For several years, for various reasons—such as comparative cost advantage and availability of skilled manpower—India has been at the centre stage of the world software and business process outsourcing (BPO) industry. Telecom infrastructure—in terms of availability of telecom bandwidth services—is a very significant requirement for the software and BPO industry to ensure appropriate connectivity with overseas clients and timely delivery of services. Typically, international bandwidth services are broken into two portions—the Indian portion (up to Indian territorial waters) and the international portion. The taxability of the service fee paid to international telecom operators for provision of bandwidth has been the subject of much debate.
Recently, however, the Authority for Advance Ruling (AAR), in the case of Dell Services India Ltd, has given a ruling on this aspect, and this article broadly examines the issue before AAR and the ruling.
Facts of the case
The applicant, Dell India, is engaged mainly in the business of providing call centre, data processing and information technology support services to its group companies.
Dell US, the parent firm of Dell India, had entered into a master service agreement with BT America, providing a framework for its group subsidiaries to enter into contracts with BT America.
Subsequently, Dell India entered into an agreement with BT America under which the latter provides Dell India with two-way transmission of voice and data through telecom bandwidth. While BT America would provide the international portion to/from the US/Ireland, the Indian portion is provided by Videsh Sanchar Nigam Ltd, with whom BT America has a tie-up.
Under the agreement with BT America, Dell India is required to pay a fixed monthly recurring charge. The consideration for services rendered by BT America is paid directly by Dell India to it, and the amount so paid is not being cross-charged to Dell US.
Illustration by Malay Karmakar / Mint
The space in the telecom network is not dedicated to Dell India, and is utilized by other customers of BT America in and out of India. There is no dedicated machinery or equipment identified and allowed to be used only for, or under the control of, Dell India.
The Income-tax (I-T) Act, 1961, lays down different sources of income that are deemed to accrue or arise to a foreign company in India, such as income in the nature of fees for technical services, royalties, etc. In the given context and facts of the case before AAR, the issue was whether fees paid by Dell India to BT America would constitute “royalties” as defined in the Act.
Royalties, as defined in the Act, inter alia include consideration payable towards use or right to use industrial, commercial or scientific equipment (the definition of royalties in article 12 of the India-US treaty also considers payment for use or right to use equipment as royalties).
Accordingly, the question that came up was whether any consideration payable by Dell India to BT America is for the use or right to use any equipment.
AAR observed that the emphasis in the agreement between Dell India and BT America was on “services” and not in respect of the use of equipment or grant of right to the user. It was held that there was nothing in the agreement that indicates that particular equipment has been leased out to Dell India and such equipment is put in the exclusive custody and control of Dell India. Accordingly, the provision of telecom bandwidth facility by means of circuits and other network equipment installed and maintained by BT America should not be construed as lease of equipment, and is a case of rendition of services by BT America using its own network and equipment. Hence, AAR drew a distinction between “rendering of service by a person using his own equipment” vis-à-vis “the grant of right to use the equipment to the recipient of the service”.
AAR, in the ruling, also held that the word “use” in relation to equipment occurring in the definition of royalties is not to be understood in the broad sense of availing the benefit of equipment. The context and collocation of the two expressions “use” and “right to use” followed by the word “equipments” suggests that there must be some positive act of utilization, application or employment of equipment for the desired purpose. Hence, if advantage is taken from sophisticated equipment installed and provided by another, it is difficult to say that the service recipient uses the equipment. The service recipient merely makes use of the facility, and does not himself use the equipment.
AAR also held, relying on the Delhi tribunal’s decision in the case of DCIT v. Panamsat International Systems Inc.103 TTJ 861, that the payment is not towards the use of any “secret formula or process”, since the word “process” is prefixed with the word “secret” (in the context of “royalties” being defined to include “secret formula or process”).
The Act provides for an exception in that payment to a non-resident, even if it qualifies as royalty, would not be subject to tax in India if the royalty payment is inter alia effected to make or earn income from a source outside India.
In this connection, AAR observed that the income earned by Dell India by data processing and other software export activities cannot be said to be from a source outside India, since the entire business activities and operations triggering the exports take place within India.
The revenue department also sought to bring the payments within the meaning of the word “process”, relying on the AsiaSat decision in the context of the fact that the definition of royalty includes payment for use of a process.
The tribunal held that both in the I-T Act and article 12(3) of the India-US treaty, the reference is to secret formulae or processes and that, in the instant case, it cannot be held that there is the use or the right to use a secret process.
The revenue department also sought, in what appears to be a feeble attempt to bring the payment within the tax net, to contend that the payment should be considered as “fees for included services” (FIS) within the meaning of article 12(4) of the India-US tax treaty, or “fees for technical services” within the meaning of the domestic I-T legislation.
AAR did not discuss this at length because, under the India-US tax treaty, the FIS definition is narrow and requires that the person receiving the services is enabled to apply the technology.
AAR held that as there is no transfer of any technology to Dell India, that is, Dell India is not enabled to apply technology itself and, therefore, the services were not “made available” as per article 12(4) of the India-US treaty, the payment would not fall within the definition of FIS under the treaty.
In the absence of appropriate details provided by Dell India with regard to constitution of a permanent establishment or PE of BT America in India, the issue of the PE was not addressed by AAR.
AAR held that even if, under an application filed by Dell India, it was concluded that BT America has a PE in India, only the appropriate proportion of profits attributable to the PE should be taxed as business income.
Though the AAR ruling is technically binding only on the applicant, it should come as a relief to many international telecom operators that offer their services to Indian firms. The ruling also establishes a sound basis to determine what constitutes “use” and “right to use” equipment.
Ketan Dalal is executive director and Manish Desai is associate director, PricewaterhouseCoopers.
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