Case Law Details

Case Name : International Tire Engineering Resources LLC, In re (Authority for Advance Rulings)
Appeal Number : AAR No. 804 of 2009
Date of Judgement/Order : 28/10/2009
Related Assessment Year :
Courts : Advance Rulings (181)

SUMMARY OF CASE LAW

It cannot be doubted that the technology/know- how transfer that is contemplated by clause 2 of the `Technology Transfer Agreement’ between the parties gets covered by more than one sub-clause of Explanation 2 to section 9(1)(vi) of the Income-tax Act, 1961 i.e., sub-clauses (i),(ii) and (iv); the services in the form of technical assistance and consultancy connected with those items fall under sub-clause (vi); therefore, the consideration received by the American Company towards technology transfer/technical know-how and the services connected therewith is clearly liable to be taxed as royalty under section 9(1)(vi).

RELEVANT PARAGRAPH

The applicant is a company incorporated in USA having its registered office at San Antonio, USA. The applicant is, inter alia, engaged in the business of supplying advance technology for the manufacture of radial tyres. Being approached by an Indian Company, namely, CEAT Limited, the applicant agreed to grant to the said company a perpetual irrevocable right to use the know-how as well as to transfer the ownership in tread and side-wall designs and patterns required for the manufacture of radial tyres for a lump sum consideration of US $ 7,10,220. The applicant states that the sale and transfer of technology know-how took place in USA and the documents 1.were executed in USA. Technology transfer Agreement was executed on 4th September, 2008 between the applicant and CEAT Limited. The applicant further states that the know-how would be transferred by the applicant to CEAT Limited in the shape of technical documentation and designs which amount to `plant’ and the sale of such plant has been made in USA and no part of the consideration was received in India. The applicant therefore submits that the income is not liable to taxation in India either under section 5(2) or Section 9(1)(i) of the Income-tax Act, 1961. Moreover, it is contended that clause (vi) or (vii) of Section 9(1) dealing with `royalty’ and `fees for technical services’ have no application. The applicant relies on clause (a) of para 5 of Article 12 of DTAA between India and USA in order to contend that the consideration received towards consultancy and assistance does not amount to `fee for included services.’ It is submitted that such services including deputation of technical personnel would take place next year after the machinery arrives.

2. The applicant has formulated the following questions for seeking advance ruling:

1. Whether on the stated facts in the “Technology Transfer Agreement dated 4th day of September, 2008 entered into between the applicant and M/s. CEAT Limited, and in law the consideration for the transfer of documentation amounting to US dollars 7,10,200 payable by M/s. CEAT Limited to the applicant is exigible to tax under the Income-tax Act, 1961, in the hands of the applicant.

2.2. Whether on the stated facts and in law the consideration for consultancy and assistance receivable by the applicant from /s. CEAT Limited in terms of para No.7 & 8 of the aforesaid agreement is taxable in the hands of the applicant in India under the Income-tax Act, 1961.

3. If the answer to query No.1 & 2 above is wholly or partly against the applicant, at what rate and on how much Remittance tax needs to be withheld under Section 195 of the Income Tax Act, 1961 for which the consideration is being remitted to the applicant?

3. The learned counsel for the applicant has pointed out that the transaction involves the sale of technical documentation viz. drawings and designs outside India (in USA) and the transfer of ownership in Tread and Sidewall designs. It is submitted that the know-how for the erection and commissioning of the plant and process for manufacturing of radial tyre is provided to the applicant under the Technology Transfer Agreement (hereinafter referred to as `Agreement’) and the same can be used by CEAT anywhere in the world, though the transfer of such technology is utilized initially in its factory being set up at Halol, Gujarat State. It is submitted that the technical document is a chattel or a plant which can be transferred and the sale transaction having taken place in America, the income accrues or arises in America but not in India. Certain decisions have been relied upon to contend that the consideration attributable to the offshore supplies cannot be subjected to Indian income-tax. It is also submitted that income is not in the nature of royalty or fees for technical/included services. In the absence of PE of the applicant in India, the income arising from the transfer of technology cannot be taxed as business profits in view of the provisions of Convention between the Government of United States of America and the Government of Republic of India for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to taxes on income (hereafter referred to as `Treaty’) between India and USA. Technical assistance rendered or training imparted is not liable to be taxed by reason of Article 12(5)(a) of the Treaty.

4. The Revenue has taken the stand that the income received by the applicant is covered under para 3(a) and 4(b) of Article 12 of India-USA Treaty both as `royalty’ and `fees for the Included Services’ and therefore, the receipts are liable to be taxed in India irrespective of the existence or otherwise of PE. Alternatively, it is submitted that the applicant will have a service PE in India having regard to the activities contemplated to be undertaken in India under the Agreement for a period of more than 100 days. Therefore, the business profits attributable to the PE are taxable in India. Applicability of Article 12(5)(a) is disputed by the Revenue. The Revenue also disputes the proposition that the transaction under the Agreement tantamounts to sale of plant outside India and therefore, no income or deemed income accrues or arises in India.

4.5. We shall now go through the relevant clauses in the agreement titled as “Technology Transfer Agreement” and note the salient features thereof.

5.1 First, we will notice the recitals in the Agreement. They refer to the fact that the transferee (CEAT Ltd.) is setting up a plant for the manufacture and sale of radial tyres for automotive vehicles, initially at Halol, Gujarat and the transferee is desirous of acquiring know-how and assistance for setting up the plant. Then it is stated that the transferor who is having requisite expertise and know-how for setting up of the plant, is willing to grant a perpetual, irrevocable right to use the know-how and also to transfer the ownership in Tread and Side- Wall design/pattern to the transferee for a lump sum consideration and on the terms set forth in the Agreement. It is stated in Cl. 9.22 that all the know-how is legally and beneficially owned by the transferor.

