Case Law Details
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
- The consideration for provision of services was in the nature of business receipts under Article 7 of the tax treaty and could not be taxed in India in the absence of a PE of the applicant.
- As per the tax treaty, furnishing of services for more than 183 days in any 12 month period would constitute a PE, however, in view of the most favored nation clause being inserted in the tax treaty, the period gets relaxed to 275 days (based on the Agreement for avoidance of double taxation between Sri Lanka and Yugoslavia). The cumulative presence of applicant’s employees was for 193 days; therefore its activities would not form a PE in India.
- Receipts for supply of software should be treated as business receipts under Article 7 of the tax treaty and not as royalty since the supply of software was incidental to the contract and the predominant purpose of the contract was service.
- Payment to the applicant was for obtaining limited rights to enable effective operation of the software and not for the end user to commercially exploit the underlying rights in the software. Furthermore, the receipt would not constitute royalty as perpetual rights in software were being given by the applicant to WAPCOS.
- The ICHPL has the expertise and had already performed similar services for Government and other entities. The services to the applicant were provided by ICHPL in an independent capacity and therefore, employees of ICHPL cannot be considered as employees of the applicant.
Revenue’s Contentions
- Since FTS has not been dealt with under the tax treaty, taxing FTS under any other article of the tax treaty other than section 9(1)(vii) of the Income-tax Act, 1961 (“Act”) would mean changing the character of the income.
- The software is not sold and has only been licensed to use the copyright, therefore the nature of the consideration is royalty under section 9(1)(vi) of the Act.
- ICHPL and Mantec being Indian entities constitute a dependent agent PE of the applicant because the applicant gave instructions to them and services rendered by these entities were under the control of the applicant.
- Under section 190 to 194 of the Indian Contract Act, 1872, ICHPL constitutes a sub-agent of the applicant in India for the reason that under the agreement between the applicant and WAPCOS, the applicant was not to outsource any part of the work relating to surveys and investigation and modeling. Under section 193 of the Indian Contract Act, 1872, where an agent has no authority to delegate work to another/appoint a sub-agent, he/she becomes responsible for the acts of such sub-agent and therefore, the duration of time spent by ICHPL employees should also be considered in determining the creation of a PE in India.
AAR Ruling
- The studies carried out by the applicant would result in providing know how to WAPCOS on a long term basis. What has been provided was not an off-the‑
shelf product but scientific equipment that has been provided for its perpetual use. - The ownership in the core of the product i.e the software was not sold. It is the use of equipment or such product which in essence was the technology transfer envisaged in the services required. The software is the heart and soul of the technology transferred by the applicant. The intellectual property rights in the software were not being transferred.
- The consideration received is for the use of scientific work, model, plan and for the use of scientific equipment and scientific experience. The payment falls under the term ‘Royalty’ under Article 12 of the tax treaty.
- Since there is no specific Article for taxation of FTS in the tax treaty, the FTS shall be governed by Article 22 of the tax treaty, which is a residuary Article and shall not be taxed under Article 7 of the tax treaty.
- The nature of activities performed by the applicant constitutes ‘Royalty’ under Article 12 of the tax treaty. Therefore, the income cannot be taxed as ‘Business Profits’.
Conclusion –This ruling assumes significance in those cases where composite contracts provide for services which are ancillary to the main objective of providing a software user license. The consideration has been treated to be in the nature of ‘Royalty’ even in a case where a tax treaty does not have any specific Article for taxation of Frs.
FULL TEXT OF THE AAR IS AS FOLLOWS:-
BEFORE THE AUTHORITY FOR ADVANCE RULINGS (INCOME TAX) NEW DELHI
16th Day of May, 2011
A.A.R. No. 874 of 2010
PRESENT
Mr. Justice P.K.Balasubramanyan (Chairman) Mr. J. Khosla (Member)
Mr. V.K. Shridhar (Member)
| Name & address of the applicant | Lanka Hydraulic Institute Limited
177, John Rodrige Mawatha Katubedda Moratuwa Sri Lanka |
| Commissioner concerned | The Director of Income-tax
(International Taxation), Kolkata |
| Present for the applicant | Mr.Rajan Vora, C.A.
