Recurring payments for leased circuit services not royalties under Article 12(3)/Explanation 2(iv)(a) to s.9(1); PE issue reserved

AAR held that recurring payments to the non-resident for leased circuit services are not royalties under Article 12(3) or Explanation 2(iv)(a) to s.9(1) because "use" of equipment requires positive utilization and the customer merely uses the facility, not the equipment. Payments also do not qualify as "fee for included services" under Article 12(4) since no technology is made available enabling the recipient to apply it. The question of permanent establishment was left open for the appropriate authority due to lack of facts. If a PE is found, only the profit attributable to it should be taxed; refunds of tax withheld under s.195 can be claimed in due course.

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Issues Involved:
1. Nature of payments under the agreement (whether "fees for included services" or "royalty").
2. Applicability of "fees for technical services" and "royalty" definitions under the Income-tax Act, 1961.
3. Applicability of exception under section 9(1)(vi)(b) or 9(1)(vii)(b) of the Income-tax Act.
4. Obligation to withhold taxes under section 195 of the Income-tax Act.
5. Existence of Permanent Establishment (PE) in India.

Detailed Analysis:

1. Nature of Payments:
The applicant, Dell International Services (India) Pvt. Ltd., sought to determine whether the payments made to BT America (BTA) for bandwidth services could be classified as "fees for included services" under Article 12 of the Indo-US Double Taxation Avoidance Agreement (DTAA). The ruling concluded that the payments are not "fees for included services" as BTA did not transfer any technical knowledge or skill to the applicant, which is a requirement under Article 12(4) of the Treaty.

2. Royalty:
The core questions addressed were whether the payments qualify as "royalty" under Article 12(3) of the Treaty and Explanation 2 to clause (vi) of section 9(1) of the Income-tax Act, 1961. The ruling determined that the payments did not constitute "royalty" because:
- The agreement did not involve the use or right to use any equipment by the applicant.
- The applicant did not have possession or control over any equipment provided by BTA.
- The recurring charges were for the service of providing bandwidth, not for the use of equipment.

3. Fees for Technical Services:
The ruling stated that the payments were not "fees for technical services" under Explanation 2 to clause (vii) of section 9(1) of the Income-tax Act, 1961, as there was no transfer of technical knowledge or skill enabling the applicant to apply the technology independently.

4. Exception under Section 9(1)(vi)(b) or 9(1)(vii)(b):
The applicant argued that the payments should be exempt under the exception provided in section 9(1)(vi)(b) or 9(1)(vii)(b) of the Income-tax Act, which applies if the payment is for earning income from a source outside India. The ruling rejected this argument, stating that the source of income from the applicant's activities (data processing and IT support) is within India, even though the end customers are located abroad.

5. Withholding Taxes under Section 195:
The ruling addressed the applicant's obligation to withhold taxes on payments made to BTA under section 195 of the Income-tax Act. The ruling emphasized that the applicant must comply with section 195A if the tax is to be borne by the applicant, implying that the income must be grossed up for tax deduction purposes. However, the determination of the existence of a Permanent Establishment (PE) in India was left open, affecting the final obligation to withhold taxes.

6. Permanent Establishment (PE):
The ruling did not provide a conclusive determination on the existence of a PE for BTA in India due to insufficient information. The applicant was advised to seek a determination from the appropriate authority under the Income-tax Act, keeping in view the observations made in the ruling.

Ruling Summary:
1. Question 1: Payments are not "fees for included services" under Article 12 of the Treaty.
2. Questions 2 & 4: Payments are not "royalty" under Article 12 of the Treaty or Explanation 2 to clause (vi) of section 9(1) of the Income-tax Act.
3. Question 3: Not addressed due to the answer to Question 1.
4. Question 5: Exception under section 9(1)(vi)(b) or 9(1)(vii)(b) cannot be invoked by the applicant.
5. Question 7: The issue of PE is left open for determination by the appropriate authority.
6. Questions 6 & 8: The applicant should approach the appropriate authority for a determination on the obligation to withhold taxes, considering the observations in this ruling.

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