‘RIGHT Florist' is not a name I was familiar with. Google search tells me that there is perhaps a Right Florist Pvt Ltd and possibly a Right Shopping Pvt Ltd. The point is that it is unlikely to be a very big company. Yet, this company of small or medium size had paid more than INR 30 Lakhs in a year to Google and Yahoo as online advertisement charges. If such is the magnitude of online advertisement from a small company, one can imagine how much Google and Yahoo will generate in the form of total advertisement revenue from India! So, what is the big deal? All this money is legit business expenditure for the payer. Yes, but such expenditure reduces the profit of these entities that is available for taxation in India. Again, what is the big deal? If instead of online advertising, Right Florist had put an ad in Times of India that would also be deductible in determining its profits. Yes, but then Times of India would have to pay tax on the amount that it received by way of advertisement.

So, what happens when one places an advertisement in Google? The money, it seems does not come to any Indian company but goes to an Irish subsidiary of Google. So, Google must have paid tax on the advertisement income in Ireland even if at a considerably reduced rate? Very unlikely, considering the controversy about a similar issue that is raging in the UK where it was found that the money eventually turns up in a tax haven. The moot point however is that substantial tax base erosion is taking place.

In India, the Revenue thought out a clever idea long time back saying that if any entity makes a payment to a non-resident, there should be deduction of tax at source. Once money goes out to a non-resident, there is no way to ensure that the non-resident will care to follow our rules. If there is no TDS, there is no deduction of the expenditure at all. But then the courts in India, have laid down the proposition that such deduction is necessitated only when the recipient has income taxable in India. In the present case, it was claimed that the foreign companies did not have PE in India and hence the income being business income could not be taxed in India.

In the Right Florist case (2013-TII-61-ITAT-KOL-INTL), the assessing authority held that there was no material to establish that these entities belonged to treaty countries and that the taxpayer should have obtained a prior authorization to remit money without deduction of tax at source and in default the sum involved could not be allowed as a deduction. The first appellate authority decided the issue in favour of the taxpayer.

The question before the Tribunal was whether the amount in question could be taxed as business income or as royalty or as fees for technical services. The Tribunal found that the foreign companies did not have PE in India and that the amount could not be taxed as royalty. The Tribunal found that although technical services were rendered in the case, but in the absence of any human intervention, the same could not be taxed as fees for technical services. One could question the Tribunal's finding about the fees for technical services. But, that is not the focus of the present article. The Tribunal, while holding that a web site could not constitute a PE relied on the revised OECD model commentary and rubbished India's official position and that's where the rub is.

OECD is the successor of OEEC, an organisation created for coordinating the policies of European countries under the Marshall Plan in the wake of the Second World War. OECD took over the charge of drafting a model double taxation agreement that could be adopted for avoiding double taxation of its members. In those days, there was no other model and all the nations including the newly independent ones had to follow it if it were to enter into a double tax avoidance treaty. At the instance of the developing countries came the UN model. [For an understanding of the working of the UN Model please refer to ‘The All (New) UN Model and the Super Model'.] The fact is that the UN model has not been able to fully represent the view points of the developing countries. The point has been articulated rather strongly by India recently. In a letter from the Permanent Representative of India to the United Nations, a letter from Mr. Sanjay Kumar Mishra, Joint Secretary (FT&TR-1) was forwarded. This letter, inter-alia mentions: “[I]t is inconceivable as to how a standard developed by Government of only 34 countries can be accepted by Government of other countries as ‘standard' of sharing of revenue on international transactions between source and resident country particularly when it only take (sic) care of the interest of developed countries and has seriously restricted taxing powers of source country.”

Taxation is a dynamic field. Many new ways of doing business constantly emerge. So do new challenges to the Revenue. How the Revenue should respond to such situations? Again the lead is taken by the OECD. Its views are sometimes not liked by big business. But, nevertheless, OECD basically represents the views of the developed countries. Of late India, China, Russia and others are becoming important economies. It is impossible to ignore these countries. If these countries are not on board, it will be difficult to consider the views espoused by the OECD to be truly ‘international'. Therefore these countries are accorded the status of observers in the OECD's committee on fiscal affairs. But these observers do not have any say in the final outcome of the decisions although their views are certainly heard.

