ACCORDING to a report titled “State of the Satellite Industry Report (August 2010)” sponsored by Satellite Industry Association [SIA], the world satellite revenues in 2009 was of the order of $ 160.9 billion with an average annual growth of 11.7% from 2004 through 2009. Out of this, the share of satellite service industry was $ 93 billion. What is remarkable is that despite worldwide recession, satellite services revenue grew by almost 11% from 2008 to 2009. Satellite technology is invaluable for propelling growth in many areas such as telecom, news, media, and entertainment - to name a few. In India, as perhaps elsewhere, the satellite industry has a symbiotic relationship with the media and entertainment and television. The Indian Media and Entertainment Industry stood at $ 12.9 billion in 2009 and according to a KPMG study, the size of this industry is expected to reach roughly 25 billion $ by 2014. In a PWC report “Indian Entertainment & Media outlook 2010”, it is predicted that the industry will reach 22.28 billion with a CAGR of 12.4%. According to another report by Media Partners Asia, India is poised to become the world's largest DTH satellite pay-TV market with a subscriber base of 36.1 million by 2012. The spectacular growth in the Television channel business in India has been possible thanks mainly to the use of satellite technology.

However, launching a satellite is a very expensive proposition and although India has broken into the elite club of countries having the technology to launch different types of satellites, it is a risky business, as the recent spectacular failures of GSLV launch will indicate. It is therefore inevitable that the services of outside satellite service providers will have to be taken by the various players involved. Telecommunication services also depend substantially on satellite technology and the size of telecom industry in India is also rapidly growing. There is therefore considerable revenue involved in a lot of cross border transactions, which are inevitable for this important sector. And whenever, there is considerable revenue in a cross-country situation, question of sharing the revenue also becomes inevitable. It is in this context that the some of the case laws relating to the satellite business that have attracted the attention of the global players and commentators need to be examined and analysed. Inevitably, the leading soft power in the world of international taxation, the OECD got into the picture. On 23rd July, 2010, the OECD council has approved the 2010 update to the Model Commentary which includes the changes in the commentary as proposed in a discussion draft released earlier on ‘common tax treaty issues in telecommunication transactions'. It is obvious that the OECD reaction was occasioned by some of the case laws by which source countries like India and China asserted their right of taxation over this important source of revenue and there is no prize for guessing that OECD has sided with the business and is against the assertion of such source country rights.

The first case coming out of India was that of Asia Satellite Telecommunications Ltd (2003-TII-03-ITAT-DEL-INTL) on 1st November 2002. This was a case in which the nature of payments made by a foreign telecasting company to a satellite company was the issue. The satellite company was based in Hong Kong and hence the interpretation was of the domestic law, there being no DTAA with Hong Kong.

Popular TV channels like STAR TV, SATAR Plus, STAR News etc was being operated in India by Satellite Television Asian Region Ltd, Hong Kong which entered into a transponder lease agreement with Asia Satellite Telecommunication Ltd, Hong Kong, so that the content developed for the Indian audience could be relayed in the footprint are of the Satellite that covered India. The satellite was of course located in geostationary orbit above the US. The ultimate territory of commercial exploitation being India, the A.O held that the assessee had a business connection in India thereby making the receipts subject to Indian taxes. In appeal, the CIT (A) accepted the contention of the taxpayer that, there being no place of operation of the company in India, it was not a case of business connection. However, he held that the income was liable to be taxed as royalty within the meaning of that term under the Indian domestic law.

The relevant portion of the definition of Royalty under the domestic law was as follows:

“9(1) The following incomes shall be deemed to accrue or arise in India: …

(vi) income by way of royalty payable by

(a) ..

(c) a person who is a non-resident, where the royalty is payable in respect of any right, property or information used or services utilized for the purposes of 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, “royalty” means consideration (including any lump sum consideration but excluding any consideration which would be the income of the recipient chargeable under the head “Capital gains”) for -

(i) ….

(iii) the use of any patent, invention, model, design, secret formula or process or trade mark or similar property ;

(iva) the use or right to use any industrial, commercial or scientific equipment but not including the amounts referred to in section 44BB ...

(vi) the rendering of any services in connection with the activities referred to in sub-clauses (i) to (v)” (emphasis supplied)

In appeal, the ITAT examined the issue in great detail including the process involved in the business. It came to the conclusion that merely because the footprint area of the satellite included India, it was not sufficient to hold that business operations of the satellite company were carried out in India.

Coming to the taxability of the sums as royalty, there were many arguments. One of these was that there was no ‘use' of the properties mentioned in the provision by the customers of the assessee; that the customers had not used the transponder for the reason that there was no physical connection between the customers and the transponder. In this context, the ITAT, inter-alia, observed as follows: “… In the present age of modernization where numerous developed applications of science have become part of life and the extend of development of technology is so fast, it would really be unfair to restrict the meaning of the word "use" to only "physical use". The plain construction of the word "use" in our considered opinion refers to the deriving advantage out of it by employing for a set purpose…."

