Case Law Details
BEFORE THE AUTHORITY FOR ADVANCE RULINGS (INCOME TAX), NEW DELHI
12th Day of October, 2011
P R E S E N T
Justice Mr. P. K.Balasubramanyan (Chairman) Mr. V.K. Shridhar (Member)
A.A.R. No. 885 of 2010
Name and address of the applicant: Upaid Systems Limited
Commissioner concerned : Director of Income-tax (International Taxation) Hyderabad
R U L I N G
[By Justice P.K. Balasubramanyan]
The applicant is a company incorporated under the laws of British Virgin Islands. It was previously known as ‘In touch Technologies Holdings Limited’, the predecessor of which in turn was ‘In Touch Technology Limited’. The applicant is engaged in the business of providing and enabling Electronic Payment Services via mobile and fixed line telecom and other telecom services networks. Over the years, the applicant has been conceiving, designing and developing Software Technology relating to payment processing platforms and services. In the year 1966, a new framework for an advanced intelligent processing platform was conceived of. In order to exploit that invention commercially, appropriate software had to be designed and developed. After developing the design, the applicant outsourced the development of software to Satyam Enterprise Solutions Limited. On 29.5.1997, a Memorandum of Understanding was entered into in that behalf with Satyam Enterprise Solutions Limited. Satyam Enterprise Solutions Limited subsequently merged with its parent Satyam Computer Services Ltd. The obligations under the MOU with the applicant were taken over by the parent Satyam Computer Services Limited under the scheme of amalgamation. The Memorandum of Understanding provided that Satyam would develop certain Operation Support Systems software which included, inter alia, products that came to be known as ‘Call Manager’ and ‘Net Manager’.
2. On 11.9.1998 as Assignment Agreement effective from 1.1.1998 was executed between the parties where under Satyam, after receiving good and valuable consideration, assigned to the predecessor of the applicant in perpetuity all worldwide right, title and interest in the software and Intellectual Property Rights and Copyright over the software developed. The Assignment Agreement also assigned to the applicant the right to seek patent protection for inventions and to own all patent applications and letters patent or similar legal protection for such inventions in all countries throughout the world. The Assignment Agreement was executed in the United States of America and the governing law was the law of the United States. On 15.9.1998, the applicant filed a provisional patent application with the United States Patent and Trademark Office in respect of ‘Call Manager’ and ‘Net Manager.’ Satyam, along with the Assignment Agreement had also provided assignment letters from its employees who had worked on the innovations sought to be patented. These letters were also relied on by the applicant before the Patent Authority.
3. The Memorandum of Understanding entered into on 29.5.1997, was then replaced by a Services Agreement dated 19.9.1999 made effective from 15.9.1998 under which Satyam was to continue to provide software development services to the applicant till the end of the year 2002. The Services Agreement reaffirmed that the predecessor of the applicant would be the owner of the Intellectual Property Rights over the software developed by Satyam.
4. There were some omissions in the application filed before the Patent Authority. These omissions were rectified by Satyam at the request of the applicant and a combined declaration was filed with the Patent Authority. Being satisfied, the Patent Authority granted ‘Patent 947’ to the applicant on 20.11.2001. Other subsidiary applications in respect of inventive work predicated in part upon ‘947 Patent’ were also filed by the applicant before the Patent Authority. The entirety of the patent portfolio of the applicant, according to it, is either wholly or partially dependent upon ‘947 Patent’.
5. During the interregnum, Satyam had acquired 22.06% equity in the applicant as per the share issuance agreement executed in the year 1999 in lieu of outstanding receivables. Disputes arose between the parties, a settlement was arrived at and a Settlement Agreement dated 31.12.2002 was executed. By it, the share issuance agreement and the Services Agreement between the parties were terminated. Satyam ceased to be the contract software developer for the applicant. Satyam also almost entirely divested itself of its shares in the applicant. The agreement affirmed that the Intellectual Property Rights over the software shall be the sole and exclusive property of the applicant. Satyam agreed to execute any document that may be needed in furtherance of filing and maintaining the applications relating to the Intellectual Property.
