Google India will be required to pay up back taxes on Rs 1,457 crore remitted by Google India to Google Ireland Limited (GIL) between 2007-08 and 2012-13, according to a ruling from the Bangalore bench of the Income Tax Appellate Tribunal. This pertains to Google Adwords, Google’s flagship and core advertising service, and the sale of advertising in India, and the deduction of tax at source.

Google Ireland is at the centre of an alleged global tax-avoidance structure for the company (more on that here), and others do this too. This report last year details how Apple paid only 0.005% tax, and this details how Microsoft avoids tax. All this, by routing sales through tax havens. In fact, earlier this year, in July, Google France narrowly avoided having to pay back taxes on $1.28 billion, after a Paris court ruled that since Google doesn’t have a permanent office in the country it couldn’t be fined.

The Bangalore bench of the Income Tax Appellate Tribunal (ITAT) dismissed all six appeals made by Google India and has ruled that it is “clear and conspicuous that they [Google India and Google Ireland] wanted to avoid the payment of taxes in India.”

The tribunal says that Google India failed to deduct tax at the time of remitting payment to Google Ireland, saying that:

“This is a clear design to skip the liability by both the assessee as well as Google Ireland Limited by having mutual understanding. Therefore in our view… the assessee deliberately not sought permission for making the payment to GIL and is taking chance to avoid taxes within the four corners of IT Act.”

Note that in its arguments, Google India said that the distribution fee payable to Google Ireland for the period December 2006 to June 2009 had remained unpaid till the fiscal year 2011-12. In November 2011, Google had approached the Reserve Bank of India (RBI) seeking approval to remit the fee to Google Ireland. Google India finally received approval on May 12, 2014 and only then it remitted the fee to Google Ireland.

Facts of the case

Google India entered into an agreement with Google Ireland Limited for resale of online advertising space under the Google AdWords Program Distribution agreement dated December 12, 2005. According to Google India, it is merely a reseller of advertisement space. It only “performs market-related activities to promote the sales of advertisement space. No right or intellectual properties were transferred by Google to Google India or to the advertiser.”

In FY 2008-09, Google India had credited a sum of Rs 119 crores to the account of Google Ireland without deduction of tax at source. Google Ireland had also not obtained a NIL deduction certificate on the sums payable to it from the Income Tax Department. It was the same for the remaining years in the period under review.

A show cause notice was issued on November 20, 2011, asking Google India to explain why it shouldn’t be treated as a tax defaulter.

Google India’s reply wasn’t satisfactory and the amounts payable to Google Ireland were determined to be royalty by the Assessing Officer, and subsequently the Commissioner of Income Tax (Appeals). That is when Google India filed its appeal with the Income Tax Appellate Tribunal.

Google India’s grounds for the appeal

Ground 1: AdWords is a standard advertisement product through which the advertiser is able to publish its advertisement on the Google website, but the the tax assessment erred in holding that the AdWords program is a complex computer software.

Ground 2: Google India is only involved in marketing and distribution of advertisement space to the Indian advertisers, and Google Ireland handles the back-end processes of actually displaying the advertisement. So, there’s no “parting with the copyright” in this case.

The Tribunal said that in their view it is not the advertisement or selling of the space rather it is focused targeted marketing for the product/ services of the advertiser by Google India with the help of technology for reaching the targeted persons based on the various parameters, information etc.

Ground 3: The tax assessment acknowledged that Google India is distributing advertisement space to advertisers in India, yet held that the amount payable towards purchase of advertisement space should be considered ‘Royalty’.

The Tribunal held that IP of Google vests in the search engine technology, associated software and other features, and hence use of these tools for performing various activities mentioned herein above, including accepting advertisements, providing before or after sale services, clearly fall within the ambit of “Royalty”.

Ground 4: The distribution agreement and service agreement between Google India and Google Ireland are not interconnected in any way, because as per the service agreement Google India “performs an independent global outsourcing function for Google Ireland for which it receives consideration and is not linked in any manner to the function of sale of advertisement space to the Indian advertisers.”

The Tribunal held that without exercising its right under this agreement [the service agreement dated 1.4.2004], the obligation of the Appellant (Google India) under the [distribution] agreement dated 12.12.2005 and under the appellant-advertiser agreements cannot be discharged. Therefore the Assessing Officer was right in relying on [service] agreement for the purposes of bringing the case under Royalty, as per the provisions of section 9(1)(vi) of the Income Tax Act read with the Indo-Ireland Double Taxation Avoidance Agreement (DTAA). As per clause 8 of the [distribution] agreement mentioned herein above, the distributor is under an obligation to maintain the user data and therefore is having access to such data. The said user data is being used by the appellant for discharging its obligation towards the advertisers and the claim of the assessee is wrong that it does not have the access to the user data.

Ground 5: The tax assessment erred in holding that “the distribution rights granted are itself IP rights covered by “similar property” used in Sec 9(1)(vi) of the IT Act.” This after it acknowledged that as per the distribution agreement Google Ireland will provide ad space to Google India via the AdWords program for distribution to India advertisers.

Ground 6: The amount payable to Google Ireland was incorrectly determined to be royalty by attributing it to the right of use of trademark, even though it was accepted that Google India had been permitted to use Google’s trademark “for the purpose of marketing and distribution of Adwords program.”

The Tribunal said that in their view the payments made by the assessee (Google India) under the agreement was not only for marking and promoting the Adword program but was also for the use of Google brand features. Needless to add that the said Google brand features were used by the appellant as marketing tool for promoting and advertising the advertisement space, which is main activity of Assessee and is not incidental activities. Hence for this reason also the payment made by the Appellant to GIL [Google Ireland Limited] also falls within the four corners of royalty as defined under the provisions of the IT Act as well as under the DTAA [Double Tax Avoidance Agreement].

