In this globalized economy, individuals and businesses often operate across borders, leading to potential double taxation issues, which is prevented by entering double taxation avoidance agreements (DTAA) between various countries. Concepts such as permanent establishment (PE) and "make available" are the creations of DTAA, which have been subject to significant litigation in India.
PE means a fixed place of business through which an enterprise carries on its business in another country. This concept determines when and where a country has the right to tax business income earned within its jurisdiction by a non-resident enterprise. Income which is attributable to such a PE is taxed in the source country. Similarly, in certain DTAA entered by India, fees for technical services (FTS) is taxable in India only if the services rendered makes available technical knowledge or skill to the service recipient. Make available test is satisfied, if the recipient of the service is equipped to carry on his business without reference to the service provider. If he is able to carry on his business in future without the technical services of the service provider in respect of services rendered, then it would be said that technical knowledge is made available.
Recently, the Hon'ble Delhi High Court (High Court) in the case of International Management Group (UK) Limited v. Commissioner of Income Tax-International Taxation [i], has dealt with the question whether the receipts which were not attributable to the PE, can be brought to tax under Article 13 of the DTAA between India and UK as FTS.
In this article, we have discussed the ruling of the High Court in the ensuing paragraphs:
Facts:
The taxpayer had entered into a memorandum of understanding and a separate services agreement with BCCI to provide advisory and managerial services for the establishment, commercialization and operation of India's premiere cricket league, IPL. During the course of the agreement, the league was held In India as well as outside India, especially, South Africa and UAE.
For all the years under consideration, the taxpayer had created a service PE under Article 5(2)(k) of the DTAA between India and UK. The taxpayer contended that only such of the receipts as would be attributable to the PE would be taxable in India. When the league was held outside India, the taxpayer argued that since BCCI utilized the services outside India for earning income from a source outside India, the fee earned by the taxpayer was outside the purview of FTS under section 9(1)(vii)(b) of the Income-tax Act, 1961 (IT Act).
However, the Indian Income-tax Authorities (IITA) through the Assessing Officer and the Dispute Resolution Panel (DRP) was of the view that the balance revenue (which was not attributed to the service PE in India) and for which services were rendered outside India, should be charged as FTS. This view of the IITA was upheld by the Income-tax Appellate Tribunal, against which an appeal was filed before the Hon'ble High Court.
Following three questions of law were admitted by the Hon'ble High Court for its consideration:
- Did the ITAT erred in holding that the business income was divisible under the India-UK DTAA, though it arose out of a single contract having regard to Articles 7 and 13 of India-UK DTAA?
- Whether the ITAT erred in holding that services provided by IMG to BCCI under the Service Agreement dated 24.9.2009 qualify as fee for technical services in terms of Article 13(4)(c) of the DTAA between India and UK?
- Alternatively, in case answer(s) to above two questions are in negative; whether the income determined as FTS can be deemed to accrue or arise in India in terms of Section 9(vii)(b) of Income Tax Act, 1961, especially when services provided by IMG, during the relevant year, were utilized by BCCI outside India?
Ruling of the High Court
PE under Article 5(2)(k) of the DTAA between India and UK
On the alleged taxability of the balance receipts as FTS, the High Court rejected the submission of the taxpayer that the IITA not only stood estopped from taking this position, but they also could not have legally bifurcated the composite consideration earned by the taxpayer into business profits and FTS.
The High Court while rejecting this contention observed that Article 5 does not concern itself with the categorization or classification of income. It has a specific and clear purpose delineated within the DTAA framework and is concerned solely with the conditions under which a service PE would be created. Sub-clause (k) focuses only on the duration and nature of services provided by the resident of a contracting state within the other contracting state. The High Court observed that "To construe Article 5(2)(k) as encompassing the authority to classify and tax income would be a fundamental misinterpretation of its avowed purpose. The Article's role is limited to defining the circumstances under which a PE could be said to exist and does not extend to the subsequent tax treatment of the income derived from the PE's activities".
Thus, the High Court held that the IITA was clearly not estopped in law from examining whether revenue other than that attributable to the service PE could be subjected to tax under the separate and individual Articles of the DTAA.
Bifurcation Of Income
In conjunction with the above, on the argument that the bifurcation of income is impermissible, the High Court, referred to Article 7(9) which provides that "Where profits include items of income which are dealt with separately in other Articles of this convention, then the provisions of those Articles shall not be affected by the provisions of this Article".
The High Court observed that from a reading of Article 7(9), profits, if otherwise classifiable or being found to have been separately dealt with by the other Articles of the DTAA, would move out of the ambit of Article 7 which stands confined to business profits. It is pertinent to note that Article 7 is clearly not intended to be an overriding, a non obstante or an umbrella provision which would eclipse all other independent Articles of the Convention.
The structure of DTAA ensures that each type of income is governed by the specific Article and thus preventing an overlap or conflict. This bifurcation also helps in avoiding inappropriate tax treatment, because a single contract may include multiple revenue streams each with its own tax implications. The mere categorization of revenue by the taxpayer does not definitively resolve the issue of tax treatment. The IITA were clearly empowered and under an obligation to accurately determine the real nature and classification of income of the taxpayer.
