India tax: ITAT rules payments for use of satellite constitute royalties

The Special Bench of the Income Tax Appellate Tribunal, Delhi (ITAT), issued a ruling on 16 October 2009 in favor of the tax authorities in appeals filed by nonresident satellite companies (SatCos). The ITAT held that consideration paid by telecasting companies to satellite companies was for the use of a "process" and, therefore, a royalty under Indian tax law even though the process was not "secret."


Facts

New Skies Satellite N.V. (a Dutch tax resident) and Shin Satellite Public Company Limited (a tax resident of Thailand) provide transponder capacity to telecasting/telecommunications service providers to enable the transmission of voice and data. The two companies provide transponder capacity from their respective satellites, enabling customers (including Indian companies) to transmit voice and data around the world. All equipment and facilities are owned, maintained and controlled by the SatCos from outside India. The SatCos have no control over the data up-linked or down-linked by customers. The process of up- or down-linking is embedded in the transponder, which is availed of by the customers at the time of up- or down-linking. The SatCos predetermine the transponder process and make it available to customers for a fee.

The Indian tax authorities took the position that the fees paid to the SatCos were in the nature of royalties under both the Indian Income Tax Act, 1961 (ITA) and India's tax treaties and, therefore, were taxable in the hands of the SatCos. The SatCos argued that the payments did not qualify as royalties and, in the absence of a permanent establishment in India, the income was not taxable in India.

In concluding that the payments were royalties and taxable in India, the ITAT rejected the arguments of the SatCos that no use of process was involved and that the process needs to be secret before the payment for such process can be characterized as a royalty. The ITAT held that the services provided by the SatCos did involve a process and that they provided their customers with a particular capacity of the transponder's pre-determined and pre-guided process. To fall within the scope of a "royalty," the process does not need to be secret. The consideration paid by telecasting companies to the SatCos is for the use and right to use the process and, thus, is a royalty under the ITA.

The ITAT's deliberations zeroed in on the interpretation of "payment for use of a process." The SatCos argued that the payments were merely for the telecaster availing itself of the service and that the telecasting company is neither concerned with the process being used nor using the process in and of itself. The ITAT rejected this argument, making several observations:
- Control and use of the transponder is complicated, involving sophisticated instruments owned by the SatCos and/or the telecasting companies. The process is predetermined and preguided by the SatCos, and then made available, for consideration, to the telecasters for their use, according to their needs.
- The argument that the telecasting companies were only interested in telecasting their programs and not in using the process is unpersuasive – without using the process involved in the transponder, the telecasting companies would be unable to telecast their programs in the desired area, at the desired time.
- After entering into the contract, satellite companies have no right to interfere in the process involved in the transponder except as provided in the agreement; the SatCos have no control over the time or programs being telecasted.

The ITAT concluded that the payments were for the use of the process and thus royalties. It appears that this conclusion was primarily influenced by the fact that the telecasting companies, while relaying live or recorded programs to their customers, use their ground stations to uplink the data to satellites, with the data also received by the telecasters' ground stations in the down linking process by which the telecasting companies provide programming to their customers.

It should be noted that the draft Direct Taxes Code released in August 2009 would increase the withholding tax on certain royalties to 20% and include payments for "the use or right to use transmission by satellite, cable, optic fiber or similar technology" within in the definition of "royalties." Interestingly, the word "process" is not used in the part of the proposed definition dealing with transmission by satellite, cable, optic fiber, etc. It therefore appears that the draft code's definition would encompass all payments made for the transmission of data irrespective of the use of process by the customer, and all such payments would be deemed to be royalties and thus taxable in India.