2016 (4) TMI 1444 - AT - Income Tax

ITAT rules web hosting payment not 'royalty' under IT Act

The ITAT upheld the CIT(A)'s decision in favor of the assessee, ruling that the payment for web hosting charges to a US company did not amount to ... Classification of payments as 'royalty' under section 9(1)(vi) - 'use or right to use any industrial, commercial or scientific equipment' (clause (iva) of Explanation 2 to section 9(1)(vi)) - deduction of tax at source under section 195 - disallowance under section 40(a)(ia) for failure to deduct tax - business income versus royalty/fees for technical services - possession and control of equipment as determinative of 'use' - taxability of non-resident income in absence of permanent establishment - distinction between a 'service' and a 'facility'Classification of payments as 'royalty' under section 9(1)(vi) - 'use or right to use any industrial, commercial or scientific equipment' (clause (iva) of Explanation 2 to section 9(1)(vi)) - possession and control of equipment as determinative of 'use' - distinction between a 'service' and a 'facility' - Payment of web hosting charges to non-resident service providers does not constitute 'royalty' under section 9(1)(vi) where the assessee has no possession, control or exclusive use of the equipment and merely avails a facility. - HELD THAT: - The Tribunal accepted the appellate authority's finding that the word 'use' in clause (iva) of Explanation 2 must be understood as actual use involving possession, control or positive acts of utilization of the equipment. The facts showed that the assessee had no access to, control over, or possessory rights in the servers/equipment which remained under the ownership, control and maintenance of the non-resident providers who offered a standard service to multiple customers. Reliance was placed on precedents which held that when a customer merely avails a facility created by the service provider and cannot operate, control or otherwise put the equipment to use, the payment is for a service/facility and not for 'use' or 'right to use' equipment within clause (iva). The Tribunal therefore held that web hosting charges could not be characterised as 'royalty' under section 9(1)(vi). [Paras 3, 7, 11, 12]The characterization of web hosting charges as 'royalty' was rejected and the payments were held not to fall within clause (iva) of Explanation 2 to section 9(1)(vi).Deduction of tax at source under section 195 - disallowance under section 40(a)(ia) for failure to deduct tax - taxability of non-resident income in absence of permanent establishment - business income versus royalty/fees for technical services - No liability to deduct tax under section 195 and no disallowance under section 40(a)(ia) arises where payments are not royalties or taxable in India because the non-resident does not have a permanent establishment and the services are rendered and paid for outside India. - HELD THAT: - Having held that the payments did not constitute 'royalty', the Tribunal proceeded that the recipients (non-resident service providers) had no taxable income in India in respect of those receipts since the services were rendered from servers located outside India and there was no permanent establishment in India. In that factual matrix, the obligation to deduct tax under section 195 did not arise and the addition under section 40(a)(ia) made by the Assessing Officer was therefore not sustainable. The Tribunal affirmed the view of the CIT(A) and followed consistent authorities holding that business income for provision of bandwidth/hosting/facility is not taxable in India in absence of PE and where the character of payment is not royalty or fees for technical services. [Paras 4, 5, 11, 13, 14]No TDS under section 195 was payable and the consequential disallowance under section 40(a)(ia) was deleted; the revenue's appeals were dismissed.Final Conclusion: The Tribunal dismissed the departmental appeals for assessment years 2007-08 to 2010-11, holding that the web hosting payments were not 'royalty' under section 9(1)(vi), did not attract taxability in India in the absence of a permanent establishment, and therefore did not give rise to liability to deduct tax under section 195 or to support disallowance under section 40(a)(ia). Issues Involved:1. Whether the payment of web hosting charges to a US company constitutes 'royalty' under Section 9(1)(vi) of the Income Tax Act.2. Whether the assessee was liable for deduction of tax under Section 195 of the Income Tax Act on the payment of web hosting charges.3. Applicability of Section 40(a)(ia) regarding the addition made by the Assessing Officer for non-deduction of tax at source.Issue-wise Detailed Analysis:1. Whether the payment of web hosting charges to a US company constitutes 'royalty' under Section 9(1)(vi) of the Income Tax Act:The primary issue before the ITAT was whether the web hosting charges paid by the assessee to its US subsidiary and other companies should be classified as 'royalty' under Section 9(1)(vi) of the Income Tax Act. The Assessing Officer (AO) had classified these payments as royalty based on clause (iva) of Explanation-2 to Section 9(1)(vi), which defines royalty as 'the use or right to use any industrial, commercial, or scientific equipment.' The AO relied on the decision of ITAT Delhi in the case of M/s Millennium Infocom Technologies Ltd. (117 ITD 114).However, the CIT(A) and the ITAT found that the assessee did not have possession or control over the equipment used for web hosting services, nor did it use the equipment solely for its own purposes. The ITAT cited several precedents, including the cases of M/s Standard Chartered Bank and M/s Atos Origin IT Services Singapore (P) Ltd., where it was held that payments for such services do not constitute 'royalty' as the assessee merely made use of the facility provided by the service provider without having any control over the equipment.2. Whether the assessee was liable for deduction of tax under Section 195 of the Income Tax Act on the payment of web hosting charges:The AO contended that the assessee should have deducted tax under Section 195 on the payments made for web hosting services, as these payments were considered royalty. However, the CIT(A) and the ITAT disagreed. They noted that the services were rendered outside India by a non-resident and were also paid outside India. Therefore, the provisions of Section 195 did not apply.The ITAT referred to several decisions, including the case of Dell International Services (India) Pvt. Ltd., where it was held that payments for bandwidth services do not constitute royalty or fees for technical services. The ITAT concluded that since the service provider was located outside India and the server was also outside India, the income was not taxable in India, and hence, no tax was required to be deducted under Section 195.3. Applicability of Section 40(a)(ia) regarding the addition made by the Assessing Officer for non-deduction of tax at source:The AO had made an addition under Section 40(a)(ia) for non-deduction of tax at source on the web hosting charges. However, since the ITAT concluded that the payments were not in the nature of royalty and were not taxable in India, the provisions of Section 195 did not apply. Consequently, the addition made under Section 40(a)(ia) was deleted.Conclusion:The ITAT upheld the order of the CIT(A) in favor of the assessee, concluding that the payment of web hosting charges did not constitute royalty under Section 9(1)(vi) of the Income Tax Act. Therefore, the assessee was not liable to deduct tax at source under Section 195, and the addition made by the AO under Section 40(a)(ia) was deleted. All the appeals by the revenue for the assessment years 2007-08 to 2010-11 were dismissed.