This article summarizes a recent ruling of the Authority for Advance Rulings (AAR) [AAR No. 811 of 2009 dated 1 December 2009] in the case of Federation of Indian Chambers of Commerce and Industry (Applicant) on the issue of taxability of payments made for obtaining certain services from a wing of the University of Texas (UT), USA, UT(IC2). Considering the facts of the case, the AAR held that as the services do not satisfy the criterion of ‘make available’ under the applicable India-USA Tax Treaty (Tax Treaty), the payments are not taxable under the same. As the payments are not liable to be taxed under the Indian Tax Law (ITL) read with the Tax Treaty, the Applicant would not be required to withhold taxes on its payments to the UT.
Background and facts of the case
- The Applicant is a non-profit company, registered under the Companies Act, 1956. The Applicant entered into a Memorandum of Understanding (MOU) with the Defence Research Development Organization (DRDO). Under the MOU, the Applicant has to assist the DRDO laboratories in the identification and business development of competitive global technologies from its inventory of existing defense-related inventions. In order to implement the MOU, the Applicant and the DRDO have jointly initiated a program wherein a major part of the services would be completed by the Applicant. The rest of the services would be done with the assistance of UT(IC2) for which the Applicant would need to make payments to the UT.
- Broadly, as far as UT(IC2) is concerned, the program involves the provision of services, which may be split into 4 components: (a) Training (b) Technology assessment (c) Business development (d) Program management. The payments made are for services rendered and assistance extended in the defense-related inventions.
- As per the provision of the ITL, payments for managerial, technical or consultancy services are taxable as ‘fees for technical services’ (FTS). As compared to the ITL, the Tax Treaty contains a narrower definition of the term ‘fees for included services’ (FIS) wherein only such services that are ‘technical’ or ‘consultancy’ in nature and which ‘make available’ technical knowledge, experience, skill etc, to the recipient, are regarded as FIS.
- Further, the Tax Treaty contains an exclusionary clause which excludes the provision of services from the ambit of FIS, if they are provided for teaching in or by educational institutions.
Issues for consideration
The key issues under consideration before the AAR are as follows:
- Whether the UT, being a tax-exempt organization in the USA, would be covered under the Tax Treaty.
- Whether the payments made to the UT by the Applicant would be taxable in India as FTS/FIS, having regard to the provisions of the ITL and the Tax Treaty respectively.
Contentions of the Tax Authority
- The Tax Treaty only covers persons who are ‘taxable’ in one of the countries (either India or the USA) as its resident. As the UT’s income may not be subjected to tax in the USA, the UT does not qualify as a ‘resident’ of the USA. Hence, the benefit of the narrower definition under the Tax Treaty cannot be considered.
- The payments made to UT(IC2) should be taxable as FTS under the ITL. Specifically, UT(IC2), through its services, is clearly ‘making available’ to the Applicant the technical expertise/knowledge and even transferring the technical plan i.e. Quicklook Report and the end product/deliverable developed by UT(IC2).
Ruling of the AAR
Tax Treaty Applicability
The certificate under the title ‘Statement of Federal Status’, obtained by the UT and filed by the Applicant, clearly mentions that the UT is a resident of the USA and is exempt from the US tax laws. However, the UT is required to pay tax on certain unrelated business taxable income and is also required to file a tax return in the USA. This is proof that the UT is liable to tax in the USA and would, accordingly, qualify as a ‘resident’ of the USA, as per the Tax Treaty. The mere fact that the UT has been granted exemption from tax under the provisions of the US tax laws, would not take it out of the category of ‘resident’ of the USA. Hence, the Tax Treaty provisions can be invoked under the present circumstance.
Taxability under the ITL
With regard to the nature of the services provided, the UT may be taxable under the broader definition of FTS as per the ITL. However, if the income is entitled to a benefit under a tax treaty, then, as per the ITL, the provisions of the tax treaty will take precedence and, accordingly, taxability under the tax treaty would also need to be determined.
Whether services would fall within the educational institution exclusionary clause
- Although the UT(IC2) is a wing of an educational institution, i.e. the UT, the real nature and predominant purpose of the services provided would need to be determined.
- Having regard to the nature of the activities undertaken by UT(IC2) in co-ordination with the Applicant, the AAR held that the same does not support the inference of teaching by an educational institution.
- The AAR referred to Example 10 appended to the Protocol of the Tax Treaty. In the said example, the fee paid was clearly for teaching by an educational institution. Therefore, though the recipient of the service intended to acquire a technical service from an educational institution, it was considered as falling within the exclusionary clause of the Tax Treaty.
- In the present fact pattern, the AAR observed that, though certain attributes of teaching are present with regard to technology commercialization, it is only incidental to the primary objective of the business promotion of technologies. Accordingly, the services will not fall within the exclusionary clause of the Tax Treaty.
Whether taxable as FIS
- The AAR observed that in order to be taxable as FIS under the Tax Treaty, a mere provision of technical and other services would not suffice. It, additionally, requires that the service provider should also make its technical knowledge, experience, skill, know-how, etc. known to the recipient of the service so as to equip him to independently perform the technical function in future, without the help of the service provider.
- The AAR referred to various judicial precedents which have elucidated on the concept of ‘make available’ as well as to the Protocol of the Tax Treaty in order to hold that the services rendered by UT(IC2) would not be regarded as FIS. With regard to the respective components as per which UT(IC2) provided services, the AAR held as follows:
The service of broadly explaining the principles involved in technology commercialization and of making the participants familiar with the various aspects of the program does not prima facie amount to ‘making available’ technical knowledge or expertise by UT(IC2). It is merely incidental to the implementation of the program. Even if it may be considered as FIS, it is not possible to apportion the consideration attributable to this component because an overall view of the entire transaction has to be seen.
The service of evaluating the potential of technologies after interaction with the experts, passing on the results of its interaction and furnishing the relevant information which is, by and large, available in the public domain, do not fall within the ambit of FIS. Further, the Quicklook Report is an end product of the technical knowledge which UT(IC2) possesses, coupled with an intensive study and inputs from various sources gathered for such a study. However, they fail to possess the character of ‘making available’ technical knowledge and experience by UT(IC2).
- Business Development and Program Management
Although most of these services may answer the description of technical and consultancy services, expression of opinion, formulation of recommendation and rendering assistance, they do not really ‘make available’ the technical knowledge or know-how, except perhaps in an incidental/indirect manner. Therefore, it would not come within the purview of FIS.
- The AAR concluded that the payments received by UT(IC2) would not be liable to be taxed as FIS under the Tax Treaty. Therefore, in view of the beneficial Tax Treaty provisions, the Applicant would not be required to withhold taxes on its payment to UT(IC2).
This ruling is generally consistent with several other rulings on the matter which have interpreted the term ‘make available’ so as to exclude payments for services not containing any technology or payments for services not enabling the recipient to apply the technology. Specifically, this ruling provides guidance on the application of the concept of ‘make available’ to services in the nature of training, technology assessment, business development and other management-related functions.
A ruling by the AAR is binding only on the Applicant, in respect of the transaction in relation to which the ruling has been sought and on the Tax Authority, in respect of the Applicant and the said transaction, unless, there is a change, either in law or in facts, on the basis of which the advance ruling was pronounced. However, the advance rulings do have a persuasive value and the Courts in India and the appellate authorities do recognize the principles and ratio laid down by the AAR, while deciding similar cases.