5.2 We may notice some of the definitions in the Agreement.

“Know-how” or “Technology” means all technical information, patents, know-how, data, drawings, designs, computer software, Machines specifications, technical specifications, methodologies, test methods, layout and process data, raw material specifications, components and assembly data, to which the Transferor has right to transfer to the Transferee as provided under this Agreement including any improvements/ modifications: (a) for the manufacture of the Products as specified in Annexure IA in the Plant; (b) for and deriving from the Basic Engineering of the Plant as identified in Annexure IIA; (c) for the installation, operation, maintenance, dismantling and repair of the Machines in the Plant, and for the Commissioning , Start-up, operation and maintenance of the Plant; (d) for the operation of the Process to manufacture the Products in the Plant as identified in this Agreement; (e) for the performance of the Supervision and Training Services; and (f) for design & development of the Products covered in Annexure IA and

Products falling in the same category.”

“Know-how Documentation” means the documentation with illustrations containing the Know-how and the Basic Engineering know-how which will be supplied by the transferor as detailed in Annexures IIA, IIB and IIC and any other documentation which may be required for the use of transferee.

“Plant” means the manufacturing plant including its test room, laboratories and R&D facility to be constructed in Halol, Gujarat by the assembly of `machines’ (all the mechanical and electrical equipment and apparatus required for the manufacture and testing of products) in accordance with the Know-how for the manufacture of products by using

the manufacturing process described in Annexure IC.

5.3 Clause 2 speaks of “TRANSFER OF KNOW-HOW AND RIGHT TO SE”. It says : “in consideration for the payment as herein for the Technology transfer… on and from the effective date, the transferor shall transfer and the transferee will acquire a non-exclusive, irrevocable, perpetual, royalty-free right to use… : (a) the know-how in the Plant and Facilities, (b) the know-how to manufacture and sell the products in the territory (i.e. anywhere in the world) and (c) to adopt the know-how contemplated in (a) above in products that the transferee may manufacture and/or design, develop at any other facility owned or controlled by the transferee. It is then clarified that save as provided in cl.3, the transferor is not alienating the Intellectual Property Rights in the know-how. Cl.2.2 states that the transferee shall have the right to sell Products with no restriction and for this purpose, grant license to any affiliate-entity. In Cl.2.3, the transferor declares that it will not grant know-how and documentation or consultancy services contemplated under the Agreement, to any other person in India for the manufacture of

products covered under the Agreement during the term of the Agreement.

5.4 The next Cl.3 provides for transfer of ownership of Tread and Sidewall design/patterns. It is better to extract the entire Cl.(3).

“The Tread and Sidewall Design/Patterns for the sizes referred to in the Annexure IA hereto, designed by the Transferor and approved by the Transferee as a part of delivery of Know-how Documentation and prepared by the Transferee in accordance with Annexure IID shall vest

exclusively with the Transferee. The Parties hereby agree that the Transferee shall be entitled to have the Tread and Sidewall Design/Patten registered in the name of the Transferee with appropriate Governmental Authority. For avoidance of doubt, the mould drawings and Tread and Sidewall Design/Patterns referred to in Annexure IID as

prepared by the Transferee will be the proprietary Intellectual Property of the Transferee.”

Tread and Sidewall Design/pattern (hereafter referred to as “TSD”) is defined to mean “(a) the design/pattern on the tread of the tyre which comes into contact with the ground and through which the driving, braking and cornering forces are transmitted referred to in Annexures IA & IB and (b) other relevant Annexures; the portions of a tyre between tread region and beads (beads hold the tyre onto the wheel rim) are the sidewalls which support the tread region, protect the bead/carcass plies from damage, and provide the tyre’s ride characteristics ………….”

5.5 The consideration for technology transfer and terms of payment is provided for in Cl.4. In consideration for the transfer of Know-how and the grant of right to use the same as well as for the transfer of ownership in TSD, the transferor shall be entitled to receive a lump sum amount of US $ 710, 220 in accordance with the terms of payment set out in Annexure-IX. The said lump sum amount is referred to as consideration for `Technology transfer’.

5.6 Delivery of know-how documentation is dealt with in cl.5. The time frame for and the mode of delivery, the effect of delay in delivery are all stipulated therein. It is stated in cl.5.3 that the transferee shall be entitled to and have a right to the know-how documentation immediately on receipt of the same.

5.7 Consultancy and assistance and fee in respect of such services are provided for by Clauses 7 and 8 of the Agreement. The method of calculation of fee for consultancy services based on man-day rates and actual number of days worked is given in Cl.8.1. The time and manner of payment is specified in Cl.8.3. As per clause 8.2, the transferor has agreed to arrange training for transferee’s employees in a radial tyre manufacturing plant in China or some other country. Clause 8.4 says that all expenses for the transferee’s personnel deputed in relation to rendering the Training and Supervision services under the Agreement shall be borne by the transferor except the expenses specified therein. The obligations of transferor in regard to supervision of installation, commissioning, product quality tests and acceptance of plant are laid down in Cl.10. The warranties and representations of both the parties are contained in Cl.10. 5.8 The term of the Agreement is specified to be 8 years from the `effective date’ and the said term may be extended at the option of the transferee on mutually agreed terms (vide Cl.13.1). Notwithstanding the termination of the Agreement other than material breach by the transferee, the transferee shall have the right to continue to use and exploit, for the manufacturing and marketing of the product, the use of the know-how acquired under the Agreement without having to make any additional payment (Cl. 13.3).

6. Annexure IIA sets out the details of know-how documentation under two heads; (i) technical know-how documentation, (ii) basic engineering documentation. It is stated therein that the know-how documentation will be illustrated and explained to the transferee’s personnel after the delivery both before and during start-up and it is further stated that the transferor shall during the term of the agreement furnish the transferee with technical know-how to the extent required by the transferee in its design, development and manufacturing of products at its facilities. The know-how documentation contains specifications and

instructions in regard to various items such as raw material, manufacturing process, quality standards and test machine specifications and drawings. Basic engineering documentation pertains to know-how consisting of basic engineering information of the Plant, Machines specification and installation, laboratory and test machine assistance, plant and machines lay-out, material handling and know-how for manufacture of the products to agreed performance criteria. The technical documentation consists of 21 items which are enumerated in Annexure IIB. The scope of consultancy and training services are dealt with in Annexures V & VI. Annexure IX deals with terms of payment of consideration for technology transfer, the lump sum consideration being USD 710,220. The stages and time schedule for payment are specified

in a Chart. The total consideration of USD 710,220 has been split up into two. The first one is consideration for technical documentation such as aw materials specifications, test procedures, standard operating procedures, etc. and it is USD 343,425. The balance amount of USD 366,795 represents consideration for TSD and product development. The break-up is given in a tabular form.

