2025 (4) TMI 1131 - AT - Income Tax

Non-resident service fees qualify as technical services but escape tax due to unmet knowledge transfer requirements under India-USA treaty

ITAT Delhi held that service fees received by non-resident from Indian affiliate constituted Fees for Technical Services under Section 9(1)(vii) and ... Income chargeable to tax in India or not - Service fees received from Indian affiliate constitute 'Fees for Technical Services' (FTS) taxable in India u/s 9(1)(vii) and Article 12 of the India-USA DTAA - meaning of the phrase ‘make available’ - HELD THAT:- Section 5(2) of the Act provides that the income of a non- resident tax payer can be taxed in India if it is received or is deemed to be received in India or accrues or arises in India. Section 9(1)(vii) of the Act provides that income by way of FTS payable by any resident assessee of India shall be deemed to accrue and arise in India in the hands of non- resident assessee. In view of the above decision in the case of IMG [2024 (7) TMI 287 - DELHI HIGH COURT], we analyze the facts that whether the service rendered by the assessee fall under the head FTS. Counsel did not bring any material on the record to contradict the finding of the AO that ‘the service provider (the assessee) is using the human resource with technical experience and expertise. The nature of service provided by the service provider (the assessee) are not limited to the general and administrative services as contended by the assessee. This suggests that the service provided by the assessee are technical in nature within the meaning of Section 9(1)(vii). By plain reading of the Article-3 of the above mentioned service agreement, the prima-facie inference emerged is that the services rendered by the assessee to the Crocs India are not purely general in nature as evident from this Article that the services had been provided by the competent technical expertise and qualified professionals. Thus, this Article buttresses the AO’s inference that the service provided by the assessee are technical in nature within the meaning of Section 9(1)(vii). We are of the considered opinion that the services rendered by the assessee to the Crocs India are in the nature of FTS. Whether the ‘make available’ condition can be said to have been satisfied? - FTS with “make available” clause restricts the interpretation of what would fall within the meaning of FTS. It is not just technical knowledge being transferred but also the recipient being able to utilise the same without any assistance from the service provider; i.e. the assessee. Section 90(2) of the Act along with well-settled jurisprudence allows assessee’s to take the Act or the DTAA whichever is beneficial to them. In the present case the assessee has preferred DTAA over the Act. Given this background, we now look at Section 9(1)(vii) of the Act and then the DTAA’s with the make available clause interpretation of Section 9(1)(vii) of the Act. Here, in the present case, the contract in the matter was only for provision of services and not for supply of technical designs or plans. The assessee has not made available the technical knowledge and its expertise to the Crocs India. Several judicial decisions have clearly outlined the ambit of the “make available”. The Hon’ble Delhi High Court in the case of IMG [2024 (7) TMI 287 - DELHI HIGH COURT] has held that the real test for “make available” clause is to ascertain that whether the recipient of service has absorbed the skills and expertise of the service provider and have the capability to deploy that knowledge or skill without reference to the original service provider. The transfer of capabilities and not just temporary use of the provider’s knowledge, skill or expertise was held to be the decisive factor for satisfaction of ‘make available’ clause. The impugned assessment order has not mentioned any fact, which may demonstrate that the condition of “make available” clause gets satisfied. Applying the above tests to the facts of the case at hand, we find that there was no expertise, skill or know-how which could be said to have been made available by the assessee to the Crocs India, inasmuch as various services provided by the assessee were absorbed by the Crocs India to enable or equip it with the special knowledge underlying the service provided. The relatively long tenure of 15 years of the agreement weighed in favour of the assessee that it was not a case of transfer of knowledge or skill to the Crocs India. Thus, we held that the condition of “make available” is not fulfilled in the present case. Therefore, the service charges received by the assessee from Crocs India, though FTS, is not chargeable to tax as per the India-US DTAA. We therefore, delete the income. Appeal of the assessee is allowed The core legal questions considered in this appeal revolve around the taxability of service fees received by a non-resident company from its Indian affiliate under the Income Tax Act, 1961, and the India-USA Double Tax Avoidance Agreement (DTAA). Specifically, the issues include:1. Whether the assessment proceedings are valid, particularly concerning the issuance of notice under section 143(2) by