6. According to the applicant, it subsequently discovered certain facts which led it to believe that some of the signatures in the inventors assignment purportedly signed by the inventor employees of Satyam and furnished to the applicant and filed by the applicant before the Patent Authority, were not genuine but were forgeries. This discovery was made during the proceedings initiated by the applicant for infringement of patent, in Texas, USA in June 2005, against Qualcomm Incorporated and Verizon Wireless, two telecom companies on the ground that those companies had infringed the applicant’s ‘947 patent’ and subsequent patents while developing their software platforms. It was in defence of those proceedings that the two companies produced declarations from two employees of Satyam involved in the developing of the software, that they had not signed the employee assignment or the combined declaration furnished by Satyam to the applicant based on which the patent had been applied for and obtained by the applicant. Having failed to get any assistance from Satyam in proving the documents as genuine, the applicant was forced to settle the proceedings for infringement commenced against Qualcomm and Verizon on unfavourable terms. This was done in April 2007.
7. On 4.4.2007, the applicant filed a complaint against Satyam in the District Court of Texas. One of the employees of Satyam was also impleaded. The complaint underwent two amendments and the third and final amended complaint was filed in October 2008. In its complaint, the applicant contended that on account of forgery, fraud, misrepresentation and breach of contractual covenants by Satyam and its employees, the value of its entire patent portfolio had been impaired and it was forced to settle the action against Qualcomm and Verizon for infringement of patent, on most unfavorable terms. It accused Satyam of breach of contractual covenants and forgery. It sought the relief of a declaration as to the validity and enforceability of its patent under the laws of the United States, damages resulting from fraud/negligent, misrepresentation and/or forgery by Satyam in providing documents containing forged signatures and in breach of contractual covenants, exemplary and punitive damages for fraud and forgery and for interest and costs. In defence, Satyam disowned any responsibility for the alleged forgeries and defended the action.
8. Satyam, challenging the jurisdiction of the District Court, Texas to entertain the complaint, approached the Queen’s Bench Division of the Commercial Court, London contending that in terms of the settlement dated 31.12.2002, the applicant was barred from pursuing its complaint in Texas since the agreement made in the complaint stood extinguished by the settlement and that in any event, the complaint fell within the exclusive jurisdiction of the English Courts. The trial judge by judgement dated 1 .1 .2008 dismissed the action, finding that the subject matter of the complaint was not extinguished by the settlement and that the Texas Court had jurisdiction to deal with the complaint. The appeal filed by Satyam was dismissed by the Court of Appeal. A Petition for Leave to Appeal to the House of Lords filed by Satyam was also rejected. Thus, the applicant was enabled to pursue its complaint in the District Court, Texas.
9. To reconcile the differences arising out of the complaint, an attempt at Mediation was made. The attempt succeeded and the parties entered into a Settlement Agreement on 18.7.2009 signed in Dallas, Texas, USA. It provided for the parties to sever all ties with each other forever and for settlement of all claims and disputes between the parties. In satisfaction of all the claims of the applicant, Satyam agreed to pay to the applicant an amount of $ 70 million in two instalments. The first instalment of $ 45 million was to be paid within 10 business days of Satyam getting the approval of its Board of Directors and of the Boards of other companies as may be necessary, of getting Governmental or Regulatory approvals as may be necessary under India law, after putting forward its best efforts for getting them. All payments were to be made “by wire transfer to a bank of Upaid‟s Choosing”. Then followed a provision for Escrow of Funds. The same is quoted below.
“3. Escrow of Funds.
a. Within 10 business days of obtaining board approvals referred in paragraph 9(a), Satyam will deposit the equivalent in Indian Rupees of the First Payment and the Final Payment in an interest bearing escrow account or accounts in India at a reputed international bank or Indian nationalized bank as reasonably and mutually agreed for the purpose of securing the payment obligations in paragraph 2.
b. In the event the First Payment is made on or before 180 days from the date of this Settlement Agreement, then Satyam shall be entitled to the principal in the amount of the First Payment and all accrued interest thereto.
c. In the even the First Payment is made more than 180 days after the date of this Settlement Agreement, then Satyam shall be entitled to the principal in the amount of the First Payment and Upaid shall receive all accrued interest with respect to the First Payment.
d. After the First Payment is received, Satyam shall have the right to replace the escrowed funds securing the Final Payment with either a bank guarantee or letter of credit in the same amount pending receipt of the Final Payment at which time security shall no longer be necessary.
e. After the Final Payment is received, Satyam shall be entitled to the principal in the amount of the Final Payment and all accrued interest thereto.”
