taxation of royalty and fts

Royalty and Fees for Technical ServicesSurprises continued ..

Romesh S A Sankhe

WIRC, Thane19 November 2011

© 2011 Deloitte Haskins & Sells

Contents

• Taxation of 'Royalty‘ and ‘Fees for Technical services’

• Indian Income Tax Act

• DTAA

• Specific Issues

• Planning Avenues

• Direct Taxes Code

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Deloitte Haskins & Sells

Taxation of ‘Royalty’ and ‘Fees for Technical Services’

© 2011 Deloitte Haskins & Sells4

Income Tax Act and DTAA | Section 90(2)

Whether taxable under the Income

Tax Act?

Analyse articles of DTAA, if any

DTAA need not to be applied

Taxable as per Articles of DTAA

Not taxable as per Articles of DTAA

Opt for DTAA , if beneficial than Act

Opt for Act, if beneficial than

DTAA

No

Yes


Income Tax Act | Scope of income (1)

Section 5(2)Income of a non-resident is liable to tax in India which is:• received or is deemed to be received in India; or• accruing or arising, or is deemed to accrue or arise in India

Section 9(1)(vi)/(vii)Income by way of royalties and fees for technical services (FTS) may deemed to accrue or arise in India which is:• payable by a resident/non-resident of India in respect of rights/services

utilised‒ for the purpose of a business or profession carried on by such person in

India or‒ earning any income from any source in India


Income Tax Act | Scope of income (2)

Situation IRoyalty/FTS received by foreign resident from Indian resident in India attributable to Indian resident’s business carried on in India - Taxable

Situation IIRoyalty/FTS received by foreign resident from Indian resident outside India attributable to Indian resident’s business carried on in India - Taxable

Situation IIIRoyalty/FTS received by foreign resident from Indian resident in India attributable to Indian resident’s business carried on outside India - Taxable

Situation IVRoyalty/FTS received by foreign resident from Indian resident outside India attributable to Indian resident’s business carried on outside India - Not taxable


Income Tax Act vs DTAA | Royalty

Royalty definition - Income Tax Act, 1961• Consideration for (includes lump sum consideration but excludes “Capital gains”) —

– transfer of all or any rights (including the granting of a license)

• patent, invention, model, design, secret formula or process or trade mark or similar property

• 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

– for use of or for imparting of any information concerning the working/use of

• patent, invention, model, design, secret formula or process or trade mark or similar property

– the imparting of any information concerning technical, industrial, commercial or scientificknowledge, experience or skill

– use or right to use any industrial, commercial or scientific equipment but not including the amounts referred to in section 44BB

– the rendering of any services in connection with the activities referred above

• Explanation to section 9(1)(vi) of Income Tax Act

Words in green present only in

the Act


Income Tax Act vs DTAA | FTS

FTS definition – Income Tax Act, 1961• 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

• consideration which would be income of the recipient chargeable under the head “Salaries”

Words in green present only in

the Act


Income Tax Act vs DTAA | Arbitrage opportunities

Taxpayer may opt for DTAA, if it’s beneficial than Act

Tax rates under the DTAA may be lesser than the tax rates under the Income Tax Act

Tax rate arbitrage

Definition under the DTAA may be narrower than the definition under Income Tax Act

Definition arbitrage

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Rate arbitrage | Royalty and FTS

Income Tax Act DTAAIncome Tax Act DTAAIncome Tax Act DTAA

40% ** on net basis (if PE exists) 40% ** on net basis (if PE exists)

10% ** on gross basis (if PE does not exist)

0 / 10% / 15% (if PE does not exist)

From 1 April 2010, in case of recipient not having Permanent Account Number (PAN), withholding tax rate of 20% will apply

** Tax rates should be increased by applicable surcharge and education cess

The above tax rates are applicable to a corporate entity


Definition arbitrage | Royalty


Transfer of all rights Only “use of or right to use” is covered

Patent, invention, model, design, secret formula or process or trade mark or

similar property

Copyright and copyrighted material

“or similar property” is not used

Only copyright is covered


Definition arbitrage | FTS


Absence of “Make available” clause Presence of “Make available” clause in some tax treaty

Make available clause

Some DTAA prescribes that payments for the rendering of any technical or consultancy services will deemed to be covered under FTS article if services:• Make available technical knowledge, experience, skill know-how, or

processes or • consist of the development and transfer of a technical plan or technical

design.


