Payments to foreign telecom operators are business income, not royalty or FTS under Sections 9(1)(vi) and 9(1)(vii)

ITAT Delhi held that payments made by the assessee to foreign telecom operators (FTOs) for interconnection usage charges (IUC) do not constitute Fee for Technical Services or Royalty under section 9(1)(vii) or 9(1)(vi) of the Act, nor under relevant DTAA provisions. Such payments are classified as business income under Article 7 of the DTAA, and since FTOs lack a Permanent Establishment in India, the income does not accrue or arise in India. Consequently, the assessee is not liable to deduct tax at source under section 195 and cannot be treated as an assessee in default under section 201. The tribunal also ruled that section 206AA's provisions on withholding tax rates cannot be applied retrospectively, with DTAA rates prevailing. All issues were decided in favor of the assessee.

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Issues Involved:
1. Whether the payment of Inter-connect Usage Charges (IUC) by the assessee to Foreign Telecom Operators (FTOs) is taxable as Fee for Technical Services (FTS) under Section 9(1)(vii) of the Income Tax Act.
2. Whether the payment to FTOs for IUCs is in the nature of royalty under Section 9(1)(vi) of the Act.
3. Whether the assessee is liable to be treated as an assessee in default under Section 201 of the Income Tax Act.
4. Whether the payment made by the assessee to the FTO can be deemed to accrue or arise in India.
5. Whether beneficial rates provided under Double Taxation Avoidance Agreements (DTAAs) override the provisions of Section 206AA and whether Section 206AA is applicable retrospectively.
6. Whether the CIT(A) acted in violation of the provisions of Rule 46A in admitting additional evidence filed by the assessee.
7. Whether the payment is revenue sharing or not.

Issue-wise Detailed Analysis:

Issue 1: Taxability of IUC as FTS under Section 9(1)(vii)
The Hon’ble Delhi High Court in the assessee’s own case (CIT vs. Bharti Cellular Ltd.) held that the expression "technical services" involves a human element, and the services rendered qua interconnection/port access do not involve any human interface. The Hon’ble Supreme Court upheld this view, emphasizing the need for human intervention for services to be considered technical. The Tribunal found no human intervention in the interconnection process, as it is automated. Therefore, the payment for IUC cannot be considered FTS under Section 9(1)(vii).

Issue 2: Nature of Payment as Royalty under Section 9(1)(vi)
The AO held that the payment for IUCs could alternatively be considered as royalty for the use of a process. However, the CIT(A) and the Tribunal found that the agreements do not grant the assessee the right to use the FTO’s network or process. The term "process" under Explanation 2 to Section 9(1)(vi) refers to a process that is an item of intellectual property, which the FTOs do not exclusively own. The Tribunal also noted that the amendments to Section 9(1)(vi) by the Finance Act, 2012, do not affect the definition of royalty under DTAAs, which require the process to be secret. Thus, the payment is not royalty under the Act or the DTAAs.

Issue 3: Assessee in Default under Section 201
The Tribunal held that since the payment for IUCs is neither FTS nor royalty and does not accrue or arise in India, the assessee is not liable to deduct tax under Section 195. Consequently, the assessee cannot be treated as an assessee in default under Section 201.

Issue 4: Deemed Accrual or Arising of Income in India
The Tribunal found that the FTOs’ operations are entirely outside India, and the income does not accrue or arise in India. Even if there is a business connection, no part of the income is attributable to operations carried out in India. Therefore, the payment cannot be deemed to accrue or arise in India under Section 9(1) read with Section 5(2).

Issue 5: Override of Section 206AA by DTAAs and Retrospective Applicability
The Tribunal held that Section 206AA cannot override the beneficial provisions of DTAAs, as per the decision in DDIT (IT-II), Pune vs. Serum Institute of India Ltd. It also held that Section 206AA does not apply retrospectively.

Issue 6: Admission of Additional Evidence under Rule 46A
The Tribunal upheld the CIT(A)’s decision to admit additional evidence, noting that the assessee was not given sufficient time by the AO to furnish the required details and that the evidence was crucial for deciding the primary issues.

Issue 7: Revenue Sharing
The Tribunal did not adjudicate this issue due to the lack of sufficient details and documents on record, leaving the question open.

Conclusion:
The Tribunal allowed the assessee’s appeals and dismissed the revenue’s appeals, holding that the payment for IUCs is neither FTS nor royalty, does not accrue or arise in India, and the assessee cannot be treated as an assessee in default. It also held that Section 206AA does not override DTAAs and does not apply retrospectively, and upheld the CIT(A)’s admission of additional evidence.

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