10. The settlement agreement reiterated that they intended it to be a full and final settlement of all disputes between the parties and that the parties intended it to sever all ties between them and to end their relationship forever. It then proceeded to provide:
“Subject to the fulfilment of paragraph 9 of the Settlement Agreement, all prior agreements or understandings between the parties or any of their respective present or past officers, directors or employees, regarding any matters whatsoever are extinguished, including the Assignment dated September 11, 1998, the Services Agreement effective as of September 15, 1998, the Share Issuance Agreement dated September 1, 1999, the previous Settlement Agreement between the parties effective as of December 31, 2002, any assignments between or among Satyam, Upaid and/ or individual present or former employees of Satyam and any amendments to such agreements. Notwithstanding this provision, Upaid shall retain whatever intellectual property rights have already been transferred to it under any assignment or agreement strictly on an “as is”or quitclaim basis without Satyam or its present or former employees making any representation or warranty about such transfer or having any further obligation to perfect such transfer. Upon dismissal with prejudice of this action, Satyam waives its rights to preclude former employees from having contact with Upaid under any nondisclosure agreements signed during the pendency of this action to the extent necessary for Upaid’s patents.”
It was also provided:
“8. Upaid will grant a perpetual worldwide, royalty free license on all of its patents, pending patents and any future patents to Satyam and its affiliates, including Tech M and M&M. Such royalty free license shall not be assignable. In addition, Upaid covenants not to sue British Telecommunications (“BT”) and AT&T for patent infringement or any other claim related to its patents.”
11. Thus, the payment made was for extinguishment of all rights and obligations between the parties, for severing their business relationship arising out of prior agreements, towards compensation for deficiency in its patent found to exist by the applicant, for grant of perpetual world wide royalty free licence by the applicant on all its patents, pending and future to Satyam, subject to Satyam not having a right to assign the licence. An undertaking of forbearance to sue two of the affiliates of Satyam by Upaid was also incorporated.
12. Satyam did not pay the amount by wire transfer to a Bank of Upaid‟s choosing, but it deposited the amount into an escrow account. Satyam seems to have insisted that it was entitled to deduct the taxes from the amounts to be paid and that the responsibility for tax was that of the applicant. The applicant adopted the stand that the compensation agreed to be paid was liable to be paid without deduction of tax and the liability for tax, if any, should be borne by Satyam. To establish its stand, Satyam moved the Supreme Court of the State of New York seeking a declaration that it was entitled to deduct the taxes from the amount to be paid. The applicant resisted that claim. It was in this context that the applicant approached this Authority for an Advance Ruling by invoking Section 245Q of the Income-tax Act. This Authority allowed the application for giving a Ruling on the following questions:
(i) Is the amount receivable by the applicant from M/s. Satyam Computer Services Ltd. (“Satyam”), in accordance with Paragraph 2 of the settlement agreement entered between the applicant and Satyam on July 18, 2009 at Dallas, USA, a capital receipt in the hands of the applicant?
(ii) If the answer to question (i) is in the affirmative, can the said amount be treated as income under any of the specified heads provided in the Income-tax Act, 1961 (“Act‟)?
(iii) If the answer to questions (i) and (ii) are in the affirmative, can the said amount be considered to accrue or arise or deemed to accrue or arise in India or upon its receipt, can it be considered to have been received or deemed to have been received in India?
(iv) If the answers to all the above questions are in the affirmative, what would be the basis and method of determination of taxable income and applicable tax rate thereon?
(v) If the answer to question (i) is in the negative, i.e. the said amount is found to be in the nature of revenue receipt, can the said amount be considered to accrue or arise or deemed to accrue or arise in India or upon its receipt, can it be considered to have been received or deemed to have been received in India?
(vi) If the answer to question (v) is in the affirmative, is the said amount taxable under the Act?
(vii) If the answer to question (vi) is in the affirmative, what would be the basis and method of determination of taxable income, applicable tax rate and applicable rate of deduction of tax at source thereon?
(viii) If the said amount is held to be taxable under the Act, and if the court of competent jurisdiction in New York, USA holds that Satyam is contractually bound to bear the tax payable on the said amount, would Section 195A of the Act be applicable for the purpose of determination of income on which tax deduction at source will be effected?