6.1 It is clarified by the learned counsel for the applicant that the know-how documentation except in regard to the TSD can only be used by the transferee (CEAT) in the plant that is being set up and to be set up in future and the same cannot be sold.

7. The Agreement although composite in nature is divisible into three distinct parts, as noticed already. The transfer of know-how i.e. the grant of right to use the know-how is the first part which is dealt with in clause 2 of the Agreement. The second part consists of the transfer of ownership of Tread and Sidewall design/patterns (TSD) which is covered by clause 3 of the Agreement. Both these items specified in clause 2 and 3 are escribed as `technology transfer’ as seen from clause 4 as well as clause 2.1. A lump sum amount of USD 710,220 has been stipulated as the consideration for both these items put together, as is clear from clause 4.

However, clause 4 has to be read with Annexure IX. The details of consideration for technology transfer and the stages of payment are set out therein. The amount of 710,220 USD has been split up into two; (i) consideration for technical documentation – USD 343,425. This consideration is sub-divided into three parts (a) Raw-materials lists, Specifications and Test procedures, (b) Compound Line-ups/ Mixing instructions, Testing Standards etc. (c) Standard Operating Procedures, Standards and Test Procedures. (They relate to radial truck tyres as well as PCR/SUV & Lt truck tyres) and, (ii) consideration for TSD and for product development – USD 366,795. This consideration is again sub-divided into four categories: (A) & (B) relates to 7 design/patterns for passenger/Lt truck and SUV and 4 design patterns for radial truck tyres. As per the break-up given, the consideration for these two items is USD

218,405. The balance amount of USD 148,390 represents the consideration for full tyre development of the passenger/light truck & SUV and radial truck tyres. The third part of the Agreement relates to consultancy and assistance including training services for which the details of fee payable are set out in Annexure VI and VIA. Together, it comes to the figure of USD 1049,500.

8. We shall first take up for consideration the first part which relates to transfer of know-how and the grant of right to use the know-how as described in clause 2.1. The applicant’s contention is that this transaction is nothing but pure and simple sale of technical documentation in the form of drawings, designs and specifications which has to be considered as sale of plant or chattel. Such sale having taken place outside India and the consideration having been received outside India (i.e. in USA), the income cannot be said to have accrued or arisen in India as per Section 5(2) nor is there deemed accrual or arisal within the meaning of Section 9 of Income-tax Act, 1961 (hereinafter referred to as `IT Act’). Neither the `royalty’ provision nor the provision relating to `fee for technical services’ comes into play in such a situation. In raising the

contention that there was sale/transfer outside India, and therefore, the receipts are not liable to be taxed under the provision of the Act, the applicant is evidently inspired by the decisions of the Supreme Court and High Courts rendered in the context of the provisions that were on the Statute book prior to the Finance Act, 1976. By the 1976 amendment to the Act, clauses (vi) and (vii), dealing with `royalty’ and `fees for technical services’, were inserted into Section 9.

9. The argument of the applicant, as noticed earlier, is based on the premise firstly that there was a sale of `technical documentation’ and secondly that the sale took place and concluded outside India. The first premise has to be tested by looking at the essence of transaction. To say that the transaction is nothing more than a sale of technical documents containing the know-how is to oversimplify the issue and to ignore the plain realities. The Agreement speaks of transfer and acquisition of non-exclusive, irrevocable and perpetual right to use the `know-how’ as defined in clause 1.1.16 coupled with an undertaking that the applicant will not grant know-how and related documentation to any other person in India for the manufacture of same or similar products during the term of the Agreement. The expression `non-exclusive’ conveys the idea that the know-how the applicant owns and possesses is not transferred absolutely to CEAT and that the applicant is not divested of the proprietary right and interest in the technology know-how. The applicant can make use of the know-how for its own purposes or it can grant similar rights to other parties outside India. The last sentence in clause 2.1 makes it clear that the transferor (applicant) is not alienating its Property or Intellectual property rights in the know-how. That means, the

applicant would still be the owner and holder of know-how pertaining to the manufacture and marketing of radial tyres. The irrevocable and perpetual nature of the right granted to CEAT may have the trappings of a sale, but legally speaking, it is not a sale and the transaction is not described to be so. Clause 2 is quite in contrast with clause 3 under which the ownership in Tread and Sidewall designs/patterns approved by the applicant is transferred to CEAT for its exclusive use and enjoyment. That is why the last sentence in clause 2.1 uses the phrase “save as otherwise provided in clause 3.”

9.1 Assuming that there was sale of technical documentation, that is not the end of the matter. Such sale is, in reality and in substance, incidental to the grant of right to use the know-how in various ways specified in cl.2.1. The transfer of technical documentation was only a step in aid for making the technical know-how available to the transferee CEAT. The essence and predominant nature of the transaction is the transfer of technical know-how to CEAT in the sense of granting the right to use the know-how which is basically contained in the documents. What is more, the applicant has undertaken to extend all the technical

assistance and advice, of course for a consideration, in order to ensure that the know-how is put to effective and proper use. The crux of the transaction is to disseminate and divert the technical know-how, knowledge and informations for the use of the Indian enterprise for the purpose of manufacture of radial tyres. It is worthy of note in this connection that 20 per cent of the consideration for technology transfer is payable only on “successful completion of the outdoor tests of selected products as per the agreed criteria referred in Annex IIIA”. Viewed from any angle, it is inappropriate to say that the consideration payable under cl.4 of the Agreement is only the price of technical documents allegedly sold in USA.

