May 15, 1989
U.S. - INDIA TAX TREATY
MEMORANDUM OF UNDERSTANDING CONCERNING
FEES FOR INCLUDED SERVICES
IN 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 ease of
understanding, the examples in this memorandum describe 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.
Under paragraph 4, technical and consultancy services are
considered included services only to the following extent: (1)
as described in paragraph 4(a), if they are ancillary and
subsidiary to the application or enjoyment of a right, property
or information for which a royalty payment is made; or (2) as
described in paragraph 4(b), if they make available technical
knowledge, experience, skill, know-how, or processes, or
consist of the development and transfer of a technical plan or
technical design. Thus, under paragraph 4(b), consultancy
services which are not of a technical nature cannot be included
services.
Paragraph 4 (a)
Paragraph 4 (a) of Article 12 refers to technical or
consultancy services that are ancillary and subsidiary to the
application or enjoyment of any right, property, or information
for which a payment described in paragraph 3(a) or (b) is
received. Thus, paragraph 4(a) includes technical and
consultancy services that are ancillary and subsidiary to the
application or enjoyment of an intangible for which a royalty
is received under a license or sale as described in
paragraph 3(a), as well as those ancillary and subsidiary to
the application or enjoyment of industrial, commercial, or
scientific equipment for which a royalty is received under a
lease as described in paragraph 3(b).
It is understood that, in order for a service fee to be
considered "ancillary and subsidiary" to the application or
enjoyment of some right, property, or information for which a
payment described in paragraph 3(a) or (b) is received, the
service must be related to the application or enjoyment of the
right, property, or information. In addition, the clearly
predominant purpose of the arrangement under which the payment
of the service fee and such other payment are made must be the
application or enjoyment of the right, property, or information
described in paragraph 3. The question of whether the service
is related to the application or enjoyment of the right,
property, or Information described in paragraph 3 and whether
the clearly predominant purpose of the arrangement is such
application or enjoyment must be determined by reference to the
facts and circumstances of each case. Factors which may be
relevant to such determination (although not necessarily
controlling) include:
1. the extent to which the services in question
facilitate the effective application or enjoyment of the
right, property, or Information described in paragraph 3;
2. the extent to which such services are customarily
provided in the ordinary course of business arrangements
involving royalties described in paragraph 3;
3. whether the amount paid for the services (or which
would be paid by parties operating at arm's length) is an
Insubstantial portion of the combined payments for the
services and the right, property, or information described
in paragraph 3;
4. whether the payment made for the services and the
royalty described in paragraph 3 are made under a single
contract (or a set of related contracts); and
5. whether the person performing the services is the
same person as, or a related person to, the person
receiving the royalties described in paragraph 3 (for this
purpose, persons are considered related if their
relationship is described in Article 9 (Associated
Enterprises) or if the person providing the service is
doing so in connection with an overall arrangement which
includes the payor and recipient of the royalties).
To the extent that services are not considered ancillary
and subsidiary to the aplication or enjoyment of some
right, property, or information for which a royalty
payment under paragraph 3 is made, such services shall be
considered "included services" only to the extent that
they are described in paragraph 4(b).
Example (1)
Facts:
A U.S. manufacturer grants rights to an Indian
company to use manufacturing processes in which the
transferor has exclusive rights by virtue of process
patents or the protection otherwise extended by law
to the owner of a process. As part of the
contractual arrangement, the U.S. manufacturer agrees
to provide certain consultancy services to the Indian
company in order to improve the effectiveness of the
latter's use of the processes. Such services
include, for example, the provision of information
and advice on sources of supply for materials needed
in the manufacturing process, and on the development
of sales and service literature for the manufactured
product. The payments allocable to such services do
not form a substantial part of the total
consideration payable under the contractual
arrangement. Are the payments for these services
fees for "included services’?
Analysis:
The payments are fees for included services. The
services described in this example are ancillary and
subsidiary to the use of a manufacturing process
protected by law as described in paragraph 3 (a) of
Article 12 because the services are related to the
application or enjoyment of the intangible and the
granting of the right to use the intangible is the
clearly predominant purpose of the arrangement.
Because the services are ancillary and subsidiary to
the use of the manufacturing process, the fees for
these services are considered fees for included
services under paragraph 4 (a) of Article 12,
regardless of whether the services are described in
paragraph 4 (b).
Example(2)
Facts:
An Indian manufacturing company produces a product
that must be manufactured under sterile conditions
using machinery that must be kept completely free of
bacterial or other harmful deposits. A U.S. company
has developed a special cleaning process for removing
such deposits from that type of machinery. The U.S.
company enters into a contract with the Indian company
under which the former will clean the latter's machinery
on a regular basis. As part of the arrangement, the
U.S. company leases to the Indian company a piece of
equipment which allows the Indian company to measure the
level of bacterial deposits on its machinery in order
for it to know when cleaning is required. Are the
payments for the services fees for included services?
