The issue whether various payments by MNCs to their foreign counterparts are taxable as royalty or not under the domestic law and the respective Double Tax Avoidance Agreement (“DTAA”), has been a matter of debate. There is a plethora of decisions dealing with this issue. The controversy again surfaced recently before the Bangalore Tribunal in the case of Google India (P.) Ltd.

Facts of the case

Google India Private Limited (‘Google India’), a wholly-owned subsidiary of Google International LLC, USA, entered into a Google AdWords Program Distribution agreement with Google Ireland Limited (‘Google Ireland’). Google India had been appointed as a non-exclusive distributor of Adwords programmes to advertisers in India by Google Ireland. The agreement was in relation to resale of online advertising space. Under the agreement, Google India was granted the marketing and distribution rights of the Adwords program to advertisers in India. Google India only performed market-related activities of selling advertisement space; no rights or intellectual properties (‘IP’) were transferred by Google Ireland to Google India or to the advertiser.

Google India had credited the distribution fees towards distribution rights granted under the aforesaid agreement, to the account of Google Ireland without deduction of tax at source. Proceedings under section 201 were initiated by issuing a show cause notice, requiring Google India to explain why it should not be treated as assessee in default for not deducting tax at source on sums payable to Google Ireland. The Assessing Officer was not satisfied by the responses of Google India and determined the amounts payable to Google Ireland to be royalty under the Income-tax Act, 1961 (‘the Act’). The Commissioner of Income-tax (Appeals) upheld the decision of the Assessing Officer. Against the said order, Google India preferred an appeal before the Tribunal.

Contentions of the assessee

Before the Tribunal, Google India contended/submitted that:

1. It was merely a reseller of advertisement space and was engaged in only performing marketing-related activities to promote the sales of advertisement space in India;

2. No rights or IP were transferred by Google Ireland to Google India or to the advertiser;

3. Google India had no control or access to the software, algorithm and data centre;

4. The server on which the Adwords program runs were located outside India, over which Google India did not have control;

5. Google India or the advertisers do not have any right of any use or exploitation or the underlying IP and software;

6. The advertisers select keywords and place a bid on the online auction. Google India periodically raises invoices on advertisers for advertising spend incurred by the advertisers;

7. The IT-enabled service (‘ITES’) division of Google India is a separate outsourcing business segment, for which it earns revenue under a separate outsourcing service agreement with Google Ireland (‘service agreement’), and

8. The amount payable to Google Ireland was an advertisement fee and not royalty in nature under the Act.

Contentions of the Revenue

On the other hand, the Revenue contended that:

1. On a combined reading of the distribution agreement and service agreement, it is clear that Google India had been provided license to use IPR for which Google India had agreed to make certain payments to Google Ireland;

2. The IPR of Google resides in search engine technology, associated software and other features. Hence right to use IPR for performing various activities like accepting advertisements and providing after sale services would fall within the ambit of ‘Royalty’;

3. Google Ireland allowed Google India access to all IPRs and confidential information, without which it is not possible for Google India to render the services to the advertisers;

4. Thus, the amount credited by Google India to the account of Google Ireland would constitute sum chargeable under the provisions of the Act, as the payment is in the nature of royalty for the purpose of license to use intellectual property rights;

5. Google India, by acquiring the distribution and marketing rights from Google Ireland in respect of the Adwords program to the advertisers, was licensed to use the search engine, which is copyrighted and therefore the payments it made fall within the definition of royalty;

6. Google India had been granted right to use trademarks and brand features;

7. Google India had been granted distribution rights involving transfer of rights in process, and

8. The income from exploitation of search engine, which is an IPR, being used by the Google India as tools of trade is royalty and therefore liable for tax under the Act as well as DTAA.

Observations of the Tribunal and analysis

Whether distribution fee payable by Google India to Google Ireland is in the nature of ‘royalty’?

The Tribunal held that the payment towards distribution rights is in the nature of royalty under the Act and as well as under the DTAA because of the right to access which is available, not only of the technology, but also of the customer data and also of the intellectual property rights.

Observations:

India has the right to tax royalty payments by its residents to non-residents, under the DTAA. Royalty payments include consideration for (a) use of or the right to use secret formula or process, and (b) for the use of, or for information concerning industrial, commercial or scientific experience. The Tribunal held that the consideration payable does fall within the purview of the definition.

In doing so, the Tribunal inter alia observed as under:

1. Google India had access to all intellectual property and confidential information used for activities related to the Distribution Agreement;

2. Google India had the right to use valuable business assets of Google Ireland. Google India used intellectual property in the products and services offered by Google Ireland. Thus, Google Ireland made available technology to Google India;

3. Google India had access to valuable information such as IP address of the desktop/laptop/ tablet, photographs of users and the time spent on websites, etc. This enabled Google India to provide effective focused ad campaign to advertisers;

4. Use of Google brand features was essential in Google India’s marketing and distribution activity. Google India was permitted to use tradename, service marks, domains, or other distinctive brand features of Google solely for use under the Distribution Agreement, on a non-exclusive, non-sub-licensable basis for the purposes of marketing and distribution of the Adwords Program, and

5. Even though Google India and Google Ireland had entered into a separate service agreement, without the inputs of ITES, there could not be any targeted marketing for advertisements and promotion of sales of advertisers. Thus, there cannot be made a distinction between distribution agreement and ITES agreement.

Whether, under the DTAA, royalty is taxable on “receipt basis” or “accrual basis”

The Tribunal rejected the contention of Google India that royalty is chargeable to tax in the hands of Google Ireland on receipt basis. The Tribunal held that the benefit of DTAA is available to a non-resident and not to a resident payer. In doing so, the Tribunal emphasised the intention of the DTAA, and did not go by literal interpretation.  

Further, the Tribunal observed that Google India had no concern about the method of accounting followed by Google Ireland. Moreover, Google Ireland followed mercantile system of accounting, and thus, income will be chargeable in the year of accrual, and not in the year of receipt.

Conclusion

The said Tribunal order on payment by Google India to Google Ireland may set another precedent for MNCs to be considered when strategizing their transactions. Though there are favorable judicial pronouncements, MNCs have to be careful while structuring their transactions.