Karnataka High Court: Pay Roll Services by IBM-Philippines Are Not FTS; Not Liable for TDS under Section 195 of Income Tax Act

Karnataka High Court: Pay Roll Services by IBM-Philippines Are Not FTS; Not Liable for TDS under Section 195 of Income Tax Act

The Karnataka High Court, by its division bench of Justices P.S. Dinesh Kumar and T.G. Shivashankare Gowda while dismissing an appeal of the department, held that payroll services by IBM Philippines are not Fees for Technical Services (FTS) and the Tax Deducted at Source (TDS) was not liable to be deducted under Section 195 of Income Tax Act (hereinafter referred to as 'the Act').

The respondent/assessee- IBM India Private Limited, is a company engaged in the business of information technology services. IBM USA had entered into a global agreement with Procter and Gamble, USA (P&G USA) to provide payroll-related services. In terms of a companion agreement, IBM India had entered into an agreement with P&G India. The services to be rendered by IBM India to P&G India was outsourced to IBM Philippines. In addition, IBM India had also outsourced certain human resource services to IBM Philippines for the project.

In an order dated 14th September, 2012 the Assessing Officer (AO) recorded that the Assessee had made payments to IBM Business Services, Philippines for payroll services without deducting tax at source. The AO concluded that in respect of payments made towards FTS, TDS ought to have been deducted under Section 195 of the Income Tax Act, 1961 (the Act for short).

Assessee was treated as 'assessee in default' under Section 201 of the Act. The Commissioner of Income Tax (Appeals) [CIT(A)] confirmed AO's order. Assessee challenged the said order before the Income Tax Appellate Tribunal (ITAT). By the impugned order, the ITAT allowed the appeal holding that the payments made by the assessee were not chargeable to tax under the India-Philippines Double Taxation Avoidance Agreement (DTAA) and hence, no tax was required to be deducted. Hence, an appeal was filed by the Revenue.

Shri. K.V Aravind, Learned Senior Standing Counsel for the Revenue, assailing the impugned order submitted that the service rendered by IBM Philippines falls under the category of managerial and consulting services. Data management is also one of the services rendered, and it would fall under the category of 'technical services.' The ITAT interpreted IBM Philippines' services as being in the course of business, and the payment received is business profit in the hands of IBM Philippines. The ITAT proceeded to hold that FTS is not defined under the DTAA. However, the definition of FTS cannot be applied in view of Section 90 of the Act. The ITAT had failed to consider that the services rendered by IBM Philippines are technical in nature as per Explanation 2 to Section 9(1)(vii), and therefore, the income is deemed to accrue in India under Section 5(2)(b) of the Act.

Per contra, the assessee/respondent argued that as per the companion agreement, IBM India has entered into an agreement with P&G India, and IBM India has outsourced the services to be rendered by IBM Philippines. IBM Philippines was not rendering any technical service to IBM India. For the services rendered to P&G India on behalf of the assessee, the assessee paid the service charges to IBM Philippines. Therefore, it was 'income earned' in the hands of IBM Philippines. As per Section 90(2), the provisions of the Act or DTAA, whichever is more beneficial to the assessee, must be applied.

The Court remarked, "as far as IBM Philippines is concerned, it works like a sub-contractor under IBM India. It earns profit by rendering service to P&G India. It does not provide any technical service to the assessee. Further, IBM Philippines does not have a permanent establishment (PE) in India. Therefore, the income in the hands of IBM Philippines from the assessee is a business income."

The Court recorded that the Revenue's case was that the transactions between the assessee and IBM Philippines were performed in the 'course of its business.' As per Article 7 of India-Philippines DTAA, IBM Philippines would be chargeable to tax in Philippines.

The first and second substantial questions were, whether ITAT was correct in holding that pay roll services rendered by IBM Philippines to the assessee is not technical service. To which the Court reckoned, "it is not in dispute that under the companion agreement, IBM India Pvt. Ltd., has entered into an agreement with P&G India. The said work has been outsourced to IBM Philippines. IBM Philippines is carrying out the work described in the agreement between IBM India and P&G India. Hence, IBM Philippines was not rendering any technical service and therefore, the income in the hands of IBM Philippines is a business income."

The third question was whether ITAT was right in holding that DTAA does not define FTS. The Court was of the view that this question does not arise for consideration because according to the impugned order, Revenue had taken a specific contention that FTS was absent under the India-Philippines Treaty.

The Court opined that ITAT had rightly recorded that as per Article 7(1) of Indian Philippines DTAA, the business profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. Admittedly, there is no permanent establishment of IBM Philippines in India. As per Article 23 of DTAA, the business profit of IBM Philippines shall be taxable in that State only.

Hence, the bench concluded that payments received by IBM Philippines shall not be liable for TDS under Section 195 of the IT Act. Therefore, assessee could not be deemed as an 'assessee in default,' and dismissed the appeal.