The Hindu Business Line : Withholding tax on Web-hosting payments?

The Delhi Tribunal, in the Millennium Infocom case, had the occasion to consider the withholding tax liability of an Indian company on payment of rentals to a US company for using the latter’s servers to host Web sites.

Sanjay Kapadia
Nikhil Rohera

Withholding tax on cross-border payments, especially in e-commerce, has always been a matter of complex analysis. This is not only because e-commerce is an evolving field but also because cross-border payments have to be, first, characterised appropriately as business income, royalty, technical service or the like before any withholding tax liability can be ascertained.

The Delhi Tribunal, in the Millennium Infocom Technologies Ltd (21 SOT 152) case, had the occasion to consider the withholding tax liability of an Indian company on payment of rentals to a US company for using the latter’s servers for hosting Web sites.

The Tribunal held that the assessee Indian company was not liable to withhold tax on such payments to the US company having regard to the provisions of Section 195 read with Section 9(1)(vi) of the Income-Tax Act, 1961. Consequently, it held that such lease rentals cannot be disallowed in the hands of the assessee Indian company under the penal provisions of Section 40(a)(i) of the I-T Act.

It is interesting to note that the year under appeal before the Tribunal was assessment year (AY) 2001-02 during which both Section 9(1)(vi), which deals with “royalty”, and Section 40(a)(i), dealing with disallowance of certain payments, were narrower in scope.

Royalty redefined

The Finance Act 2001 amended the definition of royalty w.e.f. AY 2002-03 to include therein payments for the use of, or right to use, any industrial, commercial or scientific equipment. Similarly, Section 40(a) was widened subsequently by insertion of sub-clause (ia) which now provides for disallowance even with respect to payments to residents in the event of non-withholding of tax.

The key contention of the assessee before the Tribunal was that payment of lease rentals was not covered by the definition of royalty as it stood in AY 2001-02. The Tribunal concurred with this view and observed that none of the clauses of the definition of royalty took into ambit the consideration for using space on the server to host Web sites.

A similar view was also taken by the Chennai Tribunal in the Raj Television (unreported) case and the Delhi Tribunal in the PanAmsat International (103 TTJ 861) case wherein, with respect to payments of satellite transponder charges, it was held that the same does not fall within the definition of royalty as it stood prior to its amendment.

Further, relying on the Madras High Court decision in the Skycell Communication Ltd (251 ITR 53) case, the Tribunal rightly held that such payments also do not result in the provision of any technical service to the assessee.

In other words, the rental income in the hands of the US company was held to be not chargeable to tax in India under the provisions of Section 9(1) of the I-T Act.

Bias against non-residents

The Tribunal also drew support from Article 26 of the India-US Tax Treaty (Treaty) which deals with “non-discrimination” and held that if the disallowance provisions of Section 40(a)(i) are to be applied for payments only to non-residents, it would amount to a discrimination against the non-residents.

Thus, a non-resident (payer) left with a choice of dealing with either a resident or a non-resident in business would opt to deal with a resident owing to Section 40(a)(i). Accordingly, the Tribunal upheld the assessee’s contention that it should be allowed the deduction of lease rentals on the same condition as if the payment was to be made to a resident having regard to the provisions of Article 26 of the Treaty read with Section 40(a)(i) of the I-T Act as it stood in AY 2001-02. In arriving at this conclusion, the Delhi Tribunal followed its own decision in the Herbalife International India Ltd (101 ITD 450) case wherein similar views were expressed.

Pre-clearance requirement

Having concluded that the US company is not liable to tax in India, the Tribunal made an important finding that the assessee was not bound to obtain a pre-clearance from the tax office under Section 195(2), since, under the new procedure such task has been entrusted to chartered accountants subject, of course, to furnishing of a prescribed undertaking by the assessee-payer.

Therefore, the decision of the Supreme Court in the Transmission Corporation of Andhra Pradesh Ltd (239 ITR 587) case cannot be interpreted to mean that an assessee is bound to make an application to the assessing officer (AO) under Section 195(2) even where the sum is not chargeable to tax in the hands of the recipient. It is also worthwhile to note that, although, the assessment year in question before the Tribunal was AY 2001-02, the Tribunal did remark that the payment for use of space in servers is, indeed, in the nature of royalty post its amendment. However, since the amendment was brought about only from AY 2002-03 and onwards, the Tribunal held it to be falling outside the definition of royalty.

Year of appeal

It appears that such observation of the Tribunal is an obiter dictum (passing remark) and, therefore, should be viewed only in that light. In this regard, one must bear in mind the judicial principle laid down by the apex court in the Murlidhar Bhagwan Das (52 ITR 335) case that the power of a Tribunal ought to be restricted to the year under appeal. Therefore, strictly speaking, an obiter dictum relevant to other years ought not to be regarded as a binding precedent for such years.

Be that as it may, it seems that the Tribunal also did not consider the report of the Technical Advisory Group of the OECD which, on the contrary, categorises Web-hosting payments as ‘business profits’ and not royalty. This is for the reason that in such arrangements, the customer, usually, does not have possession or control over the equipment concerned and utilises it concurrently with other customers.

In sum, it must be appreciated that the Delhi Tribunal rightly allowed the deduction to the assessee and this decision will certainly come as a relief to several assessees who may have entered into similar transactions prior to AY 2002-03.

The Tribunal also neatly explained the Supreme Court’s decision in A P Transmission case which will provide the much-needed clarity to the assessees on their obligation to approach the tax office for a withholding tax certificate, or, in the alternative, to obtain a chartered accountant’s certificate if the remittance is not taxable in India.

Having said that, the legal sanctity of the obiter dictum could be questioned and may give rise to litigation going forward. As such, one would need to take a holistic view in the matter before taking any decision on taxability of similar payments post the amendments.

(The authors are Executive Director and Associate Director, respectively, PricewaterhouseCoopers. Responses to blfeedback@thehindu.co.in)

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