Consideration received under a composite contract for services which are ancillary to the main objective of providing a software user license held to be in the nature of Royalty

Recently in the case of Lanka Hydraulic Institute Limited In AAR No. 874 of 2010, the Authority for Advance Rulings (AAR) held that where the scope of work under a contract is primarily related to technology transfer by way of software along with ancillary services in the nature of field data collection/mathematical model studies, the consideration would constitute “Royalty” under Article 12 of the Double Taxation Avoidance Agreement with Sri Lanka (the tax treaty). The applicant had argued that since there was no specific Article in the tax treaty for taxation of Fees for Technical Services (“FTS”), the consideration would constitute business profits under Article 7 of the tax treaty, which would not be taxable in the absence of a Permanent Establishment (“PE”) in India. The AAR rejected this contention and ruled that the income would be taxed under Article 12 of the tax treaty as Royalty.

Facts – The applicant, a company incorporated under the laws of and a tax resident of Sri Lanka, is in the business of providing technical feasibility studies, preparation of coastal zone management plan, port and other water related engineering projects etc. Kolkata Port Trust awarded a contract to Water and Power Consultant Limited (“WAPCOS”), a public sector undertaking in India, which in turn sub­contracted the work to the applicant through an agreement dated 10 February, 2009.The scope of work was divided into three parts which were: 1) field data collection, 2) desk study and mathematical model study to arrive at a suitable solution and 3) technology transfer. The technology transfer involved transfer of software procurement and installation of software at Central Water and Power Research Station (“CWPRS”) with perpetual license and support and maintenance for at least two years and training of CWPRS/WAPCOS personnel.A substantial part of the services were performed in Sri Lanka and only 20 per cent of the services were rendered in India. The applicant outsourced part of the services to another independent contractor in India, Indomer Coastal Hydraulic (P) Ltd. (“ICHPL”) and also appointed Mantec Consultants (P) Ltd. (“Mantec”) as its representative in India.

Issue – Considering that the tax treaty does not contain any specific Article for taxation of FTS, whether the consideration received by the applicant from WAPCOS is liable to be taxed as business profits under Article 7 of the tax treaty?Whether if consideration is not taxed as business profits can it be taxed under any other Article of the tax treaty?

Applicant’s contentions

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