Since the term ‘process' is not defined in the Act, the Tribunal resorted to the dictionary meaning and held that it meant series of actions or steps taken in order to achieve a particular end. The Tribunal held that considering the role of the assessee in the light of meaning of the term 'process', it becomes evident that the particular end namely, viewership by the public at large is achieved only through the series of steps taken by receiving the uplinked signals, amplifying them and relaying them after changing the frequency in the footprint area including India. The particular end is achieved only through the series of steps taken in this regard. Accordingly, it was held that the TV channels are using the process made available by the assessee through its transponder, giving rise to payment for royalty taxable in India.

It is also interesting to note that dealing with an argument on behalf of the assessee, the Tribunal also considered as to whether the transponder lease could be covered under equipment leasing. The Tribunal observed that a transponder is part of satellite, which is fixed in the satellite and is neither moving in itself nor assisting the satellite to move. Therefore, although the satellite is an equipment and the transponder, a part of it, playing howsoever-important role, cannot be termed as equipment. Hence the leasing out of transponders to various customers in a satellite, according to the Tribunal, cannot be equated with the leasing out of any equipment.

The same issue came up again before the Tribunal in another case, namely the PanAmsat case (2006-TII-14-ITAT-DEL-INTL) which involved a treaty country, notably the USA. In this case, the Tribunal found that there was difference in the wording of the provision of domestic law and the treaty which defines royalty as follows:

“The term ‘royalties' as used in this article means :

(a) payments of any kind received as consideration for the use of or the right to use, any copy right of a literary, artistic, or scientific work including cinematograph films or work on film, tape or other means of reproduction for use in connection with ratio or television broadcasting, any patent, trademark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience, including gains derived from the alienation of any such right or property which are contingent on the productivity, use or disposition thereof; and……” (Emphasis supplied)

In Asiasat, the Tribunal while repelling the argument that the word ‘secret' also qualifies the word ‘process', had pointed out that there is no comma after the word ‘secret' till the end of the clause and had the intention been to qualify process also with secret, there would have been a comma after the word process. Since, in the definition of royalty as per the DTAA, there indeed was a comma after process, by implication, even if there is a process involved, in order to be qualified as royalty, it needed to be a secret process which is not the case in practice in view of the fact that the literature about satellite technology was widely available in the market. It was therefore held in the PanAmsat case that the amount could not be taxed as royalty.

Considering the divergent views of the Tribunal, the Department requested for constituting a special bench. This time the Tribunal considered the cases of two other treaty countries, viz., the Netherlands and Thailand. In the case of New Skies Satellite (2009-TII-77-ITAT-DEL-INTL), the issue involved was the liability of deduction of tax at source on payments by Indian resident companies to non-resident satellite companies. In this case, the assessee was a Netherlands based company owning a satellite and providing the use of the same to Indian broadcasting and telecommunications companies, who in turn provided programmes and data to customers in India. The tax authorities held that the payments were royalties for the use of a process and hence were subject to tax as royalty both under Sec. 9(1) (vi) of the Income Tax Act and also under Art. 12 of the India–Nether lands tax treaty.

In this case, the Tribunal held that a process is involved in the transponder through which telecasting companies are able to uplink the data and downlink the same in footprint area that covers India. Disagreeing from the view expressed in PanAmsat case, it was held that it is not necessary that the process should be a secret process even in the case of treaty countries; that the process even if it is construed to be intellectual property need not necessarily be a protected one. A simple process, if it is intellectual property will also be considered as royalty. It was held that punctuation marks play insignificant role in interpretation unless it can be shown that the document was carefully punctuated which is not the case in the case of tax treaties. Thus, according to the Tribunal, user of a process, secret or otherwise will entail royalty.

Apart from the other issues, this judgement deals extensively with concept of user. In this regard, the following observation of the Tribunal is important:

“It will also be important to mention that practical aspect has also to be kept in mind. It is neither practical nor possible to have the physical control over the transponder either by the satellite companies or by their customers . The “control” or “user” if any of the transponder is through the sophisticated instruments either installed in the ground stations owned by the satellite companies or on the earth stations owned by telecasting companies. Therefore, the “control” or “user” of the transponder and its capacity has to be seen from the practical angle. Once the process in the transponder is predetermined & preguided by the satellite companies, it is made available for “user” to the customers who pay a consideration for the same. Such process is used by the telecasting companies according to their need.”

Around the same time that the Indian Tribunal was grappling with the issue of characterization of income arising out of payments made to satellite companies, similar exercise was also being undertaken by the Chinese tax administration. Here also the payment involved was to a satellite company by Chinese TV Company.

