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BEFORE THE HON’BLE INCOME TAX APPELLATE TRIBUNAL, BANGALORE

SPECIAL BENCH

ITA No.99/Blr/2010

Assessment Year 2005-06

In The Matter of:

Income Tax Officer………………………...……Appellant

Bangalore (Cross Appeal)

Versus

ABC Advertising Limited, LLC……………….Respondent

Delaware

ON SUBMISSION TO THE HON’BLE INCOME TAX APPELLATE TRIBUNAL, BANGALORE

MEMORIAL FILED ON BEHALF OF APPELLANT

TABLE OF CONTENTS

INDEX OF AUTHORITIES......................................................................................3

STATUTES REFERRED................................................................................3

INTERNATIONAL AUTHORITIES……………….………………………3

CASES REFERRED........................................................................................3

BOOKS REFERRED………………………………………………………...4

LIST OF ABBREVIATIONS......................................................................................5

FORM NO.36………………………………………………………………………....6

STATEMENT OF JURISDICTION..........................................................................8

SYNOPSIS OF FACTS...............................................................................................9

STATEMENT OF ISSUES........................................................................................10

SUMMARY OF ARGUMENTS................................................................................11

BODY OF ARGUMENTS…………………………………………………………..12

I.THAT THE ASSESSEE IS NOT ENTITLED TO THE INDIA-US DTAA BY VIRTUE

OF THE LIMITATION OF BENEFITS CLAUSE UNDER ART.24 OF THE TREATY…………12

II. THE INCOME OF THE ASSESSEE FALLS UNDER THE DEFINITION OF ROYALTY

UNDER THE ACT AS WELL AS THE TREATY…………………………………………………..14

III. THAT THE INCOME MAY ALSO BE TREATED AS FEES FOR INCLUDED

SERVICES AS UNDER THE ACT AND ALSO THE TREATY…………………………………..18

IV. THAT THE ASSESSEE HAS A PERMANENT ESTABLISHMENT IN INDIA AND

THE CIT(A) OUGHT TO HAVE ENHANCED THE TAX LEVY……………………………….20

V. THAT THERE IS BUSINESS CONNECTION OF THE ASSESSEE AS UNDER

SECTION 9(1)(i) AS THE SOURCE OF INCOME IS FROM INDIA…………………………….22

PRAYER......................................................................................................................25

INDEX OF AUTHORITIES

Statutes Referred

Income tax Act, 196

Finance Act,1976

Finance Act, 2007

Income Tax Rules, 1962

Foreign Exchange Management Act, 1999

International Authorities

India-USA Double Taxation Avoidance Agreement

India-Australia Double Taxation Avoidance Agreement

India-Netherlands Double Taxation Avoidance Agreement

India-Mauritius Double Taxation Avoidance Agreement

Cases Referred

Asia Satellite Telecommunications Co. Ltd. Vs. Deputy CIT [2003]85 ITD 478(Delhi)………………………………………………………………………………. 15,16,18,19,23

Asianet Communications Ltd. Vs. Dy. CIT (2010) 001 ITR ITAT (Chennai) 686…………….16

Bank of Chettinad Ltd v CIT [1940] 8 ITR 522……………………………………………………24

ITO v. Shriram Bearings Ltd.(1997)224 ITR 724(SC)……………………………………………23

CAg IT Vs.Bhattadiripad [1972]83 ITR 453(SC)………………………………………………….13

CIT v Hindustan Shipyard Ltd. [1977] 109 ITR 158, 170 (AP) …………………………………23

CIT v. Sun Engineering Works (P) Ltd. 1992198 ITR 297 (SC)…………………………………15

CIT v. Dhanalakshmi Mills Ltd [2002]124 TAXMAN 173(Mad)…………………..……………12

CIT(AP) Vs. Visakhapatnam Port Trust [1983]144 ITR 146(AP)………………………………22

CIT Vs. Kanpur Coal Syndicate (1964) 53 ITR 225 SC …………………………………………22

Ishikawajma-Harima Heavy Industries Ltd. Vs. DIT Mumbai [2007]288 ITR 408(SC)….…20

Maruti Udyog Ltd. v. ITAT (2001) 252 ITR 482 (Del)……………………………………………12

NTPC Ltd Vs. CIT [1998] 229 ITR 383 SC……………………………………………………..…12

New Skies Satellites Vs. Assistant DIT(Int’l Taxation) [2009]319 ITR 269(Delhi ITAT)..15,17

Shin Satellite Public Company Limited Vs. Dy. DIT [2009]319 ITR 269(Delhi ITAT) ……..17

Skycell Communication Ltd Vs. Dy. CIT [2001]251 ITR 53(Mad)…………………………….19

Union of India vs. Azadi Bachao Andolan 263 ITR 706 SC ………………………...................12

