March 2020
Article 12 of India-USA DTAA; Section 9(1)(vi), (vii) of the Act – Payment received by American company for provision of cloud hosting services to Indian customers was not royalty or fees for included services within meaning of Article 12 since the assessee was in physical control or possession over, and operating and managing, equipment without having granted its lease to customers – Since the assessee did not have PE in India, income could also not be taxed as business profits
By Geeta Jani | Dhishat B. Mehta
Chartered Accountants
22 [2020] 113 taxmann.com 382 (Mum.)(Trib.) Rackspace, US Inc. vs. DCIT ITA Nos. 4920 & 6195 (Mum.) of 2018 A.Ys.: 2010-11 & 2015-16 Date of order: 28th November,
2019
Article 12 of
India-USA DTAA; Section 9(1)(vi), (vii) of the Act – Payment received by
American company for provision of cloud hosting services to Indian customers
was not royalty or fees for included services within meaning of Article 12
since the assessee was in physical control or possession over, and operating
and managing, equipment without having granted its lease to customers – Since
the assessee did not have PE in India, income could also not be taxed as
business profits
FACTS
The assessee was a
company incorporated in, and a tax resident of, the USA. During the relevant
year, the assessee had earned income from provision of cloud services (cloud
hosting and other supporting and ancillary services) to Indian customers. The
assessee had not filed return of its income.
The A.O. issued
notice u/s 148 of the Act. In response, the assessee filed the return of its
income and contended that cloud hosting services were not taxable as
‘royalties’ under Article 12 of the India-USA DTAA because of the following
reasons:
- The customers do not
operate the equipment and do not have physical access to or control over the
equipment used by the assessee to provide cloud support services.
- The assessee does not ‘make
available’ technical knowledge, experience, skill, know-how, etc. to its
customers. Further, the cloud support services are not in the nature of
managerial, technical or consultancy services. Consequently, they do not
constitute included services under Article 12 of the India-USA DTAA.
- Hence, income from cloud
hosting services was business profits. Since the assessee did not have a PE in
India under Article 5 of India-USA DTAA, the income was not taxable in India
under the provisions of Article 7(1) of the India-USA DTAA.
However, in
accordance with the direction of the DRP, income from cloud services was
treated as ‘Royalty’ and taxed @ 10% under the India-USA DTAA.
HELD
- Customers of the assessee
had only availed hosting services. They had not used, possessed or controlled
equipment (which was owned and controlled by the assessee) used for providing
hosting services. Hence, the payment for hosting services made by Indian
customers did not fall within the ambit of the definition of royalty in
Explanation 2 to section 9(1)(vi) of the Act.
- Amendment to the said
definition by the Finance Act, 2012 clarified that irrespective of possession
or control of equipment with payer, or use by payer, or location of equipment
in India, any payment made for ‘use of equipment’ would be classified as
‘royalties’.
- Since the assessee was a
tax resident of the USA, it qualified for beneficial provisions under the
India-USA DTAA.
- The definition of royalties under Article
12(3) of the India-USA DTAA is in pari materia with the pre-amendment
definition of royalty under the Act. The definition under the India-USA DTAA
being exhaustive and not inclusive, its meaning should be only that given in
the Article.
- The assessee was providing
hosting services to Indian customers. The data centre and infrastructure
therein which was used to provide services belonged to, and was operated and
managed by, only the assessee.
- The term ‘use’ or ‘right to
use’ in the context of the DTAA contemplates that the payer has possession /
control over the property or the property is at its disposal. However, the
assessee did not give any equipment to the customers nor did it allow them to
have control over equipment. Customers did not have physical control or
possession over servers and other equipment used to provide cloud hosting
services. Customers did not even know the location of either the data centre or
the location of the server in the data centre.
- The assessee had provided
cloud hosting services which were standard services provided to customers.
Agreement between the assessee and its customers was only a service level
agreement for providing hosting and other ancillary services simpliciter
to customers and not for use, or hire, or lease, of any equipment.
- Accordingly,
payments received by the assessee could not be said to be royalty within the
meaning of Explanation (2) to section 9(1)(vi) of the Act and also Article
12(3)(b) of the India-USA DTAA. Besides, in the absence of a PE of the assessee
in India, in terms of the India-USA DTAA its income could not be taxed as
business profits in India.
