Section 9(1) of the Income-tax Act enumerates incomes deemed to accrue or arise in India, and clause (vii) deals specifically with fees for technical services. These are deemed to accrue in India if paid by the government or a resident unless certain exceptions apply. They are also deemed to accrue if paid by a non-resident for services used in India.
Clause (vii) provides that fees for technical services shall be considered to accrue in India when paid by the government, a resident (except for use in business outside India), or a non-resident when the services are used for business or income earning from a source in India.
The provision includes an exception for agreements approved by the Central Government before 1 April 1976, and clarifies that agreements entered after that date are treated as approved if based on proposals approved before that date.
Included Within the Definition of Fees for Technical Services
The scope of fees for technical services includes consideration for rendering managerial, technical, or consultancy services. It also includes any lump sum consideration for such services and the provision of technical or other personnel.
Excluded From the Definition of Fees for Technical Services
Fees paid for construction, assembly, mining, or similar projects are excluded. Additionally, any income taxed under the head Salaries is also outside the scope of FTS.
Taxability of Fees for Technical Services in the Hands of Resident or Non-Resident
The income is deemed to accrue in India in the following scenarios:
When it is paid by the government of India
When it is paid by a resident, unless it is for services used in a business or profession outside India, or for earning income from a source outside India
When it is paid by a non-resident, where the services are used in a business carried out in India or to earn income from a source in India
Situations Where Income is Not Deemed to Accrue in India
If the payment is made by a resident or government, but the services are used in business conducted outside India or to earn income from sources outside India, the fees are not considered to accrue in India and are therefore not taxable under Indian law.
Nexus Approach to Determine Taxability
The taxability under section 9(1)(vii) is based on the nexus between the services and India. If the services rendered have a connection to a business or income source in India, the FTS is taxable in India. If the services have no nexus to India, even if paid by a resident, the fees are not deemed to accrue in India.
For instance, if an Indian resident pays an overseas consultant to assist in establishing a business in another country, the fees are considered to have no Indian nexus and hence are not taxable. On the other hand, if a non-resident pays another non-resident for consultancy related to establishing a business in India, the nexus exists, and the payment is deemed to accrue in India.
Case Study on Lack of Nexus
Consider a resident Indian pharmaceutical company that plans expansion in South and Latin America. It hires a Brazilian consultant to provide industry insights and structural advice. Since the services are used to set up or expand business outside India, there is no nexus with India. Therefore, the payment to the Brazilian consultant does not accrue or arise in India and is not subject to Indian tax.
Case Study on Existence of Nexus
Consider a non-resident company based in Italy engaged in sanitaryware manufacturing. The company plans to enter the Indian market and hires a UAE-based consultant for advice on structuring its Indian business. Despite both the payer and the consultant being non-residents, the consultancy is for establishing operations in India. Thus, there is a clear nexus with India, and the fee paid may be considered taxable in India under section 9(1)(vii)(c), subject to the provisions of the India-UAE DTAA.
Foreign Companies Having a Permanent Establishment and Receiving Fees for Technical Services
Section 44DA applies when the non-resident receiving fees for technical services has a permanent establishment or fixed base in India. In such cases, the income is taxable as business income by the regular provisions of the Act. This section requires that expenses claimed must be directly and exclusively incurred for the Indian PE’s business.
The section also disallows deductions for expenses reimbursed to head offices or other branches unless they are actual reimbursements. PE is defined under this section as a fixed place of business through which the business is wholly or partly conducted.
Interpretation of what constitutes an expense wholly and exclusively incurred for the PE is subjective. Rule 6GA provides that such foreign entities must maintain books of accounts and undergo audits as required under section 44AA. An audit report in Form 3CE must be filed one month before the due date for return filing under section 139(1).
Proper documentation is critical to establish the link between expenses and the business of the Indian PE, as this helps avoid disputes and litigation.
Taxation of Fees for Technical Services on Gross Basis Under Section 115A
When a non-resident receives FTS not connected to a PE in India, section 115A applies. In such cases, the income is taxed at 20 percent on the gross amount received. To qualify for this, the agreement under which the fees are paid must be approved by the Central Government or be part of the industrial policy framework.
This section also prohibits deductions for any expenses incurred in earning such income. Thus, unlike section 44DA, which allows for deductions on a net basis, section 115A mandates gross taxation.