Other Authorities

Oxford Concise English Dictionary

Black's Law Dictionary

Johnson's Dictionary

LIST OF ABBREVIATIONS

Hon’ble ..............................................................................................................Honourable

Art...............................................................................................................................Article

V.................................................................................................................................Versus

HC ......................................................................................................................High Court

SC ................................................................................................................Supreme Court

AIR...........................................................................................................All India Reporter

SCC ....................................................................................................Supreme Court Cases

ITR…………………………………………………………………..Income Tax Reporter

Treaty………………………………………………………..India-USA Double Taxation Avoidance Agreement

DTAA…………………………………………………………Double Taxation Avoidance Agreement

DTAC…………………………………………………………Double Taxation Avoidance Convention

the Act………………………………………………………………..Income Tax Act,1961

ITO……………………………………………………………………..Income tax Officer

CIT(A)………………………………………………..Commissioner of Income Tax(Appeals)

US/ USA…………………………………………………………….United States of America

MoU………………………………………………………….Memorandum of Understanding

A Y………………………………………………………………………Assessment Year

FORM NO.36

(SEE INCOME TAX RULE 47(1))

Form of appeal to the Appellate Tribunal

In the Income Tax Appellate Tribunal Bangalore Special Bench

Appeal no. 99/Blr/2010

Income Tax Officer Versus ABC Advertising Ltd LLC

Company Circle, Bangalore Delaware, USA

Appellant Respondent

1. The State in which the assessment was made: Karnataka

2. Section under which the order appealed Section 250 of the Income Tax

against was passed: Act

3. Assessment year in connection with which

appeal is preferred: 2005-06

3A.Total income declared by the assessee for

the assessment year referred to in item 3: NIL

3B. Total income as computed by the A.O.

for the A/Y referred to in item 3: Rs.10,00,00,000/-

4. The Assessing Officer passing the original order: ITO, Bangalore

5. Section of the Income Tax Act,1961 under

which the Assessing Officer passed the order: Section 143 of the Income Tax Act

6. The Deputy Commissioner (A), Commissioner (A)

passing the order under Section 154/250/271/271A/272-A: The Commissioner of Income Tax

Appeals, Bangalore

7. Deputy Commissioner or the Deputy Director in

Respect of orders passed before 1-10-1998, or the

Joint Commissioner or the Joint Director passing the

Order under Section 154/272A/274(2): Not Applicable

8. The Chief Commissioner or Director General or

Director or Commissioner, passing the order under

Sections 154(2), 250/263/271/271A/272A: Not Applicable

9. Date of Communication of the order appealed against: -----

10. Address to which notices may be sent to the Appellant: ------

11. Address to which notices may be sent to the Respondent:-----

12. Relief Claimed in Appeal: As per Memo filed

GROUNDS OF APPEAL

(AS PER ATTACHED MEMORIAL)

Signed Signed

(Authorised Representative if any) (Appellant)

VERIFICATION

I, ______, the appellant, do hereby declare that what is stated above is true to the best of my information and belief.

Verified today the ________________________ day of ___________________.

_________________

Signed

STATEMENT OF JURISDCITION

The appellant here in has approached this Hon’ble Income Tax Appellate Tribunal, Bangalore on appeal under Section 253(2) of the Income Tax Act, 1961 against the order of the Commissioner of Income Tax(Appeals) which was passed under Section 250 of the Act.

SYNOPSIS OF FACTS

I

The assessee is incorporated in Delaware, USA and is a wholly owned subsidiary of ABC Limited which is incorporated in Cayman Islands. The assessee is involved in marketing services and neither owns the satellites nor the undersea cables/servers through which the communication signals are transmitted. The assessee only enters into agreement with customers as per the laws of United States both signed and executed in the U.S., to provide the telecommunication services. The right to provide telecommunication services by the assessee is by way of lease agreements with its parent company.The assessee has a liaison office in Bangalore, India from which no effective operations occurred. It is to only monitor the effectiveness of the signals. The office has recently filed its application with the Reserve Bank of India for closing down its operations and the same is under consideration. II

The assessee company filed its return of income for the Assessment Year 2005-06 with NIL income. The ITO levied tax on the assessee’s income as royalty income at the rate of 10 percent after giving it the benefit under the treaty. On appeal to the CIT (A), there was an observation that the income of the assessee could also be taxed as business profits as it had a permanent establishment and business connection in India by way of its liaison office and certain equipments. There was no enhancement but mere confirmation of the order.

The assessee has now preferred the present appeal before the ITAT. The department also has made a cross appeal contending that the CIT(A) after having satisfied himself that the income is also liable to be taxed as business income, he ought to have either remanded the matter to the ITO for assessing the income as business income or enhanced the demand.