9.2 It must be remembered that the deeming provisions embodied in clauses (vi) & (vii) of section 9 of IT Act were introduced with a view to reach at the income arising to the non-resident by reason of making available to an Indian enterprise the technical know-how, knowledge and informations. With a similar object in view, Art. 12 has been included in the Treaty. If in all cases of transfer of know-how documents from the State of residence of transferor, the taxing jurisdiction of the other State is to be ousted, there may hardly be any occasion to apply the royalty or

FTS provisions. Those provisions would virtually become ineffective if not otiose. 15.9.3 Secondly, even the assumption or assertion of the applicant that the so-called transaction took place outside India is open to doubt. The Agreement dated 4.9.2008, it may be noted, was executed in India (in Mumbai). In this connection, Clauses 5.1., 5.2. and 5.3 deserve notice. There is a declaration in clause 5.3 that “the transferee shall be entitled to and shall have the right to the know-how documentation immediately on receipt of the same”.

Obviously, the documents which are sent through the Courier as per the preceding clause (5.2) are received in India. Moreover, going by the plain words of clause 5.3, the transferee i.e., CEAT will derive the rights under the Agreement only on that date. The transfer is not complete till then. The mere entrustment to the Courier for delivery to the transferee is not decisive especially in view of the qualification that the delivery will be effected to the transferee “against invoices and related documents”. What exactly is meant by the phrase “against invoices and related documents” is not clear. However, one thing is clear i.e., the delivery is not automatic. The delivery seems to be conditional on the transferee/ addressee presenting certain documents to the Courier at the time of delivery. Thus, no inference of constructive delivery in US can possibly be drawn. Then, there is clause 5.1 read with Annexure IVB which sets out the time frame for delivery of know-how documentation. It shows that the delivery-schedule ranges between 1 month (from the effective date) and 9 months. It is not, therefore, a case of delivery of technical documentation once and for all, contemporaneous with the signing of Agreement. The delivery-schedule is staggered over a long period of time and we cannot presume that such deliveries would take place or have taken place in US from time to time. In the absence of any material placed before us in this behalf, the reasonable presumption to be drawn is that the delivery of various documents which is an integral part of the Agreement signed in India would take place in India. The transferee, as already noted, acquires rights only on receipt of the documents in India.

9.4 Therefore, the theory of “off-shore supply of technical documentation” sought to be developed by the applicant’s counsel has no factual foundation. The case of Ishikawajima Harima Heavy Industries vs. DIT * relied on by the learned counsel does not at all come to the aid of the applicant. That was a clear case of off-shore supply of equipment and materials in respect of which the title passed outside the Indian territory. It was observed that “the entire transaction having been completed on the high seas, the profits on sale did not arise in India” (vide p.444). But, the fact situation is different in the present case. The contract involving transfer of (2007) 288 ITR 408 technology and know-how cannot be equated to the transaction considered by the Supreme Court.

9.5 Reliance has been placed by the applicant on the decision of the Supreme Court in Scientific Engineering House Pvt. Ltd. vs. CIT, Andhra Pradesh * in support of the contention that the technical documentation and designs constitute `plant’ and that the plant having been sold in USA, the income is not taxable in India. We do not find any relevance of that decision to the point in issue here. The Supreme Court held in Scientific Engineering case that `the capital asset acquired by the assessee, namely, the technical know-how in the shape of drawings, designs, charts, plans, processing data and other literature falls within the definition of `plant’ and is, therefore, a depreciable asset and therefore the payment made by the assessee to the foreign collaborator who rendered the documentation service was attributable wholly towards the acquisition of a depreciable asset and depreciation claimed by the assessee was admissible’. We do not see how the principle laid down in that decision can be pressed into service for the purposes of this case. We are not called upon to construe the provisions relating to depreciation.

10. Now let us see whether the royalty provisions in the IT Act and the Treaty would come into play in the instant case. First we 157 ITR 86 will notice the provisions dealing with royalty in the Act. Section 9 specifies the various categories of incomes which shall be deemed to accrue or arise in India. Under clause (vi) of section 9(1), income by way of royalty payable by a resident (of India) shall be deemed to be income that accrues or arises in India. In order to avoid the possible controversies focusing on territorial nexus, the royalty payable in respect of the business or profession carried on by a resident outside India or for the purpose of earning any income from a source outside India is excluded from the ambit of clause (vi)(b). Then, Explanation 2 to clause (vi) sets out the scope and connotation of `royalty’. First, it excludes consideration which would be the income of the recipient chargeable under the head `capital gains’. Then, there are six limbs/sub-clauses in Explanation 2. The Explanation reads thus:

Explanation 2- For the purposes of this clause, “royalty” means consideration (including any lump sum consideration be excluding any consideration which would be the income of the recipient chargeable under the head “Capital gains” for-

(i) the transfer of all or any rights (including the granting of a licence) in respect of a patent, invention, model, design, secret formula or process or trade mark or similar property;

(ii) the imparting of any information concerning the working of, or the use of, a patent, invention, model, design, secret formula or process or

similar property;

(iii) the use of any patent, invention, model, design, secret formula or process or trade mark or similar property;

(iv) the imparting of any information concerning technical, industrial, commercial or scientific knowledge, experience or skill;

(iva) the use or right to use any industrial, commercial or scientific equipment but not including the amounts referred to in section 44BB;

(v) the transfer of all or any rights (including the granting of a licence) in respect of any copyright, literary, artistic or scientific work including films or video tapes for use in connection with television or tapes for use in connection with radio broadcasting, but not including consideration for the sale, distribution of exhibition of cinematographic films; or

(vi) the rendering of any services in connection with the activities referred to in sub-clauses (i) to (iv), (iva) and (v).

