Payment to Service PE for technical services when effectively connected
28 March, 2014
The importance/ impact of terms in agreements and terms of the agreement were brought to fore in the recent ruling of ITAT, Delhi in DDIT v. JC Bamford Excavators Ltd. [Order dated 14-3-2014]. The assessee had entered into an agreement with its subsidiary JCB India, deputing certain personnel who received payment for services rendered (claimed to be technical services), which was offered to tax under the head ‘Royalty and Fee for Technical Services’. The department contended that since period of stay by the personnel who provided managerial services in India, exceeded 90 days, it constituted a service PE and, the payment to the personnel was to be taxed as business profits and not royalty.
Relationship between Technology Transfer Agreement (TTA) and International Personnel Assignment Agreement (IPAA)
The TTA enabled the Indian subsidiary to manufacture and sell backhoe excavators as per the terms of license. Employees of JCB UK were deputed to ensure that licensed products were manufactured as per technical specifications. The words of the TTA read as ‘assist licensee in establishing the manufacture of licensed products’ The assessee contended that the employees performed only preparatory and auxiliary services in India and would not constitute a service PE. However, it was held that the IPAA came into effect to effectuate the TTA and they were not independent agreements. The personnel who provided managerial services were compensated separately and it was not factored into the payment for license ( transfer of IP rights). There were two categories of employees. Those providing managerial services who constituted PE and others who visited occasionally, carried out testing etc who were not taken into consideration to determine PE.
Employees of the subsidiary
To constitute a service PE (permanent establishment), the employees of the overseas entity must have rendered services in India. The assessee argued that on deputation its employees became employees of the Indian subsidiary. However the ITAT held that payment of salary by subsidiary, issuance of Form 16, etc., are not determinative of the status of employee. The terms of the TTA provided that during the time of deputation the employees would not be considered as employees of the licensee (subsidiary) and the licensee was responsible for payment of taxes. The personnel to be sent on secondment, number of persons to be sent were decided by the overseas entity. As per the terms of deputation or international assignment policy of the overseas entity, disciplinary action if any was to be taken only by the group head and further no letter of appointment etc was issued by the Indian subsidiary.
Income effectively connected with PE
Regarding tax liability on payments to personnel the assessee argued that the payment bifurcated as license fee and royalty was for transfer of IP rights alone. The ITAT considered the payment in three parts - for transfer of IP rights, for services of personnel and for services of technical personnel. It opined that payment pertaining to use of patents, copyright, etc., would be covered under royalties and use of services of personnel in relation to the same would fall under fee for technical services.
The department however sought to bring the same to tax under Article 7 of the India UK Treaty reasoning that the ‘the right, property or contract in respect of which the royalties or fees for technical services are paid is effectively connected with such permanent establishment or fixed base’. Examining the extent of ‘effectively connected’ the ITAT held that deputed personnel did not have any role to play in transfer of IP right and hence the right or property from which royalty arose was not connected to the PE. As regards the payment for deputed personnel, the payment arose from contract (the TTA and IPAA) and was taxable as technical fees under Article 13. The payment to technical personnel was part of the consideration for transfer of IP rights and had nothing to do with the PE.
Thus out of the entire amount sought to be brought under business profits by the department and under royalty by the assessee, the ITAT held that the part effectively connected with the PE will fall under Article 7.