Friday, November 29, 2013

Expenditure of Software upgrades/updates subject to obsolescence is revenue expenditure

Oracle India Pvt. Ltd vs. CIT (Delhi High Court)


 S. 37(1): Expenditure on acquiring master copy of software subject to obsolescence is deductible as revenue expenditure
 
The assessee entered into a license agreement with Oracle Corp under which it acquired a non-exclusive & non-assignable right to duplicate software products which were owned by Oracle Corp and to sub-license the same to parties in India. The assessee paid recurring royalty of 30% for the said right. In addition to the royalty, the assessee periodically paid an amount towards “expenditure on import of software master copy”. The said master copy was used to replicate the software. The assessee claimed that the said master copies were versions of Oracle’s new product offerings which had very accelerated obsolescence and that at any point of time it was not possible to say whether the version will be current for one day or one month. The AO allowed a deduction for the recurring royalty but held that the expenditure for acquiring the software master copy was capital expenditure. On appeal, the CIT(A) reversed the AO on the ground that owing to obsolescence, there was no enduring benefit as there were frequent corrections and up-gradation of the software. On appeal by the department, the Tribunal reversed the CIT(A) and held that the expenditure was capital in nature on the ground that the master copy was an asset of enduring benefit. On appeal by the assessee, HELD reversing the Tribunal:

The assessee’s claim that the master copies had high accelerated obsolescence and that even at the point of time of import it was difficult to say whether the version would be replaced by a new or updated version after one day or a month had not been disproved. Also the facts showed that there were periodical imports of the master copies and that the average price per copy was minimal. This was not a case where the master copies contained operating or system software, which normally did not require frequent up-gradation or changes. It is also not the case of an assessee which is the end user of software. It is a case where the assessee is required to repeatedly pay for the master copy media in view of frequent newer or updated versions of the application software from time to time. Once newer or better version of the application software is available, the earlier version is not saleable and does not have any market value for the seller i.e. the assessee. Also, as per the “matching concept” in accountancy, while determining whether expenditure is capital or revenue in nature, the question whether the expenditure would create an asset which is of value in further assessment periods and should be amortised (i.e. depreciated) as long as it has value (subject to the statutory provisions) requires to be considered. If the expenditure does lead to creation of an asset but of a limited or short life, it has to be treated as a liability and not as a fixed asset. The said expenditure cannot be valued for price for future financial years (Oracle Software 320 ITR 546 (SC), Ashahi India Safety Glass 346 ITR 329 (Del), G.E. Capital Services 300 ITR 420 (Del), O.K. Play 346 ITR 57 (P&H), IAEC Pumps 232 ITR 316 (SC) referred)

Source: ITAT Online

Tuesday, November 26, 2013

Non-exclusive & non-transferable license to use customized software not taxable as “royalty” - Delhi HC


Contrast to decision of Karnataka HC in Samsung Electronics 345 ITR 494, Delhi HC has held that ‘Payment for non-exclusive & non-transferable license to use ‘Software’ is not taxable as royalty under India-US DTAA.  

This goes against the basis applied in Reliance Infocom/ Lucent Technologies (ITAT Mum) where it was held that Ericson AB 343 ITR 370 (Del) & Nokia Networks OY 25 taxmann.com 225 applied only to cases where the software was embedded in the hardware and not to pure license cases.
 

Conclusion is, CONFUSION STILL PREVAILS.

 


The assessee, a USA company, set up a branch office in India for the supply of software called “MX”. The software was customized for the requirements of the customer (not “shrink wrap”). The Indian branch imported the software package in the form of floppy disks or CDs and delivered it to the customer. It also installed the software and trained the customers. The AO & CIT(A) held that the software was a “copyright” and the income from its license was assessable as “royalty” under Article 12 of the India-USA DTAA. On appeal by the assessee, the Tribunal held, following Motorola 270 ITR (AT) (SB) 62, that the income from license of software was not taxable as “royalty”. Before the High Court, the Department argued that in view of CIT vs. Samsung Electronics 345 ITR 494 (Kar), the right to make a copy of the software and storing it amounted to copyright work u/s 14(1) of the Copyright Act and payment made for the grant of a license for the said purpose would constitute royalty. HELD by the High Court dismissing the appeal:

 

In order to qualify as a royalty payment under Article 12(3) of the India-USA DTAA, it is necessary to establish that there is a transfer of all or any rights (including the granting of any licence) in respect of a copyright of a literary, artistic or scientific work. There is a clear distinction between royalty paid on transfer of copyright rights and consideration for transfer of copyrighted articles. Right to use a copyrighted article or product with the owner retaining his copyright, is not the same thing as transferring or assigning rights in relation to the copyright. The enjoyment of some or all the rights which the copyright owner has, is necessary to invoke the royalty definition. Viewed from this angle, a non-exclusive and non-transferable licence enabling the use of a copyrighted product cannot be construed as an authority to enjoy any or all of the enumerated rights ingrained in Article 12 of DTAA. Where the purpose of the licence or the transaction is only to restrict use of the copyrighted product for internal business purpose, it would not be legally correct to state that the copyright itself or right to use copyright has been transferred to any extent. The parting of intellectual property rights inherent in and attached to the software product in favour of the licensee/customer is what is contemplated by the Treaty. Merely authorizing or enabling a customer to have the benefit of data or instructions contained therein without any further right to deal with them independently does not, amount to transfer of rights in relation to copyright or conferment of the right of using the copyright. The transfer of rights in or over copyright or the conferment of the right of use of copyright implies that the transferee/licensee should acquire rights either in entirety or partially co-extensive with the owner/ transferor who divests himself of the rights he possesses pro tanto. The license granted to the licensee permitting him to download the computer programme and storing it in the computer for his own use is only incidental to the facility extended to the licensee to make use of the copyrighted product for his internal business purpose. The said process is necessary to make the programme functional and to have access to it and is qualitatively different from the right contemplated by Article 12 because it is only integral to the use of copyrighted product. Apart from such incidental facility, the licensee has no right to deal with the product just as the owner would be in a position to do. Consequently there is no transfer of any right in respect of copyright by the assessee and it is a case of mere transfer of a copyrighted article. The payment is for a copyrighted article and represents the purchase price of an article and cannot be considered as royalty either under the Income-tax Act or under the DTAA (Ericson AB 343 ITR 370 (Del) & Nokia Networks OY 25 taxmann.com 225 followed; Samsung Electronics 345 ITR 494 (Kar) not followed)
 
Source: ITAT Online

Monday, November 25, 2013

No Service Tax on Electricity Charges (Either from Grid or thru DG Set) reimbursement from Tenants - CESTAT

2013-TIOL-1751-CESTAT-MUM

 
Appeal No.ST/383, 384, 416, 469 & 504/12-Mum
Arising out of Order-in-Original/Appeal No. 27-28-/P.III/ST/ Commr /2011-12, P.III/RS/184/2012, 56-57/P.III/ST/ Commr /2011-12 & 63/P.III/ST/ Commr /2011-12,
Dated : 29.02.2012, 30.5.2012, 29.03.2012 respectively
Passed by the Commissioner of Central Excise & Service Tax Pune.III
Date of Hearing: 18.4.2013
Date of Decision: 18.4.2013
1) M/s ICC REALITY (INDIA) PVT LTD
2) M/s INDIA LAND INFRASTRUCTURE DEVELOPMENT PVT LTD
3) M/s CHITRALI PROPERTIES PVT LTD
4) M/s EON HINJEWADI INFRASTRUCTURE P LTD
5) M/s VANSUM INDUSTRIES
Vs
COMMISSIONER OF CENTRAL EXCISE, PUNE-III
Appellants Rep by: Shri Bhrat Raichandai , Adv. with Shri V Jain, CA for (sr.no. 1,2 & 4) Shri J C Patel, Adv. (sr.no.3) And Shri Shushant Murthy, Adv. (sr.no.5)

Respondents Rep by: Shri Rakesh Goyal , Addl. Commr (A.R.) And Shri P N Das, Commr .(A.R.)
CORAM: S S Kang, Vice President
S K Gaule , Member( T)

 
ST - Rule 5 of Service Tax (Determination of Value) Rules, 2006 - Applicant collecting rent and paying
 
ST under Renting of Immovable Property Service - however, electricity charges collected from tenants not included in value of taxable service – As E lectricity is goods chargeable to duty under CE Tariff as well as under the Maharashtra Value Added Tax Act, 2002, therefore, the supply of electricity to tenant amounts to sale of goods and not supply of service – In terms of Notfn . 12/03-ST value of goods supplied by service provider to service recipient is exempt from service tax – Electricity charges cannot form part of taxable value – Orders set aside and appeals allowed: CESTAT [ para 9]
Appeals allowed
ORDER NO.A/968-972/13/CSTB/C-I
Per: S S Kang:
Heard both sides Common issue is involved and therefore, these appeals are being taken up together for disposal.
 
