In today’s technology world, businesses require access to high end technology equipment like servers in order to host various services online. Due to this, requirement for these kinds of servers have increased tremendously, especially for e-commerce businesses. Owning/maintaining such servers and upkeep requires skilled manpower, which is a costly affair. So many e-commerce start-up companies are availing cloud computing services from Amazon, Google, etc.
Understanding Cloud Computing[i]
Cloud computing is the provision of standardised, configurable, on-demand, online computer services, which can include computing, storage, software, and data management, using shared physical and virtual resources (including networks, servers, and applications). Since the services are provided online using the provider’s hardware, users can typically access the service using various types of devices wherever they are located, provided they have a suitable Internet connection.
There are three major models of delivering ‘clouding computing’ services to businesses and they are as follows:
- Infrastructure as a Service (IaaS) Model – Under this model, typically utilized by large multinational businesses, IT infrastructure in the form of data centers, virtual servers, network infrastructure, equipment, etc. are sourced as a service from third party service providers.
- Platform as a Service (PaaS) Model – PaaS is a category of cloud computing services that provides a computing platform and programming tools as a service for customers.
- Software as a Service (SaaS) Model – Under this model the service provider hosts several software applications for consumers to use as and when required thereby eliminating the need to install and run the software application on the consumer’s own infrastructure. It can be provided either to business customers (B2B) or to individual customers (B2C).
Cloud computing is defined in the report of the US National Institute of Standards and Technology (NIST) as ‘a model for enabling ubiquitous, convenient, on-demand network access to a shared pool of configurable computing resources (e.g. networks, servers, storage, applications, and services) that can be rapidly provisioned and released with minimal management effort or service provider interaction.’ According to NIST, the cloud model is composed of five essential characteristics:
- On-demand self-service: A user can unilaterally act without requiring human interaction with each service’s provider.
- Broad network access: Capabilities are available over the network and accessed through standard mechanisms that promote use by heterogeneous client platforms (e.g. mobile phones, laptops, and PDAs).
- Resource pooling: The provider’s computing resources (e.g. storage, processing, memory, network bandwidth, and virtual machines) are pooled to serve multiple users using a multi-tenant model.
- Rapid elasticity: Capabilities can be rapidly and elastically provisioned.
- Measured Service: resources use can be monitored, controlled, and reported providing transparency for both the provider and consumer of the utilised service.”
Under the Cloud Computing arrangement, it is found that the customers are only allowed to store their data and process the same, with no control over the location where the same will be stored. Service Provider will have control over the data and right to transfer the same to any country. Customer is merely using a standard storage and processing facility provided by the service provider and consideration paid is only to use such facility and does not extend to any right or property or information.
Customer is only allowed to use services to store, retrieve, query, serve, and execute content which is owned, licensed or lawfully obtained by it. The customer will have no control over any other data stored in the server. Service provider also allows use of certain software as part of the services. Such software can neither be sold nor distributed by the customer and can only be used as part of service offerings. The recipient of services is only allowed to store or run a query on the content or data, which are owned by them. Customer is merely allowed to use the standard facility offered with certain sophisticated software embedded in it.
Taxability under the Income Tax Act
Income would be chargeable to tax in India if the same falls within the scope of section 4 read with section 5 of the Act. Section 4 is the charging provision under the Act. The charge is in respect of the total income for any year. The scope of total income chargeable to tax in India is outlined by Section 5. This scope of total income depends upon whether the assessee concerned is a resident or non-resident in India. Place of accrual assumes importance especially for non-resident taxation, since a non-resident is liable to pay tax only on income, which accrues or arises in India.
If the service provider do not carry out any business activity in India, then there will be no ‘business connection’ in terms section 9(1)(i) of the Act (CIT V R.D. Aggarwal & Co. (1956) 56 ITR 20). Generally, cloud service providers do not have offices, IT infrastructures and servers in India and all their services are provided from outside India. In such circumstances, it cannot be said that the income of non-resident accrues or arises in India or is from business connection in India.
Payment for Cloud Services whether Royalty:
Section 9(1)(vi) of the Act deals with taxation of Royalty. Section 9(1)(vi)(b) of the Act provides that any royalty payable by a person resident in India would deem to accrue or arise in India, except where the royalty is payable in respect of any right, property or information used or utilised for the purpose of business or profession carried on by such person outside India or for the purposes of making or earning any income from any source outside India. If the payment made for Cloud Computing Services is regarded as in the nature of “Royalty” then it would be covered under section 9(1)(vi) of the Act and hence would be taxable in India.
