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KPMG Flash News 17 February 2011 TAX

Payments to overseas telecommunication service providers towards provision of International Private Leased Circuit/ dedicated bandwidth to be taxable as Royalty

Recently, the Chennai Bench of the Income-tax Appellate Tribunal1 (Tribunal), in the case of Verizon Communications Singapore Pte. Ltd (Tax-payer) held that the consideration for provision of International Private Leased Circuit (IPLC) / dedicated bandwidth qualify as Royalty under the provisions of Income-tax Act, 1961 (Act) read with the provisions of relevant Double Taxation Avoidance Agreement (DTAA). The Tribunal held that such consideration would be regarded as towards use of process or equipment.

Facts of the case

The tax payer is primarily engaged in providing international connectivity services to customers in Asia Pacific region including India. The tax payer is not a licensed service provider in India as per the Indian Telecom Regulations and accordingly provides the services only outside India.

A customer enters into two separate contracts for availing international connectivity services – one with the tax payer for provision of international connectivity; and secondly, with VSNL for Indian Half Circuit Services Connectivity.

VSNL takes the telecommunication traffic from the customer office/site in India and transmits the traffic to a virtual point outside India. The landing station or gateway in India used in transmitting the traffic within India belongs to VSNL.

1 Source: www.allindiataxes.com [ AIT-2011-61-ITAT] (Judgement Date: 7 January

2011)

© 2011 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

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The taxpayer uses telecom services equipment situated outside India in order to provide IPLC services from the aforesaid virtual point up till the overseas customer’s destination.

The tax payer does not either ‘own’ or ‘utilize’ any landing station/ equipments in India for providing international half-circuit-services.

The customer receives two invoices – one from VSNL for providing connectivity within India and second from the tax payer for providing connectivity outside India.

Issue before the Tribunal

Whether amounts received by the tax payer for provision of IPLC/ bandwidth services outside India is royalty for use of ‘equipment’ or ‘process’ under section 9(1)(vi) of the Act read with Article 12(3)(b) of the India-Singapore DTAA?

Tax payer’s contention

The contract between the tax payer and its customers is for the provision of services and not for providing any right in any equipment and/or network used by the tax payer for providing telecom services

There is a distinction between transactions for the use of equipment vis-a-vis those for rendering of services. Also, none of the conditions laid down by the TAG of the OECD2 for classifying payments as royalties for use of equipment are satisfied in this case. In support of this, the tax payer contended the following:

- The customers do not have knowledge of the equipment being used while providing IPLC services and no equipment is identified with respect to a customer. The customers have neither knowledge nor they are a party to the inter-connect agreements entered by the tax payer with the other international telecom providers for the use of sophisticated devices

2 The Technical Advisory Group (TAG) of OECD had formulated the following tests in

its report titled “Tax Treaty Characterization Issues Arising from E-Commerce” dated

February 1, 2001 for determining whether the payments are for use of or right to use,

industrial, commercial or scientific equipments:

The customer is in the physical possession of the property or controls or has a

significant economic possessory interest in it.

The provider does not bear any risk of substantially diminished receipts or

increased expenditure in case of non performance or does not use the property concurrently to provide significant services to the entities unrelated to the services recipients; and

The total payment does not substantially exceed the rental value of the

equipment for the contract period.


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- The customer does not hold/possess own, operate, maintain or control tax payer’s telecom network infrastructure/equipment and they also do not possess significant economic/possessory interest in the telecom network infrastructure/equipment

- The telecom networks infrastructure/equipment is concurrently used to provide connectivity services to large number of unrelated users.

- In case of non-performance the tax payer bears the risk of substantially diminished receipts/increased expenditure

In light of above arguments, revenues earned by the tax payer from Indian customers for provision of IPLC services outside India cannot be taxed as royalties for use of the equipment or process under the Act and under the DTAA.

Revenue’s contention

The revenue contended based on the order of the Commissioner (Appeals) that the tax payer has provided single, composite and indivisible circuit which constitutes ‘equipment’. Further, the tax payer has merely taken VSNL as a ‘provisioning entity’ for providing local part of the services

Under the agreement, the customers acquire significant economic or possessory interest in the equipment of the tax payer to the extent of bandwidth capacity hired by the customer which is made available on a dedicated basis. Accordingly, the payment made by customers in India would constitute royalty under the provisions of the Act read with the DTAA.

