Authority For Advance Rulings (Income Tax), New Delhi
Dishnet Wireless Ltd., In Re
Section : 9, 195
Justice P.K. Balasubramanyan
A.A.R. No. 863 Of 2010
August 24, 2012
1. The applicant is a company incorporated in India under the Companies Act. It is a subsidiary of another Indian company and is engaged in the business of providing telecommunication services in a number of telecom circles in India. A company registered in Saudi Arabia, STC for identification, indirectly holds 18 5% shareholding in the applicant. STC owns and/or controls and/or operates telecommunication paths, facilities and network infrastructure in the Kingdom of Saudi Arabia and elsewhere.
2. A consortium of which STC is a part, entered into a Construction and Maintenance Agreement on 6.5.2008 (C&MA) to plan and lay a cable system, Europe India Gateway submarine cable, known as EIG, linking the Indian subcontinent and the United Kingdom (UK) with Terminal Stations at various Terminal Points. The system is a high capacity fibre-optic submarine consortium cable system. The system will link the Terminal Stations in India, UAE, Oman, Djibouti, Saudi Arabia, Egypt, Libya, France, Monoco, Gibraltar, Portugal and U.K. As per the C&MA, STC is required to make an initial investment of $ 50 million in order to acquire 7.1265% stake in the EIG cable system.
3. As per the agreement among the consortium members, the terrestrial and submarine portions of the EIG cable system have been divided into segments connected through various Terminal Stations. The segments have been further divided into sub- segments which is to provide connectivity between different Terminal Stations across the system. The segment that terminates at the Terminal Station (T13) located at Mumbai is referred to as S4j, being part of Segment 4. There is a capacity allocation to each of the consortium members in respect of portions of the EIG cable system based on the proximity to the country to which the consortium member belongs. The concerned member of the consortium is entitled to transfer capacity in the EIG cable system capacity, to other telecommunication entities from its allotted capacity on a private basis with the condition that the transferring EIG party should cause the recipient to comply with the conditions laid down in the C&MA agreement.
4. Pursuant thereto, SAT entered into an EIG – capacity transfer agreement with the applicant for transfer of a part of the capacity out of its total allocated capacity of the EIG cable system. Thereby, SAT has transferred the right to use 40% of its allotted capacity in the EIG system to the applicant. The consideration for the same payable by the applicant is a sum of $ 20 million to SAT.
5. The applicant approached this Authority, invoking section 245Q of the income-tax Act seeking advance rulings on certain questions formulated by it adopting the stand that it was the transfer of a capital asset to it by SAT and that the gains of SAT are not taxable in India in terms of the Double Taxation Avoidance Convention (DTAC) between India and Saudi Arabia. After hearing both parties, this authority allowed the application under section 245R(2) of the Act to render Rulings on the following questions:
(1) Whether payments by the Applicant to Saudi Telecom Limited (‘STC’), under the terms of the EIG Capacity Transfer Agreement, towards acquisition of the EIG capacity, comprise income chargeable to tax in India?
(2) If the answer to Question 1 is in the affirmative, whether the payments by the Applicant would suffer withholding tax under section 195 of the Act, and if so, at what rate?
(3) Whether payments by the Applicant to STC under the terms of the EIG Capacity Transfer Agreement, towards annual operation and maintenance charges, would be in the nature of FTS within the meaning of the term in Explanation 2 to clause (vii) of section 9(1) of the Act?
(4) If the answer to Question 3 is in the affirmative, whether such payments by the Applicant would suffer withholding tax under section 195 of the Act, and if yes, at what rate?
