passive income fts / fis and case study on fts / fis · passive income - fts / fis and case study...

Passive Income – FTS / FIS and case study on FTS / FIS

Geeta Jani

20 December 2014

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20 December 2014

Contents

► Basics

► FTS – under ITA

► FTS - Treaty Scenarios

► Source rule under ITA and Treaties

► Let us self study

Passive Income - FTS / FIS and case study on FTS / FIS

20 December 2014

Rules of Taxation in Cross-Border Transactions

► Foreign Enterprise (FE) pays tax in its home country

► FE “may” pay tax in source country

► Normal Treaty rule of taxing business income : Country of

residence

► Popular exceptions

► Permanent Establishment (PE) in source country

► Fees for Technical Services (FTS)/ Fees for Included Services (FIS)

► Royalties; interest; dividend


20 December 2014

Scope of taxation under ITA

Business income (if not

covered by special rule)

Incomes covered by special

Source Rule (FTS, Royalty,

Interest)

Taxation confined to income

attributable to operations

carried out in India

► Tax trigger based on:

► Status of payer

and/or

► Situs of utilisation

Overseas operations beyond

India tax net

Offshore transactions may

come within tax net


20 December 2014

Fees for Technical Services


20 December 2014

Explanation 2 to S. 9(1)(vii)

…………………. “fees for technical services” means any

consideration (including any lump sum consideration) for the

rendering of any managerial, technical or consultancy services

(including the provision of services of technical or other personnel)

but 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”.


20 December 2014

Explanation 2 to S. 9(1)(vii)

“fees for technical services” means

► any consideration (including any lump sum consideration)

► for the rendering of

► any managerial, technical or consultancy services

► including the provision of services of technical or other personnel

but 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”.


20 December 2014

Fees For Technical Services (FTS) : Domestic Law

► Consideration (including lump sum consideration) for rendering of:

► Technical Services

► Managerial Services

► Consultancy Services

► Includes provision of services of technical or other personnel

► Excludes consideration for:

► Construction, assembly, mining or like project; or

► Amount chargeable as salaries

► Exclusion in respect of services incidental to / inextricably linked to

sale of equipment


20 December 2014

Meaning of „technical‟…

► Dictionary defines „technical‟ as:

► “Involving or concerned with the mechanical arts and applied sciences”

► A „technical‟ service means a service requiring expertise in technology – MOU

to the India USA tax treaty

► OECD TAG Report

► Involves special skills or knowledge related to a technical field

► use of technology in providing a service is not determinative

► delivery of a service via technological means does not make the service

technical

Significance of Human Involvement


20 December 2014

Meaning of „managerial‟…

► OECD TAG Report:

► Services rendered in performing management functions

► Need to give ordinary commercial meaning

► Involves functions related to how a business is run as opposed to functions involved in

carrying on that business

► Management includes the act of managing by direction or regulation or superintendence.

Thus, managerial service essentially involves controlling, directing or administering the

business. [R. Dalmia v/s. CIT (106 ITR 895)(SC)]

► As an illustration, whilst the functions of hiring and training commercial agents would

relate to management, the functions performed by these agents (i.e. selling) would not.

► M/s UPS SCS (Asia) Limited v ADIT (2012) 18 taxmann.com 302 (Mum)

► “Ordinarily the managerial services mean managing the affairs by laying down certain

policies, standards and procedures and then evaluating the actual performance in the

light of the procedures so laid down.


20 December 2014

Meaning of „consultancy‟…

► Dictionaries

► “ The act of asking the advice or opinion of someone (such as lawyer)”

► “…. seek from a presumably qualified personal or an advice, opinion, etc”

► OECD TAG Report

► Services constituting in the provision of advice by someone, such as a

professional, who has special qualifications


20 December 2014

Services not regarded as FTS

► Insurance

► Underwriting services

► Guarantee Fee

► Banking & Finance services

► Logistics, transportation, freight forwarders

► Sales commission & incidental services

► Scope of pure commercial service

► Sales Promotion & Marketing Fee

► Liaison Services


20 December 2014

Scope of „construction‟ exclusion

► “Such activities virtually amount to carrying on business in India

for which considerable expenditure will have to be incurred by

NR and accordingly it will not be fair to tax such consideration

……………… on gross basis or restrict expenditure ……… to

20%” (1976 Circular)

► Exclusion in respect of services which involve man, material and

equipments and comprehensive project execution in the nature of

business enterprise.

