taxation of royalty and fts
DESCRIPTION
Presentation on taxation of Royalty and Fess for Technical Services made before WIRC on 19 November 2011TRANSCRIPT
Royalty and Fees for Technical ServicesSurprises continued ..
Romesh S A Sankhe
WIRC, Thane19 November 2011
© 2011 Deloitte Haskins & Sells
Contents
• Taxation of 'Royalty‘ and ‘Fees for Technical services’
• Indian Income Tax Act
• DTAA
• Specific Issues
• Planning Avenues
• Direct Taxes Code
2
Deloitte Haskins & Sells
Taxation of ‘Royalty’ and ‘Fees for Technical Services’
© 2011 Deloitte Haskins & Sells4
Income Tax Act and DTAA | Section 90(2)
Whether taxable under the Income
Tax Act?
Analyse articles of DTAA, if any
DTAA need not to be applied
Taxable as per Articles of DTAA
Not taxable as per Articles of DTAA
Opt for DTAA , if beneficial than Act
Opt for Act, if beneficial than
DTAA
No
Yes
© 2011 Deloitte Haskins & Sells5
Income Tax Act | Scope of income (1)
Section 5(2)Income of a non-resident is liable to tax in India which is:• received or is deemed to be received in India; or• accruing or arising, or is deemed to accrue or arise in India
Section 9(1)(vi)/(vii)Income by way of royalties and fees for technical services (FTS) may deemed to accrue or arise in India which is:• payable by a resident/non-resident of India in respect of rights/services
utilised‒ for the purpose of a business or profession carried on by such person in
India or‒ earning any income from any source in India
© 2011 Deloitte Haskins & Sells6
Income Tax Act | Scope of income (2)
Situation IRoyalty/FTS received by foreign resident from Indian resident in India attributable to Indian resident’s business carried on in India - Taxable
Situation IIRoyalty/FTS received by foreign resident from Indian resident outside India attributable to Indian resident’s business carried on in India - Taxable
Situation IIIRoyalty/FTS received by foreign resident from Indian resident in India attributable to Indian resident’s business carried on outside India - Taxable
Situation IVRoyalty/FTS received by foreign resident from Indian resident outside India attributable to Indian resident’s business carried on outside India - Not taxable
© 2011 Deloitte Haskins & Sells7
Income Tax Act vs DTAA | Royalty
Royalty definition - Income Tax Act, 1961• Consideration for (includes lump sum consideration but excludes “Capital gains”) —
– transfer of all or any rights (including the granting of a license)
• patent, invention, model, design, secret formula or process or trade mark or similar property
• any copyright, literary, artistic or scientific work
• including films or video tapes for use in connection with television or tapes for use in connection with radio broadcasting, but not including consideration for the sale, distribution or exhibition of cinematographic films
– for use of or for imparting of any information concerning the working/use of
• patent, invention, model, design, secret formula or process or trade mark or similar property
– the imparting of any information concerning technical, industrial, commercial or scientificknowledge, experience or skill
– use or right to use any industrial, commercial or scientific equipment but not including the amounts referred to in section 44BB
– the rendering of any services in connection with the activities referred above
• Explanation to section 9(1)(vi) of Income Tax Act
Words in green present only in
the Act
© 2011 Deloitte Haskins & Sells8
Income Tax Act vs DTAA | FTS
FTS definition – Income Tax Act, 1961• Consideration (including any lump sum consideration) for the rendering of
‒ any managerial, technical or consultancy services
‒ including the provision of services of technical or other personnel
‒ but does not include consideration for
• any construction, assembly, mining or like project undertaken by the recipient
• consideration which would be income of the recipient chargeable under the head “Salaries”
Words in green present only in
the Act
© 2011 Deloitte Haskins & Sells
Income Tax Act vs DTAA | Arbitrage opportunities
Taxpayer may opt for DTAA, if it’s beneficial than Act
Tax rates under the DTAA may be lesser than the tax rates under the Income Tax Act
Tax rate arbitrage
Definition under the DTAA may be narrower than the definition under Income Tax Act
Definition arbitrage
9
© 2011 Deloitte Haskins & Sells10
Rate arbitrage | Royalty and FTS
Income Tax Act DTAAIncome Tax Act DTAAIncome Tax Act DTAA
