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Income Tax Appellate Tribunal, “I” BENCH, MUMBAI
Before: SHRI PRAMOD KUMAR & SHRI PAVAN KUMAR GADALE
Appellant by : Shri.Nitesh Joshi. AR Respondent by : Shri.Milind Chavan. DR Date of Hearing 23.11.2021 Date of Pronouncement 07.12.2021 आदेश / O R D E R PER PAVAN KUMAR GADALE JM:
The assessee has filed the appeal against the order passed u/s 143(3) r.w.s 144(C)(13) of the Income Tax Act, 1961 dated 25.01.2021 passed in pursuance to the directions of the DRP order dated 09.12.2020. The assessee has raised the following grounds of appeal: Rackspace US, INC, Mumbai. Ground no. 1: Income from cloud hosting services is erroneously held as royalty within the meaning of explanation 2 to section 9(1)(vi) of the Income Tax Act, 1961 (the Act) as well as Article 12(3)(b) of the India - US tax treaty 1.1. On the facts and circumstances of the case and in law, the learned AO, pursuant to the directions of the Hon'ble DRP erred in holding that cloud hosting system is combination of hardware, software and networking elements that constitutes industrial / commercial / scientific equipment and the income of INR 3,02,37,065 earned by the Appellant from cloud hosting services is for use of or right to use industrial / commercial / scientific equipment which would constitute royalty under section 9(1)(vi) of the Act. 1.2. On the facts and circumstances of the case and in law, the learned AO, pursuant to the directions of the Hon'ble DRP, erred in holding that the income earned by the Appellant is for use of or right to use industrial / commercial / scientific equipment and constitutes royalty under Article 12(3)(b) of the India - US tax treaty. 1.3. On the facts and circumstances of the case and in law, the learned AO, pursuant to the directions of the Hon'ble DRIP, erred in holding that the definition of royalty under the Act (as retrospectively amended by Finance Act, 2012) can be applied even for the purposes of determination of royalty income under Article 12 of the India - US tax treaty in the absence of any corresponding amendment in the India US tax treaty. 1.4. On the facts and circumstances of the case and in law, the learned AO, pursuant to the directions of the Hon'ble DRP, erred in holding that the Appellant is providing license to clients for use of third party software and the income earned therefrom is also royalty under the Act as well as the India - US tax treaty. Ground no. 2: Income from cloud hosting services is also erroneously held as fees for technical services within the meaning of section 9(1)(vii) of the Act as well as fees for included services under Article 12(4)(a) of the India - US tax treaty 2.1 On the facts and circumstances of the case, the learned AO Rackspace US, INC, Mumbai. further erred in holding that the income from cloud hosting services is in the nature of Fees for Technical Services within the meaning of explanation (2) to clause (vii) of subsection (1) of section 9 of the Act. 2.2 On the facts and circumstances of the case, the Ld. AO erred in holding that the income from cloud hosting services also qualifies as fees for included services within the meaning of Article 12(4)(a) of the India-US tax treaty
The Brief facts of the case that the assessee company is incorporated in and tax resident of USA. The assessee is engaged in the business of providing cloud hosting services, data warehousing services and private cloud services etc. The assessee has filed the return of income for the A.Y 2017-18 on 30.10.2017 with a total income of Rs.3,03,57,010/- and was claimed exempt. The case was selected for scrutiny and notice u/s 143(2) and 142(1) of the Act along with questionnaire was issued. In compliance the Ld. AR of the assessee has submitted the details and the case was discussed. The assessee has filed the submissions and explained that an amount of Rs. 3,02,37,065/- received by the assessee from various Indian entities is claimed exempt and are not taxable in India. The A.O has issued show cause notice submitted that why the receipts of cloud hosting Rackspace US, INC, Mumbai. services and allied services should not be taxed as Royalty u/s 9(1)(vi) of the Act and Article 12(3) of the India-US treaty and without prejudice and alternatively why the receipts should not be taxed as a fees for technical services/included service u/s 9(1)(vii) of the Act and Article 12(4) of the India-US treaty. The assessee has made submissions vide letter dated 20.11.2019 and 16.12.2019 on the issue. The assessee has explained the various cloud posting services as cloud infrastructure as service and cloud platform as service and also cloud software. The A.O relied on the judicial decisions and dealt on the US treaty and the double taxation agreement between the two countries. Finally, the A.O is of the opinion that the receipts have to taxable in India as royalty. The assessee has brought to the knowledge of the A.O that on similar issue in the earlier assessment years the Hon’ble Tribunal has granted relief to the assessee. But the A.O. has treated the receipts as royalty u/s 9(1)(vii) read with Article 12(4) of India-US treaty taxable at 10% as per the DTTA and assessed the total income of Rs. 3,03,57,010/- and passed the Rackspace US, INC, Mumbai. draft assessment order u/s 144C of the Act dated 13.12.2019.