► Pure services / identifiable independent services not covered by

exception of S. 9(1)(vii); not consideration towards construction /

assembly / like project


20 December 2014

FTS Exclusion- construction project

► ICo entrusted by FCo with the

responsibility of laying pipeline from

east to west of India

► FCo responsible for comprehensive

contract execution including

engineering, procurement, laying the

lines and related equipments

► ICo has also appointed another

overseas project management

consultant (PMCo) to co-ordinate and

oversee work of Fco & Fco‟s sub

contractors.

► Is payment to FCo FTS?

► Is payment to PMCo FTS?

Paym

ent

for

layin

g p

ipelin

e

Paym

ent fo

r co

-

ord

inatio

n w

ith F

Co


20 December 2014

Pre-condition of Service

► Thrust is on “Services” i.e. rendering of services

► Distinguish : Product (v/s) Services

► Created (v/s) Person agrees to create, develop

► Anticipated Demand (v/s) work begins after settling specifications

► Distinguish : Technical service (v/s) Technology driven service

► Significance of Human intervention


20 December 2014

Procurement of Designs

Designs

Ready Design Customized

Design

Designs are products ? It is technical service ?


Do we see similarity in the context of

customized software v/s. off the shelf software

20 December 2014

Technology driven services

Bharti Cellular BSNL/ MTNL

Interconnection agreement

to facilitate calls made by

subscribers of one network

to another network

Payments for

interconnection/port access

Whether payments made by Bharti for interconnection/ port access be subject to WHT as

FTS?

Bharti Cellular (330 ITR 239) decision and CBDT Instruction 5 of 2011


20 December 2014

Interconnect charges – Delhi High Court Ruling

► The facility of interconnection and port access provided to Bharti by

MTNL / other companies is a service involving sophisticated

technology

► Services rendered by machines and Robots is not technical services

► „Technical service‟ is not to be construed in the abstract and general

sense but in the narrower sense as circumscribed by the expressions

„managerial service‟ and „consultancy service‟

► The expression „technical service‟ would have reference to only

technical service rendered by a human

► Interconnect services regarded as not involving human intervention;

services not regarded as technical


20 December 2014

Bharti Cellular – SC decision (330 ITR 239)

► Apparently agrees on need for human intervention; notes that there is

no technical evidence adduced by tax department

► Directed AO to obtain opinion from tax department‟s expert, to

examine him and to offer him for cross examination

► Directed CBDT to issue directions to all its officers to examine

technical experts so that such matters can be dealt with satisfactorily

and factual data provided to courts

CBDT Instruction # 5/2011 directing assessment in complex matters

only after bringing on record appropriate technical evidence and

endeavoring to obtain opinion of technical experts


20 December 2014

Intervening human intervention!!

► Siemens Ltd. V/s. CIT (142 ITD 1)(Mum)

“……..if any technology or machine developed by human and

put to operation automatically, wherein it operates without any

much of human interface or intervention, then usage of such

technology cannot per se be held as rendering of “technical

services” by human skills. It is obvious that in such a situation

some human involvement could be there but it is not a constant

endeavor of the human in the process.”

► Metro & Metro (Agra Bench)

“It is not a question of more of, or less of, human involvement. It

is, in our humble understanding, the question of presence of or

absence of human involvement.”


20 December 2014

Illustrative list of technology driven services

► Amusement park rides

► Electricity services

► Getting data processed

► Automated control system

► Telecom related services such as internet, leased line, transponder,

etc –

► But to evaluate impact of amendments to royalty definition

► Cloud computing services


20 December 2014

Cloud Computing


20 December 2014

Understanding Cloud

► Definition of cloud computing

“An abstract computing and data storage business method where dynamic IT

capabilities such as hardware (infrastructure as a service), software (software-

as-a-service) and tools (platform-as-a-service) are provided by third parties /

cloud service providers which enables users to store as well as access their data

and applications virtually from anywhere and through any connected device.

► Extract from Wikipedia

“The term "cloud computing" is mostly used to sell hosted services in the sense

of application service provisioning that run client server software at a remote

location. Such services are given popular acronyms like 'SaaS' (software as a

service), 'PaaS' (platform as a service), 'IaaS' (infrastructure as a service), 'HaaS'

(hardware as a service) and finally 'EaaS' (everything as a service). End users

access cloud-based applications through a web browser, thin client or mobile app

while the business software and user's data are stored on servers at a remote

location.”


