Royalties & fee for
technical services
Companies paying in Millions to
acquire Intangibles
• WNS acquiring Marketics for $65 million.
• Facebook acquiring Friendfeed for $50 million
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Companies paying in BILLIONs to
acquire Intangibles
• Vodafone acquiring Hutch for $19.3 billion.
• Google Inc. acquiring Youtube Inc. for $1.65 billion.
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Royalties/ FTS - INTRODUCTION
• The present era is one in which Capital is devoted by
less of Tangible assets like money and raw materials
& more of IPRs (Intellectual Property Rights).
• Royalties & FTS (Fee for Technical Services) arise
from commercialization of IPRs.
• Royalty is the sum payable for the right to use
someone else’s property for the purpose of gain.
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Royalties/ FTS - introduction
• Essential precondition for determining royalty is that
Non-Resident owner of such IPR should have
retained the property in them while allowing the right
to use such IPR.
– CIT Vs Day Ashmore India Ltd
• Primary obligation of paying the tax on Royalties & FTS is
not on Non-resident, but on the person making such payment
to him.
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Definition of Royalty u/s.
9(1) (vi) of the Act
Use of IPRs
Imparting
information on
Technical/ Industrial/
Commercial/
Scientific knowledge,
experience or skill
Imparting of
information on
working of IPRs
Transfer of rights in
respect of IPRs
Royalty
Use of Industrial/
Commercial/
Scientific Equipment
except equipments
mentioned in 44BB
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Definition of Royalty under
OECD model of Dta
Cinematographic films
Literary, artist or
scientific work
Royalty
is consideration for use
or right to use
Industrial,
commercial or
scientific equipment
or for information
concerning industrial,
commercial or
scientific experience
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Domestic law taxation of
Royalties
• Country R normally taxes worldwide income including
royalties derived by its residents.
• Country S normally tax royalties derived by non
resident of Country S.
• Typically, country S impose a FINAL non resident
withholding tax on gross amount of royalty income
derived from the user of the intangible property in
country S by the non resident provider of that right.
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PRESUMPTIVE TAXATION
Royalties & FTS
IT Act
DTA
No PE
No PE
10%
PE
PE
40%
R/FTS/IPS
As per
u/s
Fin Act, I Sch
115A (1) (BB)
Concessional
Part II
On Gross
rate
Entry No. 2 (b) (ix)
On Gross
Receipts
On Net receipts
Receipts
after expenses
BP
BP/FTS/
R/IPS
40%
No Tax
As per
Fin Act, I Sch
Part II
Entry No. 2 (b) (ix)
On Net receipts
after expenses
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Case study
• Albert Inc is a company resident in country X. Albert Inc leases an
aeroplane from Airbus, which is a corporation resident in country Y.
Albert Inc, pays Airbus a lease payment of USD 200,000. Under its
domestic law, country X levies 20% withholding tax on the lease
payment made by Albert Inc. The DTA between country X and country
Y exists which contains “Royalties clause” and allows the contracting
states to levy a withholding tax on royalties paid by residents of their
states of 10% of the gross amount of the royalty.
How much tax is to be withheld by Albert Inc?
• Take the same facts as in question above, but now assume that the
DTA between country X and country Y contains no definition of
“royalties”.
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Royalties/ FTS - How dept &
assessee look at it
Classify
income as
Tax Authorities
Tax @
Royalties/ FTS
Classify
income as
Assessees
Fixed Tax
Tax @
Business Income
Low Rate/ Nil rate Tax
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Accrual of tax on Royalties/
FTS
Reddy
(Resident)
Contract
with
Davis(US)
Import of
Drawings of
a Plant
Payment is
made
TDS
(TDS is applicable)
Iyer
(Resident)
Sets up Hotel in
London
FTS for services
for setting up
Hotel in London
No TDS
(No Payment is made in India, source of Income outside India – TDS not applicable)
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Accrual of tax on Royalties/
FTS
• Accrual of Tax on Royalties/ FTS
• India follows receipt basis in respect of international
taxation. i.e, liability is imposed even where income does not
accrue or arise within its Indian Borders
Services
rendered in India
Nexus Theory
Services are
utilized in India
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Accrual of tax on Royalties/
FTS
• This receipt basis of Taxation is subject to criticism.
