Decoding the Delhi High Court Judgment on IMG: Implications for DTAA and International Taxation

A Comprehensive Analysis of the Delhi High Court Decision in International Management Group (UK) Limited v. Commissioner of Income Tax-2 International Taxation, New Delhi

Introduction

On 3rd July 2024, the Delhi High Court delivered a landmark judgment in the case of International Management Group (UK) Limited (IMG) v. Commissioner of Income Tax-2 International Taxation, New Delhi. Spanning multiple appeals related to the assessment years (AYs) 2010-11 to 2018-19, the decision addressed critical issues concerning the classification and taxability of income earned by IMG under the Double Taxation Avoidance Agreement (DTAA) between India and the UK. This comprehensive analysis delves into the detailed aspects of the judgment, elucidating the legal reasoning and implications of the court's findings.

Background and Issues Raised

IMG, a UK-based entity, provided a range of services to the Board of Control for Cricket in India (BCCI), including advisory and managerial services for the Indian Premier League (IPL). The appeals stemmed from the Income Tax Appellate Tribunal’s (ITAT) decisions, which had upheld the bifurcation of IMG’s income into business profits and Fees for Technical Services (FTS). The key issues raised included:

1. Whether the ITAT erred in holding that the business income was divisible under the India-UK DTAA, considering Articles 7 and 13 of the DTAA.
2. Whether the services provided by IMG to BCCI qualified as FTS under Article 13(4)(c) of the DTAA.
3. If the income classified as FTS could be deemed to accrue or arise in India under Section 9(1)(vii)(b) of the Income Tax Act, 1961.

Facts of the Case

1. Memorandum of Understanding (MoU) and Service Agreement

In 2007, IMG and BCCI entered into a Memorandum of Understanding (MoU) for the establishment, commercialization, and operation of the IPL. This was followed by a Service Agreement on 24th September 2009, which detailed the scope of services to be provided by IMG. These services included advisory and managerial roles, particularly focusing on the strategic, commercial, and operational aspects of the IPL.

2. Nature of Services Provided by IMG

Under the Service Agreement, IMG was responsible for a wide range of services, including:

• Advisory Services: Advising BCCI on forming and governing the IPL, including the development of league rules and regulations, franchise agreements, and media rights agreements.
• Managerial Services: Managing various aspects of the IPL, such as sponsorship rights, official suppliership rights, stadium signage rights, and merchandising rights.
• Technical Expertise: Providing technical knowledge and expertise in areas such as franchise rights, media rights, sponsorship rights, and stadium development.

The services rendered by IMG required substantial technical expertise and were critical to the successful organization and execution of the IPL.

3. Revenue and Attribution to PE

IMG received significant revenue for the services provided to BCCI. For instance, in AY 2010-11, IMG earned a total service fee of INR 33,00,00,000. The income was attributed to IMG’s Permanent Establishment (PE) in India, established under Article 5(2)(k) of the DTAA. The attribution was based on the functions, assets, and risk (FAR) analysis performed by IMG.

4. Dispute on Classification of Income

The primary dispute arose over the classification of IMG’s income. IMG contended that the entire income should be classified as business profits attributable to its PE in India and, therefore, be taxed under Article 7 of the DTAA. However, the Income Tax Department argued that a significant portion of the income qualified as FTS under Article 13 of the DTAA and should be taxed accordingly.

5. Previous Decisions and Appeals

The Income Tax Appellate Tribunal (ITAT) upheld the bifurcation of IMG’s income into business profits and FTS, leading to the current appeals before the Delhi High Court. The appeals covered multiple assessment years, from 2010-11 to 2018-19, each addressing similar issues of income classification and taxability under the DTAA and domestic tax laws.

IMG’S Challenge

1. Bifurcation of Income

IMG challenged the ITAT’s decision to bifurcate its income into business profits and FTS. The company argued that the entire income should be treated as business profits attributable to its PE in India, falling under Article 7 of the DTAA.

2. Classification as FTS

IMG contended that the services provided to BCCI did not qualify as FTS under Article 13(4)(c) of the DTAA. The company emphasized that the services rendered did not "make available" technical knowledge, experience, skill, know-how, or processes to BCCI, a requirement for classification as FTS under the DTAA.

3. Application of Section 9(1)(vii) of the Income Tax Act

IMG argued that the income should not be deemed to accrue or arise in India under Section 9(1)(vii) of the Income Tax Act. The company highlighted the exception clause in Section 9(1)(vii), which exempts income earned for services utilized for business carried out outside India or for earning income from a source outside India.

Contentions of the Respondents

The respondents, represented by the Income Tax Department, contended that:

1. The services provided by IMG were inherently technical, qualifying as FTS under Article 13 of the DTAA.
2. The bifurcation of income into business profits and FTS was justified, as Article 5 of the DTAA only defines the existence of a Permanent Establishment (PE) and does not determine the classification of income.
3. The revenue attributable to IMG’s PE in India should be separately examined under other relevant DTAA provisions for appropriate tax treatment.

