R. Kumar, B.Com. MBA (Finance)
Intellectual property rights (IPR) have become important in the face of changing trade environment which is characterized by the following features namely global competition, high innovation risks, short product cycle, need for rapid changes in technology, high investments in research and development (R&D), production and marketing and need for highly skilled human resources. Geographical barriers to trade among nations are collapsing due to globalisation, a system of multilateral trade and a new emerging economic order. It is therefore quite obvious that the complexities of global trade would be on the increase as more and more variables are introduced leading to uncertainties. Many products and technologies are simultaneously marketed and utilized in many countries. With the opening up of trade in goods and services intellectual property rights (IPR) have become more susceptible to infringement leading to inadequate return to the creators of knowledge. Developers of such products and technologies would like to ensure R&D costs and other costs associated with introduction of new products in the market are recovered and enough profits are generated for investing in R&D to keep up the R&D efforts. One expects that a large number of IP rights would be generated and protected all over the world including India in all areas of science and technology, software and business methods.
In India, multinational companies are investing more and more in high technology industries. Even though, there are some provisions in different legislations for intellectual property taxation, government officials and industry are unaware of the application and implications of the provisions. In most of the cases there are different approaches taken by Central and State governments on taxability of intangible assets. In many cases, Indian judiciary has intervened and interpreted the provisions. In TCS Vs. State of Andhra Pradesh, Supreme Court [(SC) ] held that “software sold off the shelf” are to be considered as “goods” and therefore can be taxed under Andhra Pradesh General Sales Tax (APGST) Act.
Taxation Aspect (i.e. Direct Tax & DTAA):-
Sec. 5(2) of the Income Tax Act, 1961 provides that a non-resident is taxable in India on incomes received or deemed to be received in India and on income which accrue or arise to him in India or are deemed to accrue or arise to him in India as provided in sec. 9(1) (vi) of the Act or Article dealing with Royalty income in the treaties (i.e. Article 12). If the intellectual property right (IPR) is located in India then the consideration for its use or disposal accrues/arises in India and thus is taxable u/s 5(2) regardless of conditions in sec. 9(1)(vi).
> Under the Income Tax Act, 1961
As per Explanation 2 to Sec. 9(1)(vi) of Income Tax Act Royalty means consideration (including any lump sum consideration but excluding consideration which would be the income of the recipient chargeable under the head capital gains) for:
i. The transfer of all or any rights (including the granting of a licence) in respect of a patent, invention, model, design, secret formula or processor trade mark or similar property;
ii. The imparting of any information concerning the working of or the use of, a patent, invention, model, design, secret formula or process or trade mark or similar property;
iii. The use of any patent, invention, model, design, secret formula or process or trade mark of similar property;
iv. The imparting of any information concerning technical industrial, commercial or scientific knowledge, experience or skill;
iva. The use or right to use, any industrial, commercial or scientific equipment but not including the amount referred to in sec. 44BB.
v. The transfer of all or any rights (including the granting of licence) in respect of any copyright, literary, artistic or scientific work including films or video tapes for use in connection with television or tapes for use in connection with radio broadcasting, but including consideration for the sale, distribution or exhibition of cinematographer films, or
vi. The render in of any service in connection with the activities referred to in sub-clauses (i) to (v);
The following points comes out in respect of the above definition of royalty under the Act:
i. Royalty has been defined in an exhaustive manner with the result that what is not covered within the meaning of royalty as defined, will not be regarded as royalty for the purposes of the Act, even if the same is covered by the general/ natural meaning of the term ‘royalty’.
ii. Royalty excludes any consideration which would be chargeable under head ‘Capital Gains’ [CIT Vs. Koyo Seiko Co. Ltd. (1998) 233-ITR-421(AP)]
iii. Consideration constituting royalty may be periodic, or a lump sum consideration.
iv. In Citizen Watch Co. Ltd. Vs. IAC [(1984) 148-ITR-774 (Kar.)], the High Court held that definition of the term ‘royalty’ in Explanation 2 to sec. 9(1)(vi) is not a general definition applicable where that term occurs but is applicable to sec. 9(1)(vi) only.