STATEMENT OF ISSUES

I. Whether the assessee is entitled to the benefits under Art.24 of the India –US DTAA?

II. Whether the payments received by the assessee fall under the meaning of royalty as under Section 9(1)(vi) of the Act or under Art.12(3) of the treaty?

III. Whether the assessee’s income is to be treated as fees for included services as under Section 9(1)(vii) of the Act and under Art.12(4) of the treaty?

IV. Whether there is a permanent establishment of the assessee as under Art.5 of the treaty?

V. Whether there is a business connection of the assessee under Section 9(1)(i) of the Act?

SUMMARY OF ARGUMENTS

I.THAT THE ASSESSEE IS NOT ENTITLED TO THE INDIA-US DTAA BY VIRTUE OF THE LIMITATION OF BENEFITS CLAUSE UNDER ART.24 OF

THE TREATY.

II. THE INCOME OF THE ASSESSEE FALLS UNDER THE DEFINITION OF ROYALTY UNDER THE ACT AS WELL AS THE TREATY.

III. THAT THE INCOME MAY ALSO BE TREATED AS FEES FOR INCLUDED SERVICES AS UNDER THE ACT AND ALSO THE TREATY

IV. THAT THE ASSESSEE HAS A PERMANENT ESTABLISHMENT IN INDIA AND THE CIT(A) OUGHT TO HAVE ENHANCED THE TAX LEVY

V. THAT THERE IS BUSINESS CONNECTION OF THE ASSESSEE AS UNDER SECTION 9(1)(i) AS THE SOURCE OF INCOME IS FROM INDIA

ARGUMENTS ADVANCED

I.THAT THE ASSESSEE IS NOT ENTITLED TO THE INDIA-US DTAA BY VIRTUE OF THE LIMITATION OF BENEFITS CLAUSE UNDER ART.24 OF

THE TREATY.

Where the Tribunal was only required to consider the question of law arising from facts which were on record in the assessment proceedings there was no reason why such a question should not be allowed to be raised when it is necessary to consider that question correctly to assess the tax liability of an assessee¹.

The India-US treaty seeks to protect the misuse of the benefits arising of this treaty by incorporating a limitation of benefits clause under Art.24. If it was intended that a national of a third state should be precluded from the benefits of the DTAC, then a suitable term of limitation to that effect is normally inserted in a Double Taxation Avoidance Agreement by a limitation on benefits clause.²

A.INSTANCE OF TREATY SHOPPING WRIT LARGE OVER THE FACTUAL POSITION

For a company incorporated under one of the Contracting States to be eligible to the treaty benefit, more than 50 per cent of the number of shares of each class of the company’s shares must be owned directly or indirectly, by one or more individual residents of one of the Contracting States, one of the Contracting States or its political sub-divisions or local authorities, or other individuals subject to tax in either Contracting State on their worldwide incomes or citizens of the United States.³

B. ABC ADVERTISING LIMITED, LLC IS NOT ENTITLED TO THE BENEFITS OF THE TREATY

Notwithstanding the fact that the assessee is very much a resident company of the United States of America, it is submitted that it is not entitled to the treaty benefits due to operation of the above clause. From the fact file, it may be undisputed that the assessee company is a wholly owned subsidiary company of ABC Limited which is not only situated in Cayman Islands but also incorporated according to the company laws of Cayman Islands.

The condition laid down by Art.24 above is that at least 50 per cent of the company’s shares must be owned in connection with one of the Contracting States. The case is not so instantly. 100 per cent of the ownership of the assessee company, although incorporated according to the laws of one of the Contracting States i.e USA, vests in its parent company, ABC Ltd. which is incorporated in Cayman Islands which is not one of the Contracting States for the purpose of the Convention. Cayman Islands is a British Overseas Territory which is a separate entity is beyond the scope of application of the India-US DTAA. Since the absolute ownership of the assessee company vests in an enterprise of a third country alien to the treaty, the assessee company is not entitled to the benefits of the treaty by virtue of Art.24.

An appeal before this tribunal is nothing but continuation of assessment proceedings and the assessment is still at large. Hence, the fact that the ITO earlier held the assessee entitled to the benefits of the treaty would not vitiate the order or these proceedings. The Appellate Tribunal has all the powers of the assessing authority⁴.

II. THE INCOME OF THE ASSESSEE FALLS UNDER THE DEFINITION OF ROYALTY UNDER THE ACT AS WELL AS THE TREATY.

As pressed in the previous ground, the assessee is not entitled to the benefits of the treaty and hence, its taxability may be considered under the Act.

A.THE PAYMENTS RECEIVED BY THE ASSESSEE SATISFY THE DEFINITION OF ROYALTY AS PER EXPLANATION 2 TO SECTION 9(1)(VI) OF THE ACT

Explanation 2 to the Section 9(1)(vi) lays down the meaning of royalty for the purpose of the clause. Clause (iii) of explanation 2 applies to the facts of the instant case.

