The ITAT Bengaluru Order in the Google AdWords Royalty Tax Case – Part I

We are pleased to bring to you a two-part guest post by Adarsh Ramanujan. Adarsh is an advocate primarily assisting clients as a litigation attorney. He has recently started his own counsel practice with offices in Delhi and Chennai after having spent considerable time with Lakshmikumaran & Sridharan at their New Delhi and Geneva offices. He obtained his B.Sc. LL.B. (Hons.) degree (Gold Medalist) from National Law University, Jodhpur  and LL.M. degree from University of California, Berkeley. He is a qualified Patent Agent in India. A major portion of his time is spent, practicing in the areas of IP & Technology Laws as well as in International Trade Law. He was however branched out into doing commercial litigation and arbitration work. His expertise also extends to regulatory laws such as environmental laws, biodiversity laws and cyber laws. Adarsh is currently teaching a seminar course on commercial arbitration in NLU, Delhi and has previously taught patent law in NLU, Jodhpur and at the CEIPI Institute (University of Strasbourg). He has authored or co-authored close to 30 publications on diverse topics, including on IP, WTO, constitutional law and international tax. He has guest blogged for us in the past as well (see here and here).

In this two-part post, Adarsh analyses a recent order passed by the Bengaluru bench of the Income Tax Appellate Tribunal (ITAT), directing Google India to pay taxes on the payments made by it to Google Ireland between 2007-08 and 2015-16, towards marketing and distribution rights of Adwords programme for India. The Tribunal held that Google India was not a mere re-seller of advertising space to Indian advertisers but a licensee of Google Ireland’s IP and thus the payments made by it to Google Ireland were in the nature of  ‘royalty’, for which it was under the obligation to deduct tax at source as per the Income Tax Act. In October last year, a similar order was passed by ITAT for the assessment years 2007-08 to 2012-13, which is currently in appeal before the Karnataka High Court. Prof. Basheer had expressed disagreement with the Tribunal’s conclusion in this order as, in his opinion, Google India’s use of Google Ireland’s IP was only incidental and its main purpose was to resell ad space to the Indian customers. A piece published in the Outlook had quoted his views on the order as follows:

Basheer says the closer analogy is not a McDonalds franchisee, which would have made the case for royalties and consequent taxation a stronger one. “It’s better to think of Google as a real-­estate developer who uses third party agents to attract more people,” he says. “Google AdWords is more like digital real est­ate. It is digital real estate. Google India is using Google’s trademark (brand name) and other intellectual property only incidentally. Their main purpose is to actively go out and solicit customers who can buy the keyword space.

Adarsh offers similar critiques of the recent ITAT order in this post. Here goes Part I of the post:

The ITAT Bengaluru Order in the Google Adwords Royalty Tax Case – Part I

Adarsh Ramanujan

On May 11, 2018, the Income Tax Appellate Tribunal (ITAT) in Bengaluru dismissed a batch of appeals and cross-appeals filed by Google India Pvt. Ltd., Google Ireland Limited and the Revenue Department. A copy of the order is available here.  The appeals arose from the decision of the Commissioner of Income Tax (Appeal) (CIT(A)) pertaining to the assessments years 2007-2008 to 2015-2016.

The order is, of course, quite lengthy and deals with several different issues under the Income Tax Act relating to the Google AdWords Program and the payments made by Google India Pvt. Ltd. (Google India) to Google Ireland Ltd. (Google Ireland). At its heart, the dispute involved a contract under which Google India purchased advertisement space from Google Ireland for a price, for further resale to advertisers in India – something akin to distribution rights. Among others, the CIT(A) had ruled that the payment made for such purchase amounted to “royalty” under Section 9(1)(vi) of the Income Tax Act.

Explanation 2 to Section 9(1)(vi) of the Income Tax Act has a rather lengthy definition of “royalty”. The critical portion of this definition is extracted below:

Explanation 2.—For the purposes of this clause, “royalty” means consideration (including any lump sum consideration but excluding any consideration which would be the income of the recipient chargeable under the head “Capital gains”) for—

  • the transfer of all or any rights (including the granting of a licence) in respect of a patent, invention, model, design, secret formula or process or trade mark or similar property.
  • the imparting of any information concerning the working of, or the use of, a patent, invention, model, design, secret formula or process or trade mark or similar property;
  • the use of any patent, invention, model, design, secret formula or process or trade mark or similar property

The CIT(A) had concluded that the payment made by Google India to Google Ireland was for distribution rights and that in the circumstances of the case, this was covered under the category of “similar property” in the Explanation 2 to Section 9(1)(vi).

