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CaseK.2012/328,22March2012–BursaTaxCourt- Turkey

A

B

FRA

TUR

• AisresidentinFrancewithnoPEinTurkey• Aisanautomobilemanufacturer• BisaresidentinTurkey• AandBsignedan“AgreementontheProvision

ofCentralizedInformationSystemServices”• Theservicesconsistedof:

• theuseofsoftwareprogram• technicalandadvisoryservices

• Thesoftwareprogramwas(likely)anindustryspecific,tailor-madesoftwareprogram

• Thetaxadministrationqualifiedtheremunerationfortheuseofthesoftwareprogramasaroyalty

Legalbackground• 10%residualwithholdingtaxaccordingtoarticle12(2)oftheDTCFRA-TUR

• Article12(3):“Theterm“royalties”asusedinthisarticlemeanspaymentsofanykindreceivedasaconsiderationfortheuseof,therighttouseorthetradingofanycopyrightofliterary,artisticorscientificworkincludingcinematographfilmsandcinematographfilmandrecordingsforradioandtelevision,anypatent,trademark,designormodel,plan,secretformulaorprocessorforinformationconcerningindustrial,commercialorscientificexperience,orfortheuseof,ortherighttouse,industrial,commercial,orscientificequipment.”

• Article4oftheProtocol:“Withrespecttoparagraph3ofArticle12,remunerationfortechnicalservices,includinganalysesorstudiesofascientific,geological,ortechnicalnature,orforengineeringworksincludingplanspertainingthereto,orforconsultationorsupervisoryservicesshallnotbeconsideredasremunerationpaidforinformationreferringtoexperienceacquiredintheindustrial,commercialorscientificfield.”

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Findingsofthecourt• Thecourt ruled infavour ofthetax authorities• According to thecourt theterm «royalty»includes thepayments for the

use ofthesoftware program by theTurkish company• Suchincomequalifiesaccording tothecourtasagainreceived“for

information concerning, industrial, commercial orscientific experience”– i.e.know-how.

• But:thepayments for thetechnical services did not fallunder article 12onthebasis ofarticle 4oftheProtocol

• Thedecision contains very limitedreasoning

CaseITANo.3399/Ahd/2010, 19August2011–IncomeTaxAppellateTribunalAhmedabad

A

B

RUS

IND

• AisresidentinRussia• Itisspecializedininstallation ofgasund

liquid pipelines• Joint venturewith anIndiancompany(B)

fortheexecution ofaturnkeyproject• Taxpayerwasresponsible forproviding

technical guidanceandconsultancyinrespectofproject management

• 3%ofthegrossproject consideration asremuneration forA;97%forB

• Taxrateifarticle7(businessprofits) wouldbeapplicable– 40%

• Taxrateifarticle12(royalties)wouldbeapplicable – 10%

Jointventure

C

3%

97%

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Findingsofthecourt

• Thecourt held that theresponsibilities were clearly segregated betweenthejoint venture partners

• Thedecision contains arather detailed analysis ofthe(contractual)activities ofA

• Thetaxpayer (A)did according to thecourt notrender construction work inIndia – only technical services

• Therefore, the taxpayer only received aremuneration for technical services• Theincome is,therefore, taxable atarateof10%and notarateof40%-

calculation oftheincome?

CaseABLLCandBDHoldingsLLCvCommissioner ofSouthAfricanRevenueService, TaxCourt13276

ABLLC

X

US

SA

BDHoldingsLLC

• ABLLCand BDHoldingLLCrenderedconsultancy services inSAto anairline

• Thetwo LLCswere treated as asingleappellant

• 17employees were made available• Three core employees spent more than

183days inSA• Employees were present from Feb

2007until May2008• Employees were granted exclusive use

ofX’s boardroom• SARStaxed fees paid in2007and 2008;

and thesuccess fee paid in2009wasalsotaxed

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Legalbackground• Article 5DTCUS-SA

• “(1)ForthepurposesofthisConvention, theterm‘permanentestablishment’ meansafixedplaceofbusinessthrough whichthebusinessofanenterpriseiswholly orpartly carried on.

• (2)Theterm‘permanentestablishment” includesespecially –• [a- j]

• (k)thefurnishing ofservices,including consultancy services, withinaContracting Statebyanenterprisethrough employeesorotherpersonnelengagedbytheenterpriseforsuchpurposes,butonlyifactivities ofthatnaturecontinue(forthesameoraconnectedproject) withinthat Stateforaperiodorperiodsaggregating morethan183daysinanytwelve-monthperiod commencingorendinginthetaxableyearconcerned.”

