Tech Mahindra – Australian Full Federal Court finds that the exception in the Australia-India Treaty for “effectively connected” royalties was not intended to exempt royalties not attributable to the source country PE from source country withholding

The Indian-resident taxpayer performed technical services for its Australian customers from its offices in India, the fees for which were deemed to be royalties under the Australia-India Treaty - as well as earning fees through an Australian permanent establishment. Art. 12(4) of the Royalty Article of the Australia-India Treaty (similarly to a provision in the Canada-India Treaty) provided that the provisions of Arts. 12(1) and (2) (permitting India and Australia to tax royalties) “shall not apply” if the Indian resident entitled to the royalties carries on business through an Australian PE “and the… services in respect of which the royalties are paid… are effectively connected with such permanent establishment” – in which case “the provisions of Article 7 … shall apply.”

The Indian taxpayer argued that the royalties received by it in India (which were accepted by Australia as not being attributed under Art. 7 to the Australian PE) nonetheless were “effectively connected” to that PE in the sense that the work in India advanced the common goal with the Australian PE of servicing the Australian customers. The taxpayer then argued that the quoted statement - that Art. 12(2) “shall not apply” - meant that Australia was precluded from imposing withholding tax on these royalties.

In rejecting this argument, the Court stated:

[T]he evident purpose of Art 12(4) is to relieve the source State from the limitation on taxing rights imposed under Art 12 by taxing such royalties under Art 7, not to disentitle the source State from any taxing rights where otherwise Art 7 would not give such taxing rights.

In any event, “’effectively connected with’ should be understood to mean having a real or actual connection with the activities carried on through the permanent establishment,” which was not the case here.

Neal Armstrong. Summary of Tech Mahindra Limited v Commissioner of Taxation, [2016] FCAFC 130 under Treaties – Art. 12.