Foreign Remittance - Fees for Technical

Services

Hitesh D. Gajaria

23 January 2016

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Contents

I FTS Definition in Act

II FTS Definition in DTAA

IV Consultancy Services

VI Make Available

VII Secondment

VIII MFN Clause

V Technical Services

Managerial ServicesIII

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Fees for Technical Services (‘FTS’)

India, being a developing country is a net importer of technology and technical services. Substantial payments are made for such imports

In order to protect tax base, taxability of FTS to be considered either under Income-tax Act, 1961(‘the Act’) or DTAA - Article 7 (Business profits), or Article 14 (Independent Personal Services) orArticle 21 (Other income) – whichever is more beneficial

Model Conventions i.e. OECD, UN and US do not contain a specific Article for FTS.

Key Litigations on Taxing FTS illustratively relate to:

• Whether there is any Business Connection or Permanent Establishment in India?

• Whether the services are in the nature of managerial, technical or consultancy services?

• Whether services ‘make available’ any know-how?

• Whether concept of ‘make available’ applies even in case of managerial / consultancy services?

• Whether place of rendering of services relevant?

• Whether benefit of MFN clause available?

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Definition in Act

Current tax rate for FTS is 10% + surcharge + cess

Section 9(1)(vii)

• Government

• Resident except for business / profession / source outside India

• Non-residents where relates to business / profession / source in India

FTS deemed to accrue or arise in India if paid by:

• FTS means any consideration for the rendering of any managerial, technical or consultancy services

• Excludes Construction, Assembly, Mining, Any like project, Income chargeable as ‘Salary’

Income of Non-resident (‘NR’) shall be deemed to accrue or arise in India whether or not:

• NR has a residence / place of business / business connection in India

• NR has rendered any services in India

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• FCo to develop, design, engineer and procure equipment, materials andsupplies for provision of offshore and onshore supply and provideservices to ICo.

Rendering of service outside India -Ishikawajima Harima Heavy Industries – SC – 158 Taxman 259 – 4 Jan 2007

FCo.

ICo.

India

Japan

Facts

• Sufficient territorial nexus between the rendition of services and territoriallimits of India is necessary to make the income taxable

• Services should not only be utilized in India, but should also berendered in India or should have such a "live link" with India that theentire income from FTS becomes taxable in India

Points for discussion

Provision of offshore and

onshore supply and

services

• Explanation was inserted by the Finance Act 2007 which was further amended by Finance Act 2010, specificallymentioning that the place of rendering of services was not relevant

• Post the aforesaid amendment, Tribunals (e.g. Mumbai ITAT in Ashapura Minechem) have turned down the contentionlaid down by the Supreme Court in the above case by taking into consideration the amendment made by the FinanceAct 2010.

Subsequent Amendments

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• Whether the same falls within the meaning of managerial or technical or consultancy services?

• Applicability of exception provided in clause (b) under Section 9(1)(vii) of the Act – “for the purpose of making or earningany income from a source outside India”

• Implication of withdrawal of Circular no. 23 of year 1969 and Circular 786 of year 2000

Export Commission

Export commission paid for procuring orders abroad – whether FTS ?

• Orient Express (Madras HC) – 56 Taxmann.com 331 – following Faizan Shoes P Ltd(Madras HC) – 226 Taxman 115 – also referred to Toshoku – 125 ITR 225 (SC)

Held that Services rendered by NR selling agents can best be called as a service for completion ofthe export commitment and should not fall within the meaning of FTS.

No operations of the Agent’s Business Carried out in India

• Titan Industries Ltd (ITAT)

Held that since the payment of fees was made by assesse for earning income from the sourcesoutside India, the payment of fees was held as not liable to be taxed in India.

Case Study

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Article 12 - General Definition of FTS under most new DTAAs

Definition in DTAA

FTS means payment of any kind, other than those mentioned in Article

14 and 15 – Dependent or Independent Personal Services

• Consideration for managerial / technical / consultancy services

• Includes provision of services for technical or other personnel

Note - Older DTAAs definition differently worded but essenceremains the same

• Some of the DTAAs do not provide specific exclusion for IPS for e.g.

China, Germany, Austria, South Africa, Turkey, Brazil, etc.

