Case Law Details
Soktas Tekstil Sanayi Ve Ticaret AS Vs ACIT (ITAT Delhi)
ITAT Delhi held that consideration for permitting the licensee the right to use of brand name or trademark has to be treated as Royalty in terms of section 9(1)(vi) of the Act read with Article 12 of the tax treaty. Accordingly, the same will be taxable.
Facts- The core issue arising for consideration is whether the amount received by the assessee on account of transfer of trademark and brand name can be treated as royalty under Article 12 of India – Turkey Double Taxation Avoidance Agreement (DTAA), instead of capital gains under Article 13 of the DTAA.
Conclusion- In the facts of the present appeal, the factual position emerging on record clearly indicates that the assessee has not alienated its ownership rights over the brand names and trademarks, either fully or partially but has simply permitted the licensee the right to use of brand name and trademark in a particular geographical territory.
Thus, in terms of section 9(1)(vi) of the Act read with Article 12 of the tax treaty, it can be concluded that as per the terms of Trademark Licence Agreement (TLA), the assessee has received the consideration for the use of or the right to use of trademark/brand names. Therefore, the consideration received by the assessee has to be treated as royalty.
FULL TEXT OF THE ORDER OF ITAT DELHI
Present appeal has been filed by the assessee assailing the final assessment order dated 31.05.2022 passed under section 143(3) read with section 144C(13) of the Income-tax Act, 1961 (for short ‘the Act’) for the assessment year 2019-20, in pursuance to the directions of learned Dispute Resolution Panel (DRP).
2. The core issue arising for consideration as raised in ground no. 1, 2 and 3 is, whether the amount received by the assessee on account of transfer of trademark and brand name can be treated as royalty under Article 12 of India – Turkey Double Taxation Avoidance Agreement (DTAA), instead of capital gains under Article 13 of the DTAA.
3. The relevant facts for deciding the issue in brief are, the assessee is a non-resident corporate entity incorporated under the laws of Turkey and a tax resident of Turkey. As stated by the Assessing Officer, the assessee is specialized in designing and producing cotton and cotton fabric, which is exported around the world. The assessee had a wholly owned subsidiary Soktas India Pvt. Ltd. In the year under consideration, the assessee had entered into Trademark Licence Agreement (TLA) with the Indian subsidiary transferring exclusive, irrevocable and perpetual rights to use the identified trademarks and brand names in defined territories. The transfer of such right to use to the Indian subsidiary was for a lumpsum consideration of USD 100,000/-equivalent to Rs.77,16,800/- as on 05.03.2019. Subsequently, the assessee entered into a share purchase agreement with Grasim Premium Fabric Pvt. Ltd. transferring all equity shares of the Indian subsidiary.
4. Be that as it may, the assessee being of the view that the consideration received from transferring the right to use the trademarks and brand-names, whether is at arm’s length or not, undertook a suo motu transfer pricing adjustment of Rs.4,04,04,326/- based on an independent valuation report and offered the adjusted sale consideration of Rs.4,81,21,126/- as capital gain in the return of income filed for the impugned assessment year. However, taking shelter under Article 13 of India – Turkey DTAA, the assessee claimed exemption of the capital gain from taxation in India. In course of assessment proceeding, the Assessing Officer called upon the assessee to furnish various documentary evidences, including, the TLA. Alleging that the assessee did not furnish the requisite documents to support its claim of exemption on capital gain, the Assessing Officer proceeded to frame the draft assessment order by holding that the income derived from transfer of right to use of trademark/brand name is to be treated as income from other sources under Article 21 of the Tax Treaty. Accordingly, he completed the assessment.
