India has seen several important decisions on the tax front
take place in 2017. The Supreme Court of India ruled on several
important tax matters, including on the formation of permanent
establishments in India, taxation of the oil and gas sector,
and the treatment of dividend income as 'exempt' for the
purposes of disallowance of related expenditure.
The last few weeks saw another handful of far-reaching
judgments coming out. These are summarised below.
Royalties
One recent case involved the taxation of payments made under
Google's AdWords program. The Income-tax Appellate Tribunal
(Bangalore) held that payments by Google's Indian subsidiary
(Google India) to Google Ireland Ltd. for distribution of the
AdWords programme were in the nature of 'royalty'.
Google India and Google Ireland had entered into a
distribution agreement under which Google India was appointed
as a non-exclusive distributor of the AdWords program to
advertisers in India. Google India accordingly purchased
advertising space from Google Ireland for sale to local
advertisers.
While holding that the payments made were in the nature of a
'royalty', the tribunal held that:
- The distribution agreement was not merely
an agreement to provide advertising space, but was for
facilitating the display and publishing of advertisements to
targeted customers;
- The intellectual property of Google vested
in the search engine technology, associated software and
other features, and hence use of these tools for accepting
advertisements fell within the ambit of 'royalty'; and
- The marketing and promotion of
advertisements by Google India was possible only with the use
of a secret formula and confidential customer data. Since
these were not in the public domain, Google India was using a
secret process, the payment for which would amount to
'royalty'.
This is an important decision in the digital economy
context. With the introduction of the equalisation levy in
2016, pursuant to the BEPS Action 1, online advertising
payments will no longer be governed by the Income-tax Act or
the tax treaties. However, this judgment will still be relevant
for pre-2016 disputes.
This decision has been appealed to the jurisdictional High
Court (i.e. in the State of Karnataka) and the appeal has been
admitted.
Permanent establishments on activities outsourced to
India
On a separate case, the Supreme Court delivered an important
decision that dealt with the issue of whether a foreign company
would have a permanent establishment (PE) in India on account
of its outsourcing activities to an Indian group company.
The court held that since the outsourcing of activities did
not lead to any fixed place of business being at the disposal
of the foreign company, no fixed place PE was constituted. It
also held that no service PE came into existence since none of
the customers of the foreign company were located in India, and
hence services could not be said to have been furnished within
India.
Tax Accounting Standards partially struck down
The central government had notified 10 ICDS (Income
Computation and Disclosure Standards) with a view to
standardise income and expense recognition for tax
purposes.
These in some cases led to accelerated recognition of income
or deferment of expenditure/losses. Some of these were in
conflict with judicial precedents.
The Delhi High Court held that although the government was
empowered to notify standards for income computation, it could
not, in the exercise of such powers, override judicial
precedents or statutory provisions. Accordingly, it struck down
several standards (including those dealing with accounting
policies, valuation of inventory, revenue recognition,
construction contracts, etc.) to the extent they were contrary
to binding judicial precedents or legislative provisions.
Rakesh Dharawat (rakesh.dharawat@dhruvaadvisors.com)
and Hariharan Gangadharan (hariharan.gangadharan@dhruvaadvisors.com)
Dhruva Advisors LLP
Tel: +91 22 6108 1000
Website: www.dhruvaadvisors.com