by the Reliance India Ltd., Australia and provided output to RIL. The Delhi ITAT has held that the above service amounts to FTS under Section 9(1)(vii) of the IT Act. However, due to the presence of ‘make available’ clause in the DTAA, the payments cannot be treated as FTS.


• In Anapharm Inc., In re (305 ITR 394 ARR) – A Canadian company tested efficacy of the drugs developed by the Indian Company using sophisticated bio-analytical processes and provided final output i.e., testing result to the Indian company. In a very clear and well laid out decision, the AAR held that the payments made in this regard are not FTS since the Canadian company did not make available the technology to the assessee.

• Intertek Testing Services P. Ltd., In re (307 ITR 418 AAR) – another oft-quoted decision relating to ‘make available’ clause, the AAR held that inspection charges paid to foreign associate entities which carried out inspection on behalf of the applicant were not in the nature of fees for technical services.


• It is worthwhile to note that most of the services mentioned in the abovementioned case laws were technical services indeed and will fall under FTS u/s 9(1)(vii) of the Act but are saved by the ‘make available’ clause.

• It is also pertinent to note that not all the DTAAs have ‘make available’ clause and in those circumstances, these will be classified as FTS. Let us see some case laws in the light of above proposition.

• There are also cases where only the IT Act was in play and not DTAA and the reports prepared by non-residents are held to be taxable as FTS. They are • Cochin refineries Ltd. Vs CIT (222 ITR 354), Kerala and • Steffen, Robertson & Kirsten Consulting Engineers & Scientists In re.

(AAR 359 of 1997)


• Maruti Udyog Vs. ADIT (130 TTJ Del. 66) - In this case, the Indian assessee entered into an agreement with a French agreement (UTAC) and had impact testing fees and fees for testing reports. The Delhi ITAT held:– The impact tests performed were to be performed so as to pass the quality

tests. Therefore, they are in the nature of technical services which enhanced the product development capacity of the Indian Company.

And, as reports were used by the Indian Company for modification of its products, it would amount of rendering of technical services.

that India-France DTAA is much wider in scope when compared to India-USA & India-UK DTAA . Hence, the amounts paid would be in the nature of fees for technical or consultancy services.

Similar decision once again rendered by same Delhi ITAT in ITO Vs. Sinar Mas Pulp And Paper (India) Ltd. (85 TTJ Delhi 794) where it held provision of feasibility report is FTS.

Payments for use of ‘Standard Facility’

• Skycell Communications Ltd. Vs. DCIT (251 ITR 53) - The Madras HC held that payments made for providing a cellular mobile phone services was not taxable as FTS because it was a fee for the use of a ‘standard facility’ provided to all those willing to pay and mere collection of such fee for use of standard facility cannot be termed as FTS.

• CIT Vs Bharti Cellular Ltd. (319 ITR 139) - where the Delhi HC followed the decision of Madras HC in the case of Skycell communications Ltd. (Supra) and has held that the payment of internet charges to MTNL/other telecommunication companies does not come under fees for technical services.

• Similar view was followed in Pacific Internet (India) P. Ltd. Vs ITO (125 TTJ 966) by the Mumbai ITAT.

Payments for Satellite up linking charges, use of internet bandwidth, etc.

• The moot point with regard to the proposition is whether payments made by the Indian telecast operators (TV channels) to the foreign satellite operators to use the satellite located in the Space can be treated as FTS or not? (Of course, the other important question is whether this amounts to Royalty or not? As that aspect was already discussed we will concentrate only of FTS for now.)

• In Expediators International (India) Pvt. Ltd. Vs. ACIT (2 ITR(Trib.) 153) – the Delhi ITAT held that VSAT up linking is not in the nature of FTS as FTS as well as the mere fact that the service provider has installed sophisticated equipment which the tax payer cane use does not by itself make it FTS.

• In CIT Vs. Estel Communications (P) Ltd. (318 ITR 185) – the Delhi High Court held that payment for use of internet bandwidth will not amount to FTS and there was no privity of contract between customers of assessee and the US company.


• There is a never-ending debate as to how contracts which involve supply of designs, drawings and material with related services thereof have to be interpreted. – Should the contracts be split-up or are they indivisible? – Is the preponderance of the activity that of a sale and are the services just

incidental hence not taxable?

• In Abishek Developers Vs ITO (110 TTJ (Bang.) 698) – The Bangalore ITAT held that a Singapore Company which had no PE In India and which developed design and drawings for its Indian customers wholly outside India i.e., Singapore and the transferred the same to clients in Singapore was in the nature of sale and not FTS.

• In SNC-Lavalin International Inc. Vs. DDIT (118 TTJ Del. 802) – It was held in this case that the payments made for furnishing project report covering detailed design for rehabilitation of the existing carriage ways as well as for designing the new carriage ways are FTS as per India-Canada DTAA.


• Hindustan Aeronautics Ltd Vs ITO (121 TTJ 242) – The Indian assessee wanted engine and its prototype for its 3 aircrafts. The Russian Company supplied the same but restricted the assessee from using prototypes for any other use. The Delhi ITAT had held that the payments made was for outright purchase of engines and prototypes were only used for testing purposes and cannot be treated as FTS as per 9(1)(vii) and the India-Russia DTAA.

• CIT Vs Neyveli Lignite Corporation (243 ITR 459 (Madras HC)) – The Madras HC has held that the payments made for manufacturing, design, supply erection and commissioning to the foreign agents are not FTS because all of them are incidental to the sale of machine itself to the Indian Company.

• CIT Vs Sundwiger EMFG (262 ITR 110) - The payments made to a specialist foreign employee sent on purchase of a capital equipment cannot be considered as FTS as it is a part of sale.


• AEG Aktiengesllschaft Vs CIT (267 ITR 209) – payments made for engineering services rendered as enumerated in the Agreement between Indian company and German company could be considered as FTS u/s 9(1)(vii). – The court held that payments made for design and drawings cannot,

in all circumstances, be treated as cost of plant and machinery.

• ITO Vs Prasad Productions (125 ITD 263) – Indian company entered in to an agreement with the foreign non-resident company for purchase, installation and maintenance of IMAX theaters as well as train four projectionists. The Chennai Special Bench has held that these were incidental to the sale of the product and cannot be classified as FTS. – This decision is also important for another reason that it had held

that the application u/s195(2) is not mandatory for the assessee.


• GMP International company GmbH, In Re (AAR NO. 837 of 2009) – The applicant was a German company which was selected for supplying the architectural design and diagram for the complex TN legislative assembly. The sub-contractor of the German company followed the diagram and designs of German company. It was held that the payment constitutes FTS.

• Airports Authority of India, In re (304 ITR 216) – In this case, the USA company supplied hardware, software, software documentation, installation, testing and training to the Indian company. The AAR splitted-up the composite agreement and held as follows: a) supply of hardware amounts to Business Profits, b) supply of software amounts to Royalty and c) installation, testing and training will amount to FTS. Similar type was also rendered in International Tire Engineering Resources LLC, In re (319 ITR 228 AAR)

Payments for hosting websites abroad, subscribing to online portals, etc.

• The moot point with regard to this proposition is whether the payments made for website hosting and whether accessing/subscribing to the foreign journals and databases is FTS or not?

• Millennium Infocom Technologies Ltd. Vs ACIT (2008 117 ITD 114) – It was held that the payments made for website hosting is not FTS by following the case of Skycell(supra) where it was held that installation of sophisticated device for allowing customers to avail the benefits of the device will not amount to FTS.