the Assistant Commissioner of Income Tax, National e-Assessment Centre, and the directions issued by the Dispute Resolution Panel (DRP).2. Whether the service fees received by the appellant from its Indian affiliate constitute 'Fees for Technical Services' (FTS) taxable in India under section 9(1)(vii) of the Act and Article 12 of the India-USA DTAA.3. Whether the services rendered by the appellant are technical in nature and satisfy the 'make available' clause under the DTAA, which is essential for taxing FTS in India.4. The correctness of the Assessing Officer's (AO) computation of total income and allowance of Tax Deducted at Source (TDS) credit.5. The validity of charging interest under sections 234B and 234D and initiation of penalty proceedings under section 270A.Issue-wise Detailed AnalysisValidity of Assessment Proceedings and DRP DirectionsThe appellant challenged the validity of the notice issued under section 143(2) by the National e-Assessment Centre and the directions issued by the DRP under section 144C(5), contending non-compliance with procedural requirements, including the absence of a mandatory computer-generated Document Identification Number (DIN) on DRP directions. However, these additional grounds were not pressed before the Tribunal and were dismissed accordingly. The Tribunal observed that grounds 1 and 3, being general in nature, and grounds 6 and 7, being consequential or premature, did not require specific adjudication. The AO was directed to allow the full TDS credit claimed by the appellant after proper verification.Taxability of Service Fees as Fees for Technical Services (FTS)The appellant, a US-incorporated company engaged in designing, developing, and marketing footwear and accessories, rendered services to its Indian affiliate under a Service Agreement dated January 1, 2009. The appellant filed a nil income tax return for AY 2019-20, claiming exemption under Article 12 of the India-USA DTAA, asserting that the services rendered were general administrative and support services, not technical services.The AO initially held that the receipts from Crocs India amounting to INR 137,478,148 constituted FTS and were taxable in India. The DRP, upon reviewing the draft order, noted that the AO had passed the draft order without proper factual analysis or consideration of the appellant's submissions. The DRP directed the AO to consider all submissions, including taxability under sections 5(2) and 9(1)(iii) of the Act, provisions of the DTAA, the nature of services, and relevant judicial precedents, and to pass a reasoned and speaking order.Subsequently, the AO passed the final assessment order determining income at INR 77,311,738, still treating the receipts as FTS taxable in India.Relevant Legal Framework and PrecedentsSection 5(2) of the Act provides that income of a non-resident is taxable in India if it is received or deemed to be received in India or accrues or arises in India. Section 9(1)(vii) deems income by way of FTS payable by a resident to a non-resident to accrue or arise in India. Explanation 2 to section 9(1)(vii) defines FTS as consideration for managerial, technical, or consultancy services, excluding construction or project-related services and salary income.Article 12 of the India-USA DTAA defines 'fees for included services' as payments for technical or consultancy services that either (a) are ancillary and subsidiary to the application or enjoyment of rights or information for which royalties are paid, or (b) make available technical knowledge, experience, skill, know-how, or processes, or consist of development and transfer of technical plans or designs. The 'make available' condition is crucial for taxability.Judicial precedents relied upon include decisions emphasizing the necessity of the 'make available' clause for FTS to be taxable under the DTAA, notably the recent decision of the Delhi High Court in International Management Group (IMG) (UK), which clarified that mere provision of technical or consultancy services is insufficient; the services must enable the recipient to apply the technical knowledge independently without further assistance from the provider.Court's Interpretation and ReasoningThe Tribunal examined the nature of services rendered by the appellant to Crocs India, which included planning, distribution, logistics, customs compliance, corporate tax, treasury, shared services, legal, accounting, HR, operations finance, business intelligence, IT, and insurance coverage. The appellant charged a 5% markup over actual costs for these services.The Tribunal noted that the service agreement explicitly stated that the appellant possessed qualified personnel with administrative, business, and technical expertise to perform the services professionally and competently. This fact supported the AO's finding that the services were technical in nature within the meaning of section 9(1)(vii).However, the critical issue was whether the 'make available' condition was satisfied. The Tribunal emphasized that the 'make available' clause requires that the recipient be equipped to use the technical knowledge or skill independently without further assistance from the service provider. The