If you’ve been keeping up with the news, you may have heard of MotoGP Bharat ― India’s motorcycling Grand Prix making some noise in the headlines. It’s going to be the first motorsport event with all the pomp and show in nearly a decade at Delhi’s Buddh International Circuit since the exit of Formula One racing in India.

So in today’s Finshots, we go back in time and find out what went wrong with India’s F1 Grand Prix.

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The Story

In 2011 the Formula One Grand Prix (F1 GP) made a grand entry in India. The country said hello to the F1 madness with platforms like BookMyShow selling tickets worth ₹1.25 crores in just 3 hours of the ticket sale launch. And the hype was so intense that the inaugural GP even garnered 6 times the average television rating points than any other GP ever held, according to a TAM (Television Audience Measurement) Sports Survey.

And as you would expect all eyes were on Buddh International Circuit, the $400 million racing arena built by Jaypee Group, currently a crisis-hit conglomerate. A subsidiary of the Jaypee Group bagged the F1 hosting and promotional rights for 5 years starting in 2011. But the deal went sour after 3 seasons in 2013. And F1 said goodbye to India for good.

So, what went wrong?

Well, it all started with a contract between Jaypee Sports and Formula One World Championship Limited (FOWC), a UK-based company. Jaypee Sports was a Jaypee Group subsidiary interested in acquiring the hosting rights for the F1 Grand Prix from FOWC. So they signed two contracts. One, a $40 million Race Promotion Contract. And another, a $1 million contract that let Jaypee use FOWC’s logos, trademarks and other intellectual property.

The $40 million Race Promotion Contract granted Jaypee the right to host, stage and promote the F1 GP. The $1 million contract called the Artwork License Agreement (ALA) allowed Jaypee to use certain marks (intellectual property) owned by FOWC. Marks like the ones we’ve shown below.

Now you may wonder why hash out two separate contracts when you could have clubbed both contracts together. Well, the answer is actually quite simple. Both Jaypee and FOWC wanted to reduce their tax outgo. And to this end, they believed separating the two contracts could limit the total tax implication.

How so?

Well, before they paid the tax, they approached tax authorities  —  in this case, the Authority for Advance Rulings (AAR) and sought an advance ruling on the matter. They wanted to know how the authorities would tax these contracts. And they made a compelling pitch to voice their opinion. It went something like this.

The massive $40 million contract is neither royalty income nor business income. And therefore is not liable to be taxed in India. Now you would think that Jaypee paying a lot of money to host the race and use the intellectual marks owned by FOWC would amount to royalty. But as we noted earlier, there was a separate agreement totalling $1 million that dealt with intellectual property rights. That was Jaypee paying the “royalty” fee. But the larger $40 million Race Promotion Contract? That can’t be classified as royalty because the explicit point of the contract was to stage and promote the Formula One Grand Prix of India.

Okay, if that were the case, shouldn’t this (and all other income generated during the course of the event) be classified as business income? And therefore be taxed accordingly? Well, Jaypee and FOWC had another argument. They said that FOWC was already paying taxes in the UK. So if they had to pay taxes in India again, that would amount to double taxation. This is something that the two countries have tried to prevent by signing a Double Taxation Avoidance Agreement. Therefore it would be totally unfair to expect FOWC to pay a tax on this income. They also noted that foreign entities pay tax in India only if they have a permanent establishment (PE) here, like an office. But FOWC didn’t really have an office or even employees deputed to India. So it wanted a total tax exemption on the contract.

On the first matter, the AAR ruled that the income would be treated as royalty since Jaypee could only host the race by exploiting intellectual property owned by FOWC. Therefore they had to treat the $40 million as royalty income. And on the second matter of treating income generated in India as business income, they agreed with Jaypee and FOWC and said that this shouldn’t be the case since FOWC did not have a Permanent Establishment in India.

Now paying tax on $40 million sucks. So Jaypee and FOWC approached the High Court. Meanwhile, the Government’s revenue department also did not like the ruling since they believed that the entire income should be classified as business income. FOWC earned that money in India by conducting business in India after all.

The High Court though reversed both rulings by the AAR. It didn’t think this was royalty income. Instead, it believed the real question was whether this was business income. As such it was more interested in figuring out if FOWC had a permanent establishment in India. And even though it had no physical office, in the end, the honorable court concluded that all monies earned by FOWC had to be taxed at source in India.

Why, you ask?

Well, we will let the Supreme Court answer this. Because eventually the matter did go to the Supreme Court and here’s what it thought.

Even though the FOWC had no physical space through which they operated in India, there was something of significance — the Buddh International Circuit. For the duration of the event as well as two weeks prior to and a week succeeding it, FOWC had full access to the Buddh International Circuit through its personnel and the team contracted to it, both racing as well as spectator teams. It could also dictate who was authorised to enter the areas reserved for it. And even though Jaypee was listed as the promoter, FOWC called all the shots. Which is why the Supreme Court noted that —

“The physical control of the circuit was with FOWC and its affiliates from the inception… Omnipresence of FOWC and its stamp over the event is loud, clear and firm.. the undisputed facts were that race was physically conducted in India and from this race income was generated in India. Therefore, a commonsense and plain thinking of the entire situation would lead to the conclusion that FOWC had made their earning in India through the said track over which they had complete control during the period of race.”

This was a Permanent Establishment even if it wasn’t permanent. Thus Jaypee and FOWC had to concede and deduct taxes at source. FOWC had to shell out a 40% tax plus interest on all the income it received from the races it held between 2011 and 2013.

But that wasn’t the only problem. Even before the court saga, Jaypee sought a customs duty waiver on importing all the sporting equipment needed to facilitate the race. Things like gears, pallets and parts of completed disassembled F1 cars. And they sought these exemptions because sporting events of international importance get a waiver if the Sports Ministry allows it. It happened during the Commonwealth Games and the Cricket World Cup. But when Jaypee requested this benefit, the Ministry rejected it. It didn't agree that F1 was purely a sport. It was more like entertainment and a commercial initiative.

Also when the deals were originally signed, Mayawati was the Chief Minister of Uttar Pradesh. And her government granted an entertainment tax waiver on ticket sales. But then these exemptions were erased by her successor CM Akhilesh Yadav.

So, in effect, F1 had to leave India with minimal support from the central and state governments. Not to forget a huge tax bill.

But things have changed over the years. In 2015, the Indian government finally recognised motorsports as an actual sport. That meant it would get government backing for future events. Moto GP Bharat for example is hoping to thrive because of this recognition.

Will it actually succeed? Well, we will just have to wait and see.

Until then…

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