• TIS Two Administration (Sing.) P Ltd Vs DDIT (ITA NO. 8464/Mum/04) – It was held that subscription fees received for providing information regarding forex, commodity and hence, not taxable under India-Singapore DTAA.

Payments for hosting websites abroad, subscribing to online portals, etc.

• Cargo Community Network P. Ltd., In re (AAR No.688 of 2006) – The AAR took a view that payments made for subscribing to a journal will amount to FTS as it amounts to training subscribers and acts as a helpdesk in India.

• CIT Vs Samsung Electronics (320 ITR 209) – It was held that the payment for use of online database amounts to Royalty and the same has been followed by CIT Vs Wipro Ltd. (203 Taxman 621).

Payments made accreditation, certification, etc.

• Value of the Indian company goes up in the minds of general public if it has been accredited and certified by the foreign company. The question here is, whether the payments made to these accreditation providing companies can be termed as FTS or not?

• NQA Quality Systems Pvt. Ltd Vs DCIT (92 TTJ 946) – It has been held that the accreditation company did not make available the technical knowledge/know-how to the Indian company and hence, cannot be taxable.

• Joint Accreditation System of Australia and Newzealand, In re (AAR No. 838 of 2009) – The applicant merely evaluates and grants accreditation and does not transfer any technical knowledge to the service recipient. Hence, cannot be taxable as FTS.

Payments made for mineral oil exploration and related activities

• In ONGC Vs ACIT (12 SOT 584) – In this case, the non-resident company trained the Indian assessee on ‘ceased hole and production log evaluation’ and ‘ceased hole and production log analysis’. The Delhi ITAT has held that the consideration received was chargeable u/s 44BB (not S.44D) instead of FTS following the CBDT circular No.1862.

• In CIT Vs ONGC (299 ITR 438) – HC held that non-resident assessee supplied supervisory staff and experts in operation and management of drilling rigs and hence taxable under Section 44D r.w.s 115A of the Act.

• DIT Vs Rio Tinto Technical Services (278 ITR 599) – Delhi HC has held that the payment made for conducting feasibility reports and evaluating coal and iron ore deposits was FTS and S.44D is applicable as the income earned by assessee is taxable as FTS.

Payments made for mineral oil exploration and related activities

• In ABC, In re (234 ITR 371 AAR) – UK company rendered consultancy to Indian oil company under various agreements wherein it gave technical services to ear marked areas to enable the Indian company to perform the job by itself. The payment was considered as FTS and taxable under the provision 44D.

• Bourbon Offshore Asia P. Ltd., In re (AAR 937 of 2010)- It was held that receipts on account of provision of supply of vessels on hire cannot have the character of FTS u/s 9(1)(vii) of the Act and tax is to be with held under Section 44BB.

Payments towards reimbursement of expenses

• The proposition of whether reimbursement of expenses constitutes FTS or not? - is entirely dependent on the facts and circumstances of the case.

• In IDS Software (India) Pvt. Ltd Vs ITO (122 TTJ 410) - it was held that the reimbursement of salary to the employee seconded by the USA company cannot be brought under FTS as the employee is in the control of USA company.

• In AT&S India P. Ltd., In re (AAR NO. 670 of 2005) & Cholamandalam General Insurance Co. IN Re (309 ITR 356 AAR)– The AAR in this case basically followed the principle laid down in the IDS Software (Supra) case.

• However, Verizon Data Services Pvt. Ltd In re (AAR 865 of 2010) – It was held that since the seconded employee performed managerial services, the reimbursement is taxable u/s 9(1)(vii) of the Act and Article 12 of India-USA DTAA

Payments made for manpower supply outside India

• In ACIT Vs IIC Systems P. Ltd. (127 TTJ 435)- Assessee company entered in to an agreement with IBM,USA for supply of manpower. ITAT Hyd. held that neither the assessee nor its parent company were engaged in software programming, software development and that the developed work by the manpower supplied did not belong to the assessee or its parent company. Hence, not FIS under India-USA DTAA.

• In Tekniskil (Sendirian) Berhard Vs CIT (222 ITR 551 AAR) – another case of supplying manpower held in favour of assessee, held as not FTS

• In Steel Authority of India Ltd Vs ITO (120 TTJ 297)- Held by Delhi ITAT that the payments made for training of employees by foreign company amounts ‘making available’ technical knowledge, know-how and skills to the assessee company. Hence, taxable as FTS.

Human Intervention Test

• It has been first held by the Madras HC in the case of Skycell Communications (Supra) that in order to classify a service as technical service under 9(1)(vii) of the Act, presence of human intervention is mandatory otherwise it cannot be taxable as FTS u/s 9 of the Act.

• Recently, the Mumbai ITAT in the case of Siemens Ltd Vs CIT (ITA No. 4356 of 2010) has elaborated the term ‘human intervention’ and held that mere presence of human intervention is not enough to classify a service as FTS but there should be substantial involvement of human in that particular service.

• However, the Agra ITAT in a very recent Judgement of Metro & Metro Vs ACIT (ITA No. 393 of 2012) had held that the liberal interpretation provided in the case of Siemens (Supra) is not correct.

Re-opening u/s 147 based on FTS

• Artech Infosystems Pvt. Ltd. Vs CIT (206 Taxman 432) – In this case, the department re-opened the case on the basis that it felt the payments are for FTS and during the assessment proceedings it did not hold so.The Delhi HC held that this amounted to mere change of opinion and quashed the order u/s147 of the Act by relying on CIT VS Kelvinator (320 ITR 723 SC)

Exception clause in Section 9(1)(vii) of the Act

• We see that in Section 9(1)(vii)(b) of the Act, there is an exception clause which states that an income by way of FTS is payable by a resident for the purposes of earning income outside India then it will not be treated as FTS deemed to accrue or arise in India.

Section 9(1)(vii) income by way of fees for technical services payable by—

(a) the Government ; or(b) a person who is a resident, except where the fees are

payable in respect of services utilised in a business or profession carried on by such person outside India or for the purposes of making earning any income from any source outside India ;

Section 9(1)(vii) income by way of fees for technical services payable by—

(a) the Government ; or(b) a person who is a resident, except where the fees are

payable in respect of services utilised in a business or profession carried on by such person outside India or for the purposes of making earning any income from any source outside India ;


• The exception clause has been subjected to lot of debate and contrasting decisions has been rendered by Tribunals and HCs.

• CIT Vs. Aktiengesellschaft Kuhnle Kopp & Kausch W.Germany by BHEL (262 ITR 513 Madras HC)– where it was held that the exports of goods represented a source

outside India.– The High Court in this case was concerned with Section 9(1)(vi) of the

Act relating to payment of royalty by a person resident in India to a non-resident.

– Though the said decision was rendered in the context of royalty yet the exception provided from taxability of royalty are the same as in the case of FTS.


• Lufthansa Cargo India P. Ltd. Vs DCIT (92 TTJ (Del) 837) – payments made for repair of aircrafts which are used only for international routes only will fall under this exception clause.

• Titan Industries Ltd Vs ITO (11 SOT 206) – charges incurred for registering the IP rights in Singapore by the associate company (which is located in Singapore) of Indian company can avail this exception clause.