20 December 2014

Cloud Computing services – Key elements

Software cloud

„Software‟ as a

Service

(SaaS)

Hardware cloud or

Infrastructure cloud

Hardware as a

Service

(IaaS / HaaS)

Cloud

Computing

services


EaaS (Everything as a

service)

Desktop cloud

Platform as a

Service

(PaaS)

20 December 2014

FTS - Treaty Scenarios


20 December 2014

Technical services : Treaty scenarios

► Protection under Treaty because of:

► Absence of FTS Article

► Override due to IPS Article

► “Narrower” FIS (Make available) concept

► Impact of MFN ( Most Favored Nation )

► Restricted Source Rule

But check : Service PE applicability


20 December 2014

Absence of FTS Article

Mauritius Co

(MauCo)

Indian Co

(I Co)

Payment

made

Technical

Services

rendered

► MauCo provides technical

services to I Co in its ordinary

course of business.

► There is no special treatment

envisaged for Technical Fees

under India-Mauritius Treaty

► Is payment to MauCo

Business profits not

chargeable in absence of PE?

► Or , is it Other income?

Better View: Covered by business income and

rule of „no PE – no tax‟ applies


20 December 2014

IPS v FTS

► Treaty has Article on Independent Personal Services (Say,

Professional Fees); Treaty also has Article on FTS

► Treaty may avoid overlap. Eg. Japan, New Zealand, Germany

► If concurrent coverage, can taxpayer avail beneficial of the two

provisions?

► Usually, IPS ropes in fixed base : Individuals, Firms

► Would IPS apply to companies if IPS covers residents ?


20 December 2014

Override of IPS Article

► “Article 12(4) - The term „fees for technical services‟ ……………means

payments ………. to any person other than ……….payments to any

individual for independent personal services referred to in article

14……………………………..”

► ARTICLE 14(1) “Income derived by a resident of a Contracting State

in respect of professional services or other activities of an

independent character shall be taxable only in that Contracting

State……”


Article 12 of India-Japan DTAA excludes from scope of FTS

professional services rendered by individuals and taxable as per

Article 14

20 December 2014

Override of IPS Article

► Joho, a freelancer, specializes in

fixing bug in robotics

► Shivaraja consults Joho for

curing snags in advanced robo

named “Chitti”

► Services rendered by Joho from

Japan

► Is Joho liable to tax in India?

► What if services are rendered by

Joho Corporation, a Japanese

company owned by Joho?

Indian

Resident

Payment for

services

Japan

India

Curing Snags in

„Robo‟

Mr. Joho


20 December 2014

Article 7(7) of OECD Model

► Can there be an argument to support non applicability of FTS taxation

basis that it represents business income and in absence of PE there

is no taxation ?

► Article 7(7) needs to be specifically referred to

“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”


20 December 2014

Fees for Includes Services(FIS) : A narrower variant

► Deals with Technical Services - but, coverage is of FIS

► FIS narrower than FTS

► Definition of FIS as per India-US treaty - Article 12(4)

► technical or consultancy services is FIS if

Services are ancillary and subsidiary to the application or enjoyment of the right, property or information

giving rise to royalty

make availabletechnical

knowledge, experience,

skill, know-how or processes

consist of the development and transfer of a technical

plan or technical design


20 December 2014

Services Ancillary & Subsidiary to IPR enjoyment

► The „predominant purpose‟ test:

► enjoyment of the right, property, or information paramount

► Services to be „directly related‟ to the application or enjoyment of IPR

► Determining factors

► Extent to which services facilitate effective application of IPR

► Are these customarily provided in ordinary business arrangements ?

► Is it insubstantial in overall value?

► Is it part of single contract ?

► Rendition by same or related parties ?


20 December 2014

► Person acquiring the service is enabled to apply the technology

embedded in the services provided to him independent of the service

provider

► The technical knowledge or skills of the provider should be imparted to

and absorbed by the receiver so that the receiver can deploy similar

technology or techniques in future without depending on the provider.

► Brings in an element of enduring benefit

► Ability to replicate without recourse to service provider

► Mere requirement of technical input by a person providing services does

not necessarily mean that technical knowledge is “made available”

► Use of a product which embodies technology cannot be considered to

make technology available

Concept of „make available‟…

“Make Available” significantly narrows down the scope of FIS/FTS


20 December 2014

FIS make available : Training services / conference participation


Royalty / FIS

Training

incidental to

imparting of

know-how

Royalty / FIS

Training

imparting skill

and experience

Primarily for

acclimatization of

general topics

►Not royalty / FIS

Workshops /

conferences of

short duration

20 December 2014

Development & Transfer of Technical Plan

► US Co engaged for rendering basic

& detailed engineers designs of „sea-

link‟ to be constructed by ICo

► Designs are specific to the project

► ICo is most likely to tie-up with US

Co for getting design of another such

sea link project that ICo is likely to

pursue

► ICo believes that US Co has not

made available technical skill of US

Co to ICo & hence payment is not

FIS so as to trigger tax in India.