Mr.Mithun D‟Souza, C.A. |
| Present for the Department | Mr.Shahi Sanjay Kumar,
Addl.DIT(Intl.Taxn.)-I, Kolkata Mr.V .K.Agarwal,DDIT(Intl.Taxn.)-I(1) Kolkata |
RULING
(By Mr. V.K. Shridhar)
The applicant, Lanka Hydraulic Institute Limited (LHI), is a company incorporated under the laws of Sri Lanka and is a tax resident of Sri Lanka. It provides technical feasibility studies, preparation of coastal zone management plan, port and other water related engineering projects, etc. The applicant submits that it does not have any office or place of business in India.
4. WAPCOS remitted a sum of US$ 6,66,750 to the applicant and withheld taxes under section 195 of the Income Tax Act,1961 (Act) by treating the receipts as under section 9(1)(vii) of the Act. The applicant had approached the assessing officer for a „nil‟ withholding tax certificate under section 197 of the Act, but decided to withdraw it.
5. On these facts, the applicant desires to know whether the payments received from WAPCOS are liable to tax in India as per provisions of India and Sri Lanka Tax Treaty (Treaty) and has raised the following questions for ruling by this Authority:-
(1) On the facts and circumstances of the case, given that the „Convention between the Government of the Republic of India and the Government of the Democratic Socialist Republic of Sri Lanka for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and on capital („Tax Treaty ‟) does not contain a specific Article for the taxation of Fees for Technical Services (FTS) would the liability to tax, if any, of the consideration received by the Applicant from Water and Power Consultants Ltd. („WAPCOS‟) under the Contract be governed by Article 7 of the Tax Treaty, which deals with taxation of business profits?
(2) If the answer to the Question 1 is in the affirmative, whether based on the facts and circumstances of the case, the specific nature of activities performed by the Applicant under the contract with WAPCOS results in the constitution of permanent establishment („PE”) of the Applicant in India, within the meaning of the term as defined in Article 5 read along with the protocol of the tax Treaty?
(3) If the answer to Question 2 is in the negative, whether the consideration received by the Applicant under the contract with WAPCOS is liable to tax in India under Article 7 of the Tax Treaty?
(4) If the answer to Question 1 is in the negative, whether based on facts and circumstances of the case, the consideration received by the Applicant under its Contract with WAPCOS is taxable in India, under any other Article of Tax Treaty and the taxability thereof?
6. The contention of the Revenue is that as FTS has not been specifically dealt with under the Treaty, taxing FTS under any Article of the Treaty other than under Section 9(1) (vii) of the Act would mean changing the character of the income. The OECD convention serves as a guideline to tax the payment under contract for services under Article 7 of the Treaty. In the absence of the breakup of the consideration it cannot be concluded whether the supply of software is incidental to the provision of services or the provision of services was incidental to the supply of software. Even if the consideration received was incidental to the provision of services, the services provided are FTS and taxable u/s 9(1)(vii) of the Act. The second contention of the Revenue is that the software is not sold. It is only licenced. The licence is to use the copyright. Therefore the nature of the consideration is Royalty under section 9(1)(vi) of the Act.
Regarding the applicant‟s stand that the consideration for provision of service is business receipt and cannot be taxed in India in the absence of a PE, the revenue contended that the presence of applicant‟s employees for less than 183 days is not ascertainable. On that basis, it cannot be determined whether the applicant has a PE or not. Further, as a portion of the work was contracted out to two Indian entities ICHPL and Mantec, it cannot be denied that instructions were given by the applicant to ICHPL and Mantec. Once the instructions were given by the applicant to ICHPL the services rendered are controlled and then ICHPL and Mantec constitute dependent agency of the applicant. It is also not substantiated that the ICHPL and Mantec do not provide similar services to other concerns and hence it cannot be concluded that these two concerns are independent agencies and do not constitute dependent agent. The applicant therefore has a PE in India and the services rendered are taxable under Article 7 of the Treaty. Thus the case of the revenue is that the consideration should be chargeable under section 9(1)(vii) of the Act or under Royalties and not as business receipts under Article 7 of the Treaty.
