KPMG FLASH NEWS
KPMG IN INDIA

Consideration received by a non-resident from the Indian customers for
provision of Bandwid...


The Commissioner of Income-tax (Appeals) [CIT(A)]
upheld the AO’s order.



Referring to various decisions , the Incom...




Taxpayers’ Service agreement with customer, the
Service agreement of customer with VSNL and the
One Stop Shopping Se...


In light of the clarificatory amendments inserted in
Section 9 of the Act by the Finance Act, 2012 the
decision of the ...
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Consideration received by a non-resident from the Indian customers for provision of Bandwidth/Telecom Services outside India is royalty

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The Madras High Court (the High Court) in the case of Verizon Communications Singapore Pte Ltd. (the taxpayer) held that the consideration received by the non-resident taxpayer from the Indian customers for provision of Bandwidth/Telecom Services outside India was for the 'use of, or the right to use equipment' and therefore, royalty under Section 9(1)(vi) of the Income-tax Act, 1961 (the Act).

Alternatively, the payments can also be considered for the use of the process provided by the taxpayer and therefore royalty under the Act. The High Court also held that the definition of 'royalty' under the India-Singapore tax treaty (the tax treaty) and the Act are in pari-materia and therefore the consideration would be royalty under Article 12(3) of the tax treaty.

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Consideration received by a non-resident from the Indian customers for provision of Bandwidth/Telecom Services outside India is royalty