5. Being aggrieved with the draft assessment order, the assessee raised objections before learned DRP. After considering the submissions of the assessee in the context of facts and materials on record, learned DRP accepted that the assessee has furnished the requisite documentary evidences, including, TLA before the Assessing Officer. Thus, to that extent learned DRP did not agree with the decision of the Assessing Officer that the consideration received under the TLA is to be treated as income from other sources. However, on going through the TLA, learned DRP was of the view that the assessee had not parted its ownership rights over the trademark and brand-names while entering into the TLA with the Indian subsidiary. Learned DRP observed, through the TLA, the assessee granted an exclusive, perpetual and irrevocable licence to the Indian subsidiary for creation of brand-name/trademark. Referring to OECD Model Tax Convention Commentary, learned DRP observed, where ownership right has not been alienated, the consideration is for the use of or the right to use the trademark, hence, represents royalty. Learned DRP observed, the terms and conditions of TLA clearly make out that the payment is not in consideration for the transfer of full ownership rights on trademark/brand name but is the consideration for rights to use of brand-name/trademark, thus, partakes the character of royalty and not capital gain. Thus, ultimately, learned DRP held that consideration received by the assessee under the TLA is in the nature of royalty as defined under Article 12 of Indian – Turkey DTAA. While doing so, learned DRP relied upon the decision of the Hon’ble Delhi High Court in case of Hilton Roulunds Ltd. Vs. CIT [2019], 412 ITR 436 (Delhi). 6. Before us, learned counsel appearing for the assessee submitted that under the TLA the assessee has transferred exclusive, irrevocable and perpetual right for usage of trademark and brand-name in favour of the Indian subsidiary. In this context, he drew our attention to various clauses of the TLA. He submitted, by conferring/transferring such right the assessee has allowed the licencee to use the trademark/brand name within the defined territories in exclusion of all other persons, including, the assessee. Drawing our attention to the definition of transfer under section 2(47) of the Act, learned counsel submitted, relinquishment or extinguishment of any rights in capital asset amounts to transfer. He submitted, as per the terms of TLA the assessee has granted irrevocable right to use the trademark/brand-name for perpetuity in the defined territories.
Therefore, to that extent assessee’s rights over the trademark/brand-name in the defined territories stand extinguished. Hence, the consideration received for transferring such rights, being towards transfer of capital assets, has to be considered as capital gain. Drawing our attention to Article 13(6) of the tax treaty, learned counsel submitted, capital gain has to be taxed in the country of residence of the alienator. Proceeding further, he submitted, as per explanation 2 section 9(1)(vi) of the Act, income chargeable under the head ‘capital gains’ has been excluded from the definition of royalty. Distinguishing the decision of the Hon’ble Delhi High Court in case of Hilton Roulunds Ltd. (supra), he submitted, the decision deals with the issue, whether a particular expenditure is capital or revenue, hence, not germane to the present appeal. Without prejudice, referring to the OECD Commentary on royalty payment, as reproduced in the decision of the Hon’ble Supreme Court in case of Engineering Analysis Centre of Excellence (P) Ltd. Vs. CIT, [2021] 125 taxmann.com 42 (SC), learned counsel submitted, as per the said convention, if the payment is in consideration for the transfer of right that constitute a distinct and specific property (which is more likely in the case of geographically limited rights), such payments are likely to be business profits within Article 7 or capital gain under Article 13 rather than royalty under Article 12. He submitted, as per the Commentary, where the ownership rights has been alienated, the consideration cannot be for the use of rights. Further, drawing our attention to OECD Commentary on Model Tax Convention on Article 13, learned counsel submitted, even in case of partial alienation of capital asset, capital gain will arise. Thus, he submitted, the consideration received for transfer of right to use of brand-name/trademark has to be treated as capital gain. In support, he relied upon the following decisions:
1. Mrs. K. Bhagyalakshmi Vs. DCIT, [2019] 416 ITR 497 (Madras)
2. S.P. Alaguvel Vs. DCIT, [2014] 52 taxmann.com 231 (Madras)
3. CUB Pty. Ltd. Vs. UOI, [2016] 388 ITR 617 (Delhi)
4. CIT Vs. Finlay Mills Ltd. [1951] 20 ITR 475 (SC)
7. Strongly relying upon the observations of learned DRP, learned Departmental Representative submitted, the TLA would make it clear that the assessee has not alienated its ownership rights over trademark/brand-name. He submitted, the licencee has limited right to use the trademark/brand-name within a defined geographical territory. He submitted, though, the TLA uses, the words ‘exclusive’, ‘irrevocable’ and ‘perpetual’ right, however, in effect it is not so. Drawing our attention to financial statements of Grasim Premium Fabric Pvt. Ltd., the company which purchased the shares of assessee’s Indian subsidiary, learned Departmental Representative submitted, in the schedule of assets, the consideration paid for usage of trademark/brand-name is not shown. Thus, he submitted, licencee does not consider the brand-name/trademark to be an asset owned by it. Thus, he submitted, the contention of the assessee that the amount received towards transfer of right to use of trademark/brand name is in the nature of capital gain and not royalty, cannot be accepted. In support, he strongly relied upon the decision of the Hon’ble Delhi High Court in case of Hilton Roulunds Ltd. Vs. CIT (supra).
