Starting of a Chapter with a diagram is unorthodox. However, we are living in times of massive disruption where traditional businesses have been turned on their heads by young nimble start-ups leveraging technology. In Figure 1.1we can see how relatively new Start- Ups have gained massive Billion Dollar valuation within a short span of time gaining the popular adjective of unicorns, the mythical Norse character.
The main reason for these sky-high valuations is the Intellectual Property possessed by these new breed of Companies. As the world itself shifts to a service oriented economy, Intellectual Property Rights will only gain in value and prominence. The owners of Intellectual Property rights monetise their assets by earning Royalty income. Generally royalties are the payments for the use of or right to use the intellectual property rights. For instance, Startup Inc resident in Country X operates in IT and ITES segment. It has developed a unique app relating to healthcare. It has obtained a patent for the app. It has development and marketing centre in India, Outsource Co - as the cost of labour is lower in India. Startup Inc licenses patent to Ind co for a consideration of $10 per user per year. In this case, the Outsource co is resident of India and India is likely to tax the royalty income as the source is in India. On the other hand, Startup Inc is a resident of Country X. The Country X would tax the Startup Inc on its worldwide income. As a result, the payment made by the Outsource Co to Startup Inc will be subject to double taxation – In India on the source basis of taxation and in Country X on the resident based taxation.
In order to avoid such juridical double taxation countries have entered into Double Taxation Avoidance Agreements (DTAA) with one of the first agreements being entered on 16 April 1869. Since 1869 travelling through time, Pre-World War 1 DTAAs also normally did not contain any special article on royalties. The first special provision on royalties in respect of copyrights and patents is to be found in the 1931 draft multilateral convention of the League of Nations.
The potential double taxation in the above case is relieved by allocating the taxing rights between the resident country and the source country and enabling the resident country to provide the tax credit of the taxes paid in the source country.
Currently as mentioned in other places in this book, the Treaties are broadly based on either the OECD Model, UN Model or the US Model conventions, with alterations as per choice of the Contracting Countries. Normally, Royalty is covered by Article 12 of the Model Conventions and the main difference between the OECD Model/US Model and the UN Model being, the UN Model allocates limited taxing rights of royalty to the source state on gross basis and unlimited taxing rights to the resident state on a Net Basis, whereas the OECD and the US Model do not allocate any taxing rights to the source state and all the taxing rights are allocated to the residence state. In case of India, the Royalty clause in all our DTAAs are based on the UN Model Convention and even in the India- USA DTAA the royalty clause is based on the UN Model Convention rather than the US Model.
With regard to Fees for Technical Services (FTS), there is no article on FTS either in the OECD, UN or US Model conventions. However, some Countries have broadened the concept of Article – 12 by adding Fees for Technical Services and allowing taxing rights to be allocated similar to the UN Model for Royalties. In many of India’s DTAAs, an FTS provision is present as part of the royalties article or as a separate article.
In keeping with the theme of the book I have attempted to analyse the critical aspect of international taxation of Royalty & FTS through interactive Q & A with a friend & colleague of our favourite Mr Gopal Rao from Chapter – 1.
9:30 AM - Wednesday Morning
Mr Gopal Rao the famous retired engineer from BEML has been recalled to consult on a prestigious project BEML is undertaking as part of our Prime Minister’s Make in India campaign. The project will be undertaken through a newly formed subsidiary and will entail many international financial transactions. Mr Gopal Rao along with his colleague in the finance team Mr Madhav in the ensuing conversation seek to gain a perspective on the subject of International Taxation of Royalties & FTS:
Madhav: Q1-Dear Sir, under the new project, we will be making cross – border payments for using Patented Technology, to the foreign owner of the patent. I know this will be covered by Sec. 9(1)(vi) of the Income-tax Act, 1961, as Royalty Payments. However, what are the implications under Double Taxation Treaties?