2. The appellants are engaged in providing services of renting of immovable property. Renting of immovable property is chargeable to service tax under the provisions of Section 65(90a) of the Finance Act. The appellants are paying appropriate service tax in respect of rent received from the tenants. Show-cause notices were issued to the appellants on the ground that the appellants had received certain amounts as reimbursement of electricity charges from the tenants. Show-cause notices were issued invoked the provisions of Rule 5 of Service Tax (Determination of Value) Rules, 2006 which provides if there are expenditure or costs are incurred by the service provider in the course of providing taxable service, all such expenditure or costs shall be treated as consideration for the taxable service provided or to be provided and shall be included in the value for the purpose of charging service tax.
 
3. The adjudicating authority confirmed the demand by adding the amounts which are as reimbursement of electricity charges from the tenants in the assessable value for the purpose of service tax as provider of renting of immovable property.
 
4. The contention of the appellants is that as per the Lease Agreement, tenants are to pay the actual electricity expenses to the MSEB. In some cases when the tenants default in payment of electricity charges, the appellants will pay from their own pocket and subsequently recover the electricity charges from their tenants. In cases where the tenants paid the electricity charges late to the appellants, the appellants also charging nominal interest on such amount. In some cases, the appellants are having one main meter in respect of electricity supply and the appellants are providing sub meters to the tenants and as per the reading of sub meters the appellants have collected the electricity charges and are paying to the State Electricity Board. In the case of M/s. Vansum Industries , the appellants are also supplying electricity from the generator set when there was failure of power supply from the Electricity Board and in such cases the appellants were charging on commercial rate.
 
5. The contention of the appellants is that the charges in respect of electricity which were recovered on actual basis are nothing to do with the service of renting of immovable property. The charges are to be paid by the tenants directly to the Electricity Board or where the electricity is supplied by the appellants the tenants are to pay on actual consumption. The back up is available where the tenants opted to avail such facility provided by the landlord.
6. The contention of the appellants is that in the case of M/s. Panchshil Tech Park Pvt. Ltd. the adjudicating authority has dropped the proceedings initiated which were on the same ground vide Order-in-Original No.22-23-24/P.III/ST/ Commr /2011-12 dated 28.11.2011 by the Commissioner of Central Excise, Pune.III . The appellants also received information under the RTI Act that the Revenue has accepted that order. The appellants relied upon the Pune III Commissionerate communication dated 26.09.2012. The appellants are also situated in the same Commissionerate . The appellants also submitted that the electricity being goods, supply of electricity does not amount to service. Under the Central Excise Tariff Act, electricity is covered under Chapter 27 of the Tariff and under the Maharashtra Value Added Tax Act, 2002, electricity is chargeable to Nil rate of tax as per Schedule A 20 to the Act. Hence the charges which are on actual basis recovered from the tenants towards the electricity charges and paid to the Electricity Board or retained by the appellants as the appellants were providing back up by way of providing generator set cannot be added to the assessable value for the purpose of service tax as provider of renting of immovable property service. Appellant also relied upon the provisions of Notification No.12/03 ST dated 20.6.2003 to submit that value of goods sold by service provider to service recipient is exempted from service tax. Appellants have not availed any credit in respect of goods sold i.e. electricity.
 
7. Revenue reiterated the findings of the lower authorities and submitted that the appellants are liable to pay service tax on the gross amounts as the appellants were receiving the amounts for consumption of electricity by the tenants and these amounts are part of renting of immovable property. Hence the appellants have to pay service tax on such amounts also as provider of immovable property service. The appellants are providing bunch of services such as renting of immovable property, maintenance and repair services and provides electricity. The main activity of the appellants is renting of immovable property. Hence all the considerations received in respect of renting of immovable property including electricity charges are chargeable to service tax as provider of renting of immovable property. The Revenue also submitted that as per the Lease Agreement, the landlord has to provide electricity load to the tenants and the appellants also undertook to 100% generator back up and the tenants have to pay to the landlord a specific amount to be deposited to the appellants account in respect of such facility. In view of this, the demands are rightly made.
 
8. We find that the appellants are engaged in renting of immovable property and paying service tax. Show-cause notices were issued on the ground that the appellants were receiving certain amounts of reimbursement of charges from their clients while renting of immovable properties. Therefore, such charges are to be added to the assessable value for the purpose of service tax as provider of renting of immovable properties.
 
9. We have gone through the Lease Agreements. As per the terms and conditions of the Lease Agreements, the tenants have to pay electricity charges directly to the MSEB and the appellants are also providing electricity through generator set in case there is a power failure and the appellants are charging for the same. We find that electricity is specifically covered under Tariff Heading 27 of the Central Excise Tariff Act. We find that as per the provisions of Maharashtra Value Added Tax Act, 2002, electricity is also covered under Schedule A sr.no.20 and charged to Nil rate of tax. In view of this, we find the electricity is goods chargeable to duty under Central Excise Tariff as well as under the Maharashtra Value Added Tax Act, 2002. Therefore, the supply of electricity to tenant amounts to sale of goods and not supply of service. Further the Notification No.12/03 ST dated 20/6/2003 exempt from service tax, any value of goods supplied by service provider to service recipient. Further we find that the Commissioner of Central Excise Pune.III vide Order-in-Original dated 28.11.2011 relied upon by the appellants dropped the proceedings which were initiated on the same ground in the case of M/s. Panchshil Tech Park Ltd. The Commissioner of Central Excise in the adjudication order held that electricity is goods and chargeable to Nil excise duty. The decision of the adjudicating authority is accepted by the Revenue as per the communication dated 26.9.2012 by the Commissioner of Central Excise, Pune.III . The present appellants are also under the jurisdiction of Pune III Commissionerate .
 
10. In view of the above discussion, we find merit in the contention of the appellants that the electricity charges collected from the tenants cannot be formed part of the assessable value for the purpose of service tax as provider of renting of immovable properties.
 
11. Impugned orders are set aside and the appeals are allowed.
 
Source: TIOL 

Thursday, November 21, 2013

IPLC charges from Indian party is taxable as "royalty" under section 9(1)(vi) & DTAA


VERIZON COMMUNICATIONS SINGAPORE PTE LTD (FORMERLY MCI WORLDCOM ASIA PTE LTD) Vs THE INCOME TAX OFFICER

 
In view of retrospective amendments made to the definition of "royalty" in section 9(1)(vi) by the Finance Act,2012 by inserting Explanations 4 and 5 with effect from 1-6-1976, bandwidth payments made by Indian party to non-resident for International Private Leased Circuit (IPLC) for providing end–to-end internet connectivity outside India (where connectivity for Indian leg provided by VSNL due to Indian regulatory requirements) is taxable as 'royalty' under section 9(1)(vi) of the Act as well as under article 12(3) of Indo-Singapore DTAA
Related cases:

1.

 

M/s Poompuhar Shipping Corpn. Ltd. v ITO [2013] 38 taxmann.com 150 (Mad.) wherein it was held that the phrase "use or right to use" in the definition of "royalty" in Explanation 2 is to be interpreted in its ordinary meaning and applied in a broader sensed to mean employing for any purpose. The retrospective amendments by FA 2012 by insertion ofExplanations 4 and 5 has removed all doubts as far as interpretation of "use or right to use".

2.

 

Sanofi Pasteur Holding SA v Department of Revenue, Ministry of Finance, GOI [2013] 30 taxmann.com 222 (AP)- The Revenue's contentions that retrospective amendments by Finance Act,2012 would over-ride DTAA provisions deserves to be rejected for the following reasons:
 
  • The Finance Act,2012 introduced GAAR provisions (sections 95 to 102) which override treaties in case of abuse of treaty provisions. Section 90(2A) inserted by Finance Act,2012 enables application of GAAR even if same is not beneficial to assessee.
  • In contra-distinction, retrospective amendments relied upon by Revenue-Explanation 2 to section 2(47) andExplanations 4 and 5 to section 9 are not fortified by a non-obstante clause to override tax treaties.
  • There is a presumption against repeal by implication. Therefore, burden to show that there has been a repeal by implication of including override of tax treaties lies on party asserting the same (the Revenue in this case).
 
