Section 9, of the Income-tax Act, 1961, read with article 12

Words and phrases - ‘Use’ as occurring in clause (iva) of Explanation 2 to section 9(1)(vi) of the Income-tax Act, 1961 Facts The applicant is a company registered in India. It is a part of the Dell group of companies and is mainly engaged in the business of providing call centre, data processing and information technology support services to its group companies. It has entered into an agreement with BTA, a non-resident company formed and registered in the USA, under which BTA provides the applicant with two-way transmission of voice and data through telecom bandwidth. While BTA provides the international half-circuit from the US/Ireland, the Indian half circuit is provided by the Indian telecom company, namely, VSNL, with whom BTA has a tie-up. The bandwidth so provided by BTA would give full coverage in both the countries of delivery, i.e., the USA and India. Under the agreement, a fixed monthly recurring charge for the circuit between America and Ireland and for the circuit between Ireland and India is payable to BTA. The payment to BTA is to be net of any Indian taxes, including withholding taxes, as may be applicable. The applicant seeks advance ruling on the following questions : (1) Whether the amount payable by it to BTA under the terms of the agreement would be in the nature of ‘fees for included services’ within the meaning of the term in article 12 of the Treaty; (2) Whether the amounts so payable would be in the nature of ‘royalty’ within the meaning of the term in article 12 of the Treaty; (3) Whether the amounts so payable would be in the nature of ‘fees for technical services’ within the meaning of the term in the Explanation 2 to clause (vii) of section 9(1); (4) Whether the amounts so payable would be in the nature of ‘royalty’ within the meaning of the term in the Explanation to clause (vi) of section 9(1); (5) Whether the amounts paid by it are for the purposes of making or earning any income from any source outside India and, hence, are covered within the exception carved out in section 9(1)(vii)(b) or section 9(i)(vi)(b); (6) Whether it is required to withhold taxes under section 195 on payments made to BTA as per the agreement; and (7) Whether the declaration of BTA that it does not have a ‘permanent establishment’ in India as defined in article 5 of the Indo-US Treaty is correct, and if so, whether and to what extent, it has bearing on the applicant’s obligation to withhold tax on payments made to BTA. The applicant contends that the agreement and arrangement entered into with BTA does not involve the use or right to use any equipment within the meaning of clause (iva) of the Explanation 2 to section 9(1)(vi) or article 12(3) of the Treaty and, therefore, the consideration paid by it to BTA is not in the nature of royalty. On the other hand, the revenue contends that use of equipment clause which is common to both, the Treaty and section 9(i)(vi), is squarely attracted in the instant case as the access line consisting of circuits is within the reach of the applicant and it is through that private line/access line and related equipment placed at its premises in India, that the required bandwidth is provided. The revenue further contends that services are merely incidental to BTA, granting right to use or permitting the ‘use’ of its point-to-point circuit by the applicant and, therefore, the consideration charged partakes the character of ‘royalty’ as defined in section 9 and article 12 of the Treaty. HELD Applicability of clause (iva) of Explanation 2 to section 9(1)(vi) The applicant highlights the fact that everywhere in the agreement, the emphasis is on service element and nowhere the user of equipment by the applicant or the grant of rights for such user is contemplated. It is a case of rendition of service by BTA, using its own network and equipment. There is considerable force in the applicant’s submission. ‘Service’ is an unbroken thread running through the entire fabric of agreement between the parties. Even in the clauses specifying the charges and payment terms, the expression used is ‘recurring charges’. It is only in clause 2.1 wherein the ‘service description’ is given, the expression ‘rental charges’ is used and the same expression, i.e., ‘monthly rental’ is repeated in the Order Form. But one has to read the agreement as a whole and try to harmonize the clauses in the agreement when different expressions are used to convey the same idea. The label given to a transaction or the description of jural relationship is not important, much less decisive, more so where divergent terms are used in the same agreement. [Para 12] Legally and in ordinary sense, the expression ‘rental’ denotes the consideration paid in a transaction of lease or hire. Such transaction pre-supposes the transfer of interest in the property or goods. Right to exclusive possession/custody and enjoyment thereof over a stipulated period of time are its necessary attributes. There is nothing in the agreement in question, which indicates that particular equipment has been leased out to the applicant and the applicant has been put in exclusive custody and control thereof. Provision of telecom bandwidth facility by means of dedicated circuits and other networks installed and maintained by the BTA or its agent does not, in the absence of specific and clear indication, amount to a lease of equipment. The expression ‘rental’ used here and there in the agreement is not used in its legal sense nor can it be treated as a decisive factor. [Para 12.1] The language of clause (iva) pertaining