Withholding Tax Provisions for FTS Payments to Residents and Non-Residents
For residents, section 194J requires tax deduction at source when making payments for technical or professional services. There are exemptions:
No TDS if the payment is less than INR 30,000
No TDS if payer’s turnover is below INR 1 crore for business or INR 50 lakh for profession
No TDS by individuals or HUFs if the services are used for personal purposes
For call center services, the TDS rate is 2 percent
For specified professional services such as medical, engineering, legal, or accounting, TDS is deducted at 10 percent
In other cases of technical services, TDS is deducted at 2 percent
For non-residents, section 195 mandates the deduction of tax at source. As per the Finance Act, the rate is 20 percent, unless a lower rate applies under an applicable DTAA. The payer must also comply with additional documentation requirements under section 195(6) and Rules 37BB and 37BC.
Consequences of Non-Compliance with TDS Requirements
If TDS is not deducted or not deposited with the tax authorities, then under section 40(a)(i), the expense is disallowed while computing business income. This can significantly increase the taxable profits. The payer may also be treated as an assessee in default, attracting interest and penalties under sections 201 and 271C, respectively. Therefore, timely and correct deduction and deposit of tax is crucial when making FTS payments to non-residents.
Scope of Fees for Technical Services Under Section 9(1)(vii)
The scope of taxation under Section 9(1)(vii) of the Income-tax Act, 1961, extends to cover fees for technical services (FTS) rendered by a non-resident to an Indian resident or a foreign company having a business connection or permanent establishment (PE) in India. The section deems such income to accrue or arise in India, irrespective of where the services are rendered. As a result, the income becomes taxable in India in the hands of the non-resident service provider. The underlying idea is that the payer of the FTS—being a resident or having a business connection in India—derives benefit from the services, and therefore, the income arising to the service provider is subject to tax in India.
The explanation to Section 9(2) further clarifies that the provisions of this section apply whether or not the non-resident has a residence or place of business or business connection in India. This essentially means that the mere act of providing technical services to an Indian entity is sufficient to trigger taxation in India. This deeming fiction aims to expand the Indian tax net on non-residents providing such services from abroad. The law here overrides the general principle that income is taxed at the place where the service is performed. As a result, FTS payments made to non-residents become taxable in India, even if the services were rendered entirely outside India.
Key Judicial Interpretations on FTS
Several landmark judicial pronouncements have clarified the scope and nature of FTS. In the case of GVK Industries Ltd. v. ITO, the Supreme Court of India emphasized that for a service to qualify as FTS, there must be a clear and substantial rendering of technical or consultancy services that involves human intervention. The ruling established that mere provision of a standard facility or access to a database or network without any human element does not qualify as technical services.
In another important decision, the Delhi High Court in the case of CIT v. Bharti Cellular Ltd. ruled that interconnection services provided by telecom operators without any human involvement did not constitute technical services. The court highlighted that to be classified as FTS, the service must be specialized, involve human expertise, and be rendered through human effort. Therefore, mere automated services, or those that do not involve direct human involvement in the process of rendering, fall outside the scope of FTS.
Furthermore, the Karnataka High Court in CIT v. De Beers India Private Ltd. held that the service must make available technical knowledge, experience, skill, or know-how to the recipient. This principle has also been echoed in the context of Double Taxation Avoidance Agreements (DTAAs), particularly under the “make available” clause found in treaties with countries like the United States and the United Kingdom. Such interpretations have helped define the contours of what constitutes FTS under Indian tax law and have guided the differentiation of taxable FTS from non-taxable services.
Exclusions and Exceptions from FTS Taxation
There are certain exclusions where services do not qualify as FTS for taxation purposes. Services of a purely commercial or managerial nature that do not involve specialized or technical knowledge are not considered FTS. For instance, routine accounting, payroll processing, or data entry services may not be classified as technical services under the Act, especially if they do not involve any technical input or consultancy.
Similarly, services rendered by a non-resident that are incidental to a contract for the sale of goods or construction, installation, or commissioning of a plant, and which do not involve technical or consultancy aspects, may not be taxable as FTS. These kinds of integrated contracts, where the services form an inseparable part of a larger contract, can be excluded from the ambit of FTS if the services do not have a standalone technical or consultancy component.
