Mumbai Tribunal: Payments for line production services not FTS or royalty
Recently, the Mumbai Bench of the Income Tax Appellate Tribunal (the “Tribunal”) has held in the case of M/s Endemol South Africa (Proprietary) Ltd. v. DCIT (IT)1 that income from providing line functions is not taxable as either “royalty” or “fees for technical services” (“FTS”) under the provisions of the Income Tax Act, 1961 (“ITA”) as well as under the India-South Africa Double Taxation Avoidance Agreement (the “Treaty”).
Endemol India Private Limited (“Endemol India”) was commissioned to produce a television series called “Fear Factor” (based on the popular US show of the same name) and was required to shoot episodes in South Africa for which it needed local support. Endemol India entered into an agreement dated April 19, 2011 with Endemol South Africa ((Proprietary) Ltd. (the “Taxpayer”) to carry out line production services which involved providing various administrative services such as making logistic arrangements and (acting as a facilitator and coordinator for filming of the television series in South Africa on a work-for-hire basis (the “Agreement‟).
In terms of the Agreement, the Taxpayer received an amount of INR 96 million (approx.) from Endemol India for providing the aforementioned services in South Africa. These payments received by the Taxpayer outside India were subjected to withholding taxes by Endemol India. Since it was an accepted position that the Taxpayer did not have a Permanent Establishment (“PE”) in India, the Taxpayer declared no taxable income in its Indian tax returns.
However, the Assessing Officer (“AO”) took a view that the role of the Taxpayer was not that of a mere facilitator and that it had assigned copyright to, and provided managerial and technical services to Endemol India. The AO pointed to the fact that Endemol India had withheld tax on these payments to the Taxpayer to evidence tacit acceptance of the AO’s position by the parties to the Agreement. Accordingly, the AO concluded that the income earned by the Taxpayer from Endemol India was taxable in India as royalty and FTS at the rate of 10% as per Article 12 of the Treaty2 which was contested by the Taxpayer before the Dispute Resolution Panel (“DRP”). The DRP also held these payments to be taxable as royalty and FTS on the basis that the Agreement provided that the copyright in the format, recorded footage, scripts, visuals etc., produced by the Taxpayer for Endemol India would vest exclusively with Endemol India. Further, the DRP observed that as per the Agreement, the Taxpayer was obliged to assign all its copyrights (if any) conferred by the South Africa Copyright Act No. 98 of 1978, as well as all other intellectual rights that may be vested with it in future as a result of producing materials for Endemol India to the latter.
Aggrieved by the order of the DRP, the Taxpayer preferred an appeal against the same before the Tribunal.
Whether the revenue earned by the Taxpayer from Endemol India should be taxed in India as income in the nature of “royalty” or “FTS”?
The Tribunal went through various clauses of the Agreement to conclude that the same was a contract for providing services, and not for granting a right in any copyright. The Tribunal also observed that the entire consideration that was paid to the Taxpayer under the Agreement was in respect of the provision of the line production services and not towards any licensing rights in any work.
It was pointed out by the Taxpayer that under Section 17 of the Copyright Act, 1957 as well as the provisions of South Africa Copyright Act No. 98 of 1978, where a work is specifically commissioned under a contract of service by a person, then such person is the first owner of the copyright in that work. Thus, the Tribunal after perusing these legal provisions, held that when Endemol India was anyway the first owner of the copyright in the cinematograph work as per the operation of law, there could be no question of the Taxpayer assigning the same in favour of Endemol India.
The Tribunal considered the definition of the term “royalty” under Article 12(3) of the Treaty,3 to find that it only includes consideration received for the use of or right to use, any copyright, and thus, even if the observations of the AO and the DRP that the consideration received by the Taxpayer was for transfer of the copyright to Endemol India were accepted, this would also fall outside the scope of the term “royalty” for the purposes of the Treaty.
On this basis, the Tribunal held that the consideration received by the Taxpayer under the Agreement for line production services was not in the nature of “royalty” under Article 12 of the Treaty read with the ITA.
Fee for Technical Services:
The Tribunal considered whether the line production services being provided by the Taxpayer could fall under any of the kinds of services which are covered under the definition of FTS under the ITA and the Treaty, namely (i) managerial services; (ii) technical services; or (iii) consultancy services.
Managerial Services: The Tribunal found that the Taxpayer was in no way involved in controlling, directing, managing or administering the business or part of the business of Endemol India, and hence, concluded that the Taxpayer’s services did not fall within the scope of the term “managerial services”. In this regard, the Tribunal placed reliance on its own ruling in the case of Yash Raj Films v. ITO (IT),4 which involved a similar set of facts. The taxpayer in that case had payments to certain overseas service providers for services availed in connection with the shooting of different films where various activities involved included arranging for shooting locations, obtaining necessary permits, arranging shipping & custom clearances, shooting equipment, meals, transport etc., arranging for makeup of casts, and coordinating necessary licenses. In this ruling, the Tribunal had clarified that “merely because some managerial skill is required to render the services, it would not make the services to be managerial services as envisaged in Explanation 2 to section 9(1)(vii). Similarly, the requirement of knowledge of local laws on the part of the service providers to render the services such as obtaining the permissions for shooting from the local authorities or for arranging insurance of the crew members and shooting equipment would not change the basic nature of the services”.
