Royalty is not a Fee for Services Rendered

The Income Tax Appellate Tribunal (ITAT) recently allowed a plea filed by British company Ernst & Young Global Services, challenging the income tax department's demand that it pay ₹6.6 crore as tax.

An assistant commissioner of income tax, international taxation, raised the tax demand after assessing the company's foreign remittances for four years, which the officer termed as royalty paid to the parent company. The department taxed Ernst & Young Global under three heads: software charges, global technology charges and global wide area network (GWAN) connectivity charges.

The company provides centralised services to the member firms of EY, the global professional services group. It challenged the demand, claiming that the payments received by it from Indian member firms were mere reimbursements of costs and not taxable under the Income Tax Act and the Double Taxation Avoidance Agreement between India and the UK.

An Authority of Advance Ruling (AAR) upheld the tax assessment, but the Delhi High Court ruled in December last year that payments received for providing computer software to the member firms did not amount to royalty and were not liable to be taxed.

Agreeing to the high court ruling, the appellate tribunal last month directed the income tax assessing officer to follow the order effectively, meaning thereby to not charge the taxed amount.

Legal experts said the development could have ramifications in similar cases involving foreign companies, including the local entities of Chinese telecom companies which are facing prosecution by the income tax department.

"This judgement will have far-reaching consequences and may benefit similarly placed foreign companies embroiled in identical tax disputes," said Chetan Mittal, a senior advocate and former assistant solicitor general.

Adding a word of caution, advocate Aditya Dewan, a corporate litigator who is well-versed with taxation laws, told ET: "While representatives of Chinese companies may seek to benefit from this ruling, it remains to be seen whether they would succeed or not. Because among other issues, the Indo-China agreement of Double Taxation Avoidance will come into play in case of Chinese entities."

Unlike the local units of Chinese companies which were dealing with third-party clients, in this case, the software was shared with EY's Indian entity only for internal consumption.

EY claimed that the tax authorities had erred in not accepting its argument that reimbursement of actual costs relating to software licence and maintenance charges amounting to over ₹5.2 crore "are not in the nature of royalty under the Income Tax Act as well as Double Taxation Avoidance Agreement between India and the UK".

The department also wrongly taxed the company on account of "global technology" and GWAN connectivity charges amounting to over ₹1.1 crore, it claimed.

The company contended that it was established as a non-profit central service provider to enable EY member firms to share the costs of centralised services. It enters into agreements with each member firm and recovers various costs incurred by it from the member firms on an actual usage basis.

It had filed a "NIL" return of income in March 2012, contending that the payments received by the assessee from Indian member firms were mere reimbursements of costs.