Furthermore, payments made to foreign professionals such as lawyers, accountants, or consultants may not be considered FTS unless their services are technical or consultancy in nature and not merely legal or financial advisory. The determining factor is the nature of the service, not the designation or profession of the service provider. Each case needs to be examined on its facts to determine whether the services involved technical expertise or consultancy input that could be taxed under FTS provisions.
Tax Withholding on FTS Payments
Under Indian tax law, any person making a payment of FTS to a non-resident is required to withhold tax at the prescribed rate under Section 195 of the Income-tax Act. The current withholding rate for FTS is 10% (plus applicable surcharge and cess) in the case of payments to non-residents under the Income-tax Act. However, if the rate specified under the applicable Double Taxation Avoidance Agreement (DTAA) is lower, and the non-resident provides a valid Tax Residency Certificate (TRC), the beneficial rate under the treaty may be applied.
It is important to note that the obligation to deduct tax arises at the time of credit of such payment to the account of the non-resident or at the time of payment, whichever is earlier. The deductor is also required to furnish Form 15CA and Form 15CB (in specified cases) while making the remittance to the non-resident. Failure to deduct or deposit tax can result in disallowance of expenses under Section 40(a)(i) and may attract interest and penalty under various provisions of the Income-tax Act.
In cases where there is ambiguity as to the nature of the payment, the payer may apply to the Assessing Officer under Section 195(2) to determine the appropriate portion of the payment that is taxable. This helps avoid unnecessary litigation and provides certainty to the payer regarding the amount of tax that needs to be withheld. Hence, the process of tax withholding on FTS payments is critical and must be adhered to meticulously to remain compliant with the provisions of Indian tax law.
FTS Under Various DTAAs
Different DTAAs entered into by India define FTS differently, and the treaty provisions override the domestic law provisions in case of any conflict, subject to the taxpayer meeting the conditions laid out in Section 90 of the Income-tax Act. Many treaties—like those with the USA, UK, Canada, Australia, and the Netherlands—include a “make available” clause, which requires that the service provider make available technical knowledge, skill, or know-how to the recipient for the payment to be classified as FTS.
For example, under the India-USA DTAA, Article 12 defines FTS as services of a managerial, technical, or consultancy nature, but adds that such services must make technical knowledge, experience, skill, or know-how available to the recipient. This clause has led to a narrower interpretation of FTS, and several Indian courts have ruled that unless the service recipient is enabled to apply the technical knowledge independently in the future, the payment cannot be treated as FTS under the treaty.
Other treaties, such as the India-Germany DTAA and India-France DTA, do not contain the “make available” clause, and therefore, the domestic definition of FTS under Section 9(1)(vii) may be applied more broadly. Taxpayers must carefully evaluate the relevant treaty provisions to determine the applicability of tax on FTS payments. Where the treaty provides relief or a lower rate, and the non-resident furnishes the necessary documentation,including a valid TRC, the payer can avail of the treaty benefit.
It is also worth noting that the nature and extent of services, the presence of a PE in India, and the location where services are performed are all crucial considerations under the DTAA context. For instance, if the services are effectively connected to a PE in India, the FTS may be taxed as business income under Article 7 of the relevant treaty instead of Article 12. Thus, FTS taxation under DTAA depends heavily on the facts of each case and the exact wording of the applicable treaty.
Permanent Establishment and FTS
In certain situations, the classification of income as FTS or as business income may depend on whether the non-resident has a Permanent Establishment (PE) in India. Under several DTAs,f ifhe non-resident has a PE in India and the FTS is effectively connected with such PE, the income will be taxed as business profits rather than under the FTS clause. In such cases, the income is subject to tax on a net basis, after allowing for expenses, rather than on a gross basis as in the case of FTS.
This distinction is important because it affects the rate and manner of taxation. While FTS is generally taxed at a flat rate on a gross basis, business income taxed under Article 7 of the DTAA is taxed on net income and is subject to the normal corporate tax rate. However, the burden of proof lies on the taxpayer or the payer to establish that a PE exists and that the income is effectively connected with such PE.
Where no PE exists, FTS payments are usually taxed under Article 12 of the DTAA. Tax authorities may examine the nature of the services rendered, the duration of stay of personnel in India, and the fixed place of business or dependent agent presence to determine whether a PE exists. Careful planning and documentation are essential to defend the position taken on FTS classification and its connection to a PE.