• The Delhi HC in the case of CIT Vs Havells India Ltd. (73 DTR 57 (Delhi High Court)) dismissed the applicability of the exception clause under Section 9(1)(vii)(b) made from export sales – Disagreed with Madras HC decision and held that the export sales is NOT a

source of income outside India and that the payments are taxable as FTS u/s 9(1)(vii) of the Act.

Part VII. TDS provisionsPart VII. TDS provisions

TDS provisions

• Failure to deduct tax– Section 40(a)(i) – Section 201(1) and 201(1A)– Section 163

• Machinery provision for TDS on payments to non-residents (i.e., intl. taxation)– Section 195

S.40(a)(i)

40. Notwithstanding anything to the contrary in Sections 30 to 38, the following amounts shall not be deducted in computing the income chargeable under the head "Profits and gains of business or profession",—(a) in the case of any assessee—

(i) any interest (not being interest on a loan issued for public subscription before the 1st day of April, 1938), royalty, fees for technical services or other sum chargeable under this Act, which is payable,—

(A) outside India; or(B) in India to a non-resident, not being a company or to a foreign company,

on which tax is deductible at source under Chapter XVII-B and such tax has not been deducted or, after deduction, has not been paid during the previous year, or in the subsequent year before the expiry of the time prescribed under sub-section (1) of section 200:

S.40(a)(i)• Most payments today made without TDS are disallowed u/s 40(a)(i)

– HUGE amount of demand and litigation today is centered around this single section!

• It is a harsh provision which should be read down– Entire expenditure is disallowed; not a portion– Applies even if recipient has shown the income and paid taxes on

it• Madras High Court held its twin sister S.40(a)(ia) to be

constitutionally valid in Tube Investments of India Ltd [325 ITR 610]• Taxpayer looking at 30% disallowance at time of assessment

– Better to go with 10-15% TDS and apply for NIL withholding (u/s 195(2)) !

Proviso to S.40(a)(i)

Provided that where in respect of any such sum, tax has been deducted in any subsequent year or, has been deducted in the previous year but paid in any subsequent year after the expiry of the time prescribed under sub-section (1) of section 200, such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid.Explanation.—For the purposes of this sub-clause,—(A) "royalty" shall have the same meaning as in Explanation 2 to clause (vi) of sub-section (1) of section 9;(B) "fees for technical services" shall have the same meaning as in Explanation 2 to clause (vii) of sub-section (1) of section 9;

Proviso S.40(a)(i)

• Proviso to S.40(a)(i) allows payment after 31st March before IT return due date– Similar proviso in S.40(a)(ia) held to be retrospectively

applicable in CIT vs. Virgin Creations (Calcutta HC, ITANo.302 of 2011 dated 23-11-2011)

• What if the payee/recipient had offered inome & paid taxes ?– S.40(a)(ia) has been amended by addition of new Proviso

which finally tracks S.201(1) status i.e., whether the asessee is an assessee-in-default

– This should also apply to S.40(a)(i) and be held retrospective in effect!

S.201 – “Assessee in default”• S.201(1) – Failure to deduct or pay

– Finance Act 2012 w.e.f 1-7-2012 allows holding of assessee not in default as long as there is prescribed proof of recipient offering & paying tax on the amount paid without withholding

• Follows from Hindustan Coca-Cola Beverages (P.) Ltd. v. Joint CIT [2004] 90 ITD 720 (SC)

“We have also carefully examined the Circular No. 275, dated 29-1-1997, which was relied on by the assessee and appearing at page No. 1 of the compilation and we find that through this circular it has been clarified by the Board that no demand visualized under section 201(1) of the Act should be enforced after the tax depositor has satisfied the official in-charge of the TDS that tax due had been paid by the deductee-assessee”

Non-deduction of TDS vs. RetrospectiveAmendments

Courts have held that such payments (payments affected by retrospective amendment) being already paid cannot be made taxable by virtue of subsequent amendment carried out by Finance Act, 2010.Hence, disallowance u/s 40(a)(i) r.w.s Section 9

cannot be made by virtue of retrospective amendments.

The above view was upheld by the following judgements: Sterling Abrasives Ltd. Vs ACIT (140 TTJ 68 Ahd.) Channel Guide India Ltd Vs ACIT (139 ITD 49)

The “paid” vs. “payable” controversy

•Controversially, in Merilyn Shipping & Transport vs. ACIT (136 ITD 23 Vizag-SB) it was held that u/s. 40(a)(ia) TDS Disallowance applies only to amounts “payable” as at 31st March and not to amounts already “paid” during the year

– Upheld by CIT vs. Vector Shipping (P) Ltd. (Allahabad HC); struck down by CIT vs. Sikandhar N.Tunvar (Gujarat HC) and CIT vs. Md. Jakir Hossain Mondal (Calcutta HC)

•In the case of Metro& Metro vs. ACIT (ITA No.393/Agra/2012) - – It has held that the total disallowance u/s 40(a)(i) can be made

irrespective of whether the amount has been already paid or not. – Decisions in the case of Merilyn Shippings (supra) will not hold

good because those decisions has been rendered in the context of S. 40(a)(ia).

Controversy on tax withholding certificate(u/s 195(2) )

• U/s.195(2), where the payer considers that the whole of such sum so payable to a non-resident would not be income chargeable of the recipient, he can make an application to the Assessing Officer to determine the appropriate proportion of such sum chargeable to tax, and thereupon shall deduct tax u/s.195(1) only on that proportion of the sum chargeable to tax.

• Similarly, sections 195(3) and 197 provide for the payee making an application to the Assessing Officer for issue of a certificate that income-tax may be deducted at lower rates of tax or not deducted on payment to be received by him, where such lower rate or non-deduction is justified.

Controversy on tax withholding certificate(u/s 195(2) )

• The issue is where payment to nonresident does not comprise any income chargeable to tax in India at all whether the payer has necessarily to apply to tax authorities for certificate u/s.195(2) or whether the payment can be made without any TDS, and without obtaining any such certificate u/s.195(2) or u/s.195(3) or u/s.197?

• Controversial decision of CIT v. Samsung Electronics Co. Ltd. (320 ITR 209) holding S.195(2) certificate was mandatory– Reliance was placed on (wrong!) interpretation of the Supreme

Court in the case of Transmission Corporation of A.P. Ltd. v. CIT, 239 ITR 587.

• Controversy set to rest by Apex Court in GE India Technology Centre (P) Ltd. vs CIT (327 ITR 456) (SC).– Samsung verdict set aside. Principle explained that when no

tax is payable in India there is no necessity for TDS

Part VIII. Transfer PricingPart VIII. Transfer Pricing

What is Transfer Pricing?• Global trade consists of international transfers of goods and services,

capital and intangibles within an multinational enterprise (MNE) group. Such transfers are called “intra-group transactions”

• The structure of transactions within an MNE group can be determined by a combination of the market and group driven forces which can differ from the open market conditions operating between independent entities.

• In such situations, its important to establish appropriate price, called “transfer price” for intra-group transfers of goods and services

• “Transfer pricing” is the general term for the pricing of cross-border, intra-firm transactions between related parties.

• Transfer pricing therefore refers to the setting of prices for transactions between associated enterprises involving the transfer of property or services.

Rationale behind Transfer Pricing

• When unrelated entities deal with each other, the price of transactions for services or goods are determined by market forces

• When related entities of a group deal with each other the prices may not be affected by market forces in the same way

• Hence it is important to arrive at the appropriate “transfer price” for the intra-group transactions between related parties.

