The income-tax department has asked two leading film and entertainment companies to pay tax on the income generated from sale of distribution rights even though they are based in tax havens such as Cyprus and Mauritius. The department, in two separate orders passed in April, has asked TIFC Cyprus, owned by Network 18, and UTV Mauritius, part of UTV, to pay tax on the income generated in India.

The two companies are in the business of production and distribution of movies in India. TIFC Cyprus, a group company of Indian company Network 18, filed an application for permission, for making payment for the worldwide rights of the Akshay Kumar starrer Welcome to UTV Mauritius, a group company of UTV India.

In the application, TIFC Cyprus has claimed that it is not liable to pay withholding tax. The reason: the transaction was between two entities outside India, and since UTV Mauritius is entitled to the benefits of the Double Taxation Avoidance Agreement between India and Mauritius, there is no liability on the part of UTV Mauritius.

In a separate order, the department has held that TIFC Cyprus is liable to pay taxes in India for the income generated by the sale of Welcome in India as it has conducted business in India. The Indian connection, the department said, is evident from the exclusive rights for distribution of the film given to Studio 18, a group company of Viacom 18. Viacom 18 is a JV between Viacom and Network 18.

Sidharth Roy Kapoor, CEO, UTV Motion Pictures told ET he was not aware of this case and declined to comment further. Sandeep Bhargava, CEO, Studio 18, also said he was not aware of the case. Some tax experts have criticised the order.

The order is erroneous. Going by this order, producer of a film made abroad but given for distribution in India can also be taxed, said a senior chartered accountant TP Ostwal. Tax department sources said that the two companies have paid the tax demand but are likely to contest the order.

Under Article 12 of the DTAA, sale of cinematographic film falls under the definition of royalty, which is taxable provided the company has a permanent establishment in India. TIFC Cyprus told the income-tax department that it does not have a PE in India and therefore it is not taxable in India.

The income-tax department held that the payment made by the Cyprus company to UTV Mauritius results in a certain profit to UTV Mauritius. It held that the profit is generated in the process of doing business in India. To conclude that it has business connection in India, the assessing officer pointed out various stages at which the Mauritius company makes connection with the Indian entities and their involvement in production and distribution of the film.

The business connection in India, as is evident from the apparent involvement of the Mauritius company in the production of the film and also its association with UTV India, is an indication to the existence of a permanent establishment, the department said.