INSIGHT: Taxing Fees for Included Services under India–U.S. Tax Treaty

General Motors Overseas Corporation (GMOC), a U.S. tax resident, is engaged in the activities of rendering management and consulting services to its affiliates worldwide. GMOC entered into a Management Provision Agreement (SLA) with General Motors India Limited (GMIL), engaged in manufacturing, assembly, marketing, sale of motor vehicles and other products in India. GMOC, under the SLA, supplied executives for general management and development, finance, purchasing, sales, marketing, assembly and manufacturing activities to GMIL on cost basis.

GMOC filed an application before the Authority of Advance Ruling (AAR) to evaluate the taxability arising in India for the amount received from GMIL. The AAR concluded that services rendered were characterized as “managerial” and not “technical or consultancy” in nature within the meaning of Article 12 of the India–U.S. tax treaty (tax treaty). Since GMOC constituted permanent establishment (PE) in India under Article 5(2)(1) of the tax treaty, the amount received from GMIL was taxable under business profit, Article 7 of the tax treaty.

GMOC had assigned two expatriate executives to GMIL for the year under consideration:

• President and Managing Director (MD) who was formally appointed by GMIL to act as Chief Executive and Operating Officer of GMIL, responsible for overall management of the operations from GMIL office; and
• Vice President Manufacturing (VP) responsible for the management of GMIL manufacturing and assembly facilities in accordance with the prescribed standards.

GMOC raised invoices to recover remuneration cost paid to its expatriate executives after considering appropriate withholding tax under the Indian domestic laws and subsequently declared the amount received in the tax return under the head business profits. However, as the amount received was on a pure cost basis, no business profit was attributable to the PE (GMOC) offered to tax in the Indian tax return.

The tax authorities (revenue) issued notice on GMOC with instructions to file a service agreement of the deputies, absent which the revenue taxed the gross invoice as business income of the PE in India in compliance with the limitation under Article 7 (paragraph 3) of the tax treaty. Against the order of the revenue, GMOC filed an appeal before the first appellate authority (first appeal).

The first appeal, relying on the GMOC AAR ruling, concluded that service of the MD was managerial in nature; conversely, service of the technically qualified and experienced VP was fees for included/technical services (FIS or FTS) under Article 12 of the tax treaty to be collectively taxed on gross basis. Aggrieved by the first appeal order, GMOC filed an appeal before the Income-tax Appellate Authority (Tribunal).

Tribunal Ruling

Binding Nature of the AAR Ruling

The Tribunal discussed the AAR procedural provisions to confirm that the AAR ruling is binding on the revenue and its administrative machinery but has only persuasive value on the Tribunal. A dispute due to the AAR ruling can only be entertained by the Tribunal when the revenue bound by such ruling does not follow the ruling for valid reasons. Hence, the Tribunal stated that the findings of the AAR ruling is not absolute or an unqualified verdict and grants the revenue to examine the facts for adjudication of the matter.

FIS for Technical Services

The Tribunal upheld the first appeal order after considering the following:

• The VP is not regarded as an ordinary engineer but has sufficient experience, exposure and knowledge about the technology. The experience lies in an expert’s mind and where such an expert with know-how/expertise is appointed cross-border, this results in the transfer of technology along with the executive. In essence, technology is made available by one entity from a tax jurisdiction to another entity situated in another tax jurisdiction, through deputation of its experienced technical employee.

• In the automobile sector, assembly of the product and company standard process are generally patented technology which is exploited for royalty charged by the patent owner to share such standards and assembly process of products that is not charged by GMOC to GMIL in the immediate case. Analyzing the deputation SLA of VP to India, the transfer of employee technical services/knowledge rendered by an expert VP cannot be regarded as standard in nature for a mere cost reimbursement payable by GMIL to GMOC.

• The Tribunal identified the facts of the Rolls-Royce Indl Power (I) Ltd (Rolls-Royce) judgment that did not involve transfer of technology through deputation of technical employees. The GMOC case was unique in the sense that employees with technical expertise not only manage but also engage to ensure compliance of GMOC standards, by constant monitoring and mentoring of the production cycle.

• The Tribunal by independently adjudicating the case, relying on available facts for taxability of such transaction, upheld the order of the first appeal to tax the invoice amount on gross basis as business income under Article 7(3) of the tax treaty. It was based on the rationale that the business profits clause prescribed computation of profits attributable to a PE only after permitting such expenses as deductible that are in compliance with provisions of and subject to the limitations of the tax laws of the PE State (Indian tax laws). Accordingly, applying Indian tax laws, no deduction of expenditure/allowance is permissible in computing FTS income thus, taxing FTS/FIS as business income on gross basis under Article 7(3) of the tax treaty.

• Additionally, the Tribunal recognized the Rolls-Royce case which applied non-discrimination Article 26 read with Article 13(4)(c) of the India–U.K. tax treaty that limits revenue to discriminate against the U.K.-registered company and grant it less favorable treatment than a domestic company invoking provisions of Indian domestic laws. Accordingly, the Tribunal singled out the Rolls-Royce case as it did not extensively deal with “subject to limitation of domestic law under the India–U.K. treaty.”

Transfer Pricing Provisions

The first appeal confirmed the action of the revenue to invoke transfer pricing (TP) provisions under Indian domestic law by adding a mark-up of 10% on the invoices raised by GMOC on GMIL. Further, the Tribunal allowed the operational appeal of GMOC as the revenue did not benchmark the TP transactions applying any comparable or otherwise using the acceptable methods for TP benchmarking under Indian tax laws. The Tribunal also removed the consequential interest, relying on the cases of Ngc Network Asia LLC [2009] 222 CTR 85 (Bombay) and GE Packaged Power Inc.

Planning Points

The Tribunal interestingly adopts distinct parameters for taxing FIS and managerial services, ignoring Article 12(6) of the tax treaty that prescribes fees attributable to PE are taxable as business income under Article 7 of the tax treaty particularly where the foreign entity constitutes a PE in India that arises income from the same Indian affiliate and activity.

The attribution of profits to the PE should be computed under TP principles supported by the CBDT Circular No. 5 of 2004 and applying the case of Convergys Customer Management Group Inc. and the Supreme Court ruling of Morgan Stanley, referring that in each case, data placed by the taxpayer should be examined under TP principles for attribution of profits and will depend on the functional and factual analysis undertaken in each case. The present case lacks TP analysis without any benchmarking conducted by GMOC.

It is noteworthy that the non-discrimination provisions under the tax treaty are different from the India–U.K. tax treaty but were not comprehensively discussed in the Tribunal order. The non-discrimination Article under the tax treaty does not prevent the Contracting State from imposing the limitations described in paragraph 3 of Article 7 (business profits) and excludes Article 7(3) as an exception to the non-discrimination clause of the tax treaty.

Shailendra Sharma is a Chartered Accountant associated with a multinational financial services firm, India.

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