At a time when the contours of business are undergoing major transformations on account of technological advancement across the world, issues such as those deliberated by the Kolkata Tax Tribunal (the “Tribunal”) in ITO v. Right Florists Limited1 were bound to arise. The Tribunal in this case was presented with the question of taxability of payments made by an Indian resident to Google and Yahoo for advertisement services rendered through their respective search engines. The Hon’ble Tribunal held such payments were not taxable in India because such payments would not be considered to be fee for technical services (“FTS”) in the absence of human intervention in the course of provision of services.
Right Florists Pvt. Ltd. (“Right Florists”), an Indian company providing services in India as a florist, entered into agreements with Google Ireland Limited (“Google Ireland”) and Overture Services Inc. USA (“Yahoo USA”) for advertisement of its services on their search engines, Google and Yahoo, respectively. Right Florists made payments to Google Ireland and Yahoo USA for advertising services and a claimed deduction for these payments. However, the assessing officer disallowed the deduction for payments made pursuant to Section 40(a)(i)2 of the Income Tax Act, 1961 (“ITA”) on the ground that no tax was withheld by Right Florists on the said payments under Section 1953 of the ITA.
The main issue for consideration in this case was whether income tax was required to be withheld in respect of payments made to non-residents for rendering advertising services over the internet. It was the case of Right Florists that such payments were in the nature of business profits, which would not be taxable in India in the absence of a permanent establishment in India of such non-residents. On the other hand, the tax department’s contention was that the payments were in the nature of FTS and taxable under Section 9 of ITA. For considering the issue at hand, the Tribunal took into account both the provisions of the tax treaties with Ireland and the USA as well as the provisions of the ITA.
Before going into the aspects of taxation and the evaluation of the specific facts, the Tribunal analyzed the nature of services actually rendered by Yahoo and Google to Right Florists. The Tribunal appreciated that search engines such as Yahoo and Google provided advertisement services in a purely automated manner using algorithms and codes without any human intervention. The Tribunal also mentioned that providing online advertisement services was a complex technical activity, and that these search engines rendered highly technical service with the use of software codes designed to search for information on the web, and generated, along with search results - sponsored search results, the service which is paid for by the sponsors of those results, like Right Florists in this case.
The Tribunal thereafter examined the provisions of Section 5(2)(b) of the ITA which provides for taxation of income which accrues or arises in India or is deemed to accrue and arise in India and Section 9 which deems certain kinds of income to have accrued or arisen in India.
‘Business connection’ examination - As a first step, the Tribunal examined the taxability of the receipts of Google Ireland and Yahoo USA in India on account of having a business connection in India4. The Tribunal observed that there was no evidence to suggest or demonstrate that the advertising revenues generated by Google Ireland and Yahoo USA were supported by, serviced by or connected with any entity based in India. Hence, in the absence of a business connection in India, these receipts of Google Ireland and Yahoo USA could be not taxed in India under Section 9(1)(i).
‘Permanent Establishment’ (“PE”) examination – While examining the issue of PE under the relevant tax treaty, the Tribunal relied upon the OECD Commentary and the High Powered Committee report on taxation of e-commerce to hold that a website would normally not be considered to have a PE because a website is a made up of intangible material like software and electronic data. However, the Tribunal also mentioned that, according to the OECD Commentary, while a website by itself could not be considered to be a PE due to the absence of a fixed place, the server from where the website functions could be a fixed place of business and could hence be considered to be a PE.
Taking into account these two principles, the Tribunal was of the view that since a search engine does not carry out its business through its server, a website would not constitute a PE unless its web servers are located in the same jurisdiction. As Google Ireland and Yahoo USA did have servers in India, the basic rule of PE was not satisfied. Hence, Google Ireland and Yahoo USA could not be said to have a PE in India.
‘Royalty’ examination - In this regard, the Tribunal relied upon the judgments delivered by co-ordinate benches in the cases of Pinstorm5 and Yahoo6 which dealt with materially similar facts and issues. The Tribunals in these cases had held that services of banner hosting did not involve the use or the right to use any industrial, commercial or scientific equipment by the Indian entity and that there was no positive act of utilization of these portals by the Indian entity; hence, such fee was in the nature of business profits and not royalty.
‘FTS’ examination -In its examination of the definition of FTS, the Tribunal held that the lowest common factor in the scope of ‘managerial, technical or consultancy services’ as used in Section 9 of the ITA was human intervention. In this regard, the Tribunal relied upon the Delhi High Court ruling in Bharti Cellular Limited7 where it was held “it is apparent that both the words managerial and consultancy involve a human element. And, both, managerial service and consultancy service, are provided by humans. Consequently, applying the rule of noscitur a sociis, the word technical as appearing in Explanation 2 to Section 9 (1) (vii)8 would also have to be construed as involving a human element.” The Tribunal observed that although technical services could be rendered without human interface, a restricted approach must be taken for the purpose of FTS as defined under the ITA. As the services were rendered by Google Ireland and Yahoo USA without any human intervention payment for such services would be excluded from the purview of FTS under the ITA.
Thereafter, the Tribunal examined the relevant provision for taxation of FTS under the India-Ireland Treaty, which has materially the same definition with respect to FTS as under the ITA, and ruled out taxability using the same interpretation as under the ITA. The Tribunal then examined the provisions under the India-USA Treaty and held that the same interpretation should also not apply in the instant case as the ‘make available provision’ contained in the FTS article of the said treaty was not satisfied. This was because Yahoo USA was merely rendering services, and there was no transfer of technology to Right Florists to enable it to make use of such technical knowledge by itself.
Requirement for withholding under section 195 - The Tribunal took into account the well settled law laid down in the case of GE India Technology Centre Pvt Ltd v CIT9 where the Supreme Court has held that where the person responsible for deduction can make his own determination with regard to the requirement of deducting tax, where he is fairly certain about the same. This is independent of the requirement to seek a no-withholding certificate. It was the opinion of the Tribunal that the obligation to withhold taxes under section 195 was not a blanket requirement and that the payer had the right to determine tax liability on its own, and where no tax liability was determined, there was no need to withhold tax.
The Tribunal has rightly held that the underlying factor in case of a technical service, in the context of the ITA involves some element of human intervention and that in the absence of the same, any fee paid for use of such services should not fall within the purview of ‘fee for technical services’ and taxed in India. This is a significant departure from a number of rulings10 in the past where courts have held that payment made for services using automated systems could be treated as taxable in India. The clarity in position would be welcomed by the growing e-business community in India.
The Tribunal also made observations on the Indian Government’s reservation to the OECD’s views on websites being considered a PE. The Tribunal mentioned that there was only a limited observation made by the Indian Government in the OECD Commentary with respect to a website constituting a PE in certain specific circumstances, but did not specify those circumstances. Terming the reservations by the Government “vague and ambiguous stand of the tax administration on this issue”, the Tribunal concluded that the reservations as expressed currently could not play in any role in the judicial analysis of the issue.
It is interesting to note that while the Tribunal in this case rightly relied upon the rulings in Pinstorm and Yahoo to hold that the fee paid should not be characterized as royalty, in the absence of a positive act of utilization of the portals in questions, the tax authorities have appealed against these rulings before the Bombay High Court. It is important for the Supreme Court to settle the position of law with respect to this issue because of the differing interpretations of the provisions which has resulted in lot confusion amongst the taxpayers.