to definition of royalty or for that matter, the language in the Treaty cannot be confined to pure and simple lease transactions. The phraseology ‘the use of or right to use the equipment’ is wider in scope and can cover transactions which are not in stricto sensu ‘leases’. Transactions falling short of definition of ‘lease’ and having substantial similarities with lease or hire can also be brought within the sweep of clause (iva) of the said Explanation and article 12(3). [Para 12.3] The two expressions ‘use’ and ‘right to use’ are employed to bring within the net of taxation the consideration paid, not merely for the usage of equipment in praesenti, but also for the right given to make use of the equipment at future point of time. There may not be actual use of equipment in praesenti, but under a contract the right is derived to use the equipment in future. In both the situations, the royalty clause is invokable. [Para 12.5] The expression ‘use’ has a variety of meanings and is often employed in a very wide sense, but the particular meaning appropriate to the context should be chosen. [Para 12.7] The word ‘use’ in relation to equipment occurring in clause (iva) is not to be understood in the broad sense of availing of the benefit of an equipment. The context and collocation of the two expressions ‘use’ and ‘right to use’ followed by the word ‘equipment’ suggests that there must be some positive act of utilization, application or employment of equipment for the desired purpose. If an advantage is taken from sophisticated equipment installed and provided by another service provider, it is difficult to say that the recipient/customer uses the equipment as such. The customer merely makes use of the facility, though he does not himself use the equipment. [Para 12.8] There is no doubt that the entire network consisting of under-sea cables, domestic access lines or the BT equipment - whichever is kept at the connecting point, is for providing a service to facilitate the transmission of voice and data across the globe. One of the many circuits forming part of the network is devoted and earmarked to the applicant. Part of the bandwidth capacity is utilised by the applicant. From that, it does not follow that the entire equipment and components constituting the network is rented out to the applicant or that the consideration in the form of monthly charges is intended for the use of equipment owned and installed by BTA. The questions to be asked and answered are: (1) Does the availment of service involve user of equipment belonging to BTA or its agent by the applicant? (2) Is the applicant required to do some positive act in relation to the equipment, such as operation and control of the same in order to utilize the service or facility? (3) Does the applicant deal with any BTA equipment for adapting it for its use? Unless the answer is ‘yes’, the payment made by the applicant to BTA cannot be brought within the definition of ‘royalty’ under clause (iva). On facts, it is clear that the answer cannot be in the affirmative. Assuming that circuit is an equipment, it cannot be said that the applicant uses that equipment in any real sense. By availing of the facility provided by BTA through its network/circuits, there is no usage of equipment by the applicant except in a very loose sense, such as using a road bridge or a telephone connection. The user of BTA’s equipment, as such, would not have figured in the minds of the parties. The expression ‘use’ occurring in the relevant provision does not simply mean taking advantage of something or utilizing a facility provided by another service provider through its own network. What is contemplated by the word ‘use’ in clause (iva) is that the customer comes face-to-face with the equipment; operates it or controls its functioning in some manner, but if it does nothing to or with the equipment (in this case, it is circuit, according to the revenue) and does not exercise any possessory rights in relation thereto, it only makes use of the facility created by the service provider who is the owner of entire network and related equipment. There is no scope to invoke clause (iva) in such a case because the element of service predominates. [Para 13.1] Usage of equipment connotes that the grantee of right has possession and control over the equipment and the equipment is virtually at his disposal. But, there is nothing in any part of the agreement which could lead to a reasonable inference that the possession or control or both has been given to the applicant under the terms of the agreement in the course of offering the facility. The applicant is not concerned with the infrastructure or the access line installed by BTA or its agent or the components embedded in it. The operation, control and maintenance of the so-called equipment, solely rests with BTA or its agent being the domestic service provider. The applicant does not, in any sense, possess, nor does it have access to the equipment belonging to BTA. No right to modify or deal with the equipment vests with the applicant. In sum and substance, it is a case of BTA utilizing its own network and providing a service that enables the applicant to transmit voice and data through the media of telecom bandwidth. The predominant features and underlying object of the entire agreement unerringly emphasize the concept of service. The consideration paid is relatable to the upkeep and maintenance of specific facility offered to the applicant through the BTA’s network and infrastructure so that the required bandwidth is always available to the applicant. The fact