In order to find the answer to the question whether the royalty provisions in the Act and the Treaty are attracted, we have to consider the substance and essence of the transaction. As noticed earlier, the nature and content of the right transferred is the right to use the technology or the technical know-how supplied by the applicant for setting up the plant for the manufacture of radial tyres and to adopt the know-how in relation to the products that may be developed or manufactured in future in any manufacturing unit of the transferee-CEAT. Not only that, the applicant will provide to CEAT technical service assistance and train CEAT’s personnel for making use of the know-how supplied by it on proper lines. Otherwise, the know-how and underlying technology will only remain on paper. In fact, it has been expressly stated in cl.7.1 is

that the transferee will not be able to use the know-how unless the applicant trains CEAT’s personnel at the plant. Thus, the crux and predominant feature of the transaction involving the transfer of know-how is to equip CEAT with all that is necessary to effectively put the know-how to use. The know-how and technology which was within the exclusive domain of the applicant is parted with in favour of CEAT by granting non-exclusive but perpetual right to use the know-how and by putting in place the requisite measures to enable the transferee to effectively utilize and absorb the same. It cannot be doubted that the technology/know- how transfer that is contemplated by clause 2 of the Agreement gets covered by more than one sub-clause of Explanation 2 to section 9(1)(vi), i.e., sub-clauses (i), (ii) and (iv). The services in the form of technical assistance and consultancy connected with those items fall under sub-clause (vi).

11.1 Therefore, the consideration received towards technology transfer/technical know-how and the services connected therewith is clearly liable to be taxed as royalty under Sec. 9(1)(vi) of the IT Act, 1961. The power of taxation in this regard cannot be denied to the Indian Government from the standpoint of territorial nexus and by reference to the observations made in Ishikawajima case on the aspect of territorial nexus. First of all, the said observations at pages 445 and 447 (of 288 ITR) were in the context of technical/consultan cy services rendered outside India and not concerning royalty. In connection therewith, it was observed that such services should not only be utilized but rendered in India in order to bring the fee for technical services within the net of clause (vii) of s.9(1). This was followed by the proposition that “sufficient

territorial nexus between the rendition of services and territorial limits of India is necessary” or that the services should have `live link’ with India. In stating that the services, to fall within the scope of Section 9(1)(vii) should not only be utilized but rendered in India, the Supreme Court apparently had in view the observations in Carborandum Co. vs CIT * made in the context of a different provision i.e., Section 42 of 1922 Act. In the instant case, the theory of territorial nexus cannot possibly be invoked by the recipient of income in the nature of royalty. The technical know-how embodied in various documents is received by the applicant in

India from time to time and is put to use in India with the assistance and advice offered by the technical personnel of the applicant deputed to India. The role played by the applicant is perceivable at every stage till the plant is set up and the goods are manufactured. No doubt can possibly arise from the stand point of territorial nexus.

11.2 Apart from clause (vi) of Section 9(1), the services contemplated in clause 7 of the Agreement would also fall within 108 ITR 335 22.the ambit of clause (vii) of Section 9(1) of the Act as they are in the nature of technical or consultancy services.

12. We shall now turn our attention to Art.12 of the Treaty which deals with `royalties’ as well as `included services’. The opening para of Article 12 lays down the first rule that royalty and fees for included services arising in a contracting State (India in the present case) and paid to a resident of the other contracting State (the applicant in the present case) may be taxed in that other State (i.e. USA which is the State of residence of the recipient of royalty). However, the next para preserves the power of taxation by the source State also by declaring that the royalty and fees for included services may also be taxed in the State in which they arise and according to the laws of that State; however, the resident of the other contracting State is entitled to avail the benefit of tax rates specified in clauses (a) & (b) of paragraph 2. Paragraph 6 of Article 12 excludes the application of paragraphs 1 and 2 in certain circumstances.

12.1 The definition of `royalties’ is given in paragraph 3 and the definition of `fees for included services’ is set out in paragraph 4. They are extracted hereunder: 3. The term “royalties” as used in this Article means: (a) payments of any kind received as a consideration for the use of, or the right to use, any copyright or a literary, artistic, or scientific work, including cinematograph films or work on film, tape or other means of reproduction for.use in connection with radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience, including gains derived from the alienation of any such right or property which are contingent on the productivity, use, or disposition thereof; and (b) payments of any kind received as consideration for the use of, or the right to use, any industrial, commercial, or scientific equipment, other than payments derived by an enterprise described in paragraph 1 of Article 8 …………..

4. For the purposes of this Article, “fees for included services” means payments of any kind to any person in consideration for the rendering of any technical or consultancy services (including through the provision of

services of technical or other personnel) if such services:

(a) are ancillary and subsidiary to the application or enjoyment of the right, property or information for which a payment described in paragraph 3 is received; or

(b) make available technical knowledge, experience, skill, know-how, or processes, or consist of the development and transfer of a technical plan or technical design.

12.2 The applicant’s counsel has invoked the well established principle that the provisions of DTAA in so far as they are beneficial to the tax payer would prevail over the provisions of the Income-tax Act, i.e. Section 9(1)(vi) and 9(1)(vii) of the Act (`royalty’ and `fees for technical services’). 12.3 Though there is substantial similarity between Art.12 and Section 9(1)(vi) of the Act, the definition of `royalties’ under the Treaty is more restrictive in scope than the definition contained in Explanation 2 to S.9(1)(vi). In contrast with the wider expression used in Explanation 2 to S.9(1)(vi), it is seen that para 3(a) of the Treaty uses the expression “consideration for the use of or the right to use”. The use or right to use is related to the various items enumerated in clause (a) of para 3. The design, plan and secret formula or process is among the enumerated items. Moreover, the information concerning industrial, commercial or scientific experience is another item mentioned in para 3(a) of Art.12. Thus the know-how transfer contemplated by clause (2) of the Agreement squarely falls within the definition of `royalties’ in para 3(a). The learned counsel has not been able to point out how para 3(a) of Art.12 is not attracted. His emphasis was more on para 5 which has bearing on the consultancy and assistance services. We have no doubt that the consideration which the applicant receives for the right to use the know-how as per clause 2.1 read with clause 4 and Schedule IX to the Agreement amounts to `royalties’ within the meaning of clause (a) of para 3 of Article 12. We have already pointed out that it is not appropriate to describe the transaction as a pure and simple sale of technical documentation. Thus, the payment received by the applicant squarely falls within clause (a) of Art.12.3. The applicant has no better case under the Treaty.

