All of us purchase goods and services and use our debit card or credit card at the vendor outlet. In a few seconds, the transaction is authenticated and the payment process is complete. Have you ever wondered as to what happens in the backend; who are the parties who facilitate this transaction; what is the technology involved; and what are the tax consequences?
Mastercard Asia Pacific Pte Ltd. (MAPPL) belongs to the Mastercard Incorporated Group of Companies which is one of the leading global payment solution providers. MAPPL is a wholly owned indirect subsidiary of Mastercards Wholly Owned Direct Deleware Incorporated Subsidiary, Mastercard International Incorporated (MCI).
The cardholder and merchant relationship are managed by the customers of MAPPL who are basically banks and financial institutions in the identified region. At no point of time, there is any issue of cards or credit or collection of fees from the cardholders or interest, etc. from any customer by MAPPL. MAPPL provides services only to the banks and financial institutions under Master Licence Agreement.
The banks and financial institutions are required to pay
(i) transaction processing fee relating to authorization, clearing and settlement of transaction;
(ii) assessment fees for building and maintaining a processing network that serves the needs of customers globally and also for setting up rules that govern authorization, clearance and settlement process for every payment authorization, so as to maintain integrity and reputation of network and also to guarantee settlement.
(iii) miscellaneous fees for ancillary activities such as warning bulletin fees for listing invalid or fraudulent account, cardholders service fee, programme management service, account and transaction enhancement services, holograms and publications.
Assuming, Mr. A who has a MasterCard issued by say HDFC Bank makes a purchase at a vendor location, the parties involved are the card holder, the vendor, the card holder’s bank (issuer) and the vendor’s bank (acquirer). Behind the scenes, there is MAPPL who facilitates the authorization, clearing and settlement of payment transaction; Master India Services Pvt. Ltd. (MISPL) a subsidiary of MAPPL which owns and maintains the master card interface processor (MIP) which is located in India.
- The customer presents the credit card (MasterCard) at the vendor outlet.
- The vendor swipes the card using the point of sale device.
- In effect the vendor forwards the transaction to its bank (the acquirer) for authorization.
- This is now forwarded to the cardholder’s bank (issuer bank).
- Once the transaction is authorised, the vendor is paid by the acquirer and the transaction is complete in so far as the vendor or consumer is concerned.
- The vendor is required to pay a merchant service fee to his bank (acquirer).
- MasterCard facilitates authorization, clearing and settlement of the transaction between the cardholder and the merchant via the issuer and acquirer.
- The settlement between the issuer bank and the acquirer bank occurs through a settlement bank appointed by MCI which is usually the entity which owns the settlement bank account as it is the entity within the MasterCard group which provides settlement services to other group companies. If the settlement is successful between the acquirer and the issuer, the settlement bank account would typically end-up with a nil bank balance.
- Issuer pays the acquirer the value of the transaction less interchange fees and the transaction is posted to the cardholder’s account.
- Issuer issues the cardholder with a bill to collect the amount of the purchase.
Processing of electronic payment transaction involves initial level verification, validation of the transaction, authorization; clearing and settlement. The main processing centres of master card group are in USA and MAPPL is the owner of the processing centre located in Singapore. The customer namely, the bank or institution is provided with a Mastercard Interface Processor (MIP) which is said to be the size of a standard personal computer and is placed at the customer location in India. It is through this MIP, MAPPL is in a position to facilitate the authorization, clearing and settlement of payment transaction.
The Questions before AAR
MAPPL filed an application seeking advance ruling on the taxability of fees in respect of services rendered with regard to use of a global network and infrastructure to process card payment transaction for customers in India. The Authority for Advance Ruling in the case of Mastercard Asia Pacific Pte Ltd., Singapore – (2018) 406 ITR 43 AAR framed the following questions:
(i) Whether MAPPL has a permanent establishment in India under Article 5 of the Indo-Singapore DTAA in respect of the services to be rendered with regard to use of a global network and infrastructure to process card payment transactions for customers in India?
(ii) Without prejudice to the above, where a permanent establishment of the applicant (in the form of its Indian subsidiary) is found to exist in India, whether provision of arm’s length remuneration to such permanent establishment for the activities to be performed in India, would absolve any further attribution of the global profits of the applicant in India?
(iii) Whether the fees received by MAPPL from Indian customers namely transaction processing fees, assessment fees and transaction related miscellaneous fees would be chargeable to tax in India as royalty or fee for technical services within the meaning of the term in Article 12 of the Indo-Singapore DTAA?
(iv) Based on the answers to the above questions, whether any tax withholding at source would be required.
The AAR has ruled that
(i) MAPPL has a permanent establishment in India under Article 5 of the India-Singapore DTAA. Further, there is a fixed place permanent establishment, service permanent establishment, and dependent agent permanent establishment.
