Principally, all the income of a Resident Indian, whether accrues or arises to him in India or outside India is taxable in India. However, all the income of a Non-Resident is taxable in India only if the income accrues or arises to him in India. It is therefore important to understand which are the kinds of income that accrues or arises to a NR in India. This is important to know because if any payment is made to a NR which is taxable in India, it is obligatory on the part of the payer to deduct and pay tax (TDS or Withholding tax) from the payment so made as per section 195 of The Income Tax Act.
Consider a payment made by a resident to a NR against import of goods from the NR. The payment, by and large, will not be taxable in India because this is "Business Income" of the NR and such income is not taxable in India except under exceptional circumstances of NR having a Permanent Establishment in India.
However, if a payment made by a resident to a NR against NR rendering certain services to the resident India, a question arises whether such income accrues or arises in India and whether such income is taxable in India on which tax needs to be deducted at source.
Section 9 of The Income Tax Act provides a deeming fiction whereby certain categories of income are deemed to be accrue or arise in India. According to Section 9(1)(vii), income by way of fees for technical services payable by 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
The fees for technical services is defined to mean any 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".
Generally, Article 12 of the bilateral treaty between countries refers to the scope and taxability of income by way of Fees for Technical Services. While it is important to read the coverage of FTS in individual treaty, generally its scope in the treaty is either similar to or narrower than the scope and coverage prescribed in the Indian Income Tax Act.
As can be seen, however, there are three limbs in the defination of Fees for Technical Services (FTS) i.e. 1) Managerial Services; 2) Technical Services and 3) Consultancy Services. It is vital to understand individual meaning of all these 3 limbs to check if the payment falls within the defination of FTS.
Managerial Services: Though the term Management is not defined in the Act, the dictionary meaning of Management is "a process of planning, decision making, organizing, leading, motivation and controlling the human resources, financial, physical, and information resources of an organization to reach its goals efficiently and effectively."
The Management services necessarily involve application of knowledge, skill or expertise in the control or administration of conduct of the enterprise or an organisation. The term management needs to be understood in commercial parlance that encompasses characteristics like 'Control', 'Direction' and 'Administration' of business of the enterprise. The services must deal with all or significant part of management of an enterprise.
Some of the key characteristics of management services would include:
- Defining, evaluating and developing Goals of an organisation;
- Getting the organisation adopt to the policies and procedures;
- Checking and supervising the effectiveness of the policies;
- Scrutinising effectiveness of the policies and if required Modify, change or replace it.
Further, any service to be regarded as management service, there has to be a definite human element in rendering the same. There has to be an application of human mind. Managerial service will always have a human interface or human intervention while rendering such service.
Technical Services: The ordinary meaning of the term technical involve application of specialised knowledge, skill or expertise in the field of arts, science, profession or occupation like Law, Architect, Medicine, Engineer, Accounting and such profession. Such skills are required for rendition of such technical services. Accordingly, when fees are received against provision of such services with the use of above knowledge, skill or expertise would be fees for technical services under this provision of the Act.
Again, there has to be rendition of services to the service recipient. A mere use of standard facility does not result into provision of technical services although such facilities are developed with the use of technology. The receipt of fees must be as a result of rendition of certain services.
It was held by the Delhi Tribunal in the case of Bharati Cellular that mere collection of fees for use of standard facility provided to all those who are willing to pay for it did not amount to fee having received for technical services.
In the defination of Fees for technical services, the word technical is placed between managerial and consultancy. All the three words have to be read in conjunction with each other. It cannot be read in isolation to each other. The meaning of the word technical service would take colours from managerial and consultancy services. Likewise, in other services, the element of human intervention is necessary while rendering technical services.
Interestingly, in the A.P.Moller Maersk case, Supreme Court observed that while human intervention is necessary in rendering technical services, it cannot be lost sight that modern day scientific and technological development and fully automated processes may tend to blur specific human element necessary to provide services. It is actually the feature of 'Special, exclusive and customised services' which caters to specific needs of customers which is the distinguishing factor between 'service provided' and 'facility offered'. In absence of the above, it cannot be said to be rendering technical services.
Some of the bilateral treaties that India has signed with some of the countries has much narrower defination of the term fees for technical services. It is referred to as 'Fees for Included Services' or 'Make Available' concept. It limits the scope of applicability of technical services. When the service provider imparts the technical knowledge or technology and the service recipient absorbs such technical knowledge in a way that enables them to use this technology independently in future without the help of service provider. In other words, the service recipient derives enduring benefit, he is equipped with the knowledge and technology to utilise such knowledge and technology in future on its own, independently, without any recourse to the service provider. This concept of make available is found in treaties with developed countries like USA, UK and Singapore.