- Double Taxation Avoidance Agreement
Article 12(2) of the OECD MC 2003 defines the term royalty as under:
The term ‘royalties’ as used in this Article means payment of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience.
1. CIT Vs. Neyveli Lignite Corporation ltd. [(2000) 243-ITR-459 (Mad.)]
The Court observed that the term ‘royalty’ normally connotes the payment made by a person who has exclusive right over a thing for allowing another to make use of that thing which may be either physical or intellectual property or thing. The exclusivity of the right to the thing for which royalty is paid should be with the grantor of that right.
2. CIT Vs. HEG Ltd. [(2003 ) 263-ITR-230 (MP)]
High Court held that payment for every information is not royalty some sort of expertise or skill is required. In this case payment was made for purchase of data on carbon graphite electrode industry.
3. Goa Carbon Ltd. Vs V.M. Muthuramalingam & Anr. [( ) 251-ITR-348 (Mum.)]
High Court held that consideration of services rendered only by sending two persons for a specified period to start the working of the machinery in an agreement for transfer of technology is ‘Royalty’ & not ‘Fees for Technical Services’.
4. IMT Labs (India) Pvt. Ltd. [(2006) 287-ITR-450 (AAR)]
Advance authority ruled that payment made for use of software through internet on the server situated in USA. It was held that the software on the server is scientific equipment licensed to be used for commercial purpose and therefore the payment was held to be Royalty.
5. Wipro Ltd. Vs. ITO [(2005) 94-ITD-9 (CESTAT)]
Tribunal held that payment made to avail the users’ licence which allows electronic access to the services offered by the foreign company which is highly specialized and researched industry information in ‘secret information’ and hence royalty u/s 9(1) (vi) as well as the DTAA except for payments of professional fees in respect of consulting services, which will be ‘Fees for Included Services’ under the DTAA.
6. DIT Vs. Sheraton International Inc. [(2009) 313-ITR-267 (Delhi)]
ITC and Sheraton entered into an agreement for development of tourism, maximizing foreign exchange earning, etc. Sheraton’s expertise was to be utilized for publicity, marketing and advertising of hotel business. Use of Sheraton’s trade name and trade mark was incidental to main services. Sheraton was compensated as a percentage of room sales. ITO held that payment was for royalty. Tribunal held that payment was for publicity marketing and advertising of hotel business was neither royalty nor FTS. Delhi High Court approved the ITAT’s decision.
7. International Hotel Licensing Co. [(2007) 288-ITR-534 (AAR)]
The applicant, a non-resident company, entered into an agreement with the Indian company ( a Marriott Group Hotel). As per the agreement Indian company would participate in the marketing business promotion programmes and that the applicant would provide, inter alia, advertising space in magazines, news papers and other printed media and electronic media which would be conducted by it outside India for Marriott Group of Hotels word wide. Advance Authority of Ruling held that the payment of annual contribution of 1.5 percent of the gross revenues of the hotel made by the Indian company was for rendering managerial and consultancy services. Thus, it was held to be Fees for Technical Services.
Some of the tax planning techniques used subject to GAAR provisions in treaty/domestic laws
- Form a base company in a favourable jurisdiction which is used to own the intellectual or other intangible property belonging to the group. The objective of such a structure is either the accumulation of profits in a low tax country, the elimination or reduction of withholding taxes, or the use of a country providing a deduction for the amortization of the intangible, while reducing the corporate taxes of the manufacturing company through a licence fee.
- Another form of exploiting IP is licensing. A licence is a form of direct sale whereby a licensee is authorized to manufacture or distribute the licensor’s product or technology, in consideration for royalty payments or some other form of reward. Licensing is a mid-point between exporting products abroad and commencing overseas production.
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