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:
- Whether fees paid in foreign currency to sub-arrangers constitutes FTS under section the ITA and hence liable to withholding tax in India under section 195?
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:
- For a particular service to fall within the purview of technical service, it is sine qua non that some sort of technical knowledge or skill or education must be required for doing the activity; where the work does not require any technical knowledge, qualification or experience, then the same cannot be designated as rendition of a technical service.
- No technical knowledge, expertise or qualification was required on part of the sub-arrangers to render the aforementioned services. Merely convincing potential investors and, after convincing them, helping them in filling requisite forms and sending the amount to the designated branches, cannot be considered as a `technical service’.
- With respect to the Department’s contention that the services rendered by sub-arrangers are akin to managerial services, the Tribunal observed that managerial services in relation to any activity, refers to the management of such overall activity; doing small parts of the overall activity independently cannot be considered as rendering of a managerial service in relation to such activity.
- Services rendered by the taxpayer as well as the sub-arrangers were only a small part of the management of the IMD issue; as a matter of fact, the taxpayer was one of the several banks appointed for mobilizing deposits for the IMD scheme. Further, State Bank of India had the sole discretion of accepting or rejecting any application for the deposits mobilized by the taxpayer through its sub-arrangers. Basis these observations, the Tribunal held that the activities performed by sub-arrangers do not constitute managerial services.
- On the basis of the above facts, the Tribunal distinguished the Special Bench decision in the case of Mahindra & Mahindra Ltd. relied upon by the Department. In the case of Mahindra & Mahindra Ltd., the issue was pertaining to payment of fees to lead managers appointed by the taxpayer for management of its GDR issue and the activities of the lead manager extended to all aspect of the issue. The Tribunal clarified that if the lead managers outsourced few activities to a third party, then activities performed by such third party would be akin to mere execution of sub-activities, incapable of achieving the overall result (i.e. management of the GDR issue) and therefore it cannot be considered as managerial service.
- Admittedly the activities of the sub-arrangers were also not in the nature of consultancy services.
- Since the fees paid to the sub-arrangers was not in respect of technical, managerial or consultancy services, the same was outside the scope of FTS; thus, the provisions of section 195 and 40(a)(i) would not be applicable to such payments.
- Further, it was observed that the sub-arrangers were acting as mere commission agents or brokers, entitled to an agreed rate of commission in lieu of the deposits mobilized by them. Placing reliance on the Board circular no. 786 dated 7 February 2000, it was held that such commission payments shall not taxable in India and consequently, section 195 of the ITA would not apply.
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