Analysis:
In this example, the provision of cleaning services by
the U.S. company and the rental of the monitoring
equipment are related to each other. However, the
clearly predominant purpose of the arrangement is the
provision of cleaning services. Thus, although the
cleaning services might be considered technical
services, they are not "ancillary and subsidiary" to the
rental of the monitoring equipment. Accordingly, the
cleaning services are not "included services" within the
meaning of paragraph 4 (a).
Paragraph 4 (b)
Paragraph 4(b) of Article 12 refers to technical or
consultancy services that make available to the person
acquiring the service technical knowledge, experience, skill,
know-how, or processes, or consist of the development and
transfer of a technical plan or technical design to such
person. (For this purpose, the person acquiring the service
shall be deemed to include an agent, nominee, or transferee of
such person.) This category is narrower than the category
described in paragraph 4(a) because it excludes any service
that does not make technology available to the person acquiring
the service. Generally speaking, technology will be considered
"made available" when the person acquiring the service is
enabled to apply the technology. The fact that the provision
of the service may require technical Input by the person
providing the service does not per se mean that technical
knowledge, skills, etc. are made available to the person
purchasing the service, within the meaning of paragraph 4 (b).
Similarly, the use of a product which embodies technology shall
not per se be considered to make the technology available.
Typical categories of services that generally involve
either the development and transfer of technical plans or
technical designs, or making technology available as described
in paragraph 4 (b), include:
1. engineering services (including the subcategories of
bioengineering and aeronautical, agricultural,
ceramics,chemical, civil, electrical, mechanical,
metallurgical, and industrial engineering);
2. architectural services; and
3. computer software development.
Under paragraph 4 (b), technical and consultancy services
could make technology available in a variety of settings,
activities and industries. Such services may, for example,
relate to any of the following areas:
1. bio-technical services;
2. food processing;
3. environmental and ecological services;
4. communication through satellite or otherwise;
5. energy conservation;
6. exploration or exploitation of mineral oil
or natural gas;
7. geological surveys;
8. scientific services; and
9. technical training.
The following examples indicate the scope of the
conditions in paragraph 4 (b):
Example (3)
Facts:
A U.S. manufacturer has experience in the use of a
process for manufacturing wallboard for interior
walls of houses which is more durable than the
standard products of its type. An Indian builder
wishes to produce this product for its own use. It
rents a plant and contracts with the U.S. company to
send experts to India to show engineers in the Indian
company how to produce the extra-strong wallboard.
The U.S. contractors work with the technicians in the
Indian firm for a few months. Are the payments to
the U.S. firm considered to be payments for "included
services"?
Analysis:
The payments would be fees for included services.
The services are of a technical or consultancy
nature; in the example, they have elements of both
types of services. The services make available to the
Indian company technical knowledge, skill, and
processes.
—6-
Example (4)
Facts:
A U.S. manufacturer operates a wallboard fabrication
plant outside India. An Indian builder hires the
U.S. company to produce wallboard at that plant for a
fee. The Indian company provides the raw materials,
and the U.S. manufacturer fabricates the wallboard in
its plant, using advanced technology. Are the fees
in this example payments for included services?
Analysis:
The fees would not be for included services.
Although the U.S. company is clearly performing a
technical service, no technical knowledge, skill,
etc., are made available to the Indian company, nor
is there any development and transfer of a technical
plan or design. The U.S. company is merely
performing a contract manufacturing service.
Example (5)
Facts:
An Indian firm owns inventory control software for
use in its chain of retail outlets throughout India.
It expands its sales operation by employing a team of
travelling salesmen to travel around the countryside
selling the company's wares. The company wants to
modify its software to permit the salesmen to access
the company's central computers for information on
what products are available in inventory and when
they can be delivered. The Indian firm hires a U.S.
computer programming firm to modify its software for
this purpose. Are the fees which the Indian firm
pays treated as fees for included services?
Analysis:
The fees are for included services. The U.S. company
clearly performs a technical service for the Indian
company, and it transfers to the Indian company the
technical plan (i.e., the computer program) which it
has developed.
Example (6)
Facts:
An Indian vegetable oil manufacturing company wants
to produce a cholesterol-free oil from a plant which
produces oil normally containing cholesterol. An
American company has developed a process for refining
the cholesterol out of the oil. The Indian company
contracts with the U.S. company to modify the
formulas which it uses so as to eliminate the
cholesterol, and to train the employees of the Indian
company in applying the new formulas. Are the fees
paid by the Indian company for included services?
Analysis:
The fees are for included services. The services are
technical, and the technical knowledge is made
available to the Indian company. -
Example (7)
Facts:
The Indian vegetable oil manufacturing firm has
mastered the science of producing cholesterol-free
oil and wishes to market the product world-wide. It
hires an American marketing consulting firm to do a
computer simulation of the world market for such oil
and to advise it on marketing strategies. Are the
fees paid to the U.S. company for included services?
Analysis:
The fees would not be for included services. The
American company is providing a consultancy service
which Involves the use of substantial technical skill
and expertise. It is not, however, making available
to the Indian company any technical experience,
knowledge or skill, etc., nor is it transferring a
technical plan or design. What is transferred to the
Indian company through the service contract is
commercial information. The fact that technical
skills were required by the performer of the service
in order to perform the commercial information
service does not make the service a technical service
within the meaning of paragraph 4(b).