► Do you agree?

US Co

I Co

Payments

made

Providing project

specific designs for

building sea link

US

India


20 December 2014

FIS : Popular treaty exceptions to FIS

► Services for personal use of individuals

► Teaching in or by educational institute

► Services ancillary and subsidiary, as well as inextricably and

essentially linked to the sale of property

Treaties with US, UK, Singapore, Australia, Canada, etc. have the concept of

“make available” in the FTS definition


20 December 2014

FTS and impact of MFN Clause

► MFN triggers favourable tax implications

► “………….. Most-favoured nation clauses are occasionally included in tax

treaties. These typically have the effect of requiring one of the contracting

states to grant similar tax benefits to residents of the other contracting state to

the extent it grants such benefits (e.g. by way of a bilateral tax treaty) to

residents of other countries and those benefits are more favourable than

those in the tax treaty between the two contracting states. (source – IBFD

International Tax Glossary)

► India‟s DTAAs with Netherlands, France, UK, Spain, Belgium, Switzerland,

Israel, Sweden, Hungary, Finland have MFN clause

► MFN may restrict FTS to FIS – without consequential service PE trigger

though treaty clause may have FIS with service PE


20 December 2014

Some Fundamentals

► Anchors of treaty entitlement:

► Treaty residence

► Beneficial ownership

► Impact of LOB [E.g.: Dubai, USA]

► TRC requirement under ITA

► Separate treatment in respect of FTS effectively connected with PE

► Consequential TDS obligation and default implications

► Significance of treaty entitlement post ITL providing 25% ++ rate for FTS, royalty


20 December 2014

Certain topical issues


20 December 2014

Provision of services of technical or other personnel

► Situation 1 : F Co‟s obligation to

provide technical services and F Co

responsible for service performance

► Situation 2 : F Co a recruiting / hiring

company identifying right technical

resource for I Co for recruitment free

► Situation 3 : F Co while being legal

employer seconds its employees to

I Co

US Co

I Co

Se

rvic

e C

ontr

act (S

it1

)

Provisioning of

services through

technical or other

personnel

Se

con

dm

ent C

ontr

act

Sit 3

)

Employees of ICo

Under situation 3, critical to determine if

I Co is an employer during secondment

period paying salary / reimbursing

salary paid by F Co.


OR

20 December 2014

Reimbursement of Cost V cost of rendering services

► Reimbursement

of cost defrayed

on behalf of

service availer is

not

consideration for

service

► Routing of third

party cost

through an

affiliate / agent

► Reimbursement of

incidental cost of

services is not

income if payer

obligated to meet

the cost/ provide

facility.► Direct defrayal of

cost of travel, etc.

at par with actual

reimbursement to

service provider.

Cost incidental

to render

services

Cost paid on

behalf of service

availer

Reimbursement means “Restore back” or “Refund back”

► Towards common /

joint procurement of

services, good, etc.

from third party.

► Towards

maintenance of

common

infrastructure jointly

owned.

► Towards common/

joint research► Contribution is not

royalty as IP is still

under development

Cost contribution

arrangement

► Cost (+) a popular

model for

determination of

service fee in case

of low risk service

entity

► Cost for rendering

core services

need to be

distinguished from

incidental cost

Services under

cost plus model


20 December 2014

Source Rule under ITA


20 December 2014

S. 9(1)(vii)

1) The following incomes shall be deemed to accrue or arise in India

(vii) income by way of fees for technical services payable by

a) the Government; or

b) a person who is a resident, except where the fees are

payable in respect of services utilised in a business or

profession carried on by such person outside India or for

the purposes of making or earning any income from any

source outside India; or

c) A person who is a non-resident, where the fees are

payable in respect of services utilised in a business or

profession carried on by such person in India or for the

purposes of making or earning any income from any source

in India;


20 December 2014

Section 9(1)(vii) – ambit of source rule

Status of Payer Coverage

The Government No exception In all cases

Resident of India Excluded

only if

► Utilised for business /

profession of resident

outside India (or)

For source of income

outside India

Non-resident

Included

only if

► Utilised for business /

profession of NR in

India (or)

For source of income

in India


20 December 2014

Section 9(1)(vii)- ambit of source rule

► FTS receipt taxable in India regardless of:

► Residential status of recipient

► Situs and mode of rendition of services

► Purpose whether personal or non personal

► Situs and currency of receipt

► Situs of conclusion of contract

Cont….

How crucial is territorial nexus in the form of rendition and utilization of services in India?

Impact of subsequent amendments to section 9.


20 December 2014

Scope of 9(1)(vii) Deeming Fiction : Exclusion qua Resident

Is Mr. Lee to pay tax in India?

