Distribution of Content on Digital Media in India: Key Tax Considerations By Samira Varanasi, Ranjana Adhikari & Rajesh Simhan

We live in an age which can arguably be best described as the age of the internet; and India is not far behind the rest of the world in embracing this revolution. Growth in internet users in India was expected to reach 269 million by mid-2015.  In India, the growth in the number of internet users has primarily been driven by the penetration of internet enabled mobile devices such as smartphones and tablets and by the growing outreach of 3G. While India can do with better connection speeds, there has been a sustained increase of the average connection speeds.  (FICCI-KPMG Indian Media & Entertainment Industry reports that greater than 4 mbps speeds grew 100 per cent and greater than 10 mbps grew at 200 per cent year-on-year). Some telecom service providers such as Reliance are in fact looking to launch 4G services this year and the sales of 4G smartphones have also increased. With the availability of high speed internet and consequently, the consumption of internet based services in India is only expected to increase in the coming years.

Art and entertainment, in tandem, have also evolved so as to be consumed through the internet; often in a manner that only the internet can provide; with its interactive platform, barrier-free environment and its vast array of choices. Some of the most influential Indian and international entertainers in the Indian markets, especially in music and comedy spaces, owe their popularity to the internet. (These include Hozier, Adele, Nicki Minaj, Avicii, Justin Bieber; individual stand-up comics like Russell Peters and Lilly Singh/Superwoman; and comedy collectives like All India Bakchod, The Viral Fever Videos, Pretentious Movie reviews.) Aside from facilitating the open sharing of knowledge, ideas, culture, and entertainment, the availability of content on the internet also allows the forward thinking entrepreneur to invest in an area that creates quality and niche content whilst also allowing them to partake in the cultural capital as well as profits of artworks. This article seeks to explore the major revenue models available for tapping the appetite of Indian audiences for content distributed in alternative digital sources and major tax considerations of which businesses in this sector should be mindful.

Revenue models for the distribution of content in digital media

The modes available for the digital distribution of media content in India have also evolved over the years from the traditional peer-to-peer models (“P2P”) such as on BitTorrent, etc. to more commercially sustainable Business-to-Customer (“B2C”) and Business-to-Business (“B2B”) revenue models (providing content to internet users either for a fee or free of cost) including the following.

(a)  Over-the-top (“OTT”) Content Distribution

OTT content distribution allows for media content to be made available to the users directly over the internet where the content can either be streamed and/or downloaded including through mobile applications.

Major players providing online video and audio streaming services in the US are apprehensive to access the Indian markets because of the prohibitive and multiple layered licensing costs for the content; and the unsuitable internet infrastructure in India. However, many competitors focused on distributing both international and local content in Indian markets have already emerged. These include HOOQ; launched by SingTel in association with Sony Pictures and Warner Brothers, which should also allow for the downloading of the content in a bid to the problem of the erratic internet speed in India; Hotstar.com; Ogle; BigFlix; and Ditto TV. Though YouTube continues to be the most popular video streaming website in India. YouTube does not charge the users; and instead relies on advertising revenues. This is also true for the several content providers on YouTube; who have, over the years, been able to make use of programs like the Google AdSense to generate revenues from the cultural capital of their content.

Aside from music and video streaming sites, devices with proprietary software like Apple TV; which permit accessing of media content for a specified fee and mobile applications like PocketTV, EverywhereTV and DishOnline launched by Airtel, Tata Sky and Dish TV respectively are popular platforms for distribution of digital content.

(b)            Internet Protocol Television (“IPTV”)

IPTV transmits and broadcasts television programs through the internet using the internet protocol, instead of using traditional terrestrial, satellite signal and cable television formats. Accordingly, IPTV requires a certain amount of consistent bandwidth for data to be streamed in order to deliver the right number of moving picture frames. IPTV services may be classified into: (i) live television, with or without interactivity related to the current TV show; (ii) time-shifted television; and (iii) video-on-demand (“VOD”). IPTV, however, is not seen as a commercially viable model for distribution of online content in India because of the restrictive conditions imposed on IPTV service providers under the Guidelines for Provisioning of Internet Protocol Television (“IPTV”) Services of 2008. (IPTV Services launched by Reliance Communications, Aksh Optifibre, Time Broadband, IOL Netcom, etc. have not fared as well as was expected in the Indian markets.) Further, with direct-to-Home (“DTH”) operators such as Tata Sky allowing for recording of shows, etc. for later viewing on their set top boxes as well as through mobile applications, IPTV as a model has limited selling points in the Indian markets.

