Recent issues in Taxation ofRecent issues in Taxation of Royalties (including Software) and Fees for Technicaland Fees for Technical Services

4th International Tax Conference – CTC

21 December 2012, Mumbai

CA. Shabbir Motorwala

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Contents

Recent amendments by the Finance Act 2012

Recent judicial precedents

TRC Rule / Issues

Cloud – Tax Issues

Q & A

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Taxation of Royalty – Shrink Wrap / Off-the Shelf Software-- Landscape of disputeLandscape of dispute

R A th iti TCharacterization of Shrink WrapRevenue Authorities Tax payers

lty? e?

• Software payments involve use / right

• Software payments are for use / right to use

of Shrink Wrap software

payments to Non-Residents

her

R

oyal

ess

Inco

meinvolve use / right

to use of following:

• Copyright (license)

Copyrighted Article • OECD MC - There is no

use / right to use of copyright, patent,

Wh

eth

er

Bus

ine

Software(license)

• Patent

• Invention

copyright, patent, invention or process

• Reliance on SC -TCS = software on tangible

di i d f

Whe

the

• Process

• Taxable in India as Royalty on gross b i

medium is goods for IDT laws

• Thus, it is business income not taxable in

basis India in the absence of any Permanent Establishment in India

I d liti ti i b f b t j it i f f A

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Issue under litigation in a number of cases but majority in favor of Assessee

Widening ambit of Royalty - Computer Software-- Finance Act 2012

Expansion of Royalty definition retrospectively w.e.f. 1 June 1976

• Explanation 4 added to s. 9(1)(vi)

- 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 orright, 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 license) irrespective of the medium through which such right is transferred

• As per Memorandum to Finance Bill

- Some judicial decisions have interpreted this definition in a manner which has raised doubts as to whether consideration for use of computer software is royalty or not Considering thewhether consideration for use of computer software is royalty or not …. Considering the conflicting decisions of various courts in respect of income in the nature of royalty and to restate the legislative intent, it is further proposed to amend the Income-tax Act ….

• India in its comment on the UN MC 2011 has recommended “The use of and right to use computer software irrespective of the medium through which such right is transferred is to be construed as ‘Royalty’ (Article 12)”

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Widening ambit of Royalty – Use / Possession and Process-- Finance Act 2012

Expansion of Royalty definition retrospectively w.e.f. AY 1977-78

• Explanation 5 added to s. 9(1)(vi)

- 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

• Use of Process : Explanation 6 added to s. 9(1)(vi)

- For the removal of doubts it is hereby clarified that the expression “process” includes and shall beFor 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

• Inserted primarily to overturn Delhi High Court’s decision in the Asia Sat case

• The term Transmission not defined

• Need to distinguish customer service arrangements v commercial arrangements?• Need to distinguish customer service arrangements v. commercial arrangements?

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Retrospective amendments – whether impact Tax Treaty?

No change in Tax Treaty so retrospective amendment not relevant?

MC / Tax Treaty Article 3(2)MC / Tax Treaty Article 3(2)

Terms not defined to have meaning under the applicable tax laws of that

State prevailing over a meaning given to the term under other laws of that

State

OECD / UN MC

Recommends Ambulatory approach of interpretation Recommends Ambulatory approach of interpretation

Siemens Aktiengesellschaft – (2009) 310 ITR 320 (Bom HC)

Law applicable is not the law when the Tax Treaty was entered

Recent decisions

B4U International (Mum AT)

Payments for hiring of Transponder not Royalty

Amendments have no affect as there is no change in Tax Treaty

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Retrospective amendments – whether impact Tax Treaty?

No change in Tax Treaty so retrospective amendment not relevant?

