BSR & Co. Recent Developments And Case Studies On International Taxation Hitesh Gajaria – Chartered Accountant 13 January 2007 Tax

BSR & CO. 2 Case Study 1 Employee Secondment

BSR & Co. 3 Employee Secondment - Facts Smartpeople USA, is engaged in the business of providing software development assistance to companies around the world. Smartpeople USA has three subsidiaries, Smartpeople, India, Smartpeople, Austria and Smartpeople, Finland. Smartpeople, India inter alia develops the system to be used globally by the Smartpeople group. Software transferred to the parent and other group companies at an arms length price and the same software also sold to other customers after modifying it to meet their requirements. Subsidiaries responsible for getting and developing their own business worldwide.

BSR & Co. 4 Employee Secondment - Facts Smartpeople India entered into contract with AllSolutions Inc. USA to use their software package to develop the company’s global systems. Monthly royalty of USD 200,000 payable to AllSolutions Inc. USA. For business reasons training on any new system to be implemented and manpower planning was handled by the Finland company. The Finland company bears a part of the employee cost. The Finland company sources people from different subsidiaries and sends them for training on the software to AllSolutions Inc. Smartpeople Finland sent 5 dedicated people to AllSolutions USA to learn the software for three months.

BSR & Co. 5 Employee Secondment - Facts Of these five, two were employees of the Indian subsidiary and three were of the Austrian Subsidiary. These employees were transferred on the payroll of the Finland company for a period of two years being the estimated time for the Indian company to develop the system. Smartpeople Finland then entered into a Secondment Agreement with Smartpeople India whereby it agreed to second these five employees to the Indian company to train the Indian company in the use of the software. The salary of the Indian employees were partly paid by the Indian company and partly by the Finnish company.

BSR & Co. 6 Employee Secondment - Facts The Finish company was reimbursed on a cost to cost basis for the salary cost borne by it. Part of the salary of the Austrian employees was also reimbursed by the Indian company to the Finland company as they were considered to be seconded to India from the time the training commenced. USA company seconded two employees to acquaint the Indian subsidiary with the global standards and requirements of service. Employees remained on the payroll of the US company. Salary partly paid in India and partly abroad.

BSR & Co. 7 Employee Secondment - Facts US company compensated all direct and indirect cost for secondment. No separate secondment fee charged. Employees work under supervision of Indian company but report and are appraised by the US company. On completion of secondment employees go back to US company. US company had a right to replace any employee.

BSR & Co. 8 Employee Secondment – Tax Position for Smartpeople India ActivityBy the taxpayer in the Return By the AO in the Assessment Order a) On royalty payments to AllSolutions Inc. Not Taxable as payment for right to use the copyrighted software and not for the copyright itself. Taxable at the rate of 15 percent on a gross basis as Royalty under Article 12 of India-US Tax Treaty. Further, not allowed as a deduction as tax was not deducted at source. b) Reimbursements of the Salary of the Indian and Austrian employees seconded to the Finland company Pure reimbursement of salary cost borne by the Finland company therefore no tax has to be deducted on payments made to the Finland company. As regards the Indian employees, tax had been deducted and deposited on the entire salary. The control over the employees had been given over to the Finland company which had in turn ‘made available’ the services of these employees to the Indian company. Therefore, tax ought to have been deducted at the rate of 15% as ‘Fees for Technical Services’ (FTS) under the India-Finland Treaty. c) Reimbursement of salary cost to the US Company. Pure reimbursement of salary cost therefore no tax has to be deducted on payments made to the US company. In any event tax had been deducted and deposited on the entire salary. The US company had a “Service PE’ in India through its employees seconded. Applying the ‘force of attraction’ rule all income of the US company would be taxable in India.

BSR & Co. 9 Employee Secondment – Issues Is Smartpeople India correct in its stand that the royalty paid to AllSolutions Inc USA is not taxable in India? Is the AO correct in holding that the reimbursement of salary to the Finland company constitutes FTS? Is the AO correct in holding that the employees of the US company constitute a ‘Service PE’ in India within the meaning of Article 5(2)(l) of the India-US Tax Treaty? Is the AO justified in applying the ‘force of attraction’ rule to bring the whole of the income of the US company to tax?

