Profit apportionment for technical services must not be arbitrary

Case Summary:

Case Name: Toshiba Corporation, In Re

Citation: (2021) 431 ITR 414 (AAR)

Key Issues:

1. Taxability under Section 9(1)(vii) (of Income Tax Act, 1961): Whether the fees for technical services (FTS) rendered by Toshiba, a non-resident, are deemed to accrue or arise in India under Section 9(1)(vii) (of Income Tax Act, 1961).
2. Applicability of India-Japan DTAA: Whether the provisions of the India-Japan Double Taxation Avoidance Agreement (DTAA), particularly Articles 5 (Permanent Establishment), 7 (Business Profits) (of Income Tax Act, 1961), and 12 (Royalties and Fees for Technical Services), affect the taxability of the FTS.
3. Apportionment of Income: Whether the apportionment of profits to the technical services rendered can be done arbitrarily, or if it requires a specific methodology.

Ruling:

The Authority for Advance Rulings (AAR) held:

• Non-Arbitrary Apportionment: The apportionment of profits attributable to the technical services cannot be done in an arbitrary manner.
• Apportionment Basis: Such apportionment should be made only from the “free on board (FOB) price for the main equipment” and not from other payments.
• Role of Assessing Officer: It is appropriate for the Assessing Officer to determine the value attributable to the fees for technical services, as these were included in the sale price of the offshore supply of equipment. This determination should be made after conducting necessary inquiries and providing a basis for the valuation.

Implications:

This ruling emphasizes that when a contract includes both the supply of equipment and the provision of technical services, the income attributable to the technical services must be carefully and methodically apportioned. The inclusion of FTS in the overall contract price necessitates a clear and justified allocation to determine the taxability under Indian law and the applicable DTAA provisions.

Reference:

Toshiba Corporation, In Re (2021) 431 ITR 414 (AAR)