Authority for Advance Rulings, New Delhi– Whether the Applicant has a permanent establishment in India as regards the use of a global network and infrastructure to process card payment transactions for customers in India and as regards other related issues?
MasterCard Asia Pacific Pte Ltd, In re.
[AAR No. 1573 of 2014] /  94 taxmann.com 195 (AAR - New Delhi)
Facts of the case:
MasterCard Asia Pacific Pte Limited (the Applicant), is one of the leading global payment solution providers facilitating financial institutions, businesses, merchants, cardholders and governments worldwide, to use electronic forms of payment.
The Applicant is the regional headquarters for Asia Pacific, Middle East and Africa (APMEA) region. It carries out the MasterCard group’s principal business of transaction processing and payment related services under a family of products including ‘MasterCard’, ‘Maestro’ and ‘Cirrus’ in the APMEA region.
The MasterCard Business is structured as an open bankcard association, in which the cardholder and merchant relationships are managed principally by the Applicant’s customers which are primarily banks and financial institutions (Customers) in APMEA region. The Applicant does not issue cards, extend credit to cardholders, set cardholder fees or determine interest rates or fees charged to cardholders using MasterCard products.
The services are provided by the Applicant to APMEA customers pursuant to Master License Agreements (MLA), which the Applicant signs with each and every customer in the APMEA region. The Applicant charges its customers transaction processing fees relating to authorization, clearing and settlement of transactions, consequent to the terms of a MLA.
The transaction processing activity consists of electronic processing of payments between banks of merchants (Acquirer bank) and banks of cardholders (Issuer bank) through the use of MasterCard Worldwide Network (the Network). The Network facilitates authorization, clearing and settlement of payment transactions between Customers on a proprietary, global payment system. The Network links Issuer banks and Acquire banks around the globe for transaction processing services and through them permits MasterCard Cardholders to use their cards at millions of merchants worldwide.
In provision of its services, the Applicant provides a customer with a MasterCard Interface Processor (MIP) that connects to MasterCard’s Network and processing centers. An MIP is about the size of a standard personal computer and is placed at the customers' locations in India. It is through the network and processing centers outside India that the Applicant is able to facilitate the authorization, clearing and settlement of payment transactions.
The Applicant has a subsidiary in India, namely MasterCard India Services Private Limited (MISPL), in which it owns 99% of the shareholding. The remaining 1% is held by the Applicant’s immediate holding company, MasterCard Singapore Holding Pte Ltd. MISPL owns and maintains the MIPs placed at the Customers' locations in India.
The Applicant approached the Authority of Advance Ruling (AAR) seeking clarification on the following issues:
- Whether the Applicant has a permanent establishment (PE) in India under the provisions of Article 5 of the India-Singapore Double Tax avoidance Agreement (DTAA), in respect of the services to be rendered, with regard to use of a global network and infrastructure to process card payment transactions for customers in India?
- Whether a PE of the Applicant (in the form of its Indian subsidiary) is found to exist in India and whether provision of arm’s length remuneration to such PE for the activities to be performed in India, would absolve any further attribution of the global profits of the Applicant in India?
- Whether the fees to be received by the Applicant from Indian customers (comprising of transaction processing fees, assessment fees and transaction related miscellaneous fees) would be chargeable to tax in India as royalty/ fee for technical services (FTS) as per Article 12 of the DTAA?
- Whether any tax withholding at source would be required on the amounts to be received by the Applicant?
KEY OBSERVATIONS / CONCLUSIONS OF THE AAR:
A. Whether the Applicant has a PE in India under the provisions of Article 5 of the DTAA?
1. Whether MasterCard Interface Processor (MIP) creates a fixed place PE of the Applicant in India, under Article 5(1) of the DTAA?
- As per Article 5(1) of the DTAA, to create a PE, one has to pass three tests of: a fixed place, disposal and permanency.
- MIPs are automatic equipment placed at the site of customer banks in India and to create a PE, fixed place does not mean that the equipment should be fixed to the ground. Thus, the AAR stated that the MIPs create a PE, provided other tests are satisfied. Further, the AAR also stated that MIPs also pass the test of permanency as they are placed on the site of customer banks throughout the year.