Apportionment of Consideration Between FTS and Other Payments
Often, contracts for services or turnkey projects may involve a mix of payments, including fees for technical services, supply of goods, installation, training, and post-sales support. In such cases, the tax authorities may seek to bifurcate the consideration and allocate a portion to FTS based on the nature of services provided. This is particularly relevant in cases where a lump sum consideration is paid, and no separate break-up is provided.
To avoid potential disputes, parties should document the nature and scope of each component of the service contract and provide a reasonable break-up of the consideration in the agreement. Transfer pricing documentation may also be relevant in cross-border intra-group service arrangements.
Where appropriate, taxpayers may also approach the Advance Ruling Authority under Section 245N for a binding ruling on the taxability of a particular transaction or the classification of income as FTS. The Authority for Advance Rulings (AAR) has dealt with several complex FTS issues in cross-border transactions and can offer clarity and certainty on the applicable tax treatment.
Taxability of Fees for Technical Services in the Hands of a Non-Resident
Section 9(1)(vii) of the Income-tax Act, 1961, specifies that income by way of fees for technical services payable by the Government or a resident shall be deemed to accrue or arise in India, except where the fees are payable in respect of services utilized in a business or profession carried on by such person outside India or to make or earn any income from a source outside India. In cases where fees for technical services are payable by a non-resident, the income is deemed to accrue or arise in India only if the fees are payable in respect of services utilized in a business or profession carried on by such person in India or to make or earn any income from a source in India. Therefore, the taxability of fees for technical services in the hands of a non-resident depends on the place of utilization of such services. If services are utilized in India, then such income shall be taxable in India under section 9(1)(vii). However, if such services are utilized outside India, the fees are not deemed to accrue or arise in India and thus are not taxable in India. The terms ‘utilized in a business or profession carried on by such person outside India’ or ‘to make or earn any income from a source outside India’ are subject to factual determinations. The location of the payer is not the determining factor for taxability; it is the place of utilization of the services that determines whether the income is deemed to accrue or arise in India. This position has been upheld in various judicial decisions.
Withholding Tax on Fees for Technical Services
Any person making a payment of fees for technical services to a non-resident is required to deduct tax at source under section 195 of the Income-tax Act, 1961. The tax shall be deducted at the rates in force as per the Finance Act or as per the applicable Double Taxation Avoidance Agreement (DTAA), whichever is more beneficial to the assessee. The current withholding tax rate for FTS payments to non-residents under the Income-tax Act is 10% (plus applicable surcharge and cess) under section 115A, provided the non-resident does not have a permanent establishment in India and the FTS is not effectively connected with such permanent establishment. However, the rate of tax could vary based on the DTAA between India and the country of residence of the payee. In such cases, the payer can apply the DTAA rate if it is more beneficial and the non-resident furnishes a valid Tax Residency Certificate (TRC) and other prescribed documents as per section 90(4) and Rule 21AB. Non-compliance with TDS provisions can lead to disallowance of expenditure under section 40(a)(i), levy of interest under section 201(1A), and penalty under section 271C. Therefore, it is imperative to analyze the nature of the service and determine whether it falls within the scope of ‘fees for technical services’ as defined under the Act or the DTAA.
Double Taxation Avoidance Agreements and FTS
India has entered into Double Taxation Avoidance Agreements (DTAs) with several countries. These DTAAs may provide for a definition of FTS or may even exclude FTS from taxability unless such income is attributable to a permanent establishment in India. The definition of FTS under the Act and the DTAA may not be identical. Most Indian DTAs, including those with the United States, United Kingdom, Germany, and France, contain a clause on FTS or independent personal services. In some DTAAs, the definition of FTS includes the “make available” condition. This condition means that the recipient of the service should be able to apply the technology, knowledge, or skill provided by the non-resident service provider independently without further assistance. If the services do not “make available” technical knowledge, experience, skill, know-how, or processes to the Indian entity, then such payments may not qualify as FTS under the DTAA. This is particularly relevant in treaties with the US, UK, Canada, Australia, and Singapore, among others. Where the DTAA contains such a clause, the payer has to determine if the services make available the knowledge or skills. If not, such payments would not be liable to tax in India, provided there is no permanent establishment of the non-resident in India. Hence, it is crucial to examine the specific DTAA and apply its provisions, which may override the provisions of the Income-tax Act, owing to section 90(2), which allows the taxpayer to apply the more beneficial provisions.