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FTS under DTAA

Some DTAAs have phrase – Managerial, Technical and Consultancy’ in FTS article and there is no protocol or protocoldoes not contain Most Favored Nation clause - Norway, Italy, Japan etc.

Some DTAAs have ‘Fees for Included Services’ (FIS) article for e.g. Canada, USA, Portugal, etc. Some alsoprovide ‘make available’ concept for e.g. USA, UK, Australia, Singapore, etc.

Some of the DTAAs have article dealing with FIS (make available) and also a separate article dealing with TechnicalFees e.g. Cyprus

Some DTAAs cover FTS / FIS within the term ‘Royalties’ e.g. Australia and Brazil

* Malta was also having a make available clause which has been omitted

Some DTAAs do not have the FTS / FIS Article e.g. Mauritius, UAE, Philippines, Indonesia, Nepal, Thailand, Syria, etc.

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• Even if FTS has accrued or has arisen, but if the same is not paid, the taxability in the sourcecountry will not come into play as the treaty reads as “….arising in a contracting state andpaid to a resident of other contracting state ….” - National Organic Chemical Industries Ltd v.

DCIT (ITAT)

• FTS is taxable on payment basis and not on accrual basis - CSC Technology Singapore Pte. Ltd v.

ADIT (ITAT)

Point of Taxation under the DTAA - Accrual or payments basis

• Article 12 does not particularise the stage at which tax can be levied in India. Such income is to

be taxed in accordance with laws of India and it can be on cash basis or on accrual basis -

Flakt (India) Limited (AAR)

View 1 - Para 1 of Article 12 gets attracted only if there is actual payment of FTS

View 2 – FTS may be taxed on cash or accrual basis

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Meaning of Manager / Managerial Services

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Most of the DTAAs where ‘managerial services’ are not covered in the definition of FTS, contain the ‘make available’

provision except DTAAs like Singapore where both exist

Few Countries that do not have ‘managerial’ word

Manager

• A person who administers or supervises theaffairs of a business, office, or other organisationis a Manager.

• It refers to services rendered in performingmanagement functions

Managerial Services

• Controlling, directing or administering thebusiness.

• It signifies service for management of affairs anddirected towards the adoption and carrying outthe policies of the organisation

Australia Canada Netherlands UKSpain USA

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• Whether services generally related to human resource matters,cost control, fund management, quality and design reviews etc. areroutine managerial activities and cannot be classified as ‘technicalor consultancy service’ – Held - YES

• Whether procurement services make available any technicalknowledge of enduring benefit? Held - NO

If services are managerial services and are not in nature oftechnical services, the ‘make available’ clause will not apply andtaxable as per DTAA? – Held – YES Verizon Data Services AAR,India-US DTAA – 11 Taxmann.com 177 (AAR)

When ‘Managerial’ word is missing -Measurement Technology Ltd. – 60 Taxmann.com 1 (AAR)

FCo.

ICo.

India

UK

• Management Services provided through Director of FCo. for givinggeneral guidance to Indian affiliate through telephone, e-mails, etc

• FCo. constituted a procurement team in UK to look into globalsourcing requirements of raw materials.

Facts

Points for discussionManagement

and procurement

services

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Meaning of Consultancy Services

All kinds of advisory cannot qualify as ‘technical’ services

The expression ‘consultancy’ service involves giving of an advice or advisory services by a professional

‘Consultancy service’ may overlap the categories of ‘technical’ and ‘managerial’ services to the extent the latter typeof services are provided by a consultant

It is essential that ‘consultancy services’ should be provided by human beings

A ‘consultancy service’ can only be rendered with human interface or human intervention

Expertise in a technology is not essential while providing consultancy services. However, an element of expertise orspecial knowledge on the part of the advisor is essential

Consultation means the act of asking the advice or opinion of someone

It is necessary that a technical element is involved in an advisory

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• FCo. rendered financial advice, assessed export credit agenciesand obtained commercial bank support on competitive terms

• FCo. paid a ‘success fee’ as a % of the debt finance

• DTAA – not having “make available” clause was not invoked.