- The AAR stated that it would be relevant to examine whether the MIPs are at the disposal of the Applicant or whether they are performing activities which are of preparatory or auxiliary in character?
- There are three stages in transaction processing: authorization, clearance and settlement. The actual authorization is done by the issuer bank and the Applicant facilitates customer banks in doing that work. The work of facilitation involves, preliminary validation/verification (performed by MIP in India), security/ fraud detection/ add on service (performed by the Applicant in Singapore) and transmission of data which is crucial to authorization (this happens both in India and outside India through MIP and MasterCard network).
- The AAR observed that the role played by MIPs was a significant one in facilitating authorization process and without this initial verification/validation by MIPs, the authorization would not happen. Thus, the AAR held that, this being a significant activity for authorization part of the transaction processing, it cannot be said to be preparatory or auxiliary.
- MIPs, though shown to be owned by MISPL, are not under the control or disposal of MISPL. Further, MIPs are not under the disposal of customer banks in whose premise these MIPs are located. All risk mitigation functions are performed by the Applicant and all decisions with respect to MIPs are taken by it, hence, MIPs are under the disposal of the Applicant.
- Thus, the AAR held that the Applicant is carrying out its business of facilitation of authorization of transaction through fixed place, i.e. MIPs, since MIPs are situated in India at its disposal. The functions performed by MIPs in facilitation of authorization transaction are not preparatory or auxiliary in character and are significant functions. Hence, MIPs create a PE of the Applicant in India.
2. Whether the MasterCard Network creates a fixed place PE of the Applicant in India, under Article 5(1) of the DTAA?
- The AAR stated that it would be relevant to observe that MIP being involved only in the authorization part of the transaction, still it constituted a PE of the Applicant in India. Thus, according to AAR it was also important to examine whether MasterCard Network which is involved in all the three phases of transaction processing, i.e. authorization, clearance and settlement, constitutes a PE or not and thus, the same would be pertinent for the assessing officer (AO) for attribution purposes.
- MasterCard Network, which is in India as well as outside India, consists of:
- MIP (owned by MISPL),
- Transmission tower, leased lines, fiber optic cable, nodes and internet (owned by third party service provider) and
- Application software - Master Connect and Master Card File express (owned by the Applicant)
- MasterCard Network is helpful in authorization (through MIP and other part of network) and also helpful in clearance and settlement process. The clearing process establishes a settlement position, which is movement of the fund from issuer bank to the acquirer bank. The significant activities relating to clearance and settlement takes place in India. The actual settlement is the movement of fund between two banks and that happens in India through Bank of India (BOI).
- The transmission of data when done for the third party is not preparatory or auxiliary, since the overall activity of MasterCard is of transmission of data via signals amongst merchant and banks, and after securing them the third party is paying for such services. Further, when the functions performed by MIPs are included, the activity of MasterCard Network in India is more than just transmission of data.
- The raw data is transferred outside by various banks using the two application softwares, Master Connect and Master Card File express, which are also part of MasterCard Network. Thus, the activity of transmission of information between various banks in India and uploading of raw data and receipt of final data using application software are performed in India.
- The preparation of settlement position is incomplete unless the BOI actually moves the fund from one bank to another bank. Thus, settlement happens when BOI carries out this movement and this happens in India for more than 90% of the transactions. The Applicant in its application before the AAR has also admitted that settlement happens in India for domestic settlement. Thus, the AAR accepted the Revenue’s contention that clearance and settlement happens in India.
- The AAR noted that in order to decide existence of PE, just like MIP, the MasterCard Network should also pass the tests of fixed place, disposal and permanence.
- The AAR observed that, it was admitted in the transfer pricing (TP) report of MISPL that MasterCard Technologies LLC (MCT LLC)is responsible for management and maintenance of MasterCard Worldwide Network remotely from the USA. The Application software - Master Connect and Master Card File express are owned by the Applicant and controlled by them, and are therefore at the disposal of the Applicant. Thus, the AAR held that the MasterCard Network is at the disposal of the Applicant and creates a PE in India of the Applicant.
- The AAR compared the Applicant’s case with the case of Amadeus Global Travel Distribution SA  and Galileo International Inc. and held that the activities performed in India are significantly more than what were performed in India in the cases of Amadeus Global and Galileo International.