Judicial Interpretations and Case Law
Over the years, Indian courts and tribunals have laid down several rulings interpreting the term ‘fees for technical services’ and the applicability of withholding tax and DTAAs. The Hon’ble Supreme Court in the case of Ishikawajima-Harima Heavy Industries Ltd. v. DIT (2007) held that for income to be taxable in India under section 9(1)(vii), the services must not only be rendered in India but also utilized in India. However, this decision was nullified by the Finance Act, 2007, with retrospective effect from 1st June 1976, by inserting an Explanation to section 9. This Explanation provides that income shall be deemed to accrue or arise in India, whether or not the non-resident has a residence or place of business in India or has rendered services in India. In the case of De Beers India Minerals Pvt. Ltd., the Karnataka High Court held that payments made for managerial services, which involve human intervention, are considered FTS and taxable accordingly. In the case of GVK Industries Ltd. v. ITO, the Supreme Court held that the consultancy services provided by a foreign company were like FTS, even though the services were rendered outside India, because the benefit of such services was utilized in India. These judicial pronouncements emphasize the need to evaluate the place of utilization and the nature of services to determine the taxability. Indian jurisprudence generally supports the “source rule,” meaning income is taxed where the source of income or economic benefit lies, rather than where the service is performed.
Practical Considerations in Taxing FTS
The taxation of fees for technical services under the Indian Income-tax Act, 1961, involves a complex interplay of domestic law, judicial interpretations, and international tax treaties. Practically, businesses and tax authorities must consider various aspects before determining the taxability of a payment as FTS. One critical aspect is determining whether the service provided is managerial, technical, or consultancy in nature. The terms “managerial,” “technical,” and “consultancy” are not defined in the Act, and courts have interpreted them based on common understanding and contextual usage. Managerial services involve controlling, directing, or administering the business. Technical services involve specialized knowledge and skill. Consultancy services involve advising or guiding professionally. Each classification carries different implications for taxation and requires precise documentation and agreement drafting. Another key consideration is the source rule under Section 9(1)(vii), which deems FTS to accrue or arise in India if the services are utilized in India or if the payer is an Indian resident. This rule often leads to disputes in cases involving offshore services provided to Indian companies. Taxpayers must carefully evaluate where and how the services are utilized to determine the correct tax position. Additionally, characterizing a payment as FTS versus business income or royalty has significant consequences. If the payment qualifies as business income, the taxability depends on the presence of a permanent establishment in India. If it qualifies as royalty, different provisions and rates apply. Each classification must be supported by robust legal and factual analysis.
FTS and Transfer Pricing Implications
When FTS transactions occur between associated enterprises, transfer pricing regulations under Chapter X of the Income-tax Act become relevant. Transfer pricing aims to ensure that transactions between related parties are conducted at arm’s length. The arm’s length price must be determined using appropriate methods prescribed under the Income-tax Rules, such as the Comparable Uncontrolled Price (CUP) Method, Cost Plus Method, or Transactional Net Margin Method (TNMM). FTS transactions are often scrutinized for overpricing or underpricing, especially when Indian subsidiaries make payments to foreign parent companies. Authorities examine whether the services were rendered, whether they provided economic value, and whether the pricing was justified based on comparable transactions. Documentation under Rule 10D must include detailed descriptions of the services, agreements, benefit analysis, and benchmarking studies. The OECD’s Base Erosion and Profit Shifting (BEPS) framework also impacts the analysis of FTS in international group structures. Tax authorities may challenge the deductibility of FTS payments if they are not substantiated with appropriate evidence of services rendered and benefits derived. Therefore, taxpayers must maintain detailed records, including time sheets, deliverables, correspondence, and third-party evaluations, to demonstrate the genuineness and arm’s length nature of FTS payments.
