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KPMG IN INDIA

KPMG Flash News


17 February 2011

TAX

Payments to overseas telecommunication service providers towards


provision of International Private Leased Circuit/ dedicated
bandwidth to be taxable as Royalty

Recently, the Chennai Bench of the Income-tax Appellate Tribunal 1


(Tribunal), in the case of Verizon Communications Singapore Pte. Ltd
(Tax-payer) held that the consideration for provision of International
Private Leased Circuit (IPLC) / dedicated bandwidth qualify as Royalty
under the provisions of Income-tax Act, 1961 (Act) read with the
provisions of relevant Double Taxation Avoidance Agreement (DTAA).
The Tribunal held that such consideration would be regarded as towards
use of process or equipment.

Facts of the case

 The tax payer is primarily engaged in providing international


connectivity services to customers in Asia Pacific region including
India. The tax payer is not a licensed service provider in India as per
the Indian Telecom Regulations and accordingly provides the
services only outside India.

 A customer enters into two separate contracts for availing


international connectivity services – one with the tax payer for
provision of international connectivity; and secondly, with VSNL
for Indian Half Circuit Services Connectivity.

 VSNL takes the telecommunication traffic from the customer


office/site in India and transmits the traffic to a virtual point outside
India. The landing station or gateway in India used in transmitting
the traffic within India belongs to VSNL.

1
Source: www.allindiataxes.com [ AIT-2011-61-ITAT] (Judgement Date: 7 January
2011)

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 The taxpayer uses telecom services equipment situated outside India
in order to provide IPLC services from the aforesaid virtual point up
till the overseas customer’s destination.

 The tax payer does not either ‘own’ or ‘utilize’ any landing station/
equipments in India for providing international half-circuit-services.

 The customer receives two invoices – one from VSNL for providing
connectivity within India and second from the tax payer for
providing connectivity outside India.
Issue before the Tribunal
 Whether amounts received by the tax payer for provision of IPLC/
bandwidth services outside India is royalty for use of ‘equipment’ or
‘process’ under section 9(1)(vi) of the Act read with Article 12(3)(b)
of the India-Singapore DTAA?
Tax payer’s contention

 The contract between the tax payer and its customers is for the
provision of services and not for providing any right in any
equipment and/or network used by the tax payer for providing
telecom services

 There is a distinction between transactions for the use of equipment


vis-a-vis those for rendering of services. Also, none of the
conditions laid down by the TAG of the OECD 2 for classifying
payments as royalties for use of equipment are satisfied in this case.
In support of this, the tax payer contended the following:

- The customers do not have knowledge of the equipment being


used while providing IPLC services and no equipment is
identified with respect to a customer. The customers have
neither knowledge nor they are a party to the inter-connect
agreements entered by the tax payer with the other international
telecom providers for the use of sophisticated devices

2
The Technical Advisory Group (TAG) of OECD had formulated the following tests in
its report titled “Tax Treaty Characterization Issues Arising from E-Commerce” dated
February 1, 2001 for determining whether the payments are for use of or right to use,
industrial, commercial or scientific equipments:

 The customer is in the physical possession of the property or controls or has a


significant economic possessory interest in it.

 The provider does not bear any risk of substantially diminished receipts or
increased expenditure in case of non performance or does not use the property
concurrently to provide significant services to the entities unrelated to the
services recipients; and

 The total payment does not substantially exceed the rental value of the
equipment for the contract period.

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- The customer does not hold/possess own, operate, maintain or
control tax payer’s telecom network infrastructure/equipment
and they also do not possess significant economic/possessory
interest in the telecom network infrastructure/equipment

- The telecom networks infrastructure/equipment is concurrently


used to provide connectivity services to large number of
unrelated users.

- In case of non-performance the tax payer bears the risk of


substantially diminished receipts/increased expenditure

 In light of above arguments, revenues earned by the tax payer from


Indian customers for provision of IPLC services outside India
cannot be taxed as royalties for use of the equipment or process
under the Act and under the DTAA.

Revenue’s contention

 The revenue contended based on the order of the Commissioner


(Appeals) that the tax payer has provided single, composite and
indivisible circuit which constitutes ‘equipment’. Further, the tax
payer has merely taken VSNL as a ‘provisioning entity’ for
providing local part of the services

 Under the agreement, the customers acquire significant economic or


possessory interest in the equipment of the tax payer to the extent of
bandwidth capacity hired by the customer which is made available
on a dedicated basis. Accordingly, the payment made by customers
in India would constitute royalty under the provisions of the Act
read with the DTAA.

