Fees for Technical Services (FTS) Taxation Under IT Act – Key Provisions and DTAA Rules

Fees for Technical Services (FTS) taxation under the IT Act refers to the tax imposed on payments made for managerial, technical, or consultancy services, including the provision of technical personnel. Under Section 9(1)(vii), FTS is deemed to accrue or arise in India if paid by the government, a resident, or a non-resident (NR) when the services are used in India. However, FTS used for business or profession outside India is excluded. Non-residents may also be taxed under a Double Taxation Avoidance Agreement (DTAA) if it offers more favorable provisions.information.

Table of Content

1. Scope
2. Fees For Technical Services under the IT Act, Section 9(1)(vii)
3. Taxability of Fees for Technical Services under the IT Act
4. Fees for Technical Services under DTAA
5. Analysis of the Text of FTS Article under the MCs and the DTAAs

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1. Scope

This article deals with taxation of Fees for Technical Services (“FTS”), briefly in general and in relation to an NR. It explains the meaning of FTS under the IT Act and how it is taxed under the IT Act in the hands of a resident and an NR. It also explains the meaning of FTS and Fees for Included Services, as it is referred to in some DTAAs and explains how it is to be taxed under a DTAA.

NR who is eligible to the provisions of an applicable DTAA, would be taxed under the IT Act only if the IT Act is more beneficial in terms of its scope, meaning, and rate of tax. In all other cases, the provisions of the DTAA would apply.

In this article, for the purposes of explaining the taxability under two different sets of DTAA provisions: one where the meaning and scope of FTS is very similar to that under the IT Act, section 9(1)(vii) and the other where it requires the services to be rendered for the use of intellectual property for which royalty payment under Article 12 of the relevant DTAA is made as well as where the services make available technical knowledge, experience, skill, know-how or processes, or consist of the development and transfer of a technical plan or technical design. Therefore, in addition to providing the text of Article 12 of the UN MC and the OECD MC, this article also deals with the text of Article 12 under India-US DTAA along with the examples given in the protocol exchanged, to understand the meaning given to this article by the two states and one more DTAA.

There is a plethora of judicial precedents, dealing with the taxability of fees for technical services and this article discusses a few important and recent decisions to explain the current trend in judicial interpretation.

2. Fees for Technical Services under the IT Act, Section 9(1)(vii)

Under section 9(1), incomes of the nature listed under clauses (i) to (viii) are deemed to accrue or arise in India. Clause (vii) deals with fees for technical services. When such fees are payable by the following, then they are deemed to accrue or arise in India and become liable to tax in India.

(vii) income by way of fees for technical services payable by—

(a) theGovernment ; or

(b) a person who is a resident, except where the fees are payable in respect of services utilised in a 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 ; or

(c) a person who is a non-resident, where the fees are payable in respect of services utilised in a business or profession carried on by such person in India or for the purposes of making or earning any income from any source in India :

Provided that nothing contained in this clause shall apply in relation to any income by way of fees for technical services payable in pursuance of an agreement made before the 1st day of April, 1976, and approved by the Central Government.

Explanation 1.—For the purposes of the foregoing proviso, an agreement made on or after the 1st day of April, 1976, shall be deemed to have been made before that date if the agreement is made in accordance with proposals approved by the Central Government before that date.

Explanation 2.—For the purposes of this clause, “fees for technical services” means any consideration (including any lump sum consideration) for the rendering of any managerial, technical or consultancy services (including the provision of services of technical or other personnel) but does not include consideration for any construction, assembly, mining or like project undertaken by the recipient or consideration which would be income of the recipient chargeable under the head “Salaries”;

2.1 Included in the meaning of FTS

Consideration for :

• Rendering of any managerial, technical or consultancy services
• Any lump sum consideration in regard to rendering of managerial, technical or consultancy services
• Provision of services by technical or other personnel

2.2 Excluded from the meaning of FTS

Consideration for :

• Any construction, assembly, mining or like project undertaken by the recipient of the fee
• Any income which is characterised and taxed as salary in the hands of the recipient

2.3 When is it accrued or arisen in India in the hands of resident or NR?

• When paid by the government
• When paid by a resident
• When paid by another NR but the services are utilised by the NR payer in a business or profession that the payer carries on in India or
• When paid by another NR, and the NR payer uses the services for the purposes of making or earning any income from any source in India.