Explaining the concept of 'Make Available', The Karnataka High Court in the case of De Beers India had observed that the crux of the matter is after rendering such technical services by the service provider, whether the assessee is enabled to use the technology independently which the service provider had used. The assessee must derive an enduring benefit and in a position to utilise the knowledge, know-how in future on its own, without recourse to the service provider.
Consultancy Services: Consultancy services would mean advisory services provided by a professional and it arises out of deliberation between two parties. Usually consultancy services are professional services requiring specialised qualification, knowledge, skills and expertise. These services are more dependent on the skills, intellect and individual characteristics of the person rendering it.
Provision of consultancy services would include services like market survey, Legal, financial, location of new business opportunity, advising on production related issues, advising on business strategies, advising on development of technology platform, systems and such related services.
In case of Composite contracts, where payment has been made to foreign vendors for import of equipment and towards installation, commission and supervision activities, the payment will not be considered within the purview of Fees for technical services. The Mumbai Tribunal in the case of Gujarat Pipavav Port and Jabalpur Tribunal in the case of Birla corp. held that when there is an overlap between Article on Fees for Technical Services and Article on Construction PE, specific will prevail over general. Accordingly, Article 5 on Construction PE will prevail over Article 12 on Fees for technical services. In such cases, even if the payment is in the nature of FTS, if the threshold time limit as specified in the applicability of construction PE is not crossed, such payment will not be regarded as taxable in India.
A question arises is whether commission paid to a non-resident to secure export orders would be regarded as payment made towards rendering fees for technical services. Ahmedabad Tribunal in the case of Welspun opined that commission paid against securing export orders is Business Income for the recipient and not towards fees for technical services. Even if one assumes that there existed technical services, the triggering point of payment is not in rendering of technical services but is that of securing export order. Similarly, it was held by the Mumbai Tribunal in the case of Credit Suisse AG that 'Referral fee' paid for referring customers to the Indian branch is a Business Income of the recipient and the payment was not towards fees for technical services.
Kolkata Tribunal made an interesting observation in the case of Emami Paper when they made a distinction between 'contract of work' and 'contract of service'. The Company hired a Polland Company to dismantle and pack sea-worthy machines, stuffing all items into container and loading container on the truck. The Tribunal observed that this task predominantly involved physical work which cannot be considered as fee for technical service. The pre-requisite of a service being regarded as FTS is involvement of mental, intellect, knowledge etc.
Sometimes, the foreign company, typically the parent company, send their staff or managerial level person to work on secondment or deputation in India for their Indian subsidiary company. In such cases it is important to verify the actual terms of understanding between both the companies, the role and responsibility of the personnel deputed, in whose supervision and direction the personnel in India works under. There are various facets that need to be understood and then decide whether the payment will be governed under FTS or will be regarded as Salary.
If the foreign company has a Permanent Establishment (PE) in India and if the payment towards fees for technical services is made to the foreign company which is effectively linked to the PE, the payment, although is in the nature of FTS, would be taxed as Business Income under Article 7 of the treaty.
Before coming to any conclusion about taxability of FTS, it is very important to check and understand the Article in the respective bilateral treaty with the country of resident of the recipient. In some of the Indian treaties, one of the limbs of managerial, technical and consultancy service is excluded while in some other treaties the entire article on FTS is excluded. In such circumstances, one would like to check in detail the nature of the payment. Payment in such cases is likely to be considered under Article 7 on Business Income.
Further, if the payment is made to an individual or in many cases to a firm, one must refer to Article 15 on Independent Personal Services (IPS) to verify whether the payment would be covered under the FTS or under IPS. The scope, coverage and limitation of applicability of tax in both the cases would be significantly different.
As can be seen from above, there are various aspects that need to be checked and verified as regards the nature of services before concluding whether it will fall under the defination of Fees for Technical Services. Also, the specific wordings of the article with respective country will also have to be seen to check the taxability of the payment. Further, with the fast-growing technological advancement and dynamic environment, the defination of FTS is rapidly changing. It will be interesting to see what stand will be taken by respective courts and countries to tax such income that arises out of fully automated processes using algorithms, software and tools.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.