• Case analyzed under Section 9(1)(vii) of the Act

Financial Advisory Services - GVK Industries Ltd. (SC) – 54 Taxmann.com 347

FCo. - Advisor

ICo.

India

Switzerland

Facts

• The term “Consultancy” is not defined in the Act and thus the sameto be understood at common parlance.

• Whether FCo. was acting as a consultant as it had skill, acumen andknowledge in the specialized field? whether it should fall within theambit of the term consultancy services? – Held – YES

• Discussion on Doctrine of ‘Source Rule’ i.e. income of the recipientto be charged to tax in the country in which the payer is located.

Points for discussion

Providing financing advisory services

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Facts: The Co. received data processing services from a UK Co. which is engaged in the business ofcommunication management

Points for discussion:

• Whether Advisory service which merely involve discussion and advice of routine nature or exchangeof information be classified as consultancy services?

• Held - An element of expertise or special knowledge on the part of the consultant is implicit in theconsultancy services contemplated by Article 13(4)

Consultancy - Cases

Facts: The taxpayer, a US resident Co., had a branch office in India provided consultancy services and furnished geographical specific data and commercial information inputs to an Indian Co.

Points for discussion:• Payment should not only be in consideration for rendering technical or consultancy services but

services rendered should also ‘make available’ technical knowledge, skill, know-how or process for it to fall under FTS under the India-US treaty i.e. the twin test of rendering of consultancy services and making available technical knowledge to be satisfied at the same time.

• Whether Consultancy services which are not technical in nature are not covered under FIS?

Intertek Testing Services India P. Ltd

Mckinsey & Co Inc. v. ADIT

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Meaning of Technical Services

The installation and operation of sophisticated equipment for giving the access of its benefits to the customers for a fee did not amount to a provision of technical services

A technical service means a service requiring expertise in technology

The popular meaning associated with ‘technical’ is involving or concerning applied and industrial science

Technology used in providing a service would not necessarily conclude that technical services are provided

Services are of a ‘technical’ nature when special skills or knowledge related to a technical field are required forprovision of such services

Technical means involving or concerned with the mechanical arts and applied sciences

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Bharti Cellular Ltd. 175 Taxman 573 (Delhi) 193 Taxman 97 (SC)

• Payments made towards interconnect / port access charges.

• Facility of interconnect / port access was provided automatically

by machines and did not involve human intervention.

Facts

• No human intervention, can the charges paid for interconnect /

access / port charges be considered as FTS? – Held NO

• Whether the word ‘Technical’ would also be construed as

involving a human element? – Held - YES

• Whether services provided by highly sophisticated machines in

absence of human intervention would be construed as technical

services as envisaged under Section 9(1)(vii) of the Act? - NO

Points for discussion – Technical Services – Narrow View

Bharti

MTNL / BSNL

Interconnect / access / port

charges

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• Mere requirement of technical input by a person providing services does not necessarily mean that technicalknowledge is ‘made available’ . Mere Familiarity or Insights into Provision of Service not enough

• Use of a product which embodies technology cannot be considered to ‘make technology available’

• Few DTAAs have the concept of ‘make available’ in the FTS / FIS definition e.g. USA, UK, Singapore, Australia,Canada, Portugal, Netherlands etc.

Make Available

Technology will be considered ‘make available’ when person acquiring the service is enabled to apply thetechnology without aid of Service Provider – Singapore DTAA – Transmission of Technical Knowledge

• Engineering services (including the subcategories ofbioengineering and aeronautical, agricultural,ceramics, chemical, civil, electrical, mechanical,metallurgical, and industrial engineering)

• Architectural services

• Computer software development

Services that generally involve ‘development and transfer of technical plan or technical design’, or ‘maketechnology available’ include:

• Technical training

• Bio-technical Services

• Food processing

• Environmental and ecological services

‘Make available’ significantly narrows down the scope of FTS

CONCEPT -

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Whether payments related to design, development, supply of design, drawings, etc. are taxable as FIS?