BSR & Co. 10 Employee Secondment – Reference Material India-US Tax Treaty India-Finland Treaty Ruling of the AAR in the case of AT&S India Pvt. Ltd. In Re. [2006] 287 ITR 421 ( AAR) Ruling of the AAR in the case of Morgan Stanley and Co. In Re.[2006] 284 ITR 260 (AAR)

BSR & CO. 11 Case Study 2 Hospitality Industry

BSR & Co. 12 Hospitality Industry - Facts Comfort Chain Singapore (Comfort) manages hotels across the globe. It entered into an agreement with Wellbeing Hotels India (WHI), a popular hotel chain in India. As per the agreement the main objective of the association was to develop Indian tourism and give international level service to tourists. The said objective was to be achieved by promoting and advertising worldwide the Comfort brand for the mutual benefit of both. Comfort was to provide the following services to WHI Management Services Right to use proprietary information such as food and beverage recipes Brand Promotion and Management

BSR & Co. 13 Hospitality Industry - Facts WHI also has a separate agreement with Comfort USA to use the global reservation system. WHI would pose a query to the server located in USA for availability of rooms globally based on which it could offer rooms abroad to its Indian customers on request. WHI would also use the system to process and obtain data reports on trends in the hotel industry and projection of occupancy ratios. WHI has to pay Comfort USA a fixed licensing fee and a variable component based on number of data reports obtained.

BSR & Co. 14 Hospitality Industry – Issues WHI approached the AO for a Nil withholding tax certificate on the payments to be made to Comfort Singapore following grounds: The payments were being made under a composite agreement. The services were being provided to achieve the main objective i.e. to promote hotel business to mutual interest of both and were thus ancillary and auxiliary to the main objective Thus amounts received were in the nature of business income not taxable in the absence of a PE

BSR & Co. 15 Hospitality Industry – Issues WHI approached the AO for a Nil withholding tax certificate on the payments to be made to Comfort USA following grounds: The payments were in the nature of business income not taxable in the absence of a PE The payments were not royalty under the Tax Treaty with US as the company did not have any physical access to the mainframe computer. The company had not received the right to use any intellectual property

BSR & Co. 16 Hospitality Industry – Issues Stand taken by the AO in respect of the payments to be made to Comfort Singapore Management Services – Fees for Technical Services (FTS) as skill and know-how has been ‘made available to the Indian company. Right to use proprietary information – Royalty as payment is for a right to use the proprietary information. Brand Promotion and Management – FTS as services rendered are in nature of ‘managerial and consultancy services’.

BSR & Co. 17 Hospitality Industry – Issues Stand taken by the AO in respect of the payments to be made to Comfort USA The payments were “Royalty” under the Act and the Tax Treaty as they were for the right to use the specialised software and use of scientific equipment The fixed and variable payments were royalty under the Tax Treaty as it was for the use of the mainframe computer. Tax was deductible at the Treaty rate under “Royalty”

BSR & Co. 18 Hospitality Industry – Issues Is WHI correct in the stand taken before the AO in respect of payments made to Comfort Singapore? Is WHI correct in the stand taken before the AO in respect of payments made to Comfort USA? What is your advice to WHI on the line of argument to be taken before the AO? What is your advice to WHI on the issue of deduction of tax at source on the aforesaid payments?

BSR & Co. 19 Hospitality Industry – Reference Material India-US Tax Treaty India-Singapore Treaty Decision of the Mumbai Tribunal in the case of Sheraton International Inc. v. DDIT [2006] 10 SOT 542 (Del) Ruling of the AAR in the case of International Hotel Licensing Company S.A.R.L. In Re. AAR No. 674 of 2005 Ruling of the AAR in the case of IMT Labs (India) Pvt. Ltd. [2006] 287 ITR 450 (AAR) Decision of the Mumbai Tribunal in the case of Kotak Mahindra Primus Limited v. DDIT [2006] 105 TTJ 578 (Mum)