In Part I of this two-part guest post on the Google Adwords royalty tax case, Adarsh had explained the critical facts/evidence recorded in the case along with the critical findings of fact made by ITAT from such evidence. In Part II of the post below, he discusses the Tribunal’s findings on the legal issues and critically analyses them.
The ITAT Bengaluru Order in the Google AdWords Royalty Tax Case – Part II
Application of the Law to the Facts of the Case
1. The above findings of fact made the decision of the ITAT, quite simple. The ITAT found that the fee being paid by Google India to Google Ireland was not a fee for access to advertisement space simpliciter, but also for access to patent, technical know-how, IPRs, trade mark, the process, derivative works, brand features, etc., of Google Ireland [Para 135]. Thus, the payment made by Google India to Google Ireland under the Distributor / Reseller Contract was held to be royalty as per Section 9(1)(vi) of the Income Tax Act.
2. It bears to mention two important arguments raised by Google India to repel the above conclusion. First, Google India argued that payments made by residents to non-residents without a permanent establishment in India are subject to an equalization tax @ 6%, under the Finance Act, 2016. Thus, Parliamentary intent is to tax payments similar to the ones in the present case as business profit only. However, the ITAT rejected this argument by holding that the “equilization levy is to charged only on consideration for specified services and not others where there is use of IPR, copyright and other intangibles” and therefore, “the introduction of equilisation levy would not convert the nature of payment made by [sic] [Google India] to [sic] [Google Ireland].” [Para 139]
3. Second, it was contended that the use of trademarks by Google India was only incidental and thus, the payments cannot be termed as royalty, placing reliance on Director of Income Tax Vs. Sheraton International Inc., (2009) 178 Taxmann 84 Delhi and Formula One World Championship Ltd., Vs. CIT, (2016) 76 Taxmann 6 (Del). Both cases were distinguished on facts as those relating to advertisement services where use of trademark was considered incidental. In contrast, in this case, the ITAT observed that the use of the IPRs, technical know-how, trade mark, derivative works and other intangibles of Google Ireland was not incidental since the obligations under the Distributor / Reseller Contract cannot be fulfilled without the same [Paras 142, 145].
4. On the question of whether Google Ireland is the “beneficial owner”:
a. The ITAT notes that there are four layers of license agreements and no access was given to agreements beyond the layer of Google Netherlands Holdings BV-Google Ireland. Even this agreement, it was factually found by the ITAT, contained a clause for license fee payable by Google Ireland to the upstream company, though the quantum was not clear [Para 164].
b. The ITAT held that without all the agreements and details in place, it was not possible to predict the manner in which the revenue received by Google Ireland was being distributed to the upstream companies. On the other hand, the burden of proof was on the assessee to clarify based on evidence that Google Ireland was indeed the beneficial owner since it retained a substantial portion of the payment received from Google India [Paras 158, 165].
c. The finding also appears to be that a mere TRC or a Tax Residency Certificate, while acting as proof of residency of a company, will not amount to proof of beneficial ownership [Para 171].
d. Given the lack of evidence on this issue, the matter was remanded to the Assessing Officer solely on this issue [Para 172].
Short Critical Appraisal
Limiting myself to the issue of royalties, I have several critiques to offer:
1. First, for such a lengthy order, it is not at all clear under which specific part of Explanation 2 to Section 9(1)(vi) of the Income Tax Act, the payments were brought under. Right or wrong, at least the CIT(A) had identified distribution rights to be “similar property” and there also appear to be findings that the AdWords program is itself is a computer programme and thus, payments effectuated for transfer or use of the same would be “royalty”. This is not the finding of the ITAT. Instead, with a broad stroke, the ITAT simply declares that the transaction and the payment was for use of “patent, technical know-how, IPRs, trade mark, the process, derivative works, brand features, etc.”.
2. Second, even assuming all the findings of facts are correct, the fact remains that the composite transaction involved more than just a license to various forms of IP from Google Ireland. The findings do not negate the supply of advertising space for downstream advertisers brought on board by Google India. By its own order, ITAT has found that the payments by Google India to Google Ireland were towards: (i) obtaining advertising space; (ii) facilitating the display and publication of an advertisement to targeted customers; (iii) access to IP involved in the execution of these functions. There is no finding that items (i) and (ii) fell within the scope of Section 9(1)(iv). That being the case, in my view, the ITAT could not have assumed, without further analysis, the entire payment as being “royalty”.