2.4 When is it not accrued or arisen in India in the hands of NR under the I.T. Act?

• Though paid by the government or a resident, the services are

1. 1. Used in a business or profession carried on by the payer outside India
   2. used for the purposes of making creating – or earning any income from any source outside India.

2.5 Nexus approach for taxability in India

The exclusions and inclusions from the FTS accruing or arising in India is based on the nexus approach. If the nexus is with India, then the fees accrue or arise in India and are taxable in India. Where there is no nexus with India, e.g. when a resident pays FTS to an NR whose services are used to set up business outside India or for a project outside India, from

which the resident would earn income from a source outside India, then it is regarded that there is no nexus of that FTS with India and is therefore not considered accrued or arisen in India.

Conversely, when an NR uses the services of another NR to set up a project in India or for consultancy in respect of business in India, there is nexus with India, since the NR payer will benefit from those services in the course of earning its income from the business or project in India. In such a situation, the fee paid by one NR to another NR is considered accrued or arisen in India and considered taxable in India.

Case studies to explain nexus:

1. A, resident of India, is in the business of pharmaceuticals. The company already has several subsidiaries and branches around the world. It is considering further expansion in the South and Latin Americas. For that purpose, the company needs advice on the practical issues of pharmaceutical industry and advice on the appropriate structure. Co. A hires a pharmaceutical industry consultant in Brazil for this advice.
   In these facts of the case, the fees paid to the Brazilian consultant, may be termed as paid for business being set up outside India and hence not accrued or arisen in India in terms of the second half provision of section 9(1)(vii)(b), which excludes such fee from being regarded as accrued or arisen in India.

2. C, a resident of Italy, is engaged in the business of manufacturing and selling premium sanitaryware. Co. C is looking to set up its business in India and is considering whether it should be a wholly owned subsidiary, a joint venture company or a branch, distributorship or any other form and where in India should this be set up. For this purpose, it hires a consultant located in the UAE to advise and pays fees for the same.
   In these facts of the case, Co. C is NR and the consultant is also NR. However, the advice that Co. C receives is for its business in India and hence it would fall in the meaning of FTS which accrues or arises in India under section 9(1)(vii)(c) and may attract tax in India, subject to the provisions of the India-UAE DTAA to which the consultant may be eligible.

3. Taxability of Fees for Technical Services under the IT Act

3.1 Foreign companies with PE, receiving fees for technical services – Sections 44D & 44DA

Where the fees for technical services received by the NR are connected with the business carried out by the NR through a permanent establishment (“PE”) or a fixed base in India, such fees for technical services are taxable under section 44DA (introduced by the Finance Act, 2003). This section provides that the fees for technical services in such a situation is to be computed as per the rules applicable under the IT Act to compute the profits and gains of business or profession.

Additionally, section 44DA specifically denies the following deductions:

• In respect of any expenditure or allowance which is not wholly and exclusively incurred for the business of such PE or fixed place of profession in India; or
• in respect of amounts, if any, paid (otherwise than towards reimbursement of actual expenses) by the PE to its head office or to any of its other offices.

PE under the IT Act for the purpose of this section is specifically defined to include a fixed place of business through which the business of the enterprise is wholly or partly carried on.

It can be seen that there could be different interpretations in relation to what constitutes expenditure which is “wholly & exclusively incurred for the business of the PE or fixed place of business”. As per Rule 6GA, a foreign company being taxed under this section must keep and maintain books of account and other documents as required under section 44AA and also get such accounts audited by an accountant as prescribed in section 288. This report of audit of accounts of the NR should be in Form No. 3CE and should be furnished one month prior to the date of furnishing return of income under section 139(1) of the IT Act.

Care needs to be taken while claiming deductions under these sections to determine taxable income to avoid dispute and disagreement and proper documentation and records should help in avoiding litigation.

3.2 Taxation of fees for technical services under section 115A – on Gross basis

Where the income of an NR includes income by way of fees for technical services which is not covered under section 44DA, i.e. it is not connected with the PE of the NR in India, it will be taxed at 20% on the gross receipt of fees for technical services, if the following conditions are satisfied:

• The agreement under which fees for technical services is so receivable is entered into on or after 1 April, 1976;
• The agreement is approved by the Central Government; or
• The agreement relates to a matter included in the industrial policy of the Government in force and it is in accordance with that

Please note that section 115A(3) provides that no deduction would be allowed for any expense or allowance incurred for earning such fees for technical services income.