The term ‘royalty’ is defined in Explanation 2 to section 9(1)(vi). The scope of definition is further expanded by Explanations 4, 5 and 6 to section 9 (1) (vi). The same are extracted below:
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) the transfer of all or any rights (including the granting of a licence) in respect of a patent, invention, model, design, secret formula or process or trade mark or similar property;
(ii) the imparting of any information concerning the working of, or the use of, a patent, invention, model, design, secret formula or process or trade mark or similar property ;
(iii) the use of any patent, invention, model, design, secret formula or process or trade mark or similar property;
(iv) the imparting of any information concerning technical, industrial, commercial or scientific knowledge, experience or skill;
(iva) the use or right to use any industrial, commercial or scientific equipment but not including the amounts referred to in section 44BB;
(v) the transfer of all or any rights (including the granting of a licence) in respect of any copyright, literary, artistic or scientific work including films or video tapes for use in connection with television or tapes for use in connection with radio broadcasting, but not including consideration for the sale, distribution or exhibition of cinematographic films; or
(vi) the rendering of any services in connection with the activities referred to in sub-clauses (i) to (iv), (iva) and (v).
Explanation 4.—For the removal of doubts, it is hereby clarified that the transfer of all or any rights in respect of any right, property or information includes and has always included transfer of all or any right for use or right to use a computer software (including granting of a licence) irrespective of the medium through which such right is transferred.
Explanation 5.—For the removal of doubts, it is hereby clarified that the royalty includes and has always included consideration in respect of any right, property or information, whether or not—
(a) the possession or control of such right, property or information is with the payer;
(b) such right, property or information is used directly by the payer;
(c) the location of such right, property or information is in India.
Explanation 6.—For the removal of doubts, it is hereby clarified that the expression “process” includes and shall be deemed to have always included transmission by satellite (including up-linking, amplification, conversion for down-linking of any signal), cable, optic fibre or by any other similar technology, whether or not such process is secret;
The term Royalty is defined in Article 12(3) of India – USA DTAA as follows:
12(3) 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 a literary, artistic, or scientific work, including cinematograph films or work on film, tape or other means of reproduction for use in connection with radio or television broadcasting, any patent, trade mark, 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
- payments of any kind received as consideration for the use of, or the right to use, any industrial, commercial, or scientific equipment, other than payments derived by an enterprise described in paragraph 1 of Article 8 (Shipping and Air Transport) from activities described in paragraph 2(c) or 3 of Article 8.
Whether access to server constitutes Royalty for use of Software
Copyright is a bundle of rights including, inter alia, rights of reproduction, communication to the public, adaptation and translation of any work. Copyright ensures certain safeguards of the rights of authors over their creations. A comprehensive legislation is enacted to monitor the Copyright laws in India. It is the Copyright Act, 1957 (“CRA”). The various rights in a Copyright are transferred individually or in the aggregate or in combination thereof.
Royalties means consideration for ‘transfer’ of any of these rights. Unless any of these rights move from the recipient to the payer for consideration, the consideration would not constitute royalties. In other words, there has to be a transfer of a copyright right. If what is secured is only a product which is an embodiment of the rights, the same would be regarded as a transfer of a copyrighted article. Payments for copyrighted article do not constitute ‘royalties’. It is only payments for copyright right that constitute royalties. With respect to characterisation of software license, as to whether it constitutes royalty or business profits under DTAA, the High Court of various states in India having taken conflicting views.
The Delhi High Court in the case of DIT v Ericsson AB  246 CTR 422 held that payment towards copyrighted software does not partake the character of ‘royalty’ under the Act and the Treaty. Similar view is taken in Bombay High Court in the case of Mahyco Mosanto Biotech (India) (P) Ltd vs UOI (2016 74 taxmann.com 92(Bom) and by Madras High Court in the case of Vinzas Solutions India Pvt. Ltd. (392ITR155).
