Payment made in pursuance of Cost Contribution Agreement by various entities of a Group in the R & D activities carried out centrally would not be liable to tax in India: AAR

Facts: ABB Limited (applicant), an Indian company, has various business divisions such as power products and systems, automation systems, process automation and robotics systems. The appellant is a part of the ABB Group, which is a leader in power and automation technologies that enable utility and industry customers to improve performance while lowering environmental impact.

As per the ABB Group’s Research & Development (R &D) Policy, all basic R & D for the ABB Group is coordinated and directed through ABB Research Ltd., Zurich (ABB Zurich). ABB entities, who wish to participate in the basic R & D, enter into a Cost Contribution Agreement (CCA) with ABB Zurich. As per the CCA, the entire costs or the basic R & D are shared between the ABB entities participating in the CCA, based on an allocation key. The participating ABB entities are allowed a royalty-free unlimited access to the research results including any intellectual property rights (IPRs) generated from the basic R & D under the CCA, which are legally owned by ABB Zurich.

The operative contract research activities under the CCA are performed within the ABB Group through Corporate Research Centres (CRC) in various countries and such CRCs are remunerated on a cost plus basis by ABB Zurich. Further, a coordination fee is payable by each participating ABB entity to ABB Zurich for its role as administrator and coordinating agency under the CCA. None of the personnel of ABB Zurich are required to visit India for rendering any work. Any fee received by ABB Zurich from licensing any IPR generated under the CCA to any entity including ABB entities, is used to reduce the overall costs of the basic R & D. The ABB entities participating in the CCA are ‘economic owners’ of the result results including any IPRs generated under the CCA. The CRCs do not have any rights to the research results or the IPR, and act only as contract research units for the ABB Group.

The applicant is interested in directly participating in basic R & D activities of the ABB Group and accordingly, it proposes to enter into a CCA with ABB Zurich.

The proposed CCA provides in the preamble that the parties wish to participate the funding of corporate R & D in the ABB Group in order to make optimum use of the available resources and to increase efficiency and reduce cost.

Question before the Authority for Advance Rulings (AAR):

• Whether the payment to be made to ABB Zurich in pursuant of the CCA, representing the applicant’s share of the costs incurred towards basic R & D activities, constitutes “income” in the hands of ABB Zurich within the meaning of section 2(24) of the Income-tax Act, 1961 (Act)?
• Whether the applicant is required to withhold tax under section 195 of the Act while remitting the proposed payment?
• Whether tax is required to be withheld on the entire payment in case the cost contribution payment and coordination fee are raised under a single invoice by ABB Zurich though identified separately?

Contention of the Applicant:

• The proposed cost contribution by the applicant as a participant to the CCA represents a reimbursement of the costs incurred by ABB Zurich towards basic R & D, the results of which are freely accessible by the applicant without any further payment.
• Any fee generated by ABB Zurich from licensing any IPR generated under the CCA is used to reduce the overall costs of the basic R & D, which are being shared amongst the ABB entities participating in CCA.
• The proposed payment cannot be described as consideration for any services proposed to be provided by ABB Zurich or payment towards any royalty as defined in Article 12 of the India-Swiss Double Tax Avoidance Agreement (DTAA).
• It constitutes only a pooling and coordinating arrangement under which the amounts proposed to be contributed by the applicant and other ABB entities participating in the CCA are credited to joint account from which the basic R & D expenses are met. It is, therefore, submitted that the payments made by the applicant under the CCA, being cost re-charged, based on an allocation key, do not constitute income in the hands of ABB Zurich.
• The applicant has clarified that the ‘coordinating fee’ charged by ABB Zurich will be subject to withholding tax under section 195 of the Act; but not the cost contribution payments made by way of reimbursement. Mere reimbursement of expenses cannot be construed as a receipt bearing the characteristics of income.
• Assuming that it is income, it would partake the character of business income only and therefore, in the absence of a permanent establishment (PE) of ABB Zurich in India the same would not be taxable in India as per Article 7 of the DTAA.