3.3 Withholding tax provisions under the IT Act

Section 194J requires a payer to withhold tax at source and carry out TDS compliances when making payment to a resident as prescribed in the following manner:

• As per the first proviso to section 194J, no deduction is required to be made if the fee payable does not exceed INR 30,000.
• As per the second proviso to section 194J, no deduction is required to be made by a payer if the gross turnover of the business does not exceed INR 1 crore or INR 50 lakh in case of profession
• As per the third proviso to section 194J, if the payer of FTS is an individual or a member of a HUF and the services are used exclusively for personal purposes, then no TDS is required to be
• If the payment is made to a person who is only engaged in the business of operation of call centre, the tax is required to be withheld at the rate of 2%
• As per section 194J(1), if the payment is made for professional services, which means legal, medical, engineering or architectural, accountancy or technical consultancy or interior decoration or advertising or such other services which may be notified by the CBDT for the purposes of section 44AA, then the tax is to be withheld at the rate of 10%.
• As per section 194J(1) in case of all other types of FTS, the tax is to be withheld at the rate of 2%.

As regards payment of FTS to an NR, the withholding tax obligation is set out under section 195. Under Part II of the First Schedule to the Finance Act, 2022 tax at the rate of 20% is required to be deducted at source while making payment of FTS to an NR, subject to availability of a lower rate in case of the NR under the applicable DTAA, if any1

3.4 Consequences of not complying with withholding tax requirement

Under section 40(a)(i), if tax as required and discussed in paragraph 3.3 above is not deducted at source and is not deposited with the tax department as required under the IT Act, while making payment to an NR, then the expense of fees for technical services is not allowed as a deductible expense. The payer is then treated as taxpayer in default and the consequences in terms of interest and even penalty for failure to comply with the tax withholding provisions would apply.

4. Fees for Technical Services under DTAA

4.1 FTS under the UN MC Article 12A

The text of Article 12A, on Fees for Technical Services under the UN Model convention updated in 2017 is set out below:

Article 12A Fees For Technical Services

1. 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, notwithstanding the provisions of Article 14 and subject to the provisions of Articles 8, 16 and 17, fees for technical services arising in a Contracting State may also be taxed in the Contracting State in which they arise and according to the laws of that State, but if the beneficial owner of the fees is a resident of the other Contracting State, the tax so charged shall not exceed per cent of the gross amount of the fees [the percentage to be established through bilateral negotiations].
3. The term “fees for technical services” as used in this Article means any payment in consideration for any service of a managerial, technical or consultancy nature, unless the payment is made:

• • • to an employee of the person making the payment;
    • for teaching in an educational institution or for teaching by an educational institution; or
    • by an individual for services for the personal use of an individual

4. The provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of fees for technical services, being a resident of a Contracting State, carries on business in the other Contracting State in which the fees for technical services arise through a permanent establishment situated in that other State, or performs in the other Contracting State independent personal services from a fixed base situated in that other State, and the fees for technical services are effectively connected with:

• • • such permanent establishment or fixed base, or
    • business activities referred to in (c) of paragraph 1 of Article 7.

In such cases the provisions of Article 7 or Article 14, as the case may be, shall apply.

5. For the purposes of this Article, subject to paragraph 6, fees for technical services shall be deemed to arise in a Contracting State if the payer is a resident of that State or if the person paying the fees, whether that person is a resident of a Contracting State or not, has in a Contracting State a permanent establishment or a fixed base in connection with which the obligation to pay the fees was incurred, and such fees are borne by the permanent establishment or fixed base.
6. For the purposes of this Article, fees for technical services shall be deemed not to arise in a Contracting State if the payer is a resident of that State and carries on business in the other Contracting State through a permanent establishment situated in that other State or performs independent personal services through a fixed base situated in that other State and such fees are borne by that permanent establishment or fixed base.
7. Where,by reason of a special relationship between the payer and the beneficial owner of the fees for technical services or between both of them and some other person, the amount of the fees, having regard to the services for which they are paid, exceeds the amount which would have been agreed upon by the payer and the beneficial owner in the absence of such relationship, the provisions of this Article shall apply only to the last mentioned  In such case, the excess part of the fees shall remain taxable according to the laws of each Contracting State, due regard being had to the other provisions of this Convention.

4.2 FTS under the OECD MC

OECD MC has no article or provision for taxation of Fees for Technical Services. In general, OECD regards such fees to be business income of a person and the same is taxed in accordance with the provisions for taxation of business income under Article 7, if the person has a PE in the State where the FTS arise.