25.13. We shall now refer to the decisions relied upon by the learned counsel for the applicant in support of his contention that the income has not accrued or arisen in India. In the case of ITO vs. Shri Ram Bearings Limited 1 , there was a technical collaboration agreement with a Japanese company. The Agreement though a composite one was in two parts – under the first part the Japanese company agreed to sell to the respondent (Indian company), its trade secrets, that is to say the entire know-how relating to the manufacturing technique etc. It is also included the advice relating to plant lay out and installation and the use of patent rights. The other part of the agreement related to the rendering of technical assistance and training of personnel by the Japanese company.

On reaching the finding that undisputedly, the sale of trade secrets took place in Japan, the question considered by the Calcutta High Court was whether the amount received by the Japanese company towards the first part of the Agreement fell within the scope of Section 9(1)(i) of the Income-tax Act, 1961. It was contended by the Revenue that the sale of trade secrets cannot be disassociated from the second part of the agreement relating to technical assistance and training which was done in India. It was then contended that the business activities relating to the second part having been carried out in India, there was `business connection’ and, therefore, the Explanation to Section 9(1)(i) was attracted. 1 164 ITR 419 The contention was rejected by the High Court by holding that the “only business operation or activity that is contemplated under the Agreement is the rendering of technical assistance and the training of personnel of the respondent company for remuneration” and such income had no connection with income received by the Japanese company from the sale of trade secrets or know-how which was concluded in Japan. This decision of the Calcutta High Court was affirmed by the Supreme Court in a short order and it is reported in 224 ITR 724. The Supreme Court observed, thus:

“The agreement is in two parts. It is true that the two parts are interdependent but yet the consideration for the sale of trade secrets and consideration of technical assistance is separately provided for and mentioned under separate sections. So far as the consideration for the technical assistance is concerned, its taxability is not in doubt. The only controversy is with respect to the taxability of 1,65,000 US dollars which is stipulated as the consideration for sale of trade secrets. The agreement specifically says that the said sale is effected in Japan. We are unable to see on what basis it can be said that any part of the said amount has

been earned in India.”

13.1 Another case cited by the counsel for the applicant is the decision of the Supreme Court in Corborandum Co. vs. CIT 2 . That was also a case in which the foreign company entered into an agreement with Indian company for rendering technical and know-how services in the form of furnishing technical information and know-how with reference to manufacturing of certain products, providing factory and design layout, furnishing comprehensive 2 108 ITR 335 technical information of all developments in the manufacture of special products, training Indian personnel and providing the services of a factory manager for starting the plant and supervising its operations during the initial stages. The question there was whether any part of the business operations were carried out in India so as to justify apportionment of the profits attributable to the part of operations carried out in India. Construing sub-section (1) & (3) of Section 42 of the Indian Income-tax Act, 1922 (corresponding to Section 9(1)(i) read with the Explanation of the Income-tax Act, 1961), the Supreme Court held, while disagreeing with the High Court, that the entire services were rendered by the foreign company in the foreign territory. The foreign company had made the services of its personnel available to the Indian company outside India and the Indian company took them as its own employees, paid their salary and exercised control over them. Hence, it was held that no part of the activity or operation can be said to have been carried on by the American company in India. It was observed that in order to rope in the income of the non-resident under the deeming provision of Sec. 42(1), it must be shown that some of the operations were carried out in India. On this reasoning, the judgment of the High Court was reversed.

13.2 The above two decisions cited by the learned counsel were rendered in the context of the provisions of the Income-tax Act, 28.1961 or 1922 as the case may be, when clauses (vi) and (vii) dealing with `royalty’ and `fees for technical services’ were not on the statute book. After the said provisions were introduced, the legal position regarding the taxability of non-resident’ s income arising from transfer of technical know-how to the Indian enterprises has undergone a substantial change and the old decisions do not have much of relevance. We are not concerned here with the interpretation of clause (i) of Section 9(1) and the Explanation thereto.

13.3 The learned counsel then invited our attention to the ruling of this Authority in Pfizer Corporation in re ^ . In that case, it was ruled that the transfer of technical information in the form of a dossier was a transfer of capital asset and in view of the fact that the situs of technical information which was the subject matter of the sole agreement was not in India, the receipts were not chargeable to tax under Section 5(2) or section 9(1)(i) of the Income-tax Act, 1961. The question whether the transaction in the instant case amounts to transfer of capital assets situated outside India has not been raised in the present case. Whether or not the payment received by the applicant amounted to `royalty’ was not decided in that case. The scope and essential features of the contract in the present case are vastly different. Hence, the Pfizer ruling does not help the applicant. 271 ITR 101 29.

14. In the light of the foregoing discussion, we reach the conclusion that the sum of USD 343,425 representing consideration for the transfer of know-how and the grant of right to use the know-how can be subjected to tax in India under the Income-tax Act, 1961, treating the same as deemed income by way of royalty.

15. The balance consideration of 366,795 USD is for transfer of ownership of Tread and Sidewall design/patterns, designed by the transferor and approved by the transferee. It should be noted that a part of that consideration is charged for supplying technology for full tyre development. The details are found in Annexure-IX. It has been clarified by the counsel for the applicant that Columns (C) and (D) concerning full tyre development does not involve out-right sale or transfer of ownership.

15.1 It is clear from clause 3 of the Agreement that the TSD for the sizes specified in Annexure I-A designed by the transferor and approved by the transferee would vest exclusively with the transferee (CEAT). The second part of clause 3 entitles the transferee to have the TSD registered in its name and declares that it will constitute the proprietary intellectual property of the transferee. The learned counsel for the applicant has made it clear that technology extended for full tyre development does not involve sale of TSD. The details of activities involved in full tyre development are set out in the Note furnished by CEAT Limited, Mumbai. Having regard to the fact that the ownership in tread and side wall designs/patterns is transferred absolutely to CEAT Limited, the consideration related thereto cannot be brought within the fold of royalty under Article 12.3 of the Treaty for the reason that it is not a case of merely authorizing the use of or granting the right to use a design, plan or secret formula or process nor does it amount to furnishing information concerning industrial, commercial or scientific experience. Moreover, this part of the transaction cannot be viewed to be merely incidental to the conferment of right to use the know-how granted under clause 2 of the Agreement. It is, therefore, not liable to be taxed as royalty under the Treaty provisions. If at all, if the transfer is deemed to have taken place within India, it amounts to business profits. It can be taxed only in the event of the profits resulting from the transfer of ownership being attributable to the permanent establishment (PE). But, in the present case, PE could possibly come into existence only after the

event of transfer of ownership. The PE that may be set up for the purpose of rendering consultancy and technical services in connection with the transfer of know-how has no relation with the transfer contemplated by clause 3 of the Agreement. Hence, viewed from any angle, the amount of consideration related to the transfer of ownership in the tread and side wall designs/patterns amounting to USD 218,405 cannot be subjected to tax under the Income-tax Act, 1961. However, the consideration for product development specified in Columns (C) and (D) of Sr.No. 2 of Annexure-9, totaling 148,390 USD stands on the same footing as transfer of know-how and is liable to be taxed under the Income-tax Act.