The assessee has filed the objections against the draft assessment order before the DRP. The DRP has dealt on the objections and the submissions of the assessee in respect of royalty and dealt on the judicial decisions and the assessee’s own case for earlier years and has directed as under:
5.1 Discussion and directions of DRP 5.1.1 We have considered the facts of the case and the submissions of the assessee in this regard. It is observed tht without prejudice to this contention tha the web hosting services are in the nature of Royalty, theAO has held that these services should be characterized as fees for technical services as per section 9(1)(vii) of the Act and Article 12 of India USA DTAA. The assessee has filed a detailed submission on merit objecting to the above findings of the ld. AO.
5.1.2 We find that this issue also came up before the DRP for AY 2010-11, 2012-13, 2013-14 , 2014-15, 2015-16 and 2016- 17 and it was held that since the payments were held to be in the nature of Royalty under section 9(1)(vi) of the Act as well as under Article 12(3) of the DTAA, the question of taxig the same receipts as Fee for Technical Services u/s 9(1)(vii) of the Act and u/s 12(4)A of the DTAA becomes infructous and hence, no direction is required to be given in this regard. Rackspace US, INC, Mumbai. 3.1 Subsequently, the A.O. has passed the final ssesmnet order u/s 143(3) r.w.s.144C(13) of the Act dated 25.01.2020 and assessed the total income of Rs.3,03,57,010/-. Aggrieved by the order, the assessee has filed an appeal before the Hon’ble Tribunal.
At the time of hearing, the Ld. AR submitted that the A.O. has erred in treating the receipts as royalty u/sec9(1)(vi) of the Act. Whereas, on the similar/ identical facts the Hon’ble Tribunal in assessee’s own case for the earlier assessment years has allowed in favour of the assesee and substantiated the submissions with the paper book and ITAT orders and prayed for allowing the appeal. Contra, the Ld. DR has relied on the lower authorities orders..
We heard the rival submissions and perused the material available on record. The sole matrix of the disputed issue is with regard to treatment of receipts as royalty u/sec9(1)(vi) of the Act r.w. Article 12(3)(b) of India-USA DTAA by the Income Tax Rackspace US, INC, Mumbai. Department. We find the Hon’ble Tribunal in assessee’s own case for the A.Y 2012-13 to 2014-15 in & 1075 & 3507/Mum/2017 dated 29-05-2019 observed at page 36 Para 10 read as under.
“10. We have heard the rival contentions and gone through the facts and circumstances of the case. We noted that as per the provisions of section 9(1)(vi) of the Act royalty is taxable in India inter alia if the payer an Indian resident, except where the royalty is payable in respect of a right, property, information or service used for the payer's business outside India or for earning income outside India. Explanation 2 to section 9(1)(vi) of the Act dealing with the definition of royalty inter alia includes payment for use or right to use an industrial, commercial or scientific equipment. Considering the fact that Rackspace USA customers only avail hosting services and do not use, possess or control the equipment used for providing hosting services (which are owned and controlled by Rackspace US), the payment for hosting services made by Indian customers to Rackspace USA does not fall within the ambit of the said definition. Finance Act, 2012 inserted an amendment in the definition of royalty whereby the definition of royalty was expanded by inserting Explanation 4, 5 and 6 to section 9(1)(vi) of the Act (with retrospective effect from I June 1976). Explanation of section 9(I)(vi) of the Act reads as under: “For the removal of doubts, it is hereby clarified that the royalty includes and has always included consideration in respect of any right, property or information, whether or not- (a) the possession or control of such right, property or information is with the payer; (b) such right, property or information is used directly by the payer; Rackspace US, INC, Mumbai. (c) the location of such right, property or information is in India.
