In a recent ruling¹, the Income Tax Appellate Tribunal, Bangalore (“Tribunal“) ruled that income derived from providing pre-clinical laboratory services to Indian clients should not be subjected to taxation in India as it does not fall within the ambit of Fee for Included Services (“FIS”) under the Double Taxation Avoidance Agreement between India and the United States (“DTAA”).

Background

The taxpayer is a non-resident incorporated under the laws of United States of America (“Taxpayer“). The Taxpayer specializes in providing pre-clinical laboratory services aimed at determining the safe dosage and assessing the potential toxicity of new drugs before conducting human clinical trials by way of conducting in vitro and in vivo tests and trials. These services are largely catered towards Indian customers in the pharmaceutical, medical device and biotechnology industries. The Indian customers provide samples prior to undertaking human clinical trials, which is tested by the Taxpayer, by rendering such preclinical laboratory services and the Taxpayer provides report to its customers containing a generic protocol of the test procedure and results to conclude the preclinical phase of testing. No technology / know-how / knowledge is transferred to the customers nor any right to access/ use of such property is granted by the Taxpayer.

The case of the Taxpayer was selected for assessment and following numerous rounds of communication, including notices and replies and providing information, the Taxpayer received a Show Cause Notice (“Notice”). The Notice sought an explanation as to why the income received from Indian entities as laboratory service charges should not be subjected to taxation as technical services. In response, the taxpayer, inter alia submitted, that their services did not involve the transfer of technology, know-how, or knowledge, nor did they grant any rights for accessing or using such intellectual property. However, the Assessing Officer (“AO”) ruled that the services offered by Taxpayer came under the ambit of the term FIS and hence taxable in India.

The view of the AO was accepted by the Dispute Resolution Panel (“DRP”) who dismissed the Taxpayer’s primary argument that they did not provide any technical knowhow to their Indian customers. Instead, the DRP concluded that Article 12(4)(b) of the DTAA (which provides for the meaning of FIS) is applicable in the present case. Subsequently, the Assessing Officer issued the final assessment order against the Taxpayer based on the DRP’s directive.

Aggrieved by the order of the AO, the Taxpayer filed an appeal before the Tribunal.

Ruling

On appeal to the Tribunal, the Tribunal ruled that the income received from the Indian entities does not amount to FIS and in the absence of a Permanent Establishment (“PE”) of the Taxpayer in India, the income should be considered as business income not subject to withholding taxes in India. The Tribunal’s ruling was based on the following reasons:

• The Tribunal, in its decision, referred to the cases of Guy Carpenter² and De Beers India Minerals (P.) Ltd.³ wherein the Court while dealing with taxability of the payments received for services rendered to an Indian insurance company in the re-insurance process and services provided to Indian companies through geophysical surveys for commercial and technical data, held that the same is not taxable as fee for technical services/FIS under India-UK DTAA and India-Netherlands DTAA, respectively. It emphasized that the payment of consideration would be classified as FIS only when two conditions are met simultaneously: the provision of services and the availability of technical knowledge.
• The Tribunal further placed significant reliance on a decision by the Hon’ble Hyderabad Tribunal in the case of DCIT v. Dr. Reddy’s Laboratories Ltd⁴ (“ Reddy”). This decision was considered influential as it involved a similar factual context to the present case. In both instances, a contract research organization engaged in clinical trials and provided test reports to its Indian customers in exchange for a fee. The Tribunal eloquently held that, payment of consideration would be regarded as FIS only if the twin test of rendering services and making technical knowledge available are simultaneously met. Furthermore, the Tribunal highlighted the interpretation of ‘making technical knowledge available’, as elaborated in Dr. Reddy, by emphasizing that the service provider must not only provide technical knowledge, experience, skills, and know-how, but also ensure that the recipient of the service becomes capable of independently performing the technical function in the future, without the help of the service provider.
• In the present case, the repeated engagement of the Taxpayer for research purposes establishes the absence of “making available” of technical knowledge possessed by the Taxpayer’s employees to any of its Indian clients and hence the services of the Taxpayer do not fall within the ambit of “make available” as provided for under the Treaty. This is also evident from the fact that in Clause 13 of the master service agreement that is entered into between the Taxpayer and the Indian client provides that the Taxpayer possesses the requisite knowledge, know-how, and expertise to conduct the research and generate reports based on the agreed-upon study between the Taxpayer and their client. Furthermore, the clause explicitly stipulates that any inventions or techniques necessary for providing services to the client shall remain the exclusive property of the Taxpayer alone and hence nothing was being “made available” to the Indian clients.
• The Tribunal also distinguished the cases relied on by the AO:

• • M/s. XYZ Ltd., AAR, New Delhi ⁵: In the advance ruling sought, the applicants with varying circumstances approached the authority. The ruling determined that the applicants had a tax presence in India, thus mandating their Indian customers/clients to withhold tax under section 195 of the Act. This ruling specifically applied to an applicant who was a resident of a country without a tax treaty with India, resulting in their ineligibility for benefits under section 90(2) of the Act.
  • Stempeutics Research Pvt. Ltd. v. JDIT⁶: In this case, a Malaysian company was transferring technical information, technology documentation, know-how, and processes related to clinical trials and research and development (R&D) to Indian client(s). However, in the present case, as noted above, Clause 13 of the Master Service Agreement very clearly states that all inventions / techniques for rendering of services by Taxpayer would be the exclusive property of the Taxpayer and hence the facts of the case were different from the facts of the Taxpayer.

Analysis

Despite the well-established legal position, the tax authorities raised the issue without giving due consideration to the crucial criterion of “make available” in determining the categorization of income as FIS.

This recent ruling by the ITAT serves as a reaffirmation of the significance of the “make available” criterion in determining the classification of income as FIS.  The concept of FIS encompasses payments made for technical services that involve the rendering of services as well as the provision of technical knowledge. The Tribunal emphasized that for income to be classified as FIS, both aspects—service provision and the availability of technical knowledge—must be present simultaneously. By reinforcing this criterion, the ruling provides a clear framework for assessing the taxability of income from such services, ensuring a consistent and standardized approach.

By addressing the aforementioned key aspects, the Tribunal’s ruling brings clarity and consistency to the taxation of income derived from pre-clinical laboratory services. It highlights the necessity of fulfilling the “make available” criteria for income to be categorized as FIS, ensuring that only those payments involving the transfer of technical knowledge are subject to taxation. Overall, this decision provides valuable guidance for taxpayers and tax authorities in evaluating the tax implications of similar transactions and promoting consistency in tax assessments.

-Krishna Agarwal & Ashish Sodhani

1. M/s. Charles River Laboratories Inc. v. The Assistant Commissioner of Income Tax, International Taxation, [TS-296-ITAT-2023 (Bang)]
2. CIT v. Guy Carpenter & Co Ltd, [TS-271-HC-2012(DEL)]
3. CIT v. De Beers India Minerals (P) Ltd., [TS-312-HC-2012(KAR)]
4. [TS-216-ITAT-2013(HYD)]
5. AAR No. 928 of 2010
6. TS-560-ITAT-2016(Bang)