Periodical payments to non-resident subject to TDS: Advance Ruling

AIT News Network
NEW DELHI. Authority for Advance Rulings vide a recent ruling – AIT-2006-245-AAR  has ruled that Periodical payments made to non-resident having no office/establishment in India in connection with use of software developed by him on internet are subject to TDS under DTAA with USA.

T H E  F A C T S:

The applicants entered into an agreement with a non-resident company,  Conversagent Inc. a Delaware Corporation, New York, USA and secured licensee of a particular software , which the applicant is entitled to use . The applicant has to pay license fee for the software to the said non-resident Company. It had been categorically stated by the applicant that ‘Conversagent’ , the non-resident company does not have establishment or office in India, and therefore, the payments received by the non-resident (Conversagent) from the applicant, for allowing the applicant to download and use the software are covered  under Article 7 of there DTAA with USA (i.e. Business Profits), which are not chargeable to tax in India .On these Facts the applicants has sought ruling of the authority on the Following question:

    “Whether periodical payments made to the non-resident person, having no    office/establishment in India, in connection with the use of software developer by him on internet are Subject to tax deduction at source under DTAA with USA”

            T H E  R U L I N G

• The first aspect, which needs to be addressed, is whether the periodical payments are in the nature of business income of the non-resident (Conversagent).  This takes us to Article 7 of the DTAA, which deals with business profits.  Para 6 of article 7 shows that where profits include items of income, which are dealt with separately in other articles of the Convention, then the provisions of those articles shall not be affected by the provisions of this article.  Therefore, it follows that if the periodical payments fall under any other article of the DTAA, they will have to be dealt with under that particular article.  The plea is that they are covered by article 12 of the DTAA, which deals with “royalties and fees for included services”.  If the periodical payments fall under article 12 then article 7 is ipso facto excluded.  It is, therefore, necessary to ascertain the nature of periodical payments.

In this case the ‘License Agreement’ was entered into on 25^th day of August 2004 between Conversagent USA and IMT Labs A/S (Licensee), a Danish Corporation having office at Copenhagen, Denmark, which is the parent company of the applicant.  Subsequently the parent company assigned all the rights and obligations specified in the ‘License Agreement’ to its subsidiary in India on April 10, 2005.           

• From the study of the clauses of the ‘License Agreement’, it is seen that License is granted essentially for the use of the ‘Smarterchild’ software on the Conversagent Server Platform only, for the purpose of producing, hosting and distributing ‘Interactive Agent’ applications.  License fee to be paid monthly, is termed as Royalty in clause (4) of the agreement.  The payment of Royalty is based on the number of sessions for which the equipment (‘Smarterchild’ software on the Conversagent Server Platform) is utilized for the licensed purpose.  As per clause (6) of the Agreement, Conversagent has to provide one qualified staff member to assist the Licensee with the transfer of technical information provided, however, that such services shall not exceed an aggregate of 16 working hours and such technical assistance will be effected at the premises of Conversagent.  Further Conversagent Management Personnel shall assist the applicant’s management by making introduction to content providers currently featured in the Smarter Child Application.  The Conversagent is also duty bound to provide the applicant e-mail support not exceeding 4 hours per month.  However, there is no separate fee being charged for these technical services which are covered by the definition of included services as per Para (4) of Article 12 of the DTAA. 
  • The term ‘Royalties’ as used in sub-clause (b) of Para (3) of Article 12 means payments of any kind received as consideration for the use of, or the right to use, any industrial, commercial or scientific equipment.  As already stated, the ‘Smarterchild’ application (software) on the Conversagent Server Platform is scientific equipment, licensed to be used for commercial purposes.  Therefore, payments made for producing and hosting ‘Interactive Agent’ applications (‘Interactive Agents’) would be covered by the expression ‘royalties’ as used in Article 12 of the DTAA.  Further, the technical and consultancy services being rendered by the provision of services of technical personnel and e-mail support is covered by the description of ‘Fees for included services’.  These are ancillary and subsidiary to the application and enjoyment of the use of, or the right to use, the scientific equipment for commercial purposes.
    • Now, what remains to be seen is whether the payments being made to the Conversagent fall within the meaning of ‘Royalty’ and ‘Fees for Technical Services’ as defined in section 9(1) of the Act.We find that meaning of the term ‘Royalty’ as used in Explanation (2) to clause (vi) of sub-section (1) of section 9, is at par with the term ‘Royalties’ as used in Article 12 (3)(b) of the DTAA.  The term ‘Fees for technical services’ as used in Explanation (2) of clause (vii) of sub-section (1) of section 9, is at par with the term ‘Fees for included services’ as used in Article 12 (4)(a) of the DTAA.  In view of this position, the payments being made by the applicant (a resident), to the Conversagent (a non-resident), are chargeable to tax in India, under Article 12 of the DTAA as also under section 9 of the Act.
      • A plain reading of the sub-section (1) of section 195  shows that any person responsible for paying to a foreign company (i) any interest; or (ii) any other sum chargeable under the provisions of the Act (except salary) is required to deduct income-tax at the time of credit of such sum to the account of the payee or at the time of actual payment thereof, whichever is earlier.
        • The expression “any other sum chargeable under the provisions of this Act” would mean a sum on which income-tax is leviable.  In other words, the said sum is chargeable to tax and could be assessed to tax under the Act.  The only consideration would be whether payment of the sum to the non-resident is chargeable to tax under the provisions of the Act.  The sum may or may not be income or income hidden or otherwise embedded therein.  The scheme of tax deduction at source applies not only to the amount paid, which wholly bears “income” character, but also to gross sums, the whole of which may not be income or profits of the recipient. 
          • Periodical payments (being ‘Royalties and fees for included services’), made to the non-resident person, having no office/establishment in India, in connection with the use of software developed by him on internet are subject to tax deduction at source, under DTAA with USA.

            ( Click here for full text of Ruling AIT-2006-245-AAR  )