4.3 FTS under India-USA DTAA

Article 12 Royalties And Fees For Included Services

• Royalties and fees for included services arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State.
• However, such royalties and fees for included services may also be taxed in the Contracting State in which they arise and according to the laws of that State; but if the beneficial owner of the royalties or fees for included services is a resident of the other Contracting State, the tax so charged shall not exceed:

(A) in the case of royalties referred to in subparagraph (a) of paragraph 3 and fees for included services as defined in this Article [other than services described in subparagraph (b) of this paragraph] :

(i) during the first five taxable years for which this Convention has effect,

(a) 15 percent of the gross amount of the royalties or fees for included services as defined in this Article, where the payer of the royalties or fees is the Government of that Contracting State, a political sub-division or a public sector company ; and

(b) 20 per cent of the gross amount of the royalties or fees for included services in all other cases; and

(ii) during the subsequent years, 15 per cent of the gross amount of royalties or fees for included services; and

(b) in the case of royalties (………………..) and fees for included services as defined in this Article that are ancillary and subsidiary to the enjoyment of the property for which payment is received (this refers to royalty payment) under paragraph 3(b) of this Article, 10 per cent of the gross amount of the royalties or fees for included services.

• The term “royalties” as used in this Article means (Not dealt with here since it is dealt with in the article for Taxation of Royalties):
• For purposes of this Article, “fees for included services” means payments of any kind to any person in consideration for the rendering of any technical or consultancy services (including through the provision of services of technical or other personnel) if such services:

1. 1. are ancillary and subsidiary to the application or enjoyment of the right, property or information for which a payment described in paragraph 3 is received; or
   2. make available technical knowledge, experience, skill, know-how, or processes, or consist of the development and transfer of a technical plan or technical design.

• Notwithstanding paragraph 4, “fees for included services” does not include amounts paid:

1. 1. for services that are ancillary and subsidiary, as well as inextricably and essentially linked, to the sale of property other than a sale described in paragraph 3(a);
   2. for services that are ancillary and subsidiary to the rental of ships, aircraft, containers or other equipment used in connection with the operation of ships or aircraft in international traffic ;
   3. for teaching in or by educational institutions;
   4. for services for the personal use of the individual or individuals making the payments; or
   5. to an employee of the person making the payments or to any individual or firm of individuals (other than a company) for professional services as defined in Article 15 (Independent Personal Services).

• The provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the royalties or fees for included services, being a resident of a Contracting State, carries on business in the other Contracting State, in which the royalties or fees for included services arise, through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the royalties or fees for included services are attributable to such permanent establishment or fixed  In such case the provisions of Article 7 (Business Profits) or Article 15 (Independent Personal Services), as the case may be shall apply.
• (a) Royalties and fees for included services shall be deemed to arise in a Contracting State when the payer is that State itself, a political sub-division, a local authority, or a resident of that  Where, however, the person paying the royalties or fees for included services, whether he is a resident of a Contracting State or not, has in a Contracting State a permanent establishment or a fixed base in connection with which the liability to pay the royalties or fees for included services was incurred, and such royalties or fees for included services are borne by such permanent establishment or fixed base, then such royalties or fees for included services shall be deemed to arise in the Contracting State in which the permanent establishment or fixed base is situated.

(b) Where under sub-paragraph (a) royalties or fees for included services do not arise in one of the Contracting States, and the royalties relate to the use of, or the right to use, the right or property, or the fees for included services relate to services performed, in one of the Contracting States, the royalties or fees for included services shall be deemed to arise in that Contracting State.

• Where, by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of the royalties or fees for included services paid exceeds the amount which would have been paid in the absence of such relationship, the provisions of this Article shall apply only to the last-mentioned amount. In such case, the excess part of the payments shall remain taxable according to the laws of each Contracting State, due regard being had to the other provisions of the Convention.

