The Organisation for Economic Co-operation & Development (‘OECD’) in Action Plan 1[1] of Base Erosion and Profit Shifting project (‘BEPS’) has acknowledged that the digital economy is increasingly becoming the economy itself and hence, it would be challenging to ring-fence the digital economy from rest of the economy for tax purpose. The characterisation of payment made for digital products/services and its tax implications are contentious issues, particularly in Indian context. Already, there have been sizeable litigations on taxability of online database subscription fees, online advertisements, web hosting services, sale / downloads of software licenses, etc. In most of these cases, the businesses contend that the services do not constitute royalty / fees for technical services (‘FTS’) and in absence of any Permanent Establishment (‘PE’) in India, such services are not liable to tax in India. On the other hand, the Indian tax authorities (‘ITA’) resist that the services fall with the elaborated definition of royalty / FTS and thereby subject to tax in India.
Now, the taxability of fees from domain name registration services has come under tax scanner. Recently, the Income-tax Appellate Tribunal, Delhi Bench (‘Tribunal’) has held that domain name registration fees received by Godaddy.com LLC[2] are taxable as royalty under Indian tax laws. A summary of the said Tribunal ruling is as under:
Summary of Ruling
The taxpayer, Godaddy.com LLC is a US limited liability company and listed on New York Stock Exchange. The taxpayer is an accredited domain name registrar [authorised by Internet Corporation for Assigned Names and Numbers (‘ICANN’)] and provides domain name registration as well as web hosting services to its customers.
The taxpayer offered income from web hosting services as royalty income at the time of filing its tax return in India, whereas, the income from domain name registration services were claimed as not liable to tax in India. The taxpayer, not being tax resident of USA, was not eligible to claim any tax benefit of India-US Double Tax Avoidance Agreement (‘Tax Treaty’) and thus, taxability of the above-mentioned incomes was to be determined as per the provisions of Income-tax Act, 1961 (‘Act’).
In the context of taxability of domain name registration services, the ITA alleged that the domain name registration is a tool which equips the customer with the right to use the server of the taxpayer for consideration. Further, the ITA contended that the domain name registration is a pre-condition to web hosting and the process is highly technical in nature. Hence, ITA characterised domain name registration services as ‘royalty’ which inter alia involves granting the right to use the servers of the taxpayer, whereas, the web hosting services were characterised as FTS as per the provisions of the Act. Being aggrieved by action of the ITA, upon objections filed by the taxpayer, the Dispute Resolution Panel upheld the findings of the ITA.
During the course of Tribunal proceedings, ITA further contended that ICANN owns domain extensions but has granted the taxpayer all the rights and risks relating to the assignment, allocation, transfer and management of specific domain names within specific extensions. Whereas, the taxpayer avowed that web hosting services and domain name registration services have an independent existence. Further, the taxpayer gingerly explained the domain name registration process and emphasised on the fact that the entire process is automated ie. there is no human intervention. Further, none of the employees of the taxpayer visited India for rendering any services to customers and it does not have any physical presence/fixed base in India.
The key findings of the Tribunal in relation to characterisation of the payment made for domain name registration service as royalty are set out below:
- Domain name is an intangible asset akin to Trademark – The Tribunal relying on the decision of Hon’ble Supreme Court in case of Satyam Infoway Ltd.[3] and jurisdictional Delhi High Court in case of Tata Sons Limited[4], observed that domain names are subject to legal norms as applicable to trademark. Further, it observed that domain names are valuable corporate asset and entitled to protection equal to a trademark. Thus, Tribunal arrived at a conclusion that domain name is similar to trademark.
- Rendering of Service in connection with the use of Trademark – Thereafter, the Tribunal held that the rendering of services for domain name registration, is services in connection with the use of an intangible property (ie. trademark). Therefore, entire income received by the taxpayer for rendering services in respect of domain name is ‘royalty’ within the meaning of clause (vi) read with clause (iii) to Explanation 2 to section 9(1)(vi) of Act.
In the backdrop of the above judicial precedent, the ITA may be gearing-up to contend that similar services provided by other registrar / businesses should also be liable to tax in India (subject to provisions of applicable tax treaty). However, it is imperative to understand the operating model of such registrar / businesses which provides domain name registration services, in order to characterise the nature of such services from taxation perspective. Accordingly, in the ensuing section, based on the information available in the public domain, the operating model in relation to domain name registration has been summarised.
Operating Model[5]
Typically, a domain name is a web address that is used to locate a particular website of an enterprise. It represents a specific Internet Protocol (‘IP’) resource that serves as an address for people to access one’s website on the internet.
For registration of domain name, an enterprise makes a request to a domain name registrar (ie. Godaddy.com, etc), who in turn checks the availability of that domain name with ICANN. Subsequently, only upon confirmation from ICANN, the registrar facilitates the process of registration of the domain name. The process[6] has been depicted in the diagram below:
Based on the above, it appears that registrar acts as mere facilitator (intermediary) between ICANN (owner of domain names) and the end customer who becomes the owner of the registered ‘domain name’ post completion of domain name registration. Thus, registrar neither owns any domain name nor grants any right to use such domain name to the registrant upon registration of domain name.