16. The third question is whether the fee for consultancy and assistance payable to the applicant under the Agreement is liable to be taxed in India.

16.1 Consultancy and assistance and the fee in respect of such services are provided for by Clauses 7 and 8 of the Agreement. Under Cl.7.1, the transferor agrees to provide to the transferee during the term of the Agreement, the technical assistance as set out in Annexure-V “only in relation to the transfer of Know-how so as to enable the transferee to use the Know-how and manufacture the product in the plant in accordance with the terms of the Agreement.” It is specifically stated that the transferor acknowledges that the transferee will not be able to use the know-how unless the transferor trains the transferee’s personnel in the plant “in order to be capable of designing, developing and manufacturing the products in accordance with the Know-how”. `Consultancy Services’ include the supervision service and training service (vide cl.1.1.6). Annexure V details the scope of consultancy services. The consultancy and assistance to be provided by the transferor relate to lay out and set

up of the plant and manufacture of the products in the plant with the Know-how provided by the transferor, guidance regarding the product quality tests and testing of raw materials, semi finished and finished products, conforming to and fulfilling the Project Master Schedule etc. Then, the matters relating to which the supervision services should extend are set out in Annexure V. Inter alia the supervision services are to be provided at various stages of assembly, installation and commissioning of the machines as well as start up of the plant in conformity with the Know-how. It also extends to products quality tests, supervision of the transferee’s personnel in relation to the set up of the plant and Know-how implementation. Then, the third item in Annexure V is `Training Services’. It is stated under the head `Training Services’ that the transferor shall provide to the transferee’s designated personnel full, complete knowledge and training of the Know-how relating to technology, production process, machines etc. as well as the design, fabrication, assembly, inspection, operation and maintenance etc. of the plant. Moreover, the obligation to train the transferee’s personnel in the production, quality, technical and maintenance departments in the plant in relation to various specified aspects is emphasised in para 3 of Annexure V. The details of final training programme are also adverted to in the same para. The estimated amount payable for technical service assistance is given in clause 8 read with Annexure VI. The payments are to be made to the technical personnel deputed by the applicant according to the rates and mandays specified in Annexure VI. For the estimated 870 mandays, the total amount works out to US $ 879, 500. So also the sum payable to the key operators in imparting “inplant training lay out” is set out in Annexure VII A. The estimated mandays and the rates per day are specified therein. The total works out to US $ 170,000.

16.2 Undoubtedly, these services fall within `included services’ as defined in para 4 of Art.12 of the Treaty. There are two limbs in para 4 of Art.12: (a) the technical or consultancy services which are ancillary and subsidiary to the application or enjoyment of the right, property or information for which the payment described in paragraph 3 is received; and (b) make available technical knowledge, experience, skill, know-how, or processes, or consist of the development and transfer of a technical plan or technical design.

16.3 Whether or not the first limb applies, undoubtedly, the second limb is attracted in the instant case. The consultancy, assistance and training services make available to CEAT the technical knowledge, experience, Know-how and processes so that the transferee-CEAT will be able to derive full advantage from the Know-how supplied by the applicant and to equip itself with the requisite knowledge and expertise so that the transferee will be able to utilize the same even in the future ventures on its own and without reference to the transferor. The importance of consultancy and assistance services is highlighted by an express declaration in the Agreement which we may, at the risk of repetition, notice at this stage. The “transferor acknowledges that the transferee will not be able to use the Know-how unless the transferor trains the transferee’s personnel in the plant in order to be capable of designing, developing and manufacturing the products in accordance with the Know-how.” In the MOU concerning fees for included services appended to US-India Treaty, it is clarified:

“generally speaking, technology will be considered `made available’ when the person acquiring the service is unable to apply the technology. The fact that the provision of the service does not per se mean that technical knowledge, skills etc. are made available to the person purchasing the service, within the meaning of paragraph 4(b)”. This test is satisfied in the instant case. The fee received by the applicant under clause 8 of the Agreement, therefore, falls within the scope of fee for included services as defined in para 4 of the Art.12 of the Treaty. The position in regard to the liability under the Act is equally clear. The definition of fee for technical services in Explanation 2 to clause (vii) of Section 9(1) is even wider in its scope and amplitude that the corresponding provision in the Treaty. The restrictive phrase “make available” is not there in the Act. In fact, the learned counsel for the applicant has not disputed that the fee received by virtue of clause 7 and 8 of the Agreement constitutes 35.fee for technical services or included services as per the Act and the Treaty.

17. The applicant has rested its case on para 5(a) of Art.12 of the Treaty. The type of services received by the applicant, it is pointed out, gets excluded from the ambit of “fee for included services” by reason of the said provision in the Treaty. The services that are ancillary and subsidiary as well as inextricably and essentially linked to the sale of property {other than the sale described in para 3(b)} are covered by the exclusionary clause in para 5 of Art. 12. As discussed earlier, the essential nature of transaction is not sale of property. It is the conferment of right to use the technical know-how not merely for the plant that is being set up but also for similar plants in the future. Secondly, the plethora of technical services to be rendered by the applicant in the form of consultancy, assistance and training cannot be regarded as merely ancillary and subsidiary to the sale even assuming that the sale of technical documentation is involved. They extend over a long period of time and the consideration payable therefor constitutes the major component of the contractual amount.