• Payment made for conducting the air borne survey forproviding geophysical data neither makes available technicalknowledge nor amounts to development and transfer oftechnical plan hence cannot be treated as FTS under theNetherlands DTAA – De Beers India Minerals Pvt. Ltd ( Kar)

Cases – Make Available – Technical Services

• Technical design / blue prints ‘make available’ technicalknowledge to the taxpayer under USA DTAA - Sargent & Lundy37 Taxmann.com 134 (Mumbai ITAT)

• Providing technical drawings and reports relating toinfrastructure project qualifies as FIS under Canada DTAA - DITv. SNC Lavalin International Inc. 11 Taxmann.com 23 (Del)

Decision in favor of tax payer

Decisions in favor of Revenue

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Whether business support services make available anything to taxpayer?

• Payments for Business Support – back office financial servicesare not FTS under Netherlands DTAA - these services are notmade available as there was no involvement of the taxpayer -Shell Technology India P. Ltd. 16 Taxman.com (AAR)

Cases – Make Available – Business Support Services

• General business support services – e.g. finance, taxation,legal, media etc. involved taxpayer and made availabletechnical knowledge and hence taxable as FTS under UKDTAA - Shell India Markets Pvt. Ltd 18 Taxmann.com 46 (AAR)

• Financial, sales and risk management services and training‘made available’ technical knowledge, experience and skillsand hence taxable under US tax treaty - US TechnologyResources Pvt. Ltd. 39 Taxmann.com 23 (Cochin ITAT)

Decision in favor of tax payer

Decisions in favor of Revenue

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• Secondee remains on payroll of F.Co but works under control and direction of I.Co during secondment period

• F.Co pays salary to seconded personnel and seek reimbursement from I.Co

• Taxability issues?

Secondment

F. Co sends its employees to its local affiliate I.Co in India

• I.Co becomes employer instead of F.Co

• In secondment period, assignees do not retain theirlien on employment with F.Co

• Salaries to be determined by I.Co. F.Co merelyacts as a facilitator and has no control. I.Co toobtain Work Permit and provide housing &transportation facility

Reimbursement may not be taxable if it could be demonstrated as under

• Work performed by secondees is unconnected withactivities of F.Co

• I.Co is responsible for the act of secondees

• F.Co has no responsibility to continuation of job and toreplace vacancies

• I.Co can terminate employment if found unsuitable

• I.Co makes requisition to F.Co for secondments

CONCEPT

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Managerial Service by Secondees - Food World Supermarkets Ltd – 63 Taxmann.com 43 Managerial Service by Secondees - Food World Supermarkets Ltd – 63 Taxmann.com 43

F.Co.

Employees of F Co. seconded to India for

rendering services

Provision of highly expert

services

Hong Kong

India

I. Co.

No DTAA between HK and India

Facts

Points for discussion

• F Co. deputed its employees in India to renderhighly expert managerial services

• F Co. paid salary, deducted and paid tax u/s 192.I.Co reimbursed the salary amount to F.Co.

• I.Co submitted if payment treated as FTS, thesecondees would constitute service PE, thus onlynet expense taxable

• Services provided by Secondees in India may be termed as FTS due to following:

- Secondees rendered managerial and highly expert services

- Secondment agreement between I.Co and F.Co, Secondees not party to agreement

- No separate contract of employment between Secondees & I.Co

- Secondees are under legal obligation as well as employment of F.Co and assigned to I.Co only for short period of time

- Secondees were performing their duties for or on behalf of F.Co

• Profit element irrelevant for purpose of taxability except when NR is having fixed Place of Business in India or PE and amount is earned through PE

• HELD – Payments made to F Co. are FTS under the Act and taxable

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Centrica India Offshore (P.) Ltd 44 Taxmann.com 300 (Del HC)Centrica India Offshore (P.) Ltd 44 Taxmann.com 300 (Del HC)

F.Co.