that the international circuit as well as the access line is not meant to offer the facility to the applicant alone, but it ensures to the benefit of various other customers is another pointer that the applicant cannot be said to be the user of equipment or the grantee of any right to use it. May be, a fraction of the equipment in visible form may find its place at the applicant’s premises for the purpose of establishing connectivity or otherwise. But, it cannot be inferred from this fact alone that the bulk of consideration paid is for the use of that item of equipment. [Para 13.2] In cases where the customers make use of standard facility like telephone connection offered by the service provider, it does not admit of any doubt that the customer does not use the network or equipment of the service provider. But, where the service provider, for the purpose of affording the facility, has provided special infrastructure/network, such as a dedicated circuit (as in the instant case), controversies may arise as to the nature of payment received by the service provider, because it may not stand on the same footing as standard facility. However, even where an earmarked circuit is provided for offering the facility, unless there is material to establish that the circuit/equipment could be accessed and put to use by the customer by means of positive acts, it does not fall under the category of ‘royalty’ under clause (iva) of the Explanation 2 to section 9. [Para 13.3] Whether the payment made by the applicant to BTA is in the nature of royalty falling under clause (iii) of Explanation 2 to section 9(1)(vi) and/or article 12(3) of the Treaty ? The expression in article 12(3) is ‘for the use of or the right to use any copyright, patent, trademark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience’. It is, thus, clear that formula/process is part of the same group and the adjective ‘secret’ governs both. Going by such interpretation, it cannot be held that there is, in the instant case, the use of or the right to use a secret process. In fact, it is nobody’s case that any secret process is involved here and the applicant makes use of it. The use of secret process is alien to the minds of contracting parties. Incidentally, similar bandwidth services through private circuits are being provided by many other telecom operators. Hence, the definition of ‘royalty’ under the Treaty relating to secret process is not attracted here. [Para 14.1] Whether the amounts payable by the applicant under the agreement would be in the nature of ‘fee for included services’ within the meaning of article 12(4) or ‘fee for technical services’ within the scope of Explanation 2 to section 9(1)(vii) of the Act These questions need not be discussed at length because it has been fairly and correctly stated by the revenue that the requirement of article 12(4) of the Treaty that technical knowledge, experience, skill, etc., should be made available, has not been satisfied in the instant case. In view of such language, the ambit of technical service has been considerably reduced in scope. The phrase ‘make available’ occurring in article 12(4) has been clarified in the MoU to the Treaty itself to the situations where the person receiving the service is enabled to apply the technology. As there is no transfer of any technology in the sense that the recipient of the service is enabled to apply technology by itself, the payment does not constitute ‘a fee for included service’. When the applicant gets the advantage of the Treaty provision, there is no need to enter into a discussion on the applicability of the relevant provision of the Income-tax Act, 1961. Accordingly, it is ruled that the payments are not in the nature of ‘fee for included services’ under article 12(4). [Para 15] Whether the amounts paid by the applicant are for the purposes of making or earning any income from any source outside India and, hence, covered within the exception carved out in section 9(1)(vii)(b) or 9(1)(vi)(b) of the Act Sub-clause (b) of clause (vi) of section 9 carves out an exception to the taxability of royalty paid by a resident. According to the ‘exception’, the royalty payable in respect of any right, property or information used or services utilised : (a) for the purpose of business or profession carried out by such person outside India or; (b) for the purpose of making or earning any income from any source outside India is not an income that falls within the net of section 9. The applicant is relying on the second part of the exception, i.e., ‘for the purposes of making or earning any income from any source outside India’. It is the case of the applicant that its business principally comprises of export revenue in the sense that it provides data processing and information technology support services to its group companies abroad and receives payment in foreign exchange against such exports. Therefore, although its business is carried out from India, yet the income it gets is from a source outside India and the payment it makes to BTA is for the purpose of earning income from a source outside India. Hence, according to the applicant, the benefit of exception envisaged by section 9(1)(vii)(b) will be available to it. In the context of this argument, it is pointed out by the applicant that the two limbs of clauses (a) and (b) supra are distinct and the mere fact that the business is carried on in India and not outside India does not come in the way of invoking the exception provided by the latter limb, i.e., for the purpose of earning income from a source outside India. It was difficult