(ii) Arm’s length remuneration to the PE on account of the Indian subsidiary for the activities performed / to be performed in India, would not absolve MAPPL from any further attribution of its global profits in India since FAR of the Indian subsidiary does not reflect the functions / risks of MAPPL.
(iii) Part of the fees received / to be received by MAPPL from Indian customers (comprising transaction processing fees, assessment fees and transaction related miscellaneous fees) would be classified as ‘royalty’ within the meaning of the term in Article 12 of India-Singapore DTAA. However, since it is effectively connected to the permanent establishment it would be taxed under Article 7 and not under Article 12. Fee cannot be classified as FTS under Article 12.
(iv) MAPPL is required to withhold tax at source on amount attributed to the permanent establishment in India at the full applicable rate at which the non-resident is subjected to tax in India.
The Reasons – Why MIP constitutes fixed place PE
(i) The master card interface processor (MIP) being an automatic equipment can also create a PE. Further, to create a PE, fixed place does not mean that the equipment should be fixed to the ground. It is sufficient compliance that it remains on a particular site (note 5 on OECD commentary on Article 5 of Model Tax Convention). Further this is also clear from the definition as explained by the Supreme Court in the Formula One (2017) 394 ITR 80. Therefore, even if the MIPs are automatic equipment placed at the site of the customer bank in India, they can create a permanent establishment provided other tests are satisfied. The test of permanency is passed since the MIPs are placed on the site of the customer banks throughout the year.
(ii) The fact that the MIPs are not owned by MAPPL and are owned by the Indian subsidiary MISPL is not relevant. As laid down in 4.1 of the OECD commentary on Article 5 of the Model Convention, the mere fact that an enterprise has a certain amount of space at its disposal which is used for business activities is sufficient to constitute a place of business. No formal legal right to own or use that place is therefore required. It is sufficient it is placed at the disposal of the foreign entity.
(iii) The preliminary validation is done by MIPs which involve preliminary verification of PIN, checking card codes, name and address verification. Further, MIPs alert the acquirer bank if errors are noticed or the data is not authorised. MIPs also encrypt the date for transmission. Transmission also happens to towers, leased lines, fibre optic cable, nodes, internet owned by third party service provider, Master Connect and MasterCard file express (application software) owned by MAPPL which are located in India as well as outside India. The role played by MIPs is a significant one in facilitating, authorization of process and without this initial verification / validation by MIPs, the authorization would not happen. Thus, this is a significant activity for authorization part of the transaction processing and cannot be said to the preparatory or auxiliary.
(iv) While the MIPs are shown to be owned by the Indian subsidiary MISPL, the FAR profile of MISPL only shows that it is performing support activity and not actual transaction processing. This clearly means that authorization part of the transaction processing activity carried on by the MIPs is the activity of MAPPL and not MISPL which only performs support functions.
(v) While MIPs are shown to be owned by MISPL, the update and maintenance is carried out by a specialized third party entity under a contract with an associated enterprise of MAPPL outside India. The cost of maintenance and upgradation of MIP is charged to MISPL and MISPL charges the same cost with mark-up on MAPPL. There is a 12% mark-up in the financial year 2014-15. This clearly shows that all the cost of MIP maintenance and upgradation ultimately get charged to MAPPL.
(vi) MISPL who is the owner of MIP does not exercise any rights of the owner such as deciding whether and when to repair the instrument or buy a new one; agreeing to the terms and conditions of repair; whom to engage for repair and at what cost; etc. All these risk mitigation decisions are taken by MAPPL or its overseas associated enterprises on its behalf.
The Reasons – Why MasterCard Network constitutes fixed place PE
(i) MasterCard network in India consists of MIP owned by MISPL, transmission tower, leased line, fibre optic cable, nodes and internet owned by third party service provider and application software master connect and MasterCard file express owned by MAPPL. The network also passes the test of permanency and fixed place. It also passes the test of disposal since in the TP report of MISPL it is admitted that MCT LLC is responsible for management and maintenance of MasterCard worldwide network remotely from USA. The application software is owned by MAPPL and controlled by them and therefore at their disposal. The network provided by the third-party service provider in India is also at the disposal of MAPPL.
The Reasons – Why Bank of India premises constitutes fixed place PE
(i) Settlement process is essentially the movement of funds between issuer bank and acquirer bank. More than 90% of the settlement is done by BOI in India on behalf of the applicant through a dedicated team. Settlement activity is the function of the applicant carried out by BOI on its behalf with all responsibilities of error on the applicant.