4.4 FTS under India-Germany DTAA

Article 12 Royalties and Fees for Technical Services

1. Royalties and 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 and fees for technical services may also be taxed in the Contracting State in which they arise and according to the laws of that State, but if the recipient is the beneficial owner of the royalties, or fees for technical services, the tax so charged shall not exceed 10 per cent of the gross amount of the royalties or the fees for technical services.
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 literary, artistic or scientific work, including cinematograph films or films or tapes used 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, or for information concerning industrial, commercial or scientific experience.
4. The term “fees for technical services” as used in this Article means payments of any amount in consideration for the services of managerial, technical or consultancy nature, including the provision of services by technical or other personnel, but does not include payments for services mentioned in Article 15 of this
5. The provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the royalties or fees for technical services, being a resident of a Contracting State, carries on business in the other Contracting State in which the royalties or fees for technical services arise, through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the right, property or contract in respect of which the royalties or fees for technical services are paidis effectively connected with such permanent establishment or fixed base. In such case, the provisions of Article 7 or Article 14, as the case may be, shall apply.
6. Royalties and fees for technical services shall be deemed to arise in a Contracting State when the payer is that State itself, a land or a political sub-division, a local authority or a resident of that  Where, however, the person paying the royalties or fees for technical services, whether he is a resident of a Contracting State or not, has in a Contracting State a permanent establishment or a fixed base in connection with which the liability to pay the royalties or fees for technical services was incurred, and such royalties or fees for technical services are borne by such permanent establishment or fixed base, then such royalties or fees for technical services shall be deemed to arise in the State in which the permanent establishment or fixed base is situated.
7. Where, by reason of special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of royalties or fees for technical services paid exceeds the amount which would have been paid in the absence of such relationship, the provisions of this Article shall apply only to the last-mentioned amount. In such case, the excess part of the payments shall remain taxable according to the laws of each Contracting State, due regard being had to the other provisions of this Agreement.

5. Analysis of the Text of FTS Article under the MCs and the DTAAs

5.1 No Article in OECD for taxation of Fees for Technical Services

As the OECD favours residence based taxation, there is no article in the OECD MC to give right to the Source State to tax income from services when they accrue or arise in the Source State. The OECD regards income from services to be business income of the person and supports that such business income can only be taxed in the Source State if the recipient of services income had a PE in the Source State.

However, as can be seen from the India-USA and India-Germany DTAA (and most other DTAAs), India has negotiated hybrid model. In the case of USA, they are called fees for included services and they are connected with the enjoyment of the right of the intellectual property for which royalty payment is made.

Fees for included services in India-US DTAA are defined to be for services which:

• are ancillary and subsidiary to the application or enjoyment of the right, property or information for which a royalty payment is made; or
• make available technical knowledge, experience, skill, know-how, or processes, or consist of the development and transfer of a technical plan or technical design.

This significantly narrows the scope of fees for technical services paid or payable to a US resident who is eligible to the DTAA benefits. Accordingly, a US tax resident which is eligible to the benefits of the India-US DTAA may claim the benefit of the narrower definition of ‘fees for included services’ and therefore, not be subject to income tax on such fees in India.

The Protocol exchanged between India and the US on this Article sets out several examples to explain the intention of what is to be regarded as taxable in the Source State under this Article. The relevant text of the protocol exchanged and agreed protocol in respect of Fees for Included Services and the examples are set out below for ready reference.

5.2 Protocol under India-US DTAA

AD ARTICLE 12 – It is understood that fees for included services, as defined in paragraph 4 of Article 12 (Royalties and Fees for Included Services) will, in accordance with United States law, be subject to income tax in the United States based on net income and, when earned by a company, will also be subject to the taxes described in paragraph 1 of Article 14 (Permanent Establishment Tax). The total of these taxes which may be imposed on such fees, however, may not exceed the amount computed by multiplying the gross fee by the appropriate tax rate specified in subparagraph (a) or (b) whichever is applicable or paragraph 2 of Article 12.

Explanation
Total tax on fees for included services on which US would have right to levy tax, is not to exceed the total tax under Article 12, that is agreed by the two States to be levied by the Source State.

Article 12, Paragraph 4 (in general)

This memorandum describes in some detail the category of services defined in paragraph 4 of Article 12 (Royalties and Fees for Included Services). It also provides examples of services intended to be covered within the definition of included services and those intended to be excluded, either because they do not satisfy the tests of paragraph 4, or because, notwithstanding the fact that they meet the tests of paragraph 4, they are dealt with under paragraph 5. The examples in either case are not intended as an exhaustive list but rather as illustrating a few typical cases. For the purpose of understanding, the example in this memorandum described U.S. persons providing services to Indian persons, but the rules of Article 12 are reciprocal in application.

Article 12 includes only certain technical and consultancy services. By technical services, we mean in this context services requiring expertise in a technology. By consultancy services, we mean in this context advisory services. The categories of technical and consultancy services are to some extent overlapping because a consultancy service could also be a technical service. However, the category of consultancy services also includes an advisory service, whether or not expertise in a technology is required to perform it.