Answer: Dear Madhav, Royalty as per DTAAs includes payments,
- “for the use of, or the right to use, any copyright of literary, artistic or scientific work, including cinematograph films or films or tapes used for radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or
- for the use of, or the right to use, industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience.”
This definition is similar in all the DTAAs entered into by India barring minor variations. The above definition is also broadly similar to the OECD, UN and US Model Convention on Royalties. Under the Act, Royalty has been defined in Explanation 2 to Sec. 9(1)(vi). Though the definition begins with the expression “means”, indicating an exhaustive coverage, the use of the phrase “or similar property” at the end of some of the limbs of the definition indicates an expansive coverage having wide explanation.
Payment for the use of patents is considered as royalty as per Clause 1 of Explanation 2 to Sec. 9(1)(vi) of the Act. Once the international payment is covered by the Act, one should look at the provisions of the governing DTAA to check if it is beneficial to the assessee.
In the OECD Model Conventions, Royalty payments are only chargeable to tax in the State of Residence of the recipient. The UN Model Conventions allocate limited taxing rights to the Source State on a gross basis and the State of Residence full taxing rights on a net basis. The Royalty Clause in the DTAAs entered into by India is in line with the UN Model Convention. Therefore, payments being made by Mr. Madhav’s company for the use of any patent to the foreign owner of the payment, will suffer tax deduction at source as per rates prescribed in Sec. 115-A Clause (b) of the Act or the rates prescribed in the respective DTAA, whichever is more beneficial to the assessee.
Madhav: Q2- Sir, under the new project we will be making payments for the use of proprietary design to an Indian branch of a foreign company. What is the tax treatment for the same?
Answer: Well Madhav, as explained earlier (Q-1) for chargeability to income tax of royalty payments, we will have to look at the payment from the aspect of the Act and the governing DTAA. Payments for the use of proprietary designs are covered by the definition of Royalty given in Explanation 2 to Sec. 9(1)(vi) of the Act. The DTAAs entered into India also recognise payments for the use of design as Royalty payment. However, there is a key difference between Question No. 1 & 2. In Q.1 the payment is being made directly to the Foreign Owner/Company, whereas in Q.2 the payment is being made to the Indian Branch of the Foreign Owner/Company. The Indian branch will constitute a Permanent Establishment (PE) of the Foreign Owner and the payment is being made to such PE.
As per the Act, where royalty payment being made is connected to a PE in India, taxation moves from Sec. 9(1)(vi) to Sec. 44DA of the Act, where such royalty is chargeable on Net Basis rather than gross basis and at the rate applicable to a Foreign Company i.e. 40% + Cess & Surcharge. Even as per DTAAs, if Royalty payments are connected to the Permanent Establishment in the Source State (India), then Source State may tax such Royalty Income as Business Profits in line with Article – 7 of the OECD, UN Model Conventions. Thus income though characterised as Royalty will be treated as business profits in the presence of a PE in India. (refer fig 1.2)
Therefore Madhav, if the royalty payments are effectively connected with a PE in India, the tax deduction at source will have to be done at the rate of 40% plus surcharge & cess subject to Sec. 195(2) and Sec. 195(3) of the Act.
Madhav: Q-3: In the ensuing new project we will be making cross-border Royalty payments to related parties located in various foreign jurisdictions. Are such payments subject to the Arm’s Length Principles under the Income-tax Act, 1961?
Answer: Dear Madhav, all cross-border related party expenses will be covered by the Transfer Pricing provisions as contained in the Act. With respect to DTAAs, most of the DTAAs entered into by India contain a sub-clause in the Royalty Article, which is similar to Para – 4 of Article – 12 of the OECD, US Model Convention & Para – 6 of the UN Model Convention.
As per Para – 6 of Article – 12 of the UN Model Convention, limited taxation of royalties on gross basis by the source state is applicable only to the arm’s length amount of royalties paid for the right to use the intangible property rights granted by one party to the other. Prima facie, the excess amount of royalties is left to be treated according to the domestic laws of each state and again that could mean that the excess amount of royalties is deemed to be a dividend, and taxed as such in Source State and State of Residence.