3. Third, continuing from the second point above, again assuming ITAT’s findings on the interpretation of the Re-seller / Distributor Contract to be correct, the real question that remains unanswered in the ITAT order is whether payments for obtaining “advertising space” and “facilitating the display and publishing of an advertisement to targeted customers” would amount to “royalty”. In my respectful submission, the answer is a resounding ‘no’.
a. From an advertiser’s point of view, the AdWords program is simply a service offered by Google (ignoring the legal entities involved in the picture for the moment). For instance, the AdWords program allows the advertiser to get links of their products or services displayed during the course of displaying search results on Google’s search engine.
b. Ultimately, the advertiser gets no access to copyrighted material or any other IP.
c. Google Ireland can take any business approach to make this service available.
d. Google Ireland has chosen to follow a model whereby Google India is engaged to market this service and sign up advertisers for this service. Once an advertiser agrees to use the service, Google India takes the responsibility of signing them up, assist them in availing these services and provide any after-sales services, if required.
e. Google India signs an agreement with the advertisers, where the advertiser takes full responsibility of the website links (URLs) to be displayed and identification of the keywords, which when used in the search engine, should display these URLs. Google India gets paid on a per-click basis.
f. Presumably, and it seems logical, the search result page is not in the control of Google India and from Google India’s perspective, it is in Google Ireland’s control. In the re-seller / distributor contract, Google Ireland commits itself to providing the advertisement space on the search result page.
g. I did not see the payment clause of the Re-seller / Distributor Contract extracted in the order. However, it appears that Google India retains part of the fee paid by the advertiser and sends the rest of it to Google Ireland.
h. From the advertiser’s perspective, it is paying a certain fee to Google India for putting up their URLs on the search result page in certain cases (revenue model may be per-click). Google India retains a sort of a fee for services rendered as a distributor of another service offered by Google Ireland. Ultimately, the “advertisement space”, meaning the search results page where the URLs will be displayed, is being provided by Google Ireland and thus, Google India pays Google Ireland for providing that space.
i. Obviously, on a digital platform, this display of the URLs on the search result page involves the use of software / computer programmes. That is merely the mode of execution of the advertisement service. In the scheme of things, the primary service being rendered is providing an advertiser with space on search page results and use of any software or other means to render this service, is merely incidental.
4. Fourth, for the Service Contract, some payment was received by Google India from Google Ireland, though the ITAT order does not get into the finer details of the same. It was also undisputed that the Contracts were executed on different dates. If these were to be accounted for, prima facie, it is not as if the transactions were a sham/ surreptitiously split. If there is some mala fide involved, the story would be something like this – the parties were aware that the performance of the Distributor / Resellers Contract required use of IP and thus, payments could be taxed as “royalty”; to avoid this, the parties created a separate transaction as a Service Contract to give access to the required IP. I’m not sure if the facts narrated would lead someone to that conclusion, at least from an evidentiary stand-point. There is also no finding to the effect that there was an intentional attempt to circumvent the law.
5. Fifth, even assuming it was factually correct that the ITES services rendered by Google India were themselves limited to the AdWords Program, it is possible and logically consistent to split said ITES services from supplying online advertisement space. Imagine a contract between an OEM and a distributor for distribution of a tangible product and a separate contract awarded to the distributor for installation and after-sale services. The distribution contract may not necessarily involve IP, but installation and after-sales services may require access to confidential information / know-how / other IP. This does not convert the distributorship into an IP license agreement. It appears that this is exactly what the ITAT appears to have done. It is true that online and digital platforms may require new ways of thinking and approach on several fronts, but I am not entirely sure whether what was done in this case was appropriate. Another perspective to consider is that the two components of the transaction could have been contracted with two different entities as well – therefore, to tie them together without any finding that the transactions are a sham simply because both components were with the same entity, seems unjustified.
6. Time and again, the ITAT quotes precedents to state the contractual terms must be read to fully understand the nature of the transaction and yet, with respect, to me it appears perverse for the ITAT to have focused on only one aspect of the transaction to characterize the composite transaction (and this is assuming the two contracts were to be read together as a composite transaction).