6. It is the stand of the applicant that STC the payee is engaged in the business of providing telecommunication services and the capacity in the EIG Cable System has been acquired by STC for providing telecommunication services to its subscribers/customers and hence, it would be a capital asset of SAT. The transfer of 40% of the capacity got allocation of by it under the EIG agreement, to the applicant was hence the transfer of a capital asset. The gain therefore has not arisen in India since the capital asset was not situated in India. That part of the cable system falling within the territory of India had been allocated to an Indian member of the consortium and the grantor SAT was not its owner. The concerned segment of EIG system was not wholly lying within the territory of India. But, the capacity under segment S4j upto Terminal Station 13 allocated to SAT may be within the territory of India, but since STC is merely recouping its costs from the applicant to take part ownership in the system, no income arises to SAT in India that could be taxed as capital gains in India. STC and the applicant are not associated enterprises in terms of section 92A of the Act so as to attract sections 92 to 92F of the Act. Paragraph 6 of Article 13 of the DTAC ensure that the gains cannot be taxed in India since STC is a tax resident of Saudi Arabia.
7. The stand adopted by the Revenue was that the EIG Cable System in which SAT holds 7.1265% stake is not an independent asset which can be transferred by the stake holding company. The capacity acquired by SAT under the C&MA Agreement is not capable of being transferred or sold independent of the C&MA agreement. The applicant was paying a lump sum consideration for the right to use 40% of the EIG capacity allocated to SAT under the agreement among consortium members. The clauses in the relevant agreement would show that STC has not transferred any capital asset and it was not a case of purchase by the applicant or transfer of EIG system from SAT to the applicant. The right given to the applicant is only a right to use the capacity in EIG system and consideration was being paid by the applicant to SAT which was also having a terminal point right to use in the EIG system. The payment made by the applicant was royalty even in terms of paragraph 3 of Article 12 of the DTAC between India and Saudi Arabia. The income accrues or arises in India or at least it is deemed to arise in India and it is taxable as royalty in India in terms of paragraph 2 of Article 12 of the DTAC.
8. Some of the relevant terms of the Europe India Gateway Construction and Maintenance Agreement (EIG Agreement) dated 16.5.2008 may now be noticed. The preamble notices that the reliability of telecommunications services and its usefulness to customers required the availability of appropriate facilities and technology including EIG for diverse routing and rapid restoration of services. The parties were desirous of constructing EIG as a fully integrated network in the configuration set out in an annexure to that agreement. ‘Allocated capacity’ is defined as that part of the equipped capacity allocated to a party for activation of EIG, based upon investment level and applicable Tier Pricing Ratio. EIG is a submarine cable system linking India to the UK with Terminal Points and fibre pairs as provided for in an annexure and as described therein. The transmission system was divided into segments. The parties were to act as Terminal Parties of the segments. The Terminal Party of Segment T9 is STC and that of T13 is Bharti, an India company. Under clause 12, the parties were to own the allocated capacity on an ownership basis as shown in the schedule in that behalf. STC’s allotted capacity is shown as 2,790,622. The parties were free to designate a portion of their allocated capacity in specific parts of EIG as Jointly Assigned Circuit or Wholly Assigned Circuit. Any party was entitled to transfer Transfer Capacity to other telecommunication entities from its Allocated Capacity. Transfer of Capacity meant ‘making available to a non EIG party the right of use of capacity’. The allocated party continued liable to the others notwithstanding the transfer, for claims arising out of violations by the transferee and any injury, loss or damage. Notwithstanding the transfer of its Capacity, the transferor was to remain ultimately liable for any amounts due under the agreement attributable to the transferred Capacity Assignment of rights, and obligations could only be in terms of clause 12. With the prior written consent of the Management Committee constituted under the agreement, a party could assign, sell or transfer the whole of its rights and obligations under the Agreement and the transfer will be subject to the transferee acceding to the EIG agreement.
