Payment made to foreign company for outright purchase of plant and know-how cannot be considered as ‘Royalty’

Recently, the Himachal Pradesh High Court in the case of CIT v. Maggronic Devices Pvt. Ltd. [2009-TIOL-568-HC-HP-IT] held that payment made by the taxpayer to a Singapore company for outright purchase of plant and product knowhow cannot be considered as ‘Royalty’ within the provisions of the Income-tax Act, 1961. Accordingly, no tax was required to be deducted while making payment to the Singapore company for acquiring such know-how outside India.

Facts of the Case

• The taxpayer was engaged in the manufacture of audio magnetic sound heads, which are used in various audio appliances like tap recorders, stereos, sound systems, telephone answering systems etc.
• The taxpayer entered into an agreement with a Singapore Company called Sankyo Seiki (Singapore) Pvt. Ltd. (Sankyo) for the purchase of

-plant know-how in the form of technical and engineering data, design data, drawings, sketches, photographs etc., and

-product know-how

for a sum 15 million Yen. The said agreement was approved by the Government of India and the Reserve Bank of India.

• The consideration was payable in three installments i.e. one third was payable on the date of agreement, one third upon the delivery of the documents of designs, machinery and plant and the final installment was to be paid after the commercial production would start. As per the agreement Sankyo also offered to make available the services of trained technicians for setting up the plant and machinery, if required by the taxpayer.
• The two directors of the taxpayer traveled to Singapore for signing the agreement and to purchase the plant know-how including designs, photographs, sketches, etc. and the consideration of 5 million yen was also made in Singapore by the directors to Sankyo.
• The taxpayer applied for No Objection Certificate (NOC) to the Assessing Officer (AO) to pay the consideration to Sankyo without deducting tax at source, on the grounds that no liability to pay tax had accrued in India. However, the AO refused to grant NOC to the taxpayer on the grounds that such payments was in the nature of ‘Fees for Technical Services’ (FTS) within the meaning of section 9(1)(vii) of the Act.
• The Commissioner of Income-tax and the Income-tax Appellate Tribunal (the Tribunal) allowed the claim of the taxpayer and the Tribunal held that since the plant know-how had been purchased by the taxpayer from Sankyo in Singapore, no part of income of the Sankyo was taxable in India. Further, such payments cannot be also considered as royalty even in terms of the extended definition of royalty provided by explanation 2 to section 9(1)(vi) of the Act.

Issues before the High Court