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A favourable tax ruling on referral fee
July, 18th 2008

Sometimes having something permanent can be a drawback. The Authority for Advance Rulings (AAR) in a recent ruling has held that where a non-resident company had referred a potential customer to its Indian group company and received referral fees, the fees received being business income, would be liable to tax in India -- only if it has a permanent establishment (PE) in India. This means the absence of a permanent establishment may work out in an entitys (in this case Cushman & Wakefield Pte - CWS) favour as it doesnt have a permanent shop in the country. Says Mr Girish Mistry, Executive Director, PricewaterhouseCoopers Pvt Ltd, The AAR ruled that referral fee was not royalty or fees for technical services and was not taxable in India as business income since CWS did not have a PE in India. Under the tax treaty provisions a non-residents business income would be taxable in India only when it has PE in India. Business Line caught up with him over the email to discuss the impact of the judgment which means referral fees received by a non-resident company are not liable to tax in India.

Excerpts from the interaction

Why is income accruing to consultants working for MNCs always under some sort of doubt?

Indian economy witnessed substantial growth in last few years and it also provided business opportunities to foreign companies in the fields of infrastructure and real estate. Given the complex regulatory framework in India, consultants who provide advisory services in these fields, refer their clients (who are interested in such business opportunities in India) to their Indian subsidiary / group company, which would provide services to such clients in India. The process results in transactions between the consultants and their Indian counterparts in the form of sharing of revenue earned by subsidiary/ group company out of services rendered to such referrals in India.

Walk us through the case where authorities have decided referral fees received by a non-resident company are not liable to tax in India.

The Authority for Advance Ruling, in a recent case, has examined the taxability of referral fees paid by an Indian subsidiary to its foreign parent based in Singapore. In the facts of the case, Singapore-based Cushman & Wakefield (S) Pte. Ltd. (CWS), is engaged in the business of rendering services in connection with the acquisition and sale of real estate, and also providing ancillary services such as real estate advisory, etc.

CWS was having certain international client relationships and, in accordance with its global policy, referred its clients requiring service in other jurisdictions, to other Cushman and Wakefield (C&W) offices. Each C&W Company, to which a client was referred to, was required to pay a referral fee to the referring group company in accordance with the international fee-sharing rules of the C&W group.

CWS entered into an agreement with its subsidiary Cushman & Wakefield India Pvt. Ltd. (CWI), under which CWS would refer, or recommend, to CWI, potential clients that needed real estate consultancy and associated services in India. In consideration thereof, CWI agreed to pay CWS 30 per cent share in referral fee after CWI realised in full the consideration, for services rendered from the referred clients. The referral was made by CWS either through e-mail or telephonically.

CWS wanted to ascertain, taxability or otherwise of such receipts under the provisions of the Income-tax Act, 1961 (ITA) and the India-Singapore Double Taxation Avoidance Agreement (tax treaty). Hence, it approached Authority for Advance Rulings.

The AAR held that where a non-resident company refers a potential customer to its Indian subsidiary and receives referral fees, the fees received being business income, would be liable to tax in India only if it has a permanent establishment in India.

What was the taxmans argument?

The Revenue Authorities contended before the AAR that referral fees received by the Singapore company from its Indian subsidiary was for the use, or the right to use, commercial information and a trademark, and hence was taxable as royalty under explanation 2 to section 9(1)(vi) of the ITA.

The AAR ruled that the referral fee was not received in India, nor did it accrue or arise in India. Hence, it was beyond the scope of the charging provisions of section 5 of the ITA. Further, there was no real or intimate relationship between the activities carried on outside India by CWS and the activities carried on in India, that contributed to the earning of income; so there was no business connection in India under the provisions of section 9(1)(i) of the ITA. The AAR observed that the agreement between CWS and CWI was entered outside India.

The AAR rejected tax authorities contention that the payments constituted royalty.

It held that royalty under the ITA refers to the provision of information concerning commercial experience and does not encompass the provision of bland commercial information. Further there was no involvement of intellectual property to share. There was also no evidence that CWS maintained a database relating to commercial real estate services that were being made available to CWI, whenever a prospective customer was introduced. Therefore, the referral fees cannot be taxed as royalty under section 9(1)(vi) of the ITA.

What was the position under the tax treaty?

The revenue authorities contended before the AAR that referral fee received by the Singapore Company from its Indian subsidiary was in the nature of royalty or fees for technical services under the provisions of Article 12 of the tax treaty. It also contended that the use of trademark was in the nature of brand royalty.

The AAR held that the referral fees do not constitute fee for technical service under the tax treaty since, CWS did not render any service by making any expertise or know-how available to CWI.

The AAR held that the payment was not for the use of trademark (i.e. use of name Cushman & Wakefield) by CWI. Accordingly, it was not of a case of brand royalty.

What would be the impact of the AAR ruling?

The AAR ruled that referral fee was not royalty or fees for technical services and was not taxable in India as business income since CWS did not have a PE in India. Under the tax treaty provisions a non-residents business income would be taxable in India only when it has PE in India.

As referral fee was not taxable in India either under the provisions of the ITA or tax treaty accordingly, CWI was not required to withhold tax on the payment to CWS.

The AAR ruling is binding only on the taxpayer and the Revenue Authorities but has a persuasive value. Therefore, non-residents receiving income by referring clients to their Indian subsidiaries or affiliates and having no business connection or PE in India can take similar stand based on this ruling. The benefit can be claimed by companies which earn income based on referrals in service industry like legal, engineering, management consultancy, real estate, etc.

It may be noted that AAR has stated that it was not concerned with the justifiability of payment made by CWI and that whether the payment by CWI was at arms length; this could be examined by the assessing officer and the same cannot be decided by it.

However, taxpayers in similar situations would need to justify and maintain documentation under the Indian transfer pricing regulations. It would be required to ensure that the transaction with its affiliate / associate meets the arms length price criteria to comply with the transfer pricing regulations.

What kind of companies may benefit from this ruling?

While the percentage of the referral fees appears to be substantial, distinction between commission and the referral fee is important. Payment in the nature of commission could be in the range of 2-5 per cent. However, payment of referral fee under a revenue sharing arrangement could be higher, and both cannot be equated. Therefore, the ruling would be useful for companies receiving similar payments under any global arrangement duly supported by appropriate documentation from a transfer pricing perspective.


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