(ix) Even if said amount is held to be taxable under the Act, and regardless of the outcome of the adjudication given by the court of competent jurisdiction in New York, is Satyam legally bound to satisfy the judgment-debt arising from the afore-mentioned settlement agreement by paying the entire amount specified in Paragraph 2 of the aforesaid settlement agreement without any deduction of tax to the applicant?
(x) Is the interest receivable by the applicant in terms of Paragraph 3.c of the afore-mentioned settlement agreement taxable income under the Act and would such income be subject to tax deduction at source under the Act?
13. Before proceeding to consider the various questions posed, it seems proper to set down some of the findings by the Courts which may have a bearing on the questions falling for our Ruling. The Court of Appeal has noticed that the trial “judge found that the Assignment Agreement undoubtedly assigned the inventions and intellectual property rights which were the subject of the provisional patent application filed on that date and contained co-operation obligations upon Satyam which were intended to enable Upaid to protect those conventions and rights”. It further noticed the finding that:
“the Assignment Agreement was not the ‘subject matter’ of the Settlement Agreement, but was expressly preserved in full by its terms.”
The Court of Appeal then recorded its finding:
“My conclusion on this short point is that the object of clause 3.1 was to ensure that Upaid retained all relevant intellectual property, and clause 3.1 .(b) is not limited to confirmation of past assignments in the sense of transfers of property. The relevant term is ‘will survive and shall be governed’ and I am satisfied that that means that the assignments will continue to apply in accordance with their terms.”
14.On how the right was dealt with under the Settlement Agreement, the Court of Appeal held:
“The construction point is a short one, and I agree with the Judge. I accept Mr. Foxton’s submission that it is plain (and common ground) that in commercial terms intellectual property was very important to the parties and was treated separately in the Settlement Agreement. Since the Assignment Agreement was concerned exclusively with intellectual property it made commercial sense not to include it within the releases.”
15. Thus, it is clear from this interparties judgment, which has become final, that the parties dealt with separately the intellectual property rights which was important to both and which had been taken assignment of earlier by the applicant.
16. Clause 5 of the Settlement Agreement dated 18.7.2009 recognised the right of the applicant to retain all intellectual property rights in the software created and under clause 8 the applicant granted to Satyam a license on all its patents, pending and future to use the patents. No doubt, it was described to be royalty free license.
17. The question that arises is what is the nature of the payment made or to be made by Satyam to the applicant under this Settlement. It is clear that various claims were involved in the complaint leading to the settlement. The breach of obligations on the part of Satyam, complaint of fraudulent conduct, compensation for a dent in their patent right by having to concede the right to Qualcomm and Verizon and the costs involved in the litigation with them and the grant of a license to Satyam to use its patents perpetually, all formed components of the compensation agreed upon.
18. During the hearing under section 245R(4) of the Act, it was first submitted on behalf of the applicant that the Supreme Court of the State of New York has upheld the claim of Satyam by holding that it was entitled to withhold the taxes from out of the amount to be paid to the applicant under the Settlement Agreement. This was subsequently re-affirmed by communication dated 11.8.2011 with a prayer to withdraw question no. (viii) from the questions admitted for a ruling. The court has decreed, “Adjudged and declared that the Settlement Agreement requires that Upaid Systems Ltd., must cooperate with IDBI Bank to allow IDBI Bank to withhold taxes from the $ 70 million Settlement Account in the Settlement Agreement in anticipation of there being a tax obligation on U paid’s part to the Indian Government authorities.” We think that the proper course to adopt is to clarify that the parties will be bound by the adjudication of Court inter-parties now rendered, subject to any modification thereof in appeal or further appeal therefrom.
19. Learned counsel for the applicant submitted that the compensation to be paid by Satyam to the applicant is in the nature of a capital receipt and not revenue receipt. We find that the Revenue has not joined issue with the applicant on this aspect. It has also taken up the position that it is a capital receipt, but has contended that it has to be taxed under the head Capital Gains and that the gain has accrued in India.
20. Alternatively, it is contended that a part of the payment had to be attributed to the grant by the applicant of a license to Satyam to use the patent for all times to come and that part was liable to be taxed as royalty. It is asserted that the payment by Satyam to the applicant has three components.