Make available | FTS

Memorandum of Understanding (MOU) to India-United S tates of America (USA) tax treaty• Technology will be considered as “made available” when the person acquiring

the services is enabled to apply that technology• The fact that the provision of service may require technical input does not per

se mean that technical knowledge, skills, etc. are made available to the persons purchasing the services

• The use of the product which embodies technology shall not per se to be considered to make the technology available

• MOU also provides some illustrative examples of services intended to be covered within the definition of included services and those to be excluded

This MOU represent the views expressed by the Government of India, hence to the extent the provisions of other tax treaties are pari mateira with India-USA Tax Treaty, this explanation could be used incase of the other treaties as well• Raymond v. DCIT 80 TTJ 120 (Mum) / Sun Microsystems India Pvt. Ltd v ITO, Bengaluru

(2009-TIOL-627-ITAT-Bang) [India/UK]• DCIT v. BCG 94 ITD 31 (Mum) / McKinsey & Co. v. ADIT 99 ITD 549 (Mum) / BPCL v. Jt

DIT 111 TTJ 375 (Mum) [India/Singapore]• ITO v. De Beers India Minerals Private Limited (ITA 3400, 3401 & 3402/Blr/04)

(Bengaluru) [India/Netherlands]


Specific Issues


Treaty Applicability (1)

Scenario 1

Mauritius

Royalty payments

USA is beneficial owner of royalty

India

USA

• India-Mauritius DTAA will apply

• Withholding on royalty payments in India @ 15% as per India-Mauritius DTAA

• Beneficial to use Income Tax Act due to rate arbitrage (unless definition arbitrage results in to exemption)

India Mauritius Tax Treaty does not contain beneficial owner concept in Article 12

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Scenario 2

Mauritius Branch

Royalty payments


India

USA

• India-USA DTAA will apply

Branch of USA Co will be considered as a resident of USA (not Mauritius)

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Scenario 3

Singapore

Royalty payments


India

USA

• India-Singapore DTAA will apply, however withholding on royalty payments in India will not be at the concessional rate provided for in India Singapore DTAA

• Rates under Income Tax Act will apply (unless definition arbitrage is in favor)

India Singapore Tax Treaty contains beneficial owner concept in Article 12

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Treaty Applicability (4) | Beneficial owner

• “Beneficial ownership” terms is generally used only in article 10(dividend), 11(interest) and 12(royalty/FTS) of the DTAA

• It is an anti-abuse provision, to prevent treating shopping• The “beneficial owner” must be interpreted with reference to

treaty law, and not domestic law• If the recipient is a beneficial owner of royalties, the tax in

source country is lower• If there is a conduit or a nominee between beneficial owner and

payer, the concessional rate will not be available• When is a intermediate company a conduit company?

• When it does not have a right to decide on how to use the income;and

• When it cannot decide whether to directly use the income or makeit available to third parties[Klaus Vogel commentary / Some foreign judicial precedents]

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Copyright vs Copyrighted article

Purchase ofArtist’s copyright in

a song

Purchase ofAuthor’s copyright

in a story

Purchase ofAudio CD

Purchase ofNovel

Payments can be royalty

Payments cannot be royalty

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Software payments (1)

• Treaty does not define ‘copyright’ hence reference has to be made to the domestic law

• Section 2(ffc) and Section 14 of Indian Copyright Act, 1957 defines copyright as vesting the following rights:• to reproduce the work in any material form, including storing of it in any

medium by electronic means; • to issue copies of the work to the public, not being copies already in

circulation; • to perform the work in public, or communicate it to the public; • to make any translation of the work; • to make any adaptation of the work; • to sell or give on commercial rental or offer for sale or for commercial

rental any copy of the computer programme;

• If the owner of copyright is providing all or any of the above rights to the user, then the payments may deem to be royalty both under the Act as well as treaty


Software payments (2)

• In some DTAAs India has specifically agreed that the term royalty includes consideration paid for ‘use of computer software’ such as DTAAs with Malaysia, Morroco, Namibia, Russia, Trinadad & Tobago, Turkministan, Kazakstan, Kyrgyz Republic

• Article 12 of India-Malaysia tax treaty states as under:“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 a literary, artistic or scientific work including cinematograph films or recordings on any means of reproduction for use in connection with television or radio broadcasting, any patent, trade mark, design or model, plan, know-how, computer software program, secret formula or process, or any industrial, commercial or scientific equipment or for information concerning industrial, commercial or scientific experience”


Business / Credit Information Report

• What is Business Information Report or Credit Information Report?• The information to be supplied vide these reports is in the nature of

providing factual information about an entity/individual such as location, existence, operation, financial condition, pending litigation, etc.

