1 KPMG FLASH NEWS KPMG IN INDIA Payments for website hosting cannot be treated as Royalty under the Incometax Act or India-USA tax treaty 22 March 2012 Background Recently, the Mumbai Bench of the Income-tax Appellate Tribunal (the Tribunal) in the case People Interactive (I) P Ltd 1 (the taxpayer) held that payments for website hosting cannot be treated as Royalty under the Income-tax Act, 1961 (the Act) or India-USA tax treaty (the tax treaty). The Tribunal held that the taxpayer could not operate or even does not have physical access to the equipments system. Further the taxpayer is not using equipments but only availing the services provided by a non-resident. Therefore, such payments cannot be treated as Royalty under the Act or under the tax treaty. Facts of the case The taxpayer is owner/host of website where individuals can register and exchange the relevant information for matrimonial alliances on payment of appropriate subscription amount. This facility is available to the residents as well as non-residents. The taxpayer availed the services of Rackspace Inc, USA vide service agreement. The Rackspace Inc. offered advanced type of dedicated hosting solution to the taxpayer and the services provided are categorised as follows: Server Management: It provided dedicated servers for the taxpayer and dedicated support team with an account manager and business development consultant. It also provides direct and unlimited access to live expert and guaranteed 100 percent network uptime and hardware replacement. 1 ITO v. People Interactive (I) P Ltd [ITA Nos. 2180, 2179, 2181, 2182, dated 29 February 2012] Taxsutra.com
2 Bandwidth and connectivity: The taxpayer has millions of users across the globe which access its website, Rackspace Inc provides an aggregate bandwidth of 100 GB per server which is increased based on the usage rate. Security: Rackspace provides very high level of security for the data stored on the servers including backups and restorations, firewalls, intrusion detection, protection from Trojans, worms, etc. The taxpayer paid USD under the head computer and IT services to Rackspace Inc. However, the tax has not been deducted while making payments since the taxpayer was of the view that such payments were in the nature of business income and in absence of a Permanent Establishment (PE) it is not taxable under Article 7 of the tax treaty. The Assessing Officer (AO) held that Rackspace Inc. has given right to use the server to the taxpayer along with account manager and business development consultant in relation to its activities. Therefore, the payment made by the taxpayer to Rackspace Inc. falls under the definition of Royalty under the Act as well as under the tax treaty. The Commissioner of Income-tax Appeals [CIT(A)] observed that Rackspace Inc is providing hosting services to the taxpayer and not given any equipment on hire. Accordingly, following the order of the Tribunal in the case of Kotak Mahindra Primus Ltd 2 as well as the ruling in the case of ISRO Satellite Centre 3 it was held that the payment was not taxable. Issue before the Tribunal Whether website hosting charges paid to a non-resident can be taxable as royalty under the Act or the tax treaty? Tax department s contentions The payment was made for the use of sever or transfer of technology, etc. Further Rackspace Inc has a dedicated sever and also has dedicated support service to the taxpayer which clearly indicates that the taxpayer has right to use the whole or part of sever and support system. Accordingly, the payments for industrial, commercial or scientific equipment would be in the nature of royalty as per the Act. 2 Kotak Mahindra Primus Ltd v. DDIT  11 SOT 578 (Mum) 3 ISRO Satellite Centre (ISAS) in re  307 ITR 59 (AAR) The India-USA tax treaty is based on UN Model and the term royalty used under Article 12 of the tax treaty means the payment of any kind received as a consideration for use or right to industrial, commercial or scientific equipment. When the payment was made for the use of sever for which the taxpayer has exclusive right to use and nobody else other than the taxpayer can use the sever it falls within the definition of royalty under the Act as well as the tax treaty. Before amendment to Finance Bill 2001, the payments for right to use of industrial, commercial or scientific equipment was taxable as business income in the hands of the recipient. However, in view of the insertion 4 of clause (iva) to Explanation 2 of Section 9(1)(vi) of the Act, the payment made for use or right to use the industrial, commercial or scientific equipment needs to be assessed as royalty income in the hands of the recipient. The tax department contended that the space in server can be utilised from anywhere and no physical access or control of sever is required for using the space in sever. The payment is in the nature of royalty and therefore a PE is not relevant for withholding of tax. Accordingly, the taxpayer is liable to pay the tax on behalf of the payer as per the provisions of Section 201(1) and 201(1A) of the Act. The decision of the Tribunal in the case of Standard Chartered Bank 5 was not applicable since the facts of the case were totally distinguishable. Further the decision of Advance Authority of Ruling (AAR) in the case ISRO Satellite Centre 6 is also not applicable as it has not used any service through transponder. Taxpayer s contentions The taxpayer contended that it does not have control over the equipments as well as operating system. The equipments are used by Rackspace Inc to provide service to the taxpayer. There is no transfer of any technology process, skill or know-how or knowledge from the Rackspace Inc. Further there is no transfer or rendering of any service of technology, knowhow, etc. 4 As per the amendment to Finance Bill Standard Chartered Bank v. DDIT  45 SOT 494 (Mum) (URO) 6 ISRO Satellite Centre  307 ITR 59 (AAR)