1. Regularisation of unauthorized usages of software IPRs by Satyam and its affiliates till the date of settlement.
2. Indemnification of damages suffered by Upaid on account of, misrepresentation by Satyam and its employees in relation to IPRs that are the subject matter of the settlement agreement and;
3. Continued usage of patents after the date of settlement, including usage of future patent rights.
21. Of the above, the second component would spell in the realm of capital receipt and components 1 and 3, payment for the earlier use and the right to use the software in future might amount to royalty.
22. The settlement agreement, no doubt, recites that the liecense granted to Satyam on all its patents, pending patents and any future patents was royalty free. Does this recital by itself conclude the issue? According to the applicant, it does and according to the Revenue, it does not. It remains for us to consider it.
23. In the application, the applicant has set down the various heads as comprised in its claim against Satyam made in the Taxes Court leading to the mediation and settlement. The first is a declaration on the authenticity of the signatures furnished by Satyam and a declaration of the legal status of all its patents. The second is actual damages arising from fraud and/or negligent misrepresentation involved in its having to give up its claim for patent violation against Qualcomm and Verizon. The third is based on alleged breach of the Assignment Agreement by Satyam resulting in pecuniary loss. The fourth is damages for the defect in title to the patents conveyed to it by Satyam. The fifth and sixth counts are for actual and statutory damages under the concerned US Federal statute. The seventh head of claim was punitive and exemplary damages for alleged forgery and the eighth was for costs of all legal proceedings having to be waived by Upaid including in the proceeding that was initiated, leading to the settlement. It was in the context of these claims that the settlement in question was arrived at and Satyam agreed to pay $ 70 million while obtaining a license for use of the patents of Upaid, world wide and in perpetuity as it were. This was obviously something bargained for and secured by Satyam.
24. There is no divestiture of title of Upaid to the patent and the Intellectual Property Rights over it, earlier assigned to it by Satyam. It does not, therefore, appear that any capital gain arises to the applicant out of this transaction. What it has obtained is compensation for the imperfect title to the patent earlier conveyed to it by Satyam and also for the conduct of Satyam in leading to that situation and the costs that had to be incurred by it in initiating legal proceedings against Satyam itself. Thus, it is not possible to accept the argument that the applicant has earned an income by way of capital gains taxable in India.
25. The amount quantified as compensation takes within its fold the consideration paid by Satyam to the applicant for enabling it to use ‘947 Patent’ and all subsequent patents based on it. This is a valuable right. Its importance has been stressed by the Court of Appeal in its judgment. But for this license, the use by Satyam of the software or any of its components, it created for the applicant for a consideration and it later assigned to the applicant, would amount to an infringement of the patent rights and the copyright of the applicant. This license to use in perpetuity, is thus a valuable right secured by Satyam.
26. The settlement Agreement dated 18.7.2009 recits that this grant of perpetual worldwide right is without consideration. It is submitted that the recital is conclusive and the Revenue cannot go behind it. On going through the settlement deed, it is clear that the rights acquired and secured by the applicant over the software, a literary work, and according to the Revenue, a process as well, is acknowledged and reaffirmed. In turn, the applicant gives a right to Satyam to use that right in perpetuity. The recital that it is done for no consideration can only be viewed as an attempt to avoid payment of tax on that part of the transaction. This Authority has necessarily the power to see whether there is an attempt to avoid the net of taxation. In the commercial world it is not normal to part with such a valuable right for no consideration unless special circumstances exist. Here, as a matter of fact, the applicant and Satyam were severing all business relationship between them by entering into this settlement. In the circumstances, the plea that the valuable right was given away is not acceptable. The Court of Appeal has noticed how the two parties wanted to keep this valuable right secured and specifically provided for it. An attempt to avoid ascribing of a consideration for grant of a perpetual license over a patent and a copyright by a mere recital that it is royalty free cannot pass the test of the Ramasay principle or the McDowell principle on the non-countenance of such avoidance by a Tribunal or Court. As observed in Ramasay (1982) AC 300 by Lord Wilberforce “While obliging the court to accept documents or transactions found to be genuine, as such, it does not compel the court to look at a document or a transaction in blinkers, isolated from any context to which it properly belongs‟. Adopting this approach, we find that atleast a portion of the compensation paid by Satyam to the applicant, must be ascribed to or earmarked as consideration for licensing of the right to use the patent and the software comprised therein. This consideration paid for granting of a license in respect of a patent or obtaining the right to use the patent or a process protected by copyright, is royalty as defined in the Income-tax Act. We are therefore satisfied that a part of the $ 70 million paid as compensation by Satyam takes in also royalty paid by Satyam for obtaining the right to use the patented software for all time to come.