- Further, the AAR held that MIP alone performs activities; the same are not preparatory or auxiliary and when combined with transmission tower, leased lines, fiber optic cable, nodes, internet, application software, etc.; the scope of activity gets even bigger and cannot be called preparatory or auxiliary.
- The AAR held that, even if significant activities are happening outside India; there can still be a PE in India, if significant activities are also happening in India. In view of all of the above reasons, the AAR held that MasterCard Network also creates a fixed place PE of the Applicant in India.
3. Whether the Bank of India premises creates a fixed place PE of the Applicant in India, under Article 5(1) of the DTAA?
- The AAR observed that 90% of the transactions involve domestic INR settlement for which BOI passes necessary entries. The settlement process is essentially the movement of funds between the issuer bank and the acquirer bank. This task is done by BOI in India on behalf of the Applicant, through a dedicated team and with all responsibility of error on the Applicant. The said fact was also admitted by the Applicant, which according to the AAR clearly makes BOI the agent of the Applicant.
- Further, the settlement position transaction wise is captured in India and is already known to the respective banks. Since, settlement is an important constituent of transaction processing, there is no doubt that this function of the Applicant is being carried out by BOI, in India.
- The employees of BOI carrying out the work are under the control and supervision of the Applicant and the space occupied by them inBOI is at the disposal of the Applicant. BOI also carries out other activities, as it is an established bank in India. However, the AAR observed that to constitute PE, the space may not be exclusively used by the non-resident enterprise. AAR also referred to Note 4 of OECD commentary on Article 5 of Model Tax Convention, wherein the said principle has been accepted. Thus, the AAR held that BOI premise constitutes fixed place PE of the Applicant.
4. Whether Applicant's subsidiary i.e. MISPL in India constitutes a fixed place PE of the Applicant in India, under Article 5(1) of the DTAA?
- AAR stated that, unless the reorganization done by the Applicant serves no other purpose except bypassing tax laws, no adverse inference can be drawn by the Revenue. Hence, the AAR held that it cannot be said that the restructuring was a case of tax avoidance or a colourable device to that end.
- There were some functions and risk related to transaction processing which were earlier carried out by MasterCard International Incorporated (MCI) in India and are still carried out by MISPL (as MISPL had taken over everything), but not shown in the functional, assets and risk (FAR) analysis of MISPL. Hence, the AAR held that the subsidiary company (MISPL) creates a PE of the Applicant in India.
- The AAR held that, the fact that MISPL is carrying on work of the Applicant, to that extent, facility, service, personnel and premise of MISPL are at the disposal of the Applicant. This so, as through the facility, service, personnel and premise, the Applicant is carrying on transaction processing activity and undertaking risks which are not reflected in the FAR of MISPL.
5. Whether Applicant's employees visiting in India and employees of Bank of India constitute a service PE of the Applicant in India, as per Article 5(6) of the DTAA?
Employees’ of the Applicant visiting in India
- The AAR observed that the clients of the Applicant are in India. Thus, relying on the decision of Hon’ble Supreme Court (SC) in the case of E-Funds, the AAR held that the first test for creating service PE is satisfied since, service is provided to the Indian customers. Further, the threshold of 90 days as per Article 5(6) of the DTAA is also satisfied.
- The AAR observed that the facts are different, in the present case, as compared to Morgan Stanley, wherein the Indian subsidiary was providing services to foreign parent and the employees of foreign parent were visiting India to check if such services are meeting the requirements that it had set. It was in that context, the activities were called stewardship activitiesby the Hon’ble Supreme Court.
- However, in the Applicant’s case, it is not a case where visiting employees are checking the service provided by MISPL to see if it meets their requirement or not. In fact, they are meeting clients in India to whom they are rendering services and talking about the possibility of improving and adding services. The said services are not stewardship activity as held by Morgan Stanley (supra). This is part of the main function that is to be performed by any organization for rendering service to its clients.
- Thus, the AAR held that the employees of the Applicant visiting India are providing services to the Indian clients and hence, once they cross the threshold of 90 days in a year, a service PE is created.
