Income from cloud services was neither taxable as ‘Royalty’ nor as ‘fees for included services’

Rackspace, US INC Vs DCIT (ITAT Mumbai)

Conclusion: Income from cloud services was neither taxable as ‘royalty’ nor as ‘fees for included services’ as the customers did not operate the equipment or have physical access to or control over the equipment used by the assessee to provide cloud support services and did not make available technical knowledge, experience, skill, know-how etc., to its Indian Customers and the cloud support services were not in the nature of managerial, technical or consultancy services. Moreover, there was no PE of the assessee in India and hence, no income could be taxed in India in term of Indo-US DTAA.

Held: Assessee-company was incorporated in and a tax resident of USA. During the year under consideration, it earned income from cloud services including cloud hosting and other supporting and ancillary services provided to Indian Customers. It filed the return of income and the notes stating therein that the cloud hosting services was not taxable as ‘royalties’ under Article 12 of the India-US tax treaty and  as the customers did not operate the equipment or have physical access to or control over the equipment used by the assessee to provide cloud support services and did not make available technical knowledge, experience, skill, know-how etc., to its Indian Customers and the cloud support services were not in the nature of managerial, technical or consultancy services and consequently same did not constitute fees for included services within the meaning of Article 12 of the India-USA Double Tax Avoidance Agreement (DTAA). It further claimed that revenues earned on account of cloud hosting services constituted business profits and since it did not have Permanent Establishment (PE) in India under Article 5 of the DTAA, the same would not be subject to tax in India under the provisions of Article 7(1) of the DTAA. There was a mismatch of receipts as per 26AS and as per party-wise receipts furnished by assessee, therefore, the notice was issued. AO after considering the reply of the assessee and in accordance in the direction of the DRP, the receipt in sum of Rs. 17,12,52,670/- was considered as ‘Royalty’ and held to be taxable @ 10% as per India-USA DTAA prescribed taxation rate. It was held  that the agreement between assessee and its customers is for providing hosting and other ancillary services to the customers and not for the use of leasing any equipment. The data centre and the infrastructure therein used to provide these serves belongs to assessee. The customers were not having physical control or possession over the servers and right to operate and manage this infrastructure/servers vest solely with the assessee. The agreement was to provide hosting services simpliciter and was not for the purpose of giving the underlying equipment on hire or lease. The customer was not knowing any location of the server in data centre, web mail, websites etc. Accordingly, it could not be said as royalty within the meaning of Explanation (2) to Section 9(1)(vi) as well as Article 12(3)(b) of the Indo-USA Data by the AO and DRP. Moreover, there was no PE of the assessee in India and hence, no income could be taxed in India in term of Indo-US DTAA. Thus, the income from could hosting services was erroneously held as royalty, on the same reasoning, the income from cloud hosting services could not be taxed as fee for technical services.

FULL TEXT OF THE ITAT JUDGEMENT

The assessee has filed the above mentioned appeals against the direction of the Disputes Resolution Panel -2, Mumbai dated 27.06.2018. The assessment was framed by the DCIT (International Tax)- Circle 4(1)(1), Mumbai for the relevant A.Ys. 2010-11 & 2015- 16 u/s 144C(6) r.w.s. 143(3) of the I. T. Act. (hereinafter ‘the Act’).

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