 
Tax Case (Appeal) Nos.147 to 149 of 2011 and 230 of 2012
 
Income tax - Sections 5(2)(b), 9(1)(vi) & (vii), 208, 209(1)(d), 234B, 234D - India-Singapore DTAA - Articles 3, 5 & 12.
 
Whether when the agreement between the assessee and the customer is for providing of seamless point to point private line so as to enable the customer to communicate between its office that are geographically dispersed and in entering this the assessee had provided the necessary equipment at customer premises, configured and customised to ensure that the customer gets the uninterrupted connectivity, there is user of equipment - Whether when the service agreement assuring the service is possible and workable only when the assessee and VSNL are considered as rendering the service jointly in their respective leg, the assessee renders service in India and the consideration received attracts the incidence of taxation in India - Whether where the end to end provisioning in one single circuit is assured by the assessee and if by reason of any regulatory laws of the Country the assessee is unable to extend its service by itself but goes for such other licensed authority, it does so only as a provisioning entity to make up for the gap caused by the statutory limitation on the license - Whether it means that these facilities are independent having no connection and relevance whatsoever to the connectivity offered by the assessee - Whether when various contracts executed pursuant to the service contract with the customer are closely linked to the single transaction of providing end to end international private leased circuit facility to the customer and in order to execute the same, if the assessee has to enter into several sub- agreements, such agreements can be looked at in isolation having no relevance to the service agreement - Whether when the assessee provides the Indian customer an integrated communication system IPLC, the part of which outside India is taken care of by the assessee and the part inside India through VSNL, the same can be dissected as two independent contract having no bearing at all on each other - Whether in a virtual world, the physical presence of an entity has become an insignificant one - Whether the traditional concepts relating to control, possession, location on economic activities and geographic rules of source of income recede to the background and are not of any relevance in considering the question under Section 9(1)(vi) read with Explanation 2 - Whether when a non-resident service provider provides international connectivity services to clients in India with the help of an Indian telecom service provider, consideration received for rendering such services is to be construed as royalty for use of commercial and scientific equipment or for use of a process as per Sec 9(1)(vi)and also Article 12 of India - Singapore DTAA.
 
CASE-
 
The assessee, Verizon Communication Singapore Pte Ltd, originally called as MCI Worldcom Asia Pte Limited, and part of the global telecommunication conglomerate of MCI, USA is a non-resident company engaged in the business of providing international private leased circuit (IPLC). Being a point to point private line used to communicate between offices that are geographically dispersed throughout the world, the assessee provides a private link that can transport voice data and video traffic between the offices in different Countries. The international leg of the telecom services provided outside India was provided by the assessee. Videsh Sanchar Nigam Limited (VSNL) provided the Indian leg of the international service to the customers. Thus, a customer interested in taking a lease connection between its office in India and an overseas location entered into an arrangement with the assessee for the provision of international connectivity in the overseas leg and with VSNL for Indian half of the connectivity. VSNL transmitted the traffic of the customer in India from the customer's office in India and transmitted the traffic to a virtual point outside India and the assessee transmitted it upto the customer location outside India. Assessee used its telecom service equipment situated outside India in providing the international half circuit. The landing station in India used in transmitting the traffic within India belonged to VSNL and was used by VSNL for providing Indian end services pursuant to its contract with the customer.
 
In assessment, the Assessing Officer came to the conclusion that the payment received by the assessee in providing IPLC was taxable as 'royalty' for use of or right to use of commercial and scientific equipment under Section 9(1)(vi) read with Explanation 2 of the Income Tax Act and Article 12(3) of the Double Taxation Avoidance Agreement between India and Singapore. The Assessing Officer also held that VSNL and MCI Wordcom Asia Pte Ltd were partners in providing IPLC and related services to various customers; the assessee had business connection in India on account of the source of income and location of the business assets and software in India. Thus the Assessing Officer held that the payments were in the nature of 'royalty', taxable under Section 9(1)(vi) read with Explanation 2(iva) and (vi) as also under Article 12(3)(b) of DTAA with Singapore.
 
The assessee contended that no part of the international network was exclusive for any Indian customer or customers as a whole. The agreement between the assessee and the customers being one for rendering of service by the assessee, the payment could not be termed as 'royalty'. The collection of fee for the usage of standard facility would not amount to payment made for providing technical services. The Assessing Officer rejected these contentions holding that the consideration for rendering of services to the end user was workable only when the assessee and the VSNL were considered to be rendering the service jointly to the end user in India. The payments made by the customers for the offshore services rendered by the non-resident assessee were part of one single agreement to provide IPLC and hence, the receipts were taxable as 'royalty' under Section 9(1)(vi) read with Explanation 2 of the Income Tax Act. He held that by reason of the amendment to Section 9(1) with effect from 01.04.1976, under Finance Act 2010, the reliance on court decisions was not of any relevance to the assessee. The transmission cables and hightech instruments providing a seamless circuit were 'equipment' and the income earned by permitting the use of or right to use of equipment fell within the meaning of 'royalty', both under the Income Tax Act and under the DTAA.
 
On appeal, the CIT(A) while confirming the AO's order, held that the circuit created/developed by MCI, comprising of transmission cables and sophisticated instruments, amounted to 'equipment'. The payment made for the lease of this circuit, which expressed the quantity of dedicated bandwidth, would be taxable as 'royalty' under Section 9(1)(vi) Explanation 2 as well as under DTAA. On further appeal, the ITAT held that the payments made were for the use of tangible equipment and hence could be considered as payment for the use of or right to use of industrial, commercial and scientific equipment. The dedicated bandwidth was set aside by the service provider for the exclusive use of the customer. The Tribunal confirmed the views of the Assessing Officer.
 
Aggrieved, the assessee filed an appeal before the High Court and submitted that considering the fact that the contract between the assessee and the customer being one for providing services, the consideration received for rendering of services cannot be termed as 'royalty'. Referring to Explanation 2 to Section 9(1)(vi) of the Income Tax Act, the AR submitted that the enumeration in Explanation 2 clearly indicated that the royalty had to be given a limited meaning , it being with reference to tangible and intangible right, property or information. The Explanation says nothing about treating the consideration on rendering of services as 'royalty'. Statutorily, rendition of services was dealt with under sub-clause (vii) to Section 9(1) of the Income Tax Act. Even as per this, the receipt cannot fall under sub-Clause (vii). Thus, the assessee rendered the service of transmitting the customer's information from one location to another and the customer did not make the payment for acquiring a process, but only for a facility to communicate. Further, the service rendered was on non-exclusive basis and half circuit in India was operated by VSNL. In this, the customer did not get any right to use any equipment or has any knowledge or interest in the process/technical equipment deployed by the assessee in providing the service. Thus, access to service was different from access to right to use the equipment. As regards the role of MCI World Com India, the counsel submitted that it merely provided liaising and co-ordinating services and this could not be treated as permanent establishment. He submitted that IPLC services provided by the assessee could be compared with the goods transporter. There was no conversion of data or voice as in the case of the transponder services. In IPLC, there was only transmission of data and voice in the same form through fibre cables. The Revenue misconstrued the facts and the sophisticated technology merely concerns transmission of the data without distortion and the VSNL provided independent services within the Indian territory and was paid for separately and directly by the customers.
 
Explaining the nature of services, the assessee submitted an affidavit through the Manager giving the list of equipment owned by the customer and the operating entity in the transmission activity in this part of the World or elsewhere. The affidavit proceeded to explain how the system of transmission worked. It stated that a dedicated bandwidth was nothing but assuring an uninterrupted 24x7 provision of services at an agreed speed and efficiency to meet the conditions of the service order. It was stated that neither any capacity nor any network including the cables were earmarked or dedicated to any customer for his exclusive or sole use. Commenting on the customer equipment (CPE) and service equipment, the affidavit stated that a customer equipment was nothing but equipment owned and operated by the customers such as computers and customer routers. A customer premises equipment is the interface equipment between the customer router and local loop in the nature of modem provided by the local loop provider. Lastly, a service equipment is nothing but a cabling facility and equipment installed by the local loop service provider in the nature of a virtual local exchange.
 
