ITC-Sheraton ruling holds hope for foreign hoteliers

International hoteliers operating in the country through sales agreements with Indian hotels can expect some relief after the Delhi High Court ruled on January 30 that income paid by the Indian partner to its foreign counterpart is exempt from tax since it cannot be considered royalty or technical fees.

The ruling in favour of US-based Sheraton International Inc was in response to an appeal filed by the income-tax (I-T) department challenging the service agreement between ITC and Sheraton International Inc.

The I-T department has taxed 75 per cent of the revenues that ITC paid to Sheraton for four assessment years — 1995-96, 1996-97, 1999-2000 and 2000-01 — as royalty or technical fees under section 9 (1)(vi) of the Income Tax Act, 1961.

The high court, however, has said royalty and technical fees are strictly meant for transfer of technological know-how or other types of included services. An Indian hotelier signs a commercial service agreement for advertising, publicity and promotion of their properties worldwide. So payments (usually a percentage of the room sales) for marketing-related services and the use of trademarks are incidental to the main objective of the commercial agreement.

Before the high court order, the tribunal had ruled in favour of the assessee in 2002 but had held that such income could be taxed as business income. In this case, however, the income cannot be taxed as business income since the foreign hotel group does not have a permanent establishment (PE) in India. The significance of this is that to tax income as business income, the assessee needs to have a PE in India to which the income can be attributed.

The service agreement between ITC and Sheraton was signed in 1979. Before 1991, the year in which India and the United States signed a double taxation avoidance treaty (DTAA), this income was taxed as business income by deducting tax at source under section 195(2) of the Income Tax Act. After the DTAA came into force, the assessee claimed exemption by stating that it has no PE in India.

Thereafter since 1999, the revenue department has been taxing such income as royalty and technical fees. Sheraton International operates in India through a commercial agreement with ITC which manages Welcomgroup Maurya Sheraton, New Delhi, Welcomgroup Mughal Sheraton, Agra, Welcomgroup Chola Sheraton, Chennai, Welcomgroup Windsor Manor, Bangalore and so on.

Tax experts are of the view the high court ruling will benefit other foreign hoteliers that have signed similar agreements with their Indian counterparts to manage their brands.