2019 (5) TMI 1724 - AT - Income Tax

Income accrued in India - Income from cloud hosting services as royalty within the meaning of explanation 2 to section 9(1)(vi) - India-USA - retrospective amendment in the royalty definition - PE in India - HELD THAT - Services provided by Rackspace USA to that Indian customers are not covered by the 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. 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. See AMERICAN CHEMICAL SOCIETY VERSUS DCIT (IT) -1 (1) (1) , MUMBAI 2019 (4) TMI 1818 - ITAT MUMBAI 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 assessee in India and hence, no income can be taxed in India in term of Indo-US DTAA. - Decided in favour of assessee Chargeability of interest under section 234B - HELD THAT - Not to charge interest under section 234B - Hon ble Bombay High court in the case of DIT(IT) vs. Ngc Network Asia LLC 2009 (1) TMI 174 - BOMBAY HIGH COURT wherein it is held that when a duty is cast on payer to deduct and pay the tax at source, on payer's failure to do so interest under section 234B of the Act cannot be imposed on payee assessee

Issues Involved:
1. Classification of income from cloud hosting services as royalty under Section 9(1)(vi) of the Income Tax Act, 1961 and Article 12(3)(b) of the India-US tax treaty.
2. Classification of income from cloud hosting services as fees for technical services under Section 9(1)(vii) of the Income Tax Act and Article 12(4)(a) of the India-US tax treaty.
3. Levy of interest under Section 234B of the Income Tax Act.

Detailed Analysis:

1. Classification of Income from Cloud Hosting Services as Royalty:
The primary issue was whether the income from cloud hosting services constituted royalty under Section 9(1)(vi) of the Income Tax Act and Article 12(3)(b) of the India-US tax treaty. The assessee argued that the cloud hosting services were not for the use of or right to use industrial, commercial, or scientific equipment, but rather for providing hosting services without granting physical control or possession of the equipment to the customers.

The Dispute Resolution Panel (DRP) held that the income from cloud hosting services was royalty, stating that the services provided involved the use of industrial, commercial, or scientific equipment, and the payments for such use constituted royalty under the Act and the India-US tax treaty. The DRP relied on the retrospective amendment by the Finance Act, 2012, which clarified that payments for the use of equipment would be considered royalty regardless of possession or control by the payer.

However, the Tribunal found that the services provided by the assessee did not grant any right to use the equipment to the customers. The Tribunal referred to the case of People Interactive (I) P Ltd., where similar services provided by the assessee were held not to constitute royalty. The Tribunal concluded that the income from cloud hosting services was erroneously classified as royalty and reversed the orders of the lower authorities.

2. Classification of Income from Cloud Hosting Services as Fees for Technical Services:
The DRP also considered whether the income from cloud hosting services could be classified as fees for technical services under Section 9(1)(vii) of the Act and Article 12(4)(a) of the India-US tax treaty. The DRP affirmed the AO's view that the income was for technical services, but this issue was not adjudicated separately as it was already held to be royalty.

The Tribunal, having already decided that the income was not royalty, also concluded that the income could not be classified as fees for technical services. The Tribunal noted that the services provided did not involve imparting any technical knowledge, experience, skill, or know-how to the customers, which is a requirement for classification as fees for technical services under the tax treaty.

3. Levy of Interest under Section 234B:
The assessee contested the levy of interest under Section 234B, arguing that when the duty to withhold tax at source is cast on the payer, interest under Section 234B cannot be imposed on the payee assessee. The Tribunal agreed with the assessee, citing the decision of the Bombay High Court in the case of DIT(IT) vs. NGC Network Asia LLC, which held that no interest under Section 234B can be imposed on the payee when the payer fails to deduct tax at source.

Conclusion:
The Tribunal allowed the assessee's appeals, holding that:
1. The income from cloud hosting services was not royalty under Section 9(1)(vi) of the Income Tax Act or Article 12(3)(b) of the India-US tax treaty.
2. The income from cloud hosting services was not fees for technical services under Section 9(1)(vii) of the Act or Article 12(4)(a) of the India-US tax treaty.
3. Interest under Section 234B of the Income Tax Act could not be levied on the assessee due to the payer's failure to deduct tax at source.

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