Brief Facts of the case
1. HCL Limited (HCL) has made payment to Apollo Domain Computers (ADC), Gmbh Germany of Rs Rs.1,11,38,650/- and Rs 50,51,050 in AY 1989-90 and 1990-91 respectively in terms of the agreement dated 11th May, 1987 under Article VIIIA of the Double Taxation Avoidance Agreement between India and the then Federal Republic of Germany.
2. In the facts of the present case, if court held that the payments made by HCL to ADC were for transfer of full ownership in the know-how or intellectual properties, the same would not be taxable under Article VIIIA of DTAA, but would be taxable in the country of residence of ADC, i.e., Federal Republic of Germany, either as capital gains or as business income. However, if we hold that the payments by HCL to ADC were for mere right to use or to use intellectual property rights/know-how and not for transfer of full ownership, the said payment to ADC would be taxable in India as royalty.
3. There is no dispute that the payment if held as royalty then it would be taxed taxable in India as this is the State from where payments arose and knowhow was utilized, in accordance with the laws in India but the tax so charged cannot exceed 20% of the gross amount of such fee. But dispute is whether payment The dispute is whether the payments made under the agreement dated 11th May, 1987 are “royalty‟ within the meaning of clause (3) of Article VIIIA of the DTAA
4. HCL argue that the payment made was against sale and not as royalty whereas Revenue argues that payment made as royalty.
Whether payments of Rs.1,11,38,650/- and Rs 50,51,050 made by HCL to ADC in terms of the inter se agreement dated 11th May, 1987 was royalty payment or payment for transfer of full ownership (sale). if held as royalty then it would be taxed taxable in India and sale then it would be taxable in the country of residence of ADC, i.e., Federal Republic of Germany.
Observations/decision of High Court :
1. The dispute is whether the payments made under the agreement dated 11th May, 1987 are royalty‟ within the meaning of clause (3) of Article VIIIA of the DTAA. The term “royalty” has been defined in the said clause to mean payments of any kind received as a consideration for use of, or right to use any copyright of literary, artistic or scientific work including cinematographic films or films or tapes used for radio or television broadcasting, any patent, trade mark ,design or model, plan, secret formula or process, or for use of, or the right to use, industrial, commercial or scientific equipment or for information concerning industrial, commercial or scientific experience.
2. In royalty It is essentially payment for a user of intellectual property right or know-how, which may be lumpsum, annual or periodical payment. The term “royalty‟ is associated with the payment made for grant of the user right. Grant of user right has to be distinguished from transfer of ownership in intangible property or know-how, i.e., sale of intangible property or know-how by the proprietor to a third person. In the latter case, the consideration paid is not for use of or right to use the intangible property or know-how but to acquire full ownership.
3. In case payment is made for acquisition of a partial right in the intangible property or know-how without the transferor fully alienating as the ownership rights, the payment received would be treated as „royalty‟. Where, however, full ownership rights are alienated as intellectual property of the transferee, the payment made is not royalty, but sale consideration paid for acquisition of the intangible rights. Such acquisitions are not equivalent to acquire or have access to or right to use the intellectual property.
4. For adjudication of these appeals, we predicate our decision on the following test; where ownership of the rights is alienated and acquired by another party, the consideration is not for use of or right to use and, therefore, not royalty and vice versa.
5. Importantly, paragraph 5 of the exchange of notes between contracting States clarifies that royalty income can consist of lumpsum consideration for transfer even made outside India or imparting of information outside India. Therefore, royalty need not be confined to regular payments such as, yearly, quarterly or monthly or be dependent upon the quantum of production or use of the intellectual property right.
6. On considering the various clause of agreement between ADL and HCL, we observed that The proprietorship or ownership rights continued to vest with ADC, but right to use with trade name, technology etc. was granted by ADC to HCL. There was no transfer of the ownership in the intellectual property rights. In fact, the agreement stipulated that the HCL could protect the patents and intellectual property rights of ADC. The manufacturing and other activities undertaken by HCL was subject to quality control and inspection by ADC. Clause 4.1 clearly stipulated that technical and other information was to remain ADC‟s proprietary. Information/knowhow was to remain confidential during the term of the agreement and even after expiry or termination thereof, until the same entered public domain or was otherwise generally known. HCL could not have breached the said confidentiality clause. A material breach by HCL would have resulted in an earlier termination of the agreement and reversion of all rights granted to HCL.
7. Clause 2.3 was similarly worded and stated that HCL might sub-licence or sub-contract in whole or in part production of the licensed products and might disclose the technology provided that such disclosure would not confer upon the sub-contractor or the sub-licencee any rights other than those accorded to HCL. In case HCL was conferred full or absolute ownership in the intellectual property rights or in know-how, then it should follow as a sequitur that HCL was competent to transfer or convey to the sub-contractors and sub-licencees intellectual property rights.
8. The clause relating to further technology or information in addition to technology already transferred is illustrative that it was not a case of complete or full transfer, but only a case of right to use or permission to use the technology by HCL.
9. Considered various clauses of the agreement, we do not think the present case is one of absolute or full transfer of ownership in technology made available under Article 3 of the agreement.
10. In Shriram Pistons and Rings Limited versus Commissioner of Income Tax, (2008) 307 ITR 363 (Delhi) a clear distinction was made between outright sale and a right to use and the effect thereof. Reference was made to the decision of the Supreme Court in CIT versus Ciba India Limited, (1968) 69 ITR 692 (SC) to the effect that the technology agreement was to remain in force for a period of five years and there was a provision for earlier termination and Indian company could not have assigned the benefits and obligations without taking consent of the foreign party. What had been acquired by the Indian company was mere access to the technical information and experience in the pharmaceutical field and the licence granted was for a limited period for running of business.
11. In Triveni Engineering Works Limited versus Commissioner of Income Tax, (1982) 136 ITR 340 (Del.) to draw a distinction between outright sale and supply of technical information and details with the copyright and the intellectual property rights remaining with the foreign company. In the said case, agreement was valid for ten years, but could be terminated earlier and was limited to India. The agreement stipulated that documents, dies etc. were to be absolute property of the Indian assessee, yet the copyright remain vested with the foreign company and the assessee has been given licence to use the same during the agreement. Complete confidentiality was postulated. In the said case, it was held that the licensee had acquired merely right to use and mention of the word „sold‟ in the agreement would not undo the real effect that there was no sale of technical know-how and the assessee‟s rights were hedged with all sort of conditions.
12. The agreement in the present case refers to the tenure of five years unless it is terminated earlier, but the confidentiality obligation subsists and would be applicable even subsequently. It does not matter that no lumpsum payment or periodical payments were required to be made after five years, if what was conferred and granted to HCL was mere right to use or permission to use the intellectual rights and knowhow. As noticed above, lump-sum payments are covered under the term „royalty‟. The agreement postulated grant of permission to use or right to use intellectual property rights or knowhow and it is not a case of outright sale. Mode and manner is not determinative, but nature and character of the right acquired is definitive and decisive criteria.
13. In Alembic Chemicals Works Co. Ltd. vs. CIT (1989) 177 ITR 377 (SC), it was held that acquisition in such fields with rapid and fast strides indicate grant of right to use of knowhow, rather than ownership acquisition. This aspect, when read cumulatively with restrictions on the right of the assessee in dealing with knowhow and conditions as to non-partibility, confidentiality and secrecy, reference to intellectual property rights of ADC and their protection, reflect and reinforce our finding. ADC continued and remained the owner. The appellant HCL was only granted a right to use.
14. Hence, Appeal of the assessee is dismissed.