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.
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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