However, the Karnataka High Court in the case of CIT vs. Samsung Electronics Co Ltd 345 ITR 494 has taken a contrary view, wherein it was held that the amount paid to foreign supplier for supply of the “shrink-wrapped” software is not the price of the CD alone nor software alone nor the price of license granted. It is a combination of all. In substance unless a license was granted permitting the end user to copy and download the software, the CD would not be helpful to the end user. Further, Explanation 4 to section 9(1)(vi) clarifies that the transfer of all or any rights in respect of any right, property or information includes and has always included transfer of all or any right for use or right to use a computer software (including granting of a license) irrespective of the medium through which such right is transferred.
While availing the cloud services, the e-commerce companies are provided with limited access to the server and software functionality available on Service Provider’s IT infrastructure and not allowed to download any software. These companies do not download the software license and install on their systems. The payment is for bundle of services – storage space, software, 24/7 access etc. In this scenario, one can therefore take a view that decision of Samsung (supra) is not applicable for the reason that the Karnataka High Court proceeded on the basis that the end users gets a copy of the software and license granted is installed on the computer of the customer. In the context of cloud services, E-commerce companies do not get any ‘copyright right’ in the software instead only get the right to use the software installed on the servers of the Service Providers. It can be said that Service Providers are merely providing a ‘Standard Facility’ to store user data or content on the cloud server or IT infrastructure with software functionality available for all its users and the test of transfer of copyright right as envisaged in the tax treaties is not satisfied.
Whether access to server constitutes an Equipment Royalty
The first issue that to be addressed is whether ‘server’ can be treated as equipment. The Hon’ble Madras High Court in Poompuhar Shipping Corporation Ltd.v ITO  38 taxmann.com 150 (Madras) highlighted the need for construing’equipment’ widely, so as to embrace every article employed by the employer for the purposes of his business. ‘Equipment’, in whatever name called either as an apparatus or as plant or machinery, so long as they are employed for the purposes of one’s income, the same shall stand covered by Clause (iva). Drawing inference from the above,one can state that ‘server’ is equipment. The next aspect that needs to be addressed is whether e-commerce companies have ‘right to use’ the server. The meaning of the term ‘right to use’ is therefore of significance. In this regard, following judicial precedents may be referred.
The Hon’ble Delhi High Court in the case of Asia Satellite Telecommunications Co. Ltd v DIT  197 Taxman 263 (Delhi) has held the transponder and the process therein are actually utilized for the satellite owner for rendering the services to the customer and further that it cannot be said that the transponder or process employed therein are used by the customer.
The Mumbai Tribunal in the case of DDIT v Savvis Communication Corporation  69 taxmann.com 106 (Mumbai – Trib.) has held thatpayment received for providing web hosting services though involving use of certain scientific equipment cannot be treated as ‘consideration for use of, or right to use of, scientific equipment’ which is a sine qua non for taxability under section 9(1)(vi), read with Explanation 2 (iva) thereto as also article 12 of Indo-US DTAA.
The Chennai Tribunal in the case of ACIT v Vishwak Solutions Pvt. Ltd ITA No. 1935 & 1936/Mds/2010 dated 30.01.2015 has observed and held that the assessee was only using the storage space provided by non-resident in US namely INETU, in the machines owned by INETU situated outside India. The assessee had no right over the equipment in which data was stored. The charges were based on the volume of data stored in the machines. The charges paid to them were not for the payment of or right to use any industrial, commercial or scientific equipment and hence payment is not royalty under Article 12 of Indo-USA DTAA. It is a service rendered by the non-resident promoting connectivity to the assessee for hosting of website and not for usage of any machines. It is only for the use of server outside India and is not taxable in India and hence tax need not be deducted at source.
The Pune Tribunal in the case of EPRSS Prepaid Recharge Services India P. Ltd v ITO [TS-623-ITAT-2018(PUN)] evaluated the taxability on cloud computing services provided by Amazon and held that payment made towards web hosting charges for hiring servers from Amazon in its cloud units did not amount to Royalty under the Act and India – USA Treaty. It was observed by the Tribunal that the assessee did not use or acquire any right to use any industrial, commercial or scientific equipment while using the technology services provided by Amazon. The assessee did not possess or have any control over the server space deployed by Amazon while providing e-services and no rights in technology / IPRs were obtained from Amazon under the agreement. The Tribunal also held that retrospective amendment to ‘royalty’ definition under the Income-tax Act vide Finance Act, 2012 will not override Treaty provisions.