(c)  A Content Delivery Network (“CDN”)

CDN is essentially a system of nodes (computer used as a server) and servers deployed in multiple strategic locations; all of which cooperate to satisfy requests for content by end users across geographical locations in the most efficient manner by reducing the bandwidth and delivery costs on the backbone link. The number of nodes and servers making up the CDN may vary depending on the user base of the backbone server.

CDNs use various techniques such as web caching (to store popular content closer to the end-users), server-load balancing (to balance load and improve scalability) and request routing (to identify the best content route for the end user) to achieve the optimization goals. Caching servers belonging to the CDN are co-located by mutual agreement within data centers belonging to the hosting providers of the content providers (“Hosting Providers”), the backbone carriers (“Backbone Carriers”) which provide wide-area transport for ISPs) and/or Access ISPs (defined below). CDNs typically pay co-location fees for such services. (Sometimes, Access ISPs are also paid by the CDN for the Access ISP’s users.) Requests for content are generally directed algorithmically to nodes that are best suited for servicing the request. CDNs today serve a wide array of digital content including web objects, downloadable objects, live streaming media, on-demand streaming media and social networks.

There are two major revenue models for CDN services—the content centric model driven by the needs of the content providers; and the provider centric model driven by the needs of the internet service providers giving access to the end-users (“Access ISPs”). The content-centric CDNs like Akamai (believed to be the market leader; significantly, streamed the ICC Cricket World Cup, 2011) and Bitgravity (which has a strong place of presence in India and Australia), among others, earn their revenue from the content providers for replicating and delivering only such content as the content providers specify—thus accelerating the content received by the content consumers. On the other hand, access-centric CDNs serve popular content from caches close to the end-users subscribing to the Access ISPs’ services. By caching frequently-accessed content near the end-users, Access ISPs save on bandwidth costs and prevent the end users from defecting to other ISPs.

Major Tax Considerations for Revenue Models in digital media

Taxation in India is governed by the provisions of the Income Tax Act, 1961 (“ITA”). While Indian residents are subject to tax in India on their worldwide income, non-residents may be taxed in India only to the extent that such income may be sourced in India. Where the non-resident is entitled to benefits under a Double Taxation Avoidance Agreement (“DTAA”) entered into by India with the jurisdiction of the non-resident taxpayer, it may have the option of being taxed under the DTAA to the extent that it is more beneficial to the taxpayer.

While the corporate tax rate in India is 30% on the worldwide income of resident companies, it is 40% on the India-sourced income of non-resident companies (exclusive of surcharge and cess). Where DTAA benefits are available, business income earned by a non-resident taxpayer should not be taxed in India unless its India-focused business activities constitute a permanent establishment (“PE”) in India. If however, the income earned by a non-resident taxpayer is characterized as royalty or fee for technical services, the person making the payment of such consideration is subject to an obligation to withhold the tax amount.

As discussed above, notwithstanding whether the distributor of content is generating content or facilitating the distribution of content, internet and mobile based content distribution models could be either user-revenue models or advertising-revenue models. In user-revenue models, the user pays for a service or sale of digital content. In an advertising-revenue model, an advertiser pays the service provider for user activity like viewing a banner advertisement or clicking a hyperlink.

Until recently, courts in India were generally in favor of treating subscription fees for accessing content available online as business income, except where such content was in the nature  of technical, industrial or scientific knowledge (Infosys Technologies Ltd. v. Dy. CIT, [2011] 45 SOT 157; Gartner Ireland Ltd. v. DDIT (IT) 3(1), Mumbai, [2010] 42 SOT 21 (Mum .) (URO); In re Factset Research Systems Inc., [2009] 182 Taxman 268 (AAR – New Delhi); In re, Dun & Bradstreet Espana, S.A., [2005] 142 TAXMAN 284 (AAR – N. DELHI); Wipro Ltd. v. ITO [2004] 278 ITR 57 (Bang); ONGC Videsh Ltd. v. ITO, IT, TDS, Ward 2(1), New Delhi, [2012] 20 ITR(T) 767 (Delhi – Trib.). This position is also in consonance with the OECD Model Commentary even in the context of downloadable content where the payment does not correspond to the transfer of copyright in the content but access to the content. (Paras 17.1 to 17.4, OECD Model: Commentary on Article 12 [2010] at 231-232).