The above amendment clarified that any payments made for the 'use of equipment would be classified as 'royalties' irrespective of the possession or control of the equipment with the payer or use by the payer or the location of the equipment being in India. But, under the provisions of section 90(2) of the Act, an assesse can opt be governed by the provisions of the tax treaty to the extent they are more beneficial than the provisions of the Act. We noted the fact that Rackspacc USA is tax resident of USA and therefore, is entitled to claim the beneficial provisions of India-USA tax Treaty with respect to the taxability of its income earned from Indian payers. The Tax Residency Certificate along with Form 10F has been submitted by the assessee vide letter dated 29.01.2015 and 13.02.2015 for the years 2011 and 2012.
We have gone through the provisions of Article 12(3) of the India USA Tax Treaty, wherein the term royalties' are defined to mean:
(a) 'payments of any kind received as a consideration for the list of or the right to Use', any copyright of literary, artistic or scientific work including cinematograph or work on ten, tape or other means of reproduction for use in connection it radio or television broadcasting, any patent, trade mark, design or model, plan secret formula or process, or for information ('concerning industrial, commercial or scientific experience including gains derived from the alienation of any such rig/it or property which are Contingent on the productivity, use, or disposition thereof; and (b) Payments of any kind received as consideration for the use, or right to use, any industrial, commercial or scientific equipment, other than payments derived by an enterprise described in paragraph 1 of Article 8 (Shipping and Air Transport) from activities described in paragraph 2(c) or 3 of Article 8” (Emphasis supplied). Rackspace US, INC, Mumbai.
As may be observed, the definition of royalty under Article 12(3) of the India-USA Tax Treaty in respect of payment for use or right to use equipment is in pari-materia with the pre- amendment definition of royalties in the Act. The said definition of “royalties” is exhaustive and not inclusive and therefore, it has to be given the meaning as contained in the Article itself and no other meaning should be looked upon.
From the above, it is clear that the services provided by Rackspace USA to that Indian customers are not covered by the above definition of ‘royalties’ provided in the India USA Tax Treaty since Rackspace USA is providing hosting services to the Indian customers and does not give any equipment or control over the equipment. The term ‘use’ or ‘right to use’ for the purpose of the tax treaty entails that the prayer has a possession/ control over the property and/ or the said property is at its disposal. There is no privilege or right granted to the Indian customers over the servers and other equipment used to provide cloud hosting services. The equipments are not used by the customers and the same are used by Rackspace USA to provide service to the customers. The services provided by the Rackspace USA are in the nature of cloud hosting, data warehousing services etc. which are standard services provided to customers. There is no agreement to hire or lease out any equipment but only a service level agreement.
In the light of the above, we are of the view that the amendments in the domestic tax law cannot be read into the tax treaty as there is no change in the definition of ‘royalties’ under the India-USA Tax Treaty. Therefore, the retrospective amendment in the royalty definition under the Act does not impact the definition of ‘royalties’ in the India-USA Tax Treaty. Further, the identical issue has been decided by the co- ordinate Bench of this Tribunal in the case of American Chemical Society vs. DCIT in for the AY 2014-15 vide order dated 30.04.2019, wherein identical issue was decided by Para 17 to 19 as under: - Rackspace US, INC, Mumbai. “17. We have heard the rival submissions and perused the relevant material on record including the order of the lower authorities on the issue in dispute. We find that issue with respect to the PUBS division coincides with the issues on the CAS fee. The journal provided by the PUBS division do not provide any information arising from assessee's previous experience. The assessee's experience lies in the creation of / maintaining such information online. By granting access to the journals, the assessee neither shares its experiences, techniques or methodology employed in evolving databases with the users, nor imparts any information relating to them. As is clearly evident from the sample agreements, all that the customers get is the right to search, view and display the articles (whether online or by taking a print) and reproducing or exploiting the same in any manner other than for personal use is strictly prohibited. Further, the customers do not get any rights to the journal or articles therein. They can only view the article in the journal that they have subscribed to and cannot amend or replicate or reproduce the journal. Thus, the customers are only able to access journal/articles for personal use of the information. No 'use or right to use' in any copyright or any other intellectual property of any kind is provided by the assessee to its customers. Furthermore, the information resides on servers outside India, to which the customers have no right or access, nor do they possess control or dominion over the servers in any way. Therefore, the question of such payments qualifying as consideration for use or right to use any equipment, whether industrial, commercial or scientific, does not arise.
