In its first judicial examination of taxability of referral fees in India, the Authority for Advance Ruling (AAR) has held that referral fees received by Cushman & Wakefield, a Singapore resident company, is not liable to tax in absence of a permanent establishment in India. The AAR has held that such payments cannot be characterised as royalty under the provisions of Indian Income tax Act and India-Singapore tax treaty and hence can not be subject to withholding tax liability in India.
Under the Indian law, a non-resident foreign company is liable to Indian tax on source-based rules, which tend to be interpreted in a strict manner. Under such source rules, either the income is characterised as business income or fees for technical services. In the case of former, the presence of a permanent establishment is precondition to levy tax on such income.
Cushman & Wakefield Pte Ltd (C&W), a company incorporated and based in Singapore, offers a range of real estate services to domestic and international clients. Over the years, C&W had developed international client relationships and in accordance with the groups global policy, it provides referral services to other C&W offices. In 2005, C&W entered into a referral service agreement with its groups Indian subsidiary, C&W India, by virtue of which C&W agreed to refer/ recommend potential clients, desirous of seeking real estate consultancy services in India. In consideration, C&W India was required to pay 30 per cent of gross fees to C&W as referral fees.
Questions before AAR
Given the factual matrix, C&W sought ruling from AAR on the question whether such referral fees was liable to tax in India as royalty or business income, and if such payment was liable to withholding tax. Revenues argument
Firstly, Revenue argued that payment of referral fees to C&W Singapore was sham for avoidance of tax. C&W India failed to demonstrate that the services were actually rendered and secondly, even though such services were rendered payment of 30 per cent of gross fees was not justifiable. Revenue contended that fees were paid for use of commercial information and, therefore, would be characterised as royalty both under the domestic law and India-Singapore tax treaty.
Refuting Revenues claim, AAR held that it was inclined to premise the ruling on the fact that the referral had actually taken place and was not disputed. As regards, justifiability of the payment, AAR held that question of justifiability did not arise and Revenue could examine this aspect independently.
AAR ruled that C&W did not have a business connection since there was no real or intimate relation between activities the applicant undertook outside India and the activities in India (ie, referral of prospective customers ). Further, AAR held that it would be superfluous to refer to the treaty provisions for determination whether C&W had a permanent establishment in India, a contention which was not even pleaded by Revenue.
On Revenues contention that such fees should be taxed as royalties, AAR held that there was no intellectual property involved, nor was there any sharing of commercial experience or skills with C&W India. Payment made for a mere reference could not be regarded as royalty. Revenues alternate contention that the impugned payment was for use of trademark was rubbished by AAR, which held that C&W did not own the trademark and, therefore, it would be far-fetched to describe such payment as royalty.
In conclusion, the referral fee was held to be ordinary business income, which could not be liable to tax in India in the absence of a permanent establishment. Further, since, payment in dispute was not liable to tax, there was no obligation to withhold taxAfterthought
AARs observation that there was no business connection between the Indian entity and Singapore entity is indeed bold, given that the referral arrangement is ongoing in nature.
The AAR ruling would be reckoned important on two counts. For one, the ruling articulates the tax implication for referral fees which would be welcomed by MNC arms, more particularly in software, head hunting and financial service industry who follow a global referral policy as a matter of business practice.
Secondly, the AAR ruling reiterates the principle that liability to withholding tax does not trigger in case a payment is not subject to tax in India. Interestingly, this aspect is being examined by Mumbai High Court in the matter of Vodafone.
The ruling, however, has left one important aspect open for judicial debate sufficiency and justifiability of such payment from an Indian transfer pricing perspective. Apparently Revenue did not press it adequately.
Given the unique nature of the transaction and availability of comparables, I would not be taken by surprise if Revenue disputes the arms length nature of the quantum of referral fees!