40% ** on net basis (if PE exists) 40% ** on net basis (if PE exists)
10% ** on gross basis (if PE does not exist)
0 / 10% / 15% (if PE does not exist)
From 1 April 2010, in case of recipient not having Permanent Account Number (PAN), withholding tax rate of 20% will apply
** Tax rates should be increased by applicable surcharge and education cess
The above tax rates are applicable to a corporate entity
© 2011 Deloitte Haskins & Sells11
Definition arbitrage | Royalty
Income Tax Act DTAAIncome Tax Act DTAAIncome Tax Act DTAA
Transfer of all rights Only “use of or right to use” is covered
Patent, invention, model, design, secret formula or process or trade mark or
similar property
Copyright and copyrighted material
“or similar property” is not used
Only copyright is covered
© 2011 Deloitte Haskins & Sells12
Definition arbitrage | FTS
Income Tax Act DTAAIncome Tax Act DTAAIncome Tax Act DTAA
Absence of “Make available” clause Presence of “Make available” clause in some tax treaty
Make available clause
Some DTAA prescribes that payments for the rendering of any technical or consultancy services will deemed to be covered under FTS article if services:• Make available technical knowledge, experience, skill know-how, or
processes or • consist of the development and transfer of a technical plan or technical
design.
© 2011 Deloitte Haskins & Sells13
Make available | FTS
Memorandum of Understanding (MOU) to India-United S tates of America (USA) tax treaty• Technology will be considered as “made available” when the person acquiring
the services is enabled to apply that technology• The fact that the provision of service may require technical input does not per
se mean that technical knowledge, skills, etc. are made available to the persons purchasing the services
• The use of the product which embodies technology shall not per se to be considered to make the technology available
• MOU also provides some illustrative examples of services intended to be covered within the definition of included services and those to be excluded
This MOU represent the views expressed by the Government of India, hence to the extent the provisions of other tax treaties are pari mateira with India-USA Tax Treaty, this explanation could be used incase of the other treaties as well• Raymond v. DCIT 80 TTJ 120 (Mum) / Sun Microsystems India Pvt. Ltd v ITO, Bengaluru
(2009-TIOL-627-ITAT-Bang) [India/UK]• DCIT v. BCG 94 ITD 31 (Mum) / McKinsey & Co. v. ADIT 99 ITD 549 (Mum) / BPCL v. Jt
DIT 111 TTJ 375 (Mum) [India/Singapore]• ITO v. De Beers India Minerals Private Limited (ITA 3400, 3401 & 3402/Blr/04)
(Bengaluru) [India/Netherlands]
Deloitte Haskins & Sells
Specific Issues
© 2011 Deloitte Haskins & Sells
Treaty Applicability (1)
Scenario 1
Mauritius
Royalty payments
USA is beneficial owner of royalty
India
USA
• India-Mauritius DTAA will apply
• Withholding on royalty payments in India @ 15% as per India-Mauritius DTAA
• Beneficial to use Income Tax Act due to rate arbitrage (unless definition arbitrage results in to exemption)
India Mauritius Tax Treaty does not contain beneficial owner concept in Article 12
15
© 2011 Deloitte Haskins & Sells
Treaty Applicability (2)
Scenario 2
Mauritius Branch
Royalty payments
USA is beneficial owner of royalty
India
USA
• India-USA DTAA will apply
Branch of USA Co will be considered as a resident of USA (not Mauritius)
16
© 2011 Deloitte Haskins & Sells
Treaty Applicability (3)
Scenario 3
Singapore
Royalty payments
USA is beneficial owner of royalty
India
USA
• India-Singapore DTAA will apply, however withholding on royalty payments in India will not be at the concessional rate provided for in India Singapore DTAA
• Rates under Income Tax Act will apply (unless definition arbitrage is in favor)
India Singapore Tax Treaty contains beneficial owner concept in Article 12
17
© 2011 Deloitte Haskins & Sells
Treaty Applicability (4) | Beneficial owner
• “Beneficial ownership” terms is generally used only in article 10(dividend), 11(interest) and 12(royalty/FTS) of the DTAA
• It is an anti-abuse provision, to prevent treating shopping• The “beneficial owner” must be interpreted with reference to
treaty law, and not domestic law• If the recipient is a beneficial owner of royalties, the tax in
source country is lower• If there is a conduit or a nominee between beneficial owner and
payer, the concessional rate will not be available• When is a intermediate company a conduit company?