8. We have considered rival submissions in the light of the decisions relied upon and perused the materials on record. As far as factual aspect concerning the issue in dispute is concerned, there is no dispute between the parties. It is a fact on record that under a TLA executed on 04.03.2019 with the Indian subsidiary, the assessee had transferred exclusive, irrevocable and perpetual right of usage of trademark/brand-name in favour of the Indian subsidiary for a lumpsum consideration of USD 100,000/-. The assessee, on its own volition had made a suo motu adjustment of Rs.4,04,04,326/- to the sale consideration based upon a valuation report of the independent valuer. However, the adjusted consideration of Rs.4,81,21,126/- has been treated as capital gain and claimed exempt under Article 13(6) of Indian – Turkey DTAA. Though, the Assessing Officer had treated the income as income from other sources, however, reversing the decision of the Assessing Officer, learned DRP has held it as royalty under section 9(1)(vi) as well as Article 12 of the tax treaty. Therefore, the issue arising for consideration is, whether the amount in dispute is to be treated as capital gain or royalty income. For this purpose, it is necessary to look into the TLA as a whole and the specific terms of the agreement.
9. On perusal of TLA, copy of which is placed at page 27 of the paper-book, it is observed that as per paragraph (C) of the Preamble, the licensor (assessee) has granted an exclusive, perpetual and irrevocable licence to licencee for the usage of certain brand-names and trademarks and further, the assessee has also granted similar licences to the licencee to use the brand-name/trademark as part of licencee’s corporate name. Under the agreement, brand-name is defined as certain brand-names solely owned by the licensor as specified in Schedule I and Schedule II to the agreement. The brand booklet is defined as brand usage guidelines issued by the licensor as updated from time to time in relation to the brand names as set out under clause (7) of the agreement. Trademark means the trademark owned by the licensor as specified in Schedule I and Schedule II to the agreement. Under clause (3) of the agreement, the licencee has been granted a transferable, irrevocable (subject to the terms of the agreement), exclusive and perpetual licence and permission to use the brand-names and trademarks in the territory in relation to the products. The territory has been defined to mean specific geographical territories with respect to each of the brands. Clause (4) of the agreement stipulates the licence fee to be paid on one time lumpsum basis. Clause (5) of the agreement provides that ownership of the brand-names and trademark shall always remain with the assessee and the licencee accepts such fact. Licencee further agrees that it shall not at any time do or cause to do any act or thing directly and indirectly which contests or in any way impairs any part of licensor’s rights in or title to the brand-names or trademark and the goodwill attached thereto. The licence shall also not act or do anything in contravention to or inconsistent with the directions of the licensor set out in the brand booklet. It further clarifies that the licencee agrees and acknowledges that the use of brand-names and trademarks by the licencee shall inure to the benefit of and be on behalf of the licensor and also agrees to assist the licensor in recording the trademark licence agreement with appropriate Government authorities. Clause 5.3 makes it further clear that the licencee agrees that nothing in the agreement shall give the licencee any right, title or interest in the brand-names and trademark other than the right to use the same in accordance with the terms of the agreement. It further makes it clear that the licencee shall not attack or deny the title of the licensor to the brand-names or trademarks under any circumstances whatsoever. Clause 6 stipulates that licencee shall, on a best effort basis, maintain high quality standard of the products so that the brand-names and trademarks retain their goodwill and all efforts should be made by the licencee to ensure that the goodwill of the brand-names or trademarks is not jeopardized under any circumstances whatsoever. Clause (7) provides that the licensee shall use the brand-names/trademarks either in plain writing or only in the form and manner as provided under the brand booklet. Clause (8.2) again makes it clear that the licencee has not acquired, nor shall it acquire any right, title or interest in the brand-names or trademarks other than the right to use the same in accordance with the terms of the agreement. Clause (9.4) provides that neither the agreement, nor any of the rights or agreement of licencee arising under agreement may be assigned or transferred without licensor’s prior written consent. Most importantly, clause (14) of the agreement empowers the licensor to terminate the TLA under certain circumstances, including, material breach of the brand booklet by giving prior notice of 30 days.
10. Thus, a reading of the TLA, as discussed above, would make it clear that though, the TLA speaks of granting exclusive, irrevocable, perpetual right to usage of trademark/brand name, however, in reality such right is circumscribed by various conditions as enumerated in the agreement, including the brand booklet guidelines. In fact, the TLA makes it abundantly clear that the proprietary ownership right over the brand name and trademark will always remain with the assessee and the licensee can use the brand-name/trademark in terms with the conditions set out in the agreement. It further empowers the assessee to terminate the agreement in case of certain breach of conditions including conditions of brand booklet. Therefore, it cannot be said that the assessee had alienated, relinquished or extinguished its rights over the brand name/trademark in favour of the licensee, while entering into the TLA. Rather, the so called ‘exclusive’, ‘irrevocable’ and ‘perpetual’ right, is subject to various conditions and restrictions imposed under the brand booklet and other clauses of the agreement. The TLA read as a whole makes it clear that the assessee has not alienated its ownership rights over the brand names/trademarks, either fully or even partially.