Employees of F Co. seconded to India for

rendering services

Provision of support services

Outside India

India

I. Co.

DTAA between India – UK & Canada

Facts

Points for discussion

• F Co. deputed its employees in India to render support to I.Co on its payroll

• Secondees trained the personnel in I.Co and provided initial support

• Secondees worked under direct control of I.Co

• I.Co reimbursed salaries to F.Co

• Services provided by Secondees in India may be termed as FTS dueto following:

⎯ F.Co., through the seconded employees, provided ‘technicalservices’ to I.Co since the expression expressly includes theprovision of services of personnel

⎯ Nature of services – business support services – within the meaningof term ‘technical or consultancy’

⎯ Secondees not only provided services to I.Co but ensured that goingforward, the skill set of I.Co.’s employees is built and these servicesmay be continued without assistance – ‘make available’ conditionsatisfied as per India- Canada treaty

⎯ Seconded employees retained their entitlement to participate inoverseas entities retirement, social benefit plans and otheremoluments. No purported employment relationship between I.Co.and Secondees

• Doctrine of divergence of Income by overriding title – payment not innature of reimbursement but for services rendered

Most Favoured Nation (MFN) Clause - Concept

General meaning under International Trade:

The object of the MFN clause is two fold:

Treaty-based and not unilaterally available

Generally used in DTAAs when countries are reluctant to forgo their right to tax some elements of income

A treatment extended by a country (say A) to another Country (Say B) which is not less favorable than thetreatment extended by A to a third country (say C)

More favorable tax treatment negotiated with another country - automatically apply / re-negotiated

• To guarantee that no discriminatory treatment when compared with a third Country

• To offer a better treatment because of a favourable change in policy

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MFN in Indian DTAAs

Benefit of more favorable rate and restricted scope granted to other countries is extended to existing DTAA

Generally MFN clause is provided in the Protocol to Tax Treaties

In most Indian DTAAs - MFN clause applies automatically except Switzerland and Philippines where fresh negotiationis required

MFN clause usually applies prospectively

Indian DTAAs with MFN clause

• Lower tax rate

• Narrowing scope

Belgium, Sweden, UK, Finland, Spain, France, Hungary, Switzerland, Israel, Netherlands, Phillipines, Kazakastan, Saudi Arabia

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Benefit of MFN - Shell Global Solutions International BV (ITAT) Benefit of MFN - Shell Global Solutions International BV (ITAT)

Facts

Points for discussion

• F Co. provided services to I Co. and considered 50% ofbasic refinery service as non taxable being acommercial service

• It considered other 50% basic refinery service and alloptional services taxable as per Article 12

• F. Co. took benefit of MFN clause (India- USA) in Indo-Dutch treaty with respect to Article 12 of Treaty

Dutch

India

F Co.Basic refinery package and

certain optional services

I Co.

• Benefit extended under Indo - US treaty by virtue of MFN

clause in the Indo-Dutch Treaty, extends to it.

• Further, the benefit of the India US-MOU and Confirmation of

Understanding will apply

• To decide the scope of fees for technical services, one has to

see scope of taxability of similar payments under the Indo- US

Treaty as per which consultancy services not of a technical

nature are not to be included in FIS

• Provisions of Indo-US Treaty will apply and managerial or

consultancy services not involving transmitting of technology

are not taxable as FTS under India-Dutch Treaty

• Mere fact that commercial or managerial service are linked

with technical services does not change the character of

commercial or managerial services

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Yes

If FTS Article is missing under DTAA

Taxability when FTS article is missing in Tax Treaty

Whether Taxable under Article 7?

Taxable

When PE exists?

Whether taxable under Article 22?

Whether taxable under the Act?

Not taxable

No

Bangkok Glass Industry ( Madras HC)- (No FTS clause – No PE – Not taxable)

Whether taxable under the Act?

TVS Electronics(Chennai ITAT) - (No FTS clause – Taxabilityunder the Act) ??

Lanka Hydraulic(AAR) - (Article 22 needs to be examined)??

Not Taxable Under Article 7

No

Yes

View 1

View 2

Spice Telecom (ITAT)- (No FTS clause – Not taxable)

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FTS under E-commerce scenario

Sr. No. E-Commerce Transaction OECD E-Commerce Report HPC view

1 Application Hosting – separate license

Business Profits Royalty / FTS

2 Data warehousing Business Profits / FTS Royalty

3 Customer support over computer network

Business Profits FTS

4 Application Hosting – Bundled contract

Business Profits / FTS Royalty / FTS

5 Software Maintenance Business Profits / FTS Business Profits / FTS

6 Electronic access to professional advice (e.g. Consultancy)

FTS FTS

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Thank You

Hitesh D. Gajaria

Email: hgajaria@bsraffiliates.com