Madhav: Q-4: Sir, under the new project we will be making cross-border payment to a Russian Satellite Service provider to use the data transmitted by satellites in the guidance system of the Unmanned Ariel Vehicles manufactured by our company. How will these payments be taxable?
Answer: Madhav, as per Sec. 9(1)(vi) of the Act, Royalty includes payments for transfer of all or any rights in respect of a process. In reference to the DTAAs, there is a fair bit of controversy, although as per Model Conventions and the DTAAs entered into by India, Royalty includes payments for transfer of all or any rights in respect of a process, the OECD commentary on Article – 12 does not consider payment for satellite operator under transponder leasing agreements as Royalties. The Indian judiciary has delivered conflicting decisions on whether payments under transponder leasing agreements are Royalty payment. In the case of Asia Satellite Telecommunications Co. Ltd. vs. DIT (2011) 332 ITR 340 it was held that, payments for transponder leasing cannot be considered as Royalty payments as per Sec. 9(1)(vi) of the Act and in the case of New Skies Satellites N.V. vs. ADIT (Intl. Taxation) (2009) 121 ITD 1 it was held that payments for transponder leasing will be chargeable to tax as Royalty.
In view of the controversy & to settle the controversy, Finance Act – 2012 has introduced explanation 6 to Sec. 9(1)(vi) of the Act to clarify that process includes and shall be deemed to have always included transmission by satellite. However, even though the Act has been amended retrospectively in respect of process, the DTAAs which had been entered into have not been amended & it could be argued that the introduction of an explanation in the Act explaining the expression “process” is specific to the definition contained in the source rules of the Act and may not be extended to apply where a DTAA exists. But a counter argument would be that OECD Commentary has been considered as only of persuasive value by the Indian judiciary and the DTAAs incorporate that any term not defined therein shall, unless the context otherwise requires, have the meaning which it has under the laws of that State primarily concerning the taxes to which the Agreement applies.
Madhav: Q-5: Dear Sir, under the new project we will be making cross-border payment to procure an expensive software to use it as a designing tool. How will these payments be taxable?
Answer: Dear Madhav, as per Sec. 9(1)(vi) of the Act, Royalty includes payments for transfer of all or any rights in respect of a literary work. Computer programme is protected in India as a literary work. In addition to rights in relation to a literary work such as reproduction of work, issuing copies of the work to the public, translation and adaptation, a right to sell the computer programme or give it on commercial rental or offer for sale or for commercial rental any copy of the computer programme is available to the copyright owner for commercial exploitation of the copyright. Also the Finance Act, 2012 has introduced Explanation 4 to Sec. 9(1)(vi) of the Act w.r.e.f. 1-6-1976, where it has been clarified that the transfer of all or any rights in respect of any right, property or information includes and has always included transfer of all or any right for use or right to use a computer software (including granting of a license) irrespective of the medium through which such right is transferred.
Characterization of cross-border software payments, as either royalty or business profits, has been a contentious issue in India. The issue is concerned with whether a software transaction is “transfer of a copyright” or whether it is only “transfer of a copyrighted article” akin to purchasing a book.
