Ruling Widens Scope & Interpretation of the ‘Make Available’ Clause
It is common amongst multinational groups for a parent company to support its subsidiaries by providing technical, operational and management support. Such support services attract the attention of the Revenue authorities from the perspective of transfer pricing ("TP") and withholding tax ("WHT"), and with an increase in such payments, the Indian Revenue authorities have been particularly belligerent. In a recent ruling, the Authority for Advance Ruling ("AAR") in the case of Perfetti Van Melle Holding B.V. ("Perfetti Van Melle case") has ruled that such support service would be chargeable to tax in India under the Double Taxation Avoidance Agreement ("DTAA") between India and Netherlands which is regarded as a Treaty with a narrower scope for taxation of fees for technical services. Taxand India reviews the recent Perfetti Van Melle case and how that ruling has impacted the scope and interpretation of the ‘make available' clause, not only with The Netherlands and US with which India has entered into a DTAA, but also other countries such as Canada, Singapore and the UK.
The Perfetti Van Melle Holding B.V. ("the Applicant") applied to the AAR on the issue of whether the consideration for provision of support services rendered by it to its Indian subsidiary ("Perfetti India") would be subject to WHT in India as a fee for technical services as per the provisions of the DTAA. The Applicant, a tax resident of Netherlands, rendered services in the nature of, inter alia, accounting, budgeting and reporting, foreign exchange management, human resource services, support in local strategy and financial control and support in risk management under a Service Agreement with Perfetti India. Invoices were raised by the Applicant, at cost, without a mark-up. The services were rendered via the Service Agreement and did not involve the physical presence of its employees in India.
The Applicant placed reliance on the Memorandum of Understanding ("MoU") concerning fees for included services under the DTAA between India and USA on the basis that the treaties had identical definitions for "fees for technical / included services" ("FTS/FIS"). The Applicant argued that the services rendered were in the nature of managerial services as opposed to technical or consultancy services as it did not equip the recipient with the knowledge or expertise to apply it in future without support from the Applicant.
The Revenue Authorities ("RA") drew reference to a separate Trademarks Technology License Agreement ("License Agreement") entered into by the Applicant with Perfetti India and contended that the Service Agreement specifically provided for support services in respect of aspects broadly covered in the License Agreement. Further, the RA argued that the reports, codes and procedures furnished by the Applicant equipped Perfetti India to manage its affairs efficiently and were available to Perfetti India in the form of technical knowledge, skill and experience.
The AAR held that reliance placed by the Applicant on the MoU in the DTAA between India and USA cannot be used as an aid to understand the meaning of terms used in such DTAA. The AAR heavily stressed on the fact that a Treaty is a contract between two sovereign countries and a protocol appended to a particular Treaty cannot be universally applied in respect of a Treaty to which the same countries are not parties. Although the AAR noted that the Mumbai Tribunal had, in the Raymond Ltd ruling, upheld the applicability to the India UK DTAA. The meaning of ‘make available' clause, as explained under the DTAA between India and USA, it has departed from this view and it was held that an explanation in one DTAA cannot be borrowed to interpret another DTAA.
Based on the scope of services of the Service Agreement and the broad parameters covered under the License Agreement, the AAR noted that one agreement granted the intellectual property rights to manufacture and the other facilitated the efficiency in such manufacture and ruled that the two agreements were inextricably linked and were complementary to each other. Consequently, the AAR held that the Service Agreement was ancillary and subsidiary to the application and enjoyment of the right, property or information vested on Perfetti India by virtue of the License Agreement for which a payment of royalty was being made by Perfetti India in terms of the DTAA between India and Netherlands.
In conclusion, the AAR ruled that the payments received by the Applicant under the Services Agreement were in the nature of FTS and were subject to WHT in India under the DTAA between India and Netherlands.
This ruling departs from the general understanding that the MoU in the DTAA between India and USA, which explains the scope of FIS and the ‘make available' clause, would apply in interpreting other DTAA which has been entered into by India.