The Contract Structure

The judgment delved into the intricacies of the contracts between IMG and BCCI, highlighting:

1. Nature of the MoU and Service Agreement
2. Advisory and Managerial Services
3. Technical Expertise and Knowledge Transfer
4. Revenue Attribution
5. Dispute on Revenue Classification

The Article 5(2)(k) Question

Article 5(2)(k) of the DTAA pertains to the definition of a Service PE. The court clarified that:

1. Article 5 addresses the existence of a PE and does not concern the classification or tax treatment of income derived from the PE’s activities.
2. The existence of a PE does not restrict tax authorities from examining the nature and classification of income under other applicable DTAA articles.

Bifurcation of Income: Whether Sustainable?

1. Legal Basis for Bifurcation

The court emphasized the principle laid down in Article 7(9) of the DTAA, which states that the provisions of Article 7 concerning business profits do not affect the application of other articles in the DTAA that deal with specific types of income. This provision allows for the bifurcation of income if it includes items dealt with separately in other DTAA articles, ensuring each type of income is subjected to its specific tax treatment.

2. Examination of Articles 7 and 13 of the DTAA

The court's detailed examination of Articles 7 and 13 revealed that:

• Article 7: Concerns the taxation of business profits, stating that such profits are taxable only in the country where the enterprise has a PE, and only to the extent attributable to the PE.
• Article 13: Defines FTS and stipulates that such services are taxable in the country where they are rendered, unless effectively connected with a PE.

The court concluded that these provisions allow for the bifurcation of income to ensure that different income streams are taxed under the appropriate DTAA articles, reflecting their intrinsic nature.

3. Nature and Classification of IMG's Income

The court assessed the nature of IMG's income, determining that:

• Business Profits: Income attributable to the PE for activities directly related to the core business operations of IMG, such as managing the IPL.
• FTS: Income derived from technical or consultancy services provided to BCCI, which involved making available technical knowledge, experience, skill, know-how, or processes.

The court noted that the bifurcation was necessary to accurately reflect the distinct nature of each income stream and ensure appropriate tax treatment.

4. Relevant Judicial Precedents

The court referred to several judicial precedents to support its decision on bifurcation, including:

• Delhi High Court in Centrica India Offshore Pvt. Ltd.: This case established that services involving the transfer of technical knowledge qualify as FTS and can be bifurcated from business profits.
• Supreme Court in GVK Industries Ltd. v. ITO: The Supreme Court upheld the bifurcation of income into different streams to ensure specific tax treatment under relevant DTAA articles.

These precedents reinforced the court's view that bifurcation is permissible and necessary to ensure compliance with DTAA provisions and domestic tax laws.

5. Analysis of FAR (Functions, Assets, and Risks)

The court conducted a detailed analysis of the functions performed, assets used, and risks assumed (FAR) by IMG in India. This analysis included:

• Functions: IMG's PE in India performed significant functions related to the management and operation of the IPL, including coordinating with BCCI and managing local logistics.
• Assets: The PE utilized substantial assets, including office infrastructure and personnel, to support its operations.
• Risks: The PE assumed various business risks, such as market and operational risks, associated with managing the IPL.

The FAR analysis supported the bifurcation by highlighting the distinct roles and responsibilities of the PE in generating business profits and providing technical services.

6. Conclusion on Bifurcation

The court upheld the bifurcation of IMG’s income, concluding that:

• The bifurcation ensures specific tax treatment based on the intrinsic character of each income stream and the particular circumstances under which it is earned.
• The division of income into business profits and FTS aligns with the principles of international taxation and the DTAA, ensuring fair and equitable tax treatment.

The FTS Issue

The court’s analysis of Article 13 of the DTAA highlighted:

1. FTS is defined as consideration for rendering technical or consultancy services, which lead to the recipient acquiring technical knowledge, experience, skill, know-how, or processes.
2. The services provided by IMG involved substantial technical knowledge and expertise, qualifying as FTS under Article 13.

Article 13(6) and Effective Connection

Addressing the contention regarding effective connection under Article 13(6):

1. The court noted that if services rendered by IMG amounted to FTS, the revenue earned would be excluded from Article 13 by virtue of Paragraph 6, provided the FTS was effectively connected with the PE.
2. The court emphasized that this aspect need not be conclusively resolved given the findings on FTS classification.

The Section 9(1)(vii) Exception

Section 9(1)(vii) of the Income Tax Act outlines an exception for income earned by a non-resident for services utilized for business carried out outside India or for earning income from a source outside India. The court concluded:

1. The income earned by IMG for services provided outside India fell within this exception and thus was not liable to be taxed as FTS.
2. The court emphasized the retrospective applicability of the Finance Act, 2010, which clarified the taxation of FTS irrespective of the place of service rendition.