Crux of Transfer pricing

The crux of TP is that the transaction between related parties should be at the same price which would have been established if the transaction had happened between two unrelated parties in the open market (i.e., the Arm’s Length Price)

Basic TP Glossary• “Associated Enterprises” (AE) – Also called “related

parties” wherein there is direct or indirect relationship via management, control or capital between them

• “Controlled” transactions - Transactions between related parties

• “Uncontrolled” transactions – Transactions between parties that are not associated i.e., independent parties

• “Arm’s Length Price” (ALP) – Price of the uncontrolled transactions i.e., price in the open market

A TP ExampleWatch mfg. company

In Country AWatch mfg. company

In Country A

Subsidiary company in country

B

Retail price $1600

Transfer price $1500

Mfg. Cost in country A = $1400

Distribution cost $100

• Country B tax authorities want Transfer Price set at $1400 so that $100 profit is brought to tax in country B

• This approach is a problem for Country A which is already paying tax on $100 profit!

Thumb Rule of Transfer Pricing• Tax authority (of any country!) will seek the answer to

the following questions:– If you are a taxpayer of that country who exports goods,

services, capital or intangibles to a foreign Associated Enterprise (AE), have you received too less of consideration compared to open market?

– If you are a taxpayer of that country who imports goods, services, capital or intangibles from a foreign Associated Enterprise (AE), have you paid too much consideration compared to open market?

• Bottomline: Has there been a revenue (and hence tax) deficit due to the intra-group transaction being conducted at a price different from the ALP?

Introduction to basic issues underlying TP

• “Transfer price” influences the tax base of the countries involved in cross-border transactions– The parties involved are the relevant entities of the

MNE group along with the tax authorities involved in the transaction

• When one country’s tax authority adjusts the profit of a member of the MNE group, this may have an effect on the tax base of another country. – In other words, cross-border tax situations involve

issues related to jurisdiction, allocation of income and valuation

Jurisdiction issues in TP• Key issue is which government should tax the

income of the group entities engaged in the transaction, and what happens if both governments claim the right to tax the same income? – If the tax base arises in more than one

country, should one of the governments give tax relief to prevent double taxation of the relevant entities’ income, and if so, which one?

Jurisdiction issues in Transfer Pricing• The aim of non-arm’s length transfer pricing in such cases

is usually to reduce an MNE’s worldwide taxes. – Achieved by shifting profits from AE’s in higher tax

countries to AE’s in relatively lower tax countries through either under- charging or over-charging the associated entity for intra-group trade.

Price paid by ACo (overcharged by BCo,profits shifted to country B)

Widgets sold by BCo to ACo

Parent company ACo(situated in country A with tax rate 30%)

Subsidiary BCo(situated in country B with

tax rate 20%)

Jurisdiction Issues in Transfer Pricing• While most obvious motivation may be to reduce the MNE’s

worldwide taxation, other factors may influence transfer pricing decisions– Such as imputation of tax benefits in parent company’s country of

residence• Another motivation for an MNE to engage in such practices is to use a

tax benefit (such as a tax loss) in a jurisdiction in which it operates. – Maybe current year loss or a loss that has been carried forward

from a prior year by an associated company. In some cases an international enterprise may wish to take advantage of an associated company’s tax losses before they expire, in situations where losses can only be carried forward for certain num. of years.

– Even if there are no restrictions on carrying forward tax losses, there is incentive to use the losses as quickly as possible.

– In other words profits may sometimes be shifted to certain countries in order to obtain specific tax benefits

Allocation Issues in Transfer Pricing• Perspective of MNE: MNEs are global structures sharing common

resources and overheads. From MNE’s perspective these resources need to be allocated with maximum efficiency in an optimal manner. – Any trade or taxation barriers in the countries in which MNE

operates raise the MNE’s transaction costs while distorting the allocation of resources.

– Also many of common resources which are a source of competitive advantage to MNE cannot be separated from the income of the MNE’s group members for tax purposes.

• Perspective of Government: From Governments’ perspective, allocation of costs and income from MNE’s resources is essential in calculating tax payable.

• There can thus be a dispute between countries in the allocation of costs and resources, owing to their objective of maximizing the tax base in their respective jurisdictions.

Valuation issues in Transfer Pricing• Mere allocation of income and expenses to one or more members of

the MNE group is not sufficient; the income and expenses must also be valued. – Hence valuation of intra-group transfers is a key TP issue

• MNE’s are integrated structure with the ability to exploit international differentials and to utilize economies of integration not available to a stand-alone entity– Therefore transfer prices within the group are unlikely to be the

same prices that unrelated parties would negotiate.• TP rules are essential for countries in order to protect their tax base,

to eliminate double taxation and to enhance cross-border trade. – For developing countries, TP rules essential to provide climate of

certainty and environment for increased cross-border trade at the same time ensuring country is not losing out on tax revenue.

Evolution of Transfer Pricing

OECD Report on Transfer Pricing (1979)

OECD Report on Transfer Pricing (1984)

OECD Transfer Pricing Guidelines (1995, 2010)

We have to note the importance of the USA Transfer Pricing Regulations (26 USC 482), EU Common Consolidated Tax Base (CCTB) and the EU Council “Codes of Conduct” (2011) in the evolution of TP worldwide

UN “International Income Taxation and Developing Countries” (1988)UNCTAD Report on Transfer Pricing (1999)

UN Practical Manual on Transfer Pricing (2013)

Concepts in Transfer Pricing

• The Arm’s Length Principle• Applying the Arm’s Length Principle• Global Formulary Apportionment - Alternative

to ALP

The Arm’s Length Principle

Where:(a)an enterprise of a Contracting State participates directly or indirectly in the management, control or capital of an enterprise of the other Contracting State, or (b)the same persons participate directly or indirectly in the management, control or capital of an enterprise of a Contracting State and an enterprise of the other Contracting State, and in either case conditions are made or imposed between the two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of these conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly

Article 9(1) - UN Model Convention

The Arm’s Length Principle• Transaction between two related parties must be at ALP

– ALP is not a term used in Article 9 but it is well accepted by all countries as encapsulating the approach in Article 9

• The Arm’s-Length Principle is thus the guiding principle in establishing a transfer price under Article 9

• The marketplace comprising independent entities thus is the benchmark for verifying the transfer prices between related parties

• ALP is claimed to be geographically neutral– Conditional on consistent rules and administration of ALP

throughout jurisdictions • Easy to describe ALP but establishing guidelines on practical

application of ALP is a complex task

Need for applying ALP– An Example

PCorp in country A

SCorp in country B

Car seats sold to SCorp

Car seats sold to public in country B

If tax rate of country A > country B, PCorp may want to undercharge SCorp

If tax rate of country B > country A, PCorp may want to overcharge SCorp

Bottomline: Need to establish the ALP for determining correct transfer price of PCorp to SCorp transaction

If tax rate of country A > country B, PCorp may want to undercharge SCorp

If tax rate of country B > country A, PCorp may want to overcharge SCorp

Bottomline: Need to establish the ALP for determining correct transfer price of PCorp to SCorp transaction

The Arm’s Length Principle – Assumptions

• There are many factors affecting the arm’s length price– Government policies, regulations, cash-flow of entities, tax

benefits etc.• NO implicit assumption should be made that there is

profit manipulation by MNE just because there is adjustment to approximate the ALP

• Also incorrect to assume that commercial or financial transactions between AE’s and the marketplace will ALWAYS be different and at odds with each other– MNE’s may even set arm’s-length price to judge true

performance of underlying entities!• Bottomline: The Arm’s Length Principle has been widely

accepted and has found its way into most TP legislation

Applying the Arm’s Length Principle

• Comparability analysis• Evaluation of transactions• Evaluation of separate and combined transactions• Use of an arm’s length range or a central point in the range• Use of multiple year data• Losses• Location savings and location rents• Intentional set-offs• Use of customs valuation.

