The applicant is a pharmaceutical company and has filed application before this authority on 10th December, 2013. In the application the applicant mentioned that in order to promote its sales in Russia and develop a local brand plan for the same, it proposed to enter into a Service Agreement with its subsidiary, i.e. DRL Russia, to avail of product promotion services. In the application the applicant further mentioned that under the agreement, DRL Russia was to render marketing services related to promotion of goods from the producers to the end customer by way of meeting with medical and pharmaceutical experts, participation in pharmaceutical circles and distribution of promotional materials to medical and pharmaceuticals experts. In consideration for these services the applicant was to remunerate DRL Russia on cost plus markup basis. Subsequently, this agreement came into effect from 30th January 2014.
2. The applicant requested for ruling on the following questions:-
1) Whether, on the facts and circumstances of the case, the service fee payable by the Applicant to DRL Russia under the Service agreement will be regarded as Fees for Technical Services (‘FTS’) under Section 9(1)(vii) warranting withholding of tax at source under section 195 of the Act?
2) Whether on the facts and circumstances of the case, the service fee payable under the Service agreement will be regarded as fees for technical services under Article 12 of the Agreement for avoidance of double taxation and prevention of fiscal evasion between India and the Russian Federation (‘the India-Russia DTAA’)?
3) If the answer to Question 1 & 2 is negative, whether on the facts and circumstances of the cases, the service fee payable by the Applicant to DRL Russia is taxable in India under Article 7 of the India-Russia DTAA?
4) If the answer to the Questions 1, 2 & 3 are in negative, whether on the facts and circumstances of thecase, the service fee payable by the Applicant to DRL Russia is taxable under Article 22 of the India-Russia DTAA?
5) If the answers to any of the Questions 1, 2, 3 or 4 is in negative, whether on the facts and circumstances of the case the provisions of Section 40(a)(i) of the Act are applicable on the payment being made by the Applicant to DRL Russia?
3. In the application the applicant took the stand that DRL Russia is a mere marketing and distribution arm for the applicant in Russia and accordingly service fee could be considered as income arising through or from any business connection in India under the Act. It was also mentioned that the service fee paid did not fall within the ambit of the definition of FTS as these were not managerial, technical or consulting in nature. The applicant further submitted that the service fee received by DRL Russia was business income but in the absence of its PE in India, the income arising to DRL Russia was not chargeable to income-tax in India under the India-Russia DTAA. As the service fee, according to the applicant, was business income, it was argued that such income could not be categorized as other income within the scope of Article 22 of India- Russia DTAA.
4. During the course of hearing it was further revealed that the applicant had entered into three separate agreements with DRL Russia (and not only one as disclosed in the application). These agreements are:
A. Distribution agreement dated 16.2.2012 under which DRL Russia imports goods from the applicant and distributes the same in the Russian markets.
B. Market research service agreement dated 30.1.2014 to provide market, product and competitor intelligence to the applicant.
C. Product Promotion Service agreement dated 30.1.2014 for undertaking the activity of promoting specific product/brand awareness with the related stake holder.
5. As regards treatment of service fee under Article 7 or Article 22 of India-Russia DTAA, the Department of Revenue also did not come up with any arguments.
6. During the course of hearing before us, the main arguments centered on the following issues:-
A. Whether the product promotion services can be treated as Fees for Technical services (‘FTS’) under the provisions of Income-tax Act 1961 (‘Act’) or under the provisions of India Russia Double Taxation Avoidance Agreement.
B. If it is treated as FTS, whether it will be covered by exception under section 9(1)(vii)(b) of the Act.
7. Article 12 of the India Russia DTAA defines FTS as follows:
‘For the purposes of this Article, “fees for technical services” means payments of any kind in consideration of the rendering of any managerial, technical or consultancy services including the provision of services by technical or other personnel but does not include payments for services mentioned in Article 14 and 15 of this Agreement.”
