Case Law Details
Court: Bangalore bench of the Income-tax Appellate Tribunal
Citation: Robert Bosch GmbH Vs. ACIT [2010-TII-149-ITAT-BANG-INTL]
Brief : Recently, the Bangalore bench of the Income-tax Appellate Tribunal (the Tribunal) in the case of Robert Bosch GmbH v. ACIT [2010-TII-149-ITAT-BANG-INTL] (the taxpayer) while rejecting the contention of the tax department held that the taxpayer is not expected to make royalty income with reference to the sale effected to it by an Indian company, when the know how for manufacture of the same is supplied by the taxpayer itself. Accordingly, such notional royalty income was not taxable within the provisions of Section 5(2) and Section 9(1)(iv) of the Income-tax Act, 1961 (the Act) read with India-Germany tax treaty (the tax treaty).
The Tribunal also held that the taxpayer has every right to arrange itself legally in a position in order to reduce its incidence of tax. Therefore, the Assessing Officer (AO) was not justified in arriving at a conclusion that the royalty receivable in the hands of the taxpayer having been adjusted against the purchase consideration payable to the contracting party for the products manufactured to the taxpayer lead to evasion of income from taxation.
Further, the Tribunal also held that obtaining approval of Ministry of Commerce and Industry (the Ministry) for technical collaboration agreement is required only for foreign exchange remittance and when there was no foreign exchange remittance further sanction to that effect from the Ministry does not arise.
Facts of the case
• The taxpayer, a German Company, entered into a technical collaboration agreement (the Agreement) with Motor Industries Company Limited (MICO) for the supply of know how, right to use the technology, patent, design etc. By virtue of the right to use know how, MICO will manufacture certain products which will be sold to the taxpayer and to other parties. As per the Agreement entered into between both the parties, MICO will pay 5 percent royalty on all the products manufactured by it, i.e. products manufactured for the taxpayer and for others. However, 5 percent royalty paid to the taxpayer on the products manufactured for the taxpayer will be recovered by MICO from the sales invoice charged to the taxpayer.
• With effect from 1 January 2001, the terms of the Agreement were altered to charge 5 percent royalty only on sales made to customers outside the manufacturing territory. However, no royalties have to be paid for the export of contract products to the taxpayer provided the prices invoiced by MICO for these contract products do not include any value for royalties.
• During the year under consideration, the MICO raised invoices of INR 1.75 billion against the taxpayer on contract products which did not include the value of royalty. However, the AO observed that if those products were sold to any other party, they would have included the value for royalty and the same would have suffered TDS. Accordingly, the AO held that since the invoices raised by MICO on the taxpayer were already reduced by the value of royalty, the same was deemed to have been paid to the taxpayer by MICO without deduction of tax and consequently, there was understatement of income by the taxpayer to that extent.
Taxpayer’s contentions
• The taxpayer contended that as per Article 12 of the tax treaty, only such royalty that was actually received by the taxpayer in India could be brought to tax and since taxpayer had not received any part of the payment in India, it was not liable to be taxed in the taxpayer’s hands in India. The amount calculated by the AO was a ‘notional income’ and since it does not fall within the ambit of Section 5(2) read with Section 9(1)(vi) of the Act and the tax treaty, the amount received by the taxpayer was not taxable in India. Further, while taxing the said sum, the AO had not invoked any relevant provisions of the Act in support of his stand to tax the income alleged to have been evaded by the taxpayer.
• Obtaining approval of Ministry with regard to the agreements entered into between the taxpayer and MICO has no relevance to as far as the provisions of the Act are concerned. Further, the terms and conditions in the Agreement and approval or otherwise of such agreements are within the domain of the Ministry and as far as the Income-tax department is concerned, its role is confined to whether the tax at source has been effected within the relevant provisions of the Act while making any payments.
• The taxpayer also contended that since the taxpayer was the owner of the know how the question of MICO paying royalty to the taxpayer for the use of its know how in the manufacture of the contract products sold exclusively to the taxpayer did not arise.
Tax department’s contentions
• The tax department contended that the amount calculated by the AO constitutes ‘real’ income and not the notional income of the taxpayer. Royalty worked out by the AO does form part of its total income in accordance with the provisions of Section 5(2) read with Section 9(1)(vi) of the Act and Article 12 of the tax treaty.
• Word ‘received’ includes ‘receivable’ and the provisions of Section 5(2) of the Act makes it clear that the total income of a non-resident includes all incomes from whatever source derived which accrues or arises or deemed to accrue or arise in India during such year.