 In the alternative, the payments made for IPLC services are towards
connectivity through dedicated bandwidth to Indian customers and
would constitute payment for use of ‘process’ and hence, would
qualify as ‘Royalty’.

Tribunal’s Ruling

 The Tribunal held that while determining the nature of payment all
relevant facts having bearing on the substance of the transaction
should be taken into account.

 In the given case, the customer acquires significant economic or


possessory interest in the equipment of the tax payer to the extent of
bandwidth hired by the customer. This capacity is made available on
a dedicated basis to the customer for the entire contract period,
usually a year

© 2011 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with
KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
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 Even if the bandwidth is not used, the customer has to pay the
committed charges. Thus, the tax payer does not bear any risk of
diminution in receipts or increase in expenditure if the customer
does not make the use of the capacity. Therefore the payment made
for hiring bandwidth would correspond to the rental value.

 Even as per the TAG of OECD, physical possession of the


equipment is not mandatory.

 The agreement with VSNL for split billing is merely to overcome


the regulatory regime prevailing in India and VSNL is only a
‘provisioning entity’ on behalf of the tax payer. IPLC is a seamless
composite service and it cannot be divided into two parts. The
agreement entered into with VSNL shows that it involves hiring of
circuit on lease. From an analysis of various agreements, a
conclusion can be derived to the effect that payments for the use of
tangible equipment can be considered as a payment for the use of or
the right to use equipment.

 The agreement may be only for the provision of services but in


effect, it grants right to the extent stated above in the network of the
tax payer. The decisions in the case of Call World Technologies Ltd
v. DCIT, [2008-TIOL-422], and that of AAR in the case of Cargo
Community Network (P) Ltd [289 ITR 355], are exactly on the point
and would hence be applicable.

 The case of provision of dedicated bandwidth is similar to that of a


cable TV or Satellite TV and is different from the use of a standard
facility like that of a telephone. This is because, unlike in the case of
a standard facility of a telephone, in a satellite transmission, a
particular frequency is assigned to the customer and in cable
transmission, the customer gets a dedicated bandwidth. With a
dedicated connection the service provider sets aside and always
make available the bandwidth for the customer’s use.

 The amount received by tax payer from Indian customers is also for
the use of a ‘process’ and would therefore qualify as royalty.
Reliance in this regard is placed on the decision of Special Bench,
New Delhi in the case of New Skies Satellites N.V v. ADIT (Int.
Tax) [319 ITR 269] and the decision of ITAT Mumbai in the case of
Sanskar Info TV(P) Ltd [24 SOT 87]

Our comments
The Chennai Tribunal has held that payments towards IPLC / dedicated
bandwidth are towards use of ‘equipment’ or ‘process’ and therefore
would qualify as royalty under the Act as well as DTAA.
It may be noted that the proposition on ‘process’ element under a
service contract, similar to the one laid down by ITAT Special Bench in
the case of New Skies Satellite N.V (which has been relied on by the

© 2011 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with
KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
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Chennai Tribunal in this case) has been not been adopted by the recent
Delhi High Court judgment in case of Asia Satellite Communications
Co. Ltd. v. DIT [2011-TII-05-HC-DEL-INTL]
This judgment also comes close on the heels of the Bangalore Tribunal
decision in the case of Infosys Technologies wherein, it has been held
on similar facts that payments will not be considered as Royalty/ FTS.
In this judgment the Chennai Tribunal has observed that the case of
provision of dedicated bandwidth is different from that of provision of a
standard facility. Further it has interpreted the TAG Report of OECD to
mean that physical possession of the equipment is not mandatory to
qualify as ‘equipment’ royalty. Whereas a contrary view have been
adopted in the Advance Rulings in the case of M/s Dell International
Services India (P) Ltd. [305 ITR 37] and M/s Cable & Wireless [315
ITR 072].
The judgment is therefore expected to have significant impact on the
taxability of remuneration from provision of bandwidth/ IPLC services
especially from the perspective of equipment royalty. Considering the
plethora of diverse judicial precedents, finality of the issue may take
some more time.

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KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
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