(ii) The applicant sends instruction to BOI regarding which account to debit / credit. Employees of BOI carrying out this work are under the control and supervision of the applicant and the space occupied by them in BOI is at the disposal at the applicant. It is true that BOI is an established bank carrying out other activities but for constituting PE, the space may not be exclusively used by the non-resident enterprise. Bank of India premises constitutes fixed place PE of the applicant.
The Reasons – Why MISPL constitutes Dependent Agent PE
(i) MISPL provides proposals to Indian Banks that are prepared, validated and approved by the Applicant. The proposals contain the rates at which applicant proposes services to the bank. If customer does not agree, the counter proposal is uploaded on the portal of the Applicant by the employees of MISPL. This process clearly establishes that orders or agreements are routed through MISPL though the finalization of the contract is by the Applicant in Singapore.
(ii) The above position may not satisfy the requirement of ‘concluding contract’ but it certainly satisfies the requirement of ‘securing order’.
(iii) The term ‘habitually’ has to be interpreted in the context of the business of the applicant. When there are only 7 new agreements in 3 years, even though only 2 or 3 contracts are entered into a year, the requirement of ‘habitually’ would be satisfied.
(iv) MISPL constitutes a dependent agent PE under Article 5(8) of the India-Singapore DTAA on account of habitually securing orders wholly for the applicant.
The Reasons – Royalty
(i) Licensing of trademark / mark / logo, etc. (IC) is the dominant purpose as can be seen from the license agreement between MCI, US and the Applicant. Royalty paid by the applicant to the MCI, US (in INR) is for the use of IP in India for and in connection with the promotion and sale of goods or services. The agreement clearly establishes that royalty paid is for the use of intangibles in India. The applicant has further licensed the IPs to banks so that the banks can use them for selling their cards which would increase the transaction processing activities of the applicant.
(ii) Whether MCI is rendering transaction processing services or not does not matter. What matter is that these IPs for which the applicant is paying royalty to MCI is further sub-licensed by the applicant to various banks in India. Thus, the payment received by the applicant represents consideration for use of the IP in India and hence is to be classified as ‘royalty’.
(iii) It may appear that the banks are making the payments to the applicant but in reality, the incidence of these payments falls on the final consumer as merchants’ price their products keeping in mind the fee that they have to pay to MasterCard. Thus, the person who swipes the MasterCard to make plastic payment is the one who bears the actual fees paid by banks to the applicant. The fee paid by the acquirer bank is recovered from the merchant and merchant recovers the amount from the price of the product / service paid by the consumer. It is consumer who is using the IPs and hence the payment made by it to merchant as a part which represents payment for use of MasterCard IP. That part is then paid by the merchant to the acquirer bank and by the acquirer bank to the applicant.
(iv) There is nothing like standalone provision of MIP and application software. The use of software inside MIP and cards in the application software are essential part of the transaction without which no transaction can be completed. Use of software is royalty and is effectively connected to the permanent establishment.
The Reasons – Non-applicability of FTS
(i) The ultimate beneficiary is the final consumer and whether a particular payment is royalty or service or facility needs to be seen from his perspective. The relation between final customer and applicant is of use of a standard facility and hence transaction processing services rendered by the applicant cannot be taxed under FTS in India-Singapore DTAA.
(ii) There are services other than transaction processing and these are not standard facility and are in the nature of technical services. However, since technical knowledge, experience, skill, knowhow is not made available to the service recipient it cannot be classified as FTS under the India-Singapore DTAA.
The Reasons – Further attribution
(i) Where a subsidiary has a fixed place PE, the Morgan Stanley ruling would not apply. The FAR undertaken by the non-resident enterprise through the subsidiary is not fully captured in the FAR profile of the subsidiary. In this case, earlier there was a PE in India and all the functions, assets and liabilities were taken over by MISPL. The FAR profile of MISPL does not capture the full functions performed, assets employed and risk undertaken by the erstwhile PE. Since MISPL constitutes PE of the applicant, the assessing officer may consider further attribution to this PE on this score.
(ii) Even in the case of dependent agent PE in this case, there is need for further attribution since all the functions / risks are not reflected in the FAR of MISPL.
(iii) All the revenues received by the applicant from customers in India would not be attributed to the Indian PE since significant activities are also carried out by the applicant outside India. There is need for attribution and on such attribution of income, the tax is required to be withheld at full applicable rates at which the non-resident is subjected to tax in India.
The deciscions distinguished
(i) The decision of the Delhi High Court in the case of UAE Exchange Centre Vs. UOI (2009) 313 ITR 94 is not applicable since in that case, the LO in India was like a post office downloading remittance particulars and printing cheques / drafts for delivery. They were held to be subsidiary activity as the main activity of fund transfer had happened outside India. In the instant case, the transaction processing and authorization is happening through MIPs which is a significant activity.