  1. 1. KPMG FLASH NEWS KPMG IN INDIA Consideration received by a non-resident from the Indian customers for provision of Bandwidth/Telecom Services outside India is royalty 4 December 2013 Background Recently, the Madras High Court (the High Court) in the 1 case of Verizon Communications Singapore Pte Ltd. (the taxpayer) held that the consideration received by the nonresident taxpayer from the Indian customers for provision of Bandwidth/Telecom Services outside India was for the 'use of, or the right to use equipment' and therefore, royalty under Section 9(1)(vi) of the Income-tax Act, 1961 (the Act). Alternatively, the payments can also be considered for the use of the process provided by the taxpayer and therefore royalty under the Act. The High Court also held that the definition of 'royalty' under the India-Singapore tax treaty (the tax treaty) and the Act are in pari-materia and therefore the consideration would be royalty under Article 12(3) of the tax treaty. Facts of the case  The taxpayer is a non-resident company engaged in the business of providing international connectivity services in the Asia Pacific region including customers in India. Taxpayer provides these services through a circuit known as ‘International Private Lease Circuit’ (the IPLC) which is an end to end dedicated circuit used for providing bandwidth services to customers.  Videsh Sanchar Nigam Limited (VSNL) is the service provider in India responsible for providing seamless end to end connectivity to customers in the Indian half of the IPLC.  VSNL transmits the traffic from the customer's office in India to a virtual point outside India and the taxpayer transmits it upto the customer location outside India. The taxpayer uses its telecom service equipment situated outside India in providing the international half circuit.  The Assessing Officer (AO) concluded that the payment received by the taxpayer in providing bandwidth services using IPLC was taxable as 'royalty' for ‘use of or right to use of commercial and scientific equipment’ under Section 9(1)(vi) of the Act and Article 12(3) of the tax treaty. _________________ 1 Verizon Communications Singapore Pte Ltd. v. ITO [2013] 39 taxmann.com 70 (Mad) © 2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
  2. 2.  The Commissioner of Income-tax (Appeals) [CIT(A)] upheld the AO’s order.  Referring to various decisions , the Income-tax Appellate Tribunal (the Tribunal) held that the payments could be considered as payment for the use of or right to use of industrial, commercial and scientific equipment. The Tribunal also held that IPLC is a hightech circuit comprising transmission cables and sophisticated equipment, and the payments can also be considered as payment for the use of the 'process'. Accordingly, the AO’s order was confirmed. 2 Tax department’s contentions  In relation to tax qua royalty, there need not be a ‘right to use’ to the user. So long as there is nexus between the user, the situs of the usage (in India) and the purpose of the use (for offering seamless internet facility), there is economic exploitation of the equipment giving rise to the income to be taxed as 'royalty'.  Cable is also treated as commercial equipment and hence for the equipment usage and the services utilised, the payment falls within the meaning of 'royalty'. Further, a right to access and exploit a part of segment of a larger system and the consideration paid therefore would be royalty. Even otherwise, it is a right to use a process and a right to use equipment coming within Explanation 2 to Section 9(1)(vi) of the Act.  As per Article 3(2) of the tax treaty, the term not defined in the tax treaty would be understood by the definition contained in the law (i.e. the Act) of the contracting state. According to the Explanation in the Act giving the definition on 'royalty' and 'process', and no prohibition in Article 12 of the tax treaty in assessing royalty in India, the receipts are rightly taxed as royalty.  The Customer has significant economic interest in the taxpayer’s equipment to the extent of the bandwidth hired by the customer  The taxpayer has provided the composite and indivisible circuit which constituted equipment. The taxpayer has to take the services of VSNL for providing the services in India having regard to the Regulations of the Telecom Regulatory Authority of India.  The taxpayer did not provide any service to its customers but only leased out equipment for use of its Indian customers. The taxpayer provided the Indian customer an integrated communication system, part of which is outside India and part of which is inside India for use by the Indian customer and such system is inseparable and incapable of vivisection for the purpose of taxation in India. Issue before the High Court  Whether the payment received by the taxpayer from the Indian customers for provision of Bandwidth/Telecom Services outside India is royalty under the Act and the tax treaty? Taxpayer’s contentions  The customer does not get any right to use any equipment nor has any knowledge or interest in the process/technical equipment deployed by the taxpayer in providing the service. The customer is only interested in the transmission of information and is unconcerned regarding the equipment / process used by the taxpayer.  It was stated that neither any capacity nor any network including the cables are earmarked or dedicated to any customer for its sole and exclusive use.  The access to service is different from access to right to 3 use the equipment. Relying on various case laws , the taxpayer submitted that the consideration received is only for services and not for the individual use or right to use any equipment/ process and could not be taxed as royalty.  There is no conversion of data or voice as in the case of the transponder services, and there is only transmission of data and voice in the same form through fibre cables. Neither any capacity nor any network including the cables are earmarked or dedicated to any customer for its exclusive use.  