Supreme Court in Ishikawajima-Harima Heavy Industries
had reversed the proposition. Nexus theory was upheld.
• This judgment is sought to be nullified by amending Section
9 of the Act.
• Expl is inserted stating that where income is deemed to
accrue or arise in India u/s. 9(1)(v),(vi) and (vii), such
income shall be included in Total Income of Non-resident
whether or not Non-resident has a place of business or
Business Connection in India.
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Royalties/ FTS - Composite
agreements
Distinctive test
Royalty/ FTS
TDS Applicable.
Reimbursements
TDS Applicable?
Composite
Agreements
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Royalties/ FTS - Composite
agreements
Does the contract
stand if contract
were to be split
Yes
No
No TDS on
Reimbursement
portion
TDS to be made
on Gross Amount
Sultan Bros
Sedeo Forex Intl
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Royalties/ FTS - Composite
agreements
Sodeo forex Intl
Is the TDS on Gross sum or net
profit comprised in Gross Sum?
ACC Cement Co.
Apply to Assessing Officer for
determination of embedded income
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Royalties - challenges
Use of Trade Mark of reputed
Car Manufacturer
Payment from
Indian Company
Purchase of Software on Disk
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Software on Disk
Doctrine of Essential Character - Sprint RPG India Ltd Vs Commissioner of Customs
(S.C)
Copy rights
Copy righted article
Property contained in copyright is
Software
Rights over Copyrighted material
No right of distribution of copyrighted
material
Right of distribution of copyrighted
material
Royalty
Akin to Sale of goods
TDS applicable
No Royalty
Sonata Information Tech Ltd
Lucent Technologies
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Royalties - Challenges
ITC paid Sherton 3% of room sales as consideration
for use of :
1. Experience & expertise of Sherton
2. Providing interface between CRS & ITC hotels
3. allow to use Sherton’s Trademark
Consideration paid by ITC is treated as Business
Income & not as royalty because use of TM is
only incidental to rendering of services
Royalties - challenge
• Subscribing to a journal – mere characteristic of being
commercial in nature would not make it a thing for
which royalty would be payable. Some sort of
expertise or skill required.
• Payment to journal is not a royalty.
– CIT Vs HEG Ltd
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Royalties - challenges
• Subscription to Gartner data base which publishes
business data base pertaining to software technology.
• Experience should be one’s own experience in the
realization of Industrial, Commercial or Scientific
and not compilation of somebody else’s experience.
– Wipro Ltd Vs ITO
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Royalties - challenges
Royalty for use of Equipment
Acquiring use of equipment
Acquiring service of equipment
Control & Physical possession over the
equipment
No Control or physical possession over
equipment
Equipment should be available for
exclusive use
Equipment is available for use by
anyone
Royalty
No Royalty
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What is not Royalty?
• Sale, distribution or exhibition of cinematographic
films.
• Capital Gains on sale of IPR
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Royalties derived through
Permanent establishment
• Royalties are to be treated as business profits or income
from Independent professional services where the
intangible property that produces them is effectively
connected with a permanent establishment or fixed base
that the non resident owner of the intangible property
has in the source state.
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Royalty payments between
associated enterprises
• Non taxation of royalties in Country S applies only to
arm’s length of royalties paid for the right to use the
intangible property granted by one party to the other.
Prima facie, the excess amount of royalties is left to be
treated according to the domestic laws od each state and
again that could mean that the excess amount od
royalties is to be treated as deemed to be dividend and
taxed as such in country R and Country S.
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Fees for Technical Services Definition
Consideration
(including lump
sum) for
rendering
Managerial
Technical
Consultancy
Provision of
services of other
personnel
FTS does not include consideration for any construction,
assembly, mining or like project undertaken by the recipient or
consideration which would be income of the recipient
chargeable under the head “Salaries”.