• When it does not have a right to decide on how to use the income;and
• When it cannot decide whether to directly use the income or makeit available to third parties[Klaus Vogel commentary / Some foreign judicial precedents]
18
© 2011 Deloitte Haskins & Sells
Copyright vs Copyrighted article
Purchase ofArtist’s copyright in
a song
Purchase ofAuthor’s copyright
in a story
Purchase ofAudio CD
Purchase ofNovel
Payments can be royalty
Payments cannot be royalty
19
© 2011 Deloitte Haskins & Sells20
Software payments (1)
• Treaty does not define ‘copyright’ hence reference has to be made to the domestic law
• Section 2(ffc) and Section 14 of Indian Copyright Act, 1957 defines copyright as vesting the following rights:• to reproduce the work in any material form, including storing of it in any
medium by electronic means; • to issue copies of the work to the public, not being copies already in
circulation; • to perform the work in public, or communicate it to the public; • to make any translation of the work; • to make any adaptation of the work; • to sell or give on commercial rental or offer for sale or for commercial
rental any copy of the computer programme;
• If the owner of copyright is providing all or any of the above rights to the user, then the payments may deem to be royalty both under the Act as well as treaty
© 2011 Deloitte Haskins & Sells21
Software payments (2)
• In some DTAAs India has specifically agreed that the term royalty includes consideration paid for ‘use of computer software’ such as DTAAs with Malaysia, Morroco, Namibia, Russia, Trinadad & Tobago, Turkministan, Kazakstan, Kyrgyz Republic
• Article 12 of India-Malaysia tax treaty states as under:“3. The term “royalties” as used in this Article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of a literary, artistic or scientific work including cinematograph films or recordings on any means of reproduction for use in connection with television or radio broadcasting, any patent, trade mark, design or model, plan, know-how, computer software program, secret formula or process, or any industrial, commercial or scientific equipment or for information concerning industrial, commercial or scientific experience”
© 2011 Deloitte Haskins & Sells22
Business / Credit Information Report
• What is Business Information Report or Credit Information Report?• The information to be supplied vide these reports is in the nature of
providing factual information about an entity/individual such as location, existence, operation, financial condition, pending litigation, etc.
• This may be provided along with the ratings• These reports are standard for all the buyers and not customized as per
consumer needs• Seller retains the copyright in the BIR sold
• The sale of BIR are akin to sale of copyrighted article such as books and it may not tantamount to imparting of any commercial knowledge or experience as well as any right in respect of a patent, invention, etc., hence may not deem to be royalty or FTS
• Reliance may be placed on• M/s Dun & Bradstreet Information Services India Pvt. Ltd. v. ADIT [2010-TII-59-ITAT-
MUM-INTL]• Dun and Bradstreet Espana S.A., In re [2005] 272 ITR 99 (Authority for Advance
Ruling (AAR))• Dun and Bradstreet Limited (AAR No. 656 of 2005 dated 27 October 2005)• Dun and Bradstreet Europe Limited (AAR No. 657 of 2005 dated 27 October 2005)
© 2011 Deloitte Haskins & Sells23
Facilities through automated process
• “Automated process” is the service/facility provided through machineries and no human intervention is required such as:• Vending machines• Digital transmission of data, etc.