27. Then arises the question, as to what part of the compensation paid by Satyam to the applicant ought to be attributed to the license of the right to use the patented software and any improvement to be made on it. Counsel for the applicant while standing firm in his argument that no portion is taxable, suggested, in case we come to the view now taken, that the assessing officer may be directed to determine the portion that may be attributable to ‘royalty’ and thereafter he may be directed to consider the question whether that will be taxable in terms of Section 9(1)(vi) of the Act. In the absence of adequate material available before us, we think that it will be appropriate to accept this suggestion made by counsel for the applicant. We reiterate that this suggestion was made by counsel without prejudice to his main contention that no part of the $ 70 million was taxable, which contention we have rejected.
28. Other than the royalty segment of the $ 70 million to be paid by Satyam to the applicant, we find that the rest of the compensation will be capital receipt, but not a capital gain. It is not shown that any part of such capital receipt is taxable under the Income-tax Act. Therefore, it has to be ruled that the compensation paid other than the portion attributable to royalty will not be taxable in India.
29. In the light of the above reasoning, we rule as follows on the questions:
(i) The answer is that (subject to tax-ability of a portion as royalty) the compensation of the $ 70 million paid by Satyam to the applicant would be capital receipt in the hands of the applicant.
(ii) In the light of the ruling on question no.(i) and the finding that no capital gain is involved, the ruling is that the amount less that portion attributable to royalty, cannot be treated as income under any of the specified heads under the Income-tax Act.
(iii) Other than the part of the compensation attributable to royalty, the balance cannot be considered to be income accruing or arising in India to the applicant.
(iv) The issue is as to what would be the basis and method of determination of the taxable income and the applicable rate of tax thereon. The question regarding the apportionment of the compensation and earmarking a portion of it towards royalty has been left to be decided by the Assessing Officer as suggested by senior counsel for the applicant. The Assessing Officer will decide that question. The determination of the taxable income and the applicable tax rate will be decided by the assessing officer after considering the relevant materials, if necessary after calling upon the applicant to produce the same and after hearing the applicant.
(v) Does not arise since other than the royalty segment of the compensation, the rest is capital receipt not taxable in India.
(vi) is also ruled on the same lines as (v).
(vii) Will be determined by the Assessing Officer, after hearing the applicant.
(viii) In the light of the decision rendered by Supreme Court of New York holding that Satyam is entitled to deduct the tax payable on the compensation to be paid, the ruling on this question is that the parties will be governed by that decision subject to any appeal they may have against the decision in the appropriate court.
Counsel for the applicant submitted that the applicant has not been able to withdraw any portion of the amount in the Escrow account because of the dispute and as a measure of safeguarding the interests of both sides, as an interim measure, it may be directed that 10% of the amount of $ 70 million may be deducted, without prejudice to the contention of the applicant that no portion of the amount is taxable and the balance released to the applicant. We find that adopting such a course would not prejudice the revenue because ultimately what would be taxable, would only be the royalty element and interest as ruled in answer to question (x) in the total compensation and deduction of 10% of $ 70 million would be adequate to cover the tax that may be found to be due if the liability to tax a portion is ultimately found. Therefore, we rule that the concerned bank will be free to deduct 10% of the entire amount in terms of Section 195 of the Act and release the balance to the applicant from the Escrow account.
(ix) Though it was initially argued that what was involved was a judgement debt and hence the entire amount was liable to be paid to the applicant without deduction of any tax, it was not shown to us that the settlement arrived at by the parties was made a rule of Court and hence the liability metamorphosed into a judgement debt. We, therefore, decline to rule on this question.
(x) The amount deposited in the Escrow account by Satyam has earned interest. The interest is earned in India. The applicant is now entitled to receive that interest alongwith the principal in two instalments. We accept the contention of the Revenue that this interest portion is taxable in India as that is income arising in India. It is, therefore, ruled that the interest earned on the deposit in Escrow is taxable in the hands of the applicant.
30. Accordingly, the ruling is pronounced on this 12th day of October, 2011.