Judicial Precedents on FTS Taxation
Several landmark rulings have shaped the interpretation of FTS taxation in India. In the case of CIT v. Bharti Cellular Ltd. (2011), the Supreme Court held that merely using technical systems does not amount to receiving technical services unless human intervention is involved. This ruling clarified that automated services without a human element may not qualify as technical services. In another key decision, GVK Industries Ltd. v. ITO (2015), the Supreme Court addressed the meaning of consultancy services and held that professional advice on a project falls under consultancy services and is taxable as FTS. The decision also reinforced the source rule by holding that utilization of services in India triggers taxability under Section 9(1)(vii). The Delhi High Court in DIT v. Rio Tinto Technical Services (2012) examined the issue of the make available clause under the India-Australia DTAA. It ruled that unless the services enable the recipient to apply the technology independently, the make available condition is not satisfied, and hence the payment is not taxable as FTS under the treaty. Another important decision is the ruling in CIT v. De Beers India Minerals Pvt. Ltd. (2012), where the court held that geological survey services provided by a non-resident constituted FTS and were taxable in India. However, under the applicable DTAA, the services were not taxable in the absence of a permanent establishment. These judgments illustrate the evolving jurisprudence around FTS taxation and emphasize the importance of analyzing each case on its own merits, considering the nature of services, contractual terms, and treaty provisions.
Recent Legislative and Administrative Developments
Over the years, the Indian government has introduced various amendments and clarifications to address issues related to FTS taxation. One notable amendment was made by the Finance Act, 2010, which clarified that fees for technical services include services provided through transmission of satellite, cable, optical fiber, or other similar technology, thereby expanding the scope of FTS. Another significant change was introduced by the Finance Act, 2020, which revamped the Equalization Levy regime. Although not directly under FTS, the Equalization Levy applies to digital services and may overlap with certain technical services, raising classification issues. Additionally, the introduction of the Significant Economic Presence (SEP) concept under Section 9 in 2020 aimed to tax the income of non-residents based on their digital presence in India. While SEP primarily affects digital businesses, its interplay with FTS provisions, especially for cloud-based technical services, is still evolving and may result in overlaps or dual taxation risks. On the administrative front, the CBDT has issued various circulars and instructions guiding the interpretation FTS provof of FTS provisions. For instance, Circular No. 786 clarified that tax need not be deducted on commission payments to non-residents where services are rendered outside India. Although later withdrawn, this circular influenced several judicial interpretations. The tax authorities have also been increasingly relying on data analytics and artificial intelligence to scrutinize cross-border FTS transactions. Companies engaging in such transactions should ensure robust internal controls, documentation, and compliance to mitigate audit risks and litigation.
Planning and Compliance Strategies
Taxpayers dealing with cross-border FTS transactions must adopt proactive tax planning and compliance strategies. First, review all service agreements to ensure clarity on the nature of services, pricing, responsibilities, and deliverables. Vague or loosely worded agreements may invite scrutiny and recharacterization of the payments. Second, evaluate the applicability of tax treaties and determine if the payment qualifies for exemption or lower tax rates under the make available clause. If applicable, obtain a tax residency certificate (TRC) and maintain Form 10F and other necessary documentation. Third, ensure compliance with withholding tax obligations. If the payment is taxable in India, the payer must deduct tax at source under Section 195. In case of doubt, the payer can apply to the Assessing Officer or the Authority for Advance Rulings (AAR) for a determination. Fourth, maintain detailed transfer pricing documentation for payments between associated enterprises. Benchmarking studies, benefit analyses, and proper invoicing are essential to demonstrate the arm’s length nature of the transactions. Fifth, consider obtaining Advance Pricing Agreements (APAs) or Mutual Agreement Procedures (MAPs) in complex or high-value cases to achieve certainty and avoid disputes. Finally, monitor legislative and judicial developments regularly and update internal policies accordingly to align with the latest interpretations and regulatory expectations.
Conclusion
Taxation of fees for technical services under the Indian Income-tax Act remains a dynamic and evolving area. The interpretation of what constitutes FTS, the interaction with international tax treaties, and the procedural requirements for compliance are critical to determining the correct tax treatment. As globalization increases and service delivery becomes more digital and cross-border, the significance of understanding FTS taxation will continue to grow. Taxpayers must stay vigilant, maintain proper documentation, and seek expert guidance when dealing with complex FTS arrangements. Sound planning, compliance, and dispute management strategies can help mitigate risks and ensure tax efficiency in an increasingly scrutinized area of international taxation.