Findingsofthecourt• Thequestionwaswhether theapplication ofarticle 5(2)(k)DTCUS-SA

requires that theconditions ofarticle 5(1)DTCUS-SAare met• According to thecourt theOECDCommentary could provide no assistancein

this respect because theOECDMCdoesnotcontain anarticle similiar to article5(2)(k)DTCUS-SA.

• Instead,Vally Jplaced reliance ontheUSTechnicalExplanations,i.e.theapplication ofarticle 5(2)(k)DTCUS-SAdoesnotrequire that theconditionsofarticle 5(1)DTCUS-SAare met.

• 183day threshold wasmet• Thecourt ruled that thetwo LLCshave aPEinSouthAfrica (solely)based on

article 5(2)(k)DTCUS-SA• But:the court even concluded that therequirements ofarticle 5(1)DTCUS-SA

were met• Taxes due+penalty of100%+interest;decision is final(no appeal)

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3– QuarkSystemsPvTLtdv.ITO• QSS:developmentofspecializedsoftwarefor

mediacompanies(layoutfornewspaperandperiodicals)

• QSPvT:localsubsidiary• ContractbetweenQSSandQSPvT:QS

providesservicestocustomersofQSSfacingtechnicalissuesregardingthesoftware

• RemunerationofQSPvT:cost-pluswithamark-upof13,5%(TransactionNetMarginMethod)

• Courtcase– LitigationoccursinIndia– TaxpayerisQSPvT– Yearofassessment:2003/04– Issue:determinationofthefeefortaxpurposes

QSSARL

QSPvT Ltd

100%shareholding

CH

IndiaTechnicalservices

Fee

3– QuarkSystemsPvTLtdv.ITOProcedure• Taxpayer

– selectedascomparablesthecompanies operatingintheIT/ITenabledservices

• Taxauthorities (audit):– Excluded oneof thecompaniessinceitwasarecentoneandlossmaking– Excluded the+/- 5%asprovidedbydomesticlaw

• Appeal(Commissioner ofIncomeTax):– TAarerightintheexclusionofthelossmakingcompanyascomparable– TAarewrongintheexclusionofthe5%marginasprovidedbydomesticlaw

• AppealtotheIncomeTaxAppelateTribunal– Aloss-makingcompanycanbeincluded ascomparable(noissues)– Nonetheless,incasu,therewasnoproperanalysisandastart-upwithlossescouldnotbe

considered ascomparable– Thetransactionsinquestionwerealsonotcomparabletotheactivitiesofthetaxpayer’s.

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3– QuarkSystemsPvTLtdv.ITOIssuesforfurther discussion regardingremuneration oftechnicalservices• Howshouldtheremuneration fortheseservicesbeset?• Incaseofassociatedenterprises, whatisarm’s length remuneration?

– Whichmethodscould beapplicable?– Ifcomparables required,whataretherightcomparators?Whatconditionsinwhat

concerns theentity?Whatconditionsinwhatconcernsthetransactions?

• Specificissuesfordevelopingcountries– HaveTaxAuthoritiesthecapacityofapplyingOECDguidelines?– Whatdocuments shouldberequired?

QuarkSystemsPvt. Ltd.

QSSA• Developerofspecialisedsoftware

formediacompanies• Softwareusedforpagelayoutof

newspapers

QuarkSystemSARL(Switzerland)(“QSSA”)

QuarkSystemsPvt. Ltd.(India)(“QSPL”)

100%

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QuarkSystemsPvt. Ltd.

Serviceagreement• QSPLwasacaptiveunitandworked

exclusivelytoQSSA• ProvidedservicesexclusivelytoQSSA• Typesofservices:

– TechnicalservicestoQSSAandcustomers

– Advisoryservicestocustomers• Fees =costsplus10%initially(4

months)butchangedtocostsplus13.5%

QuarkSystemSARL(Switzerland)(“QSSA”)

QuarkSystemsPvt. Ltd.(India)(“QSPL”)

100%

QuarkSystemsPvt. Ltd.