Detailed Analysis of Key Aspects

1. The Nature of Services Provided by IMG

The court meticulously examined the nature of services provided by IMG under the Service Agreement with BCCI. These services included:

• Advisory Services: Advising BCCI on forming and governing the IPL, including the development of league rules and regulations, franchise agreements, and media rights agreements.
• Managerial Services: Managing various aspects of the IPL, such as sponsorship rights, official suppliership rights, stadium signage rights, and merchandising rights.
• Technical Expertise: Providing technical knowledge and expertise in areas such as franchise rights, media rights, sponsorship rights, and stadium development.

The court observed that these services were highly technical and required substantial expertise, qualifying them as FTS under Article 13 of the DTAA.

2. Examination of Article 13(4)(c) of the DTAA

Article 13(4)(c) of the DTAA defines FTS as payments for rendering technical or consultancy services that "make available" technical knowledge, experience, skill, know-how, or processes. The court analyzed this definition in detail, noting that:

• "Make Available" Requirement: For services to qualify as FTS, they must result in the recipient acquiring the technical knowledge or skills to apply independently in the future without further assistance from the service provider.
• Application to IMG’s Services: The court concluded that IMG’s services met this requirement as they involved transferring technical knowledge and expertise to BCCI, enabling BCCI to utilize this knowledge independently in managing the IPL.

3. Effective Connection under Article 13(6)

Article 13(6) provides that FTS shall not apply if the FTS is effectively connected with the PE. The court’s analysis included:

• Effective Connection Test: The court examined whether the services provided by IMG were effectively connected with its PE in India. This required evaluating if the services were performed through or facilitated by the PE.
• Court’s Conclusion: The court concluded that while some services were performed through the PE, a significant portion of the services were provided directly by IMG UK and were not effectively connected with the PE. Thus, the income from these services could not be excluded from FTS under Article 13(6).

4. Application of Section 9(1)(vii) of the Income Tax Act

Section 9(1)(vii) deals with income deemed to accrue or arise in India, including FTS. The court’s examination of this section included:

• Exception Clause: The section includes an exception for income earned by a non-resident for services utilized for business carried out outside India or for earning income from a source outside India.
• Retrospective Amendment: The court considered the retrospective amendment introduced by the Finance Act, 2010, which clarified that income from FTS is taxable in India irrespective of where the services are rendered.
• Court’s Conclusion: The court held that IMG’s income for services rendered outside India fell within this exception, thus exempting it from tax as FTS under Section 9(1)(vii).

Analysis of Paragraph 121

Findings on Article 13(6):

In Paragraph 121, the Delhi High Court:

• Refrains from Final Opinion: The court chooses not to deliver a final verdict on the "effectively connected" issue due to its detailed findings on the classification of FTS. This approach prioritizes resolving the classification of income as FTS under Article 13.
• Reservation on Tribunal’s View: The court expresses reservations about the Tribunal’s conclusions regarding the effective connection of FTS with the PE, indicating the need for further scrutiny in this aspect.

Implications:

The findings highlight the nuanced approach required in international tax disputes, particularly under DTAAs. By desisting from a definitive opinion on effective connection, the court emphasizes the complexity of interpreting the relationship between the services and the PE.

Key Takeaways:

1. Primary Focus on FTS Classification: Resolving the classification of income as FTS was prioritized.
2. Caution on Effective Connection: The cautious stance indicates the need for detailed scrutiny in such matters.
3. Tribunal’s View Not Fully Affirmed: The decision not to fully affirm the Tribunal's view on effective connection allows room for further examination.

Conclusion

The Delhi High Court’s judgment in the case of IMG v. Commissioner of Income Tax-2 International Taxation is a landmark decision that clarifies the classification and taxability of income under the DTAA and the Income Tax Act. The judgment provides a detailed analysis of the bifurcation of income, the definition and application of FTS, and the exceptions under Section 9(1)(vii). This comprehensive analysis offers valuable insights into the interpretation of international tax treaties and their interplay with domestic tax laws.

Dispositif

The court's disposition partially allowed the appeals, providing detailed reasoning for each key issue, ensuring adherence to both domestic tax laws and international tax agreements. This judgment serves as a significant reference point for interpreting the interplay between domestic taxation provisions and international tax treaties, particularly in the context of cross-border service agreements and technical consultancy services.

Author - Sunil Maloo (JAIN) | [email protected]

Disclaimer - The views expressed in this article are personal and do not represent the official stance of any organization. This content is for informational purposes only and is not intended as legal advice. Consult a professional for advice specific to your situation. The author is not liable for any errors or omissions.