In a recent judgment the Mumbai Bench of the Income Tax Appellate Tribunal (Tribunal) has held that the payments received by Marriot International Inc. from the Indian hotels characterised as payments on account of international sales and marketing are not expense reimbursements but are income taxable as ‘royalty’ in India. This decision may have significant implications for the tax positions of both hotel owners (Owner) and hotel operators (Operator) under similar hotel management agreements for Indian hotels.
Marriot International Inc. (Marriott) is a tax resident of the United States of America (US) and is a member of the ‘Marriott Group’ of companies (Marriott Group), which is engaged in the business of operating hotels worldwide under different brands including ‘Marriott’ and ‘Renaissance’ (Brands).
The Marriott Group companies which had owned the Brands licensed them to another group company, namely Marriott Worldwide Corporation (MWC), which in turn sub-licensed the Brands to hotels around the world operated by Marriott Group companies.
Three Indian hotels had entered into separate license agreements with MWC (as sub-licensor) for the use of Brands and paid a royalty for that purpose on which due taxes were paid in India.
Separately, Marriott entered into International Sales and Marketing Agreement (ISMA) with each of these Indian hotels to provide international sales and marketing services outside India. The ISMA provided for the following payments:
Marketing contribution (as a fixed percentage of hotel gross revenue) for international services for advertising, marketing, promotion, public relations and sales, including purchase of print and electronic media space, provided on a centralised or group basis for the benefit of the Marriott Group hotels;
Fees for advertising services (as a fixed percentage of gross hotel revenue);
Reimbursement of expenses incurred in providing services on a centralised basis to all the Marriott Group hotels, allocable between the hotels on a reasonable basis, including:
Special Chain Services (Frequent Traveller Program etc.);
Reservation System; and
Special Advertising Costs.
Marriott declared nil income in its (Indian) tax return claiming the receipts to be in the nature of expense reimbursements and therefore regarding such payments as not taxable in India. According to Marriott these receipts could at the most be considered as business receipts which are not taxable in India in the absence of a permanent establishment in India.
The Indian tax authorities held that the ISMA payments were taxable in India as a royalty and “fee for included services” under the India – US tax treaty.
Marriott appealed to the Tribunal against the order of the Indian tax authorities.
The Tribunal decided the issue against Marriot holding that the payments were, for Indian tax purposes, a royalty; and based its judgment on the following rationale:
The survival of the ISMA was dependent upon the survival of the Hotel Management Agreement (HMA) which was entered into with another Marriott Group company;
The Marriott Group had undertaken tax planning and organised its affairs so as to separate and allocate each facet of the “job to be done” in managing each hotel to different companies in the Marriott Group. Each of those companies had entered into separate agreements with the Owners of the Indian hotels. However, all the agreements were interdependent so that all the operations could be ultimately controlled by Marriott Group only;
For each hotel the Marriott Group divided a single transaction, being the management of the hotel, into several components so as to ensure that each respective revenue stream was received by a separate Marriott Group entity;
Marriott’s claim that the ISMA payments were merely expense reimbursements on a cost-to-cost basis without any mark-up defied business logic as a commercial company would never work without profit;
The fact that Marriott maintained that it had no profit motive proves that Marriott was only an extended arm of the Brand owner and can be considered as a facade of that company;
The division of payments between the royalty payable to MWC (as sub-licensor of Brands to hotels) and payments to Marriott under the ISMA was tax planning through colourable device resulting in a loss to the revenue by reducing the amount of the royalty to MWC;
The corporate veil should be lifted because of the structured approach adopted by the Marriott Group; and
The responsibility to maintain and/or enhance the ‘brand value’ always remains with the brand owner. In the instant case, Marriott had undertaken the job of marketing the Brands. Thus, the amount received by Marriott should be considered from the perspective of the original brand owner. As the advertising program would go to promote the Brands, the ISMA payments were in the nature of a royalty under Article 12 of the India - US tax treaty.
In dismissing the appeal, the Tribunal held that the ISMA payments were taxable as royalty and it remanded the matter back to the tax authorities to determine the entity in whose hands this income should be assessed i.e., whether such income should be assessed in the hands of Marriott as a representative assessee or in the hands of any other Marriott Group entity.
It is important to note that the Tribunal also distinguished the following important cases which were relied upon by Marriott in support of its appeal:
M/s Marriot International Licensing Company BV (BV): The Tribunal observed that in this case the nature of receipt of charges as per BV’s ISMA was considered independently without linking the same with the royalty payment. Unlike in the instant case, the tax authorities had not raised the argument of bifurcation of royalty payment into more than one component and thus, this view point of the tax officer was not available before the Tribunal; and
Sheraton International Inc.: The Tribunal observed that in this case there was no separate royalty agreement and the Tribunal in this particular case gave a clear finding that there was nothing on record to show that the real transaction was other than what was stated in the agreements.
In this matter the Tribunal applied the “substance over form" principle guided by the material facts in this case, including inter alia:
There being extensive cross-referencing and interlinking of otherwise independent agreements entered into with separate entities within the same Marriot group and each such agreement having the same term;
The relevant Marriott Group entities having the same address; and
The royalty for use of the Brands being a small percentage (0.5%) of hotel gross revenue while reimbursements and payments under the ISMA amounted to about 3% of the hotel gross revenue.
The circumstances and HMA documentation structure will determine the outcome of any challenge of this nature by the tax authorities and Operators need to be mindful of these matters.
This decision while directly impacting the tax position of Operators in similar circumstances also has important implications for Owners because Owners will have a corresponding withholding tax obligation with respect to payments they make to an Operator which are taxable in the hands of the Operator in India. Failure to comply with this withholding tax obligation can result in recovery of any withholding tax short fall along with interest and penalty and denial of corresponding business expenditure. Thus, it is imperative to consider the impact of this ruling on existing HMA structures as well as future hotel agreements.
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 ITA No.1996 & 1997 / Mum / 2011
 ITA No.416 / Mum / 2008
 313 ITR 267