Refer to Chapter 5 of the UN TP Manual for more details

Global Formulary Apportionment – Alternative to ALP

• Formulary Apportionment would allocate the global profits of an MNE group amongst the associated enterprises on the basis of a multi-factor weighted formula – Using factors such as property, payroll and sales for example, or

such other factors as may be defined • Current use of Formulary Apportionment

– Used by some states of USA, cantons of Switzerland and provinces of Canada.

– Brazilian TP rules sets maximum ceiling on deductible expenses of imports and lays down minimum level for gross income in relation to exports – effectively using set formula to allocate income to Brazil.

– The EU is also considering a formulary approach, at the option of taxpayers, to harmonize its corporate taxes under the Common Consolidated Corporate Tax Base (CCCTB) initiative

Transfer Pricing Methods

• Comparable Uncontrolled Price Method (CUP)• Resale Price Method (RPM)• Cost-Plus Method (CP)• Transactional Net Margin Method (TNMM)• Profit-Split Method (PSM)• Use of unspecified methods….

Transfer Pricing Methods• First three in the list (CUP, RPM and C+) are

called “traditional methods”• Last two in the list (TNMM, PSM) are called

“transactional profit methods”• No hierarchy or preference of methods is

formally prescribed. • Bottomline: No single TP method is prescribed

for every possible situation – depends on the characteristics of the particular transactions involved. Most appropriate method must be found and used

Comparable Uncontrolled Price (CUP)

• Compares the price charged for a property or service transferred in a controlled transaction to the price charged for a comparable property or service transferred in a comparable uncontrolled transaction in comparable circumstances.

• Maybe “internal” CUP where the tested party has similar transaction with AE as well as non-AE (or) “external” CUP where two unrelated parties have similar transactions with each other

Comparable Uncontrolled Price (CUP)

• ACo & BCo are “related parties” / “associated enterprises”• ACo & CCo, DCo & ECo are independent parties

ACo

BCo CCoCCo

Identical Widgetssupplied

ALP is the ACo to CCo price

ACo

BCo ECoECo

DCoDCo

ALP is the DCo to ECo price

Similar Widgetssupplied by bothACo and DCo

Internal CUP example External CUP example

Resale Price Method (RPM)

• Used to determine the price to be paid by a reseller for a product purchased from an associated enterprise and resold to an independent enterprise.

• The purchase price is set so that the margin earned by the reseller is sufficient to allow it to cover its selling and operating expenses and make an appropriate profit

Cost-Plus Method (CP)

• Used to determine the appropriate price to be charged by a supplier of property or services to a related purchaser.

• The price is determined by adding to costs incurred by the supplier an appropriate gross margin so that the supplier will make an appropriate profit in the light of market conditions and functions performed.

Transactional Net Margin Method (TNMM)

• TNMM (and Comparable Profits Method of USA TP Regulations) are called “Profit comparison” methods

• As their name suggests, they seek to determine the level of profits that would have resulted from controlled transactions by reference to the return realized by the comparable independent enterprise.

• The TNMM determines the net profit margin relative to an appropriate base realized from the controlled transactions by reference to the net profit margin relative to the same appropriate base realized from uncontrolled transactions

Profit Split Method (PSM)

• Profit-split methods take the combined profits earned by two related parties from one or a series of transactions and then divide those profits using an economically valid defined basis that aims at replicating the division of profits that would have been anticipated in an agreement made at arm’s length.

• Arm’s length pricing is therefore derived for both parties by working back from profit to price

Indian Transfer Pricing provisions

Indian TP provisions• Indian TP provisions were introduced under

“Chapter X : Special Provisions Relating to Avoidance of Tax”– Chapter X, Section 92 of the Income Tax Act (1961)

and Rule 10A-D of the Income Tax Rules (1962) – TP regime was introduced via Finance Bill 2001 w.e.f

April 1st 2001. – In other words, India is a relatively new entrant into

the TP vortex!• Birds-eye, one-line overview of Indian TP: OECD-

Lite

Indian TP Provisions – Chapter X, Section 92Sections/Rules Provisions

s 92 Computation of Income, expenses, CCA

s 92A Associated Enterprises (“AE”)

s 92B International Transactions

s 92C(1) (Rule 10B, 10C) Computation of Arm’s Length Price (“ALP”)

s 92C/92CA Powers of Assessing Officer (“AO”) and Transfer Pricing Officer(“TPO”)

s 92CB Power of Board to make Safe Harbor Rules

s 92CC Advance Pricing Arrangement (APA)

s 92D (Rule 10D) Documentation requirements

s 92E (Rule 10E, Form 3CEB) Accountant’s report

s 92F (Rule 10A) Definitions

s 94A Transactions in notified jurisdictional areas

Transfer Pricing Penal provisions

Reference under the Income-tax Act

Particulars Penalty

271AA Failure to maintain documentation

2% of the value of each international transaction

271G Failure to furnish/submit any information / document to the transfer pricing officer

2% of the value of the international transaction for each such failure

271BA Failure to furnish accountant’s report

INR 100,000

271(1)(c)(iii) read with Explanation 7

Transfer pricing adjustment considered as concealed income

100-300% of amount of tax on adjustments

Indian TP vs. OECD GuidelinesConcepts Indian regulations OECD Guidelines

Associated Enterprises

Very wide definition Restricted to controlled entities

Comparable range (FY 2013)Allows 3% range band on avg. results of comparables

Allows for range of comparable data

Multiple year data Only allows data for current year (earlier 2 years only in special cases)

Permitted

Foreign comparables

Not permitted in practice Permitted

Priority of methods “Most appropriate method” rule Originally, a preference for “traditional” methods

Use of unspecified method

A sixth method….allowing any other method recently prescribed

Permitted

Documentation Stringent Prudent business principles

Intangibles Definition added only in Finance Act 2012. Lack of guidelines/discussion on Intangibles

Definition, discussion, reports, guidance etc.

Indian TPAssessment &

Litigation

Commissioner of Income Tax (Appeals)

Assessing Officer (AO)

Transfer Pricing Officer (TPO)

Dispute Resolution panel (DRP)

Income Tax Appellate Tribunal (ITAT)

High Court

Supreme Court

TPO reference

TPO Order u/s 92CA(3)

Appeal againstCIT(A) order

Form 3CEB

Appeal againstAsst. order

Appeal againstDraft Asst. order

Appeal againstFinal Asst. Order

Set-aside / Remanded back to AO

Sept.2006

TPO: Dec. 2008

AO:Dec. 2009

May 2010

May 2011

2011+

2011+

FY 2005-06

TP ASSESSMENT TIMELINE EXAMPLE

Few observations about Indian TP• Five (now six!) methods – NO preferred method

– CUP, Cost-Plus, RPM, TNMM and Profit-split are the FIVE usual suspects and a sixth “method” allowing any other quantifiable method was recently notified

– TNMM (and CUP) rules the roost in practice• ALP is calculated via arithmetic mean of comparable prices• Threshold limit of international transactions for reference to

TPO reference is Rs.15 crores (Rs.150 million) • Prowess™ & CapitalLine™ company databases are used for

TP reports by all parties including Revenue Dept.• High volume of transfer pricing litigation today; most TP

litigations have not reached High Courts/Apex Court– “Litigation loop” – many cases remanded back to AO/TPO

Recent TP “earthquakes” Finance Acts 2012 & 2013

• Many new TP changes with recent two Finance Acts– A reaction to recent judicial rulings!