• The Supreme Court (SC) in Bharti Cellular Ltd decision, 44 DTR 190, has held that the requirement for human intervention is necessary in order for services to be considered as FTS under the provisions of the Act, it has observed that:• The meaning of the term “technical” as used in section 9 is not defined in
the Act and since the same has been used in the company of two other words namely “managerial” and “consultancy”, the word “technical” will draw its meaning from the meaning of the words “managerial” and “consultancy”
• From an analysis of the meaning of the words managerial and consultancy, it is clear that both these services are provided by humans. Accordingly, the expression “technical service” would also require the presence of a human element in the course of providing services
© 2011 Deloitte Haskins & Sells24
Access to e-portals
• The data on the e-portal is accessed in the following manner:• The customers of the data reports are granted access rights in the server
through login username and password• Through this access rights, customers places request of reports of the
desired persons or entities• On the receipt of the request, server generates the reports and provide it
to customers• Based on the login reports generated by servers, service providers
invoices the customers as per the mutually agreed terms
• The transfer of data may not deemed to be copyright or service, however the use of server may deem to be ‘use of equipment’ and hence covered under ‘royalty’ if:• The server is actively controlled by the users and server owners does not
have any control over the specific use of the server made by its customer
• Following decision may be useful:• Held to be use of equipment - Cargo Community Network Pte. Ltd, 289
ITR 355 (AAR) / New Skies Satellites satellite, 85 ITD 478 (Delhi ITAT (SB)• Held otherwise - Kotak Mahindra Primus Ltd. v. DDIT, 11 SOT 578 (Mumbai
ITAT) / Vodafone Essar Limited, 2010-TIOL-789-ITAT-MUM
© 2011 Deloitte Haskins & Sells25
E-Commerce transactions
• In the era of increasing e-commerce the way the transactions are executed have been rapidly redefined and hence a physical possession of the service provider is no longer necessary or required, in such case the understanding of the facts assumes great importance to determine its tax implications
Reference material for taxation of e-commerce trans actions
• Report on “tax treaty characterization issues arising from E-commerce” issued by Technical Advisory Group (TAG) of Organization for Economic Cooperation and Development (OECD) dated 1 February 2001, analyzing 28 categories of transactions
• High Powered Committee on ‘Electronic Commerce and Taxation’ constituted by Central Board of Direct Taxes (CBDT) of February 2001, commenting on 28 categories of transactions analyzed in TAG report
Deloitte Haskins & Sells
Planning Avenues
© 2011 Deloitte Haskins & Sells
Need for cross-border tax planning
• The cross-border transactions of Indian companies are increasing, some key reasons for such growth are as under;• These transactions facilitates the exchange of best ideas, talent and
intellectual property across the globe,• These results into saving of cost and human time of Indian companies which
they would have spent on Research & development activities,• Foreign association and techniques gives edge in market as it improves
creditability & productivity of the products and services,
• However, these are subject to certain direct tax issues as well, such as;• These transactions are generally subject to withholding tax which is on the
gross amount paid to nonresidents, normally 10% in India• Most of the times, the withholding tax in India exceeds the tax liability of
nonresident in its host state which leads to unutilized foreign tax credit,• Therefore, nonresidents usually enters into gross-up contracts in India
As gross-up contracts results into increase in the project cost of Indian company, it makes these transaction unfeasible and hence it is vital to
explore the tax optimizing avenues in cross border transactions
27
© 2011 Deloitte Haskins & Sells
Offshore supply of drawing, design
• The offshore supply of drawing, design etc may be taxed @10.51% on gross amount as ‘Royalty’ income, under the Act
• However, payment towards ‘outright purchase of designs and drawings’ may be outside the ambit of royalty/FTS subject to fulfillment of following conditions;
• Transfer of property in the designs and drawings to the buyer,• No rights in the designs and drawings retained by the seller,• ‘Ownership’ rights with the buyer to sell or transfer the property as he/she likes,• Price determined upfront and not subject to escalations,• Any deficiencies in the property have to be completed or corrected by the seller,• Payment to be made irrespective of the use of the property,• Payment not for ‘use of’ designs and drawings,• Payment not for ‘services’
Issue is fact sensitive !!