18. To put a comparison, if someone purchases a book, then the consideration paid is not for the use of the copyright in the book/ article. The purchaser of a book does not acquire the right to make multiple copies for re-sale or to make derivative works of the book, i.e., the purchaser of a book does not obtain the copyright in the book. Similarly, the purchaser of the assessee's journals, articles or database access does not have the right to make copies for re-sale and does not have Rackspace US, INC, Mumbai. the right to make derivative works. In short, the purchaser has not acquired the copyright of the article or of the database. What the buyer gets is a copyrighted product, and accordingly the consideration paid is not royalty, but for purchase of a product. In the instant case too, what is acquired by the customer is a copyrighted article, copyrights of which continue to lie with assessee for all purposes. lt is a well settled law that copyrighted article is different from a copyright, and that consideration for the former, i.e. a copyrighted article does not qualify as royalties.
Thus, the principles noted by us in the earlier part of this order in the context of the income earned by way of CAS fee are squarely applicable to the subscription revenue received from customers of PUBS division for sale of journal also, and accordingly PUBS fee also does not qualify as ‘Royalty’ in terms of section 9(1)(vi) of the Act as well as Article 12(3) of the India-USA DTAA.”
From the above facts and circumstances, we are of the view that the agreement between the assessee and its customer is for providing hosting and other ancillary services to the customer and not for the use of / leasing of any equipment. The Data Centre and the Infrastructure therein is used to provide these services belong to the assessee. The customers do not have physical control or possession over the servers and right to operate and manage this infrastructure / servers vest solely with the assessee. The agreements entered into the service level agreements. The agreement is to provide hosting services simpliciter and is not for the purpose of giving the underlying equipment on higher or lease. The customer is not even aware of the specific location of the server in the Data Centre where the customer application, web mail, websites etc. In view of these facts, we are of the view that income from cloud hosting services has erroneously held as royalty within the meaning of explanation (2) to section 9(1)(vi) of the Act as well as Article 12(3)(b) of the Indo-USA DTAA by the AO and DRP. Even otherwise, there is no PE of the Rackspace US, INC, Mumbai. assessee in India and hence, no income can be taxed in India in term of Indo-US DTAA. We reverse the orders of the lower authorities and allow this issue of assessee’s appeal.
The second common issue in these appeals of assessee is as regards to the order of DRP and AO holding the income from cloud hosting services as fee for technical services within the meaning of section 9(1)(vii) of the Act as well as fee for included services under Article 12(4)(a) of the Indo-US DTAA. For this assessee has raised the following ground No. 2: - “Ground No. 2: Income from cloud hosting services is also erroneously held as fees for technical services within the meaning of section 9(1)(vii) of the Act as well as fees for included services under Article 12(4)(a) of the India-US tax treaty 2.1 On the facts and circumstances of the case, the learned AO further cmxl in holding that the income from cloud hosting services is in the nature of Fees for Technical Services within the meaning of explanation (2) to clause (vii) of subsection (1) of section 9 of the Act.
2.2 On the facts and circumstances of the case, the learned AO erred in holding that the income from cloud hosting services also qualities as fees for included services within the meaning of Ankle 12(4)(a) of the India-US tax treaty.”
As we have already decided the above issue that income from could hosting services is erroneously held as royalty, on the same reasoning, the income from cloud hosting services cannot be taxed as fee for technical services and this issue has been decided by the DRP against Revenue by holding the same as infructuous. For this Revenue is not in appeal.
We find in the present case, the A.O. has treated the receipts as royalty income and the facts are Rackspace US, INC, Mumbai. similar and identical to the Honble Tribunal decision discussed in the above paragraphs. We respectfully fallow the judicial precedence and set aside the order of the Lower authorities and direct the Assessing officer to delete the addition and allow the grounds of appeal in favour of the assessee.
In the result the appeal filed by the assessee is allowed.