7. In response, the applicant stated that the receipts for supply of software should be treated as business receipts under Article 7 of the treaty and not as Royalty. The supply of software is incidental to the contract and the predominant purpose of the contract is service. The receipt cannot be considered as Royalty as the payment is for obtaining rights limited to enabling effective operation of the software and not for the end user to commercially exploit the underlying rights in the software. Without prejudice, it is stated that the receipts would not constitute Royalty as perpetual rights in software are given to WA PCOS by the applicant.
The applicant states that the consideration for provision of service is business receipt. It does not have any fixed place of business or place of management, branch office in India. As per clause (i) of Article 5(2) of the Treaty, it can have a PE only if the furnishing of services is for a period exceeding 183 days in any 12 months period. Further, since most favored nation clause has been inserted in the Treaty, the period gets relaxed to any period of longer duration in any of the DTAAs entered into by Sri Lanka. Since in the Treaty between Sri Lanka and Yugoslavia the period is 275 days, the period in Article 5 should be read as 275 days in any 12 months. As only 20% of the work is rendered in India, the cumulative presence of employees in India from 26.1.2009 to 22.2.2010 was 193 days. Further deputation of employees would not exceed 10 days up to the completion of the contract.
“The term “permanent establishment” shall include especially:
(i) The furnishing of services, including consultancy services, by an enterprise through employees or other personnel, where activities of that nature continue within the country for a period aggregating more than 183 days within any twelve month period.”
It is stated that in the present case, the services to LHI were provided by ICHPL in its independent capacity as a service provider. ICHPL has the expertise and has performed similar engagements for governmental and other entities. ICHPL services are rendered by it through its employees to work under its own direction, supervision and control. The employees of ICH PL cannot be considered to be “other personnel” within the meaning of Article 5(2)(i) of the Treaty. Hence the duration of time spent by such personnel is not to be considered in determining the creation of a PE of the applicant in India.
10. Under the Act income by way of fees for technical services payable by a person who is a resident shall be included in the total income of the non-resident whether or not the non-resident has a residence or a place of business or business connection in India. In other words existence of a PE is not a condition to tax the income arising from technical services. Consultancy services come within the meaning of FTS under the Act. If we go by the Treaty, consultancy services would come under the term “permanent establishment” only where the activities of that nature continue for a period aggregating to more than 183 or 275 days within any 12 months as averred by the applicant. Even if a payment to the applicant is not within the scope of section 9(1)(vii) of the Act, it makes no difference as the treaty would prevail over the Act. There is no incompatibility between recognizing the receipts as FTS and also looking upon it as the profit of the business. To that extent we agree with the contention put forth by the Learned Advocate.
11. Let us place the facts in a more comprehensive manner to answer the questions raised in the application. For the survival of Haldia Port, the channel depth is required to be improved and the quantity of dredging is required to be restricted. Model studies are proposed to evolve River Regulatory Measures (RRM) to improve the channel. WAPCOS expressed the necessity to bring global expertise to participate in the proposed study and to adopt technical collaboration of CWPRS with foreign consultancy having required software and experience in the field under its logistical support. The scope of the work for foreign consultant was divided into 3 parts:
i) Field data collection.
ii) Desk study & Mathematical Model study to arrive at suitable solution.
iii) Technology transfer.
The technology transfer component involved transfer of software procurement and installation of software at CWPRS with perpetual licence and support and maintenance for at least two years and training of KoPT/CWPRS/WAPCOS personnel. The facts stated in the application are that a tender was floated by WAPCOS for “Mathematical Model Studies For River Regulatory Measures For Improvement of Drafts in Hugli Estuary”. Quotations were invited for the work of software supplies, installations, modeling, field data collection, transfer of on-job training/technology, maintenance, monitoring, handover of software, designs and submissions of reports, etc. LHI appointed Mantec as its representative in India and utilized its services to win the tender for an agreed representative fee of 5% of the contract price. WAPCOS communicated the award of the said project to LHI for an amount of US$ 14,98,321 inclusive of all taxes and duties. LHI was informed to make preliminary arrangements to commence work and to sign the agreement. It may be stated that in the letter of award, it was made clear to LHI that the:
“award of the project is considered based on your quote and confirmations about utilization of Mike software packages developed by D H I Water Environment Health, Denmark and making available all necessary support of D HI in various processes to achieve the project study requirements and schedules agreed for the studies under consideration. ….”