(ii) The Australian Taxation Office (ATO) has ruled that the Applicant does not have a PE in Australia on account of MIP. In the Australian case, the MIPs were continued to be owned by a group company outside Australia and were not transferred to the Australian subsidiary. In the Australia-Singapore DTAA there is a special clause for substantial equipment and in the case of equipment constituting PE, the term ‘substantial’ has to be satisfied. There is no such clause in India-Singapore DTAA and hence whether MIP would constitute PE would be governed by general clause alone.
(iii) The decision of the Special Bench in the case of Motorola Inc. Vs. DCIT (1004) 95 ITD 269 is not applicable since in the instant case, the employees of BOI are doing the activities of the applicant and are dedicated to carry out that function and have space available to them in the office for which they have free access.
The decisions applied
(i) The AAR has ruled that the Delhi Tribunal in the case of Amadeus Global Travel Distribution SA Vs. DCIT (13 TTJ Delhi 757) and the decision in the case of Galileo International Inc. Vs. DCIT (2008) 19 SOT 257 is applicable. What was CRS in these cases is MIP and application software in the instant case. It is this important instrument and software which conducts the business of the applicant in India. The software and process technology which is part of MIP is owned by the applicant and installed in the premises of the customer (banks and FIs) in India. The customer swipes the card and the data flows between two banks in India and money also moves in India whereby income is generated for the applicant. Thus, like Galileo revenue generating activity is happening in India. MIPs are performing more than what CRS was doing in India.
(ii) AAR also makes a reference is made to the Delhi High Court decision in Formula One (390 ITR 199) which referred to the Swiss Server decision at page 245 wherein the server functions without involvement of D Co’s employees in Switzerland and another affiliated company managed the server. The German Tax Court of First Instance had held that server constituted D Co’s fixed place of business and fixed place PE in Switzerland. Any equipment could amount to a fixed place PE even if it functioned fully automatically without human intervention. Thus, it is clear that automatic equipment like server can also create PE.
(iii) Mere fact that space was made available for the applicant is sufficient for PE inference and the decision of the Supreme Court in Formula One World Championship Ltd. Vs. CIT (2017) 394 ITR 80 was applied.
(iv) There can be an inference of business connection or PE because of the fact that exclusive ownership with interface processes continued and the decision of the Madras High Court in Verizon Communications Singapore Pte Ltd. Vs. ITO (2014) 361 ITR 575 and Google India Pvt. Ltd. Vs. ACIT (2017) 60 ITR (Tribunal)(S.N) 40 was applied.
MasterCard Ruling – Open Issues
The Ruling of the AAR in MasterCard would obviously be tested before the High Court and the Supreme Court and it remains to be seen as to what would be the final outcome. The decision of the Supreme Court in the case of Formula One will obviously have impact. There are also interesting aspects in the ruling where FAR plays a critical role; passive ownership without taking decisions with reference to asset usage and risk mitigation have been questioned. However, the following key questions do arise from the rulings which require debate and discussions:
(i) When a customer obtains a credit card from a bank which has a Master or Visa affiliation, can it be said that the customer is paying for the IP through the merchant who pays to the bank and who ultimately pays to the foreign company?
(ii) When a customer swipes the credit card for the goods or services, the price is only for the goods or services. Can it be said that the customer is paying for the IP of MasterCard as part of the price of the goods and the parties are at consensus ad idem on the nature of such payment?
(iii) Is it correct to assume that the charges paid by the merchant have been factored in the price of the goods or services and hence it is the customer who indirectly pays for usage of IP?
(iv) When payments are made by the customers namely the banks or FIs to the foreign company, applicable service tax (now GST) would be discharged by treating it as an import of service. If the foreign company is considered to have a fixed PE or a dependent agent PE in India would such PE become a fixed establishment for the purpose of GST?
(v) Assuming, a PE under Income Tax law is considered as an FE under GST, should the PE obtain GST registration in India and charge GST?
(vi) Whether the banks and FIs should pay IGST on import of service or it is the responsibility of the PE to charge GST?
(vii) Whether GST is applicable in the absence of any payment being made to the PE?
(viii) If automatic equipment such as an interface processor can constitute fixed place PE what would be tax position in future in the light of new developments such as block chain, artificial intelligence; automated bots; etc.?
(ix) Can automated verification of data and initiation of a transaction using technology be considered as a significant activity?
(x) What would be the implications for usage of software tools; software applications; moulds; dies; tools which belong to a foreign enterprise?
(xi) What would be the implications for system providers who are now required to store entire data relating to payment systems only in India as mandated by RBI directive issued under Section 10(2) read with Section 18 of Payment and Settlement Systems Act 2007?
Originally published in International Fiscal Association, Chennai Souvenir.