Gary D. Sprague January 24-25, 2008 Mumbai, India Baker & McKenzie International is a Swiss Verein with member law firms around the world. In accordance with the common terminology used in professional service organizations, reference to a “partner” means a person who is a partner, or equivalent, in such a law firm. Similarly, reference to an “office” means an office of any such law firm. IFA (India Branch) – OECD International Tax Conference Technical Fees, Royalties and Services

©2007 Baker & McKenzie 2 Why this Topic Is on the Agenda The issue to address - what payments should be subject to withholding tax The essential conflict - a system oriented towards source basis taxation vs. those dedicated to reducing withholding tax burdens

Technical Fees, Royalties and Services ©2007 Baker & McKenzie 3 Manifestations of the Tensions U.S.-India Treaty - “included services” concept –Significant departure from U.S. domestic law Software and E-commerce Payments –High-Powered Committee Report –OECD Technical Advisory Group on Income Characterization Report Significant Controversies at Audit, Tribunal, Court and Competent Authority Levels

Technical Fees, Royalties and Services ©2007 Baker & McKenzie 4 Policy Aspects What should be the basis of withholding tax imposition? –Impose tax on local source income –Respond to real or perceived imbalances in investment and reward flows –Other industrial/fiscal policy goals Justification for imposing tax on gross income –Pure (or close to it) profit flows –Not true for rents/royalties (as compared to dividends/interest) –Enforcement and collection concerns

Technical Fees, Royalties and Services ©2007 Baker & McKenzie 5 Practical Aspects The core technical issue tends to be characterization Globally connected economy raises these issues in many contexts Presentation will cover differences in treatment in three areas –Labor oriented services –E-commerce payments –Software payments

Technical Fees, Royalties and Services ©2007 Baker & McKenzie 6 Labor Oriented Services Know-how transfers Technical services without know-how transfer Managerial, etc. services

Technical Fees, Royalties and Services ©2007 Baker & McKenzie 7 Labor Oriented Issues How have these issues been handled? U.S. domestic law guidance Indian domestic law guidance U.S.-India Treaty and MOU Treaty creates significant disparities in source country treatment –Indian providers can still rely on U.S. domestic law –But PE Article opens big gap in protection for on-site services

Technical Fees, Royalties and Services ©2007 Baker & McKenzie 8 E–commerce Transactions Purchase of digitized information Subscription to on-line portal or information services Subscription to on-line entertainment sites Remote data processing Single payments for non-tangible features

Technical Fees, Royalties and Services ©2007 Baker & McKenzie 9 E–commerce Transactions The characterization challenge - requires a thoughtful consideration of the essence of the transaction What are the possibilities (e.g. remote database access) –Service? –Property (sale)? –Property (rent)? –Intangible property (royalty)?

Technical Fees, Royalties and Services ©2007 Baker & McKenzie 10 E–commerce Transactions Lack of active human involvement at point of service - does it matter? Is there an acquisition of property? Does the user gain possession and control of property? Was the property itself the essence of the transaction (as opposed to e.g. data storage and processing)?

Technical Fees, Royalties and Services ©2007 Baker & McKenzie 11 E–commerce Transactions Who is using the intangible property in these transactions? –Supplier –Purchaser Service classification is something of a default category

Technical Fees, Royalties and Services ©2007 Baker & McKenzie 12 E–commerce Transactions How have these issues been resolved? Income Characterization TAG report OECD Art. 12 Commentary –Look to what the consideration essentially is for Indian guidance Other international practice - what can we tell so far?

Technical Fees, Royalties and Services ©2007 Baker & McKenzie 13 Software Transactions Characterization issues appear in many contexts –Perpetual, single user licenses –Site and enterprise licenses –Limited duration licenses –Transactions through resellers –Customization, localization and installation

Technical Fees, Royalties and Services ©2007 Baker & McKenzie 14 Software Transactions How have these issues been handled? OECD Art. 12 Commentary (original and revised) U.S. Treasury Regulations High-Powered Committee report Indian Court and Tribunal decisions

Technical Fees, Royalties and Services ©2007 Baker & McKenzie 15 Software Revenue Characterization Major source of friction for U.S. software companies International developments have been steady and consistent

Technical Fees, Royalties and Services ©2007 Baker & McKenzie 16 Remarkable Elements Number of decided cases Sources of authority relied upon by tribunals and courts Absence of governmental policy action Little consequence at audit level