The Revenue also filed an affidavit explaining what IPLC network was about by enclosing a detailed discussion by Dr Nitin Chandrachoodan, Associate Professor, Department of Electrical Engineering, IIT, Madras. It was stated that the circuit developed by the assessee comprised transmission cables and sophisticated equipment starting from the Data Circuit-Terminating Equipment (DCE) at the customer premises to the other end of the network DTE (Data Terminating Equipment), referred to as Customer Premises Equipment (CPE), and the Data Circuit Terminating Equipment (DCE) were referred to as 'Service Equipment' in the assessee's agreements. The assessee provided connectivity to the customer at its premises at both ends of the network and the connectivity was for a dedicated bandwidth capacity for the agreed time. The customer could now monitor the extent and quality of signal transmission at various nodes located all along the network pathway through 'Network Management Software'. The customer thus paid for the use of and the right to use of the equipment. It was pointed out that the assessee engaged the services of VSNL as a provisioning entity for performing certain services in India for which the assessee did not have the license. Thus the Revenue contended that the receipt was nothing but royalty.
 
Referring to the Board's circular on the amendment 2012, the counsel for the Revenue submitted that the declaratory amendment now cleared whatever doubts that were there on the scope of the Explanation. Referring to Article 12 of the DTAA, he submitted that there was no prohibition therein in assessing royalty in India. As per Article 3.2 of the DTAA, the term not defined in the agreement would be understood by the definition contained in the law of the contracting state. Thus, going by the Explanation giving the definition on 'royalty' and 'process', the receipts were rightly taxed .
 
Countering the stand of the Revenue, the counsel for the assessee replied that even though wide meaning was given under Section 9(1)(vi) read with Explanation 2 on 'royalty, yet, the transaction being one of pure rendering of service, the consideration could not be taxed as 'royalty'.
Having heard the parties, held that,
 
Section 5 &section 9
 
+ the Scheme of Section 5 of the Income Tax Act is that all income received by a resident in India, irrespective of all income deemed to be received in India, irrespective of whether it accrued or arise within India; all income accruing or arising to him in India during the previous year and all income accruing or arising to him outside India during the previous year are assessable in India as per the provisions of the Income Tax Act. Section 9 of the Income Tax Act specifically deals with the assessability of non-resident tax payer in respect of income from whatever source derived, received or deemed to be received in India or which accrues or arises or deemed to arise or accrue in India. Under Finance Act, 1976, a source rule was provided in Section 9 for taxing the income of a non-resident through insertion of Clauses (v), (vi) and (vii) in sub-section (1) of Section 9 for income by way of interest, royalty or fees for technical services respectively by creating a legal fiction in Section 9 that even in cases where services are provided outside India, it is the situs of the payer, or the situs of utilisation of service by the payer which would determine the taxability of such services in India;
 
Amendments:
 
+ after the decision in Ishikawajama-Harima Heavy Industries Ltd. V. Director of Income Tax that there should be territorial nexus between such income and territory of India and that the services had to be rendered in India and utilised in India, an explanation was inserted below sub-section 2 of Section 9, with effect from 01.06.1976 under Finance Act, 2007 clarifying that when income is deemed to accrue or arise in India under Clauses (v), (vi) and (vii) of sub-section 1 to Section 9, such income shall be included in the total income of the non-resident regardless of whether the non-resident has a residence or place of business or business connection in India. Thus, while in the case of resident, irrespective of place of accrual or arising of income, it is taxable in India, in the case of non-resident, unless the place of accrual or arising is within India, he cannot be subjected to tax. Thus only to the extent of any income accruing or arising within India, income is fictionally deemed to arise or accrue in India, and the non-resident would be liable to be taxed by reason of Section 5(2)(b) of the Income Tax Act. By Finance Act, 2010, with effect from 01.06.1976, the Explanation inserted by Finance Act, 2007 was substituted with retrospective effect from 01.06.1976 that income of a non-resident shall be deemed to accrue or arise in India under Clauses (v), (vi) and (vii), irrespective of the fact whether the non-resident has a residence or a place of business or business connection in India or non-resident has rendered service in India;
 
+ thus Section 9 of the Income Tax Act deals with taxation on income of the non-resident on accrual basis. In contrast to the residence being the focus in the case of the assessees falling for consideration under Section 5(1), Section 9 lists out income arising or accruing in India in cases of (i) non-residents directly or indirectly through or from any property in India, or through or from any asset or source of income in India or through the transfer of a capital asset situate in India; (ii) income which falls under the head "Salaries" earned in India; (iii) income chargeable under the head "Salaries" payable by the Government to a citizen of India for service outside India; (iv) a dividend paid by an Indian company outside India; (v) income by way of interest payable by the Government or by a resident or non-resident in the stated circumstances and (vi) income by way of royalty;
 
Treaties:
 
+ in the background of Section 9, considering the conflicting claim that may arise among nations to exercise jurisdiction to tax the entity by reason of choosing to emphasise on one or more connecting reasons such as the location of the source residence of the taxable entity, maintenance of permanent establishment and so on to exercise their fiscal jurisdiction to tax that entity and that some income of the same entity might become liable to taxation in different countries leading to harsh consequences, to avoid such jarring results, incongruous and anomalous situation and to foster economic development among nations, different Countries enter into bilateral treaties convention, agreements for getting relief against double taxation called Double Taxation Avoidance Treaties or Convention Agreements. The power to enter into a treaty is held as an inherent part of the sovereign power of the State. By Article 73 of the Constitution, subject to the provisions of the Constitution, the executive power of the Union extends to matters with respect to which the Parliament has power to make laws;
Royalty under section 9:
 
+ keeping in mind the settled principles, we are concerned about the treatment of income under the head 'royalty'. As per Clause (b) of sub-clause (vi) to Section 9(1) of the Income Tax Act, where, income by way of royalty is payable by a person, who is a resident, to a non-resident, the same shall be taxable as income under the provisions of the Act. Explanation 2 to sub-clause (vi) gives the definition of 'royalty'. As is evident from the reading of the provision, 'royalty' means the consideration for transfer of intellectual property rights; for imparting of any information regarding the working of, or the use of the intellectual property rights, use of any intellectual property, imparting of any information concerning technical, industrial, commercial, scientific knowledge, experience or skill; use or right to use any industrial, commercial or scientific equipment but not including the amounts referred to in Section 44BB; transfer of all or any rights including the granting of a licence in respect of any copyright, literary, artistic or scientific work including films or video tapes for use in connection with television or tapes for use in connection with radio broadcasting, but not including consideration for the sale, distribution or exhibition of cinematographic films or rendering of any services in connection with the activities referred to in sub-clauses (i) to (iv), (iva) and (v);
 
+ the amendment relating to 'royalty', particularly with reference to use or right to use any industrial, commercial or scientific equipment, etc. was inserted with effect from 01.04.2002 under the Finance Act 2001. The said expression came up for consideration before the Authority for Advance Ruling in the decision of Dell International Services (India) Pvt. Ltd., a decision strongly relied on by the assessee in support of its contention that the payment to the assessee herein is not 'royalty'. The Authority for Advance Ruling held that the predominant object of the entire agreement was concept of service. The Authority, however, observed that even where an earmarked circuit is provided for offering the facility, unless there is material to establish that the circuit/equipment could be accessed and put to use by the customer by means of positive acts, it does not fall under the category of 'royalty' in Clause (iva) of Explanation 2. Referring to Klaus Vogel's commentary on Double Taxation Convention, the Authority held that the nature of transaction was only a service and there was no use or right to use the equipment to regard the consideration as 'royalty';
 
Use or right to use:
 
+ recently, in the case of M/s. Poompuhar Shipping Corporation Ltd., V. The Income Tax Officer, Chennai concerning the case of time charter, this Court considered the meaning of the expressions 'right to use' and 'equipment' and held that payment made for taking ship on time charter constituted 'royalty' as defined under Section 9(1)(vi) of the Income Tax Act. This Court considered the issue on use or right to use, particularly with reference to the term 'royalty' as defined under Explanation 2 and held that the expression 'use or right to use' is intended to take its ordinary meaning and applied in the broader sense, to mean employing for any purpose. Referring to the amendments made through insertion of Explanations 4 and 5, this Court held that the retrospective amendment has thus removed all doubts in so far as the expression 'use or right to use' to be understood in the context of possession, control or location;
Dell and Cable and Wireless Networks distinguished:
 
+ Before going into the details of the agreement and the arguments in this case, we may point out that the decisions in Dell International Services (India) Pvt. Ltd., In re Cable and Wireless Networks India (P) Ltd., In re are not of any assistance to the assessee, considering the amendment that had come in the wake of those decisions under Finance Act 2012 by the insertion of Explanations 5 and 6 in particular having relevance to the issue on hand.
Asia Satellite distinguished
 
