Fees received on assignment of contractual rights not taxable: Authority of Advance Ruling

A recent ruling of the Authority of Advance Ruling (AAR) [2010-TIOL-06- ARA-IT] in the case of M/s Laird Technologies India Pvt. Ltd. (Applicant) on the issue of tax ability of fees received by a US company (US Co) for assigning contractual rights to the Applicant to supply products in India.

The AAR held that the fee received by US Co from the Applicant is in the nature of business profits of US Co and the same is not taxable in India in the absence of US Co constituting a permanent establishment (PE) in India under the India-US tax treaty (Tax Treaty). Further, the Applicant is not required to withhold taxes under the Indian Tax Law (ITL) while making remittance to US Co as it has not derived any income chargeable to tax in India.

Background and facts of the case

• The Applicant, a company incorporated in India, is engaged in the business of designing and manufacturing antenna and battery packs for the mobile phone industry. The Applicant is a group company of a UK company, the ultimate parent company, which is a leading international supplier of custom-designed electronic components and solutions to the global electronic industry. The Applicant is UK company’s first manufacturing facility in India.
• US Co, a tax-resident of USA and another group company of UK company, is a globally known designer and manufacturer of antenna, data communications etc. US Co has entered into a product purchase agreement (PPA) to manufacture and supply products to Nokia Corporation (Nokia) globally, including India.
• In connection with the supplies of products to Nokia’s group company in India (Nokia India) under the PPA, US Co entered into an assignment agreement (Agreement) with the Applicant for a period of 5 years. Under the Agreement, US Co irrevocably assigned all its beneficial rights, title, interest, obligations and duties in connection with the supplies to Nokia India under the PPA in favor of the Applicant. In consideration to above, the Applicant agreed to pay a lump sum amount to US Co (Assignment fee).
• The Applicant was of the view that the Assignment fee received by US Co under the terms of the Agreement is not taxable in India under the ITL or the Tax Treaty and hence it was not required to withhold taxes on the remittance of the Assignment fee.

Issues before the AAR

• Whether the Assignment fee receivable by US Co is taxable in India under the provisions of the ITL and the Tax Treaty.
• If the answer to above is negative, whether the Applicant is required to withhold tax under the ITL while making remittance of the Assignment fee to US Co.

Contentions of the Applicant

• The PPA entered into by US Co with Nokia constitutes a capital asset as US Co had acquired the right to manufacture and supply the specified products to Nokia globally. Under the ITL, ‘right to manufacture, produce or process any article or thing’ or ‘right to carry on any business’ is recognised as a capital asset.
• The situs of the PPA is outside India where it was entered into and signed by the parties. The Agreement was also executed outside India and the Assignment fee would be received by US Co outside India.
• By assignment, the transfer of the above capital asset had taken place and a capital gain has accrued to US Co. But as the capital asset is situated outside India, the capital gains tax cannot be levied in India.
• Even if the consideration received by US Co under the Agreement is construed as business profits, the charge to tax fails both on account of the absence of business connection between US Co and the Applicant under the ITL and in the absence of a PE of US Co in India under the Tax Treaty.
• US Co has no fixed place of business in India through which any business activity was or is being carried on.
• The Applicant is not acting as an agent of US Co in any capacity and the Applicant would supply the products to Nokia India on a principal- to-principal basis.
• The Applicant has been carrying on its business operations by itself without any economic dependence or any control over management or instructions from US Co. The Applicant has been bearing the risk and responsibility of its business transactions.

 Contentions of the Tax Authority

• US Co and the Applicant are ‘affiliates’, being ‘sub-subsidiaries’ of UK company, and, therefore, the Applicant shall be deemed to be a party to the PPA. Hence, the question of assignment of rights and obligations under the PPA by US Co to its affiliate does not arise.
• The PPA only casts a host of obligations upon US Co without any consideration flowing to it and any contractual right derived by it. In the absence of any legal right accruing to US Co under the PPA, there is no question of assignment of any rights in favour of the Applicant.
• Under a contract, there can be an assignment only of the rights and benefits but not of the burden and obligations. Assignment of obligations alone is not recognised by law and such assignment of obligations of US Co under the PPA to the Applicant requires a novated tripartite agreement.
• Under the PPA, US Co has an obligation to deliver its products to Nokia for which it has to avail the services of a domestic logistic service provider (LSP) for warehousing and delivering the products at the plant site of Nokia. The business network of LSP who would import goods on behalf of the US Co and deliver them to Nokia at its site constitutes the PE of US Co.
• The Applicant is wholly dependent on US Co for its business of supplies of products to Nokia India. Further, under the Agreement, US Co continues to have legal commitments in respect of guarantee of risks of volume of sales and minimum insurance cover.

Ruling of the AAR

 Classification as a capital gain arising on transfer of a capital asset

• There is no valid assignment in the eye of law since it is not clear if Nokia had consented to or ratified the Agreement. The mere fact that Nokia India was accepting the goods from the Applicant does not lead to the necessary inference that it was being done pursuant to the approval of assignment by Nokia.
• In the absence of any valid assignment, it is rejected that there was legal transfer of capital asset and that the consideration shall be deemed to be capital gains.
• However, irrespective of the validity of the assignment and irrespective of the fact that there is no transfer of a capital asset as per law, the consideration received by US Co would still be income, which would be in the nature of business profits.

Tax ability of business profit

• As stated by the Applicant, US Co had no fixed place of business in India through which its business was carried on. Further, no LSP was ever appointed by US Co to fulfil its obligations of delivery of products to Nokia.
• There is nothing on record to show that US Co played any role in the manufacturing and business activities of the Applicant. Once the necessary authorisation to manufacture and supply the products to Nokia India has been given by US Co to the Applicant, US Co cannot carry on the same business in India or interfere with the business carried on by the Applicant.
• The business profits of US Co, i.e. the Assignment fee, cannot be attributable in the absence of a PE in the form of LSP or any other place of business. Further, based on the facts on record, the Applicant does not constitute an agency PE for US Co in India under the Tax Treaty.
• The amount of the Assignment fee received by US Co from the Applicant is in the nature of  business profits that has accrued or arisen in India under the ITL. However, as US Co has no PE in India the same is not liable to be taxed in India as per the Tax Treaty.
• The Applicant is not required to withhold tax under the ITL while making remittance to US Co as it has not derived any income chargeable to tax in India.

 Our View

The ruling affirms that consideration received for assignment of contractual rights should be treated as business profits not taxable in India, in the absence of the consideration being attributable to a PE of the transferor.

The ruling also clarifies that insulating an Indian affiliate from business risks by a foreign company by itself would not militate against a principal-to principal relationship of the parties. As such terms are meant for the business interests of the parties, they cannot create a dependent agency relationship.

There has been a recent controversy on whether withholding tax is applicable on all payments made to non-residents that are in the nature of income, regardless of the tax ability in the hands of the recipient. Despite a recent unfavourable High Court ruling on this point, the AAR has affirmed that in the absence of the payment being taxable in India, there would not be any requirement to withhold tax.

A ruling by the AAR is binding only on the Applicant, in respect of transaction in relation to which the ruling is sought and on the Tax Authority, in respect of the Applicant and the said transaction. However, it does have persuasive value and the Courts in India, the Tax Authority and the appellate authorities do recognise the principles and ratio laid down by the AAR, while deciding similar cases.

NF