However, in Commissioner of Income Tax v. Wipro Ltd., ([2013] 355 ITR 284 [Karn. HC], the Karnataka High Court reversed a subordinate tribunal’s decision (Wipro v ITO, [2004] 278 ITR 57 [Bang.] on the matter and held that payments for accessing online databases should be considered “royalty” under the provisions of the ITA read with the India-US DTAA since “such right to access would amount to transfer of right to use the copyright held by M/s. Gartner and the payment made….is for the licence to use the said database maintained by M/s. Gartner.” The court thus created an alternate precedent for subordinate authorities within its jurisdiction (see also, Bangalore v. Cross Tab Marketing Services (P.) Ltd., [2014] 149 ITD 678 (Bangalore – Trib.) The Karnataka High Court did not note the observations of other cases including that of the Madhya Pradesh High Court in Commissioner of Income Tax v. HEG Ltd.  ([2003] 130 TAXMAN 72 (MP) which required the tax characterization of payments to depend on the nature of information being accessed. Therefore, in spite of this ruling of the Karnataka High Court, if there is no license of the copyright in the content given to the user, revenues of a non-resident content distributor in user-revenue models should be characterized as business income under the Indian income tax law and not subject to tax in India in the absence of a PE in India.

On the other hand, Indian judicial precedent is clear on the view that advertisement revenues earned by non-resident digital content distributers should not be characterized either as royalty (Pinstorm Technologies Pvt Ltd v. ITO, TS 536 ITAT (2012) [Mum]; Yahoo India Pvt. Ltd. , ITA No.506/Mum/2008) or as fees for technical services (Income Tax Officer v. Right Florists, [2013] 25 ITR(T) 639 (Kolkata – Trib.) and should therefore not be subject to tax in India in the absence of a PE in India.

One of the major concerns regarding CDNs operating in India is the risk of the content provider being regarded as having a PE in India through the servers of the CDN. Therefore, it remains to be examined whether where a sports website company having its headquarters and main servers in the USA distributes content in India through a CDN that has edge servers in India, the sports website company may be considered to have a PE in India. In order for the presence of a server to constitute a PE risk for a non-resident enterprise in India, the following requirements need to be fulfilled:

  • The server should be fixed;
  • The server should be used to carry on the business of the non-resident;
  • The server should be at the disposal of the non-resident;
  • The server should be operated and maintained by the non-resident or the dependent agent of the non-resident.

The issue of the server having to be at the disposal of the nonresident has been emphasized even in cases such as Amadeus Global Travel Distribution SA v. DCIT, ((2008) 113 TTJ (Delhi) 767); and Galileo International Inc. v. DCIT, (ITA No1733/Del/2001), which was upheld by the High Court of Delhi in DIT  v. Galileo International Inc, [2009] 180 TAXMAN 357 (Delhi).

Therefore, as with the use of ISPs, which according to the OECD Commentary, should not by itself constitute a PE in India (see, Para 42.3 of the OECD Model: Commentary on Article 5 at 110-111), the use of a CDN having servers in India should not trigger a PE risk for the US based sports website in India.

Having said this, the position on the above issues continues to be in flux. India is among the many countries cooperating towards the implementation of the OECD’s Base Erosion and Profit Shifting (“BEPS”) Action plan by the end of this year; and one of the key areas looking to be addressed is the digital economy.  Jurisdictions like Spain have already tested the idea of a website, as opposed to a server, constituting a virtual PE for a non-resident enterprise having online customers in Spain (Dell Spain v. AgenciaEstatal de la AdministraciónTributaria, case 00/2107/2007, Tax Treaty Case Law IBFD.  With issues like the possibility of a “virtual PE” test and nexus rules based on significant digital presence being on the table, we may be at the cusp of a sea-change in the tax rules concerning distribution of content on digital media.

The authors are members of the law firm of Nishith Desai Associates, Mumbai, India. Samira Varanasi is a member of the International Taxation Practice at the firm, headed by Rajesh Simhan; Ranjana Adhikari is a senior member of the Media & Entertainment Practice at the firm.

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