In a series of articles published in this Journal (November, 2009 to March, 2010) the concept of ‘Make Available’ used in the article in the Tax Treaties relating to ‘Fees for Technical Services (FTS)’ or ‘Fees for Included Services (FIS)’ has been discussed and analysed. We have also analysed in brief, Indian judicial decisions dealing with the subject and provided relevant information regarding all Indian DTAAs and related aspects and issues dealing with the subject. In this case study, we have sought to illustrate application of this concept.
1. Facts of the case :
1.1 An educational foundation established by a leading Indian industrialist is in the process of setting up a world-class educational complex/university to provide cutting-edge higher education in all streams of physical sciences, technology, medicine and management services.
1.2 The foundation has engaged a consultant in the USA to conduct a search for the Vice-Chancellor for the University and to locate, screen, interview and present qualified candidates for this position in the foundation.
1.3 The main financial terms and conditions of the contract are as follow :
Professional fees :
The consultant works on a retainer arrangement. The minimum retainer fee for this assignment will be $ 1,50,000. The fee will be invoiced in four instalments.
Engagement expenses :
The consultant will also be reimbursed for direct and indirect expenses (‘Reimbursable Expenses’), which are invoiced on a monthly basis.
Direct expenses are costs associated with the candidate development, interview and overall selection process.
Examples include candidate’s travel, consultants’ travel to meet with the client and to interview candidates, project-specific advertising and mailing costs. Indirect expenses are costs that are attributable to client projects as incremental costs, but are not possible to be attributed to each individual project. Examples include com unications, courier and external database research costs.
1.3 The consultant is a company incorporated in the USA and is a Tax Resident of USA and that it does not have a Permanent Establishment in India.
2. Issues for consideration :
In the context of deducting tax at source from payment of Professional Fees to the consultant and reimbursement of expenses, the major issues for our consideration are as follows :
(a) Whether the Professional Fees payable under the contract constitute ‘Fees for Included Services’ (FIS) as defined in Article 12(4) & (5) of the Double Taxation Avoidance Agreement (DTAA) with the USA ?
(b) Whether the said Professional Fees payable are taxable as ‘Business Profits’ under Article 7 read with Article 5 of the DTAA with the USA ? In other words, whether service activities of the consultant constitute a Service PE in term of Article 5(2)(l) of the India-USA DTAA ?
3. Analysis and observations :
3.1 Fees for Included Services — Meaning thereof :
The DTAA with the USA uses the term ‘Fees for Included Services’ (FIS), whereas other tax treaties use the term ‘Fees for Technical Services’ (FTS); both terms essentially relate to rendering of technical services. However, the term FIS has been defined differently in the India-USA DTAA when compared with the definition of the term FTS as used/defined in other tax treaties.
3.2 Definition of FIS in Tax Treaty with USA :
The term FIS has been defined in Article 12(4). Paragraphs (4), (5) and (6) of Article 12 of the India-USA DTAA are reproduced below :
Article 12 — Royalties and fees for included services
1.
2.
3. The term ‘royalties’ as used in this article means :
(a) …………………
(b) …………………
4. For purposes of this article, ‘fees for included services’ means payments of any kind to any person in consideration for the rendering of any technical or consultancy services (including through the provision of services of technical or other personnel) if such services?:
b. are ancillary and subsidiary to the application or enjoyment of the right, property or information for which a payment described in paragraph 3 is received; or
a. make available technical knowledge, experience, skill, know-how or processes, or consist of the development and transfer of a technical plan or technical design.
5. Notwithstanding paragraph 4, ‘fees for included services’ does not include amounts paid:
a. for services that are ancillary and subsidiary, as well as inextricably and essentially linked, to the sale of property other than a sale described in paragraph 3(a);
b. for services that are ancillary and subsidiary to the rental of ships, aircraft, containers or other equipment used in connection with the operation of ships or aircraft in international traffic;
c. for teaching in or by educational institutions;
d. for services for the personal use of the individual or individuals making the payment; or
e. to an employee of the person making the payments or to any individual or firm of individuals (other than a company) for professional services as defined in Article 15 (Independent Personal Services).
6. The provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the royalties or fees for included services, being a resident of a Contracting State, carries on business in the other Contracting State, in which the royalties or fees for included services arise, through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the royal-ties or fees for included services are attributable to such permanent establishment or fixed base. In such case the provisions of Article 7 (business profits) or Article 15 (Independent Personal Ser-vices), as the case may be, shall apply.
7. (a)
(b)
8. …………………
3.3 Extract from the Memorandum of Understanding dated 15th May, 1989:
The Governments of India and the USA have signed a Memorandum of Understanding intended to give guidance in interpreting various aspects of Article 12 relating to the scope of ‘included services’ i.e., paragraph 4 of Article 12. We reproduce below the relevant extracts from the said MOU. Various examples given in the MOU have not been reproduced here as the same are different from the facts of the case and therefore, not relevant.