Agreement between WAPCOS and LHI took place on 10.2.2009. As per clause 2 of the agreement, all the softwares/modules shall be installed at CWPRS by LHI with perpetual license and version, which would be followed by all exclusive training to the officers of KoPT/CWPRS/WAPCOS by LHI. LHI would also indemnify WAPCOS against intellectual property rights. As an all-important aspect of the project study required utilization of Mike software packages developed by DHI, LHI ensured its procurement from DHI through a letter dt. 31.12.2008. The letter especially states that DHI on behalf of LHI will supply through DHI India the software for the Mathematical Model studies on RRM in the Hoogly Estuary for the work awarded to WAPCOS. The total cost of the software packages and modules with license to use along with annual service maintenance agreement is also mentioned in the offer. It is made clear that LHI is not entitled to any commission as the end client is based in India. The DHI software licence agreement is not an agreement for sale of software. It has given only limited rights to use the proprietary DHI software in object code form. The rights granted are non-transferable and non-exclusive right to use one or more copies of the software. For field data collection, LHI outsourced the work to ICHPL, Chennai, for a consideration of US$ 2,95.000. The scope of work involved measurement programmes on tides, currents, sediment load etc. in the channel area from Sagar Island to Hoogly point at a stretch of about 100 km upstream. A report is required to be submitted by ICHPL.
12. The term „royalties‟ as used in Article 12 of the Treaty with Sri Lanka is extracted below:
Article 12
Royalties
3. The term “royalties” as used in this Article means payments of any kind received as a consideration for the use of or the right to the any copyright of literary, artistic or scientific work including cinematography films, or tapes for television or broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for the use of, or the right to use, industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience.”
13. The objective for which the tender is invited is to obtain best possible studies to improve the channel depth and restrict the quantity of dredging. The studies would result in providing know-how to WAPCOS on long term basis. The scientific experience in hydrology possessed by LHI to study and adopt the required model is what is intended in the tender. The ancillary activities carried out by Indomer in collecting the data is a part of the exercise of the model studies. Therefore, what has been provided to WAPCOS is not an off-the-shelf product which is sold to it but scientific equipment for its perpetual use. The ownership in the core of the product, that is to say, the software, is not sold. It is thus the use of the equipment or of such a product which in essence is the technology transfer that is envisaged in the tender document. The nature and form of technology is transferred by means of field data collection and by desk study of the data available to arrive at the best mathematical model by making use of the software. The software is the heart and soul of the technology transferred by LHI. The intellectual property rights in the software are not transferred. The accumulated fund of knowledge acquired by years of observation, search, experimentation and experience possessed by LHI is transferred through the above means as intended in the tender by WAPCOS, without incurring any liability for violation of intellectual property rights or copyrights embedded in the technology transfer. The consideration received is for the use of scientific work, model, plan, and for the use of scientific equipment and scientific experience. The payment falls under the term royalties as per Art 12 of the Treaty.
14. It is true that the treaty does not contain a specific article for the taxation of fees for technical services. In that event reference is to be made to Article 22 of the Tax Treaty which reads as follows:
“Item of income of a resident of a Contracting State which are not expressly mentioned in the foregoing Article of this Agreement in respect of which he is subject to tax in that state shall be taxable only in that state.”
Accordingly, Question No.1 is answered by holding that the fees for technical services shall be governed by Article 22 of the Tax Treaty and not as per Article 7 of the Tax Treaty which deals with taxation of business profits.
14.1 In the view that the nature of the activities performed by the applicant constitute „Royalties‟ under Article 12 of the Tax Treaty, the answer to Question No.2 is academic.
14.2 The consideration received by the applicant is liable to tax under Article 12 of the Tax Treaty and not under Article 7 of the Tax Treaty. Accordingly, Question No. 3 is answered in the negative.
14.3 The tax ability of the entire consideration received by the applicant under contract with WAPCOS is in the nature of “Royalties” to be taxed under Article 12 of the Tax Treaty. Question No.4 is answered accordingly.
Accordingly, ruling is given and pronounced on 16th day of May, 2011.
| (J. Khosla)
Member |
(P.K.Balasubramanyan)
Chairman |
(V.K.Shridhar)
Member |
