In an order that will have a far-reaching effect on the tax regimes of developing countries, the income-tax tribunal in Mumbai held that the training fees paid to a US-based company, which are integral to the import of knowhow from that company, are taxable in India. The income-tax appellate tribunal (ITAT) made this decision in the case of AV Birla group major Hindalco.
Hindalco has not disputed the taxability of the fees for assistance provided by the US company. But it was attempting to claim exemption on another set of payments, a quarterly fee for training of Hindalcos personnel. At the core of the dispute is Article (12) of the Indo-US tax treaty. Article 12 (4) covers royalties and fees for included services which are taxable.
Hindalco took a stand that training fees cannot be construed as fees for included services that are taxable. Instead, training fees are to be considered as integral and inextricably and essentially linked to the sale of knowhow, and therefore of property, and hence are outside the tax purview in India.
The ITAT disagreed with this view and held that training fees in this context are not exempt from tax because knowhow cannot be treated as property for the purposes of Article 12. Based on judicial precedents, including those by western courts, and the context in which Article 12(5) exists in tax treaties, ITAT held that the scope of property under Article 12 is very limited and narrow.
The tribunal held that the provision under Article 12 of the Indo-US tax treaty is meant to put the taxation of fees for a subsidiary transaction on a par with the taxation of the main transaction. According to the tribunal, the meaning of the expression sale of property as used in Art 12(5) is limited in that the expression refers only to sale of property that would not give rise to compensation that could be construed as royalty.
The facts of the case are as follows. Hindalco had entered into a technical assistance agreement with Reynolds (Europe), USA. Under the arrangement , the assessee had to pay $50,000 (net of taxes) each calendar year as fees for technical services and another $12,500 as basic fees for training of Hindalcos personnel at the Reynolds facilities abroad.
For training at Hindalcos premises in excess of 120 mandays, training fees were fixed at $650 per person per day while for training at Reynolds subsidiaries outside India, fees were payable at $200 per person per day. This is a landmark judgement as until now know-how was treated as property for the purpose of Article 12(5) of the Indo-US treaty, and therefore exempt from income-tax in India.
The training fees in connection with the sale of knowhow were thus not taxable in the source country. Since other global tax treaties have identical provisions, this will affect the taxation of training fees in other source countries also, which are mainly developing economies.
Yet, this judgement has found acceptance by western tax gurus like Prof Klaus Vogel. In his monthly column in one of the most respected tax journals Bulletin for International Taxation, published by the Amsterdam-based International Bureau of Fiscal Documentation, Prof Vogel has advocated acceptance of this view of the matter and said it deserves to be accepted.