Consultancy and IT Services from Non-Residents: When Tax Authorities See Royalties
The line between services and royalties is growing ever finer. Current court practice shows that in certain cases, fees for services are reclassified as royalties for the transfer of commercial experience (know-how). The consequence of such a classification is taxation of the non-resident's income at source.
What proves decisive is no longer so much what the parties called the contract, but what the non-resident actually transferred to the Kazakhstani company.
What caught the court's attention
In a recent dispute, the courts took into account a combination of circumstances:
- the non-resident possessed specialised professional knowledge and experience and advised the Kazakhstani company on matters relating to its operations;
- the services included business analysis and the preparation of recommendations for management decisions, financial planning and IT;
- the client received analytical materials, professional knowledge, specialised information and commercial experience;
- the contract provided for separate obligations of confidentiality and protection of the information transferred.
This last point received particular attention. The presence of a confidentiality regime was treated as one indication that the parties had established a special regime for using the information transferred — information that may potentially bear the characteristics of undisclosed information or know-how.
The contract is only the starting point
The court did not confine itself to the text of the contract. It examined service acceptance acts, invoices, quarterly reports and other documents capable of establishing the real substance of the relationship between the parties.
On that analysis, the court concluded that the non-resident was not merely applying its own knowledge in providing advice but was in fact transferring professional knowledge, commercial experience and specialised approaches capable of being used in the client's subsequent activity. The payments were accordingly classified as royalties for the transfer of commercial experience.
What about the OECD Commentaries?
The court's position on international sources of interpretation is also of interest.
The Vienna Convention and the OECD Commentaries were not recognised as an independent source of law. At the same time, the court allowed them to be used as a supplementary instrument for interpreting an international tax treaty.
The basis for classification remains the provisions of the Tax Code, the relevant tax treaty and — crucially — the factual circumstances of the transaction.
Where the line runs between a service and know-how
This is the central practical question.
One situation is where a foreign consultant uses its own knowledge, experience and methodologies to analyse a problem and deliver the result of that work to the client.
Another is where the knowledge, methodologies, technologies or commercial experience themselves are transferred to the client in such a way that the client can go on to use them independently.
In the second case, the risk that the payment will be classified as a royalty rises significantly.
Practical points to consider
Labels such as "consultancy services" or "IT services" no longer offer protection against reclassification in themselves. The whole construction of the relationship needs to be examined.
The subject matter of the contract. Describe the result of the work rather than the transfer of a methodology. "Preparation of an opinion on X" and "transfer of a methodology for assessing X" are fundamentally different constructions with different tax consequences.
Confidentiality clauses. A standard non-disclosure clause covering information about the client is ordinary practice. But obligations to protect information supplied by the consultant may be read by a court as evidence of a special regime for the use of know-how. These provisions are worth separating.
Acts and reports. It is these documents, rather than the contract, that reveal the real content of the services. General wording such as "consultancy services were rendered" works against the company: it makes it impossible to establish what actually took place. Detail describing specific tasks and outcomes is in the client's own interest.
What happens to the methodology. The key question is whether the toolkit stays with the consultant or passes to the client. Handing over templates, models, algorithms and internal methodologies for independent use is a strong argument in favour of royalty treatment.
Timing of the assessment. Tax consequences should be analysed before the contract is signed and before payment is made, not after a notice arrives. Once payment has been made, the documentary picture can no longer be changed, and the withholding obligation arises at the moment the income is transferred.
Applying the treaty. Even where a treaty reduces the rate on royalties, it does not undo the reclassification itself or the assessments and penalties that follow. Applying it will also require compliance with the requirements on the certificate of residency and beneficial ownership status — and Kazakhstani courts approach those requirements strictly.
Conclusion
In a tax dispute, what proves decisive may not be the name of the contract but the answer to a simple question: did the non-resident use its know-how for the client, or did it transfer that know-how to the client?
If your company purchases consultancy, management, technical or IT services from non-residents, the tax consequences should be assessed before the contract is signed and before any payment is made.
The Fortune Partners team can help analyse your contractual model, the actual substance of the services and the supporting documentation, so that potential tax risks are identified in advance.