Network equipment remained under the possession, control, operation and use of the taxpayer and VSNL respectively and the same is never handed over at any point of time to the customers. Being in the nature of provision of services, the consideration for the service did not come within the scope of clause (iva) of Explanation 2 to Section 9(1)(vi) of the Act or under Article 12(3) of the tax treaty, to be taxed as royalty. _____________ 2 New Skies Satellites N.V. v. ADIT [2009] 121 ITD 1 (Del) (SB), ACIT v. Grandpix Fab (P) Ltd. [2010] 128 TTJ 60 (Del) , Ansaldo Energia SPA v. ITAT & Others [2009] 310 ITR 237 (Mad), eFunds Corporation v. ADIT [2010] 42 SOT 165 (Del) High Court’s ruling Observations on the contractual framework  Based on the terms of all the relevant agreements, parties have agreed to go for OSS, which allows a customer to place a single order with a single carrier for two private leased circuits for two offices in two different Countries, the Indian half by VSNL and the other half by the taxpayer. 3 Skycell Communications Limited v. DCIT [2001] 251 ITR 53 (Mad), Wipro Ltd. v. ITO [2003] 80 TTJ 106 (Bang), Software Technology Parks of India v. ITO [2005] 3 SOT 529 (Bang) © 2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
  3. 3.   Taxpayers’ Service agreement with customer, the Service agreement of customer with VSNL and the One Stop Shopping Service (OSS) agreement between the taxpayer and VSNL are part and parcel of one composite agreement, split for the purposes of convenience with the ultimate aim to give the customer a point-to-point private line to communicate between offices that are geographically dispersed throughout the world. The various contracts executed pursuant to the service contract with the customer are closely linked to the single transaction of providing end to end IPLC facility to the customer and in order to execute the same, if the taxpayer has to enter into several subagreements/agreement, such agreements cannot be looked at in isolation having no relevance to the service agreement.  The arrangement between the taxpayer and the VSNL has to be necessarily integrated, and technically and financially viable having regard to the close functional relationship between the two and for this the Indian customer pays through the single billing system (i.e. OSS) for the integrated services.  The end to end provisioning in one single circuit is assured by the taxpayer and if by reason of any regulatory laws of the Country (i.e. India), the taxpayer is unable to extend its service by itself but goes for such other licensed authority, it does not mean that these facilities are independent having no relevance to the connectivity offered by the taxpayer.  The service order cum agreement for IPLC Service between customer and VSNL, and between VSNL and taxpayer and the OSS agreement points out that the payment to the taxpayer is for the online service from one point to the other as a whole and it is difficult to accept the contention of the taxpayer seeking dissection of the same as two independent contract. Observations on the equipment   A user having a particular IPLC service connection has a dedicated bandwidth between the computer and the internet provider, though the provider itself may have 1000 such service connections to other location. To provide the contracted bandwidth, the Master agreement read with the Service Order gives the selected bandwidth for each customer which is assumed end to end and for this, the equipment at the customer's end are delivered by the taxpayer itself. The agreement provides an indefeasible right to the customer to use the facility of communicating the data/voice. The efficacy of transmitting data/voice depends on the originating signal from the customer end which means there is the use of the Customers' Premises Equipment (CPE) by the customer installed by the taxpayer.  CPE refers to routers, switches, private board exchange, installed in customers' premises. On the basis of the clauses in the agreements and the Customer Premises Equipment at the customer's location, there was use of scientific/commercial equipment in the present case.  There is use of equipment and cable in the transmission of the data/voice from one end to the other. Accordingly, the contention of the taxpayer that the nature of transaction is only that of service cannot be accepted. Observations on IPLC/ Bandwidth Services  There is a symmetric telecommunication facility permanently connecting one end to the other. Thus, the contract ensures that the customer has an active internet bandwidth dedicated to that particular customer. Accordingly, the two half circuits (i.e. the service at customer’s end in India and other office abroad) being the mirror image of each other, the taxpayer renders service in India and hence the consideration received attracts the incidence of taxation in India.  The customer has a significant economic interest in the taxpayer's equipment to the extent of the bandwidth hired by the customer.  When the Indian customer transmits data between locations for the purposes of its business, the data goes over the bandwidth which is reserved and is exclusively in the control of the customer and not the taxpayer. The taxpayer cannot see the data that is passing through the network dedicated for the use of the customer and thus the customer obtains an economic interest in the equipment which need not result in the ownership. Observations on legal aspects and the judicial precedents Consideration for use of equipment amounts to royalty  After the amendment was introduced [in Section 9(1)(vi) of the Act] in the year 2012, irrespective of possession, control with the payer or use by the payer or the location in India, the consideration would nevertheless be treated as 'royalty' and therefore, the 4 decisions cited by the taxpayer cannot be relied to understand the scope of the expression 'royalty' and the Advance Ruling in the case of Cargo Community 5 Network Pte Ltd. would be applicable to the facts of the taxpayer. ________________ 4 Cable & Wireless Networks India Private Limited, In re [2009] 315 ITR 72 (AAR), Dell International Services (India) Pvt. Ltd. In re, [2009] 308 ITR 37 (AAR) 5 Cargo Community Network Pte Ltd. [2007] 289 ITR 355 (AAR) © 2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