The issue of FTS
The High Court dealt with the principal question of whether the services rendered by the taxpayer can be characterized as FTS or not. FTS stands defined as being consideration received for rendering technical or consultancy services. However, Article 13(4) makes it clear that mere rendition of technical or consultancy services is not sufficient and provides an additional condition of "make available" of technical knowledge, experience, skill know-how or processes to the recipient of the service. Thus, the tax liability would be triggered only when the technical knowledge, skill, know-how is being made available to the service recipient.
The High Court observed that "the expression "make available" must be construed as an enablement, conferral of knowledge and which would lead to the payer becoming skilled to perform those functions independently". The make available stipulation ensures that only those services that impart lasting technical benefits are classifiable as FTS. Thus, mere usage or utilisation of technical or consultative material in aid of business will not be sufficient to attract Article 13 of DTAA.
On the taxability as FTS, the High Court held that "A reading of the various obligations that were placed upon IMG clearly establish that all facets of the IPL and the entire gamut of activities connected with the proposed league were not only to be created by it, IMG was also tasked with managing and administering all commercial and media rights of the BCCI. There was no discernible intent on the part of BCCI to absorb or internalise IMG's unique skills and knowledge in the curation of sporting leagues. No part of that knowledge or skill stood transferred to BCCI. Merely because research material would have been shared with BCCI or the service rendered by it been put to use and utilised cannot possibly lead one to conclude that the payer stood enabled or equipped with the special knowledge underlying the technical and consultancy service which was extended". The fact that the taxpayer was retained to perform all of the aforenoted functions for a period of ten years is yet another indicator of BCCI having not been enabled or made available the special knowledge and skill possessed by the taxpayer.
Article 13(6) – effective connection
The High Court also addressed the alternative argument of the taxpayer, wherein it was contended that if the services rendered by the taxpayer amounts to FTS, then the revenue earned would stand excluded from the ambit of Article 13 by virtue of Para 6 thereof. Para 6 of Article 13 stipulates that where the FTS arises through a PE which exists and the right, property or contract in respect of the same is effectively connected with such PE, Article 13 would cease to apply, and the income would then be taxable under Article 7 or 15 of the DTAA. In this context, it was contended by the taxpayer that it is the contract which must be found to be effectively connected as opposed to the activity that may have been undertaken by the PE. It was further contended by the taxpayer that since it has a service PE in India, and the source of revenue is one single contract, the taxpayer is liable to be taxed under Article 7 only to the extent of the income that is attributable to the PE.
In order to understand the phrase "effectively connected", the High Court after referring to various commentaries and authorities, observed that there were divergent and varying views which have been expressed on this issue. Considering the High Court had already held that the service fee does not amount to FTS, as it does not make available any technical knowledge, it held that there was no need for the High Court to delve into the intricacies of the phrase "effectively connected" in this case.
Exception under Section 9(1)(vii)
The last aspect dealt with by the High Court was the applicability of the exception as provided under section 9(1)(vii) of the IT Act to the assessment years, when BCCI conducted IPL outside India. As per section 9(1)(vii)(b) of the IT Act, income earned by way of FTS payable by a resident Indian would, by virtue of the deeming provision becomes taxable. However, it creates an exception in cases where FTS is payable in respect of the services utilized in a business or profession outside India or for the purposes of earning income from any source outside India.
The taxpayer contended that the income earned from BCCI will fall within the exception not only because the event was held outside India, but also the services were availed of for earning income from a source outside India. On this issue, the High Court held that "Undisputedly, IPL in 2009 and 2014 though originally slated to be held in India, was, for exceptional reasons, shifted out and ultimately held in South Africa and UAE respectively. The services which were rendered by IMG in connection with those two events were clearly utilized outside India and were availed of for the purposes of earning income from a source outside India. The geographical shift meant that the services rendered by IMG were utilized outside India and were integral to earning income from sources outside India".
Conclusion:
The High Court concluded that the services rendered by the taxpayer from its UK office does not qualify for taxation under Article 13, since the "make available" test does not stand fulfilled. Though High Court ruled in favor of the taxpayer, however, as regards divisibility of profits, it was concluded that income is divisible between Article 7 and 13, even though arising from a single contract. It was also held by the High Court that the fee earned by the taxpayer, when the event was held outside India falls within the exception of Section 9(1)(vii) of the IT Act and thus, is not taxable in India.
Our thoughts:
The Hon'ble High Court of Delhi has pronounced its ruling on various propositions of law, which will have a far-reaching impact specially while analysing PE and FTS taxation issues. The High Court has established a significant proposition regarding the divisibility of profits between different articles in a DTAA to arrive at the correct taxability of income. Taxation of FTS is restricted on account of the make available test, which is fulfilled only if the service recipient absorbs the technology and is able to use the same independently without having any recourse to the service provider. Though the concept of make available has been explained in various rulings, yet substantive litigation has arisen on this issue. Lastly, the High Court has re-affirmed that if a resident uses the services rendered by a non-resident for its business outside India or for earning any source of income from outside India, then the same is not taxable in India on account of the exception provided in section 9(1)(vii)(b) of the IT Act.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.