India has adopted the source rule for taxing royalties and technical services since 1976. The rule which is an exception to the general rule deems technical services to arise if the services are utilized in India irrespective of where the services are rendered. Given that the term ‘fees for technical services’ (hereinafter referred to as FTS) as defined under Explanation 2 to section 9(1)(vii) of the Income tax Act (hereinafter referred to as ITA) inter alia covers consideration for any technical, managerial and consultancy services, the Revenue has always tried to bring practically every service within its ambit. There have been numerous judicial precedents rendered on this issue; nonetheless, ‘whether a particular payment made by a taxpayer, especially to non-residents, would fall within the aforesaid definition’ continues to remains a perpetual ground of dispute between the Income-tax Department and taxpayers.
Recently the Mumbai bench of the Income tax Tribunal had another chance to examine this issue in respect of payment of sub-arranger fees to non-residents for mobilization of deposits.
The taxpayer, a non-resident bank operating in India through its branches, was appointed by the State Bank of India to act as arranger as well as collecting bank in respect of one of its deposits i.e. the India Millennium Deposit (hereinafter referred to as IMD) scheme. As arrangers, the taxpayer was responsible for mobilizing the deposits from eligible depositors under the IMD Scheme and as collecting bank, it was responsible for collecting and handling the application forms of deposits.
In lieu of its services, the taxpayer was entitled to arranger’s fee and commission at a fixed rate. Further, the taxpayer was also entitled to receive a 5 year deposit from State Bank of India equivalent to 50% of the total amount so mobilized.
The taxpayer appointed sub-arrangers in India as well as overseas. The role of the sub-arrangers was primarily to mobilize maximum deposits for the taxpayer. Fee was paid to the sub-arrangers at various rates depicted as percentage of the amount mobilized by them. In certain cases, the sub-arrangers shared the fee with the final depositors whereas in few other cases the sub-arrangers invested their own funds in the IMD scheme.
The Assessing Officer held that fee paid to sub-arrangers falls within the scope of FTS as defined under Explanation 2 to section 9(1)(vii) and since no taxes were withheld in respect of payment of such fee in foreign currency, provision of section 40(a)(i) r. w. s. 195 would apply. Accordingly, the taxpayer’s contention was rejected and the entire sub-arranger’s fee paid in foreign currency was disallowed.
The first appellate authority held that the fees paid to sub-arrangers is in the nature of commission and does not constitute FTS.
The Department filed an appeal with the Tribunal, inter alia, in respect of the following issue:
The Tribunal examined the nature of services to be rendered by the taxpayer as arranger and collecting bank for the IMD issue and inter alia noted that the services rendered by the sub-arrangers are essentially in the nature of soliciting non-resident customers for IMD. It therefore held as follows:
This is welcome decision, especially for non-resident entities earning service fee from India, as it goes to clarify the scope of managerial services as stipulated in the FTS definition under the ITA. It correctly highlights the principle in order to constitute managerial services, it is necessary to manage the overall activity as a whole; merely contributing to the overall scheme of things by performing sub-activities, incapable of independently achieving the desired result, cannot be construed as managerial services.
In the recent past, the Mumbai Tribunal has rendered few decisions clarifying that the definition of FTS under the ITA cannot be interpreted in a narrow sense so as to include pure commercial services which are primarily in the nature of execution of activities. Further, the Calcutta Tribunal has also held that services rendered without the human element cannot be taxed as FTS.
It would be a great relief for taxpayers if the Department takes note of the principles laid down in these decisions and applies the same at the time of finalizing assessments.
Above Article is compiled by
N.C. Hegde is ‘Partner’ at Deloitte Haskins & Sells
Alpana Rao is a ‘Manager’ at Deloitte Haskins & Sells
Nikita Chothani is ‘Assistant Manager’ at Deloitte Haskins & Sells