9. On the strength of this, STC entered into the Capacity Transfer Agreement with the applicant dated 5.3.2009. It does not purport to be a transfer of the whole of the rights and obligations of STC. It is recited in the preamble, among other things, that under the EIG C&MA, an EIG party may transfer part or all of its ‘Terminal Point Right of use’ to a telecommunication entity to whom it can transfer its Allocated Capacity in accordance with the agreement. Since the applicant was desirous of acquiring certain EIG capacity from STC and STC is ‘willing to provide’ the applicant with such capacity utilizing the EIG system over the lifetime of the EIG system, the agreement was being entered into. It is recited that STC and the applicant are independent companies and the agreement will only establish a relationship and partnership relating to participation in the EIG consortium. Except as stated in the agreement, no right of ownership, property in or title to the Capacity, Facilities or Network Infrastructure, Equipment or Software was conveyed to or vested in the applicant under the agreement except where expressly stated to the contrary. The participation of the applicant is described as indirect participation. It is agreed that the investment level of STC in EIG shall be $50 million, the direct contribution of STC was $30 million and the applicant’s indirect contribution via STC being $20 million. On this consideration, STC agreed to grant the applicant 40% of all the benefits, obligations and liabilities accrued to and/or attributed to STC as a result of STC’s participation in the EIG system including through STC’s signature of the EIG, C&MA and the EIG Supplier contract. It is provided that the applicant would have access to the cable system as per the provisions of the C&MA from EIG PoPs/Cable Landing Stations to use the capacity transferred to the applicant. STC is to transfer the applicant’s share of capacity in accordance with the provisions of the C&MA. It is emphasized that the parties agree that the right to use the transferred EIG capacity from STC to the applicant is exclusive to the applicant and is non-transferable to any third party. It is provided that the agreement is to continue in effect until the termination of the EIG C&MA. In the event of termination of the agreement, all rights of capacity that had been transferred to the applicant shall revert back to STC immediately unless mutually agreed otherwise.
10. From a reading of the two agreements it is seen that the latter agreement cannot be understood as a transfer of ownership in the system. Under the EIG C&MA, STC is given the right to assign the Allocated Capacity. Allocated Capacity cannot be understood as conferring on STC an absolute title to a segment of the system. It would be proper to understand it as a right to exclusive user or exploitation of a segment of the system with a right in it to share the user with another. The agreement between STC and the applicant also suggests that it is only the right to participate in the use of the EIG System that is given to the applicant. It is discernible from the agreements that a transferee like the applicant is only permitted to operate and use the capacity and permitted to activate it at the relevant terminal point. The restraint placed on the applicant from transferring the capacity to any third party and the reverting back of the rights of the applicant to STC on the termination of its agreement with STC negates the theory of a part of the ownership having passed to the applicant.
11. A transfer of a capital asset is different from the transfer of a right to use exclusively a part or segment of the system. I am therefore, not in a position to accept the argument on behalf of the applicant that what is involved is the transfer of a Capital Asset that generates capital gains. Hence the argument that what is generated is Capital gains cannot be accepted.
12. It is then argued that what is paid as consideration for the exclusive right to exploitation of the segment, is only reimbursement and it is not the income of SIC. It is submitted that STC has the obligation to pay $50 million to the consortium for the right and STC has passed on a part of the right to the applicant, apportioning the liability of STC to the consortium and assigning it the liability of paying $20 million out of it. That means, STC only takes $20 million from the applicant out of its obligation to pay $50 million to the consortium and passes on $20 million thus received to the consortium and this can only be reimbursement or recoupment of a part of STC’s costs. The Revenue on the other contends that what is paid by the applicant to STC in consideration for the right to exclusive user of the concerned segment and the consideration cannot be claimed to be reimbursement, but it can only be royalty as defined in the Act and in the DTAC.
13. It is argued on behalf of the applicant that by making a payment of $20 million to STC, which amounts to 40% of the total commitment of STC to the consortium, the applicant is enabled to enjoy 40% of the total rights/responsibilities/obligations of the STC in the EIG cable system. The applicant thereby steps into the shoes of STC to the extent of 40% of the allocated capacity in the EIG cable system. The EIG cable system is largely located outside India. As far as the income of that part is concerned, since it is transfer of a capital asset it would not be taxable in India. I have already found on a true construction of the two agreements that it is not the transfer of a capital asset, but it is only the right of user that is granted to the applicant. Once that conclusion is arrived at, the character of the payment made by the applicant has to be ascertained, not on the basis that it is a capital gain arising out of a sale of a right by STC but as consideration for the right to use a segment of this system.