In the alternative, the payments made for IPLC services are towards connectivity through dedicated bandwidth to Indian customers and would constitute payment for use of ‘process’ and hence, would qualify as ‘Royalty’.

Tribunal’s Ruling

The Tribunal held that while determining the nature of payment all relevant facts having bearing on the substance of the transaction should be taken into account.

In the given case, the customer acquires significant economic or possessory interest in the equipment of the tax payer to the extent of bandwidth hired by the customer. This capacity is made available on a dedicated basis to the customer for the entire contract period, usually a year


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Even if the bandwidth is not used, the customer has to pay the committed charges. Thus, the tax payer does not bear any risk of diminution in receipts or increase in expenditure if the customer does not make the use of the capacity. Therefore the payment made for hiring bandwidth would correspond to the rental value.

Even as per the TAG of OECD, physical possession of the equipment is not mandatory.

The agreement with VSNL for split billing is merely to overcome the regulatory regime prevailing in India and VSNL is only a ‘provisioning entity’ on behalf of the tax payer. IPLC is a seamless composite service and it cannot be divided into two parts. The agreement entered into with VSNL shows that it involves hiring of circuit on lease. From an analysis of various agreements, a conclusion can be derived to the effect that payments for the use of tangible equipment can be considered as a payment for the use of or the right to use equipment.

The agreement may be only for the provision of services but in effect, it grants right to the extent stated above in the network of the tax payer. The decisions in the case of Call World Technologies Ltd v. DCIT, [2008-TIOL-422], and that of AAR in the case of Cargo Community Network (P) Ltd [289 ITR 355], are exactly on the point and would hence be applicable.

The case of provision of dedicated bandwidth is similar to that of a cable TV or Satellite TV and is different from the use of a standard facility like that of a telephone. This is because, unlike in the case of a standard facility of a telephone, in a satellite transmission, a particular frequency is assigned to the customer and in cable transmission, the customer gets a dedicated bandwidth. With a dedicated connection the service provider sets aside and always make available the bandwidth for the customer’s use.

The amount received by tax payer from Indian customers is also for the use of a ‘process’ and would therefore qualify as royalty. Reliance in this regard is placed on the decision of Special Bench, New Delhi in the case of New Skies Satellites N.V v. ADIT (Int. Tax) [319 ITR 269] and the decision of ITAT Mumbai in the case of Sanskar Info TV(P) Ltd [24 SOT 87]

Our comments

The Chennai Tribunal has held that payments towards IPLC / dedicated bandwidth are towards use of ‘equipment’ or ‘process’ and therefore would qualify as royalty under the Act as well as DTAA.

It may be noted that the proposition on ‘process’ element under a service contract, similar to the one laid down by ITAT Special Bench in the case of New Skies Satellite N.V (which has been relied on by the


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Chennai Tribunal in this case) has been not been adopted by the recent Delhi High Court judgment in case of Asia Satellite Communications Co. Ltd. v. DIT [2011-TII-05-HC-DEL-INTL]

This judgment also comes close on the heels of the Bangalore Tribunal decision in the case of Infosys Technologies wherein, it has been held on similar facts that payments will not be considered as Royalty/ FTS.

In this judgment the Chennai Tribunal has observed that the case of provision of dedicated bandwidth is different from that of provision of a standard facility. Further it has interpreted the TAG Report of OECD to mean that physical possession of the equipment is not mandatory to qualify as ‘equipment’ royalty. Whereas a contrary view have been adopted in the Advance Rulings in the case of M/s Dell International Services India (P) Ltd. [305 ITR 37] and M/s Cable & Wireless [315 ITR 072].

The judgment is therefore expected to have significant impact on the taxability of remuneration from provision of bandwidth/ IPLC services especially from the perspective of equipment royalty. Considering the plethora of diverse judicial precedents, finality of the issue may take some more time.


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© 2011 KPMG, an Indian Partnership and a member firm

of the KPMG network of independent member firms

affiliated with KPMG International Cooperative (“KPMG

International”), a Swiss entity. All rights reserved.

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