11. Even, in the defined geographical territory the licensee cannot use the brand names/trademarks independently and in accordance with its own will, as, the right to usage of brand name/trademarks given to the assessee has been circumscribed/restricted by various terms and conditions of the TLA, including the guidelines set out in the brand booklet.
12. The expression ‘transfer’ with reference to a capital asset, as defined under section 2(47) of the Act, speaks of sale, exchange or relinquishment of the asset or the extinguishment of any rights therein. In the facts of the present appeal, it is patent and obvious, the assessee has not sold, exchanged or relinquished or extinguished its rights either wholly or partially with reference to the trademarks/brand names. What the assessee has permitted the licensee to do is to use the brand name/trademark in the defined geographical territory as per the terms and conditions set out in the TLA. The expression ‘transfer’ in its ordinary sense and in common parlance as well as in law means, transfer of complete right, title, interest and ownership over an asset. Once an asset is transferred, the original owner loses its right, title and interest and cannot exercise any control over the transferee with reference to usage of the asset. Even, Article 13 of the Tax Treaty, which provides for taxation of capital gains, speaks of alienation of any property. In the facts of the present appeal, the factual position emerging on record clearly indicates that the assessee has not alienated its ownership rights over the brand names and trademarks, either fully or partially but has simply permitted the licensee the right to use of brand name and trademark in a particular geographical territory.
13. Of course, explanation 2 to section 9(1)(vi) excludes any income chargeable under the head capital gains from being treated as royalty. However, such income, in the first place, must come within the purview of capital gains. On the contrary, clause (i) of Explanation 2 clearly says that the consideration received including any lumpsum consideration towards transfer of all or any rights, including, the granting of a licence in respect of patent, invention, model, design, secret formula or process or trademark or similar property shall be treated as royalty. Even, Article 12(3) of India – Turkey DTAA defines the term royalty to mean payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific works, including, cinematograph films or films tapes used for television or broadcasting, any patent, trademark, design or model, plan, secret formula or process etc. Further, Article 12(2) empowers the source country to tax royalty according to the laws of the source country. Thus, in terms of section 9(1)(vi) of the Act read with Article 12 of the tax treaty, it can be concluded that as per the terms of TLA, the assessee has received the consideration for the use of or the right to use of trademark/brand names. Therefore, the consideration received by the assessee has to be treated as royalty.
14. At this stage, we propose to deal with the decisions cited before us. In case of Hilton Roulunds Ltd. Vs. CIT (supra) relied upon by the Revenue, though, the issue was whether a particular expenditure was revenue or capital in nature, however, the Hon’ble jurisdictional High Court, while dealing with the issue, whether a particular trademark has been licensed or assigned, has observed as under:
“27. The fundamental test to determine as to whether a particular mark has been licensed or assigned is to see if the licensor/assignor has retained any rights in the mark. If rights are retained with the owner, usually it is a license and if no rights are retained by the owner, then it would usually be an assignment. A license is, therefore, nothing but a permissive use of the mark, which permission, is revocable. A `right to use’ is usually a license and not an assignment, except in certain circumstances. Some of the questions that determine whether an arrangement is a license or an assignment include:
i) Whether the user acknowledges the licensor‟s right and title over the mark?
ii) Whether it is a mere right to use the mark or it was a transfer/assignment of a permanent nature?
iii) Whether the manner of use is specified and restricted and the effect thereof on the rights of the user?
iv) Whether the payment made by the User is one-time, fixed running royalty or a percentage of sales, with or without investment made by the Licensor on marketing and advertising?
v) Whether the licensor has right of supervision and control over the use of the mark?
vi) Whether sole and exclusive right was conferred on the user and the effect thereof?
vii) Whether the user can further transfer his rights to third party, with and without consent of the licensor and the effect thereof?
viii) Whether the licensor had the right to terminate the license and if so, under what circumstances?
ix) Whether upon termination by the licensor, the user has to stop use of the mark?
x) Whether or not the right to sue is given and conferred on the user?
xi) Whether there is a transfer of goodwill of the business and/or goodwill in the mark?
xii) Whether there are multiple users of the same mark?