• Determinationofprice:– UsedtheTransactionalNetMarginMethod(“TNMM”)– IdentifiedcompaniesoperatinginInformationTechnology/InformationTechnologyEnabledServicessector

– IncludedImercius TechnologiesIndiaPvt. Ltd.(tele-marketer)whichwasacompanyshowinganet lossandwasinstart-upphaseofbusinessoperations

– IncludedDataMatrixTechnologiesLid.whichmadesalesof31.27%toassociated concerns

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QuarkSystemsPvt. Ltd.• RequirementsofTNMM:– comparesthenetprofitmarginofataxpayerarisingfromanon-arm’slengthtransactionwithnetprofitmarginsrealizedbyarm'slengthpartiesfromsimilartransactions

– examinesthenetprofitmarginrelativetoanappropriatebasesuchascosts,salesorassets

– usuallyappliedtotheleastcomplexpartythatdoesnotcontributetovaluableoruniqueintangibleassets

– importanttochoosetheappropriatebasetakingintoaccountthenatureofthebusinessactivity

QuarkSystemsPvt. Ltd.

• AdjustmentmadebyTransferPricingOfficer(“TPO”):– ExcludedImercius Technologies IndiaPvt. Ltd.ongroundsthat• itisacontinuous loss-makingcompany• notfunctionallycomparablewiththetestedparty

– Excludedmark-up (Indiaallowed5%mark-up atthetime)

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QuarkSystemsPvt. Ltd.

• TaxpayerraisedadditionalargumentforexclusionofDataMatrixTechnologiesLid.fromcomparablestatingthat itmadeamistakewhenitwasincluded

QuarkSystemsPvt. Ltd.• Ruling:– Basicrequirementsoffunction,assetsandrisksanalysiswerenotmetbytaxpayertojustifyinclusionofImercius TechnologiesIndiaPvt. Ltd.

– Salessupportandtechnicalservicesinherentlydifferentincharacterandscopefromtele-marketingservices

– Riskanalysisshowedthatthetwoentitieswerenotonevenground

– However,acompanycannotbeexcludedfromlistofcomparables merelybecauseitissufferinglosses

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QuarkSystemsPvt. Ltd.

• Rationaleforruling– Decisionunderscores importanceofsearchstrategyandfunctional analysisofbothtestedandcomparablecompanies

– Acceptanceofloss-making companyafterdetailedanalysis ongrounds thatitispartandparcelofeconomicactivityisnoteworthy

Technicalfeesandtransferpricing

• Casehighlightssomeofthechallengesfacingmulti-nationalenterprises(“MNEs”)toobtainsuitablecomparables

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Technicalfeesandtransferpricing

• OtherchallengesfacingMNEs:– Determinationofcoststoprovideservices– Identificationofcomparableenterprises– Determinationofappropriatemark-up forspecialised services

– Iswithholding taxonservices acost?

4– CopesulvsFederalUnion• Copesul:Brazilian resident withmachinesand

other equipments• SEP:SurfaceEngineering product (Canada)• Siem:SiemensPowerGeneration (Germany)• Transactions:

– Copesulaskedfortechnicalservice from these twocompanies

• Normativebackground(7ºor12º...ornoneofthem?)– Art.7ºcanNOTbeapplicablesinceunderdomesticlaw

considersthesepaymentsas“revenue”butnotas“profits”.

– Art.12isnotapplicablesinceacircularorder(COSIT1/200)establishesthattechnicalservicesthat donotincorporateatransferoftechnology,arenotroyalties(Art.12)butshouldbeframedunderArt.21.

– Brazil’streatiesnormallyallowforsourcetaxationofotherincome

SEP

Copesul

Canada

Brasil

Technicalservices

Fee

Germany

Siem

Fee

Technicalservices

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4– CopesulvsFederalUnionDecisionofthecourts:• Taxpayer(Copesul)

– Ruling1/2000isnotapplicablesincethesepaymentsfallwithinArt.7oftheapplicabletreaties

• LowerFederalCourt– Rejectedtheappeal

• FederalRegionalCourt(4thregion)– Thisshouldbeframedunderart.7– TheTAanddomesticlawdistinctionbetween“revenues”and“profits”is

irrelevant:i)revenuesarecomponentsofprofits;ii)toacceptthisdistinctionwouldbeequivalenttorenderArt.7inapplicable

• FederalRegionalCourt(4thregion):again!– AppealfromtheBrazilianTaxAuthoritiestothesamecourt– Samedecision(andargumentation)asinthefirstdecision

4– CopesulvsFederalUnion• SuperiorCourtofJustice

– Feesshouldbeframedunder art.7– The treaty term “businessprofits” is not limited tothe domestic

definition of “realprofit” (difference between grossreceipts anddeductible expenses,plus adjustments).It should be understood as“operational profit” (that includes the income at stake)