The cloud services may include use of certain SaaS products, server storage space, and standard web services. These services are availed from foreign vendors such as Google Inc, Amazon and other players. The services availed are a mere standard facility provided by the foreign vendors, which is open for all. The Indian companies are only allowed to access the cloud storage services and the entire right to use of server or equipment remains with the Service Provider. These companies will have no right over the equipment in which data is stored. The charges are generally based on the volume of data stored in the server. Therefore, it could be argued that charges paid to them are not for the payment of or right to use any industrial, commercial or scientific equipment.
In this context, it is important to refer to Explanation 5 to section 9(1)(vi) of the Act. Explanation 5 specifically provides that for determination as to what constitutes Royalty, the possession or control of right/property/information or direct use of such right/property/information by the payer or location of such right/property/information in India are not relevant consideration. Therefore, it appears that the Legislature has made its view very clear that even a remote use of right/property/information would also constitute royalty for the purpose of the Income tax Act. Viewed in this context, the companies in India availing cloud services would be remotely using the right/property/information and the possession or location of the server is not relevant consideration for determination as to whether payment for cloud services constitutes royalty.
However, the interpretation of Explanation 5 to section 9(1)(vi) will not be applicable in the context of tax treaties. As held by various judicial pronouncements, the 2012 amendment to the Income tax Act will not be applicable in the context of tax treaty. With these conflicting positions, it would be interesting to see the future development in this space. Without amendment to tax treaties, the full effect of Explanation 5 to section 9(1)(vi) cannot be achieved.
Fees for Technical Services
Section 9(1)(vii) of the Act deals with taxability of Fee for Technical Services (“FTS” for brevity). This provision is in line with section 9(1)(vi) dealing with taxation of Royalty and provides that payment made by Indian resident to non-resident would be taxable in India if the services are in nature of technical, managerial or consultancy services and services are utilised for the purpose of business in India. The definition of FTS in the USA tax treaty is narrower wherein “make available” test is prescribed.
The question that needs to be answered is whether the Cloud Service Provider are rendering any technical services or making available standard facility to their customers. If the payment is towards standard facility, then the same would not be classified as FTS under section 9(1)(vii). The judicial precedents in this context are discussed below.
The Delhi Tribunal in the case of Bharti Airtel Ltd v ITO  67 taxmann.com 223 (Delhi – Trib.) has held that inter-connect usage charges to foreign telecom operators in connection with its International Long Distance telecom service business, was neither FTS nor royalty as there was no manual or human intervention during the process of transportation of calls between two networks. The Hon’ble Karnataka High Court in the case of CIT v Vodafone South Ltd  72 taxmann.com 347 has held that payment to another mobile service provider for utilization of roaming mobile data and connectivity could not be termed as technical service as roaming process between participating entities was fully automatic and did not require any human intervention.
The Hon’ble Supreme Court in the case of CIT v Kotak Securities Ltd  67 taxmann.com 356 (SC)hasheld that payments made for facilities provided by the Stock Exchange does not attract TDS. It also distinguishes between service provided and facility offered. The Hon’ble Madras High Court in the case of Skycell Communication Ltd. v. Dy. CIT  19 Taxman 496/ 251 ITR 53 had examined the scope of term ‘technical services’ and held that installation and operation of sophisticated equipments with a view to earn income by allowing customers to avail of the benefits of the user of such equipments does not result in the provision for technical service to the customer for a fee.
As detailed above, the services availed by e-commerce companies are standard facility provided by the cloud service providers, which are open for all. Accordingly, providing of space on the servers by the service providers for the purpose of storage of data or processing of data or hosting of the website would not result in the provision for technical service liable to be taxed in India.
Since the nature of services provided by Service Provider are in the nature of standard facility, they do not fall within the meaning of the term Royalty and Fees for Technical Services as defined in the tax treaties. The income therefore would be classified as business income, which would be taxable in India if the non-resident Service Providers have Permanent Establishment (“PE”) in India. The cloud service providers render services from outside India and their servers and IT infrastructure are located outside India. In absence of PE, the income of cloud service providers would not be chargeable to tax in India.
[i] BEPS Action Plan 1 – Addressing the Tax Challenges of the Digital Economy