Lloyd’s Register U K is having a subsidiary in the name Lloyd’s Register Asia UK, which has an Indian branch in India. In other words, the assessee is an Indian branch of Lloyd’s Register Asia UK, which in turn is a subsidiary of Lloyd’s Register UK. The main holding company is into the business of survey and inspection of ships, industrial inspection activity and drawing appraisal. Earlier Lloyd’s Register UK was operating in India through its branch. From the relevant financial year (i.e. A Y 2005-06), it floated a subsidiary company, Lloyd’s Register Asia and all the Indian operations thereafter are being carried out through branch of this entity. Lloyd’s Register UK entered into a license agreement on 16.07.2003 with all its subsidiaries all over the world, including Lloyds Register Asia UK, whereby it has granted license to use the brand “Lloyd’s Register” i.e. use of trademark and trade name owned by Lloyd’s Register UK. Besides this, the licensor (Lloyd’s Register UK) also provides general, technical and marketing support services to all its products, which have been referred in the license agreement as “Intellectual Property Rights”. The royalty and the license fees was payable as per Schedule VI of the license agreement, which has been incorporated at page 3 of the appellate order and also at page 23 of the paper-book. As per the worldwide policy, the invoices are sent from Lloyd’s Register UK to Lloyd’s Register Asia UK which in turn, allocates the royalty attributable to its Indian branch. The Indian branch pays the same to Lloyd’s Register Asia UK, which in turn pays Lloyds Register UK. Further, another “Management Services Agreement” dated 16.07.2003 was entered into between Lloyd’s Register UK and Lloyd’s Register Asia UK for providing services such as:
|Corporate finance and group reporting services,|
|Group quality assurance,|
|Integrated business system (IBS project)|
|Internal audit services|
|Operational management and reporting (mainly provided by regional and area management centres)|
|Risk management and secretarial services and|
|Taxation and treasury services.|
The determination of management service fees has been enumerated in Schedule 4 of the Management Service agreement, the relevant portion of which has been incorporated by the CIT(A) at pages 3 & 4. During the relevant assessment year, the assessee has paid ‘management charges’ and ‘license fees’ of Rs.18,32,12,834/-to Lloyd’s Register Asia UK i.e. its head office, which in turn has been given to Lloyd’s Register UK. The break-up of the management and license fees were as under:
|Particulars||Amount in Rs.|
These expenses should be treated as Head office expenses u/s. 44C. As per AO what is relevant to see here is, who has incurred the expenses and who has accounted for it as their expenses. In this case the expenses were incurred by Lloyd’s Register UK for various group companies, which were reimbursed through Lloyd’s Register Asia UK and these expenses are very much in the nature of head office expenses for the purpose so far as assessee is concerned. Lloyd’s Register Asia UK i.e. head office is only the intermediary for the accounting purpose and it will not change the real nature of expenses. After going through the management service and license agreement, the learned AO held that both the payments are covered within the definition of head office expenditure as defined under section 44C. Thus he restricted the management and license fees to 5% of the adjusted total income. The addition was made by the AO in the following manner:
“Thus, Rs.18,32,12,834/- of Management and License Fees is restricted to 5% of the adjusted total income, which is Rs.35,65,954/- (i.e. 5% of total income of Rs.7,13,19,080/-) The difference of Rs.17,96,46,880/- is added to the total income of the assessee. Penalty proceedings u/s. 271(1)(c) initiated for furnishing of inaccurate particulars of income.”
Assessee Contention :
The sum and substance of the assessee’s submission was that, firstly, it is not a transaction between the head office and the branch but between Lloyd’s Register UK and Lloyd’s Register Asia (India Branch office). The payment is only routed through the head office i.e. Lloyd’s Register Asia UK. Lloyd’s Register UK is filing separate income tax return in India for the said income. These transactions have also been verified by the Transfer Pricing Officer and held that it was at arm’s length and, therefore, provisions of section 44C do not arise. Secondly, the license fees and management fees cannot be held to be covered with the definition of ‘head office expenses’ as defined in section 44C of the Act, as the said section is only applicable to general and administration expenditure as referred to in Explanation (iv) to section 44C, because the head office expenditure includes only executive and general administration expenditure of the nature enumerated in clause (a) to (d).