+ the decision relied on by the assessee, particularly with reference to the Delhi High Court in Asia Satellite V. DIT is also distinguishable. This relates to a case of an assessee/lessee of a satellite called AsiaSat 1 which was launched in April 1990 and was the owner of a satellite called AsiaSat 2 which was launched in November 1995. These satellites were launched by the appellant and were placed in a geostationary orbit in orbital slots, which initially were allotted by the International Telecommunication Union to UK, and subsequently handed over to China. These satellites neither use Indian orbital slots nor are they positioned over Indian airspace. The footprints of AsiaSat 1 and AsiaSat 2 extend over four continents, viz., Asia, Australia, Eastern Europe and Northern Africa. It enters into an agreement with TV channels, communication companies or other companies who desire to utilize the transponder capacity available on the appellant's satellite to relay their signals. The customers have their own relaying facilities, which are not situated in India. From these facilities, the signals are beamed in space where they are received by a transponder located in the appellant's satellite. The transponder receives the signals and on account of the distance the signals have travelled, they are required to be amplified. The amplification is a simple electrical operation. Thereafter, the frequency on which the signals are to be downlinked is changed only in order to facilitate the transmission of signals so that, there is no distortion between the signals that are being received and the signals that are being relayed from the transponder. The transponder operations are commonly known, which are carried out not only in satellite transmission but also in the case of terrestrial transmission. There is no change in the content of the signals whatsoever that is carried out by the appellant in the transponder. Thereafter, the signals leave the transponder and are relayed over the entire footprint area where they can be received by the facilities of the appellant's customers or their customers. Its role is confined in space where the transponder which it makes available to its customers performs a function which it is designed to perform. It is claimed by the appellant that no part of the income generated by it from the customers to whom the aforesaid services are provided was chargeable to tax in India and for this reason no return income was filed in India. The Tribunal found that the transponder was not equipment and hence the payment made by the TV channels to the appellant could not be regarded as one for use of equipment. The Tribunal held that the appellant had not leased out any equipment but had only made available the process that was carried out in the transponder to its customers. Insofar as income earned by the appellant from its customers in India is concerned, the Tribunal held that this would qualify as 'royalty' as defined in Explanation 2 to Section 9(1)(vi) of the Act;
 
+ therefore, issues which arose for consideration in the appeal before the Delhi High Court related to Clauses (i), (vi) and (vii) of sub-Section (1) of the Section 9 of the Act. The High Court held that even when the appellant had business connection in India, no part of the appellant's income was chargeable to tax in India in terms of Section 9 (1)(i), as no operations to earn the income were carried on in India. The Delhi High Court held that carrying out the operations in India, wholly or at least partly, is sine qua non for the application of Clause (i) of sub-section (1) of Section 9 of the Act. Merely because the footprint area included India and ultimate consumers/viewers are watching the programmes in India, even when they are uplinked and relayed outside India, would not mean that the appellant is carrying out its business operations in India. No machinery or computer, etc. is installed by the appellant in India through which the programmes are reaching India. The process of amplifying and relaying the programmes is performed in the satellite which is not situated in the Indian airspace. The transponder functioned on its own. The High Court held that the terms 'lease of transponder capacity', 'lessor', 'lessee' and 'rental' used in the agreement would not be the determinative factors. It is the substance of the agreement which is to be seen. The High Court went through the various clauses of the said agreement and held that the control always remained with the appellant and the appellant had merely given access to a broadband available with the transponder, to particular customers. Merely because the transponder has its footprint on various continents, it would not mean that the process has taken place in India. Thus the Delhi High Court followed the decision of the Apex Court in Ishikawajama-Harima Heavy Industries Ltd. V. Director of Income Tax and held that services rendered outside India would have nothing to do with the permanent establishment in India and hence there was no process carried out in India or was there any business in India which could be attributed to the Indian territory. Thus the High Court held that the income earned by the assessee would not qualify as 'royalty', as defined in Explanation 2 to Section 9(1)(vi) of the Income Tax Act. As seen from the facts, the said judgment was rendered in the year 2011, much before the amendment under Finance Act, 2012. Further after the decision in Ishikawajama-Harima Heavy Industries Ltd. V. Director of Income Tax an explanation was inserted below sub-section 2 of Section 9, with effect from 01.06.1976 under Finance Act, 2007 to get over the decision of the Supreme Court. Hence this decision of the Delhi High Court is distinguishable and has no relevance to the case on hand which has to be considered on the strength of the law prevailing now.
 
Bandwidth:
 
+ technological advancement in the field of communication has brought in sea change in public ability to connect and communicate seamlessly with people in different parts of the World. Computer and related services are considered as the basis of the modern information and communication sector. From a manual economy to automated economy, development of technology today has ushered in electronic commerce where business or trade is conducted over a network that uses computer and telecommunication. Internet, in the most simplest of the term, is a group of millions of computers connected by networks. It is the size of each network connection that determines how much bandwidth is available. Bandwidth therefore is a measure in bits (0 to 1). Bits are grouped in bytes which form words, texts and other information that is transferred between the computer and the internet. Thus, an user having a particular server connection to the internet has a dedicated bandwidth between the computer and the internet service provider. But the internet service provider may have thousands of service connections to their location. The service provider has enough bandwidth to serve a person's computing needs as well as that of the other customers;
+ bandwidth is the number of lanes as in the highway through which data at a speed designed is transmitted. Bandwidth is the capacity of transmission medium or amount of data, measured usually in bits per second that can be sent through a dedicated (leased) transmission circuit. Thus the equipment at the customer's premises must have the capacity to send and receive data at a required speed. Circuit is the complete path of an electric current, a communication link between two or more point. A leased line is a service contract between a provider and a customer, whereby the provider agrees to deliver a symmetric telecommunication live connecting two or more location in exchange for a monthly rent, hence, the term 'lease'. Unlike a PSTN line, it does not have a telephone number, each of the line being permanently connected to the other. The lease line is always active. Typically, these lines are used in business to connect geographically distant offices. The connection does not carry anybody or everybody else's connection, and the carrier assure the customer a given level of quality and speed for carrying the data or voice. Thus, leased line is a private, high performance circuit leased by a common carrier between a customer and a service providers' network. It carries usually data, voice or both. It delivers dedicated guaranteed bandwidth straight to the internet backbone, for which, the customers pay a premium for the leased line and it is supported by a comprehensive service level agreement;
 
+ leased lines are normally made up of the following equipments, viz., a router - usually managed by the service provider and is installed into a customer room; the circuit is connected with a connector; Local loop circuit is usually provided by the carrier linking the router to the service provider's local point of presence (POP); Network Termination Equipment (NTE) is attached to the wall in the customer's room and is connected to either a fibre optic or copper local loop circuit. Depending upon location, a back haul circuit may be used to link a customer to the service provider POP and then on to the internet gateway. This takes place behind the scenes and may run over a third party' national network. CPE - the Customer Premises Equipment is the telecommunication equipment owned by an organisation and located on its premises. It refers to all types of routers, switches, PBXs (Private Branch Exchanges), telephones, key system facsimile products, modems, voice processing equipment and video communication equipment;
Assessee's expert evidence:
 
+ thus IPLC is a point-to-point private line used by an organisation, providing bandwidth for global communication networks between offices that are geographically dispersed internationally. IPLCs are the basic building blocks for international communication. These point-to-point private line services are supported by an exclusive range of bandwidth option dedicated to the customers' exclusive use, providing quality reliable digital transmission seamlessly integrating data, voice and imaging services. To simplify, IPLC ordering and billing, a concept called, One Stop Shopping (OSS) was developed. It allows an organisation to place a single order with a single carrier for two private leased circuits for two offices in two different Countries. OSS consolidates the billing for both circuits into a single invoice, handles all currency issue and allows the organisation to report all problems from either circuit to one carrier. Giving the diagram on the circuit layout for IPLC under sea cable, the affidavit filed by the assessee explains technical explanation to the IPLC services, that it is a point to point service with two half circuits starting from one end of the customer and terminating to the other end. One half of the circuit is a mirror image of the other from the midpoint outside the Indian territorial waters;
+ in the affidavit filed by the assessee, it is stated that neither any capacity nor any network including the cables earmarked or dedicated to any customer for his exclusive or sole use. It is also stated that it is a technological impossibility to dedicate or allocate any infrastructure or capacity to any customer. It is further stated that every operator and service provider need not own the entire infrastructure. Likewise, the owner of the infrastructure need not be a service provider and service provider need not necessarily own the infrastructure. They can as well hire or lease;
 
