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The Lowdown: No TDS Deduction On Advertising Payments To Google Says Income Tax Tribunal

The issue of taxation of International services in India is a tricky one: payments made to services delivered from outside of India’s boundaries do not generate any tax income for the Indian government, and this leads to a rather tricky situation when, in principle, services are delivered via the web to Indian companies targeting Indian citizens. Google, in particular has been facing the heat from India’s tax department over crediting of revenues to Google Ireland. On Friday, the Kolkata bench of the Income Tax Appellate Tribunal ruled that payment made by a florist company (Right Florists) were made to Google Ireland and Overture USA, and since those companies did not have any permanent establishment in India, Right Florist was under no obligation to deduct tax at source for those payments, given double taxation treaties between India and both the USA and Ireland.

What this suggests is that for payments made to Google Ireland and Overture US from India, tax needn’t be deducted at source. The taxation issue, especially where cloud computing is concerned, was raised on MediaNama by Abhishek Singh, then the Director, E Governance in the Department of Information Technology, Government of India, albeit in his personal capacity. Do read his views at Taxing the Internet economy.

Some statements from tribunal’s judgment (download it here), indicating things it considered, and how it came to its conclusion, are worth noting:

Material facts: Right Florist is a florist advertising on Google and Yahoo to generate business. They paid Rs 30,44,166 in online advertising to Google Ireland and Overture Services Inc USA (Yahoo USA), but no taxes were withheld from these payments. The income tax Assessing Officer asked the company why these payments shouldn’t be disallowed. as a deduction in computation of its income. Right Florist said that these payments were made to foreign entities, who did not have any permanent establishment in India.

– What Google gets paid for: for a technical service which involves “the use of software code” which serarches the World Wide Web for information, and generates alongside search results, sponsored search results. adserver, an expression which refers to technology and service that places advertisements on web sites.” In addition, they have an adserver which is used to embed advertisements into a web page. An ad server is a web server which stores advertisements used in online marketing.

– Pinstorm vs ITO Ruling: The judgment cites a case of Pinstorm versus ITO ruling from the Mumbai tribunal, wherein, Pinstorm hadn’t deducted tax on payments of Rs 1,09,35,108 of advertising expenditure. In this case, it was ruled that the situation was similar to that of a 2008 case of a payment by the department of tourism to Yahoo Holdings (Hong Kong) Ltd, and it was not chargeable to tax in India, because of no permanent establishment of Yahoo Holdings (Hong Kong) Ltd in India.

– Income accruing or arising in India: In the present case, the payment was not received or deemed to have been received in India. However, the tribunal tried to assess the income from the perspective of “income accruing or arising in India” and “income deemed to accrue or arise in India”, let us pick up the scope of ‘income accruing or arising in India’ first. It cites the Supreme Court of India ruling in a case involving Hyundai Heavy Industries that in order to attract taxability in India, the income must relate to such portion of income of the non-resident, as is attributable to business carried out in India, and the business so carried out in India could be “through its branches or through some other form of presence such as office, project site, factory, sales outlet etc” as “branch or through some other form of its presence in India such as office, project site, factory, sales outlet etc”. As per the tribunal, “a website per se, which is the only form of Google’s presence in India – so far as test of primary meaning i.e. basic rule PE is concerned, cannot be a permanent establishment under the domestic law.”

– Google Ireland doesn’t do business in India: “There is nothing on record do demonstrate or suggest that the online advertising revenues generated in India were supported by, serviced by or connected with any entity based in India. It is, therefore, essential to examine whether or not the online advertising services in question can be said to be technical services of the nature which can be covered by the scope of Explanation 2 to Section 9(1)(vii).”

– Website not a permanent establishment unless servers are located in India: “The interpretation of the expression ‘permanent establishment’, even in the context of tax treaties, does not , therefore, normally extend to websites unless the servers on which websites are hosted are also located in the same jurisdiction. The underlying principle is this. While website per se, which is a combination of software and electronic data, does not constitute a tangible property as it cannot have a location which constitutes place of business, a web server, on which the web site is stored and through which it is accessible, is a piece of equipment having a physical location and such location may thus constitute a “fixed place of business” of the enterprise that operates that server. A search engine, which has only its presence through
its website, cannot therefore be a permanent establishment unless its web servers are also located in the same jurisdiction. That’s not the situation here and it is not the case of the revenue that servers are located in India.

– Indian governments point of view on websites as permanent establishments: “India does not agree with the interpretation given in para 42.2; it is of the view that website may constitute a permanent establishment in certain circumstances” and “India does not agree with the interpretation given in para 42.3; it is of the view that, depending on facts, an enterprise can be considered to have acquired a place of business by virtue of hosting its website on a particular server at a particular location.”

– Google’s Advertising Services haven’t been rendered by a human: the tribunal looked at whether the services rendered – of producing sponsored results could be seen as technical services”as set out in Explanation 2 to Section 9(1)(vii)”, but then cites ‘fees for technical services’ as meaning the “rendering of any managerial, technical or consultancy services’ (citing Explanation 2 to Section 9(1)(vii), as also Article 12 (2)(b)), and that this indicates human intervention because of the way these three have been clubbed together. Since it is clear that Google’s services are rendered by machines, and, as the tribunal puts it “a machine cannot be a manager” and “A machine cannot be regarded as a consultant”.

Our Take

The “servers not in India” and “the Indian office is just a sales house” arguments have been heard in the past, largely in connection with Google India Pvt Ltd and Facebook India being sued in Indian courts over their platforms being used to spread hate speech. As we said then, these arguments lead to only one logical conclusion – that to be held liable, and to do business in India, Google and Facebook will be forced by the Government of India to set up servers in India. While there are privacy and freedom of speech concerns there, which we support, given the antecedents of the Indian government, when it comes to taxation, we feel that if business is being conducted in India, targeting Indians, then tax must be paid by Google in India; The structuring of the businesses perhaps allows the company to not pay tax in India, but while Google Ireland doesn’t have business operations in India – and correct us if we’re wrong – Google surely does, via Google India Pvt Ltd.

The current situation puts Indian businesses at a disadvantage, because their TDS is cut, while that for Google and Yahoo (Hong Kong) isn’t; the difference is also evident, as we had pointed out earlier, when it came to the treatment of payments made via international payment gateways versus Indian payment gateways. There needs to be a level playing field, and allowing these situations only unfairly creates an incentive structure for businesses to not set up operations in India. If companies are operating in India, it should be under Indian jurisdiction.

Note: this is our opinion, and we’re not experts in taxation. Contact your CA in case you want to check how it impacts you. We’ve linked to the judgment in the beginning of the post.

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