Section 44C, is a non obstante clause stating that “notwithstanding anything to the contrary contained in sections 28 to 43A in the case of an assessee, being non-resident, no allowance shall be made in computing the income chargeable under the head “Profits and gains of business or profession”, in respect of so much of expenditure in the nature of head office expenditure as is in excess of the amount computed as an amount equal to five percent of the adjusted total income ; or the amount of so much of the expenditure in the nature of head office expenditure incurred by the assessee as is attributable to the business or profession of the assessee in India, whichever is less”. The meaning of the term “head office expenditure” for the purpose of section 44C has been enumerated in clause (iv) of Explanation to section 44C. The said clause reads as under:
“(iv) “head office expenditure” means executive and general administration expenditure incurred by the assessee outside India, including expenditure incurred in respect of—
|(a)||rent, rates, taxes, repairs or insurance of any premises outside India used for the purposes of the business or profession;|
|(b)||salary wages, annuity, pension, fees, bonus, commission, gratuity, perquisites or profits in lieu of or in addition to salary, whether paid or allowed to any employee or other person employed in, or managing the affairs of, any office outside India;|
|(c)||travelling by any employee or other person employed in, or managing the affairs of, any office outside India; and|
|(d)||such other matters connected with executive and general administration as may be prescribed.|
From the aforesaid definition/illustration of the scope of head office expenditure, it is evident that it is in the nature of executive and general administration expenditure incurred by the assessee outside India. The nature of such expenditure has been illustrated to include certain kinds of expenditure. From the nature of expenditure as enumerated in sub clause (a) to sub clause (c) of the aforesaid Explanation and if compared with the nature of expenditure incurred by the assessee branch, then it will be seen that none of the expenditure under the head “license fees” falls within this category, even remotely. The payment of ‘license fee’ is purely for using of brand/trademark and other business intangibles, which are in the nature of intellectual property. Nowhere such types of expenditure fall within the scope of “head office expenditure” as illustrated in clause (iv). So far as general, technical and marketing support services are concerned, they are in the following nature:
|–||Provision of sales and marketing materials including brochures and product factsheet.|
|–||Provision of market research data and analysis|
|–||Provision of training and standards for use by operations and their clients in training surveyors, inspectors and assessors|
|–||Technical support and advice on the technology documents including product updates and the marketing and sale thereof|
|–||Specialised technical services such as Ship Emergency Response procedures, Condition Assessment Programme procedures and Fuel and Lubricant Analysis procedures|
|–||Co-ordination function for marketing and sales activities in relation to major contract opportunities and/or quotations for specialized industrial sectors|
|–||Sales support in respect of global customer accounts.|
These again are neither in the nature of rent, rates, taxes, repairs, insurance, salary, wages, bonus, commission, etc., or travelling by any employee. Expenditure under the “License fee” have nothing to do with these kind and nature of expenditures. Thus, the entire payment of license fees do not fall within the ambit of section 44C as illustrated in clauses (a) to (c) of the Explanation and, therefore, the learned CIT(A) has rightly held that royalty or license fees expenditure cannot be treated as head office expenditure.
Now coming to the nature of head office expenditure under clause (d) of the Explanation i.e. “such other matters connected with executive and general administration as may be prescribed”. Such an exercise for illustrating the said expenditure under the said sub clause has to be prescribed by the CBDT. However, no such illustration has been given or prescribed by the Board, atleast nothing has been brought before us that CBDT has issued any Circular or clarification illustrating “such other matters connected with executive and general administration”. Therefore, it cannot be held that the nature of expenses under the head license fees falls even under sub clause (d).
Now coming to the “management charges”, it can be noticed from the nature of expenses as elaborated in Schedule 3 of management services agreement dated 16.07.2003, prima facie they are specialized services under various heads as enumerated above in para 13. None of these services are in the nature of head office expenditure as illustrated in sub clause (a) to (d). For computing the deduction of head office expenditure, it is sine-qua-non that the nature of head office expenses must fall within the illustration given in clause (iv) of Explanation. If any expenditure itself is beyond the scope of head office expenditure, then needless to say that, it cannot be brought within ambit of section 44C. The learned CIT(A) has held that the 50% of management fees is hit by section 44C, without even analyzing the nature of expenses, as how or how much they fall within the scope and ambit of nature of head office expenditure as defined in Section 44C. In the appellate order of Lloyd’s Register India office, which has been followed by the learned CIT(A), it is seen that 50% of the management charges has been treated as taxable fees for technical services and balance 50% as head office expenses. However, the learned CIT(A) in the impugned case of the assessee has merely stated that 50% of the management fees is hit by section 44C, whereas for the balance he has not held that it is in the nature of FTS and here it is not the case of the AO. Even in the revenue’s grounds of appeal, it has not been challenged that 50% of the management charges/license fees are in the nature of FTS. Thus, we need not go on the issue of FTS as neither it is a case of the AO nor the case of the CIT(A). Otherwise also, the technical fees are not covered under the head office either executive or general administration expenditure as specified in section 44C. This aspect of the matter has been clarified vide Board Circular no.649 dated 31.03.1993, reported in (1993) 200 ITR (ST) 230. Lastly, fees for technical services in the case of a non-resident companies has to be seen in accordance with the DTAA read with I T Act, which here in this case need not be gone into as it is not the case of the revenue.
Thus, in our conclusion, neither the payment of “license fees” nor the “management charges”, falls within the ambit and purview of section 44C and, accordingly, the nature of adjustment to the total income for the purpose of disallowance is not required.
Thus it is held that “license fees” and “management charges” do not fall in the nature of head office expenses u/s. 44C and accordingly, the disallowance made by the AO and partly confirmed by the CIT(A) stands deleted.
Compiled by our Team Member CA Amit Handa