Despite the huge success of the inaugural edition of the Formula One Grand Prix of India held in October 2011 and of the two iterations thereafter in 2012 and 2013 respectively, the famous Buddh International Circuit has been conspicuously absent from the Formula One (F1) calendar ever since. One of the reasons for this could be the tax controversy relating to the characterisation of income earned by Formula One World Championship Limited (FOWC) from Jaypee Sports International Limited (Jaypee / Promoter) in India. The Delhi High Court in its recent ruling Formula One World Championship Ltd v. CIT[1] has reversed the decision of the Authority for Advance Rulings (AAR) to hold that the Buddh International Circuit constituted a permanent establishment (PE) of FOWC in India.
Background
Federation Internationale de L´Automobile (FIA), the international motor sports events regulating authority originally owned all commercial rights in the FIA Formula One World Championship (F1 Championship). These were transferred in 2001 to SLEC Holding Company (parent company of FOWC) for a consideration and then to Formula One Asset Management Limited (FOAM). By way of a new Concorde Agreement of 2009 between FIA, FOAM and FOWC, FOAM licensed all commercial rights in the F1 Championship with effect from 1 January 2011 to FOWC, a tax resident of the United Kingdom for a 100-year term.
Various F1 race teams, known as Constructors" also signed the Concorde Agreement with FOWC and the FIA, undertaking to participate in every F1 event included in the official annual F1 racing calendar. FOWC entered into a Race Promotion Contract dated 13 September 2011 (2011 RPC) with Jaypee granting it the right to host, stage and promote the Formula One Grand Prix of India for a consideration of USD 40 million. An Artworks License Agreement (ALA) contemplated in the 2011 RPC was also entered into between FOWC and Jaypee on the same day permitting the use of certain marks and intellectual property belonging to FOWC for a consideration of USD 1.
Certain conditions precedent to the 2011 RPC required Jaypee to enter into independent contractual arrangements with FOWC’s affiliates, namely, Beta Prema 2 Ltd, Allsports Management SA and Formula One Management Ltd.
FOWC and Jaypee both approached the AAR to seek an advance ruling on the following issues:
- Whether the consideration receivable by FOWC from Jaypee outside India in terms of the 2011 RPC was royalty as defined in Article 13 of the India – UK Tax Treaty;
- Whether FOWC was justified in its position that it did not have a PE in India in terms of Article 5 of the India – UK Tax Treaty; and
- Whether Jaypee was required to withhold tax from the consideration payable to FOWC outside India in terms of Section 195 of the (Indian) Income Tax Act, 1961 (IT Act).
AAR Ruling
1. Royalty:
- The AAR observed that use of the mark “Formula One Grand Prix of India” was a sine qua non for organizing the event, without which Jaypee could not have staged or hosted it in terms of the 2011 The ALA, though signed separately, was integral to the 2011 RPC and was not a standalone agreement. The creation of a separate ALA with nominal and insignificant consideration of USD 1 was purely artificial. Insufficiency of consideration in the ALA could not have diminished its importance as the use of the F1 marks permitted thereunder was not merely incidental to the 2011 RPC.
- Notwithstanding the nomenclature of the agreements, and the use of words such as ‘incidental’ in the 2011 RPC, the dominant intention of the parties to the 2011 RPC and the ALA (i.e. FOWC and Jaypee) was to host, stage and promote the “Formula One Grade Prix of India”, which was a licensed mark of FOWC. Since the definition of “royalty” both in terms of the India – UK Tax Treaty and the IT Act covered payments received as consideration for the use of a trade mark, the payments made by Jaypee were for the use of the mark “Formula One Grand Prix of India” and therefore, were held to be in the nature of royalty.
2.Fixed Place and Dependent Agent PE:
The AAR held that the contention of the revenue authorities that mere access to the racing circuit owned by Jaypee amounted to a place of business through which FOWC conducted business was completely misleading. FOWC was the Commercial Rights Holder as per the Concorde Agreement and had been necessarily involved since the very beginning in order to ensure that the race circuit met the requisite design specifications and standards of the Formula One Grand Prix. Access to the pit and paddock buildings and surrounding areas of the circuit was granted to FOWC, its competitors, its affiliates, contractors and licensees and for their respective personnel and equipment to facilitate the work relating to the event and did not mean that the circuit was FOWC’s place of business. The AAR further held that FOWC’s affiliates, Beta Prema 2 Ltd, Allsports Management SA and Formula One Management Ltd, were not acting on behalf of FOWC. It was finally concluded that FOWC had no fixed place of business, was not doing any business activity in India and had not authorised any organisation or entity to conclude contracts on its behalf and therefore had no PE in India.
High Court Ruling
1. Whether FOWC had a fixed place PE in India in terms of Article 5(1) of the India – UK Tax Treaty
(a) The Court held that the Buddh International circuit itself constituted a fixed place of business for FOWC based on the following observations:
(i) For the duration of the event as well as two weeks prior to it and a week succeeding it, FOWC had full access to the circuit, its personnel, the teams contracted to it, both racing as well as spectator teams and could also dictate who all were authorized to enter the areas reserved exclusively for itself.