The definition of FTS under the India-Russia DTAA is similar to the definition of FTS under the Act. Section 9(1)(vii) of the Act reads as below:
“(vii) income by way of fees for technical services payable by –
(a) The Government ; or
(b) A person who is a resident, except where the fees are payable in respect of services utilized in a business of profession carried on by such person outside India or for the purposes of making or earning any income from any source outside India ; or
(c) A person who is a non-resident, where the fees payable in respect of services utilized in a business or profession carried on by such person in India or for the purposes of making or earning any income from any source in India:
Explanation 2 – For the purposes of this clause, “fees for technical services” means any consideration (including any lump sum consideration) for the rendering of any managerial, technical or consultancy services (including the provision of services of technical or other personnel) but does not include consideration for any construction, assembly, mining or like project undertaken by the recipient or consideration which would be income of the recipient chargeable under the head “Salaries.”
Under section 9(1)(vii) of the Act, any income in the nature of Fees for Technical Services (‘FTS’) payable by a resident to a nonresident is deemed to accrue or arise in India.
8. The applicant took the stand that since in pursuance of product promotion agreement the Applicant has engaged DRL, Russia merely for marketing and promoting the products of the Applicant, the same did not fall within the ambit of the definition of FTS as these are not managerial, technical or consultancy in nature. It was submitted that the information collected by medical representatives are in relation to stock availability and demand for products in a pharmacy, which is not required by and relevant to the market research team. It was further mentioned that work of market research team and that of product promotion team are not at all related and interdependent and, consequently, the Service fee payable by the Applicant for product promotion shall not be regarded as a sum chargeable to tax under the provisions of the Act warranting withholding of tax at source under Section 195 of the Act.
9. It was further submitted by the applicant that DRL Russia does not have a PE in India in terms of Article 5 of the DTAA and the consideration received by DRL Russia from the applicant in relation to the product promotion services rendered in Russia is business income not chargeable to tax in India in the absence of PE. It was also submitted that when an item of income is covered by Article 7 of the DTAA, there is no question of going to the residuary Article 22 (other income).
10. During the course of hearing it was explained by the applicant that the services, being rendered by product promotion team consisting of medical representatives of DRL, Russia, comprised merely promotion services in nature by way of meeting doctors and pharmacies and thus, the activities carried out by product promotion team of DRL, Russia were purely commercial in nature and its role was that of an executor rather than of a manager managing the business of DRL India in Russia. It was submitted that such services did not require/ involve any expertise or technology and the services did not partake the rendering of any advice or opinion to the Applicant and thus such services did not fall within the ambit of “consultancy services” under section 9(1)(vii) of the Act. Without prejudice to the above, the applicant has stated that even if the product promotion service is considered as FTS, still it falls under the exception provided in Section 9(1)(vii)(b) of the Act and, hence, service fee payable to DRL Russia shall not be chargeable to tax as FTS. The applicant has argued that under the principle of source rule, income of a recipient is chargeable to tax in the country where the source of payment is located, where service provider or payee is located and where services are rendered by non-resident. The applicant has also submitted that expenditure on account of service fees was incurred in order to enhance its export in Russian Federation and in hiscase the ownership of exported goods pass on to the importer only after acceptance of the registration at the customs of the Russian Federation and, thus, export activity is fulfilled or concluded in Russia. Based on this premise the applicant has taken the stand that the source of income is not located in India.
11. In support of its stand the applicant relied on several case laws like Intertek Testing Services India Ltd (307 ITR 418), Linde A G vs ITO (62 ITD 330), R. Dalmia Vs CIT (106 ITR 0895), UPS SCS (Asia) Limited (2012) (50 SOT 268) (Mumbai ITAT), GVK Industries Ltd. V. ITO [2015] (317 ITR 0453), Mahindra & Mahindra (2009) (122 TTJ 0577 (SB) (Mumbai ITAT), CIT Vs Bharti Cellular Limited and others (319 ITR 139), UPS SCS (Asia) Limited (2012) (50 SOT 268), Lufthansa Cargo India Pvt Ltd (2015) (375 ITR 0085)
12. The Department of Revenue in its initial comments dated 11.12.2015 had agreed with the reasonings given by the applicant that the consideration received for product promotion services was not FTS. As regards the issues relating to PE and other income also the Department did not dispute the stand of the applicant. However, later on the Department changed the stand saying that consideration received by DRL Russia was in the nature of FTS. The main points of Department’s submissions are as under:-
(a) The applicant, a manufacturer of pharmaceutical products in India, is exporting and selling its products to DRL Russia (its Russian subsidiary) under a contract for supply of goods dt. 16.02.2012 (Contract No.DRL/01/2012). The salient features of the contract are summarized below:
I. It was entered on ‘principal-to-principal’ basis
II. It is for a fixed period, upto 31.12.2016
III. It is for a fixed price, i.e. 10 billion Russian Roubles approximately.
IV. The applicant is, in no manner, involved in or accountable for selling of the goods in Russia.
(b) Almost 2 years after entering into the contract for supply of goods (referred to above), the applicant entered into two separate agreements with the same company, i.e. DRL Russia, for provision of services by the latter. The salient features of the contract are:
I. Both the contracts were entered on the same date and are the same except in respect of the “Subject of Agreement”.
II. One agreement is for provision of ‘Consultancy and market research services’ while the other is for provision of “Marketing services”
III. Both were entered on ‘principal-to-principal’ basis.
IV. Both are open-ended in terms of periodicity.
V. In both, the consideration was fixed similarly, i.e. cost plus 4%.
VI. In both, DRL Russia has to send periodical reports in confirmation of services having been rendered.
Thus, in respect of ‘goods’, the applicant is the supplier and DRL Russia is the customer; in respect of the ‘services’, the relationship is just the reverse, i.e. DRL Russia is the supplier and the applicant the customer.
(c) Considering that the contract for supply of goods by the applicant to DRL Russia, had been entered into in February, 2012 and there is nothing in the contract to suggest that the applicant would be involved in any manner in the actual marketing of those goods in Russia, there is no occasion to entertain the proposition that the marketing service rendered by the later to the applicant is in connection with actual marketing of any goods in Russia.
(d) Marketing of pharmaceutical products is a specialized field. It is quite different from marketing of consumer goods which may involve just brand promotion, advertising, etc and can be done by engaging laymen or even by seeking endorsement by celebrities. According to the applicant, the marketing services are rendered by DRL, Russia by engaging 700+ medical representatives.
(e) DRL, Russia has the specified knowledge of the dynamics of the Russian market. This is discernible form the service agreement the relevant part of which is as under:
“1.1 The Service provider has the experience and resources to provide services related to the medical affair support and service related to the monitoring of Russian pharmaceutical market;
1.2 The Service Provider has the extensive knowledge of the Russian pharmaceuticals market.”
(f) The reports were sent by DRL, Russia and were utilized by the applicant for purposes of its own business in India.
(g) Two separate agreements were entered into on the same day i.e. 21.12.2013 by the applicant with DRL, Russia for services. It is noticed that two kinds of services are actually inter-connected and together constitute marketing services.
(h) As per the information furnished by the applicant on 05.01.2016, DRL Russia has engaged 24 individuals for market research services and 717 individuals for marketing (product promotion) services (as per October, 2015 payroll). The market research team of DRL Russia does research on Russian market by comparing DRL India with other pharmaceutical companies operating/selling products in Russia, comparing DRL brands/portfolio (trade names) with other brands in the Russian market and submits monthly reports on marketing strategy services to the applicant. The DRL Russia then prepares a yearly ‘Brand Plan’ for brand/portfolio of the applicant. A brand plan of a portfolio includes the sales summary, region-wise performance, competitor strategy review, prescription audit, current strategy, strategy assessment, SWOT analysis, planned strategy and approach for the coming year. The market research team also prepared ‘Strategic Competitors Analysis’ report wherein analysis of important competitors’ brands in the Russian market is done. Thereafter, the market research team prepares presentations for the purpose of utilization by the market/medical representatives when they make field visits. These presentations are prepared only in the Russian language as they are used in Russia. All other previous reports – Report on marketing strategy services, Brand Plan and Strategic Competitor Analysis – are submitted in English by DRL Russia to applicant. The presentations prepared by the market research team highlights the advantages that brands of DRL India have over other similar products of the competitors. As per the submission of the applicant, the DRL Russia adopts a two-pronged strategy to increase awareness about the products and thereby enhance sale of goods. The medical representatives promote the brands of DRL India by displaying the presentations prepared by the market research team before the doctors and experts in the relevant area.