Expert evidence of Revenue
 
+ the Revenue has also filed an affidavit supported by the expert view by Associate Professor, Department of Electrical Engineering, IIT, Madras and stated that the connectivity is provided by the service provider, in this case by the assessee company to the customer at the customer premises at both ends of the network. This connectivity is for a Dedicated Bandwidth capacity for the agreed time period. Thereafter, it is the customer who feeds the data/voice inputs into the IPLC network at the interface located at his place and also receives the data/voice inputs coming from the opposite direction. It is upto the customer whether he uses the hired Dedicated Bandwidth capacity fully, in part or not. In any case, the agreed charges are payable by the customer to the assessee company. The DCE is installed at the customer premises and is owned by the assessee company, MCI, since it is the point of connection between the customer and the carrier. It provides clock and switching services to the data from the customer to the carrier. The assessee owns the Data Circuit Termination Equipment (DCE) installed at the customer premises. The customer is given a choice only in respect of the Data Terminating Equipment (DTE). The DTE can be either supplied by the assessee or can be acquired and installed by the customer himself in accordance with the terms and conditions of the 'MCI Asia Pacific Master Services Agreement'. The reply affidavit disputes certain statement in the affidavit filed by the Revenue on technical aspects that the Data Terminal Equipment equal to terminals, personal computers, routers and bridges are all owned by the customers and are not Customer Premises Equipment of the service provider. The transmission network involves various legs of operations involving multiple players. Like a passenger booking the ticket, a customer has to book for his service which can be 2mbps. Like an airline, a service provider after using the network and transmission equipment of multiple operators would provide or deliver the end service, namely, transmission of voice or data and the customer does not gain control in any manner either physically or economically either over the network or processes involved;
 
Various agreements:
 
+ the case of the assessee, hence, has to be seen in the context of the agreement between the assessee and the customer, assessee and VSNL, VSNL and customer and Master agreement. The agreement between the assessee and the customer, called Service Order Form, gives the nature of service contracted to by the customer and the terms subject to which services are given. The Data Service Order Form states that it shall be read in conjunction with the terms of Asia Pacific Master Terms and Conditions, which the customer is stated to have agreed prior to executing the service order. The Asia Pacific Master Terms and Conditions, the parent document, which govern the provision of services to the customers by MCI in Asia pacific region, requires immediate attention. The Asia Pacific Master terms and conditions gives the scope of the agreement as concerning of a) Master Terms and Conditions (Master Terms), b) specific terms which apply to particular categories of service as attached in the schedule to the Master terms and c) the service order. it is stated that to the extent that there is any inconsistency between the terms set out in (a), (b) and (c), the service order will prevail over the schedule and Master Terms. It is stated that each service order issued and accepted pursuant to the terms of the agreement would create an individual contract relationship between the parties to such service Order. The relationship would be governed by the Master Terms and schedules together with relevant service order in addition to the provisions set forth in the agreement; the service would also be subject to all mandatory local law requirements, including but not limited to the regulatory and data protection requirements in the respective countries;
 
Definition of terms used:
 
+ the Master Terms gives the definitions of various terms used. "Customer Equipment" is defined to mean equipment, systems, cabling and facilities provided by Customer and used in conjunction with the service equipment in order to obtain the service and includes CPE. "CPE" means equipment installed by MCI whether owned by the customer or not, which is located at the customer site for the purpose of receiving a service. "Service" is defined as specific service supplied by MCI or a Provisioning Entity to customer identified in a relevant service order and any related service equipment support or consulting provided. "Service Equipment" means the equipment, systems, cabling and facilities provided by or on behalf of MCI at Customer Site in order to make the Service available to customer. Ownership of the Service Equipment does not pass to customer from MCI and does not include the network. The Master Terms also contains MCI termination and consequences of termination. It also refers confidentiality information, data protection and privacy. It also states that if MCI consider it necessary, it shall conduct one initial survey at the customer site identified on the Service Order prior to receipt of the CPE to evaluate the accommodation for the CPE, the necessary wiring required, the compatibility of the CPE configuration, interfaces with the connecting equipment and to identify any potential deficiencies within the customer site. The customer site survey will also confirm the CPE configuration and all CPE interfaces will be compatible with the local PBX/telephone and data equipment to which it will be connected. Customer Site surveys shall be conducted between 9 am to 5.30 p.m. on a working day in the location in which the Customer Site is located . Equipment vendors other than MCI may be consulted, in MCI's sole and reasonable discretion, to determine the compatibility of their equipment. All charges for such consultancy visits by third party vendors shall be borne solely by Customer;
 
Customers' responsibilities:
 
+ as regards the customers' responsibilities, it is stated that the customer has to have the site prepared and ready for installation of the CPE by MCI or its designee on the delivery date specified by MCI. The clause further states that the customer is solely responsible for ensuring that the Customer Equipment is compatible with MCI's requirements and that it continues to be compatible with subsequent revision levels of MCI provided equipment and services. The customer has to maintain each analogue line and to ensure installation of the CPE proceeds as planned. The customer should provide details of the analogue line a minimum of 14 days prior to the installation of the CPE. Upon expiry of the service term or upon termination of service for any reason whatsoever including due to the default of MCI, the customer would return the CPE, freight pre-paid, to such location as MCI may designate in writing in good repair, condition and working order, ordinary wear and tear resulting from proper use thereof only excepted. It is stated that CPE must be returned to MCI from the termination of service and if the same is not returned within 15 days of the termination of service, the customer would be billed for the price of the CPE, such invoice will be payable in accordance with terms;
 
Equipment sale:
 
+ as regards Equipment Sales in Schedule C, it is stated that MCI is only acting as a reseller with respect to the hardware and software offered for sale to Customer under the agreement, which was manufactured by a third party. It is stated that MCI would ship the current MCI-tested version of the equipment to customer. Customer's use of the equipment is subject to the terms and conditions of the manufacturer's end user agreement for the equipment. 40% of the price of the equipment purchased by the customer would be paid by the customer upon execution of the service order and the remaining 60% of the price would be invoiced upon shipment of the equipment and title to the equipment would remain with MCI until the customer has paid for the equipment in full. It is stated that title in any software and associated documentation with the CPE (software) remain at all times with the licensor and use of such software must be in accordance with the accompanying licence agreement;
 
Service order form:
 
+ in the background of this Master Agreement, when we look at the Service Order Form, we find that from the additional terms and conditions of service attached to the order form that the customer has ordered for IPLC services and has appointed MCI as its agent with regard to the provision of direct supply services. The order form defines provisioning entities as the local licensed telecommunication supplier for any portion of the service not provided by MCI or its affiliates; MCI, if requested by the customer in the service agreement has to arrange the provisioning of direct supply services on the terms specified therein, namely, (i) the customer appoints MCI for the duration of the term; should be the customer's sole agent for the provisioning and continuing supply of the direct supply services described therein; (ii) MCI shall have authority to select the provider of the Direct Supply Services; (iii) the Customer shall contract as principal with the provider of the Direct Supply Services on the terms and conditions of supply notified by MCI to customer and (iv) MCI will act as the customer's agent to receive and pay invoices for the Direct Supply Services. The invoice issued by the MCI to the customer for IPLC clearly mentions that it is for Circuit billing from the originating A End - Chennai in India to terminating B end - SanJose, USA. Direct Supply Services is defined as a circuit or service, including a local circuit or service directly connecting the customer's premises in a country or an international capacity connecting to circuits or services supplied by MCI, which by reason of regulatory requirements in the relevant country, MCI cannot supply direct to the customer. The order form says that MCI may appoint Direct Supply Services, Provisioning Entities as its debt collection agent for charges for Direct Supply Services. Service form gives a single ID appointing MCI as its agent with regard to provision of Direct Supply Services. The initial service period is for one year. The monthly services, recurring charges are also given thereon. Attachment B(2) defines International Private Line (IPL), which is a bilateral Service - MCI is only responsible for its half circuit in terms or ordering, provisioning, billing and fault reporting. Customer has to liaise directly with the correspondent carriers for the distant half end circuit. One Stop Shopping (OSS) is an IPL service that provides a single point-of-contact for the planning, ordering, billing, management and maintenance of a customer's IPL. OSS is an optional arrangement whereby, a single carrier handles the coordination between the customer and the other carrier(s) involved in the provision of the customer's IPL.
 