WNS (Mum AT)( )

Reimbursement of International Connectivity Charges

Explanation added to definition of Royalty under Section 9(1)(vi) cannot b t d t h b dd d t th di d fi iti dbe construed as to have been added to the corresponding definition under the Tax Treaty

Article 3(2) - Tribunal seems to have interpreted the term not defined under the Treaty to refer to the whole definition and not to each components of the definition

Any amendment to the Tax Treaty can be only bilateral

Nokia Networks OY (Del HC)

Supply of Hardware and Software – Telecom Equipment

Seem to have relied literally on Siemens decision (supra) that ‘amendments cannot be read into the Tax Treaty ‘

Followed its earlier decision in Ericson

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Retrospective amendments - Withholding tax implications?

Whether any obligation to withhold tax under Section 195?

FA 2012 also amended the provisions of Section 195 – NR to NR

Lex non cogit ad impossiblia

Law cannot possibly compel a person to do something which is impossible – (2006) Krishnaswamy 281 ITR 205( SC) and other decisions of SC

No retrospective withholding tax can be imposed under Section 195 and consequently no disallowance under Section 40(a)(i)

Channel Guide – (2012) Mum AT / Satellite Broadcasting

Other key decisions on retrospective amendments not imposing withholding tax obligations g g

National Aviation – (2011) 43 SOT 362 (Mum)

Sterling Abraive – (2011) 44 SOT 652 (Ahd)

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R / FTS : Section 9(1)(vi) / (vii) - Source of Income

Whether source of income is the payer of income?

Havells India Ltd - Del HC

Whether exports sales proceed received from goods manufactured and

exported from India constitute a source in India or outside India?

Delhi HC went through plethora of decisions on the subject

Place / situs of person who makes the payment for exports sales is not

the source of income but only source of monies

Exports contract concluded in India, manufacturing activity located in IndiaExports contract concluded in India, manufacturing activity located in India

and thereafter goods exported from India - thus, source is in India

Such facts not akin to source or business carried out outside India

Thus, FTS paid to US Company relating to exports sales are not for the

purpose of making or earning income from any source outside India

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R / FTS – Point of Taxation

Whether R/ FTS taxable only when paid to Non-Residents?

R/ FTS held to be taxable only when ‘paid’ to Non-Residents

Siemens Aktiengesellschaft – Bom HC: India-Germany Tax Treaty

Pizza Hut International – Del AT: India- USA Tax Treaty

CSC Technology – Del AT: India-Singapore Tax Treaty

Paid defined under Section 43(2) of the Income tax Act 1961 Paid – defined under Section 43(2) of the Income-tax Act 1961

‘Paid’ means actually paid or incurred according to the method of

accounting – computing of business income

Whether above definition relevant - Article 3(2)

OECD MC on Article 12 – Para 8.3:

Paid has a very wide meaning i.e. fulfillment of the obligation to put funds

at the disposal of the creditor in the manner required by the contract or by

custom

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custom

R/ FTS - E-Commerce Taxation

Tax Treatment of Website Operating, Website Hosting and Online Ad ti tAdvertisements

eBay International AG – Mum AT

User fee for operating India specific website providing online auction is not User fee for operating India specific website providing online auction is not

FTS under the India-Switzerland Tax Treaty

People Interactive – Mum AT

Payments for Website Hosting not Royalty as no physical access to the

equipment system and arrangement is only availing of services

Decision before Finance Act 2012 – Impact of Amendments?

Pinstorm Technologies – Mum AT

S i i ti ith l di d di l f b Services in connection with uploading and display of banner

advertisement on portal was not in the nature of R/ FTS

Followed earlier decision Yahoo.com

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Royalty – Online subscription

Online subscription and access to information database

Thoughtbuzz – AARThoughtbuzz AAR

Subscription fees paid for social media monitoring services (for a company, brand, or brand in the form of reports by gathering information from internet and mapping blogs etc) taxable as Royalty under the Actfrom internet and mapping blogs, etc) taxable as Royalty under the Act and the India-Singapore Tax Treaty

Applicant construed to be engaged in the business of gathering, collating d ki il bl i ti i f ti i i d t i l dand making available or imparting information, concerning industrial and

commercial knowledge, experience and skill

ONGC Videsh – Del AT

Subscription fees for accessing website providing information of oil and gas industry is Royalty under the Act and the India-UK Tax Treaty

f f Information access has a character of intellectual property compiled on the website and the information obtained by customer is technical in nature