In the process of being an observer in 2006, India was asked to state its views on the OECD model treaty and its commentaries. By the way, India was requested to become an observer, not the other way around. India stated its position in the year 2007. These were incorporated in the OECD model, 2008. India's treaty position has been at odds with the OECD model right from the very beginning. India is a capital importing country with many mouths to feed. It does not have the luxury of giving up any tax revenue. In the OECD model which is essentially for the rich countries, trade and investment being in balance, giving up the right of taxation in the source country might not have been a big issue. However, the position is very different in the case of India.

Before proceeding further, it may also be interesting to note that when a member of the OECD has a different take on any of its model articles, it states its ‘reservation' which will indicate to the partner countries that it may adopt a different posture in its treaties. In case the OECD member country does not agree with a particular commentary, then it sates its ‘observations'. Non-OECD members including the observers can merely state their ‘positions' on both the articles and the commentary.

While stating India's positions on a model in the development of which it had no say, the tax administration had to ensure that India should not bind itself to an interpretation that is contrary to the Indian practice and that would lead to loss of any revenue. It was an exhaustive exercise and unlike some others who would practice one thing and preach something different, India was upfront on many of the contemporary issues. It is true that on many of the issues there was no consensus even at the level of the Indian judiciary. Some of the issues might also have been decided at the level of the lower judiciary against the Revenue. Thus many commentators expressed shock when in its 2008 model India stated its position on at least 78 items!

But, there is nothing to be shocked. Take for example, the case of transfer of shrink-wrapped software. Most of the Tribunals decided the issue against the Revenue till the Samsung decision (2009-TII-25-HC-KAR-INTL) came along. Now, one may not like what the court held but that is not to say that another view was not possible or should not be followed by the Revenue. Unless there is a legislation or a Supreme Court judgement, it is not possible for the Indian Revenue to agree with the OECD view that sale of shrink wrapped software will not amount to royalty. Obviously, while commenting on such issues, India stated as much.

The current issue with which we began our discussion is again one such issue. We have seen that tremendous erosion of tax base takes place if the OECD view of no business taxation without fixed place of business is accepted. In fact, in the Right Florist decision the honorable Member laments as such: “ Clearly, conventional PE test fails in this virtual world even when a reasonable level of commercial activity is crossed by foreign enterprise. It is a policy decision that Government has to take as to whether it wants to reconcile to the fact that conventional PE model has outlived its utility as an instrument of invoking taxing rights upon reaching a reasonable level of commercial activity and that it does fringe neutrality as to the form of commercial presence i.e. physical presence or virtual presence, or whether it wants to take suitable remedial measures to protect its revenue base. Any inertia in this exercise can only be at the cost of tax certainty.”

However, while interpreting the treaty provision the Members chose to be governed by the OECD commentary. True, that OECD commentary has been used in the past also. But, that has been as an aid to interpretation, not like a binding ratio of a court decision. To that extent the decision seems to be flawed. I must hasten to add that the ultimate decision might be otherwise right but that is not the point here.

In the context of e-commerce transactions, OECD has made a distinction between a server and a website. In Paragraph 42 of the Commentary on Article 5, the Commentary said that while website per se, which is a combination of software and electronic data, does not constitute a tangible property as it cannot have a location which constitutes place of business, a web server, on which the website is stored and through which it is accessible, is a piece of equipment having a physical location and such location may thus constitute a “fixed place of business” of the enterprise that operates that server. A search engine, which has only its presence through its website, cannot therefore be a permanent establishment unless its web servers are also located in the same jurisdiction.

Relying on this observation, the Tribunal held that these conditions have not been fulfilled in the Right Florist case and it was not the case of the Revenue that servers are located in India. Had the Tribunal stopped here, even then one could not have complained much. One problem with the Tribunal's decision in this case is that it does not state what was the arguments of the parties - particularly of the Revenue was.

The Tribunal, on its own then goes on to observe India's position on the above commentary of the OECD model:

"33. India does not agree with the interpretation given in para 42.2; it is of the view that website may constitute a permanent establishment in certain circumstances.

34. India does not agree with the interpretation given in para 42.3; it is of the view that, depending on facts, an enterprise can be considered to have acquired a place of business by virtue of hosting its website on a particular server at a particular location."

