- Tribunal upholds Madras High Court's ruling in Verizon, rules that bandwidth fees are royalties;
- Bandwidth and router management fees considered as payments for the use of 'equipment' or 'process';
- Scope of 'royalties' under Article 12 of the India-US tax treaty not considered.
The Chennai bench of the Income Tax Appellate Tribunal ("Tribunal"), in the case of DCIT v. Cognizant Technology Solutions India Private Limited1, has held that the payments made for bandwidth services and router management services are taxable in India as 'royalty' under Section 9(1)(vi) of the Income Tax Act, 1961 ("ITA"). The Tribunal has based this ruling solely on the decision of the Madras High Court in Verizon Communications Singapore Pte Ltd. v. ITO2 where it was held that payments made for international connectivity services such as bandwidth services are in the nature of 'royalties' under the ITA and the India-Singapore tax treaty on the basis that such payments would qualify as payments made for the use of an 'equipment' or a 'process'.
Cognizant Technology Solutions India Private Limited ("Cognizant"), is engaged in the business of software development and export in India. During the assessment years 2002-03 and 2003-04, Cognizant made payments to a US based company, M/s Sprint USA ("Sprint") for providing bandwidth services via International Private Leased Circuits ("IPLC"). An IPLC is a point to point private line used by an organization to communicate between offices that are in different parts of the globe. Sprint was providing IPLC services to the assessee for internet access, business, data exchange, video conferencing and other telecommunication facilities to enable dedicated high speed connectivity. While Sprint was providing the US based half channel, Videsh Sanchar Nigam Limited provided the Indian half-channel.
Sprint provided inter-connectivity services via private leased circuit and frame relay circuit which allowed Cognizant to connect to its affiliates in a secure and private environment. In addition, Sprint provided router management services i.e. by assuming responsibility for installing and configuring routers at the US and UK based entities of the Cognizant group and at Cognizant's customer sites in the US and UK. The payment to Sprint covered router rental, management, maintenance, installation and software initialization charges.
The payments by Cognizant to Sprint were made without any withholding of tax since Cognizant was of the view that these payments were not taxable in India. The tax officer was of the view that these payments were in the nature of payments for the use of an 'equipment' or 'process' and hence, taxable in India and subject to withholding tax. On appeal, the first appellate authority (Commissioner of Income Tax (Appeals) ("CIT(A)")) held that these payments were made merely for a service and that hence, no withholding tax was applicable.
RULING OF THE TRIBUNAL
The Tribunal reversed the CIT(A)'s decision and held that the payments made were chargeable to tax under the ITA as 'royalty' as they constituted payments for the use of 'equipment' or 'process'. The Tribunal based this conclusion on the decision of the Madras High Court in Verizon3.
In Verizon, the non-resident service provider provided bandwidth and related telecommunication services (involving the transmission of data and voice) in the Asia Pacific region (including India). Accordingly, where the international half of the services were provided by this company, the Indian half was provided by an Indian service provider using its own equipment. Even so, the Madras High Court held that the payments made to the non-resident company were for the 'use of equipment'. In addition, the Court also held that such payments may also be held to be in relation to the 'use of process' since the provision of assured bandwidth and guaranteeing the transmission of data and voice would qualify for the same, irrespective of the fact that the bandwidth is shared with others.
The Tribunal followed this reasoning while concluding that the payments made by Cognizant to Sprint constituted 'royalty' under the ITA.
The tax characterization of contractual payments for services as 'royalties' has become a contentious issue in India in recent years. This is especially so when services involve the use of scientific or technical equipment. Internationally, it is accepted that when payments are made for such services, they are not in the nature of 'royalties' as long as there is no control established over the equipment. For example, the use of a transportation service such as a taxi does not give the passenger control over the vehicle and thus, the payment made for such service is not in the nature of 'royalties'. This view has been endorsed by the OECD Model Commentaries as well.4 This view has specifically been upheld by the Authority for Advance Rulings in India in the Cable and Wireless5 and Dell6 rulings in light of the definition of 'royalties' under the ITA and the concerned tax treaty read together. Likewise, the Delhi High Court has held that payments made for satellite broadcasting services do not constitute royalty since the payments made were not for the use of transponder, but for the service provided.7
In 2012, a retroactive amendment was introduced to the definition of royalties the ITA where it was clarified such payments would be classified as made for the 'use of equipment' and thus, classified as 'royalties' irrespective of the possession or control of the equipment with the payer or use by the payer or the location of the equipment being in India.
However, this retroactive amendment does not impact the definition of 'royalties' in the tax treaties entered into by India. Whilst the definition includes payments for the use or the right to use of industrial, commercial or scientific equipment and the use or the right to use of a secret formula or process as 'royalties', as mentioned above, it has been internationally accepted that payments for satellite broadcasting services, transponder services, bandwidth services etc. are not to be considered 'royalties'. Further, it is also accepted that bandwidth fees cannot be considered as payments for the 'use of process'.
It is an accepted principle in international tax jurisprudence that tax treaties are to be interpreted in 'good faith' and in light of the 'international fiscal meaning'.8 The Chennai Tribunal, in the present case, has unfortunately not considered the definition of 'royalties' under the India-US tax treaty or the internationally accepted approach. This also goes against the decisions of the Bombay High Court in Siemens9and the Delhi High Court in Nokia10where it was held, in the context of 'royalties' that retroactive amendments made under domestic law cannot be relied upon for the interpretation of provisions in tax treaties.
Unilateral approaches such as the retroactive amendment to the definition of 'royalties', in conflict with issues covered by bilateral tax treaties, reduce the possibility of creditability in the other jurisdiction and increases chances for double taxation. It is hoped that the new Government shall put an end to retroactive law-making and foster good faith interpretation and implementation of India's tax treaties.
1 ITA. Nos. 1535, 1536/09, ITA 460 & CO.27/2010, ITA Nos. 751, 864 & 1922/Mds/2010.
2  361 ITR 575 (Mad).
4 Para 9.1, OECD Model Commentary provides as follows:
"9.1 Satellite operators and their customers (including broadcasting and telecommunication enterprises) frequently enter into transponder leasing agreements under which the satellite operator allows the customer to utilize the capacity of a satellite transponder to transmit over large geographical areas.Payments made by customers under typical transponder leasing agreements are made for the use of the transponder transmitting capacity and will not constitute royalties under the definition of paragraph 2; these payments are not made in consideration for the use of, or right to use, property, or for information, that is referred to in the definition of paragraph 2 of Article 12; they cannot be viewed, for instance, as payments for information or for the use of, right to use, a secret process since the satellite technology is not transferred to the customer...."
5 Cable and Wireless Networks India (P) Ltd., In re, 315 ITR 72 (AAR).
6 Dell International Services (India) Pvt. Ltd., In re, 305 ITR 37 (AAR).
7 Asia Satellite v. DIT, 332 ITR 340 (Del HC); Also see Convergys Customer Management Group Inc. v ADIT,  212 Taxman 613 (Delhi) (in respect of link charges)
8 Vienna Convention on the Law of Treaties of 23rd May, 1969, principle followed in Hindalco Industries v. ACIT,  278 ITR 125 (Mum); Modern Threads India Ltd. v. Dy. CIT, (1999) 69 ITD 115..
9 DIT v. Siemens Aktiengesellschaft, ITA No. 124 of 2010 (Bom).
10 DIT v Nokia Networks OY, 253 CTR 417 (Delhi).
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