The Indian judiciary has issued several rulings appreciating the difference between “copyright” and “copyrighted article”, at the same time there have been some rulings, where this distinction has not been accepted. Significantly in the Karnataka High Court ruling in the case of CIT vs Samsung Electronics Co Ltd & Ors  320 ITR 209 where the High court had to rule on whether the Tribunal was correct in holding that since the assessee had purchased only a right to use the copyright i.e. the software and not the entire copyright itself, & the payment cannot be treated as royalty as per the DTAA and treaty is beneficial to the assessee and consequently Sec. 9 of the Act should not be taken into consideration, the Karnataka High Court appears to have taken a broad interpretation of the expression, “consideration for the use of, or right to use, any copyright” in a DTAA and “transfer of all or any rights (including the granting of a license) in respect of a copyright” in the Act to reach a conclusion that mere purchase of a product protected by copyright is likely to result in the payment of royalty. However, the Delhi High Court in the case of DIT vs Infrasoft Ltd.  220 TAXMAN 273 where the assessee is an international software marketing and development company opened a branch office in India and imports package in form of floppy disks or CDs customized according to requirements of customers, it was held that, to be taxable as royalty income covered by Article 12 of DTAA, income of Assessee should have been generated by "use of or right to use of" any copyright. License granted to licensee permitting him to download computer programme and storing it in computer for his own use is only incidental to facility extended to licensee to make use of copyrighted product for his internal business purpose. Said process is necessary to make programme functional and to have access to it and is qualitatively different from right contemplated by said paragraph because it is only integral to use of copyrighted product. Apart from such incidental facility, licensee has no right to deal with product just as owner would be in a position to do. There is no transfer of any right in respect of copyright by Assessee and it is a case of mere transfer of a copyrighted article. Payment is for a copyrighted article and represents purchase price of an article and cannot be considered as royalty either under Income Tax Act or under DTAA. This decision at the same time has also distinguished the Samsung Decision of the Karnataka High Court.
Madhav: Q-6: Dear Sir, under the new project we will be making cross-border payment for the outright purchase of certain Intellectual Property. How will these payments be taxable?
Answer: Dear Madhav, as per Sec. 9(1)(vi) of the Act, any consideration which would be the income of the recipient chargeable under the head “Capital Gains” is excluded from being chargeable to tax as Royalty. Even as per DTAAs where a sum is paid in consideration for the alienation in full, of rights attached to intellectual property, the consideration cannot be a royalty because the definition of “royalties”in Article 12(2) of the OECD and UN Model Convention requires that the payment be made “for the use of, or the right to use,” the property. Where the rights are alienated in full, the payment cannot be for the use of (or the right to use) those rights. The payment is for the rights themselves. The sum paid in consideration is therefore generally treated as business income of the alienator (which falls within Art. 7) or a Capital Gain (which falls within Art. 13). However, following the US Model Convention, the United States of America reserves the right to treat as a royalty a gain derived from the alienation of property referred to in Art. 12(2) of the OECD model convention if the gain is contingent upon the productivity, use or disposition of the property.
Madhav: Q-7: Dear Sir, under the new project we will be making cross-border royalty payment to a non-resident company. However, the said non-resident company has a branch in India carrying out some activity unrelated to the Royalty payments. In Q-2 earlier you have mentioned when making payment to a PE of the non-resident company for Royalty it will be considered as Business Income chargeable to tax in India. Will such cross-border royalty payment to a non-resident company in the present case also be considered as Business Income chargeable to tax in India as the non-resident company has a PE in India?
Answer: Dear Madhav, in the DTAAs entered into India and as per the OECD & UN Model Convention, the royalties that arise through a permanent establishment of a non-resident in the Source State are chargeable to tax as business profits and do not qualify for the concessional treatment available under the Royalty Article of a DTAA. However, to be chargeable as business income all the Model Conventions and the DTAAs entered into by India require such income to be “effectively connected” to such PE. The Income-tax Act does not clarify what is ‘effectively connected’; generally it would mean ‘related to’ or ‘arising from the activities of’. A right or property in respect of which royalties are paid will be effectively connected with a PE, if the “economic” ownership of that right or property of that right or property is allocated to that PE to exploit the asset.
Madhav as in your case, the PE is not carrying out any activity relating to the exploitation of Intellectual Property for which the Royalty payments are arising, such payments will be taxable in India as Royalty Income itself under the Royalty Article of the DTAA and not as Business Income of the PE.
Madhav: Q-8: Dear Sir, under the new project we will be making cross-border payments for obtaining services from non-resident entities. How will these be taxed?