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These decisions upset the applecart of several earlier favorable decisions

Section 9(1)(vii) : Supervisory Services

PE v. FTS

Toyo Engineering Corporation Japan (‘TEC’)– Mum AT (AY 1999-2000) Toyo Engineering Corporation, Japan ( TEC )– Mum AT (AY 1999-2000)

TEC offered its income from Project Management Contract on net income

basis following the Percentage Completion Method – supervision of

detailed engineering, constructions and start up assistance

Under Section 9(1)(vii) - the above activities were held as not qualifying

for exclusion limb of FTS as they are not construction assembly miningfor exclusion limb of FTS as they are not construction, assembly, mining

or like project.

Taxation on gross basis under Section 44D / 115A of the Act as attempted

by the AO construed as not applicable as Article 7 of India-Japan DTA

does not contain the rigor – ‘in accordance with and subject to the

limitation of the taxation laws of that state’limitation of the taxation laws of that state

In view of above, taxation on net basis was accepted even while income

of the PE characterized as FTS

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Section 44BB v. Section 44DA

Presumptive scheme v. Gross / Net basis of taxation as FTS

OHM – Delhi HC (appeal arising from AAR Ruling) (India-UK Tax Treaty)OHM Delhi HC (appeal arising from AAR Ruling) (India UK Tax Treaty)

Section 44BB – NR engaged in business of services / facilities in connection with or supplying plant and machinery on hire – prospecting and extracting or production of mineral oilsproduction of mineral oils

Section 44BB inapplicable where Section 42/44D/44DA/115A / 293A apply

Specific provisions prevail over General provisions – Generallia specialibus d t’non derogant’

Even if two provisions accepted / applicable, effect to be given to both

Section 44BB to become redundant if not applied on the basis of coverage by other general article

Note: Good decision considering adverse Rulings of AAR in 2012 on this issue

De Beers India – Kar HC (India-Netherlands Tax Treaty) De Beers India – Kar HC (India-Netherlands Tax Treaty)

Geophysical Survey – ‘Make Available’ condition construed not satisfied – No imparting of skill / absorption by receiver or development / transfer of technical plan / design Not FTS under India Netherlands Tax Treaty

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technical plan / design– Not FTS under India-Netherlands Tax Treaty

‘Make Available’

Providing Technical Personnel Avion System Inc (‘ASI’) – Mum AT (India-USA Tax Treaty)y ( ) ( y)

ASI engage in provision of qualified technocrats and in this case for a telecom projects for a telecom on a cost plus mark-up (No PE in India)

ASI not otherwise involved in the execution of the contract or providing any kind of technical / consultancy services

Outsourcing of employee construed as employer –employee relationship

Tribunal held that the purpose of outsourcing was making available the expertise of the personnel in the telecom sector – deputation case laws distinguished - Services were construed as FTSdistinguished - Services were construed as FTS

Apollo Consulting – Mum AT (India-USA Tax Treaty)

Procurement of software personnel for work in USA

Final product or result on account of technical personnel is not pre-determined and no product or software development, etc on record

Better view for Section 263 Not FIS under the India USA Tax Treaty

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Better view for Section 263 –Not FIS under the India-USA Tax Treaty

Routing Repairs, Grossing-up and Section 206AA

Several issues Bosch Ltd – Bang AT (India-Germany Tax Treaty)g ( y y)

Contract for repairs of machinery outside India - repair construed to mean to put something damaged, broken or not working correctly back into conditioncondition

Delhi AT in Lufthansa - Repairs carried out without participation of personnel of customer in normal course – not FTS [BHEL – Hyd AT]

Services of analyzing and solving technical problem including telephonic advise, analysis and assistance constitute FTS

PAN - Section 206AA of the Act applicable to Non-Residents PAN - Section 206AA of the Act applicable to Non-Residents

Grossing up under Section 195A - rate or rates in force – this is the rate of Tax Treaty at 10% and not 20% under Section 206AA

Therefore , grossing up of 10% results in 11.11% and compare with 20% on gross basis under Section 206AA?

