INSIGHT: Taxability of Fees for Technical Services under India–U.K. Tax Treaty

An Indian Tribunal affirmed that in the absence of being able to justify the supply of project specific technical designs/drawings/plans, capable of being used by an Indian entity for any subsequent projects, such supply can neither be construed as fees for technical services (FTS) under Article 13(4)(c) of the India–U.K. tax treaty (tax treaty) nor become taxable under the business profit clause in the absence of a permanent establishment (PE) in India.

Facts

Buro Happold Ltd (Buro or taxpayer) is a U.K. registered tax resident company engaged in providing engineering design and consultancy services used in structural and mechanical, electrical and public health engineering for constructions.

The revenue authority during its tax audit observed that Buro earned income from its Indian affiliate Buro Happold Engineers India Pvt. Ltd (BHEI) towards:

• provision of consulting engineering services; and
• cost recharge of head office expenses.

It was alleged that such income was accrued and arose in India treated as FTS under Indian domestic law and under Article 13(4)(c) of the tax treaty. Accordingly, the revenue authority regarded FTS as taxable in India subject to tax on gross basis under the tax treaty.

The first appeal rejected Buro’s argument which stated that while rendering engineering consultancy services no technical knowledge or skill was made available to BHEI for independent application; thus, the amount received by the taxpayer did not qualify as FTS and would be characterized as business income under Article 7 of the tax treaty.

In relation to the common cost recharge, the taxpayer explained that common costs such as legal, I.T., human resources, incurred and recovered for/from group entities on predetermined cost allocation/apportionment from BHEI on a cost-to-cost basis without any profit element, are not taxable in India.

Therefore, in the absence of a PE in India, such income/payment is not taxable under Article 7 of the tax treaty.

The matter was contested by the taxpayer before the Indian Income-tax Appellate Tribunal of Mumbai (Tribunal) on the question of taxability of such income in India.

Tribunal Ruling

On review of the sample copies of the service agreement, the Tribunal dealt with the core issue of whether the amount received by the taxpayer towards supply of technical designs, drawings, plans, etc., under the engineering consulting service arrangement is regarded as FTS under the tax treaty.

Due to the revenue authority’s argument, the amount received by the taxpayer was treated as FTS within the terms of the tax treaty, disregarding the conditions of Article 13(5) of the tax treaty. Post clarity on the characterization, treatment of cost recharge shall automatically be resolved on the premise that such cost recharge is ancillary and incidental to the consulting services.

Buro, a U.K. tax resident, is entitled to tax treaty benefits which are more beneficial than Indian domestic tax laws. Article 13 of the tax treaty regards royalty and FTS arising in the source country and paid to a resident country to be taxed in the home country, with the concessional tax rate prescribed in the source country, subject to certain restrictions and conditions as enumerated in Article 13(2) of the tax treaty.

The amount received may fall under the term of FTS under the meaning of Article 13(4)(c) of the tax treaty, defined as “or consists of the development and transfer of a technical plan or technical design” in the second limb.

However, it should be read with the first limb, “make available technical knowledge, experience, skill, know-how or processes” in the clause, following the principle of ejusdem generis, where the second limb of the clause derives its terminology from the first limb. The standalone rationale used in the second limb under clause 13(4)(c) of the tax treaty cannot be read in isolation as interpreted by the revenue authority.

Under the settled principle of law, technology is made available when the recipient of the said technology can independently make use of the technical knowledge, experience, skill, know-how or processes in his business or for his own benefit, without recourse to the service provider.

Transmission of such technical knowledge from the service provider to the service recipient is a prerequisite effectively permitting the service recipient with liberty to use such technical knowledge for its own right. Considering the material placed on record and lack of sufficient evidence, the project specific technical design/drawings/plans supplied by the taxpayer to the Indian entity cannot be used on a standalone basis by the Indian entity for any subsequent project.

The Tribunal relied on the decision of Pune Tribunal, in the case of Gera Developments (P) Ltd (160 ITD 439/72 taxmann.com 238) which held that merely approving project specific architectural drawings and designs with measurements does not amount to imparting technical knowledge, experience, skill, know-how or processes made available. In dealing with a dispute of an identical nature concerning FTS, as per the India–U.S. tax treaty the term “fees for included services” under Article 12(4)(b) is worded similarly to Article 13(4)(c) of the India–U.K. tax treaty.

Relying on the analogy of that ruling, the Tribunal stated that as the revenue authority could not establish on record that, through development and supply of technical designs/drawings/plans the taxpayer has made available technical knowledge, experience, skill, know-how or processes to the service recipient, the amount received cannot be brought within the meaning of FTS under Article-13(4)(c) of the tax treaty. Hence, such payments excluded from FTS can be treated as business profit under Article 7 of the tax treaty and in the absence of a PE in India, cannot be brought to tax in India.

The Tribunal, relying on the treatment of the consulting engineering services, specifically excluded ancillary and incidental services from the FTS definition, and rejected the revenue authority’s premise to treat cost recharge as FTS, to conclude that the amount received towards pure cost recharge is not taxable in India in the absence of a PE.

Planning Points

The issue of characterizing consultancy services that do not make available technical know-how or impart knowledge has been a subject of debate before the courts for a considerable time, even though the treatment is discussed and resolved in a large number of rulings.

The examples to tax as FTS are reasonably clarified under new Article 12A Updated 2017 UN Model Tax Treaty (Model Treaty). Specific situations in paragraphs 15 and 95 in the Commentary to the Model Treaty are discussed, as the character of FTS or business profits subject to Article 7 is based on the nature of services transferred for independent implementation and commercial expediency.

The decision has taken cognizance of the holistic meaning of the “make available” clause, to be read consistently with the paragraph for taxability rather than read in isolation, thus regarding services as taxable as business income.

Accordingly, the principle of the ruling would have to be applied taking into account the specific facts of each case. It is also relevant to note that the conditions are explicitly referred to in certain treaties besides the U.K. treaty (e.g. Singapore and Portugal), where the development and transfer of technical design should enable the service recipient to apply the technology being treated as FTS.

Shailendra Sharma is a chartered accountant for a multinational consulting firm, India.