  4. 4.  In light of the clarificatory amendments inserted in Section 9 of the Act by the Finance Act, 2012 the decision of the Delhi High Court in the case of Asia 6 Satellite is distinguishable and has no relevance to the case on hand.  Accordingly, the plea of the taxpayer that the payment made is not in consideration for the use of the equipment by the customer and the services are provided, are rejected.  Based on the case law of Skycell Communications Ltd., provision of service is not possible without the use of equipment ensuring the assured bandwidth for transmission of data/voice which provides the internet access to the customer to and fro. However, after the insertion of Explanation 5 to Section 9(1)(vi) of the Act, possession, control of such right, property or information, usage directly by the payer, location of the right are not matters of concern in deciding the character of payment as 'royalty'.  Accordingly, the receipts are liable to be treated as 'royalty' for the use of IPLC under Section 9(1)(vi) read with Explanation 2(iva) and correspondingly Article 12(3) of the tax treaty. Consideration for use of process amounts to royalty  The bandwidth capacity is made available on a dedicated basis for the entire contract period, even if it does not involve a possessory interest. Accordingly, even if the payment is not treated as one for the use of the equipment, it should be for the use of the process provided by the taxpayer.  The fact that the bandwidth is shared with others has to be seen in the light of the technology governing the operation of the process and this by itself does not take it out of the scope of royalty. Thus the consideration being for the use and the right to use of the process, is 'royalty' within the meaning of Clause (iii) of Explanation 2 to Section 9(1)(vi) of the Act. Our comments Taxability of bandwidth/telecom services has been a matter of litigation since several years. In the recent past, in certain decisions it was held that provision of end-toend international long distance telecommunication services by non-resident service providers to the Indian customers was not taxable under the relevant tax treaty and the Act. Subsequently, the Finance Act, 2012 has retrospectively inserted Explanations in Section 9(1)(vi) of the Act, inter alia, to include transmission by satellite, cable, optic-fiber or by any other similar technology within the scope of process and consequently within royalty. Further, royalty included payments relatable to the right, property or information irrespective of its control or possession, use or location. Accordingly, such bandwidth/telecom services are subject to source based taxation in India and in the present case the High Court, relying upon these Explanations, held that payment made by Indian customers to a Singapore Company for providing end-to-end internet connectivity outside India was taxable as royalty under the Act. The High Court has distinguished certain favourable rulings, including the Advance Rulings in case of Dell International Services India (P.) Ltd. and Cable & Wireless Networks India (P.) Ltd. on the similar issue by using one common argument i.e. the insertion of Explanations 5 and 6 in Section 9(1)(vi) of the Act has expanded the scope of royalty to include the transactions present in this case within the purview of royalty. Further, the High Court held that the definition of ‘royalty’ under the tax treaty is in ‘pari materia’ with the definition under the Act and therefore, the consideration was taxable as royalty under the tax treaty. However, it is pertinent to note that the Andhra Pradesh High Court in the case of Sanofi Pasteur held that rules and principles of interpretation laid down to interpret the Act may not be adopted while interpreting the tax treaties. Taxability as Royalty under the tax treaty  The definition of 'royalty' under tax treaty and the Act are in pari-materia. Explanation 6 to Section 9(1)(vi) of the Act, defines 'process' to mean and include transmission by satellite (including uplinking, amplification, conversion for downlinking of any signal) cable, optic fibre, or by any other similar technology, whether or not such process is secret.  By reason of the long distance, to maintain the required speed, boosters are kept at periodical intervals and hence, in any event, the payment received by the taxpayer was 'royalty' and would constitute so for the purposes of the tax treaty. _________________ 6 Asia Satellite Telecommunications Co. Ltd. v. DIT [2011] 197 TAXMAN 263 (Del) © 2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
  5. 5. www.kpmg.com/in Ahmedabad Safal Profitaire B4 3rd Floor, Corporate Road, Opp. Auda Garden, Prahlad Nagar Ahmedabad – 380 015 Tel: +91 79 4040 2200 Fax: +91 79 4040 2244 Hyderabad 8-2-618/2 Reliance Humsafar, 4th Floor Road No.11, Banjara Hills Hyderabad 500 034 Tel: +91 40 3046 5000 Fax: +91 40 3046 5299 Bangalore Maruthi Info-Tech Centre 11-12/1, Inner Ring Road Koramangala, Bangalore 560 071 Tel: +91 80 3980 6000 Fax: +91 80 3980 6999 Kochi 4/F, Palal Towers M. G. Road, Ravipuram, Kochi 682 016 Tel: +91 484 302 7000 Fax: +91 484 302 7001 Chandigarh SCO 22-23 (Ist Floor) Sector 8C, Madhya Marg Chandigarh 160 009 Tel: +91 172 393 5777/781 Fax: +91 172 393 5780 Chennai No.10, Mahatma Gandhi Road Nungambakkam Chennai 600 034 Tel: +91 44 3914 5000 Fax: +91 44 3914 5999 Delhi Building No.10, 8th Floor DLF Cyber City, Phase II Gurgaon, Haryana 122 002 Tel: +91 124 307 4000 Fax: +91 124 254 9101 Kolkata Infinity Benchmark, Plot No. G-1 10th Floor, Block – EP & GP, Sector V Salt Lake City, Kolkata 700 091 Tel: +91 33 44034000 Fax: +91 33 44034199 Mumbai Lodha Excelus, Apollo Mills N. M. Joshi Marg Mahalaxmi, Mumbai 400 011 Tel: +91 22 3989 6000 Fax: +91 22 3983 6000 Pune 703, Godrej Castlemaine Bund Garden Pune 411 001 Tel: +91 20 3050 4000 Fax: +91 20 3050 4010 The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such 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. © 2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity“ are registered trademarks of KPMG International Cooperative (“KPMG International”), a Swiss entity. © 2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

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