Employees’ of the Bank of India
- The employees of BOI are neither the employees of the Applicant nor are they other personnel engaged by the Applicant to render its services. The employees of BOI render services to the bank in lieu of the salaries they receive from the bank. Further, as employees of the bank, they are also rendering services on behalf of the bank to the Applicant.
- Thus, the AAR held that the employees of BOI, in India, do not constitute a service PE of the Applicant in India.
6. Whether Applicant's subsidiary (MISPL) is legally and economically dependent on the Applicant, and whether it is a dependent agent PE of the Applicant in India, as per Article 5(8) of the DTAA?
- The AAR observed that the clauses (a) and (c) of the Article 5(8) of the DTAA would be relevant to determine whether there is PE or not. Clause (a) talks about an agent habitually concluding contracts, on behalf of the non-resident enterprise. With respect to clause (c), the requirement is that, MISPL should habitually secure orders in India wholly or almost wholly for the Applicant.
- Further, in respect of the clause (a) of the Article 5(8), the AAR noted that the Revenue has not placed any evidence on record which indicates that MISPL habitually concludes contracts on behalf of the Applicant. Further, the replies from various banks in response to the information called for by the Revenue under section 133(6) of the Act, and discussed by the Applicant, clearly suggest that MISPL is not habitually concluding contracts.
- MISPL is legally and economically dependent on the Applicant, being a 100% subsidiary of the Applicant. MISPL gets its instructions and remuneration from the Applicant. The Applicant has given the process of how agreements are concluded with the banks, as regards to habitually securing orders as referred to in clause (c) of the Article 5(8) of the DTAA. MISPL provides the proposals to the Indian banks; the same are prepared, validated and approved by the Applicant.
Further, in case the customer does not agree with the proposed terms and makes a counter proposal, the same is uploaded on the portal of the Applicant outside India by the employees of MISPL. Thereafter, it is completely up to the Applicant whether to accept the counter proposal of the customer or reject the same. This process clearly establishes that, orders or agreements are routed through MISPL, though the finalization of the contract is by the Applicant in Singapore.
- Thus, AAR observed that the requirement of ‘concluding contract’ is not satisfied but the requirement of ‘securing order’ is clearly satisfied. The AAR placed reliance on the decision of Delhi ITAT and Hon’ble Delhi High Court in the case of Rolls Royce Plc.
- The AAR further stated that, if the above process is followed in all the new agreements, even though only two or three new contracts are entered into in a year, the requirement of ‘habitually’ would be satisfied. Thus, the AAR held that, MISPL constitutes a dependent agent PE under Article 5(8) of the DTAA, on account of habitually securing orders wholly for the Applicant.
7. Whether the employees of the Applicant on deputation to MISPL, creates a PE of the Applicant in India?
- The AAR observed that the Applicant had categorically stated that none of its employees have ever been deputed to MISPL. Thus, the AAR held that there is no PE on this account at present, unless subsequent facts are different and in that case, the Ruling of the AAR on this issue would become inapplicable.
B. Whether the fees to be received by the Applicant from Indian Customers, such as transaction processing fees, assessment fees and transaction related miscellaneous fees, would be chargeable to tax in India, as royalty or FTS as per Article 12 of the DTAA?
1. Whether the licensing and use of various IPs amounts to Royalty?
- The AAR observed that, the Applicant had classified its activities as a service and had entered into agreement with the banks and for this reason the banks also understood the same as a service. The AAR held that one has to look at the real nature of the transaction and not by how it has been classified by the Applicant. The AAR placed reliance on the decision of the Bangalore ITAT in the case of Google India Private Limited and the Delhi ITAT in the case of Godaddy.com LLC.
- In the case of the Applicant, there was no distribution right for any product or service involved. The role of the banks/ FIs was to issue their own cards and on that they wanted to use the logo/ trade mark and other marks owned by Master Card. The banks did not obtain distribution right for the cards, as the cards were not owned by the Applicant. The cards were owned by the banks/ FIs. The banks/ FIs do not make payment for obtaining such distribution rights of cards.
- The AAR placed reliance on the MasterCard Electronic License Agreement between MCI (AE of the Applicant) and the Indian customer banks (who pay fees to the Applicant), which were later assigned to the Applicant. The AAR stated that MCI had granted the licensee right to use various trademarks and marks owned by it, solely in connection with licensee’s payment card programs.
