Taxation of Royalty and FTS

Royalty and Fees for Technical Services
Surprises continued ..

Romesh S A Sankhe

WIRC, Thane
19 November 2011

Contents

• Taxation of 'Royalty‘ and ‘Fees for Technical services’
• Indian Income Tax Act
• DTAA
• Specific Issues
• Planning Avenues
• Direct Taxes Code

2 © 2011 Deloitte Haskins & Sells

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

Deloitte Haskins & Sells

Income Tax Act and DTAA | Section 90(2)

DTAA need not to
be applied

No

Opt for DTAA , if
beneficial than Act
Whether taxable
under the Income
Tax Act?
Taxable as per
Articles of DTAA
Yes

Opt for Act, if
Analyse articles of beneficial than
DTAA, if any DTAA

Not taxable as per
Articles of DTAA


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

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

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

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


Words in green
Income Tax Act vs DTAA | Royalty present only in
the Act

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 scientific
knowledge, 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
Income Tax Act vs DTAA | FTS present only in
the Act

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”


Income Tax Act vs DTAA | Arbitrage opportunities

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

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

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


Rate arbitrage | Royalty and FTS

Income Tax Act
Income Tax Act
Income DTAA
DTAA
DTAA

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

10% ** on gross basis (if PE 0 / 10% / 15% (if PE does
does not exist) 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

Income Tax Act
Income Tax Act
Income DTAA
DTAA
DTAA

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

Patent, invention, model,
design, secret formula or “or similar property” is not
process or trade mark or used
similar property

Copyright and copyrighted Only copyright is covered
material


Definition arbitrage | FTS

Income Tax Act
Income Tax Act
Income DTAA
DTAA
DTAA

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 States
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

USA is
beneficial
Mauritius USA owner of
India Mauritius Tax royalty
Treaty does not contain
beneficial owner
concept in Article 12

Royalty • India-Mauritius DTAA will apply
payments
• Withholding on royalty payments in
India @ 15% as per India-Mauritius
DTAA
• Beneficial to use Income Tax Act due
India
to rate arbitrage (unless definition
arbitrage results in to exemption)



Scenario 2

USA is
beneficial
Mauritius USA owner of
Branch of USA Co will royalty
Branch be considered as a
resident of USA (not
Mauritius)

Royalty • India-USA DTAA will apply
payments

India



Scenario 3

USA is
beneficial
Singapore USA owner of
India Singapore Tax royalty
Treaty contains
beneficial owner
concept in Article 12

Royalty • India-Singapore DTAA will apply,
payments however withholding on royalty
payments in India will not be at the
concessional rate provided for in India
Singapore DTAA
India • Rates under Income Tax Act will apply
(unless definition arbitrage is in favor)


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 make
it available to third parties
[Klaus Vogel commentary / Some foreign judicial precedents]


Copyright vs Copyrighted article

Purchase of
Purchase of
Artist’s copyright in
Audio CD
a song

Purchase of
Purchase of
Author’s copyright
Novel
in a story

Payments can be royalty
Payments cannot be royalty


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 transactions

• 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

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 !!


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 India


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 countries will not be
liable to withholding tax in the absence of non-resident’s PE in India


Direct Taxes Code


Royalty and FTS | Amendments
Tax provisions Income tax Act DTC

Use or right to use of Not taxable in certain Included in ‘royalty’
transmission by satellite, cases, based on the
cable, optic fiber or similar judicial precedents
technology

Sale, distribution or Exemption under Included in ‘royalty’
exhibition of cinematographic ‘royalty’
films
Withholding tax on royalty 10.51% 20%
and fees for technical
services
Permanent Establishment Includes fixed place of Includes building site,
business through which construction site,
the business is carried furnishing of services,
on substantial equipment in
India, etc


Royalty and FTS | Implications
• Increase in withholding tax rate from 10.51% to 20% for royalty and fees
for technical services - The payments to non-residents may liable to higher
withholding tax in following situations:
• India has over 75 tax treaties, out of which 25 plus treaties provide for withholding
tax rate of 15% to 20% like Australia, Brazil, Canada, Cyprus, Denmark, Finland,
Greece, Indonesia, Korea, Mauritius, Poland, United Kingdom, USA, etc., where the
tax 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 for
construction site, building site, services rendered etc. hence such activities
within India may lead to constitution of PE
• Treaty protection may be availed in above situation, however residents of non tax
treaty country may expose to higher taxation

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

If wish to know further, please write @
rsankhe@deloitte.com

or

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


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 the
review of the facts and prevailing judicial position is of utmost importance in the analysis of tax implications.

© 2011 Deloitte Haskins & Sells

Taxation of Royalty and FTS

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