International Tax Updates

published on 30 July 2024 I reading time approx. 4 minutes

1.Foreign tax credit is not allowed for the taxes paid in contravention of the double tax avoidance agreement (‘DTAA’) : holds Italy’s Supreme Court

A telecom company, tax resident of Italy, provided telecommunication services to a company based out of Pakistan. The Pakistan company considered such telecommunication services as Royalty and withheld taxes as per Article 12 of the Italy-Pakistan DTAA. The service provider filed its tax return in Italy and claimed credit of the taxes paid in Pakistan.

The Italian tax authorities denied the tax credit stating that consideration for such services is not a Royalty income, rather these are business profits of the Italian company which are not taxable in Pakistan as per the provisions of Italy-Pakistan DTAA. However, tax payer contended that foreign tax credit should be available otherwise it will lead to double taxation on the same income. Therefore, the matter reached Italy’s Supreme Court.

Italy’s Supreme court decided the matter against the taxpayer and held that such services do not qualify as Royalty under Italy-Pakistan DTAA. Italy’s Supreme Court held that the resident State, i.e. Italy, is not obligated to provide foreign tax credit of the taxes paid in Pakistan in contravention of the provisions of the Italy-Pakistan DTAA. Supreme Court held that the Italian Company should request for the refund of the taxes wrongly paid from the source state i.e., Pakistan in the present case.

2. Chennai ITAT holds the activities of identifying and liaising with customers in the USA as marketing services and not Fees for Included Services (‘FIS’) under India-USA DTAA

In the instant case, taxpayer was a tax resident of USA and specialised in e-publishing services, which fell under IT-enabled services (‘ITES’) involving software and digital technology. It entered into a marketing agreement with its Indian holding company to execute marketing strategies and support customer identification and liaison activities, receiving a sales commission in return.

The taxpayer filed its income tax return in India and did not offer the sales commission for taxation in India. However, the tax authorities classified these services as FIS under Article 12(4)(b) of India-USA DTAA. Chennai ITAT observed that services performed were in the nature of marketing services and the taxpayer was not a party to the contract entered between the Indian Holding Company and the end customer in USA. The marketing services also included training to marketing personnel as it was essential to understand the customer requirements and was in the nature of technical inputs.

Additionally, ITAT observed that the Indian Holding Company was solely responsible for undertaking and executing e-publishing work and taxpayer’s role was limited to the extent of identifying the customers and understanding their workflow requirements and communicating the same to the Indian holding company for its project execution. Consequently, ITAT allowed the taxpayer’s appeal and held that the nature of work carried out should be considered as sales commission as the taxpayer charges the commission on a percentage of sales and cannot be considered as FIS and thus deleted the addition made.

3. Sale of online subscription-based products under a reseller agreement constitutes Royalty under the India-Ireland DTAA

In the instant case, the taxpayer, a tax resident of Ireland, was engaged in the business of distributing of research products to the customers in the form of subscription. The subscription allowed the customers to access the research products over the internet from its data servers which was located outside India. The taxpayer implemented a reseller arrangement whereby an Indian subsidiary of the taxpayer would resale such subscription products to the customers in India.

The products sold by the taxpayer to its Indian subsidiary comprised of – Resale of products by the Indian subsidiary to the customers on a principal-to-principal basis; Sale of products for internal use in exchange for a research access fees. The tax officer alleged that such payments were taxable as Royalty, in absence of a Permanent Establishment (‘PE’) in India. Aggrieved by the order, the taxpayer preferred an appeal before the ITAT.

While adjudicating on the issue, the ITAT made following important observations:

The Indian subsidiary had reported a sale of INR 2,526 Million from the sale of products, however, the purchase of subscription from the taxpayer stood at INR 358 Million. Further, no stock was recorded by the Indian subsidiary.
A consolidated invoice was raised by the taxpayer for all the products sold to the Indian subsidiary, but the same did not mention the quantity of products or the price per product.
The taxpayer was asked to correlate the sale of products to the Indian subsidiary and further resale of such products to the customers, which the taxpayer failed to substantiate.
It was submitted that the requests for products raised by the customers with the Indian subsidiary was forwarded to the taxpayer, who further provided the User ID and password directly to those customers for accessing / downloading the subscription. However, the ITAT observed that such activity was done on behalf of Indian subsidiary only and even if the products had been depicted to be sold on quarterly basis, there was no mention of the quantity sold.
A statement of working for the consideration charged to the Indian subsidiary was furnished, which was derived as a function of gross revenue less operating costs less assured return to the Indian subsidiary @ 3.7 per cent. No specific remark was recorded by the ITAT.

In view of the above, the ITAT held that in substance, the Indian subsidiary had purchased the right of copying the research products and selling the same to customers in India multiple times. Thus, the transaction for all practical purposes could be characterized as sale of copyright in the database of research products of the taxpayer. Hence, the ITAT held that the sale involved transfer of copyright in the products and accordingly, the transaction was taxable as Royalty under the India-Ireland DTAA. With respect to taxability of research access fees, ITAT remanded the matter to the tax officer to examine how the subscription was utilized by the Indian subsidiary and whether any exploitation of copyright was involved.

In view of the peculiar facts of the case, the ITAT upheld the taxability of consideration under the reseller agreement as Royalty under the India-Ireland DTAA. While the ruling does not stray away from the principles of copyright taxation as laid down by the Hon’ble Supreme Court in the landmark ruling of Engineering Analysis Centre of Excellence Private Limited v. CIT 432 ITR 471 (SC) delivered in 2021, it requires that the benefit from application of Engineering Analysis ruling can be claimed only in such cases where the taxpayer is able to substantiate that the sale of product does not involves transfer of any copyright therein.

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