Commenting on the relevance of India's reservations, the Tribunal held: The Government of India's reservations on the OECD Commentary are relevant only to the extent that OECD Commentary, to that extent, cannot be treated as a fair index of intention of the Government of India and as contemporaneaexpositio in respect of tax treaties entered into by India after so expressing its reservations. Beyond that, these reservations have no role in judicial analysis.

While going by the OECD's logic, the Tribunal failed to appreciate the logic of India's position that servers can be placed anywhere thereby making taxation impossible. Moreover servers, by themselves are dumb instruments and can be useful only in conjunction with a website.

Anyway, as we have seen earlier, there was no reason for India to express its views on the OECD model and the commentary before it became an observer. It does not and cannot mean that India accepts everything that the OECD says. Both the OECD Model and the commentary is the subject of a recommendation by the OECD council to the member countries under Art 5(b) of the OECD Convention. These are not binding even on the OECD member countries. Interestingly, the OECD Commentary itself in para 29 of the Introduction says as much: “…Although the Commentaries are not designed to be annexed in any manner to the conventions signed by Member countries, which unlike the Model are legally binding international instruments they can nevertheless be of great assistance in the application and interpretation of the conventions and, in particular, in the settlement of disputes”. For a non-OECD member country therefore, the constituting treaty of the OECD cannot serve as a legal basis to apply the commentary.

In so far as India's reservation is concerned, again it is no body's case that it should be accepted as gospel truth. But to reject it out of hand is again erroneous. In fact in one of the earlier cases, Linklaters LLP Vs ITO Mumbai [ 2010-TII-80-ITAT-MUM-INTL], the Honorable Member had this to say about India's position about another contentious issue - whether a transparent partnership is entitled to treaty benefits:

“77. As we hold that the partnership firm is eligible for treaty benefits in the source country even as it is not taxable in its own right in the residence country, we are alive to the fact that the OECD Report on Partnership does not approve that proposition. As evident from paragraph 40 of the said report – reproduced earlier in the order, even when partnership firm is not taxable in the residence in its own right, the treaty entitlements to the firm are to be denied. However, in the same report, at paragraph 56, the OECD report recommends that, in such a situation, the treaty benefits should accrue to the partners in the partnership firm. However, that is a solution rejected by India, and 2008 update to OECD Model Convention records this reservation as follows:

3. Gabon, India, Ivory Coast, Morocco and Tunisia do not agree with the interpretation put forward in paragraphs 5 and 6 above of the Commentary on Article 1 (and in the case of India, the corresponding interpretation in paragraph 8.7 of the Commentary on Article 4) according to which if a partnership is denied the benefits of a tax convention, its members are entitled to the benefits of the tax conventions entered into by their State of residence. They believe that this result is only possible, to a certain extent, if provisions to that effect are included in the convention entered into with the State where the partnership is situated.

78. In this situation, i.e. when the Government of India has rejected the stand taken in the OECD partnership report and the changes made in the OECD Model Convention Commentary as a result of the same, it cannot be open to hold that in the light of the OECD report, the partnership firm must be declined treaty entitlement benefits. The remedy to unintended consequence of a treaty provision in the said report has been rejected, and, therefore, the treatment accorded to the said provision, in the same report, cannot be accepted either. Any other view of the matter will lead to absurd consequences rather than avoiding the absurd consequences.'' (Emphasis supplied)

In the context of allowing benefits of the treaty to partnership, the AAR took a different view. In SchellenbergWittmer case [2012-TII-41-ARA-INTL], relying on the OECD report on the 'The application of OECD Model Conventions to partnership' it was argued that the partners would be entitled to the benefit of the Convention.

In this connection, the AAR held: “[A]dmittedly, India not a member of the OECD countries has not agreed to this and has adopted the position that it can be so, only if provisions to that effect are included in the Convention entered into with the State where the partnership is situated. Clearly, there is no such provision in the present DTAC. The argument that the partners are residents of Switzerland and their incomes from the partnership are taxable in Switzerland is of no avail since what is involved is not the income, the partners receive from the partnership but the income derived by the firm from an Indian entity.”(Emphasis supplied).

Thus, though the tax effect in the Right Florist case may not be much, it needs to be contested for relying on the OECD Commentary as if that was law and also for the observation that India's differing position is either not relevant or is applicable only in respect of treaties entered into after July, 2008.