• Further, the Ministry in its approval letter dated 30 January 2001 had only given approval to extend the terms of the original agreement for another five years on the existing terms of payment. The taxpayer could not produce Ministry’s approval for non-payment of royalty for contract products.
• Terms of the Agreement was drafted in such a way that receivables of royalty in the hands of the taxpayer have been adjusted against the purchase consideration payable to MICO led to evasion of income from taxation. Thus, the decision of the Supreme Court in the case of McDowell & Company Limited v. CTO [1985] 154 ITR 148 (SC) was applicable to the present case.
Tribunal’s ruling
• The Tribunal observed that the AO’s conclusion was based only on presumption that royalty was deemed to have been paid to the taxpayer by MICO without deduction of tax. However, the AO had not brought any tangible proof on record to suggest that he has been armed with powers to lift the corporate veil and see the real and true nature of the transaction.
• The AO who concluded the assessment in the case of MICO could have analysed the pros and cons of the agreements entered into between the taxpayer and MICO, and the TDS deductible under Section 195 of the Act and/or could have taken recourse under the Transfer Pricing provisions of the Act. However, no reference has been made by either party to suggest that the AO, who concluded the assessment in the case of MICO, disputed the amount payable to the taxpayer by MICO, TDS implication, etc.
• Further, the effect of the terms of the Agreement, prior to 1 January 2001, was that the royalty income was taxable in the hands of taxpayer in India and simultaneously it became allowable expenditure on the profit & loss account in the country where the taxpayer belonged to. Therefore, in order to avoid this situation the taxpayer had arranged its affairs in such a way that the receipt of royalty was eliminated and to that extent payment on purchases was reduced.
• When the know how belongs to the taxpayer, it is its prerogative to charge MICO for the use of its know how. Charging royalty from MICO for the products supplied to the taxpayer and the same to be added back to the invoice by MICO will have nil effect. The taxpayer is not expected to make royalty income with reference to the sale effected to it by MICO, when know how for manufacture of the same is supplied by the taxpayer itself.
• The taxpayer has every right to arrange itself legally in a position in order to reduce its incidence of tax. The AO is not justified in arriving at a conclusion that the royalty receivable in the hands of the taxpayer having been adjusted against the purchase consideration payable to MICO lead to evasion of income from taxation.
• The Tribunal, while rejecting the tax department’s contention with regard to absence of approval from Ministry for non-payment of royalty for contract products, held that the approval from the Ministry is required only for foreign exchange remittance. When there is no foreign exchange remittance further sanction to that effect from the Ministry does not arise.
Our Comments
This is a welcome ruling by the Bangalore Tribunal where it has held that the taxpayer has every right to arrange itself legally in a position in order to reduce its incidence of tax and the adjustment of royalty receivable in the hands of the taxpayer against the purchase consideration payable to MICO does not amount to taxable notional royalty and it does not lead to evasion of tax. The fact that an assessee has a right to legally arrange his affairs has been endorsed by the Supreme Court in the case of Azadi Bachao Andolan and very recently upheld in the ruling of the Mumbai Tribunal in the case of Besix Kier Dabhol, SA v. DDIT [2010-TII-158-ITAT-MUM-INTL].
Further, it is important to note that the Tribunal has drawn attention to the fact that the AO, who concluded the assessment in the case of MICO, could have taken recourse to either the Transfer Pricing provisions or the withholding tax provisions in the Act. Thus, the tenability of the same from a Transfer Pricing and a withholding tax standpoint would need to be carefully considered before undertaking any course of action. Further, it would also be interesting to observe whether arrangements of this kind would pass the litmus test laid down in the oft quoted General Anti- Avoidance Rules (GAAR) of the Direct Tax Code (DTC).
The Tribunal also observed that obtaining approval of Ministry for technical collaboration agreement is required only for foreign exchange remittance and when there was no foreign exchange remittance further sanction to that effect from the Ministry does not arise. Accordingly, one may argue that approval of Ministry with regard to technical collaboration agreement has no relevance as far as the provisions of the Act are concerned.
It is pertinent to note that the Reserve Bank of India vide A.P. (DIR Series) Circular no. 52 dated 13 May 2010 had notified that royalty and lump-sum payments overseas under technical collaboration agreements would no longer require the approval of the Ministry. Earlier prior approval of the Ministry had to be obtained for drawing foreign exchange for remittances under technical collaboration agreements where payment of royalty exceeds 5 percent of local sales and 8 percent on exports and lump-sum payment exceeds $2 million.