Delaware based PanAmsat entered into an agreement with China Central Television (CCTV) in terms of which PanAm agreed to make its satellite system available for the distribution of TV programme supplied by CCTV. The State Administration of Taxes asked CCTV to withhold taxes @7% on the rent paid by CCTV to PanAm as per Article 11 of the DTAA. PanAm argued that the payments represented business profits. Upon the notice being upheld on administrative review, the taxpayer appealed to the intermediate Level People's Court of Beijing which upheld the notice holding it to be for the use of or right to use industrial, commercial or scientific equipment. The verdict given in December 2002 is of course based on the interpretation of the old China-USA DTAA (1984) and this has since been revised.

In this context, the Chinese Court, inter-alia, observed as follows:

“… Under the Agreement, in normal situations, the designated part. of the bandwidth of the satellite transponder shall be used to transmit the third party's television signal only, which means the third party solely owns the right to use the designated part of the bandwidth. Since the bandwidth is provided by the satellite system, the third party's right to use the bandwidth shall be viewed as the right to use the satellite system.”

The Income Tax Tribunal in the New Skies case quoted from the above Chinese Court decision to buttress its point that there was user even though according to the Chinese Court, there was user of equipment whereas according to the Indian Tribunal, there can not be question of user of transponder, but there was user of a process in the transponder.

The New Skies decision came out in the month of October, 2009. Coincidentally or otherwise, on 25/11/2009, OECD issued a discussion draft on the issues specifically arising out of the taxation of telecom companies and suggested changes in the Commentary, reiterating its stand of no change in the context of changing business environment. In respect of payment to satellite companies, the OECD proposed a change in the commentary as follows:

“Satellite operators and their customers (including broadcasting and telecommunication enterprises) frequently enter into “transponder leasing” agreements under which the satellite operator allows the customer to utilise the capacity of a satellite transponder to transmit over large geographical areas. Payments made by customers under typical “transponder leasing” agreements are made for the use of the transponder transmitting capacity and will not constitute royalties under the definition of paragraph 2: these payments are not made in consideration for the use of, or right to use, property, or for information, that is referred to in the definition (they cannot be viewed, for instance, as payments for information or for the use of, or right to use, a secret process since the satellite technology is not transferred to the customer). As regards treaties that include the leasing of industrial, commercial or scientific (ICS) equipment in the definition of royalties, the characterisation of the payment will depend to a large extent on the relevant contractual arrangements. Whilst the relevant contracts often refer to the “lease” of a transponder, in most cases the customer does not acquire the physical possession of the transponder but simply its transmission capacity : the satellite is operated by the lessor and the lessee has no access to the transponder that has been assigned to it. In such cases, the payments made by the customers would therefore be in the nature of payments for services, to which Article 7 applies, rather than payments for the use, or right to use, ICS equipment. A different, but much less frequent, transaction would be where the owner of the satellite leases it to another party so that the latter may operate it and either use it for its own purposes or offer its data transmission capacity to third parties. In such a case, the payment made by the satellite operator to the satellite owner could well be considered as a payment for the leasing of industrial, commercial or scientific equipment.” (Emphasis supplied)

In other words, according to the proposed OECD commentary, payment for transponder leasing by source countries cannot be taxed as royalty and can only be taxed as business income and for business income to be taxed by source countries, there must be a PE. Lest any one claims that there is a PE because of the satellite being above their space, the move is also preempted by the addition of another Para in the commentary to Article 5 dealing with the permanent establishment as follows:

“Clearly, a permanent establishment may only be considered to be situated in a Contracting State if the relevant place of business is situated in the territory of that State. The question of whether a satellite in geostationary orbit could constitute a permanent establishment for the satellite operator relates in part to how far the territory of a State extends into space. No member country would agree that the location of these satellites can be part of the territory of a Contracting State under the applicable rules of international law and could therefore be considered to be a permanent establishment situated therein. Also, the particular area over which a satellite's signals may be received (the satellite's “footprint”) cannot be considered to be at the disposal of the operator of the satellite so as to make that area a place of business of the satellite's operator.”

In plain English, it means that the source states don't get a penny out of the huge tax pie, if the OECD wish is to be followed by the others, particularly countries with booming markets like China, India, and Brazil etc. It may be observed that OECD prefers to stick to an obsolete view of the notion of use by insisting on physical contact whereas the Indian Tribunal points out that with the changed time and the changed way of doing business, it is unrealistic to insist on only physical use. Although Courts and Tribunals in India generally take a view irrespective of the revenue effects, revenue considerations do have importance for the stance taken by the tax administration. India stated its position on the OECD model and its commentary for the first time in 2007. The total number of reservations expressed by India on the OECD Model and its commentary exceeds 75.The main reason for such a large number of reservations by India is due to the insistence of OECD in sticking to an interpretation that is unduly favourable to residence countries even in the changed business environment. When the time comes for India to state its position on the revised version of the commentary, it is quite likely that India might as well score a century of reservations!