• This may be provided along with the ratings• These reports are standard for all the buyers and not customized as per

consumer needs• Seller retains the copyright in the BIR sold

• The sale of BIR are akin to sale of copyrighted article such as books and it may not tantamount to imparting of any commercial knowledge or experience as well as any right in respect of a patent, invention, etc., hence may not deem to be royalty or FTS

• Reliance may be placed on• M/s Dun & Bradstreet Information Services India Pvt. Ltd. v. ADIT [2010-TII-59-ITAT-

MUM-INTL]• Dun and Bradstreet Espana S.A., In re [2005] 272 ITR 99 (Authority for Advance

Ruling (AAR))• Dun and Bradstreet Limited (AAR No. 656 of 2005 dated 27 October 2005)• Dun and Bradstreet Europe Limited (AAR No. 657 of 2005 dated 27 October 2005)


Facilities through automated process

• “Automated process” is the service/facility provided through machineries and no human intervention is required such as:• Vending machines• Digital transmission of data, etc.

• The Supreme Court (SC) in Bharti Cellular Ltd decision, 44 DTR 190, has held that the requirement for human intervention is necessary in order for services to be considered as FTS under the provisions of the Act, it has observed that:• The meaning of the term “technical” as used in section 9 is not defined in

the Act and since the same has been used in the company of two other words namely “managerial” and “consultancy”, the word “technical” will draw its meaning from the meaning of the words “managerial” and “consultancy”

• From an analysis of the meaning of the words managerial and consultancy, it is clear that both these services are provided by humans. Accordingly, the expression “technical service” would also require the presence of a human element in the course of providing services


Access to e-portals

• The data on the e-portal is accessed in the following manner:• The customers of the data reports are granted access rights in the server

through login username and password• Through this access rights, customers places request of reports of the

desired persons or entities• On the receipt of the request, server generates the reports and provide it

to customers• Based on the login reports generated by servers, service providers

invoices the customers as per the mutually agreed terms

• The transfer of data may not deemed to be copyright or service, however the use of server may deem to be ‘use of equipment’ and hence covered under ‘royalty’ if:• The server is actively controlled by the users and server owners does not

have any control over the specific use of the server made by its customer

• Following decision may be useful:• Held to be use of equipment - Cargo Community Network Pte. Ltd, 289

ITR 355 (AAR) / New Skies Satellites satellite, 85 ITD 478 (Delhi ITAT (SB)• Held otherwise - Kotak Mahindra Primus Ltd. v. DDIT, 11 SOT 578 (Mumbai

ITAT) / Vodafone Essar Limited, 2010-TIOL-789-ITAT-MUM


E-Commerce transactions

• In the era of increasing e-commerce the way the transactions are executed have been rapidly redefined and hence a physical possession of the service provider is no longer necessary or required, in such case the understanding of the facts assumes great importance to determine its tax implications

Reference material for taxation of e-commerce trans actions

• Report on “tax treaty characterization issues arising from E-commerce” issued by Technical Advisory Group (TAG) of Organization for Economic Cooperation and Development (OECD) dated 1 February 2001, analyzing 28 categories of transactions

• High Powered Committee on ‘Electronic Commerce and Taxation’ constituted by Central Board of Direct Taxes (CBDT) of February 2001, commenting on 28 categories of transactions analyzed in TAG report


Planning Avenues


Need for cross-border tax planning

• The cross-border transactions of Indian companies are increasing, some key reasons for such growth are as under;• These transactions facilitates the exchange of best ideas, talent and

intellectual property across the globe,• These results into saving of cost and human time of Indian companies which

they would have spent on Research & development activities,• Foreign association and techniques gives edge in market as it improves

creditability & productivity of the products and services,

• However, these are subject to certain direct tax issues as well, such as;• These transactions are generally subject to withholding tax which is on the

gross amount paid to nonresidents, normally 10% in India• Most of the times, the withholding tax in India exceeds the tax liability of

nonresident in its host state which leads to unutilized foreign tax credit,• Therefore, nonresidents usually enters into gross-up contracts in India