appellant contended that the services were general administrative and support services, not technical, and did not enable Crocs India to perform these functions independently.The Tribunal relied on the IMG decision, which held that the 'make available' test is met only if the recipient absorbs the skills and expertise and can deploy them without reference to the original service provider. The Tribunal found no evidence in the assessment order or on record demonstrating that the appellant made available any technical knowledge, skill, or know-how to Crocs India that would enable independent use.The long-standing nature of the service agreement (over 15 years) and continuous payments by Crocs India suggested that the services were ongoing and not a one-time transfer of technical knowledge or plans. The services were customized and core to the appellant's business but did not satisfy the 'make available' requirement.Application of Law to Facts and Treatment of Competing ArgumentsThe appellant's reliance on the DTAA's 'make available' clause and supporting judicial precedents was accepted. The Tribunal distinguished the AO's reliance on Mahindra & Mahindra Ltd. and Foster Wheeler France S.A. cases, noting that those involved different facts and treaties without the 'make available' clause applicable in the India-USA DTAA.The Revenue's contention that administrative support services fall under technical services was countered by the Tribunal's analysis of the DTAA and authoritative commentaries, which clarify that only services involving specialized knowledge, skill, or expertise that are made available to the recipient qualify as FTS.The Tribunal also considered the authoritative UN Model Convention commentary and scholarly analysis, which emphasize that technical services must involve the application or transfer of specialized knowledge or skill and exclude routine or ancillary services.ConclusionsThe Tribunal concluded that while the services rendered by the appellant were technical or managerial in nature, the 'make available' condition under Article 12(4)(b) of the India-USA DTAA was not satisfied. Therefore, the receipts from Crocs India, though characterized as FTS, were not taxable in India under the DTAA.The Tribunal allowed the appeal, deleting the income of INR 77,311,738 from the appellant's taxable income in India. It also directed the AO to allow the full TDS credit claimed by the appellant after proper verification.Significant HoldingsThe Tribunal preserved the following crucial legal reasoning verbatim from the IMG decision and other authoritative sources:'The mere rendition of technical or consultancy service would not lead to revenue, income or profits being placed under the broad head of FTS unless the taxing authority additionally finds that technical knowledge, skill, know-how or processes were made available. What we seek to emphasize is the impetrative of the 'make available' condition being met and the imperative of the knowledge, skill, know how being made available to the payer.''The real test for 'make available' clause is to ascertain that whether the recipient of service has absorbed the skills and expertise of the service provider and have the capability to deploy that knowledge or skill without reference to the original service provider. The transfer of capabilities and not just temporary use of the provider's knowledge, skill or expertise was held to be the decisive factor for satisfaction of 'make available' clause.''The services rendered were tailor made and were core work of the assessee. Therefore, the same cannot be termed as ancillary services.''The services had been customized to cater to the specific needs of the service recipient; Crocs India and the same were not made available globally to each service recipient.'Core principles established include:The taxability of fees for technical services under the India-USA DTAA depends not only on the nature of services rendered but critically on whether the services 'make available' technical knowledge, skill, or know-how to the recipient.General administrative and support services, even if technical or managerial in nature, do not constitute taxable FTS unless they satisfy the 'make available' test.The 'make available' test requires the recipient to be equipped to independently apply the technical knowledge or skill without assistance from the service provider.Continuous, ongoing service arrangements without transfer of independent capability do not satisfy the 'make available' condition.Procedural compliance in assessment proceedings, including issuance of notices and DRP directions, must be adhered to, but non-pressed procedural grounds may be dismissed.Final determinations on the key issues were:The assessment proceedings were valid as the procedural objections were not pressed.The service fees received by the appellant were technical or managerial services but did not satisfy the 'make available' clause under the DTAA.The income assessed by the AO as FTS taxable in India was deleted.The appellant was entitled to full TDS credit subject to verification.Interest and penalty proceedings raised were dismissed as premature or consequential.