SKP Tax Alert
29 March 2016 | Volume 8 Issue 33
Enlarged definition of royalty as per the Act, cannot be applied to a tax treaty; for data transmission services through a transponder

Recently, the Delhi High Court in the case of DIT vs New Skies Satellite BV and DIT vs Shin Satellite Public Co Ltd (ITA. No. 473&474/2012; ITA No. 500&244/2012) ruled that income earned by non-resident assessees (companies incorporated in Thailand and Netherlands) from the lease of satellite transponders, would not constitute ‘royalty’ under Article 12 of the respective Double Taxation Avoidance Agreements (DTAA) of Thailand and Netherlands. It also, discusses extensively the interpretation of term ’process’ referred to in the definition of royalty under Article 12 and concludes that only a ’secret process’ qualifies as royalty and hence, data transmission services cannot be taxed royalty. It also upheld the principle that unilateral legislative amendments made within the domestic laws of the state cannot be applied to a treaty concluded between two sovereign states.

Facts of the case
  • The taxpayers, Shin Satellite and New Skies, were companies incorporated in Thailand and the Netherlands respectively. Both these companies were engaged in providing digital broadcasting services to their customers (residents as well as non-residents).
  • The taxpayers earned income from the ‘lease of transponders’ of their respective satellites. The lease was for the object of relaying signals of their customers, who wished to broadcast their programmes for a particular audience in a particular part of the world. The footprint of the satellites i.e. the area over which the satellite can transmit its signal, included India.
  • Both the taxpayers, filed a ‘Nil’ return of income in India.
  • The Assessing Officer (AO) contended that the income was in the form of royalty under the provisions of the ITA, and was thus liable to tax. The AO also held that since the definition of royalty under the ITA and the treaty were Pari Materia, the income would be regarded as royalty even within the meaning of Article 12 of the Thailand treaty and the Netherlands treaty.The Income Tax Appellate Tribunal, (ITAT) set aside the assessment order and held that the case is squarely covered by the judgement of Asia-Satellite Telecommunication Company Ltd (322 ITR 340) 2011 (Del HC) and that while providing the transmission services to its customers, the satellite control is always with the satellite operator and the customers are only provided an access to transponder capacity. Therefore, the customer does not use the satellite or process.
  • Aggrieved by the above decision of the ITAT, the revenue preferred the appeal before the Delhi High Court (High Court).
  • While the appeal was pending before the High Court, the definition of the term royalty was enlarged under the domestic tax law retrospectively from 1 April 1976 vide Finance Act, 2012 to include within its ambit the consideration in respect of any right, property or information whether or not possession or control is with the payer or used directly by the payer or location of such right, property or information lies in India. Furthermore, the definition of the term process is also enlarged to include transmission by satellite (including uplinking, amplification, conversion for downlinking of any signal) cable, optic fibre or by any other similar technology whether the process is secret or not.
Key issues before the High Court
  • Whether the amendment to the definition of royalty under section 9(1)(vi) vide Finance Act 2012 applies to the definition under the respective DTAAs?
  • Whether the ruling given in the case of Asia-Satellite Telecommunication Company Ltd (322 ITR 340) 2011 (Delhi HC) holds true even if the amendment of the Finance Act 2012 is applied retrospectively?
 Revenue’s contention
  • Distinguishing the case of PanAmSat International Systems Inc (ITA no. 1796/2001(Del)), it was held that the taxpayer was providing complete digital broadcasting services right from receiving the signals from its customers, to encoding the signals, feeding them into the uplinking system and transmitting these to the required space segment. These activities constituted the ‘process’ which was required to consider the income under Section 9(1)(vi).
  • The agreement signed by the taxpayer with its customers showed that the services were not for satellite hiring, but for providing digital channels. Thus, the taxpayer was receiving payments from its customers for the use as well as the right to use a process and not merely for hiring the transponder.
  • After the enlargement of the definition of the term royalty, and since the meaning ascribed to term ‘process’ is  retrospective in nature, the taxpayer  cannot rely on the ruling in case of Asia Satellite as it has been undone and stays academic.
  • It was also argued that before the amendment (vide Finance Act 2012,) the meaning of royalty under the Act and DTAA were similar. Hence, even the explanations provided on the basis of the amendment in the definition of Royalty according to the Act should be applied to the definition in the tax treaty.
Taxpayer’s contention
  • Any change in the substantive law cannot automatically result in a similar change with respect to the taxability of a transaction or service, which is otherwise exempt from tax by a DTAA, or which is subject to a lower rate of taxation if mandated by a treaty.
  • It is not possible for one nation, by way of a unilateral amendment, to tax income which was otherwise not subject to tax under the treaty.
  • Relying on the judgement of the AAR in the case of ISRO it was contended that through the transponder lease agreements, the customers get only a mere access to the transponder’s broadband capacity and not control over the parts of the satellite and the transponder. Thus, it cannot be termed as the use or right to use any industrial commercial or scientific equipment.
 High Court Ruling
  • With respect to the application of the amendment to Section 9(1)(vi) to the definition of royalty under the DTAA, the court relied on the provisions of the Vienna Convention on the Law of Treaties, 1969 which is universally accepted as authoritatively laying down the principles governing the law of treaties. Article 39 provides that the treaty may be amended by an agreement between the parties. Thus, unilateral amendments are categorically prohibited.
  • Pertinently, the court in the case of DIT vs Nokia Networks 2015 (358 ITR 259) specifically dealt with the question of the effect of the amendments to domestic law and the manner of their operation on parallel treaties. The court in this case relied on what was held in CIT vs Siemens Aktiongesellschaft (310 ITR 320), that the amendments in domestic tax laws cannot be read into the tax treaty.
  • Consequently, since it was held that the amendment vide Finance Act, 2012 will not affect Article 12 of the DTAAs, it would follow the first determinative interpretation given to the word royalty in the case of Asia Satellite Telecommunications Pvt Ltd.
  • Thus, a change in executive position cannot bring about a unilateral legislative amendment into a treaty concluded between two sovereign states. It is imperative that such an amendment is brought into the agreement as well.
SKP's comments
  • This is a welcome ruling and protects the international instrument, in the form a tax treaty, from any retroactive amendments made from domestic law. It clearly remarks that any clarificatory or declaratory changes to domestic law which may lead to a contradictory position such as a tax treaty would not hold good.
  • The decision is contrary to the view adopted by the Madras High Court in the case of Verizon Communication Singapore Pte Ltd [361 ITR 525]. With due respect to the Madras High Court, in our view, the view of the Delhi High Court seems to be a better view being in conformity with the principles of International tax laws, Vienna Conventions and the decisions of Mumbai High Court and Andhra Pradesh High Court.


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