Typically, Indian hotel chains have tie-ups with international hotel chains. Under such collaboration, any of the following services could be procured: design, layout and architectural planning of the hotel; operation and management of the hotel; and global marketing, publicity and sales promotion.
Of these, the arrangements for global marketing and sales promotion enable Indian hotel chains to gain high visibility worldwide, which would be a big challenge in the absence of such a tie-up.
A 30 January decision of the Delhi high court dealt with taxability of the fees payable for global publicity and marketing services.
Sheraton International Inc., a company incorporated in the US and engaged in the business of providing services to hotels across the world, had entered into various agreements with ITC Ltd for providing services to certain ITC hotels. The services broadly included publicity, advertisement and sales, including reservation services. Under the agreement, Sheraton was not only to provide marketing services but on an ancillary basis, had also granted free use of its trademark/brand name. In addition, the ITC hotels were also made part of certain schemes introduced by Sheraton for promoting global sales. Sheraton was entitled to 3% of the room sales as payment.
In respect of the years prior to the notification of the India-US tax treaty in 1991, the fee received by Sheraton was taxed as “business income” on which taxes were withheld. Subsequent to the treaty, Sheraton claimed that fees received were not taxable in India as it had no permanent establishment in India. The revenue authorities held that based on the terms and conditions of the agreement, the fees received by Sheraton were in relation to technical and consultancy services being made available by Sheraton. Accordingly, the revenue authorities held that fees were taxable as royalty/fees for technical services (FTS) under the Income-tax Act as well as royalty/fees for included services (FIS) under the tax treaty.
The Delhi tribunal in its order decided the appeal in favour of Sheraton, holding that fees/contribution received by Sheraton were in the nature of business income not taxable in India.
The revenue authorities contended that Sheraton had acquired vast knowledge and experience in the hotel business.
Accordingly, such experience in the hospitality industry was in the nature of information pertaining to industrial, commercial and scientific experience and payments received for it were chargeable to tax under the Act as well as the treaty.
They also held that synchronization of the Indian hotel’s computer systems with Sheraton’s through satellite links, enabling Indian client hotels to access the reservations system, resulted in the imparting of technical knowledge. Also, they said the composite payment envisaged under the agreement was in fact a colourable device in order to cover up payments made towards use of trademark, supply of information concerning industrial, commercial and scientific experience, reservations of rooms, etc.
Sheraton held that the entire services of advertisement, publicity and sales were rendered outside India, through systems and facilities located outside India.
Illustration: Jayachandran / Mint
Also, the primary service rendered by Sheraton was marketing, publicity and reservation services, and it was only to facilitate this objective that Sheraton permitted the use of its tradename/trademark, including the stylized ‘S’ service mark. The use of trademark and tradename was to promote mutual business as it enabled Sheraton to earn more profits. The agreements had been approved by various statutory authorities and had been considered as at arm’s length. Hence, it could not be termed a colourable device to evade tax.
The international chain also said that payments received by it were not for the use of any patent, trademark, model, design, secret formula or process and hence could not be regarded as royalty under the Act or treaty.
It said that the services rendered by Sheraton not being in the nature of technical/consultancy services, which make available any technology to the recipient of service, these could not be regarded as FIS under the treaty.
The high court upheld the ruling of the tribunal and held that the payments under the agreement neither constituted royalty nor FTS/FIS under the Act/treaty. The court relied on the following key findings of the tribunal:
• The entire transaction between Sheraton and ITC was an integrated business arrangement under which the main purpose was to carry out advertisement, publicity and sales promotion for mutual benefit and all other services, that is, use of trademark, tradename, computer reservations, were incidental to the main purpose.
• ITC also had its own brand by the name WelcomGroup.
• What was transferred to the client hotels under the agreement was “commercial information” and the mere fact that technical skills were required by the service provider did not make the service a technical service taxable under the treaty.
• Article 12(4)(b) of the treaty applied to those services which related to areas where technology was made available, whereas services rendered by the assessee relating to advertising, publicity and sales promotion were not in the nature of technical or consultancy services which involved making any technology available.
• Since both the assessee and its clients were operating at arm’s length, no collusion could be attributed to the parties to the agreement. Further, the statutory requirements had been complied with, including obtaining an order from the tax authorities for remittance of fees without deduction of tax at source.
Given this, the court ruled that the payments received by Sheraton would constitute business profits and in the absence of a permanent establishment in India, these were not subject to tax in India. The court also agreed with the tribunal to hold that there was no evidence on record that the agreement was a colourable device.
In this regard, it would be pertinent to note that Authority of Advance Ruling (AAR), in the case of International Hotel Licensing Co. SARL [288 ITR 534], has held a contrary view that business activities in relation to the promotion of enterprises and international advertising, marketing and sales programmes result in business connections in India. Further, it was also held that the payments to be received were for managerial and consultancy services, and would be taxable as FTS under the Act. However, the Delhi high court decision could have more persuasive value.
This decision is a welcome decision which should put at rest the controversy of revenue authorities alleging that payment under service agreements for commercial services such as marketing, sales promotion is royalty/FTS since the agreement on an ancillary basis also provides for the free use of the trademark/brand name of the service provider. This decision once again promulgates that an agreement has to be looked at in its entirety to understand the substance, objective and true intent of the agreement between parties.
Ketan Dalal is executive director and Manish Desai is associate director, PricewaterhouseCoopers. Your comments and feedback are welcome at firstname.lastname@example.org