Answer: Dear Madhav, performance of services is generally considered as an active stream of income. In case these services satisfy the definition of Fees for Technical Services (FTS), they are taxed as a passive stream of income (like royalties) based on the tax residence status of the payer of the income. Accordingly, the source rules also have a separate provision for taxation of FTS. As in the case of royalty, the term ‘FTS’ is defined in the Act vide explanation 2 to Sec. 9(1)(vii) of the Act. The definition of FTS is of wide application. It comprises consideration for the rendering of managerial, technical or consultancy services. An explanation is also included to clarify that income of a Non-Resident shall be regarded as sourced in India irrespective of whether or not the Non-Resident has a residence or place of business or business connection in India or has rendered services in India.
With respect to DTAAs, there is no separate article on FTS either in the OECD, UN or US Model Conventions. However, in many of India’s DTAAs, an FTS provision is present as part of the royalties article or as a separate article.
Therefore, if the payment for services obtained fall within the scope of the definition contained in Explanation -2 to Sec. 9(1)(vii) of the Act and the relevant DTAAs, the same will be chargeable to tax on a gross basis at the rate prescribed under Sec. 115-A of the Act or the relevant DTAA whichever is lower, similar to cross-border payments of Royalties.
Madhav: Q-9: Dear Sir, under the new project we will be making cross-border payments for obtaining services from a non-resident entity based in the USA. For taxing payments made on technical services obtained from USA does any additional condition need to be fulfilled in reference to other Countries?
Answer: Dear Madhav, Broadly, there are two approaches which India has adopted in negotiating its DTAAs in case of FTS:
- The “broad approach” under which the term is defined to include all managerial, technical or consultancy services (similar to the Act definition). DTAAs with countries such as Germany, Austria, Ireland, Japan, adopt this approach.
- The “narrow approach” under which the term is defined to cover only those technical services which “make available” technical know-how, skill etc. to the recipient of the services. DTAAs with countries such as US, UK, Canada, Singapore, adopt this approach. This is popularly referred to as the FIS (Fees for included services) provision.
In most of the cases where a “narrow approach” is adopted, it is normal to have a broader definition of the term Permanent Establishment (PE) to cover furnishing of services (Services PE Clause).
DTAAs entered into by India with USA, UK, Canada, Singapore cover only technical services which “make available” technical know-how, skill etc. to the recipient of the services and fall under the narrow approach. The concept of “make available” is explained in the memorandum of understanding (MoU) to the India – USA DTAA. The USA MoU explains that “Generally speaking, technology will be considered “made available” when the person acquiring the service is enabled to apply the technology.” The provision of service may at times require technical input by the service provider. This does not mean that technical knowledge, skills, etc. are “made available” to the service recipient. Similarly, use of a product which embodies technology does not, per se be considered to make the technology available since the person would not be enabled to apply the technology. In the Singapore DTAA, this concept is captured in the text of the DTAA itself where “make available” is explained as, “which enables the person acquiring the services to apply the technology contained therein.”
Several decisions have dwelled on the issue. The following conclusions drawn by the Karnataka High Court in the case of CIT vs De Beers India Minerals (P) Ltd.  346 ITR 467 are relevant:
- The service provider rendering technical service should “make available” technical knowledge, experience, skill, know-how or process to the service recipient, so that the recipient also acquires technical knowledge, experience, skill, know-how or process so as to render such technical services
- Once such technology is “made available”, it is open to the recipient of service to make use of the said technology and the taxation is not dependent on use of the technology by the recipient
- Merely because a business is dependent on the technical service received from the service provider, it does not follow that the recipient is making use of the technology which the service provider utilizes for rendering technical services
- What is relevant is that, after rendering of such technical services by the service provider, whether the recipient is enabled to use the technology which the service provider had used
To conclude in simple terms, the idea of not making available vs make available can be equated with giving a man a fish vs. teaching him to fish. The fact is that the service recipient must be equipped to do the service thenceforth is the key criteria of the ‘make available’ clause which therefore restricts from the classification of all and every technical service as FTS which is taxable in India.