13. The Department has made a distinction on the basis of facts involved with respect to the judgments relied upon by the applicant and has relied upon following case laws:-
(i) International Hotel Licensing Company [2006](288 ITR 534) (AAR)
(ii) GVK Industries vs ITO (2015) 54 taxmann.com 347 (SC)
(iii) Wallace Pharmaceuticals (P) Ltd [2005] 278 ITR 97 AAR
(iv) Intertek Testing Services India Pvt. Ltd., [2008] (175 Taxman 375) (AAR)
14. We have gone through the facts of the case in detail during the course of hearing spread over several days. It is true that in the application filed by the applicant only one agreement relating to product promotion service was mentioned and the application was silent on other agreements signed by it with DRL Russia. However, later on it disclosed that it had first entered into a contract for supply of goods on 16th February, 2012, called as “Distribution Agreement”. According to this agreement the applicant was to sell customer medicines and food supply to the Russian company. The research service agreement and product promotion services agreements were signed on much later i.e. on 30th January, 2014. The first agreement was in respect of market research services on study of characteristics of the brand, identifying unsatisfied needs in relation to the brand, identifying the current perception of the image of the goods in a competitive environment. The second agreement was in respect of marketing services related to promotion of goods from the producer to the end-customer by way of meeting with medical and pharmaceuticals experts, participation in pharmaceutical circles, distribution of promotional materials to medical and pharmaceuticals experts.
15. It is true that the second agreement relating to promotion of goods signed on 30th January, 2014 cannot be related to the distribution agreement dated 16th February, 2012, which was signed about 2 years prior to this agreement. However, the main argument of the Department of Revenue is that even promotion of goods involving brand promotion and advertising etc has been done by DRL Russia utilizing the specialized knowledge of the dynamics of the Russian market and, therefore, services rendered by DRL Russia by utilizing services of professionally qualified personnel were professional in nature. The stand of the Department is based on the assumption that the reports of medical representatives of DRL Russia are sent to India which is being utilized in India for the purpose of brand promotion in Russia. The Department has further assumed that the marketing services for research agreement and marketing services for promotion of goods agreement are interconnected and they together constitute marketing services. According to the Department the marketing research team prepares presentations for the purpose of utilization by medical representatives when they make field visits and such presentations highlight the advantages that brand of DRL India have over other similar products of the competitors. During the course of hearing we repeatedly asked the CIT (IT & TP), Hyderabad, Mr. Singhania, whether he had any evidence to support his assumptions, particularly the fact that reports prepared by the product promotion team were in respect of brand promotion and were utilized in India by the applicant. He could not produce any. It is also noticed that the Department had conducted a survey u/s 133A of the IT Act in the business premises of the applicant but could not find any such evidence and did not even ask any question relating to this aspect in the statements recorded of senior executives.
