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Verizon Ruling:Taxability Of Bandwidth Payments

Published on Wed, Nov 27,2013 | 16:38, Updated at Wed, Nov 27 at 16:38Source : 

By: Sandeep Chaufla & Prabhat Lath,PwC India

Recently, in the case of Verizon Communications Singapore (Verizon) the Madras High Court (MHC)  held that payments made by Indian customers to Verizon for bandwidth services is liable to tax in India as ‘royalty’ under the Income-tax Act, 1961 (the Act) as well as under Tax Treaty between India and Singapore (treaty). 

In a detailed order, after discussing the judicial precedents on the matter, MHC held that payments for bandwidth services are for ‘use of equipment’ / ‘use of process’ and therefore, liable to tax in India as ‘royalty’.  The MHC held that a user having a particular server connection to the internet has a dedicated bandwidth between the computer and the internet service provider.  Once the bandwidth is dedicated for the use of the customer who paid consideration for end-to-end service, what data goes over the bandwidth reserved for the customer is exclusively in the control of the customer and not Verizon, and therefore, the customer obtains an economic interest in the equipment (which need not result in ownership thereof).  This interpretation is significantly different than that of other Courts / Tribunals on similar matters.  On the basis of above conclusion and relying on the retrospective amendments made by the Finance Act, 2012 through insertion of Explanations to the definition of ‘royalty’ under the Act, MHC held that the payments made were in the nature of royalty..

This decision poses question again for taxpayers as some Courts / Tribunals had taken a view that  amendments made in the Act do not alter the interpretation of the term ‘royalty’ under the tax treaties. .The MHC held that the definition of 'royalty' under the treaty and the Act (after amendments) are pari materia, which is contrary to decisions of the Bombay HC in the case of Siemens Aktiengesellschaft  and that of the Delhi HC in the case of Nokia Networks OY,  wherein the respective Courts held that amendments under the domestic law cannot be read into the tax treaties.

The decision of MHC contradicts the earlier position that payments for telecom services and bandwidth are for ‘use of standard service’ and do not involve ‘use of equipment’ or ‘use of process’ The earlier landmark decision of MHC in the case of Skycell Communications  that held that telecom services availed by a customer from the  operator  is a  standard service not constituting ‘technical services’ has been distinguished in Verizon decision  by  holding that in the given case the payment is not for service but for use of equipment and by further holding that even services cannot be rendered without ‘use of equipment’.  The MHC in Verizon’s case did not consider that in order to constitute ‘royalty’, the ‘use of equipment’ should be by the service recipient and not by the service provider, the significance of which was considered by other Courts / Tribunals while dealing with similar issues.  The MHC distinguished the rulings of Delhi HC in the case of Asia Satellite  and AAR rulings in the case of Dell International  and Cable and Wireless  by holding that these decisions were prior to the amendments in the Act and also held that Indian customer availing bandwidth services has significant economic interest in the equipment to the extent of the bandwidth hired.

On the issue of Permanent Establishment, the HC made an observation that in a virtual world, the physical presence of an entity today has become insignificant. The presence of equipment of the entity, its rights and responsibilities vis a vis customers clearly shows the extent of virtual presence which operates through its equipment placed at the customer' premises through which the customer has access to data.     

This decision again highlights the point that on payments related to new technology, there is a cleavage of opinion among the High Courts.  The finality on these issues can only be achieved from decision from the Apex Court. 

  310 ITR 320
2 358 ITR 259
3 251 ITR 53
4 332 ITR 340
5 308 ITR 37
6 315 ITR 7


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