Madhav: Q-9: Dear Sir, under the new project we will be making cross-border payments for obtaining services from non-resident entities. The definition of FTS in the Act includes Managerial Services Fees. Please explain the scope of the same?
Answer: Dear Madhav, the term ‘management fee’ is not defined in the Act or any of the DTAAs entered into by India with various countries.
Advanced law Lexicon defines the term ‘management’ as:
- Government, control, superintendence, physical or manual handling or guidance
- The act of managing by direction or regulation, or administration
- A group of persons responsible for smooth running of business. The group may divide their responsibilities within themselves, or work collectively, to fulfil their obligations towards planning, directing, organising, controlling and running efficiently various affairs of the organisation…..
The Supreme Court in the case of R. Dalmia vs CIT  106 ITR 895, while referring to the term ‘management’ held that, “in the context of business, “manage” means “to control, to guide, to administer, to conduct or direct affairs; carry on ‘business’”. The Mumbai Income Tax Appellate Tribunal in the case of Linde AG vs ITO  62 ITD 330, observed as follows, “the managerial services as aforesaid, is towards the adoption and carrying out the policies of an organisation. It is of permanent nature for the organisation as a whole”.
In the other words, the term ‘management’ refers to the activity of controlling, directing or supervising any particular function or task and thus, payment made for any such activity is covered within the ambit of ‘management fees’.
It may be noted that some of India’s DTAAs do not contain the term ‘managerial’ in the FTS/FIS definition (e.g.: US, UK etc.) In such cases, an issue arises as to whether such services get covered under the FTS/FIS article or whether these should be considered under the business profits article of the DTAA. The matter has been subject matter of a number of rulings. Some have held that is the absence of the FTS clause, the receipt should be taxable as business profits under Article 7, McKinsey & Company (Thailand) Co. Ltd. vs DDIT [TS-332-ITAT-2013-Mum], whereas some others have held that in the income should be taxable as “other income” under the relevant DTAA, Lanka Hydaulic Institute Ltd., In re  337 ITR 47 (AAR).
Madhav: Q-9: Dear Sir, under the new project we will be making cross-border payments for obtaining services from non-resident entities. The definition of FTS in the Act includes Technical Services Fees. Please explain the scope of the same?
Answer: Dear Madhav, the term Technical Services has not been defined in the Act. The Supreme Court in the case of CIT vs Bharati Cellular Ltd.  330 ITR 239 held that, “the term ‘technical services’ appears between ‘managerial’ and ‘consultancy services’ in the FTS definition. Accordingly, all three limbs – technical, managerial and consultancy services – would require some element of human intervention”.
The OECD has taken a view that services are of technical nature when special skills or knowledge related to a technical field are required for the provision of services. The techniques related to applied science or craftsmanship would generally correspond to such skills or knowledge whereas the provision of knowledge acquired in fields such as arts or human sciences would not. The fact that technology is used in providing a service is not indicative of whether the service is of a technical nature.
Madhav: Q-10: Dear Sir, under the new project we will be making cross-border payments for obtaining services from non-resident entities. The definition of FTS in the Act includes Consultancy Services Fees. Please explain the scope of the same?
Answer: Dear Madhav, the term ‘Consultancy Service’ has not been defined the Act. The MoU to the India – USA DTAA states that consultancy services could be advisory in nature. The advisory service may or may not require expertise in a technology for its performance. The Delhi High Court in CIT vs Bharati Cellular Ltd.,  319 ITR 139, referred to the meaning of the word ‘Consult’ to arrive at the meaning of consultancy services and noted that, “Similarly, the word consultancy has been defined in the said Dictionary as the work or position of a consultant; a department of consultants. Consultant itself has been defined, inter alia, as a person who gives professional advice or services in a specialized field. It is obvious that the word consultant is a derivative of the word consult which entails deliberations, consideration, conferring with someone, conferring about or upon a matter. Consult has also been defined in the said dictionary as ask advice for, seek counsel or a professional opinion from; refer to (a source of information); seek permission or approval from for a proposed action. It is obvious that the service of consultancy also necessarily entails human intervention. The consultant, who provides the consultancy service, has to be a human being. A machine cannot be regarded as a consultant”.