(ii) Even though Jaypee was designated as the Promoter or the event host, a combined reading of the terms of the 2011 RPC together with the agreements between Jaypee and FOWC’s affiliates suggested that Jaypee’s capacity to act was extremely restricted. At all material times, FOWC had exclusive access to the circuit, and all the spaces where the teams were located. Even though Jaypee created the circuit for the purposes of the event and other events, yet, during the F1 championship, no other event was possible.
(iii) Though FOWC’s access or right to access was not permanent, in the sense of it being everlasting, the model of commercial transactions it chose was such that its exclusive circuit access was for up to six weeks at a time during the F1 Championship season. This nature of activity, i.e. racing and exploitation of all the bundle of rights the FOWC had as Commercial Rights Holder meant that it had a shifting or moving presence – the teams competed in a race at a given place and thereafter moved on to another locale where a similar race was conducted. The Court observed that with such an activity, although there may not be substantiality in an absolute sense with regard to the time period, both the exclusive nature of the access and the period for which it was accessed made FOWC’s presence fixed, as contemplated under Article 5(1) of the India – UK DTAA.
(iv) FOWC’s presence was neither ephemeral nor fleeting or sporadic. The fact that the tenure of the 2011 RPC was five years meant that there was a repetition. Furthermore, FOWC was entitled even in the event of a termination, to two years’ payment of the assured consideration of USD 40 million.
(b) The Court also discussed various illustrative examples across jurisdictions on the interpretation of a fixed place PE, such as Universal Furniture Ind AB v. Government of Norway[2], the Swiss Server decision[3] and Joseph Fowler v. Her Majesty the Queen[4]. The Court also discussed In re: Golf in Dubai LLC [5] where the AAR had observed that the word, “permanent” though contrasted with temporary or transitory did not necessarily connote “everlasting” and that the question of permanence was purely one of fact and degree. No conclusive rule could be laid down as to the number of days which could impart a degree of permanence to a place of business to make it a fixed place. The AAR also noted that a place of business could constitute a PE even for a very short period of time because of the nature of the business. Therefore, even if the business was done for a short duration with intermittent gaps, the existence of a fixed place of could not be ruled out.
(c) Further relying on the OECD commentary and Klaus Vogel’s commentary on the general principles applicable to a fixed place PE, the Court noted that as long as the presence was in a physically defined geographical area, permanence in such fixed place could be relative having regard to the nature of the business.
2. Whether FOWC carried on business and commercial activity in India
(a) The Court held that on a conjoint reading of the terms of the Concorde Agreement and the 2011 RPC, it was apparent that FOWC alone had the right to include a venue in any FIA annual calendar and the FIA was bound to accord permission to such inclusion. Other than a limited class of rights relating to paddock entry, ticketing, hospitality and a restricted class of advertising, FOWC was the exclusive owner of all commercial rights in relation to the event, including inter alia, rights towards making sound, television and other recordings and exploitation of media rights. It had copyright over databases and all related information generated during the event. It was also entitled to charge fees or such other consideration as it deemed appropriate for the recording, telecasting, broadcasting and creation of internet and media rights, including data transmission, and all other such commercially exploitable rights. The Court observed that a bulk of the revenues were generated from the exploitation of media, television and other related rights. Additionally, FOWC also charged a fee of USD 40 million annually from Jaypee for hosting the Formula One Grand Prix of India.
(b) By virtue of the Concorde Agreement, the F1 teams had undertaken to participate with at least two cars in every race in any circuit chosen by FOWC, which fact was guaranteed by FOWC to the Promoter/Jaypee under the 2011 RPC. Given the peculiarity of the sport, FOWC’s dominant role was evident – its presence and control was all pervasive. With the undertakings given to it by various actors, such as the racing teams, the constructing teams, the Promoter and its group affiliates, FOWC was central to the conceptualisation and successful organization of the F1 Championship. Jaypee, as the Promoter of the event merely held title to the circuit in the sense that it owned the land. On the other hand, FOWC was the commercial rights owner of the event. The right to include a particular circuit, to decide the venue and the participating teams etc. all vested with FOWC. The Court held that these factors unequivocally demonstrated that FOWC carried on business and derived income in India for the duration of the race (and for two weeks before the race and a week thereafter) within the meaning of Article 5(1) of the India – UK Tax Treaty.
3. Whether FOWC carried on business and commercial activity in India through its agents under Article 5(4) or Article 5(5) of the India – UK Tax Treaty
(a) Given that it had found FOWC to carry on business through its fixed place PE in India, the Court noted that the discussion on whether FOWC had dependent agents which created a PE was rendered academic. However, given that its decision was likely to be preferred in appeal, it proceeded to discuss the issue of existence of a dependent agent PE.
(b) For an entity to be treated as a dependent agent, it must have the authority to conclude contracts, which bind the represented enterprise, and it must habitually exercise such authority. In this context, the Court rejected the contention of the revenue authorities that as the affiliates / subsidiaries of FOWC, Beta Prema 2 Ltd, Allsports Management SA and Formula One Management Ltd acted on its behalf and thus became dependent agents. The mere circumstance that the three subsidiaries had a connection with FOWC was not enough – what had to be shown was that the contracts they entered into and the businesses they were engaged in were for and on behalf of FOWC. Each of the three agreements independently entered into by them with Jaypee on a principal to principal basis contained no pointers to this fact.