The very basis of the AAR ruling that the MoU appended to the DTAA between India and USA cannot be referred seems questionable. Clearly, the DTAA between India and Netherlands carries a most-favoured-nation ("MFN") clause which binds India to apply, to the tax treaty with Netherlands, any lower rate of tax in respect of dividend, interest or royalties and FTS or a scope more restricted as under any other tax treaty entered into by India. The MFN clause, notification dated 30 August 1999 was issued which explicitly states that the MoU to the royalty and FTS provision under the Indo-USA DTAA would apply mutatis mutandis to the India-Netherlands DTAA. The AAR does not seem to have considered this notification applicable to the DTAA between India and Netherlands while concluding this case.
This ruling opens up questions relating to interpreting the ‘make available' clause in the other DTAAs which India has entered into with countries such as Singapore, Canada and UK.
The ruling may lead to double taxation if the Dutch authorities do not allow a tax credit for the Indian withholding tax, which they could do if they deny India's right to tax. The treaty with the Netherlands contains a mutual agreement clause, but there is no obligation for the states to resolve an issue. In the worst case, the Dutch authorities could claim that the arm's length remuneration for the service should reflect the risk of withholding tax, requiring the Dutch company to seek compensation for the Indian tax withheld, as is usual under many service contracts. It is unlikely that the Indian authorities will accept the higher fee as deductible.
Foreign companies with Indian operations should be aware that fees for support services rendered to the Indian company may be subject to Indian withholding tax, also under treaties with a most-favoured-nations clause, like the Netherlands.
From a Canadian perspective, the ARR's views that the weight that should be given to a MOU agreement between two different countries is minimal, at best is agreeable. The Canadian competent authority would probably not be prepared to accept a non-discrimination article argument either. But Canada has a lot more reservations on the non-discrimination article of the OECD Model than most other countries and is generally reluctant to apply it loosely.
This Ruling does not appear to be much of a concern to Canada. Any concern is obviously limited to Canadian companies with subsidiaries in India. And at the end of the day Canada would be required to give foreign tax credit relief if India refused to refund the withholding taxes and the Canadian taxpayer was unsuccessful in its dispute resolution processes (e.g. India appeals or MAP). So unless the Canadian taxpayer is a loss company, there is no double tax or additional tax cost.
Finally, in Canada, a "know-how" contract generally differs from a contract for the provision of services. In a contract for the provision of services, a person undertakes to use the customary skills of his or her calling to execute work for the other party. This distinction is of vital importance in order to avoid disputes as regards to whether or not Article 12 is applicable in most of Canada's treaties. This is because the inclusion of a "service" clause in Article 12 of a treaty, such as is the case with Article 12 of the Canada-India Treaty, is very unique to Canada's treaty network and Canada has very little experience on this matter.
This new ruling has the potential to affect any multinational enterprise with an affiliate entity in India. The imposition of withholding tax on a charge-out for costs of services incurred outside India related to "accounting, budgeting and reporting, foreign exchange management, human resource services, support in local strategy and financial controlling and support in risk management" is clearly not consistent with practices in most of the OECD states. Withholding taxes are meant to approximate the tax that would have been imposed had the offshore entity filed a tax return in the withholding country and reported the income from the payment received and related expenses. Withholding taxes are often reduced by treaty where the benefit to such a reduction is reciprocal, i.e., when flows of payments occur in both directions between trading partners such that foregone withholding taxes on outbound payments one side are compensated by withholding taxes not imposed on local taxpayers for inbound payments. In the instant case, the "fee" here was only a reimbursement of cost, with no profit element whatsoever. Moreover, tax laws of many countries require the "charge-out" or reimbursement of costs that provide a benefit to an offshore party, so that the benefits and burdens of those expenses are matched in the right jurisdiction. With no profit element, the imposition of a gross-basis withholding tax on such fees amounts to an exorbitantly high effective rate of tax on the activity for which the fee was paid. In addition, the failure to look to the explanatory materials for other tax treaties using the exact same language creates variable outcomes on similar provisions, which further frustrates international commerce.
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