• Summary of main changes in Finance Bill 2012/2013– Domestic TP introduced for the first time– Increase in scope of powers of Transfer Pricing Officer (TPO) – Increased penalty provisions for TP– Allow “re-opening” of certain TP assessments – Arm’s-length range is restricted to +/- 3% tolerance band – Retrospectively enlarge the scope of ‘international transactions’ to

include guarantees, any debts, business restructuring etc. – GAAR introduced but then postponed to 2016

Evolution of Indian TP• INITIAL YEARS

– First TP assessments made –ambiguity as it was a new area– ALP concept was being understood and put to practice

• DISPUTE RESOLUTION PANEL (DRP) initiated to handle TP cases– TP fundamentals tested and explained by many judgments by DRP and

various Tribunals. – Controversies on Arm’s-length range, international transactions etc.– Comparability analysis (FAR) was deep-dived into

• CATCHING UP WITH THE WORLD…..– GAAR provisions, APA , Safe Harbor Rules ….

• ERA OF INTANGIBLES : CURRENT PHASE– Financial txns: Corporate Guarantee / Interest-free loans to foreign AE– BRAND: reimbursement with markup from AE

• DOMESTIC TRANSFER PRICING INTRODUCED

Bottomline: Evolution and maturing of Indian TP……

TP theory meets reality

A look at Indian TP in practice

Issue #1Comparables: Whither art thou?

• There is a lack of comparables in many segments– Problem especially acute in developing countries where there

are a number of ‘sunrise’ or emerging industries• Result of this data paucity is not merely a lack of comparables

but the serious consequence of using incorrect comparables in the TP assessment– International comparables data is nearly impossible to gather

and many times are rejected by Revenue or by Courts– It often becomes a case of non-technical people trying to do

technical work (classic example - choosing KPO software companies for comparison with BPO assessee, choosing comparables across different software verticals etc.)

Bottomline: The whole comparability analysis exercise may at times become unsound and indefensible

Issue #1Example 1 : Software development industry

A.E.(USA network security

software company)

Assessee Indian subsidiary

(Engaged in network security software

development)

TPO: Adopt TNMM with third-party Indian software co’s taken as comparables

1. A transport logistics software company2. A generic application outsourcing co.3. An ERP (SAP) software vendor4. Infosys™ - India’s a mega-IT major

• Department rejected cost-plus and used TNMM with its set of comparables

• Comparables in completely different software verticals – an apples to oranges comparison.

• This is not only a problem with the TP assessment order but also a flaw in the underlying system– Comparable search in “software services” may yield

these companies!

Bottomline: An apple and orange are both fruits – hence valid comparables under TP!

XCost-plus + 15%

Issue #2 Adjustments to comparables

“(iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market” Rule 10B(e)(iii) on TNMM

• TP provisions are vague!

• TP adjustments in practice is not the same as theory. In India following are observed:– Foreign AE’s are typically not accepted as tested party– Foreign comparables are almost always not accepted due to data

paucity on adjustments• What are the adjustments which will be accepted?– No specific guidance or certainty on this– From practice, adjustments typically disputed by Revenue are: Idle

capacity, depreciation, risk, differences in accounting policy etc.. • How to quantify any of these TP adjustments?

– Quantification of adjustments are usually ad-hoc or supported using suitably tweaked formulae.

– Department and taxpayer spar regularly on this issue in CourtsBottomline: Fundamental lack of clarity & guidance with respect to

Transfer Pricing Adjustments

Issue #2 Adjustments to comparables

Issue #2Adjustments to comparables (contd.)

• Comparables are rejected using “filters” . Some popular filters used are:

• Minimum employee cost of 25% over sales • Different year ending filter• Diminishing revenue filter• Related party filter• On-site revenue filter• Turnover filters• Super-profit (& loss-making) filters• Functional difference filters

• These filters are not prescribed in any provision or Rule nor guidance is provided for them.

Issue #2Example 1: Adjustments to comparables

• Internal CUP with company AE as tested party rejected by TPO– Typically foreign companies are

not allowed as tested parties. – No good answers for India vs.

Brazil, India vs. Mexico geographical market adjustments

• TNMM chosen with “Auto ancillaries”– Only one proper comparable but

no segmental data available– Other comparables are in “shock-

absorbers”, “battery companies”• Moving from one incomplete

puzzle (CUP) to an incorrect result (TNMM) is better?

AE (USA)

Assessee (Indian automotive axles manufacturer)

Mexico and Brazil axle manufacturers

Axle raw material import

Issue #3Data sources – TPO data gathering powers

• TPO has the “power to call for information” under Section 133(6) of the Act to obtain information from any firm – This power is used often in the TP

assessment to gather data on comparables

• Practically speaking, assessee may not be given a chance to analyze or provide rebuttal to the info– Also many companies supply

information which are prone to wide interpretation

• This is a common issue across the board in TP assessments in India

AE (UK)

Assessee (India)

Third partyIndian co’s

AO/TPOTP study

Tax return

Issue #3Data sources – Using customs data

• Taxpayer: Internal CUP with Indonesian AE as the tested party was submitted

• TPO:– Rejects Internal CUP and

uses External CUP– Uses customs data of

third-party transactions not in public domain

– Cherry-picks data and chooses transactions without reference to gross-calorific value (quality) of coal, quantity etc.

– Assessee requests competitors and obtains few invoices used by TPO which show even CIF vs. FOB difference ignored

AE (Indonesia)

Assessee(Indian co)

Coal import

AO/TPO

Non-AE(anywhere)

Third-party coal importer

(India)

Customs Data

External CUP (using customs data)

Third-partyIndian cos.

TP study:Internal CUP

Rule 10B(4) states “The data to be used in analysing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered intoProvided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared.”

Issue #4Multiple year data

• Not accepting multiple year data flies against the face of logic– What about business cycles, recessionary effects, gestation

period etc.• Onus on assessee to prove usefulness of multi-year data…..

Issue #5The Indian arm’s-length range controversy

• ALP is computed with reference to arithmetic mean of comparables with a uniform tolerance of 5% around the transfer price (Proviso’s to Section 92C(1))– Example: arithmetic mean of comparable PLI of operating profit/total

cost is 10% would mean an arm’s-length range of 4.76% to 15.79%• It was further interpreted by taxpayers to mean that this +/-5%

standard deduction was available to the taxpayer and not a binary band. – Example: In case of standard deduction, if net profit margin were 4.75%

in the above scenario then only 0.01% is the adjustment and not entire 4.75% as in the case of a band where you are either in the band or out.