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R/ FTS - Other selected key decisions

UPS SCS – Mum AT: Hong Kong Entity

International freight forwarding and logistic services is not in the nature of FTS as it is:

Neither managerial (no planning , etc),

Nor consultancy (some advice or opinion, etc) services

Nor technical (involvement of direct human element critical keeping in mind that the word technical is sandwich between managerial and consultancy)technical is sandwich between managerial and consultancy)

Clearwater Technology – Bang AT: India-USA Tax Treaty

P t t d i h t N t l USA i IT bl b i / i i t t l Payment towards voice charges to Novatel USA in IT enable business / services i.e. to a telecom service provider connecting calls to / from USA

Department inter alia relied on the retrospective amendments by FA 2012 to Section 9(1)(vi) p p y ( )( )

ITAT held that the payment was for services but not in the nature of ‘managerial, technical or consultancy services

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R/ FTS - Other selected key decisions

Hughes Escort Communication – Del AT (India-USA Tax Treaty)

Affiliate marketing agreement ith USA Compan in connection ith co rses offered b a USA Affiliate marketing agreement with USA Company in connection with courses offered by a USA University

Got various rights from the university towards marketing of courses offered but not in any material / course

Amount paid to USA company was apportionment of fees after retaining portion of fees collected for providing enrollment infrastructure in order to access study material by students p g y y

No case of Royalty or FTS

TUV Management Service GmbH – Mum AT (India –Germany Tax Treaty)

ISO certification and audit services – evaluation of quality system and environmental system

Incidence of advice given at the time of evaluation cannot result in ‘audit’ being termed as ‘technical services’services

As per IAF guidance, auditor cannot give prescriptive advice or consultancy as part of assessment

Services are not FTS under the Act or Tax Treaty

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R/ FTS - Tax Residency Certificate for Claiming Relief under Tax Treaty

Sub-Section (4) of Section 90 as inserted by FA 2012 w.e.f AY 2013-014 - Restricts the treaty benefit to Non-Residents, unless the Non-Resident obtains a tax residency certificate (TRC) from the Tax Authorities in the Home Country containing the specified particularsAuthorities in the Home Country containing the specified particulars.

Income Tax Rules / CBDT Notification No. S.O. 2188(E), dated 17 September 2012 - With effect from 1 day of April 2013, Details required to be submitted in the TRC:

N f th• Name of the assessee

• Status (individual, company, firm etc.) of the assessee;

• Nationality (in the case of an individual); y ( );

• Country or specified territory of incorporation or registration (in the case of others);

• Assessee’s tax identification number in the country or specified territory of residence or in the case there is no such number then a unique number on the basis of which the person is identified by theis no such number, then a unique number on the basis of which the person is identified by the Government of the country or the specified territory;

• Residential status for the purposes of tax;

• Period for which the certificate is applicable; and

• Address of the applicant for the period for which the certificate is applicable.

Several issues arise especially – date of commencement of Rule LLPs which are pass through

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Several issues arise especially – date of commencement of Rule, LLPs which are pass through, countries which issue TRC in their own format only or after the year end, etc.

Section 9(1)(vi) / (vii) : Cloud Taxation

Taxation issues in Cloud arrangements

Types of Cloud Service Providers Types of Cloud Service Providers

Software applications

Infrastructure and storage g

Platform to develop applications

All management and control is with CSP

Indian Company enters into agreement with CSP – Nature very relevant

CSP can in turn have several back –to- back support / service agreements with

other Non-Residents

Issues with respect to classification of income

R lt Royalty

FTS

Business income – No PE / No Tax

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Business income – No PE / No Tax

Q & A

Questions

AnswersAnswers

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Thank You!

CA. Shabbir MotorwalaEmail: smotorwala@kpmg comEmail: smotorwala@kpmg.com

The information contained herein is of a general t d i t i t d d t dd thnature and is not intended to address the

circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it issuch information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.g p