16. The facts presented by the applicant do not support the assumptions made by the department. The applicant has stated that medical representatives of DRL Russia merely promote the goods by way of meeting doctors and pharmacies and their activities are executory in nature since such services do not entail the rendering of advice to the applicant. Based on this fact it cannot be said that DRL Russia is providing any consultancy service. The Department has based its arguments merely on the assumptions. They have not been able to establish that the reports prepared by market research team were utilized by medical representatives and their reports, in turn, related to brand promotion which were further utilized by DRL India. On the contrary sample reports submitted by the applicant show that the information collected by medical representatives are in relation to stock availability and demands for product in a pharmacy. If this is so such reports are not relevant to the research team. There is no evidence to suggest that the reports prepared by medical representatives have been utilized by DRL India in respect of brand promotion or for deciding the strategy for sale of goods in Russia. In order to establish that consultancy services have been provided based on work undertaken by medical representatives it is necessary that these services should be utilized by DRL India for brand promotion. Both the department and the applicant have relied on the decision of the Hon’ble Supreme Court in the case of GVK Industries (supra). This decision makes it very clear that consultation entails deliberations, consideration, conferring with someone, conferring about or upon the matter. As there is no evidence to suggest that DRL India is consulting DRL Russia in pursuance of the agreement for promotion of goods, this agreement cannot be considered for providing consultancy services. As regards other agreement for marketing research services, the applicant has already offered the same for taxation.
17. The Department has also relied on the ruling given by this authority in the case of International Hotel Licensing Company (supra) wherein it was held that services provided in the form of advertising, marketing promotion, sales program and special service and other programmes amounted to rendering of managerial and consultancy services. However, the facts in the case of International Hotel Licensing clearly indicated that the services were being rendered to the Indian company by the foreign company. The Authority had gone into the classification of expenses relating to services provided by the foreign company and then it had concluded that it was providing services both within and outside India in the form of advertising, marketing promotion, sales programme and special services. In the instant case it is not possible to derive any such conclusion on the basis of agreement for promotion of goods. The reports prepared by DRL Russia in respect of this agreement are merely statistical in nature and do not support this stand. Therefore, the services relating to promotion of goods cannot be categorized as consultancy services.
18. The alternative argument of the department relating to services being managerial in nature is also far-fetched because the job of medical representatives is merely to meet doctors and pharmacies. Such jobs cannot be said to be managing the affairs of DRL India in Russia. The ruling of this authority in the case of Intertek Testing Services India Ltd (supra) held that managerial services essentially includes controlling, directing or administering the business. All such elements are absent in this case. Therefore, the services rendered pursuant to this agreement cannot be classified as managerial services either.
19. As we have concluded the services rendered by DRL Russia in respect of agreement for promotion of goods cannot be treated as fees for technical services, it is not necessary to go into the argument whether such services will be covered by exception u/s 9(1)(vii)(b) of the Act though the applicant has argued that his case is covered by exception. However, it is suffice to say that the stand and argument of the applicant is completely faulty mainly because the product promotion agreement dated 30.1.2014 cannot be related with distribution agreement dated 16.2.2012 signed two years ago, under which exports were made. Therefore it cannot be said that service fees under product promotion agreement were paid in order to promote its products for enhancing export in Russian market. Even in the case of exports the issue has already been settled by the Delhi High Court in the case of Havells India Limited 21 taxman.com and the relevant para is reproduced as under:-
“Section 9(i)(vii)(b) contemplates a source located outside India. It is difficult to conceptualize the place/situs of the person who make payment for the export sales as the source located outside India from which assessee earned profits. The export contracts obviously are concluded in India and the assessee’s products are sent outside India under such contracts. The manufacturing activity is located in India. The source of income is created at the moment when the export contracts are concluded in India. Thereafter the goods are exported in pursuance of the contract and the export proceeds are sent by the importer and are received in India. The importer of the assessee’s products is no doubt situated outside India, but he cannot be regarded as a source of income. The receipt of the sale proceeds emanate from him from outside India. He is, therefore, only the source of the monies received. The income component of the monies or the export receipts is located or situated only in India. We are making a distinction between the source of the income and the source of the receipt of the monies. In order to fall within the second exception provided in Section 9(1)(vii)(b) of the Act, the source of the income, and not the receipt, should be situated outside India.”
20. The answers to the questions raised by the applicant are given as under:-
Ques 1&2 The service fee payable by the applicant to DRL Russia under the agreement for promotion of goods cannot be regarded for the purpose of fees for technical services.
Ques 3&4 The service fee paid by the applicant to DRL Russia is not taxable either under Article 7 or Article 22 of the India-Russia DTAA.
Ques 5 Not applicable as the question is consequential in nature.