+ there is also an agreement between MCI Worldcom Asia Pte Limited and Videsh Sanchar Nigam Limited on International Private Leased Circuit. One stop shopping service agreement specifically gives the details of the service description as OSS Service by which customers can order both of the half circuits comprising an IPLC Service through a single point of contact at either of the Administrations, with the option of requesting SEO(Single end ordering), SEB (single end billing) and SPFR (single point fault repairing). The agreement further states One Administration, selected in each case by the customer, shall be the single point of contact for the customer in respect of the IPLC Service and shall liaise in relation thereto with the customer and with the other Administration. The provision of OSS Service is without prejudice to the contractual relationship that each Administration has or may have with its respective customers. Each Administration shall separately contract with customers to provide IPLC half circuits whether originating or terminating in its operating territory and each such customer will be liable to that Administration for all charges, fees and taxes billed under that contract;
 
+ where an Administration introduces the IPLC services of the other Administration to any customer, it shall notify the customer that such services will be provided under the relevant terms and conditions of the other Administration. The Administrations will exchange instructions on the method of completion of their respective Order Forms. Once the customer has signed Administration B's original Order Form, it must be returned to Administration B for approval. Administration B will notify Administration A immediately if Administration B's order documents are in any way incomplete or inaccurate. If Administration B does not provide Administration A with such notification, it will constitute that Administration B has accepted the order along with Administration B's order documents as complete. The overall provisioning interval for the IPLC Service will be the longer of the two lead times of each of the Administrations;
 
+ schedule I gives the obligation when VSNL is the Administration A and Schedule II when VSNL is Administration B. VSNL shall get the relevant documents, including the MCI Warranty of Agency, filled by the customer at Indian end as per the customer order form made available to VSNL by MCI. This document has to be handed over to MCI at the earliest time possible, by courier and also communicated by facsimile/email to contacts of MCI as provided, for expediting the order. The charges or fees raised by MCI through its invoices will be the total charges to be paid by VSNL under the Agreement. When VSNL is Administration B, under SEO, MCI shall get the relevant documents filled by the customer at their end as per the customer order form made available to them by VSNL. This document shall be handed over to VSNL at the earliest time possible, by courier and also communicated by facsimile/email to contacts of VSNL as provided, for expediting the order. The charges or fees raised by VSNL through its invoices will be the total charges to be paid by MCI under this Agreement;
Agreement with Indian subsidiary
 
+ there is also an agreement between the assessee and MCI WorldCom India Private Limited. MCI WorldCom India is a service provider. The agreement states that the assessee and the service provider are both members of the WorldCom group of companies and the assessee wish to avail of certain support services from the service provider on terms and conditions mentioned therein in the agreement. The nature of services to be provided are given in appendix (1) to the agreement, namely, Market Development, Providing information on potential customers, liaising with potential customers for dispersing information about the company' products and services, liaising with customers for obtaining feedback on behalf of the company and exploring new service lines/ventures for the company in India. The obligations of the service provider are given in clause 2 of the agreement. The service fee and payments are given in clause 5 of the agreement and the duration of the agreement at the initial term is for a period of two years. The agreement states that at all times, the service provider shall only provide marketing assistance, advice and other information to the company;
 
+ MCI Global Access Corporation and VSNL have also entered into agreement, called VSNL/WCom Global Network Services, on 8th February, 2001. The scope of services are given in Clause 3; the functions, practices and procedures required to enable WCom and VSNL are described in Appendix A. The intention of entering into the agreement is given in Clause 3.03. It states that the intention of the parties is to provide WorldCom Global Network Services by utilising the respective strength and capabilities of VSNL and Wcom. Clause 3.05 states that WCOM Global Network Services will be offered for VSNL customers to communicate internationally. Clause 3.06 states that the agreement is non-exclusive and shall not restrict either party from offering similar services independently or in combination with other organizations. Neither shall it create a partnership between VSNL and WCOM.
 
Composite contract:
 
+ in the background of the service agreement with the customer, Service agreement with VSNL and the one between customer and VSNL, it is clear that these are part and parcel of one composite agreement split into four for the purposes of convenience and the nature of services to be offered through the different agencies having a bearing on each other. The ultimate aim however being to give the customer a point-to-point private line to communicate between offices that are geographically dispersed throughout the world for the purposes of accessing business data exchange, video conferencing or any other form of telecommunication. As is evident from the reading of the terms of all these agreements, parties have agreed to go for One Stop Shopping, which allows an organisation, namely, customer to place a single order with a single carrier for two private leased circuits for two offices in two different Countries, here the Indian half by VSNL and the other half by MCI. Nevertheless, this consolidation in a single invoice at the agreed currency enables the customer to report its problem from either circuit to one carrier. It fixes the responsibility on the parties herein for ensuring undisturbed enjoyment of the private leased line. There is a symmetric telecommunication facility permanently connecting one end to the other. Thus, the contract ensures that the customer has an active internet dedicated to that particular customer at a particular speed agreed upon, namely, 2 Mbps. VSNL is a provisioning entity whose services the assessee has to direct the customer to avail of, since as per the Indian law, the assessee is not the licensed operator in the Indian half circuit. Thus, when the customer requires a seamless dedicated point to point IPLC service for transmission of voice and data, it requests the assessee' affiliate in India who arranges for the assessee MCI singapore to enter into an agreement with the customer on the terms and conditions of the service provided by it;
 
+ the counsel appearing for the assessee submitted that even though the assessee provides end to end service, as far as the half of the leg upto the Indian sub-continent is concerned, it has nothing to do with the maintenance or providing service by VSNL. Whatever bandwidth is assured is again a shared one. There are no equipment strictly speaking of the assessee to process the data of the customer;
 
Agreement to be looked at in a holistic manner:
 
+ the case of the assessee is that the agreement between the assessee and customer contemplated rendering of service only and hence the consideration paid would not partake the character of royalty and the agreement with VSNL could not be read into the agreement or the service order form that the assessee has with the customer. We do not agree with the assessee principally for the reason that the decision of the Delhi High Court reported in Asia Satellite V. DIT and the Rulings of the Authority for Advance Ruling reported in Dell International Services (India) Pvt. Ltd. and Cable and Wireless Networks India (P) Ltd., on which heavy reliance was made were all rendered prior to the insertion of Explanation 5 and that the decision of the Delhi High Court rested on the facts therein. The amendments by insertion of Explanation 5 gives a very expansive meaning to the term 'royalty' and this has a bearing on the issue, so too the various clauses in the agreements which are to be looked at in a holistic manner. The agreement entered into between the assessee and the customer herein is for providing of seamless point to point private line so as to enable the customer to communicate between its office that are geographically dispersed. The service order reveals that the parties had agreed for a particular bandwidth and in entering this the assessee had provided the necessary equipment at customer premises, configured and customised to ensure that the customer gets the uninterrupted connectivity from one end to the other end in different geographical point;
 
+ a reading of the agreement with VSNL also shows that the configuration at the customer's end and at the VSNL end and in the other half managed by the assessee match with each other and compatible for ensuring the integrated service to the customer. The arrangement between the assessee and the VSNL has to be necessarily integrated and technically and financially viable having regard to the close functional relationship between the two. For this, the Indian customer pays through the single billing system called OSS for the integrated services. Thus the service agreement assuring the service is possible and workable only when the assessee and VSNL are considered as rendering the service jointly in their respective leg. Thus the two half being the mirror image of each other and going by the terms of the agreements, the assessee renders service in India and the consideration received attracts the incidence of taxation in India.
 
Master agreement:
 
+ bandwidth is defined as the amount of traffic that is allowed to occur between the customer website and the rest of the internet. Bandwidth is measured in bits a single 0 to 1 and are grouped in bytes which form words texts and other information transferred between the computer and the internet. It is stated that an user having a particular IPLC service connection has a dedicated bandwidth between the computer and the internet provider though the provider itself may have 1000 such service connection to other location. Evidently, service provider has to have enough bandwidth to serve a person's computing needs as well as all of its other customers. Thus, being high speed internet connection, to achieve this, the equipment at the customer's end must have the capacity to send and receive data at the required speed. In order that the contracted bandwidth is provided, the Master agreement read with the service order clearly gives the selected bandwidth for each customer which is assumed end to end and to this end, the equipment at the customer's end are delivered by the assessee itself.
 