3 The services provided were in the nature of data storage, data security and bandwidth provision. The taxpayer is not the only one who is receiving service from Rackspace Inc but there are customers of the Rackspace Inc to whom the standard service is provided. The taxpayer contended that the payments are not for use or right to use the industrial, commercial or scientific equipment and does not fall within the meaning of royalty under Section 9(1) (vi) of the Act or under the tax treaty. The payment is a business income in the hands of Rackspace Inc and is not liable to tax in the absence of PE in India. There is no agreement to hire or lease out any equipment but only service level agreement and payments were made as per service level agreement. The taxpayer referred the service level agreement and contended that Rackspace Inc has agreed to provide services through dedicated sever as described in the agreement. The equipments/servers were under the control and possession of the Rackspace Inc for providing the services. Therefore, the taxpayer was not hiring out the equipments but only ensuring the uninterrupted and round the clock service. The monthly cost of ownership of server mentioned in the agreement is between USD 25 to 82 whereas the average amount charged by the Rackspace Inc from the taxpayer is between USD 1100 to 1200 which indicates that the payments are towards service provided by the Rackspace Inc to the taxpayer through its expertise in providing managed hosting solutions and not for the server. The taxpayer relying on the Delhi High Court s decision in the case of Asia Satellite Telecommunications Co Ltd 7 contended that the payments were made for the services received outside India and accordingly, not taxable in India as per the provisions of Section 9 of the Act. The taxpayer relying on the Mumbai Tribunal s decision in the case of Standard Chartered Bank contended that it s case does not fulfill any of the criteria of test brought out by the Technical Advisory group of OECD on the term royalty and used of equipment. Therefore, the payment does not fall within the meaning of royalty. Tribunal s ruling On a perusal of the agreement it is clear that payments were made for providing web hosting services with all backup, security, maintenance and uninterrupted services. There is no dispute that all the equipments and machines relating to the services provided to the taxpayer are under the control of Rackspace Inc and situated outside India. The Tribunal observed that the taxpayer could not operate or even does not have physical access to the equipments system which clearly indicates that the taxpayer would not be using the equipments but only availing the services provided by Rackspace Inc. The Tribunal relied on the Delhi High Court s decision in the case of Asia Satellite Telecommunications Co. Ltd. and held that when the equipments were not operated, used or under the control of the taxpayer, the payments made for availing the services of Rackspace Inc. could not be treated as royalty. When the payments are not in the nature of royalty as per the tax treaty and under the Act, the recipient of the said payments which does not have PE is not liable to tax in India. When payments are not in the nature of royalty as per the tax treaty and as per the Act, the recipient of the payment being a non-resident which does not have PE in India is not liable to tax. Accordingly, tax withholding is not required under Section 195 of the Act in view of the Supreme Court s decision in the case of GE India Technology Cente P. Ltd 8. Our comments The Tribunal observed that the taxpayer was not using the equipments but only availing the services provided by a non-resident. Further, since the equipments were not operated, used or under the control of the taxpayer, the payments made for availing the services of Rackspace Inc. could not be treated as royalty. 7 Asia Satellite Telecommunications Co Ltd v. DIT  332 ITR 340 (Del) 8 GE India Technology Centre P. Ltd v. CIT  327 ITR 456 (SC)
4 It is important to note the decision of the Delhi Tribunal in the case of Millennium Infocom Technologies Ltd1 where it was held that the payments made to non-residents on account of lease rentals for hosting of websites on servers were not in nature of interest or royalties or fee for technical services or other sum chargeable to tax in India. It is pertinent to note that the Finance Bill, 2012 has proposed to insert an explanation with retrospective effect from 1 June 1976 that Royalty includes consideration in respect of any right, property or information, whether or not the possession or control of such right, property or information is with the payer. Therefore, it would be interesting to analyse various e-commerce payments in light of the proposed amendment.
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