- The IPs, for which the Applicant is paying royalty to MCI, is further sublicensed by the Applicant to various banks and are used by these banks in India for selling their cards. Thus, the AAR held that the payment received by the Applicant represents consideration for use of the IPs in India and hence is to be classified as royalty.
- Thus, the AAR held that the licensing of various IPs in the form of brand/ trade name/ mark, etc. are not incidental to the activity of transaction processing and the payment made by various customer banks in India to the Applicant was also for the use of these IPs and hence, the same is royalty. The AAR also held that the same is effectively connected with various types of PEs, as discussed above. Thus, it would get taxed with the PE under Article 7 of the DTAA and not under Article 12 of the DTAA.
2. Whether the use of equipment (MIP) amounts to Royalty?
- The AAR stated that in order to classify a payment as royalty for use of equipment, it is necessary that the MIP is to be owned by the Applicant or is under license to it.
- According to AAR, the possession of MIPs was with the customer banks in India. Hence, the AAR held that the MIPs are equipment whose use constitutes royalty and they are effectively connected with PE created on account of MIPs as well as other PEs.
3. Whether use of secret process amounts to Royalty?
- The AAR observed that, although Explanation 6 to section 9(1)(vi) of the Act makes it clear that process may not be secret, the Revenue has submitted that the payment for use of or right to use of secret process in the operation of MIP is royalty, which is not in public domain.
- The AAR observed that only three patents are granted in India, and the same would not have an impact on the inference that technology is patented and hence secret. The AAR thus held that, since they are patented they cannot be known to and be used by the public and hence, the same are secret process.
- Further, the AAR also observed that patented and secret technology was being used in transaction processing, some of which was developed in India. The list of patents granted included such technologies. Thus, there was use of a secret process and hence, the AAR held that a part of the fee paid to the Applicant was also for use of secret process and hence, royalty. Further, the said royalty was also effectively connected to the PE, created on account of MasterCard Network as well as other PEs.
4. Whether use of software amounts to Royalty?
- The AAR observed that the use of software inside MIP and cards in the Application Software was essential part of the transaction, without which no transaction can be completed.
- The Applicant relied upon the decision of the Hon’ble Delhi High Court in the case of Infrasoft Limited and contended that there was no standalone provision of MIP and application software (MasterCard Connect and MasterCard File express) and that the transaction was of rendering transaction processing service and not for use of software.
- However, the AAR observed that the AAR in the case of SkillSoft Ireland Limited has considered the decision of Infrasoft Limited (supra) and still ruled that use of software is royalty. Thus, the AAR held that the use of software is royalty and is effectively connected to the PE.
5. Whether the fee payable to the Applicant amounts to Fees for technical services (FTS)?
- The AAR stated that, in order to examine the question of applicability of FTS, as per the DTAA, it is to be seen whether the service is a facility, as laid down by various courts. The AAR observed that the judgement of the Hon’ble SC in the case of Kotak Securities Limited, has held that the fees paid in connection with standard facility cannot be classified as FTS.
- The AAR rejected the stand taken by the Revenue and held that ultimately the beneficiary is the final consumer who is using the card. Hence, the AAR held that, the relation between the final consumer and the Applicant is of use of a standard facility and hence, transaction processing service rendered by the Applicant cannot be taxed under the Article of FTS in the DTAA.
- Further, the AAR observed that there were services other than transaction processing services. The said services were in the nature of:
- warning bulletin fees for listing invalid or fraudulent accounts either electronically or in paper form,
- cardholder service fees,
- program management services (e.g. foreign exchange margin, commissions, load fees),
- account and transaction enhancement services,
- holograms and publication fees,
- advisory services, etc.
- The AAR thus held that, the abovementioned services were not standard facility and specific service is required to be rendered to specific customer who shall request for such services and hence, the same are technical services. However, the AAR stated that, they do not make available technical knowledge, experience, skill, know-how to the service recipient. Hence, the AAR held that the same cannot be classified as FTS under Article 12 of the DTAA.
C. Whether provision of arm’s length remuneration to PE for the activities to be performed in India, would absolve any further attribution of the global profits of the Applicant in India.