Technical Services: The Tribunal then proceeded to hold that the administrative services being provided by the Taxpayer (such as arranging for logistics, etc.) did not involve use of any technical skill or technical knowledge, nor any application of technical expertise on its part and hence, the same cannot be characterized being in the nature of as “technical services”. Again, the ruling of Tribunal in the case of Yash Raj Films (supra)5 becomes relevant as in this case, in the context of logistics support for film shooting, it had also been clarified, that such activities do not constitute “technical” services.
Consultancy Services: The Tribunal held that since consultancy services typically require specialized qualification, knowledge, expertise of a professional person and is a function of the skill, intellect and individual characteristics of the person rendering it, the line production services rendered by the Taxpayer under the Agreement could not fall under this category as well.
Based on the above, the Tribunal rejected the argument of the revenue department and held that the consideration received by the Taxpayer under the Agreement could not be characterized as being FTS.
Applicability of AAR Rulings:
The Tribunal referred to the two rulings of the Authority for Advance Ruling (“AAR”) delivered in the case of Endemol Argentina, In Re6 and Utopia Films, In Re 7 where the issue of taxability of consideration received in lieu of providing line production services had been considered and decided upon. Through these two rulings, the AAR had clearly laid down the position that such services did not fall within the scope of FTS under the ITA.
However, the AO and the DRP had disregarded these rulings on the grounds that (i) AAR rulings are only binding in respect of the applicant only in respect of the transactions in relation to which advance ruling was sought; and (ii) the AAR rulings were in the context of tax treaties other than the South Africa Treaty.
While the Tribunal agreed with (i) above, it held that AAR Rulings still carry a persuasive value and accordingly, may be relied upon by the AAR itself or by other taxpayers or the revenue department itself. The Tribunal referred to the judgment of the Supreme Court of India in the case of Columbia Sportswear Company v. DIT, Bangalore8 in support of this view.
On point (ii), the Tribunal observed that no material was placed before it to differentiate between the definitions of “FTS” which were included in the DTAAs involved in the aforementioned AAR Rulings and the definition of “FTS” as included in the Treaty which was the subject matter of discussion in the instant matter. Accordingly, the Tribunal ruled that the AO and the DRP had erred in not considering the rulings of the AAR while considering the case of the Taxpayer as these rulings had persuasive value.
The ruling of the Tribunal in the instant case is a very welcome one for taxpayers as it contains specific comments by the Tribunal towards lower tax authorities, clearly articulating the need for lower tax authorities to consider advance rulings delivered by the AAR while adjudicating on tax disputes since they are of persuasive value. The ruling also relevant for the issue of characterization of income, especially since the Tribunal, in this case, did not go ahead to re-write the commercial understanding between the parties as to the services under the agreement. This seems to be distinct from the approach taken by the Bangalore Tribunal in Google India (P.) Ltd. v. Joint Director of Income-tax (IT), Bengaluru;9 (please click here to read our hotline on this ruling of the Tribunal) although the reasons were different in the two rulings.
The Tribunal, rightly rejected a rather strange argument by the revenue department that by making reference to a clause in the Agreement which specified that all copyright and other intellectual property in the work would vest with Endemol India, it would imply that there is an assignment of intellectual property by the Taxpayer in favour of Endemol India. This argument was advanced despite the fact that Endemol India was anyway the first owner of the intellectual property in the work being commissioned under the Agreement as per the applicable law.
It is a well-established risk mitigation practice which lawyers follow to insert clarificatory language while drafting a contract to ensure that there is no ambiguity even where the law is clear on a subject. For instance, even though under the Copyright Act, 1957 an employer is always the first owner of any copyright which his employee creates while acting in the course of his employment, it is a standard practice to include a clause on the assignment of intellectual property to the employer in the employment agreement.
By deciding in favour of the Taxpayer, the Tribunal upheld both the form and substance of the Agreement as accepting the contentions of the revenue would have amounted to a virtual redrafting of the Agreement which should never be done by courts.
1 ITA No. 1732/Mum/2016
2 “Article 12: Royalties and Fees for Technical Services
1. Royalties or fees for technical services arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State.
2. However, such royalties or fees for technical services may also be taxed in the Contracting State in which they arise, and according to the laws of that State, but if the recipient is the beneficial owner of the royalties or fees for technical services, the tax so charged shall not exceed 10 per cent of the gross amount of the royalties or fees for technical services.
3 Article 12(3): “The term "royalties" as used in this Article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work (including cinematograph films and films, tapes or discs for radio or television broadcasting), any patent, trade mark, design or model, plan, secret formula or process, or for the use of, or the right to use, industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience.”
4 (2013) 140 ITD 625 (Mum).
6 AAR No. 1082 of 2011; dated December 13, 2013
7 AAR No. 1081 and 1082 of 2011; dated February 19, 2014
8 (2012) 346 ITR 161 (SC)
9  93 taxmann.com 183 (Bangalore - Trib.)