Tax Hotline January 23, 2010

Outbound payments for quality-control testing services held taxable in India

In a recently published decision, the Delhi bench of the Income Tax Appellate Tribunal (“Tribunal”) has ruled that payments received by M/s. UTAC, France for quality control testing provided to the Indian car manufacturer Maruti Udyog Ltd, would be subject to withholding taxes in India.

UTAC is a French independent technical organization that undertakes testing of quality of components in the automobile industry. Maruti had remitted certain amounts to UTAC as consideration for certain tests done on its cars to ensure compliance with safety standards. When Maruti applied for a certificate of zero tax withholding, the Indian tax authorities took view that the payments received by UTAC were in the nature of fees for technical services under the domestic tax law and hence would be subject to applicable withholding taxes in India. This view was upheld at the first level of appeal.

On further appeal to the Tribunal, Maruti contented that the services provided by UTAC were in course of its business and not in the nature of technical services. It also relied on the Protocol1annexed to the India-France tax treaty, which allows a French resident the benefit of a more restricted treatment for fees for technical services that may be provided in any other tax treaty signed by India post 1989.2 For example, under the treaties with the US and UK, fees for technical services only contemplate those services which ‘make available’ or transfer certain technical knowledge, skill or knowhow allowing the recipient to independently apply such knowhow. Further, in both these treaties, services that are ancillary or inextricably linked to the sale of property are not considered fees for technical services. Maruti, thus argued that the services provided by UTAC would not come within the definition of fees for technical services under either the US / UK treaty or the treaty with France.

While deciding against the taxpayer, the Tribunal acknowledged the relevance of the Protocol to the French treaty and the application of the restricted provisions on fees for technical services figuring in treaties such as those with the US and UK. However, it only focused on the exclusion provided to services that are ancillary to the sale of property. Since the services provided by UTAC did not involve any transfer of property the Tribunal held that the exclusion does not apply.

On examining UTAC’s scope of services, the Tribunal concluded that they were clearly technical in nature. Further, the source of income was also held to be in India as the test reports were utilized by Maruti in India to develop and improve their products. Therefore, Maruti was thus required to withhold taxes on payments made to UTAC.

Analysis:

In our view, the Tribunal has not considered the following points. Firstly, it seems that the restricted scope of the ‘fees for technical services’ clause in other tax treaties has not been properly applied. Under the US and UK tax treaties, services that do not envisage a transfer of technical knowledge or experience do not qualify as technical services. The quality control certification provided to Maruti did not lead to a transfer of the underlying technology used in the impact tests. The services rendered in this case were therefore not likely to be in the nature of technical services and the imposition of withholding tax may not have been justified. Secondly, in a number of cases it has been held that services rendered outside India, though utilized in India, have a non-Indian source and hence cannot be taxable in India.3 Such offshore services lack the required territorial nexus to justify a jurisdiction to tax. Surprisingly, in a case where the rendition of services was fully outside India, this principle does not find any place in the Tribunal’s analysis.

-          Vivaik Sharma & Mahesh Kumar

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1 A protocol is an indispensable part of the treaty with the same binding force as its main clauses.

2 A similar provision exists in the Protocol to the tax treaty between India and Switzerland.

3 See, Ishikawajma-Harima Heavy Industries, [2007] 288 ITR 408 (Supreme Court) and Clifford Chance, [2009] 31 ITR 237 (Bombay High Court)


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