14. It appears to me that the payment made by the applicant cannot be considered to be a payment made to the consortium on behalf of STC. The obligation of STC to the consortium is independent of the obligation of the applicant to STC. The payment is to STC and that payment is for the right to use and the use of equipment or capacity. The applicant cannot be said to be reimbursing the costs of the STC. STC has farmed out the right of user over a part of the segment, the exploitation of which is allotted to it under the EIG C&MA, for a consideration. The concept of reimbursement does not arise. Even if the applicant does not pay STC, the obligation of STC to pay the consortium will remain. The applicant also does not have an obligation to pay the consortium. It has entered into no agreement with the consortium. What is to be seen is the character of the payment based on the payer and what he pays for. So viewed, what the applicant has paid STC is for the right to use the system with a right to access it and exploit it.
15. What is the right to use in this case? That is the right to access the particular segment of a larger system to use the capacity of the system powered by the equipments of the whole system. The consideration paid for this right to access and the right to use and exploit the system, is royalty according to the Revenue. It is pointed out that Explanations 5 and 6 to Section 9(1)(vi) of the Act introduced by the Finance Act, 2012 with retrospective effect, makes it clear that the consideration being paid by the applicant to STC is royalty under the Act. Even otherwise, it was a right to use a process and a right to use equipment coming within Explanation 2 to section 9(1)(vi) of the Act.
16. Under paragraph 3 of Article 12 of the DTAC, consideration paid for use of or the right to use a design or model plan, commercial or scientific equipment would be royalty. Under paragraph 2, if the consideration is royalty it is taxable in the country of the prayer according to the laws of the State of the payer. Here, that would be according to the laws of India. Especially in view of the clarificatory amendment of Section 9(1)(vi) of the Act, there cannot be much doubt that what is paid by the applicant is for a right to use a process and/or a right to use a commercial or scientific equipment. Hence the finding has to be that the consideration paid by the applicant is royalty chargeable to tax in India in terms of paragraph 2 of Article 12 of the DTAC between India and Saudi Arabia.
17. In the light of the discussion above, the ruling on question No.1 is that the payment made by the applicant to STC under the EIG Capacity Transfer Agreement towards acquisition of EIG capacity is chargeable to tax in India as royalty in terms of paragraph 2 of Article 12 of the DTAC between India and Saudi Arabia.
18. In view of the above ruling, the ruling on question no. 2 is that the payment by the applicant would suffer withholding tax under section 195 of the Act, since the applicant is a resident, the payee is a non-resident and the payment is chargeable to tax in India under the Act.
19. Question No.3 is whether the payment of annual operations and maintenance charges would emerge as fees for technical services. The argument of the applicant is that the payment is on account of the ownership of certain capacity in the EIG Cable System and not as consideration in respect of any technical service being rendered by STC to the applicant. The right to use that part of the system has been farmed out to the applicant for a consideration which is found to be royalty payable by the applicant. The operations and maintenance charges are paid to ensure that right to use without break down.
20. From the facts now available, (the Revenue is seen not to have pleaded anything specific about it) it appears that this is a share of the annual operations and maintenance charges incurred for maintaining the entire system. As at present advised, I am inclined to rule that the share of charges paid cannot be treated as fees for technical services and can be treated as the share of costs for maintenance incurred for the right to use the system acquired by the applicant.
21. Question 4 is whether withholding of tax is called for in respect of the payment of the Operations and Maintenance charges if what is paid is fees for technical services. In view of my ruling that it is not fees for technical services, this question has to be ruled in favour of the applicant. No other basis for withholding tax on it has been put forward before this Authority by the Revenue.
[Citation : 353 ITR 646 ]