17.1 In the Memorandum of Understanding concerning fees for services (Art.12) appended to US-India Tax Treaty, while referring to the expression “ancillary and subsidiary” occurring in paragraph 4(a) of Art.12, it has been clarified that “the clearly dominant purpose of the arrangement under which the payment of the service fee and such other payments are made must be the application or enjoyment of the right, property or information described in paragraph 3”. One of the relevant factors that could be taken into account for this purpose is “whether the amount paid for the services (at arm’s length) is an insubstantial portion of the combined payments for the services and the right, property or information described in paragraph 3”. “The extent to which such services are customarily provided in the ordinary course of business arrangements involving royalties described in paragraph 3” is another relevant factor. For the purpose of explaining paragraph 5 of Art.12, certain examples are given after the following prefatory remarks:

“Paragraph 5 of Article 12 describes several categories of services which are not intended to be treated as included services even if they satisfy the tests of paragraph 4. Set forth below are examples of cases where fees would be included under paragraph 4, but are excluded because of

the conditions of paragraph 5″.

17.2 One of the examples given i.e. No.9 may be noticed. “Example 9

Facts: An Indian hospital purchases an X-ray machine from a U.S. manufacturer. As part of the purchase agreement, the manufacturer agrees to install the machine, to perform an initial inspection of the machine in India, to train hospital staff in the use of the machine, and to service the machine periodically during the usual warranty period (2 years). Under an optional service contract purchased by the hospital, the manufacturer also agrees to perform certain other services throughout the life of the machine, including periodic inspections and repair services, advising the hospital about developments in X-ray film or techniques which could improve the effectiveness of the machine, and training hospital staff in the application of those new developments. The cost of the initial installation, inspection,

training and warranty service is relatively minor as compared with the cost of the X-ray machine. Is any of the services described here ancillary and subsidiary, as well as inextricably and essentially linked, to the sale of the X-ray machine?

Analysis:

The initial installation, inspection, and training services in India and the periodic service during the warranty period are ancillary and subsidiary, as well as inextricably and essentially linked, to the sale of the X-ray machine because the usefulness of the machine to the hospital depends on the service, the manufacturer has full responsibility during this period and this cost of the service is a relatively minor component of the contract * . Therefore, under paragraph 5(a) these fees are not fees for included services, regardless of whether they otherwise would fall within paragraph 4(b). Neither the post-warranty period inspection and repair services, nor the advisory and training services relating to new developments are “inextricably and essentially linked”” to the initial purchase of the X-ray machine. Accordingly, fees for these services may be treated as fees for included services if they meet the tests of paragraph 4(b).”

17.3 Apart from the fact that the services in question cannot be considered to be ancillary and subsidiary to the alleged sale, the ingredient of inextricable link will also be missing, if the applicant’s contention is to be accepted. If what had happened in the present case is mere sale of technical documentation as contended by the applicant, then, it cannot be said that there is an inextricable link between such sale and the magnitude of post-sale services to be rendered as per clause (7) and (8) of the Agreement. They are no emphasis supplied doubt the services allied or consequential to the alleged sale but they cannot be characterized as `inextricable’ or `inseparable’ from sale. In the case of ITO vs. Shri Ram Bearings (supra), as seen from the judgement of Calcutta High Court, the rendering of technical assistance and training was considered to be independent of the sale of trade secrets though the Agreement was a composite one.

17.4 Thus, for more than one reason, we hold that para 5 of Art. 12 of the Treaty cannot be invoked by the applicant. In the view we have taken, it is not necessary to consider whether the payments received by the applicant towards consultancy and assistance and training could be taxed as business profits under Art.7 even if they are not fees for included services. In fact, such alternative argument has not been addressed before us.

18. Our answer to the second question, therefore, is that the consideration received for consultancy, assistance and training as per Clauses 7 and 8 of the Agreement is liable to be taxed as fee for included services under the Treaty and as fee for technical services under the Income-tax Act, 1961.

19. The third question relates to deduction of tax at source. Section 195(1) of I.T.Act reads thus :

“Section 195 (1) – Any person responsible for paying to a non-resident, not being a company, or to a foreign company, any interest or any other sum chargeable under the provisions of this Act (not being income chargeable under the head “Salaries”) shall at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rates in force.”

The expression `rates in force’ is defined in Section 2(37A) as follows:

“rate or rates in force” or “rates in force”, in relation to an assessment year or financial year, means- (iii) for the purposes of deduction of tax under section 195, the rate or rates of income-tax specified in this behalf in

the Finance Act of the relevant year or the rate or rates of income-tax specified in an agreement entered into by the Central Government under section 90, or an agreement notified by the Central Government under

section 90A, whichever is applicable by virtue of the provisions of section 90, or section 90A, as the case may be.”

19.1 Under part II of the First Schedule to the Finance Act, 2009, the rates for deduction of tax at source in certain cases are specified. In regard to royalty and fees for technical services payable by an Indian concern in pursuance of an Agreement made by a foreign Company with the Indian concern on or after 1 st June 2005, 10% rate is prescribed, where it relates to a matter included in the Industrial Policy, for the time being in force, of the Government of India and the Agreement is in ccordance with that Policy. The tax deduction follows the same pattern as that envisaged in S.115A(1) of I.T.Act which prescribes the tax rates on royalty and FTS. There is no doubt that the Agreement entered into between the applicant and the CEAT is in respect of a matter covered by the Industrial Policy of the Government of India. Various objectives specified in the opening part of the Industrial Policy and other specific provisions clearly point to that conclusion. Thus the rate of tax at which the deduction shall be made is 10% plus surcharge at the prescribed rate. In this regard, there is no provision in the Treaty which is more beneficial to the applicant and/or its customer. It is at this rate the tax is liable to be withheld, as the fact situation now stands.

19.2 As regards the quantum of income in respect of which the obligation to withhold the tax at 10% arises, the amount receivable under the contract less the consideration for the transfer of ownership in Tread and Sidewall design/pattern (which works out to 218,405 USD) shall be taken as the basis.

20. Accordingly, the three questions are answered and the ruling is given and pronounced on the 28th day of October, 2009.

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