Nothing comes free when you carry out a transaction, there is always one or the other kind of tax that you have to pay. In today’s world where boundaries are continuously getting blurred owing to the technological marvels, transactions hitherto impossible are being carried out quite easily and with great flair. While the impossibles are being made possible on a daily basis, one must consider that such possibilities also have their own price tags attached. The matter of taxation vis-a-vis technology is of utmost importance, especially owing to the complex nature of technological activities. One such issue in the field of taxation is that whether ‘data processing charges’ are taxable as ‘royalty’ under the Income Tax Act. Especially given the large number of commercial transactions involving data processing that take place between organizations based in India and abroad by way of outsourcing, the matter of taxing data processing charges as ‘royalty’ becomes especially important. In case the tax laws of the foreign countries also provide for such taxation, will the Indian laws impose a further burden? Or can there be anything like a Double Tax Avoidance Agreement (DTAA) between India and such countries that can lessen such burdens of taxation of data processing charges? Since a large amount of data processing transactions happen between India and Singapore in terms of outsourcing, perhaps a look at the India-Singapore Double Taxation Avoidance Agreement’s position on this taxation of data processing charges as royalty won’t be amiss either. In order to determine this, however, we must first understand what data processing is and secondly, what royalty is.
These days many organisations require data processing and to cater to their needs, there are several service providers too offering this service. Data processing in simple terms would mean the sorting of data. For example, suppose if you are given information about a thousand random individuals, what they do, their salary, educational qualification, individual performance and so on, you may not be able to gauge all that information properly, but suppose you are given this information in a proper order, all information properly arranged, properly sorted out in tabular or other formats in a comparable manner, then it would be far more easy for you to read, understand and remember those information. So this sorting of data is very important for every organisation in its day-to-day work.
For this purposes many organisations have a separate department, while others may outsource this work. Nowadays computer software play a key role getting this work done.(Remember the complexities of technology)
Royalty simply means the fee you pay to someone else for using his resources. For example, if I am a music radio station owner, I may play hindi music songs composed by music composers. Now for playing those songs on my radio channel, I will have to pay certain amounts of money to those composers or to the copyright owners of such songs. This amount of money that I pay to them would be the royalty. Similarly, I may use other resources and pay royalty for them. In the field of taxation, royalty includes, among other things, (as per the Income Tax Act, 1961)
Any consideration paid for the transfer of all or any rights (including the granting of a license) in respect of a patent, invention, model, design, secret formula, process, trademark or similar property or their use, or for the use of any industrial, commercial or scientific equipment as well as the consideration paid in rendering services connected to the above. (For details please see the Income Tax Act, 1961)
Now we move further into our issue, which is deducing whether the data processing charges can be taxed as royalty, but let us keep ourselves limited to the Income Tax Act, 1961 and the India-Singapore DTAA, as stated in the beginning. Another reason why that DTAA is of relevance is the recent ruling by the ITAT Mumbai on this point. The case was the Standard Chartered bank (Taxpayer) (ITAT No. 3827/MUM/2006). It is by way of an analysis of this judgment that I will reveal the latest position in Indian tax laws on the taxability of data processing charges.
Following is a brief summary of the facts of the case for the readers’ benefit:
Standard Chartered is a non-resident company doing business of Banking in India. A non-resident company is the one that is incorporated in a foreign country but has a place of business in India. They entered into an agreement with SPL, a Singapore company. As per the agreement, SPL was providing them with data processing support and disk storage capacity in its data centre at Singapore for their exclusive use.
The Tax Authority said that the payment by Standard Chartered to SPL were ‘royalty’ under the Income Tax Act as well as the India-Singapore DTAA and hence taxable. The tax authority said that
● Processing of raw data by SPL by using its computers was a ‘process’
● SPL made available CPU and disk capacity of Standard Chartered and hence there was a use of ‘scientific equipment’
Decision by the Income Tax Appellate Tribunal (ITAT): Data Processing Charges not Royalty
The ITAT replied to the issues of process and use of scientific equipment in the following manner.
It said that for process to qualify as royalty, it is necessary that there is an actual use or a right to use it. However, in this case, Standard Chartered had no real access or control. It also said that the software, which was embedded in the mainframe computer that processed all the data, was not actually accessible to Standard Chartered. What Standard Chartered only got was the processed data and nothing else. So, since there was no actual control over the processing and no physical control, there was no ‘royalty’ and hence the data processing charges cannot be taxed under such head.
Further, with reference to ‘use of scientific equipment’, the ITAT said for the ‘use the equipment’ to happen;
● The customer must come face to face with the equipment, which was not the case here since Standard Chartered was given a space on hardware and network which was owned by SPL. There may be several other entities that may have a space in its data storage capacity; this does not mean that they were all the owner of it. (This is in fact a very pertinent ground on which other organizations can escape liability too, since it seldom happens in technological outsourcing transactions that the client is given the ownership of the entire hardware and network by the service provider)
● The customer must have possession (actual or constructive) but in this case, Standard Chartered was only earmarked a space on an equipment (the data storage capacity, which may be a server or a memory storage device) and hence there was no possession of the equipment. Also, Standard Chartered only paid for the storage space and not for the whole equipment.
Also, it is worth mentioning here certain criteria (specified by OECD) in order to determine whether a given transaction is that of ‘use of equipment’ and were also referred to in this case.
1. Customer must be in physical possession or control or significant economic/possessory interest in the property; here standard chartered was nowhere near to any interest or possession. What Standard Chartered was really concerned was that it got the processed data on time. Hence, this criterion is also not satisfied in the present case.
2. Risk of substantially diminished receipts or increased expenditures on account of non- performance under a contract are not borne by the provider; here if there was non-performance by SPL, the cost would also have been borne by SPL and Standard Chartered would definitely have demanded that SPL ought to pay the same and hence this criteria also remains unsatisfied.
There are also other criteria prescribed by OECD, including a clarification that data warehousing services will not give rise to use of equipment, but since the above two are not satisfied, the ITAT did not discuss them and held that in the present matter, the transaction does not consist of any ‘use of equipment’ and hence the charge concerned cannot be taxed as “royalty” either under the Income Tax Act, nor does it fall within the purview of the India-Singapore DTAA under such head.
So in short, what can be laid down is that there cannot be any royalty charges if there is a use of a facility and control over such facility by the user. In order to consider a payment as royalty, there must be a positive act of use or possession or use of that property or equipment and if it is a case of ‘process’ that it is very necessary that there is real access to the whole process rather than just the end result. Mere data processing charge cannot be taxed as royalty, something which should provide a relief to companies such as Standard Chartered involved in data process outsourcing.