28
© 2011 Deloitte Haskins & Sells
Services
• Services may be taxed @10.51% on gross amount as ‘Fees for technical services’ income under the Act
• However, under certain DTAAs of India, services which does not make available any technical knowledge excluded from purview of FTS, such as Australia, Belgium, Canada, Cyprus, Finland, France, Hungary, Israel, Kazakhstan, Malta, Netherland, Portuguese, Singapore, Spain, Sweden, United Kingdom, USA• In certain countries ‘Service PE’ exposure has to be mitigated, such as Australia,
Canada, Singapore, United Kingdom, USA
• Further, following DTAAs does not have FTS and service PE clause such as Bangladesh, Greece, Libyan Arab Jamahiriya, Mauritius, Philippines, and United Arab Republic
Services procured above countries may not be liable to withholding tax in the absence of non-resident’s fixed base PE in Indi a
29
© 2011 Deloitte Haskins & Sells
Lease of equipment
• After the amendment in finance Act 2002, “Royalty” under the Act includes payment for use of right to use of any industrial, commercial or scientific equipment's and hence taxed @10.51% on gross income under the Act in the absence of PE
• Most of India’s DTAAs on the line of the domestic law, includes payment for equipment in the definition of royalty except Belgium, France, Greece, Israel, Kazakhstan, Netherlands, Spain, Sweden
Equipment's leased from tax resident of the above c ountries will not be liable to withholding tax in the absence of non-res ident’s PE in India
30
Deloitte Haskins & Sells
Direct Taxes Code
© 2011 Deloitte Haskins & Sells
Royalty and FTS | Amendments
32
Tax provisions Income tax Act DTC
Use or right to use oftransmission by satellite,cable, optic fiber or similartechnology
Not taxable in certaincases, based on thejudicial precedents
Included in ‘royalty’
Sale, distribution orexhibition of cinematographicfilms
Exemption under‘royalty’
Included in ‘royalty’
Withholding tax on royaltyand fees for technicalservices
10.51% 20%
Permanent Establishment Includes fixed place ofbusiness through whichthe business is carriedon
Includes building site,construction site,furnishing of services,substantial equipment inIndia, etc
© 2011 Deloitte Haskins & Sells
Royalty and FTS | Implications
• Increase in withholding tax rate from 10.51% to 20% for royal ty and feesfor technical services - The payments to non-residents may liable to higherwithholding tax in following situations:
• India has over 75 tax treaties, out of which 25 plus treaties provide for withholdingtax rate of 15% to 20% like Australia, Brazil, Canada, Cyprus, Denmark, Finland,Greece, Indonesia, Korea, Mauritius, Poland, United Kingdom, USA, etc., where thetax rate to increase from current level of 10.51%
• Also resident of non tax treaty country such as Hong Kong, British Virgin Island, etc.to liable for higher withholding tax rate of 20%
• Permanent establishment - No threshold limit has been specified forconstruction site, building site, services rendered etc. hence such activitieswithin India may lead to constitution of PE
• Treaty protection may be availed in above situation, however residents of non taxtreaty country may expose to higher taxation
33
Gross-up contracts with non-residents will have be analysed carefully, as the same may increase the cost of cross-border t ransactions
© 2011 Deloitte Haskins & Sells34
Royalty : Demystified
Open house
34
© 2011 Deloitte Haskins & Sells
If wish to know further, please write @[email protected]
or
please call @ 022 6619 8839 (D)9892 89 25 04 (M)
35
© 2011 Deloitte Haskins & Sells
The views expressed in this presentation are solely that of the speaker and do not constitute any kind of professional advice.These views or opinion expressed in this presentation should not be applied or used without a prior professional advice, as thereview of the facts and prevailing judicial position is of utmost importance in the analysis of tax implications.