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Last week, the Bangalore Tribunal rendered a 134 page judgement to Google India (GI) [TS-468-ITAT-2017(Bang)] which has generated significant debate in the International tax fraternity. The judgement, details of which are yet to be absorbed, has certainly raised anxiety levels in the minds of digital/e-commerce business models as regards their tax positions in India.

The controversy surrounds tax position of GI’s payouts to its Irish subsidiary Google Ireland (GIr) for usage of the latter’s platform, Adword program being the back bone of its digital advertisement, enabling advertisers to us the Google website & its search capabilities.

The issue at hand was if such payouts (called distribution fees) should be classified as being made for availing of (simpliciter) services or for the ‘right to use’, which the Tribunal labels as complex computer program. The tax position under both scenarios differ since the former characterizes such payments as being in the nature of business income and if GIr does not have a business presence ( Permanent Establishment ) in India, it would not be liable to tax. If however, the payment is made for the right to use an intellectual property (the program), it would be taxed as ‘Royalty’ and liable to withholding tax under applicable rates. Google argued that as independent advertisers get the advertisement uploaded onto Adword via GI’s website, the ads are displayed in the manner determined by the programs run by Google servers outside India. The Tribunal, deciphering the agreement for such payouts, came to the conclusion that it was in the nature of Royalty on all counts – that the payment was for use of trademarks, tool to trade, transfer of rights for process, knowhow etc. In coming to the conclusion, the Tribunal laid out details of the program, how the digital advertisement contracts work on such platform with use of algorithms etc. Google’s argument that there have been precedents by way of judgements by the Delhi High Court for Sheraton International where a similar program was used to make hotel reservations, was negated. Interestingly, Mumbai Tribunal judgements rendered in the context of Yahoo! & E-bay in relation to online advertisement models were distinguished. These decisions relied on findings of the high powered committee on E commerce, which has conclusively held that advertisement revenues are not in the nature of Royalties. The conclusions of the Committee, besides relying upon the recommendations of the then Technical Advisory Group of the OECD was predicated on the principle that mode of delivery of services ( advertisement specifically) should not change the character of income for tax purposes. Tax Tribunals in India have dealt with the above principle in many cases. Even the Supreme Court in the Formula one case, while concluding that Formula 1 had a place of business in India by way of a PE, affirmed the conclusion of the Delhi HC that payment for usage of the Formula 1 brand was not in the nature of Royalty.

Another related aspect the Tribunal dealt with was the withholding tax liability on such payments. It came to the conclusion that since such income characterized as ‘royalty’ was income chargeable to tax, withholding tax should apply. The Tribunal whilst specifically dealing with this question negated the Supreme Court view laid down in GE’s case [TS-201-SC-2010]  , wherein it was held by the Apex Court that, ‘unless income is chargeable to tax, the provisions of withholding tax shall not arise’. The Tribunal reasoned it out by holding that since there was no doubt as regards taxability of income, principles laid down by the Apex Court in Transmission Corporation’s case (an earlier decision) would instead apply. As regards, definition of the term royalty under Ireland- India treaty, the Tribunal in its wisdom held that the use of the words ‘payment of any kind’ was adequate to cover distribution payments, within the ambit of ‘royalty’.

Whereas, there is no doubt that Google will appeal the verdict in a higher forum, several questions remain open:

  1. The veracity of position held by tax administration in the high powered e-commerce committee on advertisement payments: The fact remains that successive administration erred to take a tax policy stance on taxability of e-commerce transactions in general and advertisement payments, in particular. Though, it is clear from an international law stand point that Indian position to hold such payments as ‘royalty’ is at variance with global practice.
  2. This is further exacerbated by retrospective amendment to definition of the term ‘royalty’ undertaken as part of budget 2012. Though, this is not what the Tribunal relied upon to come to the conclusion, the said amendment continues to haunt Indian tax policy in terms of its certainty and magnitude. It is interesting to note that several High Courts, Delhi High Court in particular have relied upon definition of the term royalty under the relevant treaties, thereby negating the tax administration view and reliance on retrospective amendment to the domestic law.
  3. The vexed issue of characterization is yet to be decided by the Apex Court and a batch of cases will be heard in early 2018.
  4.  India legislated equalization levy on B to B advertising transaction as part of BEPS Action Plan 1 to overcome tendencies on part of non-resident portals to avoid permanent establishments. Such levy was made applicable from April 1, 2016 to tax such transactions avoiding traditional PE rules on the ground that there is ‘virtual or digital’ presence. Though, most international policy experts labelled India’s decision as unilateral, other EU nations have proposed a similar tax. The point to debate is if such tax applies in the context of changing landscape, shouldn’t the earlier transactions be grandfathered? This larger issue left with the Tribunal decision is of course if such payments are indeed for ‘use of copyright’ or use of ‘copy righted’ software program.
  5. Undoubtedly, all of these developments spell uncertainty for past transactions, besides going against the grain of ‘digital India’ economic policy that is being pursued with vigour. The administration will do well by clarifying its position and not be driven by considerations of tax collection and litigation. This of course, is over and above the merits of Google’s case, which seems to have missed the ‘tree for the wood’.

The writer is Managing Partner, BMR Legal. The views are personal.

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