– Number of cases in different Tribunals in favour of and against the assessee

• Amendment in Finance Act 2009 tried to rest controversy about arm’s-length range by saying the 5% tolerance is not a standard deduction (as well as changed base of determination of allowable band linking it to transaction price instead of arithmetic mean)– However post 2009 period also remained ambiguous due to

conflicting judicial decisions• Retrospective amendment recently in Finance Act 2012 w.e.f

1/4/2002 clarifying the 5% is not a standard deduction (from 1/4/2013 to be 3%)

Bottomline: Lots of litigation on simple issues due to lack of clarity

Issue #5The Indian arm’s-length range controversy

Issue #6Practical TP oddities - Few nuggets from the field

1. TNMM Adjustments applied to all transactions of taxpayer enterprise: (Il Jin Electronics India Pvt. Ltd. –Delhi Tribunal)

2. Adjustments resulting in illogical results : Total amount of adjustment made, along with ALP already reported, exceeded total revenues earned by the taxpayer and its AE from dealing with third party clients! (Global VantEdge Pvt. Ltd – Delhi Tribunal)

3. Excess profits being disallowed under regular provisionsAO held that excess profits (above ALP) would be disallowed u/s 10B for IT companies in SEZ (Tweezerman India, Chennai ITAT)

4. “Contemporaneous” data used even if not available at specified date : TPO empowered to determine ALP by using public domain data even after “cut-off date” (Kodiak Networks India vs. ACIT –Bangalore Tribunal)

Indian judiciary & TP

Assessee / Taxpayer Judicial forum Short point of ruling

DIT vs. Morgan Stanley

Supreme Court Once TP analysis is undertaken, no further need to attribute profits to a PE

E-Gain Commn. P. Ltd ITAT Pune TNMM may afford a practical solution to otherwise insoluble transfer pricing problems if used sensibly and with appropriate adjustments

TNT India ITAT Bangalore For arriving at the net margin of operating income, only op. income & expenses for relevant business activity of assessee to be taken into consideration

Aztec Software & Technology

ITAT SB All characteristics of controlled transaction which are likely to affects its open market value must be taken into account

Mentor Graphics Ltd. ITAT Delhi If one point in arm’s length range is satisfied, onus shifted to Dept. ALP not mean max. price or profit in range

UCB India (P) Ltd. ITAT Pune Method adopted by assessee is rejected, Revenue duty bound to compute ALP and substantiate and justify use of its method


Schefenacker Motherson Ltd. ITAT Delhi Depreciation cost may be adjusted to eliminate material differences in ‘asset’ profile

ACIT vs. Wockhardt Ltd. ITAT Mumbai TNMM refers only to net margin realized by enterprise from international transactions but not operational margins of enterprise as a whole

Il Jin Electronics (India) Pvt. Ltd. ITAT Delhi Proportionate adjustment under TNMM on the ratio of international transactions with AEs to transactions with non-AEs

ACIT vs. Frost & Sullivan Pvt. Ltd. ITAT Mumbai No basis for excluding only loss making comparables and not excluding high profit marging comparables or companies which are not at all comparable based on size, turnover and other factors

Global Vantedge Pvt. Ltd. ITAT Delhi Total amount of adjustment made, along with ALP already reported, cannot exceed total revenues earned by the taxpayer and its AE from dealing with third party clients

Genisys Integrating Systems ITAT Bangalore TP adjustment restricted to AE segment, exclusion of super-profit making companies, application of upper turnover filter, std. deduction of +/- 5%, capacity utilization adj. granted. Sent-back to TPO

Trilogy, Bearing Point, Yodlee, Curam etc.

ITAT Bangalore Set of principles being evolved for software companies TP assessment. Standard set of filters approved by ITAT.


Philips Software vs. ACIT ITAT Bangalore Rule 10A(a) means co. having even single rupee of related party txn. not comparable

Sony India ITAT Delhi Contractual terms agreement to be looked into, consider cos. with less related party txns & losses too

Demag Cranes & Components

ITAT Pune Duty of AO/TPO/DRP to minimize/eliminate difference which is likely to materially affect the price

Vertex Customer Services

ITAT Delhi No penalty under S.271(1)(c) for bonafide TP adjustments

Honeywell Automation India Ltd.

ITAT Pune Under Indian TP, consideration of subsequent year or average profits not permitted though OECD prescribes the same

In Re Dana Corporation AAR No capital gains in a business reorg. if consideration not determinate. TP law does not apply if there is no income

SSL-TTK Ltd. ITAT Chennai Penalty under 271G not to be levied for benign reasons in nature of procedural issues

Delphi TVS ITAT Chennai Re-visit by TPO for correctly assessing the prices under CUP for comparison after adj.

Ranbaxy Labs & Devel. Consultants

ITAT Delhi Selection of overseas comparable maybe allowed provided such data is available in public domain

Quark Systems ITAT Chandigarh (SB)

Filters to be based on ‘cogent reasoning’ and not unsound assumptions

Agnity Delhi HC Confirmed ITAT use of turnover filter to reject Infosys

Indian TP & Intangibles

Indian TP & Intangibles:BRAND VALUATION OF FOREIGN AE

• The current hot-topic of TP discussion & litigation throughout India is about returns to the “brand” (marketing intangible) of the foreign AE due to advertising spend of its branded products by Indian subsidiary in India:– VERY common scenario is Indian subsidiary is established by big

foreign brand for entering India; Indian subsidiary spends a lot on advertising , marketing & sales promotion (AMP) expenditure in India….

• Questions being asked by the Revenue Department – Does the foreign company’s brand get enhanced by the advertising &

marketing spend (AMP) of its Indian subsidiary?– Shouldn’t the foreign AE therefore reimburse its Indian subsidiary

with markup the excess AMP spend (or subsidize rates of products supplied to India or reduce Royalty rates)?

Indian TP & Intangibles:The India Govt’s viewpoint

• Reply in Chapter X to UN TP Manual spells Indian Govt’s current view clearly:– Position is that there should be reimbursement by the

foreign AE of excess Advertising & Marketing expenditure (AMP) with a markup

– High-risk Indian subsidiaries need to get additional returns in the form of reimbursement of AMP

– “Bright-line test” for marketing intangibles may be used– Developer of marketing intangibles having economic

ownership IS ENTITLED to ADDITIONAL RETURNS (i.e., the Indian company is entitled to additional returns!)

Indian TP & Intangibles:Reading between the lines…

• The Indian Government rationale seems to be as follows:– Indian subsidiaries sells millions of branded items but consistently shows

losses in India. Thus, no immediate benefit (i.e., taxes paid) to India– Main expenditure items for Indian subsidiary seems to be

advertising/marketing & sales promotion (AMP) spend – Economic owner (typically Indian subsidiary co.) can never become called

“owner” of brand – legal owner is “owner” of the brand– Economic owner (Indian subsidiary) spends all the money but does not get

returns - legal owner (foreign AE) getting benefit but not being shared with Indian subsidiaries

– Indian companies are actually undertaking high-risk and should get returns on the risk & costs

– Only available & immediately taxable indicator of value accretion to marketing intangible is the AMP spend –this AMP spend needs to be shared by foreign AE

Indian TP & Intangibles: OECD vs. India

• Convergence in theory – All parties seem to basically agree that excess of advertising

expenditure (AMP) maybe reimbursed– OECD Revised Draft on Intangibles (specifically Examples #6,

7) similar to India’s stand• Divergence in practice

– Indian stand on ownership for purpose of intangible returns may not be in line with OECD as Indian Govt. & Court seem to look only at underlying legal owner for determining sharing of returns from intangibles

– Effective control, beneficial ownership, risk are all bones of contention

Indian TP & Intangibles:Indian Judiciary’s tangible role

• The Government stand on brand reimbursement seems to be supported by recent landmark Judicial judgments!– Maruti Suzuki vs. ACIT (Delhi HC)– L.G.Electronics vs. ACIT (Special Bench Tribunal)– Ford India vs. ACIT (Chennai Tribunal)– Panasonic India vs. ACIT (Chennai Tribunal)– BMW, Diageo India, Glaxo Smithkline, Haier Appliances India,

RayBan, Reebok India, Samsung India, Sony India etc.– the list goes on!