1. Fixed Place PE - Attribution
- The AAR on various grounds, as seen above, has held that, MISPL creates a fixed place and dependent agent PE of the Applicant. The Applicant has relied on the decision of Morgan Stanley (supra), and contended that, no further attribution can be made to the PE even if there is a PE.
- The AAR observed that the decision of Morgan Stanley (supra) is with respect to agency PE and not with respect to fixed place PE. Thus, where a subsidiary is a fixed place PE, the decision of Morgan Stanley (supra) would not apply.
- Thus, the AAR held that, there were functions which were performed by MISPL; risks were undertaken by MISPL, on behalf of the Applicant, and the same were not reflected in the functions performed, assets utilised and risk assumed (FAR) profile of MISPL in its TP Report. Thus, as MISPL constitutes a PE of the Applicant, the AAR held that the AO may consider a further attribution to the PE.
2. Agency PE - Attribution
- The AAR held that even in the case of dependent agent PE, the FAR profile of the Applicant is different from FAR of the Indian subsidiary (dependent agent). It is only when the two FAR are the same; one can say that, there cannot be any further attribution.
- The AAR stated that, if the transfer pricing analysis, do not adequately reflect the functions performed and the risks assumed by the Applicant, then there would be a need to attribute further profits. Thus, the AAR held that, even in the case of a dependent agent PE in this case, there is a need for further attribution, since all the functions/ risks are not reflected in the FAR of MISPL.
D. The last issue raised by the Applicant was with regard to tax withholding at source; as to whether the same would be required on the amounts to be received by the Applicant, and what would be the applicable rate?
- The AAR stated that all the revenues received by the Applicant from customers in India would not be attributed to the Indian PE, since; significant activities were also carried out by the Applicant outside India.
- Thus, the AAR held that, there is a need for attribution which is required to be done by the AO and on such attribution of income to the PE; the tax is required to be withheld at full applicable rate at which the Applicant is subjected to tax in India.
The ruling once again brings to fore the disconnect with the traditional understanding of the concept of a PE and trying to fit that understanding, to the technological innovation of carrying on business in the source country, through revolutionary methods of information technology and communication via digital means.
The decision relies on the doctrine advocated by a host of nations to tax digital transactions which have a connection with the source state, but which requires a more broader interpretation of tax laws, including DTAAs, to tax income emanating from transactions carried out by non-residents in the source state.
It would need to be seen how in India tax jurisprudence will evolve when there is tension generated between the traditional concept of PE and the broader approach adopted by the AAR.
Further, the methodology adopted by the AAR determining a PE from various digital and connected equipments located in India, may tend to eliminate or shift such equipments outside the source country, subject to technological innovation/ regulations and security of the transactions. This would be against the purpose of broader interpretation of tax laws, which is adopted by the countries globally, to shore up the treasury.
This decision also brings out the critical importance of understanding the very basis and philosophy of correctly documenting the transactions between the opposing philosophy and law of transfer pricing and attributing income to a transaction, as there is an inversely proportional relationship between transfer pricing and determination and attribution of income to a non-resident for business activities carried out in the source state, that is, PE and its taxation.
 The two main processing centers of the MasterCard group which are in the USA are owned by MasterCard Technologies LLC, a wholly owned direct subsidiary of MCI
 Amadeus Global Travel Distribution SA vs DCIT  113 TTJ (ITAT Delhi) 767
 Galileo International Inc. vs. DCIT  19 SOT 257 (Delhi)
 DIT v. E-Funds IT Solution and Ors, (86 Taxmann 240)
 DIT(IT) vs. Morgan Stanley & Co. Inc (292 ITR 416)
 Rolls Royce Plc vs. DIT (IT) [(2008) 19 SOT 42] (Delhi ITAT)
 Rolls Royce Plc vs. DIT (IT) [(2011) 339 ITR 147 (Del)]
 Google India Pvt Ltd vs. ACIT [ITA no 1511 to 1518/Bang/2013]
Godaddy Com LLC vs. ACIT [ITA no 1878/Del/2017]
DIT vs. InfrasoftLimited(ITA No.1034/2009)
SkillSoft Ireland Limited, In re. (AAR no 985 of 2010)
CIT vs. Kotak Securities Limited (383 ITR 1)