Paragraph 5
Paragraph 5 of Article 12 describes several categories of
services which are not intended to be treated as included
services even if they satisfy the tests of paragraph 4. Set
forth below are examples of cases where fees would be included
under paragraph 4, but are excluded because of the conditions
of paragraph 5.
Example (8)
Facts:
An Indian company purchases a computer from a U.S.
computer manufacturer. As part of the purchase
agreement, the manufacturer agrees to assist the Indian
company in setting up the computer and installing the
operating system, and to ensure that the staff of the
Indian company is able to operate the computer. Also,
as part of the purchase agreement, the seller agrees to
provide, for a period of ten years, any updates to the
operating system and any training necessary to apply the
update. Both of these service elements to the contract
would qualify under paragraph 4(b) as an included
service. Would either or both be excluded from the
category of included services, under paragraph 5(a),
because they are ancillary and subsidiary, as well as
inextricably and essentially linked, to the sale of the
computer?
Analysis:
The installation assistance and initial training are
ancillary and subsidiary to the sale of the computer,
and they are also inextricably and essentially linked to
the sale. The computer would be of little value to the
Indian purchaser without these services, which are most
readily and usefully provided by the seller. The fees
for installation assistance and Initial training,
therefore, are not fees for included services, since
these services are not the predominant purpose of the
arrangement.
The services of updating the operating system and
providing associated necessary training may well be
ancillary and subsidiary to the sale of the computer,
but they are not inextricably and essentially linked to
the sale. without the upgrades, the computer will
continue to operate as it did when purchased, and will
continue to accomplish the same functions. Acquiring
the updates cannot, therefore, be said to be
inextricably and essentially linked to the sale of the
computer.
Example (9)
Facts:
An Indian hospital purchases an x-ray machine from a
U.S. manufacturer. As part of the purchase agreement,
the manufacturer agrees to Install the machine, to
perform an initial inspection of the machine in India,
to train hospital staff in the use of the machine, and
to service the machine periodically during the usual
warranty period (2 years). Under an optional service
contract purchased by the hospital, the manufacturer
also agrees to perform certain other services throughout
the life of the machine, Including periodic inspections
and repair services, advising the hospital about
developments in x-ray film or techniques which could
Improve the effectiveness of the machine, and training
hospital staff in the application of those new
developments. The cost of the initial Installation,
inspection, training, and warranty service is relatively
minor as compared with the cost of the x-ray machine.
Is any of the service described here ancillary and
subsidiary, as well as inextricably and essentially
linked, to the sale of the x-ray machine?
Analysis:
The initial installation, inspection, and training
services in India and the periodic service during the
warranty period are ancillary and subsidiary, as well as
inextricably and essentially linked, to the sale of the
X-ray machine because the usefulness of the machine to
the hospital depends on this service, the manufacturer
has full responsibility during this period, and the cost
of the services is a relatively minor component of the
contract. Therefore, under paragraph 5(a) these fees
are not fees for included services, regardless of
whether they otherwise would fall within paragraph 4(b).
Neither the post-warranty period Inspection and repair
services, nor the advisory and training services
relating to new developments are "inextricably and
essentially linked" to the initial purchase of the x-ray
machine. Accordingly, fees for these services may be
treated as fees for included services if they meet the
tests of paragraph 4(b).
Example (10)
Facts:
An Indian automobile manufacturer decides to expand into
the manufacture of helicopters. It sends a group of
engineers from its design staff to a course of study
conducted by the Massachusetts Institute of Technology
(MIT) for two years to study aeronautical engineering.
The Indian firm pays tuition fees to MIT on behalf of
the firm's employees. Is the tuition fee a fee for an
included service within the meaning of Article 12?
Analysis:
The tuition fee is clearly intended to acquire a
technical service for the firm. However, the fee paid
is for teaching by an educational institution, and is,
therefore, under paragraph 5(c), not an included
service. It is Irrelevant for this purpsoe whether MIT
conducts the course on its campus or at some other
location.
Example (11)
Facts:
As in Example (10), the automobile manufacturer wishes
to expand into the manufacture of helicopters. It
approaches an Indian university about establishing a
course of study in aeronautical engineering. The
university contracts with a U.S. helicopter manufacturer
to send an engineer to be a visiting professor of
aeronautical engineering on its faculty for a year. Are
the amounts paid by the university for these teaching
services fees for included services?
Analysis:
The fees are for teaching in an educational
institution. As such, pursuant to paragraph 5(c), they
are not fees for included services.
Example (12)
Facts:
An Indian wishes to install a computerized system in his
home to control lighting, heating and air conditioning,
a stereo sound system and a burglar and fire alarm
system. He hires an American electrical engineering
firm to design the necessary wiring system, adapt
standard software, and provide instructions for
installation. Are the fees paid to the American firm by
the Indian individual fees for Included services?
Analysis:
The services in respect of which the fees are paid are
of the type which would generally be treated as fees for
included services under paragraph 4(b). However, because
the services are for the personal use of the individual
making the payment, under paragraph 5(d) the payments
would not be fees for included services.