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Fee for technical services
(FTS)
The service must be
one which requires
skills which is to be
performed when the
service is being
performed.
Contemplates
service to the payer
of the fee
We must distinguish
Technical Services
from Commercial,
official & admin
related services.
FTS
We must distinguish
technical services
with technology
driven services
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FTS - India view
• Analysis of the DTAAs entered by India with
Mauritius, Philippines, and Saudi Arabia will show
that there is a deliberate absence of an article relating
to technical services. Similarly, the DTAA signed with
USA does not provide recognition for managerial
services, in contrast with sec 9(1)(vii) of the IT Act.
The consequence of this is that assessees from such
countries can claim profits arising by way of technical
services to be business income, which is taxed at very
low or nil rates by virtue of the DTAAs
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Composite agreements & Technical Services
Distinctive Test
Whether the contract still could have stood if the contract were split?
Purchase of steam generating plant along with
design, manufacture & supply of imported
equipment
Electrical Contract & Drawings in connection
thereto
Supply of drawing is incidental to the total
contract which included supply of machinery
Both are independent
No FTS
Consideration for Drawings – FTS
Neyveli Lignite Corp
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FTS - challenges
• Service which employ technology as well as IPR whether
service could be held to be “Technical Service” even in the
absence of service?
Skycell is a mobile
network service
operator
Subscription to a
data base of
business
information paid by
WIPRO.
IT Authorities
claimed that
technical services
involved in the
business of Skycell
Court held fee for
use of Standard
facility provided to
all those willing to
pay for it cannot be
FTS.
IT authorities held
that technical
services involved in
this transaction.
Court held fee for
use of Standard
facility provided to
all those willing to
pay for it cannot be
FTS.
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FTS - challenges
Diamond testing
institute rendered
services in connection
with grading of
diamonds
IT authorities held that
grading constitutes
“Technical Services”
Court held that institute
was using its experience
in grading diamonds.
Such grading could not
be said to have
transferred its
experience, knowledge
or skill to customer.
Therefore transaction is
not “TS”
Contract for installation
of mobile telephone
system and to impart
training for Indian
personnel for continued
operations of the system
in India
IT authorities held that
technical services
involved in this
transaction.
Court upheld the views
of Department.
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FTS - Make available
• The MOU entered between India and USA shows
that for a service to be considered as an included
service it should be not only a technical or consultancy
service but it should also be ancillary and subsidiary to
the application or enjoyment of a right, property or
information for which a royalty payment is made; or if
it makes available technical knowledge, experience,
skill, know-how, or processes, or consists of the
development and transfer of a technical plan or
technical design.
33
FTS - make available
Teach Fishing Rather than giving a Fish
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Limitation of Benefit (LOB)
clause:
• It is an anti-abuse provision
• Treaty benefits are extended to only those residents of
contracting state for which the benefits are intended.
• The purpose of LOB is to limit the ability of residents of
third country to obtain benefits under the said treaty.
• When resident of third country establishes companies in
Contracting states with the principal purpose of
obtaining treaty benefits – it is known as treaty
shopping
35
Types of LOB Clauses
• Look through approach
– Pierce the corporate veil to examine country of
residence of the conduit companies ultimate
shareholder.
• Channel Approach
− Treaty benefit is denied to conduit companies that is
used to channel a substantial part of its income via
tax deductible expenses to a party that controls it.
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Types of LOB Clauses
• Bonafide Business Test
– Intermediary company is allowed benefits of DTA if it is
engaged in the active conduct of business in country S.
• Exclusion Approach
– DTA benefits are refused to companies that enjoy
privileges in country R.
• Subject to tax Approach
– Companies that enjoy DTA benefits in country S must be
subject to tax in country R on the income in respect of
which DTA benefits are granted
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Presented By
CA Swatantra Singh, B.Com , FCA, MBA
Email ID: singh.swatantra@gmail.com
New Delhi , 9811322785,
www.caindelhiindia.com,
www.carajput.com
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