Further, web hosting is an independent process of allocating space on a server to store all website files and make the website accessible through the World Wide Web. Hence, the web hosting service can be rendered only after a domain name has been created. Thus, one can appreciate that domain name registration services and web hosting services are two different activities in all respects, though the former precedes the latter.
Taxability – Royalty / FTS
Having broadly understood the operating model in relation to the domain name registration, some of the key indicative factors towards determining the character of the domain name registration services as royalty / FTS are as under:
- As per clause (iii) to Explanation 2 to section 9(1)(vi) of the Act, any sum paid for use of trademark shall fall within the definition of the term ‘royalty’. However, in case the registrar is neither the owner of the domain name nor grants any right to use such domain name, a question does arise whether such services would fall with the ambit of aforesaid clause. In this regard, an analogy can be drawn from a case where lawyer’s services are utilized for registering a trademark of the company with trademark registry in India, the same cannot be construed as lawyer granting any right to use such trademark.
- Additionally, the true test of whether sum paid is royalty or not depends on whether the said sum is paid for the provision of services, which may involve the use of trademark / domain name or paid for the use of trademark / domain name. Thus, as long as the aforesaid clause aim to tax only those receipts as royalty which result in actual usage of trademark by the customer and not receipts for mere provision of services, which may involve the use of trademark by the taxpayer for rendering of such services it cannot be characterized as ‘royalty’. Thus, as long as registrar merely provided services (although involving use of its own server) the same should not be characterized as ‘royalty’.
- As per clause (vi) to Explanation 2 to section 9(1)(vi) of the Act, any sum paid for rendering of services in connection with the activities referred to in sub-clause (i) to (iv), (iva) and (v) shall be characterized as ‘royalty’. In view of the said clause, although the services of registrar are in connection with the domain name registration however the proximity of such services falling within the ambit of above clause would also need to be determined so as to ensure that each and every service in-and around domain name registration do not fall within the ambit of this clause. Separately, whether the aforesaid clause is applicable only in cases where such services are provided by the same person who grants the right to use the trademark also requires closer examination? As in the contrary case ie. where services need not be provided by the same person granting the right to use trademark, one may arrive at a conclusion that the lawyer fees in connection with domain name registration would also fall within the ambit of aforesaid clause.
- Lastly, as the domain name registration is an automated process which do not require any human intervention. Accordingly, one would need to deliberate whether a service rendered without any human intervention would constitute FTS under section 9(1)(vii) of the Act as there are several Indian court cases[7] upholding the view that services rendered without human intervention, even if it be a technical service, it cannot qualify as FTS under section 9(1)(vii) of the Act.
Concluding thoughts
In light of the above judicial precedents and indicative factors, it appears that taxability of domain name registration services doesn’t seem to be settling and the ITA and registrar / businesses / Indian customers are headed towards one more tug of war tussle. Thus, it may be suitable for the Central Board of Direct Taxes to examine the matter in detail and thereafter issue necessary guidance, with an intent to reduce litigation.
Separately, on a going forward basis, the Indian government has introduced Equalization levy (with effect from June 1, 2016) which is currently applicable only on specified payments made for online digital advertisements to overseas businesses not having a Permanent Establishment (‘PE’) in India. However, the Indian Government has also left the window open to include other digital services (such as designing, creating, hosting or maintenance of website, etc.) within the ambit of Equalization Levy at a later point in time. Additionally, in budget 2018, the definition of ‘business connection’ under the Act has been widened to include concept of ‘Significant Economic Presence’ for overseas businesses who provide digital services without having physical presence in India, above certain threshold to be notified shortly. Thus, with advent of Equalization levy, expansion of scope of ‘business connection’ and existing definition of ‘royalty’ / ‘FTS’, it is imperative for the Indian government to set-out rules classifying payments for digital products / services in one of above definitive categories so as to avoid income characterization issue and facilitate ease in tax compliances from perspective of overseas businesses as well as Indian customers.
(Views expressed in this article are authors personal views and the same should not be considered as a professional advice. This article is co-authored by Mr Pranay Bhatia, Mr Bhavin Shah and Mr Mayank Chamria. Mr Mayank Chamria is Senior Manager – Tax & Regulatory Services, BDO)
[1] OECD released final report on “Addressing the Tax Challenges of the Digital Economy” (Action 1) on Oct 5, 2015
[2] Godaddy.com LLC v. ACIT [2018] 92 taxmann.com 241 (Del. Trib.)
[3] Satyam Infoway Ltd. v. Siffynet Solutions Pvt. Ltd. [2004] Supp. (2) SCR 465 (SC)
[4] Tata Sons Limited v. Mr. Manu Kishori & Ors. 90 [2001] DLT 659 (Del. HC)
[5] The operating model has been summarized based on the information available in the public domain. In absence of necessary and sufficient information, we are not able to comment whether the said operating model was applicable in the case of Godaddy.com as well.
[6] Source: https://whois.icann.org/en/domain-name-registration-process
[7] CIT v. Bharti Cellular Ltd. [2010] 193 Taxman 97 (SC); ITO v. Right Florist (P) Ltd. [2013] 32 taxmann.com 99 (Kol. Trib.)