+ in the Master agreement, Clause 4 deals with Managed Services Complete, Clause 4.1 stipulates Service Description, Clause 4.2 stipulates Customer Site Surveys, Clause 4.3 stipulates CPE Installation, Clause 4.4 stipulates CPE Rental, Clause 4.5 stipulates CPE Maintenance Services, Clause 4.6 stipulates Customer Responsibilities and Clause 4.7 Termination of Service stipulates the return of the CPE to the location specified by MCI. The Master Agreement specifically refers to the use of the equipment by the assessee and throughout the contract period, the assessee has the right to supervise its maintenance. The customer's responsibility as stated in the agreement thus points out that during the currency of the agreement, the customer cannot in any manner tinker with it or its rights in any manner alienated;
 
+ it is a matter of record that the terminal equipment with the VSNL has to have the compatibility to match to the mirror like operation in the other half of the leg to see that the end to end connectivity is really assured to the customer. Being an end to end dedicated telecommunication transmission for customers' exclusive use, leased line are available only to those who seek private circuits. The customers' premises equipment thus refers to routers, switches, private board exchange, installed in a customers' premises. Thus, in the bandwidth services for transmission of data/voice through IPLC network, the data/voice are converted into signals at the customer' end which are then picked up by the local loop service provider and carried into the Indian carrier, namely, VSNL's half circuit. VSNL carries this to the international terminal which interconnects the domestic network to the international network. An international terminal is present in the appellant's side of half circuit performing identical function as in the Indian half circuit, where the steps in respect of Indian half circuit is replicated and the recipient receives the voice/data. The agreement is silent on what is involved in the ITOC in the current layout that interconnects the domestic network to the international network. Yet, looking at the various clauses in the agreement and the service order form, it is clear that the customer is assured of a particular bandwidth; to provide the assured bandwidth, the agreement ensures that the necessary equipment are placed at the customer's end in the Indian half that is compatible with the equipment in the other half outside India, so that the switching facility converts and receives the signal in the network and transmit through the transmission network cable to the ultimate destination;
 
Service cum order agreement
 
+ the service order-cum-agreement for Inter nation Private Leased Line Service between the customer and VSNL and between VSNL and the MCI WorldCom Asia Pte Ltd. on One Stop Shopping Service Agreement thus clearly point out that the payment to the assessee is for the online service from one point to the other as a whole and it is difficult to accept the case of the appellant seeking dissection of the same as two independent contract;
 
+ it is no doubt true that the agreement between the assessee and the VSNL states that one is not the agent or the representative of the other. This, however, does not mean that VSNL has provided its server independently without any connection whatsoever with the service order that the customer places with the assessee. A reading of the service agreement shows that parties agreed that the provisioning entities in the Indian half circuit shall be VSNL and in getting the seamless end to end connectivity, the customer enters into a further agreement with VSNL. If the agreement with VSNL has to have no relevance or reference to the customer agreement with the assessee, then, there is no need at all in the service agreement to refer to VSNL as the provisioning entity or for that matter to go for OSS. The Telecom Regulatory Laws thus can have no reference to the agreement that the assessee may have with the Indian customer except to the extent of providing of the connectivity in the Indian half circuit through VSNL. Thus, the end to end provisioning in one single circuit is assured by the assessee and if by reason of any regulatory laws of the Country the assessee is unable to extend its service by itself but goes for such other licensed authority, it does so only as a provisioning entity to make up for the gap caused by the statutory limitation on the license and thus it does not mean that these facilities are independent having no connection and relevance whatsoever to the connectivity offered by the assessee. The various contracts executed pursuant to the service contract with the customer are closely linked to the single transaction of providing end to end international private leased circuit facility to the customer and in order to execute the same, if the assessee has to enter into several sub- agreements/agreement, such agreements cannot be looked at in isolation having no relevance to the service agreement;
 
Effect of insertion of Explanation 5:
 
+ in the background of this, we reject the plea of the assessee that the payment made is not in consideration of the use of the equipment by the customer. We also reject the argument of the assessee that what is provided is in the nature of service. We hold that providing of service is not possible without the use of the equipment ensuring the assured bandwidth for transmission of data/voice which provides the internet access to the customer to and fro. After the insertion of Explanation 5, possession, control of such right, property or information usage directly by the payer, location of the right are not matters of concern in deciding the character of payment as 'royalty' and but for the use of the connectivity by the payer, the service agreement itself has no meaning. Thus the amendment introduced as a result of the decision of the Authority for Advance Ruling in Dell International Services India (P) Ltd. clearly answer the question raised in this regard against the assessee;
 
Integrated contract
 
+ it is rightly pointed out by the Solicitor General, the customer has a significant economic interest in the assessee's equipment to the extent of the bandwidth hired by the customer. The service order form shows the customer contracting for IPLC service and MCI is appointed as its agent as regards the provision of direct supply service. The OSS is a facility which the customer is provided with for availing of the economic interest in the services provided. The bandwidth capacity made available on a dedicated basis for the entire contract period, even if it does not involve a possessory interest, the amount received by the assessee in a way is also for the use of process. The service order form clearly points out that the assessee is at liberty to change the equipment, modify the configuration or change the routing of the network in providing the service and the assessee could provide the service either directly or through a provisioning entity. Thus the assessee provides the Indian customer an integrated communication system called IPLC, the part of which outside India is taken care of by the assessee and the part inside India through VSNL, which cannot be dissected as two independent contract having no bearing at all on each other. In the light of the above, we reject the contention of the assessee;
 
Royalty under the DTAA:
 
+ the definition of 'royalty' under DTAA and the Indian Income Tax Act are in pari materia. As rightly pointed out by the Revenue, Explanation 6 defines 'process' to mean and include transmission by satellite (including uplinking, amplification, conversion for downlinking of any signal) cable, optic fibre, or by any other similar technology, whether or not such process is secret. Thus, apart from the relevance and applicability of Clause (iva) that the payment is for the use or right to use of the equipment, the Tribunal held that payment for the bandwidth amounts to royalty for the use of the process. The Tribunal also pointed out that out by reason of the long distance, to maintain the required speed, boosters are kept at periodical intervals. Going by this too, in any event, the payment received by the assessee was rightly assessed as 'royalty' and would constitute so for the purposes of DTAA;
 
PE in the virtual world:
 
+ we may also note that except for making the submission on the question that the transaction is only a service and hence the consideration is not royalty, no arguments are made on permanent establishment or on the effect of the amendments. The assessee had submitted a detailed written submission on the clauses in the agreement and on the legal submissions. After considering the same, with reference to the arguments made by the counsel on the issue of royalty, vis-a-vis the agreement terms, we hold that the order of the Tribunal does not call for any interference. Although in his reply, the counsel appearing for the assessee pointed out to Article 5 on permanent establishment to contend that VSNL is not an agent and hence cannot be construed as a permanent establishment of the assessee, no arguments are advanced on this account. In any event, in a virtual world, the physical presence of an entity has today become an insignificant one; the presence of the equipment of the assessee, its rights and the responsibilities of the assessee, vis-a-vis the customer and the customers' responsibilities clearly show the extent of the virtual presence of the assessee which operates through its equipment placed in the customer's premises through which the customer has access to data on the speed and delivery of the data and voice sent from one end to the other. The Explanations inserted thus clearly point out that the traditional concepts relating to control, possession, location on economic activities and geographic rules of source of income recede to the background and are not of any relevance in considering the question under Section 9(1)(vi) read with Explanation 2. Thus, more so when it comes to the question of dealing with issues arising on account of more complex situations brought in by technological development by the use of and role of digital information, goods etc., the foreign enterprise does not need physical presence at all in a country for carrying on business. Hence, we do not think that we need to go in depth in this regard for the reason that we have already given;
 
+ in the circumstances, we reject the case of the assessee holding that the receipts are liable to be treated as 'royalty' for the use of IPLC under Section 9(1)(vi) read with Explanation 2(iva) and correspondingly Article 12(3) of DTAA between India and Singapore. We also agree with the Tribunal that even if the payment is not treated as one for the use of the equipment, the use of the process was provided by the assessee, whereby through the assured bandwidth the customer is guaranteed the transmission of the data and voice. The fact that the bandwidth is shared with others, however, has to be seen in the light of the technology governing the operation of the process and this by itself does not take the assessee out of the scope of royalty. Thus the consideration being for the use and the right to use of the process, it is 'royalty' within the meaning of Clause (iii) of Explanation 2 to Section 9(1)(vi) of the Income Tax Act;
 
+ in the circumstances, we affirm the order of the Tribunal holding that the consideration paid by the customer to the assessee is 'royalty' within the meaning of Explanation 2(iva) or in the alternative under Explanation 2(iii) of Section 9(1)(vi) of the Income Tax Act and Article 12(3) of the DTAA between India and Singapore. With regard to levy of interest under Section 234 A, 234B and 234 D of the Income Tax Act, as the case may be, we remand this issue alone to the Income Tax Appellate Tribunal for its consideration on merits and in accordance with law.
 
Source: Taxmann & TIOL

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