Given that I am on a platform for sharing and discussing IP and related issues, I have tried my best to avoid highly tax-centric issues. In these parts (Part-I and Part-II), I will only deal with two issues examined by the ITAT in its order:

– the nature / status of the payments made by Google India to Google Ireland – whether the payment is to be treated as ‘royalty’ as opposed to just business income in the hands of Google Ireland, and

– who is the beneficial owner of the sum paid / payable by Google India.

I will not deal with the issues arising under the Transfer Pricing regime – that requires its own space.

Setting the Legal Context

On the first issue, it is relevant to note that Google Ireland did not have a permanent establishment in India and if the payment by Google India was solely treated as business income for Google Ireland, it is not chargeable to tax in India. If, however, the payment is ‘royalty’ under Section 9 of the Income Tax Act, the income is taxable in India. There would be a consequential and concomitant obligation to deduct TDS on Google India, depending on the finding on this issue.

On the second issue, if Google Ireland is not the “beneficial owner”, the beneficial rate of 10% under the Indo-Ireland DTAA would not be available. This requirement of being the “beneficial owner” to take advantage of the Indo-Ireland DTAA, arises from the text of the DTAA itself.

Critical Facts / Evidence Recorded

Google India and Google Ireland had entered into two separate contracts, which are at the heart of this decision:

1. The Distribution / Reseller contract (Paras 85-91):

a. Here, Google India was hired as the distributor / reseller of Google Adword program to advertisers.

b. The language of the contract states that Google Ireland is “providing advertisement space through the distribution program” for distribution by Google India and Google India, agrees to “market and distribute AdWords Program to Advertisers in the designated Territory”.

c. The “AdWords Program” was defined to mean the advertising program currently offered by Google under the name “AdWords.”

d. Google India is made responsible for any services to the advertisers, including signup, after-sales service and responding to queries.

e. No party was stated to acquire any intellectual property rights through this agreement, except for the limited purposes as may be required to implement the agreement.

2. Service Agreement (Paras 82-84):

a. Here, Google Ireland hired Google India for certain IT-enabled services, which were to be performed using the software / technology of Google Ireland. This agreement indicated that the ownership of IP right over such software, including confidential information, as well as over any derivative works, shall rest with Google Ireland.

b. There was oral testimony on record to state that the IT services offered by Google India primarily involved approving and administering advertisements to conform to Google editorial guidelines and responding to customer queries and other typical back office functions (Paras 93-94). Part of this included an assessment of whether a proposed ad violates any trademark. Use was made of an internal tool where trademark violations in an ad text are detected and if any such violation is detected, the ad is rejected. This internal tool is not available to the advertisers directly (Para 95).

3. The legal owner of the AdWords Program was Google Inc. USA and through two intermediate companies (Google Ireland Holdings, Google Netherlands Holdings BV), it was licensed to Google Ireland. Google Ireland, of course, licenses the same to Google India. During the course of the proceedings before the lower tax authorities as well as the ITAT, a request was made to produce all agreements at all four levels. However, only the agreements at the last two levels, i.e. Google Netherlands Holdings BV-to-Google Ireland and Google Ireland-to-Google India, were produced [Para 164].

Critical Findings of Fact from Evidence

4. On a wholesome reading of the Distribution / Reseller contract, the ITAT concluded that the Distribution / Reseller contract is not merely an agreement to provide / resell advertisement space but it is an agreement for facilitating the display and publication of an advertisement to targeted customers (Para 107).

5. Under the Service Agreement, the only IT enabled services rendered by Google India to Google Ireland related to the AdWords Program and nothing more.

6. Based on this inference, the ITAT concluded (Paras 108, 116):

“108. We have also examined the obligations cast upon [sic] [Google India] under the agreements and found the obligation cast upon [sic] [Google India] under the Google Adword distribution agreement can only be discharged with the help of the ITES division. Therefore, the Google Adword distributor agreement and the service agreement are to be read together as they are interconnected with the navel cord and without resorting to the service agreement the terms and conditions under the Google AdWord Distribution Agreement cannot be complied with. Therefore, in order to understand the function of Google Adword program, we have to read both the agreements together.

116…But in the instant case, [sic] [Google India] has not purchased the advertisement space for putting its advertisement online from [sic] [Google Ireland]. The assessee has been duly appointed a distributor under the Google Adword Distribution Agreement to distribute and sell the advertisement space obtained from [sic] [Google Ireland] under the Distribution Agreement. Under the distribution agreement, [sic] [Google India] was under obligation to provide pre-sale and after sale services with the help of ITES division. While providing after sales services / technical services, the assessee had access to the intellectual property rights and tools and informatives, derivative works owned by [sic] [Google Ireland]. In the instant case, assessee is not a simpliciter buyer of AdWord Space for putting the advertisement either for himself or for others…”

(Emphasis supplied in bold)

7. The findings of fact noted in paras 108 and 116 of the ITAT order, above, are repeated across several other portions of the order.

Please click here to view Part II of this post.

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