• Thousands of millions of Rupees tax demand for reimbursement by foreign AE on excess AMP spend to Indian subsidiaries currently being litigated!

Indian TP & Intangibles:Maruti-Suzuki case (Delhi Tribunal & HC)

• Maruti-Suzuki issue was whether Suzuki™ derives benefit from advertising expenditure incurred by Indian company while promoting the co-branded Marut-Suzuki car in India – Court supported the “Bright-line test” of the US judiciary– Made a distinction between mandatory and discretionary use of

brand name to decide whether AMP expenditure of Indian AE increased brand value of foreign AE

– Gave due recognition to OECD principles relating to intangibles – As usual with TP, no specifics and only general guiding principles

outlined and case sent back to lower authorities• Supreme Court however set-aside the Maruti-Suzuki judgment! So,

is it still good law….?

Indian TP & Intangibles:L.G. Special Bench decision

• Elaborate, popular judgment (~300 pages) analyzing the concept of foreign AE returns on its “brand” being promoted in India

• Underlying theme is that the foreign brand gets exposed to, developed and enhanced in India and hence this accretion of marketing intangible of foreign AE ought to be reimbursed

• Assessee’s prima facie contention that local advertising expenditure did not amount to an international transaction – Rejected outright

Indian TP & Intangibles:L.G. Special Bench (contd..)

• Enumerated 14 questions/principles to determine the nature of the relationship between the AE’s and their use and cost/value of the intangibles shared

• Held that:– Position taken by assessee that economic ownership (based on

developer-assistor rule) by the Indian subsidiary leads to it becoming the “owner” of brand is flawed AND

– Position that the underlying intangible legal owner (foreign AE) does NOT obtain returns on its “brand” is unacceptable

• Direct selling expenditure may be excluded in calculation of reasonable AMP!– What constitutes direct selling as opposed to brand promotion?

Confusion still prevails….

Indian TP & Intangibles:Points to ponder....

• How can valuation of the marketing intangible be tied directly to excess of AMP spend ALONE?– Methods for valuation of intangibles such as Income-Based

methods, Super-profit, Replacement-cost, Binomial/non-traditional methods not being used at all.

– Quality, execution and other factors by Indian subsidiary also matter over time; not just Brand

• What about intangible value reduction?– Consider Blackberry™ which no longer have same brand recall in

India; consider companies which have series of flops…..• Exception needs to be given for initial years extraordinary

advertising and marketing

Indian TP & Intangibles:Few more intangible problems…..

• CONTRACT R&D: Indian Govt’s stand (Chapter X – UN TP Manual)– Indian subsidiaries are NOT risk-free entities and hence low cost+

can’t be accepted– Disputes the ability of parent to control risk remotely when core

functions of R&D and services are located in India – Holds that Indian entity should be entitled to a higher returns– Completely disagrees with CAPM model for risk adjustments

• Taxpayers are in total disagreement with above viewpoint!– No risk / minimal risk borne by Indian entities– Indian entities typically used for executing the work given to them at

low cost : that is our USP– In most cases product vision, design, direction, innovation and control

is by foreign AE and not India – we merely get the job done

Indian TP & Intangibles:Few more intangible problems in Indian TP….

• FINANCIAL TRANSACTIONS (Guarantees, loans, debts etc.)– Checkered history of litigation with many different Tribunals

holding contrary positions– Retrospective amendments to include loan, debt &

guarantee transactions under definition of “international transaction” (S.92B) was passed in Finance Act 2012

– Position is becoming clear now:• Notional interest or guarantee fees has to be charged• Dispute exist as to what rate interest/fees to be charged:

Revenue Department takes view that Prime Lending Rate (PLR) should be taken and NOT LIBROR/EURIBOR rate

– Safe harbors introduced in this area of financial transactions

Indian TP & Intangibles:Few more intangible problems in Indian TP….

• LOCATION SAVINGS– Indian Govt. has recognized the need for allocation of location

savings and rents between AE’s using profit-split methods. – No clarity or TP tax demands on this issue yet

• INTRA-GROUP SERVICES– Biggest challenge is allocation of costs using appropriate keys

which are usually disputed by the Revenue– Whether or not it is necessary for services provider to make a

profit is another key area of dispute – No clarity yet but has been identified as high risk area for

Indian TP by the Govt.

Streamlining current Indian TP provisionsSector-wide safe harbors

• Hue & cry from industry resulted in “N.Rangachari Committee” culminating in publication of Safe Harbor rules by CBDT

S.No. International transaction Safe harbor margin

1 Software development 20% or more on oper. expenses

2 BPO 20% or more on oper. expenses

3 KPO 30% or more on oper. expenses

4 Intra-group loan (< INR 500million) State Bank rate + 150 basis pts

5 Intra-group loan (> INR 500million State Bank rate + 300 basis pts

6 Corporate Guarantee to WOS 2% per annum on amount

7 Software contract R&D 30% or more on oper. expenses

8 Pharma contract R&D 29% or more on oper. expenses

9 Mfg & export of auto components 12% or more on oper. expenses

10 Mfg & export of non-core auto 8.5% or more on oper. Expenses

Streamlining current Indian TP provisionsProfit Splits, Formulary Apportionment etc.

• Formulary apportionment approach is promising in certain areas and ought to be tried?– Attacks the crux of the TP problem that at end of the day it is a tax-

sharing formula which all governments want to work out– Correct approach of using math to solve an economics problem. Run

predictive models, tweak the formula and try again….

• Profit-split holds promise when it comes to “intangible” transfer– Other methods of valuation of intangibles should be accepted. Good

theory but never accepted in practice

Streamlining current Indian TP provisionsMore points to Ponder….

• Allow 3% standard deduction as arm’s-length range• Use inter-quartile ranges instead of arithmetic mean• Allow multiple year period data across the board• Allow foreign comparables, allow foreign AE as tested party• Provide clear guidance on adjustments specifically risk, idle

capacity, depreciation and working capital• Prescribe clear turnover range filters for comparables• Do not reject loss-making comparables outright• Allow technical expert reference for selecting functionally

similar comparables

• Ameliorate the data gathering system by the TPO and mandatorily involve the assessee at every step

• Use Advance Pricing Arrangements (APAs) as much as possible• MAP process should be pursued more and made time-bound and

effective • Clear guidance on Intangibles and their valuation methods.

• Need of the hour is more discussion, technical reports, analysis on intangibles.

• TP assessments should NOT result in a pyrrhic exercise

Bottomline: Currently, TP is not art nor science….its magic! Indian TP regime has to change to help both the Department and

taxpayer to achieve respective goals

Streamlining current TP provisions More points to ponder…

Thanks!

Acknowledgments to V.P.Thangadurai, Advocate (

[email protected])Bhavya Rangarajan, Advocate (

[email protected])



Taxation of International Transactions V. Vikram, Advocate M/s Subbaraya Aiyar, Padmanabhan &...

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