Mumbai ITAT explains distinction between “sale” and “right to use” capacity in telecom cable network

This Tax Alert summarizes a recent ruling of the Mumbai Tribunal (ITAT)  in the case of Flag Telecom Group Ltd. (Taxpayer), a company incorporated in Bermuda.

 

The Taxpayer was set up to build a high capacity fibre optic telecommunication link cable system between the UK and Japan. For this purpose, the Taxpayer entered into a Memorandum of Understanding (MOU) with various national telecommunication companies (TCs). From India, Videsh Sanchar Nigam Ltd. (VSNL) was a party to the MOU and part of this consortium. VSNL made a lump sum payment to the Taxpayer for the purchase of certain capacity in the cable system. In addition, VSNL was also required to make payments for standby maintenance. The nature of these payments in the hands of the Taxpayer, whether business income or royalty or Fee for Technical Services (FTS), was the issue before the ITAT.

 

The ITAT ruled that as VSNL acquired full ownership rights and obligations in respect of capacity purchased in the cable system, it was a sale transaction (business receipt) in the hands of the Taxpayer. As the Taxpayer did not have a business connection or any asset or source of income in India it was not taxable in India. Further, as there was no actual rendering of services, but mere collection of an annual charge to recover the cost of standby facility, the payment for standby maintenance was held not taxable as FTS in India.

 

The present ruling explains the subtle distinction between a “sale” and “royalty” transaction on purchase of capacity in the context of telecommunication services. The ITAT has explained that the key factor in determining whether sale has taken place or not, is to see, whether the benefit and burdens of ownership with all the rights and obligations and risks have been shifted from the seller to the buyer or not.

 

The ITAT also explains that payment for maintenance of standby facility does not answer the definition of FTS under the ITL where there is no actual rendering of services, but mere collection of an annual charge to recover the cost of standby facility.