Ground 7: Without appreciating the facts of the case, the tax assessment erred in holding that the amount payable by Google India to Google Ireland Limited towards purchase of advertisement space to be in the nature of ‘royalty’ under Section 9(1)(vi) of the IT Act.

Ground 8: That the tax assessment erred in upholding the order of the AO that the amount payable by Google India to Google Ireland is towards right to use of trademark and copyrighted computer program and process, hence is in the nature of ‘Royalty’ as per the Article 12 of the India-Ireland DTAA.

Ground 9: The training provided to Google India’s distribution team in regards to functionality, tools available, etc., is “restricted to use of the Adwords program and not how to develop the Adwords program,” yet it was incorrectly determined to be services rendered to Google India by Google Ireland.

Ground 10: Erred in not following the principle laid down by Hon’ble Mumbai Tribunal in the case of Yahoo India and Pinstorm Technology on similar facts by stating that the facts and issues are completely different and at no stage the Mumbai Tribunal consider what exactly is the Adwords Program, nor did it have occasion to examine the right to use trademark or other IP rights.

Ground 11: Erred in not following the decision of the Calcutta Tribunal in the case of Income Tax Officer vs Right Florists Pvt Ltd (ITA No. 1336/KolI2011) on similar facts.

The Tribunal said that: we are unable to persuade ourselves to agree with the reasoning for treating the payment made by the advertisers as a business profit and not as a royalty. As in our opinion, the detailed working of the AdWords program of the appellant and GIL clearly shows that the appellant is having the right to access not only to the patented technology but also to the customer data, information (like telephone number, user behaviors, region, gender , language, colour, photographs, place of visit, mobile device used, time spent etc.,) and which was not the case in the the decisions in Yahoo India, Pinstorm and Right Florist (supra). As clear from the distribution agreement, the assessee is also having right, title and interest over the intellectual property right of Google. Further, as per the standard advertisement with the advertiser, which specifically empowers the appellant to delete / remove / withdraw the advertisement.

Key Learnings

The tribunal’s order is elaborate and complex, but from it two key issues emerge, which led to the final decision.

Should the distribution fee payable to Google Ireland be considered as royalty or not? Should the non-resident (in this case Google Ireland) show royalty on receipt basis or accrual basis in its book of accounts? And hence, tax it on receipt basis or accrual basis?

In regards to the first question, let’s take a look at how royalty is defined and how it is to be taxed as per Article 12 of the Indo-Ireland Double Tax Avoidance Agreement [DTAA]:

1. Royalties or fees for technical services arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State. 2. However, such royalties or fees for technical services may also be taxed in the Contracting State in which they arise, and according to the laws of that State. 3. (a) The term “royalties” as used in this Article means payments of any kind received as a consideration for the use of or the right to use, any copyright of literary, artistic or scientific work including cinematograph films or films or tapes for radio or television broadcasting any patent, trade mark, design or model plan, secret formula or process or for the use of or the right to use industrial, commercial or scientific equipment, other than an aircraft or for information concerning industrial, commercial or scientific experience.

The tribunal has categorically stated that:

In our view, the assessee [Google India] has used the information, patented technology, etc., from GIL which in the opinion of the bench, is royalty and therefore, as per the mandate of Article 12(2) [of the Indo-Ireland Double Taxation Avoidance Agreement], the royalty is to be taxed in the contracting state (India) in accordance with the laws of India.

Hence, in this case it is quite clear that the amount payable to Google Ireland is indeed to be considered as royalty, and accordingly taxed at source. This can also be used as a benchmark for future disputes of this nature.

Now, in regards to the second question, Google India had contended that as per Indo-Ireland Double Tax Avoidance Agreement, royalty is chargeable to tax in the hands of the non-resident (in this case Google Ireland) on receipt basis. However, ITAT said that “the benefit of DTAA [Double Tax Avoidance Agreement] is only available to non-resident and not to the resident payer (in this case Google India). In addition, ITAT said that since Google Ireland Limited follows the mercantile method of accounting and not the cash method of accounting, “GIL [Google Ireland Limited] should have shown the distribution fees (royalty) on accrual basis and not on receipt basis. Therefore, the argument of chargeability of royalty in the hands of non-resident (GIL), on receipt basis is required to be rejected.”

Further, the income arising on account of royalty payable by resident or non-resident in respect of any right, property or information used or services utilized for the purposes of business or profession shall become due and payable as per the provisions of the IT Act, as well as under DTAA [Double Tax Avoidance Agreement] when such information is used or service is utilized by the recipient. In the present case, the distribution fees was credited as accrued by the assessee after utilizing the benefit under the distribution agreement to the account of GIL. Therefore, the same is chargeable to tax when it was credited to the account of GIL and the appellant (Google India) is duty-bound to deduct TDS at the time of crediting it to the account of GIL.

Note that Google India had “treated the said payment as a business profit of GIL [Google Ireland] in its books of account.” To which the tribunal said that “whether it is business profit or royalty, in both the circumstances, so far as the assessee (i.e., Google India) is concerned, the assessee is duty-bound to deduct the TDS.”

Google will appeal this decision

Google India told ET that it will appeal against the the Tribunal’s order “as this ruling is a clear departure from previous judgments on the issue and is not in line with India’s double-taxation avoidance agreements.” It also added that Google India complies “with all tax laws in India and pay all applicable taxes.”

We’ve written to Google India to learn more about how it plans to proceed and will update once we hear back from them.

Also Read: On Taxing The Internet Economy – Abhishek Singh, Director, E-Governance, DIT