4. Whether the consideration receivable by FOWC from Jaypee outside India in terms of the 2011 RPC was royalty as defined in Article 13 of the India – UK Tax Treaty
(a) The Court observed that when a trade vendor or establishment sells branded goods, it is incorrect to state that the income earned by the vendor is generated from the brand or mark associated with the product, rather than from sale of the product itself. Similarly, in the case of distribution, when a distribution agent is under an agreement with the manufacturer to sell its goods, it also possesses the right to advertise the goods and brands of the manufacturer. In such an event, the distributor need not pay for the right to use the intellectual property under which the goods are sold – he merely pays for obtaining the exclusive commercial right to sell the goods he buys from the manufacturer.
(b) The Court also discussed the OECD commentary on Article 12 of the Model Convention, according to which, payments solely made in consideration for obtaining the exclusive distribution rights of a product or service in a given territory are not royalty, since the resident distributor does not pay for the right to use the trade name or trade mark under which the products are sold but merely obtains the exclusive right to sell in his state of residence the product that he is agreeing to buy from the manufacturer – such payments will be characterized as business income.
(c) Under the Concorde Agreement and the 2011 RPC, FOWC clearly had the exclusive right to exploit the commercial rights in the F1 Championship and to award Jaypee the right to host, stage and promote the Formula One Grand Prix of India. While Jaypee was prohibited from making any audio or visual image of the event, it was permitted to make incidental use of certain intellectual property rights solely for the limited purpose of promoting the event. Upon termination of the 2011 RPC, Jaypee’s right to use the F1 trademarks, logos and other intellectual property was to cease instantly.
(d) In the case of DIT v. Ericsson A B [6], it was held that a lump sum payment which is not based on or connected with the extent of the user of the intellectual property rights would not constitute “royalties”. Likewise, the Court in the instant case held that the lump sum amounts payable to FOWC by Jaypee under the 2011 RPC were in respect of the three separate race events held in each of the three years (i.e. 2011 to 2013). They were not payments which were based on either the number of tickets sold or the total amount of revenue earned by Jaypee in each of the said years. Therefore, the lump sum payable to FOWC by Jaypee would not constitute royalties.
(e) The main purpose of neither the ALA nor the 2011 RPC was the grant of trademark rights or privilege or license to use FOWC’s marks resulting in royalty payment within the meaning of Article 13 of the India – UK Tax Treaty. What was granted to Jaypee under the ALA was the incidental use of certain intellectual property rights and artwork “solely for the limited purpose of facilitating the hosting, staging and promotion of the event”. Jaypee was not permitted to use these marks for merchandising or for other products or services and therefore it enjoyed no intellectual property rights independently of the staging and hosting of the event. As the payments made by Jaypee were not for the use of trademarks or intellectual property rights, but for the grant of the privilege of staging, hosting and promoting the event, which could not have been utilized for any other purpose, such payments could not be regarded as “royalty” either under the India – UK Tax Treaty or the IT Act.
5. Whether Jaypee was required to withhold tax from the consideration payable to FOWC outside India in terms of Section 195 of the IT Act
(a) Since it was found that FOWC carried on business in India through a PE at the circuit, the Court held that payments made to it by Jaypee under the 2011 RPC were a part of its business income and accordingly chargeable to tax in India. Jaypee was therefore bound to withhold tax before making payments to FOWC.
Comments
This ruling marks an important development in international tax jurisprudence. Both the AAR and the High Court have applied the law to the given facts based on valid reasons of their own and have arrived at different conclusions in relation to taxability as royalty and existence of a PE, being mixed questions of law and facts.
To determine whether payments were in the nature of royalty or not, the AAR considered the importance of the trademarks and the associated reputation and brand as deciding factors, in the absence of which, the event could not have been organised on the same scale. However, on the same aspect, the High Court considered the payments to be made towards the privilege of hosting the F1 Championship race and not for the use of any intellectual property. In the Court’s view, since the event Promoter (Jaypee) had to publicise the championship, it was bound to use the F1 marks, however, it was not authorised to use the marks on any merchandise or service offered by it and thus, the use of the mark was purely incidental. Further, in relation to existence of a PE, the AAR found FOWC’s presence in India necessary to ensure that the event met globally established standards of F1 racing, and not as one through which it carried out its business. However, the High Court considered dedicated access to the circuit as a critical factor in treating the circuit itself as FOWC’s PE in India.
Given that both the decisions of the AAR and the Delhi High Court seem to be based on sound legal reasoning, it will be interesting to see how the Supreme Court evaluates the case, should this decision be preferred in appeal.
[1] [2016] 76 taxmann.com 6 (Delhi)
[2] Stavanger Court, Case No 99-00421
[3] Case No. II 1224 / 97 dated 6 September, 2001, Finanzgericht of Schleswig-Holstein
[4] 1990 (2) CTC 2351
[5] AAR No. 770/2008
[6] [2012] 343 ITR 470 (Del)
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