The OECD in one of its reports is of the view that provision of advice by a professionally qualified person would be ‘consultancy services’. In Intertek Testing Services, In re  307 ITR 418 (AAR) it was held that advisory services which merely involve discussion and advice of routine nature or exchange of information cannot be appropriately be classified as ‘consultancy services’ under a DTAA which requires an element of expertise or special knowledge. This ruling was rendered on the context of India – UK DTAA which contains a ‘make available clause in the FTS definition’.
Madhav: Q-10: Dear Sir, under the new project we will be making cross-border payments for obtaining services from non-resident entities. The definition of FTS in the Act excludes consideration for any construction, assembly, mining, or like project. Please explain the scope of the same?
Answer: Dear Madhav, in the definition of FTS one of the exceptions that is carved out is consideration for any construction, assembly, mining or like project undertaken by the recipient. The Delhi High Court in DIT vs Rio Tinto Technical Services  340 ITR 507 has explained the intent of the legislature in carving out this exclusion. Some key points from the decision are enumerated below:
- Construction, assembly or mining projects are normally not regarded as services relating to FTS
- FTS definition makes and draws a distinction between income earned by way of rendering services in contradistinction to income earned from manufacturing or trade activity.
- Construction, assemble or mining activities may not strictly fall within and be regarded as the manufacturing or trading activity, when interpreted in a narrow manner, and the intention of the legislature is that such narrow interpretation is not warranted
- The exclusion given by the legislature to the aforesaid projects is, therefore, merely clarificatory
- Use of the term ‘project’ in the said expression mandates that there should be a construction project, an assembly project, a mining project or a like project undertaken by the recipient and the consideration paid should be on the said account
Further in other judicial rulings it has been held that a service provider cannot be engaged in mere supervision or rendering services for construction, assembly, mining or like project to apply this exclusion but should be engaged in actual construction, assembly, mining, or like project.
Madhav: Q-11: Dear Sir on going through the above summary I gain an understanding that FTS can be construed in a broad manner& is capable of covering a host of services. However, are there any specific exclusions from FTS apart from Q-10?
Answer: You are correct when you say that FTS can be construed in a broad manner. However, Article 12(5) of Indian DTAAs lists several categories of services which are not intended to be treated as FIS/FTS even if they satisfy the tests of Paragraph 4 of such Indian DTAA. These are exception clauses which cover the following areas:
- Services which are ancillary and subsidiary, as well as inextricably linked, to the sale of property other than a sale described in paragraph 3 of Article – 12;
- Services which are ancillary and subsidiary to the rental of ships, aircraft, containers, or other equipment used in connection with the operation of ships or aircraft in international traffic;
- For teaching in or by educational institutions;
- Services for the personal use of the individual or individuals making the payment;
- To an employee of the person making the payments or to any individual or firm of individuals (other than a company) for professional services as defined in Article 15 (Independent Personal Services);
These exceptions seem quite logical; they cover the important point that when the preponderance of the arrangement is a sale then certain services linked to it should not be treated as FTS. This has been quite hotly debated because the revenue authorities would in these cases, like to make the sale divisible into its component parts and treat the service as FTS. The other exception is for educational purposes as well as for personal use. Finally, to ensure that those services that come under Independent Personal Services should not be construed as FTS there is an exception clause in Article 12(5)(e).
With the above interactive analysis I have aimed to provide the reader with a basic understanding of international taxation on cross-border payments of Royalty & FTS. With increased globalisation and digitisation, we practicing professionals come across a gamut of payments proposed to be made by clients for varied services, & it is pertinent to be aware of the governing tax laws to give the best advice. There is an ocean of literature on the subject of Royalties & FTS for the interested & I hope through this Chapter I have provoked the curiosity of the reader to discover this fascinating area of international taxation.
Wish you Happy Reading