Memorandum of understanding concerning fees for included services in Article 12
Paragraph 4 (in general):
This memorandum describes in some detail the category of services defined in paragraph 4 of Article 12 (Royalties and Fees for Included Services). It also provides examples of services intended to be covered within the definition of included services and those intended to be excluded, either because they do not satisfy the tests of paragraph 4, or because, notwithstanding the fact that they meet the tests of paragraph 4, they are dealt with under paragraph 5. The examples in either case are not intended as an exhaustive list but rather as illustrating a few typical cases. For ease of understanding, the examples in this memorandum describe U.S. persons providing services to Indian persons, but the rules of Article 12 are reciprocal in application.
Article 12 includes only certain technical and con-sultancy services. By technical services, we mean in this context services requiring expertise in a technology. By consultancy services, we mean in this context advisory services. The categories of technical and consultancy services are to some extent overlapping because a consultancy service could also be a technical service. However, the category of consultancy services also includes an advisory service, whether or not expertise in a technology is required to perform it.
Under paragraph 4, technical and consultancy services are considered included services only to the following extent?: (1) as described in paragraph 4(a), if they are ancillary and subsidiary to the application or enjoyment of a right, property or information for which a royalty payment is made; or (2) as described in paragraph 4(b), if they make available technical knowledge, experience, skill, know-how, or processes, or consist of the development and transfer of a technical plan or technical design. Thus, under paragraph 4(b), consultancy services which are not of a technical nature cannot be included services.
Paragraph 4(a):
Paragraph 4(a) of Article 12 refers to technical or consultancy services that are ancillary and subsidiary to the application or enjoyment of any right, property, or information for which a payment described in paragraph 3(a) or is received. Thus, paragraph 4(a) includes technical and consultancy services that are ancillary and subsidiary to the application or enjoyment of an intangible for which a royalty is received under a licence or sale as described in paragraph 3(a), as well as those ancillary and subsidiary to the application or enjoyment of industrial, commercial, or scientific equipment for which a royalty is received under a lease as described in paragraph 3(b).
It is understood that in order for a service fee to be considered ‘ancillary and subsidiary’ to the application or enjoyment of some right, property, or information for which a payment described in paragraph 3(a) or (b) is received, the service must be related to the application or enjoyment of the right, property or information. In addition, the clearly predominant purpose of the arrangement under which the payment of the service fee and such other payment are made must be the application or enjoyment of the right, property, or information described in paragraph 3. The question of whether the service is related to the application or enjoyment of the right, property, or information described in paragraph 3 and whether the clearly predominant purpose of the arrangement is such application or enjoyment must be determined by reference to the facts and circumstances of each case. Factors which may be relevant to such determination (although not necessarily controlling) include:
1. the extent to which the services in question facilitate the effective application or enjoyment of the right, property, or information described in paragraph 3;
2. the extent to which such services are customarily provided in the ordinary course of business arrangements involving royalties described in paragraph 3;
3. whether the amount paid for the services (or which would be paid by parties operating at arm’s length) is an insubstantial portion of the combined payments for the services and the right, property, or information described in paragraph 3;
4. whether the payment made for the services and the royalty described in paragraph 3 are made under a single contract (or a set of related contracts); and
5. whether the person performing the services is the same person as, or a related person to, the person receiving the royalties described in paragraph 3 (for this purpose, persons are considered related if their relationship is described in Article 9 (Associated Enterprises) or if the person providing the service is doing so in connection with an overall arrangement which includes the payer and recipient of the royalties).
To the extent that services are not considered ancillary and subsidiary to the application or enjoyment of some right, property, or information for which a royalty payment under paragraph 3 is made, such services shall be considered ‘included services’ only to the extent that they are described in paragraph 4(b).
Paragraph 4(b):
Paragraph 4(b) of Article 12 refers to technical or consultancy services that make available to the person acquiring the service technical knowledge, experience, skill, know-how, or processes, or consist of the development and transfer of a technical plan or technical design to such person. (For this purpose, the person acquiring the service shall be deemed to include an agent nominee, or transferee of such person.) This category is narrower than the category described in paragraph 4(a), because it excludes any service that does not make technology available to the person acquiring the service. Generally speaking, technology will be considered ‘made available’ when the person acquiring the service is enabled to apply the technology. The fact that the provision of the service may require technical input by the person providing the service does not per se mean that technical knowledge, skills, etc., are made available to the person purchasing the service, within the meaning of paragraph 4(b). Similarly, the use of a product which embodies technology shall not per se be considered to make the technology available”.