to accept the applicant’s contention. No doubt, the factum of the applicant carrying on business in India does not come in the way of its getting the benefit of the exception. It is possible to visualize the situations in which the business is carried out principally in India whereas a particular source of income is wholly outside India but, that is not the situation here. The income which the applicant earns by data processing and other software export activities cannot be said to be from a source outside India. The ‘source’ of such income is very much within India and the entire business activities and operations triggering the exports take place within India. The source, which generates income, must necessarily be traced in India. Having regard to the fact that the entire operations are carried on by the applicant in India and the income is earned from such operations taking place in India, it would be futile to contend that the source of earning income is outside India, i.e., in the country of the customer. Source is referable to the starting point or the origin or the spot where something springs into existence. The fact that the customer and the payer is a non-resident and the end product is made available to that foreign customer does not mean that the income is earned from a source outside India. [Para 16.1] There is another angle from which the issue can be approached. The network of telecommunication facility availed of by the applicant for the purpose of two way transmission of voice and data is not for the avowed purpose of making or earning income from a source outside India. Nothing precludes the applicant from making use of the facility which it secured for the purpose of its business in India. That is why the applicant has cautiously used the words that it ‘is, inter alia, engaged in the business of providing call centres and data processing and information technology support services to its group companies’ and at another place, the expression used is ‘principally comprises of export revenues’. No material has been placed to show that the network is not being availed of and not meant to be availed of for doing similar business within the country. It cannot, therefore, be said that the payments made to BTA for establishing and maintaining the requisite telecommunication network is for the purpose of earning income from a source outside India only. Another hurdle that comes in the way of the applicant is that it cannot be said with certainty that the transfer has taken place outside India. The property could have very well passed in India, even though the terminating point of export is in a foreign country. There is no material in this regard to come to a definite conclusion. [Para 16.2] Permanent establishment For the purpose of hearing, the applicant made it clear that it was not in a position to obtain any further information from BTA and the question of existence of PE may, therefore, be kept open for decision by the appropriate authority. In that background, no finding is given on the point of existence of the PE. This question may be left open for determination by the appropriate authority. [Para 17.1] Whether the applicant is required to withhold taxes under section 195 on payments made to BTA as per the agreement and to what relief the applicant is entitled to These questions would have been answered straight away in favour of the applicant, but for the fact that the issue regarding permanent establishment still lingers. Unless the concerned authority decides the same in an appropriate proceeding under the Act, the applicant will not be in a position to deviate from the previous practice of deducting tax and to get the relief which could have otherwise flown from this ruling. However, it is open to the applicant to take resort to sub-sections (2) and (3) of section 195 or other relevant provision of the Act and seek a determination by the authority concerned in the light of this ruling. Any such application has to be disposed of most expeditiously. [Para 18.2] Ruling Payment is not liable to be treated as fee for included services within the meaning of the article 12 of the Treaty. Payment is not ‘royalty’ within the meaning of the term in article 12 of the Treaty or the Explanation 2 to clause (vi) of section 9(1). The exception carved out in sub-clause (b) of clauses (vi) & (vii) of section 9(1) cannot be invoked by the applicant. Case review Rashtriya Ispat Nigam Ltd. v. CTO [1990] 77 STC 182 (AP); BSNL v. UOI [2006] 3 STT 245 (SC); Skycell Communication Ltd. v. Dy. CIT [2001] 251 ITR 53/119 Taxman 496 (Mad.) and Asia Satellite Telecommunications Co. Ltd. v. Dy. CIT [2003] 85 ITD 478 (Delhi) Distinguished. Cases referred to Rashtriya Ispat Nigam Ltd. v. CTO [1990] 77 STC 182 (AP) [Para 12.5], BSNL v. Union of India [2006] 3 STT 245 (SC) [Para 12.6], Skycell Communication Ltd. v. Dy. CIT [2001] 251 ITR 53/119 Taxman 496 (Mad.) [Para 13.6], Wipro Ltd. v. ITO [2003] 86 ITD 407 (Bang.) [Para 13.6], Asia Satellite Telecommunications Co. Ltd. v. Dy. CIT [2003] 85 ITD 478 (Delhi) [Para 14.1], Panamsat International Systems Inc. v. Dy. CIT [IT Appeal No. 1796 (Delhi) of 2001, dated 11-8-2006] [Para 14.1], Rhodesia Metals Ltd. v. Commissioner of Taxes [1941] 9 ITR (Suppl.) 45 [Para 16], Synopsis India (P.) Ltd. v. ITO [IT Appeal No. 919 (Bang.) of 2002] [Para 16.1] and CIT v. Akliengesellschaft Kuhnle Kopp & Kausch W. Germany by BHEL [2002] 125 Taxman 928 (Mad.) [Para 16.1]. N. Venkataraman, Ms. K. Indira and Pramod Jain for the Applicant. S.D. Kapila, Yeshwant U. Chauvan and Prakash Chand Yadav for the Department.