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Re-definition of ‘Royalty’ Has No Impact On Tax Treaties
The Indian Budget 2012 (enacted by way of the Finance Act, 2012) has introduced significant changes in the tax legislation in India. For example: the retrospective amendments to negate the Supreme Court ruling in the Vodafone case; the re-definition of the term 'royalty', transfer pricing provisions being extended to specified domestic transactions; and the introduction of General Anti Avoidance Rules (effective from 1 April 2013).
The royalty re-definition is of particular interest, given the recent B4U International Holdings Ltd. case. Specifically, it has been clarified (effective from 1 April 1976) that consideration for use or right to use computer software (including granting of license) irrespective of the medium through which such a right is transferred is covered within the definition of royalty. Additionally, the term 'process' has been clarified to include transmission by satellite, cable or similar technology, whether or not the process is a secret. Taxand India explores this re-definition in more detail, examining the B4U International Holdings Ltd. case.
The recent case of B4U International Holdings Ltd saw the Mumbai Bench of the Income Tax Appellate Tribunal (Tribunal) considering the amendment to the definition of 'royalty' by the Finance Act 2012. The redefinition had an impact on the reliance placed by the taxpayer on the Double Taxation Avoidance Agreement (DTAA).
B4U International Holdings Ltd (the taxpayer), a tax resident of Mauritius holding a valid Tax Residency Certificate (TRC) issued by the Government of Mauritius, is a company engaged in the business of broadcasting of television channels. The taxpayer had engaged advertisement collection agents in India to collect revenue from Indian advertisers who were allotted time slots for telecasting their advertisements. The principal issues before the Tribunal were (i) whether the Indian collection agents constituted a permanent establishment (PE) of the taxpayer in India and (ii) if they did, whether upon the payment of arm's length remuneration for agency services, no further profits can be attributed to the PE in India.
Separately, the taxpayer has made payments to entities in the US, UK, Mauritius and Isle of Man. The Tribunal had to decide whether these payments were royalties and, in the absence of tax withholding, were liable for disallowance when computing the business income of the taxpayer in India.
The Tribunal considered the conduct of the parties and the terms of the agency agreements, and concluded that the Indian collection agents do not constitute the dependent agent PE (DAPE) of the taxpayer in India. The Tribunal held that in order to create a DAPE, the agent's authority to conclude contracts on behalf of the taxpayer should either be present legally, i.e the contractual ability to bind the taxpayer, or the actual conduct of the parties should demonstrate the habitual exercise of such authority by the collection agents. In the absence of either of these factors instrumental to the creation of DAPE, the Tribunal held that the DAPE provision under the DTAA between India and Mauritius cannot be applied. Further, the Tribunal categorically held that once the agency remuneration is accepted by the transfer pricing authorities to be at arm's length, even if there is a PE in India, no further profits could be attributed to a PE of the taxpayer.
On the controversy of whether or not the payments made by the taxpayer were in the nature of a 'royalty', the Tribunal held that the hiring of a transponder was merely the provision of a standard facility and does not make technical knowledge available to the taxpayer. Accordingly, it was ruled that the payment of hiring charges does not amount to payment of fee for included services (FIS)/ fees for technical services (FTS) as narrowly defined under the DTAA entered into by India with USA and UK respectively. The Tribunal rejected the contention of the Revenue Authorities (RA) that the payments are taxable as royalties due to the retrospective amendment to the term 'royalty' by the Finance Act, 2012 (which seeks to clarify that royalty includes consideration in respect of any right, property or information, whether or not (i) the possession or control of such right, property or information is with the payer; (ii) that right, property or information is used directly by the payer; and (iii) the location of the right, property or information is in India). Although the amendment was pending for the President's assent at the time of this ruling, the Tribunal held that there was no corresponding change in the DTAAs, and an amendment to the Act would not affect the beneficial treatment bestowed on the taxpayers under the relevant DTAAs.
The Tribunal has reiterated the principle of Treaty override and held that the retrospective amendment to the domestic tax laws would not adversely impact the beneficial treatment afforded to the taxpayers under the DTAA. The DTAAs provide for a narrower definition of royalties as compared to the provisions of the Act.
Extending this principle to the licensing of software, even though the Act treats consideration for use or right to use software as a 'royalty', it is not so treated under the DTAA with the US. As per the DTAA, there must be a transfer of all or any statutory rights of a copyright holder for consideration in order to treat the consideration as a royalty. The provisions of the DTAA, being more beneficial to the taxpayer, would be applied and a transaction providing a license for use of a software ought not to be covered as a royalty.
However, the Finance Act 2012 has also introduced new provisions where it has been clarified that taxpayers should obtain a TRC from their country containing certain particulars which would be prescribed by the Indian Government. In the absence of such a TRC, the DTAA benefits would not be available to the taxpayers. The Government is yet to prescribe the particulars required in the TRC, which would be an important development to watch out for.
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