(Emphasis supplied)
3.4 In view of the above, in our opinion, the Professional Fees payable to the consultant do not satisfy the requirements of either clause or clause (b) of Article 12(4) as above and therefore the Professional Fees payable by the foundation to the consultant do not constitute FIS under Article 12(4) of the India-USA DTAA.
3.5 Thus, we are of the opinion that professional fees payable by the foundation to the consultant do not constitute FIS as defined in Article 12(4) of the India-USA DTAA. We may, however, add that the same would constitute Fees for Technical Services (FTS) u/s.9(1)(vii) of the Income-tax Act, but in view of S. 90(2) of the Act, the Foundation has the option to be governed by the provisions of the Tax Treaty, if the same are more beneficial.
However, though the payment would not constitute FIS, one has to consider whether the payment would be taxable as Business Profits. We shall discuss the issue in the following paragraphs.
3.6 Whether the consultant’s activities in India would constitute a Service PE :
Article 5 of the DTAA defines the term ‘Permanent Establishment’ as under :
“Article 5 — Permanent Establishment
1. For the purposes of this Convention, the term ‘permanent establishment’ means a fixed place of business through which the business of an enterprise is wholly or partly carried on.
2. The term ‘permanent establishment’ includes especially :
(a) a place of management;
(b) a branch;
(c) an office;
(d) a factory;
(e) a workshop;
(f) a mine, an oil or gas well, a quarry, or any other place of extraction of natural resources;
(g) a warehouse, in relation to a person providing storage facilities for others;
(h) a farm, plantation or other place where agriculture, forestry, plantation or related activities are carried on;
(i) a store or premises used as a sales outlet;
(j) an installation or structure used for the exploration or exploitation of natural resources, but only if so used for a period of more than 120 days in any twelve-month period;
(k) a building site or construction, installation or assembly project or supervisory activities in connection therewith, where such site, project or activities (together with other such sites, projects or activities, if any) continue for a period of more than 120 days in any twelve-month period;
(l) the furnishing of services, other than included services as defined in Article 12 (royalties and fees for included services), within a Contracting State by an enterprise through employees or other personnel, but only if :
(i) activities of that nature continue within that State for a period or periods aggregating to more than 90 days within any twelve-month period; or
(ii) the services are performed within that State for a related enterprise [within the meaning of paragraph 1 of Article 9 (associated enterprises)].
3. Notwithstanding the preceding provisions of this article, the term ‘permanent establishment’ shall be deemed not to include any one or more of the following :
(a) the use of facilities solely for the purpose of storage, display, or occasional delivery of goods or merchandise belonging to the enterprise;
(b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or occasional delivery;
(c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;
(d) the maintenance of a fixed place of business
solely for the purpose of purchasing goods or merchandise, or of collecting information, for the enterprise;
(e) the maintenance of a fixed place of business
solely for the purpose of advertising, for the supply of information, for scientific research or for other activities which have a preparatory or auxiliary character, for the enterprise.
4. Not relevant
5. Not relevant
6. Not relevant”
What is relevant for our purposes is Clause (l) of paragraph 2 of Article 5. All the Professional Services will be rendered in/from the USA, and, the con-sultant’s visits to India in this connection are not likely to exceed 90 days in a year. In other words, the professional activities of the consultant to the foundation would be for less than 90 days within 12-month period. The payee company does not appear to be covered under any other paragraph of Article 5 of the treaty. Therefore, the service activities of the consultant would not constitute a PE in India within the meaning of Article 5, and therefore, the professional fees receivable by the consultant, would not be taxable as Business Profits under Article 7 of the Tax Treaty.
3.7 In view of the above, the foundation need not deduct any TDS from payment of Professional Fees to the consultant.
4. Reimbursement of expenses:
Reimbursement of expenses will stand on the same footing as payment of Professional Fees. In view of discussion in paragraphs 3.1 to 3.8, the foundation need not deduct any TDS from reimbursement of various expenses under the said Contract.
5. Precautions:
The foundation should obtain a Tax Residency Certificate from the consultant to the effect that it is a tax resident of the USA in terms of Article 4 of India-USA DTAA to ensure that it is eligible to access the India-USA DTAA and that it does not have and is not likely to have a Permanent Establishment in India under Article 5 of the Treaty.
6. Summation:
We wish to reiterate that the concept of ‘make available’ is still continuously subject to judicial scrutiny under different circumstances and in respect of various kinds of services. In some cases, there are conflicting/differing views and in some cases the concept has not been considered/applied while examining the taxability of the payment of FIS/FTS. As the law is not yet settled, continuous and ongoing monitoring and study of various judicial pronouncements would be necessary for the proper understanding and practical application of the concept in practice.