As gross-up contracts results into increase in the project cost of Indian company, it makes these transaction unfeasible and hence it is vital to

explore the tax optimizing avenues in cross border transactions

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Offshore supply of drawing, design

• The offshore supply of drawing, design etc may be taxed @10.51% on gross amount as ‘Royalty’ income, under the Act

• However, payment towards ‘outright purchase of designs and drawings’ may be outside the ambit of royalty/FTS subject to fulfillment of following conditions;

• Transfer of property in the designs and drawings to the buyer,• No rights in the designs and drawings retained by the seller,• ‘Ownership’ rights with the buyer to sell or transfer the property as he/she likes,• Price determined upfront and not subject to escalations,• Any deficiencies in the property have to be completed or corrected by the seller,• Payment to be made irrespective of the use of the property,• Payment not for ‘use of’ designs and drawings,• Payment not for ‘services’

Issue is fact sensitive !!

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Services

• Services may be taxed @10.51% on gross amount as ‘Fees for technical services’ income under the Act

• However, under certain DTAAs of India, services which does not make available any technical knowledge excluded from purview of FTS, such as Australia, Belgium, Canada, Cyprus, Finland, France, Hungary, Israel, Kazakhstan, Malta, Netherland, Portuguese, Singapore, Spain, Sweden, United Kingdom, USA• In certain countries ‘Service PE’ exposure has to be mitigated, such as Australia,

Canada, Singapore, United Kingdom, USA

• Further, following DTAAs does not have FTS and service PE clause such as Bangladesh, Greece, Libyan Arab Jamahiriya, Mauritius, Philippines, and United Arab Republic

Services procured above countries may not be liable to withholding tax in the absence of non-resident’s fixed base PE in Indi a

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Lease of equipment

• After the amendment in finance Act 2002, “Royalty” under the Act includes payment for use of right to use of any industrial, commercial or scientific equipment's and hence taxed @10.51% on gross income under the Act in the absence of PE

• Most of India’s DTAAs on the line of the domestic law, includes payment for equipment in the definition of royalty except Belgium, France, Greece, Israel, Kazakhstan, Netherlands, Spain, Sweden

Equipment's leased from tax resident of the above c ountries will not be liable to withholding tax in the absence of non-res ident’s PE in India

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Direct Taxes Code


Royalty and FTS | Amendments

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Tax provisions Income tax Act DTC

Use or right to use oftransmission by satellite,cable, optic fiber or similartechnology

Not taxable in certaincases, based on thejudicial precedents

Included in ‘royalty’

Sale, distribution orexhibition of cinematographicfilms

Exemption under‘royalty’

Included in ‘royalty’

Withholding tax on royaltyand fees for technicalservices

10.51% 20%

Permanent Establishment Includes fixed place ofbusiness through whichthe business is carriedon

Includes building site,construction site,furnishing of services,substantial equipment inIndia, etc


Royalty and FTS | Implications

• Increase in withholding tax rate from 10.51% to 20% for royal ty and feesfor technical services - The payments to non-residents may liable to higherwithholding tax in following situations:

• India has over 75 tax treaties, out of which 25 plus treaties provide for withholdingtax rate of 15% to 20% like Australia, Brazil, Canada, Cyprus, Denmark, Finland,Greece, Indonesia, Korea, Mauritius, Poland, United Kingdom, USA, etc., where thetax rate to increase from current level of 10.51%

• Also resident of non tax treaty country such as Hong Kong, British Virgin Island, etc.to liable for higher withholding tax rate of 20%

• Permanent establishment - No threshold limit has been specified forconstruction site, building site, services rendered etc. hence such activitieswithin India may lead to constitution of PE

• Treaty protection may be availed in above situation, however residents of non taxtreaty country may expose to higher taxation

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Gross-up contracts with non-residents will have be analysed carefully, as the same may increase the cost of cross-border t ransactions


Royalty : Demystified

Open house

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If wish to know further, please write @[email protected]

or

please call @ 022 6619 8839 (D)9892 89 25 04 (M)

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The views expressed in this presentation are solely that of the speaker and do not constitute any kind of professional advice.These views or opinion expressed in this presentation should not be applied or used without a prior professional advice, as thereview of the facts and prevailing judicial position is of utmost importance in the analysis of tax implications.

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