A1.THERE IS ‘USE OF PROCESS’ IN THE SATELLITE/TRANSPONDER

Royalty means consideration for the use of any patent, invention, model, design, secret formula or process or trademark or similar property⁵. This meaning squarely reflects in the facts of this case. The assessee is receiving consideration by way of yearly payments from the telecasting companies for the use of process in the transponder and satellite.

The first meaning assigned to the word "used" is "to employ to any purpose"⁶. The plain construction of the word "use" refers to the deriving advantage out of it by employing for a set purpose. That physical connection with the item to be used is not necessary to constitute “use” was upheld in the New Skies’ and Asia Satellites’ cases.

Considering the contention whether there is “right to use” in the instant contract is inconsequential. The test laid down by Hon'ble Supreme Court in BSNL's case cannot be applied to the present case as in the present case the transactions considered are not for the transfer of right to use the goods for which it is very much necessary that there must be goods available for delivery. Therefore, these observations of Hon'ble Supreme Court are not relevant for deciding the present case.

A2.THERE IS A PROCESS INVOLVED IN THE OPERATION OF SATELLITES

The word 'process' has not been defined either under the Act or the treaty and if a word is not defined in the relevant statute, then, according to well established principles of interpretation, the natural or prevalent meaning of that word has to be considered⁷. The word "process" is defined as is a "series of actions or steps towards achieving a particular end"⁸and as "a series actions, motions, or occurrences; progressive act or transaction; continuous operation; method, mode or operation, whereby a result or effect is produced"⁹.

The function of the satellite in the transmission chain is to receive the modulated carrier that earth stations emits as uplinking, amplify them and retransmit them and downlink for reception at the destination earth stations. The act of transmission of voice, data and programmes belonging to the customers is a process used in the transponders. Thus, the activity of uplinking and downlinking done by the transponder has been held to be a process¹⁰.

A3. THE WORD “SECRET” DOES NOT QUALIFY THE WORD “PROCESS” NEITHER IN THE ACT NOR THE TREATY

The contention that the word “secret” applies to “process” also while interpreting clause (iii) of explanation 2 to Section 9(1)(vi) must not be allowed in respect of judicial views adopted earlier on several occasions.

Law is trite on the point that the interpretation which leads to absurdity has to be avoided. If it were that word 'secret' prefixed to "formula" should be prefixed to "process" as well, in that case it will also have to be read before the subsequent words used in Clause (iii), namely, "trademark" and 'similar property'. Trademark is affixed or placed on the product to convey it to the users that this product is of that company which has registered it as its trademark. Obviously the trademark can never be 'secret'. If we cannot employ the word 'secret' before 'trademark', by natural implication it cannot be prefixed to "process" also. Hence, the legislature has confined the application of the word 'secret' only before the word 'formula' and not 'process' or 'trademark' or 'similar property'¹¹.

B.EVEN IF THE TREATY APPLIES TO THE ASSESSEE, THE PROCESS NEED NOT BE SECRET

The contention that the presence of a comma after the phrase “secret formula or process” in Art.12(3)(a) of the DTAA qualifies the word secret for process cannot stand. The special bench in New Skies’ case, while considering the view of the division bench in Pan Amsat’s case in which the qualification of the word “secret” as used in the treaty provision was upheld, overruled such contention and held that “secret” does not qualify “process” also but only “formula”.

Principles of literal interpretation do not apply to interpretation of tax treaties. Literal meanings of these items are not really conclusive factors in the context of interpreting a tax treaty which ought to be interpreted in good faith and ut res magis valeat quam pereat, i.e., to make it workable rather than redundant.

Therefore, that simply as comma is placed after the word secret formula or process, the process need not be construed to be "secret" to bring the consideration within the ambit of royalty. The payments received by assessee from their customers is on account of use of process involved in the transponder and it amounts to royalty within the meaning of Section 9(1)(vi) of IT Act, 1961. It also amounts to royalty within the meaning of respective Articles of DTAA¹².

To sum up, it is submitted that the facts of New Skies’ case are squarely applicable here under and as the payments in the case were affirmed as royalties by the Special Bench there under, the ratio of the case may be applied in the instant case and may be held to be royalty income as under the Act as well as the treaty. Also, the facts of Shin Satellite’s case are applicable in toto where the assessee was not the owner of the instruments but was a licensee of satellites from the Thailand Government and received payments from Indian telecasting companies. These payments were also held as royalty by the Special Bench¹³.

III. THAT THE INCOME MAY ALSO BE TREATED AS FEES FOR INCLUDED SERVICES AS UNDER THE ACT AND ALSO THE TREATY

Although this may be an additional ground raised, the subject-matter for taxation is still the same, namely, deemed accrual or arising of income in India and it was only the consideration of the correct Sub-clause of Section 9(1)