For use in ICO‟s branch at China


20 December 2014

Scope of 9(1)(vii) Deeming Fiction : Inclusion qua NR

Is Mr. Lee to pay tax in India?

Payment

Services


20 December 2014

Source Rule under ITA*

► Info-Pro (ICO) proposes to acquire

existing company in Brazil (B Co).

► It engaged a professional firm

from Brazil (BLF) to undertake

feasibility & due diligence analysis

► Based on the report, a decision is

taken after the year end not to

acquire B Co

► Is BLF liable to pay tax in India?

* Ignore treaty provisions for the time being.

Brazilian Law

Firm (BLF)

Info Pro

(ICo)

Proposed

target

B CO

Brazil

India

Payment

made


20 December 2014

„Source‟ of FTS paid in connection with export activity

► An Indian company (ICo), exports its

products to UK.

► Sale of products in the UK is allowed

only if such products are certified

and allowed fit for use in UK as per

the specified certification procedures

► ICo availed certification services of

FCo

► Export contracts concluded in India ,

goods manufactured and exported

from India

► ICO claims certification services

utilised for business or source of

income outside India

► Please advise

FCO

India Co

(I Co)

UK

India

Testing &

Certification

service Payments

made


20 December 2014

Source rule under treaties


20 December 2014

Source rule - DTAA

► General Source rule :

► Payer rule: deemed to arise in India when the payer is

a) Indian State itself, a political sub-division, a local authority of India

b) a resident of India.

► PE rule: arises in country of PE if

a) liability to pay FTS is incurred in connection with PE; and

b) fees are borne by such PE

► PE can be of enterprises of treaty residents or any third country

person


20 December 2014

Significance of PE linked Source Rule

► Soft Co, an Indian company is in

the business of development of

software

► Soft Co established an overseas

office for marketing and onsite

support

► Overseas branch appoints FCo

for designing interiors of office

► Is payment to FCo protected by

PE source rule of the treaty ?

Payment

Services

Overseas


20 December 2014

Restricted source rule – few peculiar DTAAs

► Article 12(6) of India Japan DTAA

Fees for technical services shall be deemed to arise in a Contracting

State (India) when the payer is that Contracting State (India) itself, a

political sub-division, a local authority thereof or a resident of that

Contracting State (India). ……………………..

► Article 13(5) of India Israel DTAA

Fees for technical services shall be deemed to arise in a Contracting

State (India) when the services are rendered in that State (India)

and the payer is that State (India) itself, a political sub-division, a local

authority or a resident of that State (India)


20 December 2014

Restricted source rule – few peculiar DTAAs

► Article 12(5) of India Finland DTAA

Fees for technical services shall be deemed to arise in a

Contracting State (India) when the payer is that (India)

State itself, a political sub-division, a local authority, or a

resident of that State (India). Where, however,

……………… when the fees for technical services relate

to services performed, within a Contracting State

(Finland), then such fees for technical services shall be

deemed to arise in the State in which the services are

performed (Finland).


20 December 2014

Let us self study


20 December 2014

Certain issues

► Treaty provides rate of 10%. Will you increase it by SC + EC?

► Is taxation under treaty triggered only when amount is paid or can the

tax trigger even on accrual basis ?

► FCo does not obtain PAN : Can treaty rate control application of S.

206AA?


20 December 2014

Evaluating coverage of FTS and FIS

Issue FTS FIS

Commission paid for purchase of sophisticated

CNC machine

Underwriting commission

Getting samples of mineral ores tested from

laboratory at Japan

Charges for one time advice on configuring and

dealing with technical snags in operation of

infrastructure of cloud computing

Professional fees paid to attorney for filing suit

on account of patent infringement


20 December 2014

Evaluating coverage of FTS under ITA

Issue FTS FIS

Designing of an airport to be built at Navi

Mumbai

Buying costly book which contains repository of

complex designs

Charges paid for getting product advertised on

foreign TV channels. TV channels air the

programme making use of most advanced and

sophisticated technology


Thank You

“This Presentation is intended to provide certain general information existing as at the time of

production. This Presentation does not purport to identify all the issues or developments. This

presentation should neither be regarded as comprehensive nor sufficient for the purposes of decision-

making. The presenter does not take any responsibility for accuracy of contents. The presenter does

not undertake any legal liability for any of the contents in this presentation. The information provided is

not, nor is it intended to be an advice on any matter and should not be relied on as such. Professional

advice should be sought before taking action on any of the information contained in it. Without prior

permission of the presenter, this document may not be quoted in whole or in part or otherwise.”

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