28. A license agreement usually has some or all of the above stipulations. Thus, the nature of the agreement can be easily deduced from the existence of all or any of the above conditions/characteristics. In some circumstances however, an exclusive licence which excludes the owner from using the mark and vests perpetual rights without any termination clause, could constitute an assignment. However, the present case is not one such case.”
15. As could be seen from the parameters set out by the Hon’ble Jurisdictional High Court to differentiate between licence and assignment, one of the important factor to examine is, whether the user acknowledges the licensor’s right and title over the trademark. Some of the other factors are, whether it is a mere right to use the trademark or it was a transfer/assignment of a permanent nature. Further, whether the mode and manner of use is specified and restricted and the effect thereof on the rights of the user. Further, the Hon’ble Court has observed, an exclusive licence which excludes the owner from using the trademark and vests perpetual rights without any termination clause could constitute an assignment. If we apply the parameters set out by the Hon’ble Jurisdictional High Court in the aforesaid case to the facts of the present appeal, it can be seen that the licensee acknowledges the licensor’s rights and title over the trademark, the manner of use of trademark/brand name is specified and restricted in the TLA and the licensee is bound by such conditions/restrictions. Further, the TLA authorizes the licensor to terminate the agreement in case of any breach of the conditions. That being the case, it has to be held that it is a case of licence conferring right to use the trademark/brand name and not assignment/transfer of brand name/trademark in favour of the licensee.
16. In so far as the decisions cited by learned counsel for the assessee, in case of Mrs. K. Bhagyalakshmi Vs. DCIT (supra), the issue was, whether the consideration received in respect of sale of television rights for films through irrevocable deed of transfer for a period of 99 years would fall within the definition of royalty under section 9(1)(vi) of the Act. Hon’ble Court after referring to section 26 of the Copyright Act, 1957, held that the said provision stipulates period of 60 years. Further, taking note of the undertaking of the transferors that they will not sale the VCD/DVD rights to any other party in future, held that the transferor has transferred full and absolute right upon the transferee. However, the facts in assessee’s case are different, as, there is no such undertaking by the licensor with regard to the brand names/trademarks. In case of S.P. Alaguvel Vs. DCIT (supra), the Hon’ble Court has followed the observations made in case of Mrs. K Bhagyalakshmi (supra) with reference to section 26 of the Copyright Act. In case of CUB Pty Ltd. Vs. UOI (supra), the issue was whether the licensor has transferred its rights over the trademark or has permitted to use the trademark. Ultimately, the court held that citus of the ownership of the intangible assets would be the closest proximate of the citus of the intangible assets. In other words, intangible asset by its very nature does not have physical form. Therefore, the citus of the owner would be citus of such asset. In our view, this decision would be of no help to the assessee. In case of CIT Vs. Finlay Mills Ltd. (supra), the issue was whether the expenditure incurred for registering trademark will be allowable as business expenditure. In our view this decision will also be of no help to the assessee. Even, the decision of the Hon’ble Supreme Court in case of Engineering Analysis Centre of Excellence (P) Ltd. (supra), though, was cited by learned counsel for the assessee, however, it has no application to assessee’s case.
17. Thus, on overall consideration of facts and materials on record and applying the ratio laid down in various decisions cited before us, we have no hesitation in holding that the consideration received by the assessee for permitting the right to use of brand name/trademark under TLA is nothing else but in the nature of royalties as defined under section 9(1)(vi) read with Article 12(3) of India – Turkey tax treaty. Therefore, we concur with the view expressed by learned DRP. Grounds are dismissed.
18. In ground no. 4, the assessee has raised the issue of taxation of royalty income at the rate of 15% as per the treaty provision instead of applying the lower rate of tax as per the provisions of the domestic law. We find, the claim of the assessee has neither been examined by learned DRP, nor by the Assessing Officer. Therefore, we restore this issue to the Assessing Officer for examining assessee’s claim with reference to the provisions of treaty and section 90(2) of the Act. Needless to mention, the assessee must be provided reasonable opportunity of being heard before deciding the issue.
19. In ground no. 5, the assessee has raised the issue of set off of royalty income against the long term capital loss. Having heard the parties, we find, this issue also has not been addressed either by the DRP or by the Assessing Officer. Therefore, we restore this issue to the Assessing Officer for examining assessee’s claim, keeping in view the provisions of section 71(3) of the Act. Before deciding the issue, the assessee must be given a reasonable opportunity of being heard. This ground is allowed for statistical purposes.
20. Ground nos. 6 and 7, being consequential and premature at this stage, are dismissed.
21. In the result, the appeal is partly allowed for statistical purposes.
Order pronounced in the open court on 22nd December, 2022
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