Contention of the Revenue: The proposed payment would fall under ‘fees for technical services’ and therefore, the same would be liable to tax.

AAR Observation and Ruling:

• The contention of the Revenue is unsupported by reasons. It cannot be said that ABB Zurich has rendered any service of technical or consultancy nature to the applicant when it makes available the results of corporate research to the applicant and other parties to the CCA. From the statement of facts and the contents of the CCA, it is clear that rendering of any service of the nature of managerial, technical or consultancy is not involved and moreover, ABB Zurich does not deploy any personnel to perform any services in India.
• The Payment is not being made by the applicant to ABB Zurich in consideration of the conferment of any rights in respect of any of the items enumerated in the definition of ‘royalty’ as given in DTAA and the Act. These are broadly IPRs. ‘Information’ is defined in CCA as “the knowledge (data, technical documents, experience)”. The information obtained by the applicant as a result of corporate R & D envisaged by the CCA would normally fall within the definition clause. It could be “information concerning industrial or scientific experience”. However, ABB Zurich or the CRCs would not be receiving the consideration for transferring or conferring such rights or benefits. As far as the CRCs are concerned, they do not retain any IPR in the fruits of research and they do not commercially exploit them.

• ABB Zurich has not any right to withhold the research information/ results from the participating group entities who are signatories to CCA. Even the grant of license of license by ABB Zurich is not contemplated. Every party to the CCA has a right flowing under the terms of the CCA itself to avail of the fruits of research in its own right.
• Though the legal ownership of IPR rests with ABB Zurich as a matter of convenience and by mutual agreement, the beneficial ownership of the products of research belong to all those ABB Group entities which have signed the CCA. The resources are pooled by all the entities which are parties to CCA to promote corporate R & D for common benefit. The cost contribution formula is evolved so as to ensure the distribution of the burden of actual cost amongst the participating entities.
• The fact that R & D information can only be accessed by the parties to CCA and the licensed income derived by the limited commercial exploitation of IPR would go to reduce the amount which the participants would have to contribute are clear pointers that an internal arrangement has been evolved by the participating group entities through a joint endeavour to reap the benefits of research conducted by an organised set up of R & D Board consisting inter alia of the representatives of those entities.
• ABB Zurich merely acts as a coordinating agency for the purpose of recouping the costs that are contributed by the various participants and acts as medium for organising and providing the CRCs with the funds for the research that is carried out.
• The manner in which the corporate funding will be arranged by the R & D Board and ABB Zurich based on budgeted cost and revised cost would indicate that the parties to CCA have devised a methodology to reimburse the actual cost.
• In view of the above, the payments made by the applicant to ABB Zurich cannot be treated as payments in the nature of royalties or fees for technical services as defined under Article 12 of the DTAA. As ABB Zurich has no PE in India, the business income would also not be liable to be taxed as per Article 7 of the DTAA. The applicant is, therefore, not under an obligation to withhold tax under section 195 of the Act. However, the AAR has held that its ruling does not preclude inquiry in an appropriate proceeding as to whether the cost contribution is on arm’s length basis.
• In this connection, the AAR has relied upon the decisions in the case of CIT v. Dunlop Rubber Co. Ltd. (143 ITR 493)(Cal) and Decta (237 ITR 190)(AAR). Further, the AAR has observed that ruling in the case of Danfoss Industries Ltd. (268 ITR 1 )(AAR) does not in any way support the plea of royalty. The AAR has also referred to para 8.3 on CCA given under Chapter VIII of the OECD Guidelines on Transfer Pricing for Multinational Enterprises and Tax Administrations.
• As regards the coordination fee is concerned, the applicant is under an obligation to withhold the tax thereon even though the same and cost contribution payment are raised and identified separately under a single invoice.

Our View: This is an important AAR ruling on a cost contribution arrangement for participation by various entities of a Group in the R & D activities carried out centrally. This ruling, while coming to the conclusion whether the payment by way of cost contribution is royalty or fees for technical services, has also touched base upon important ingredients of CCA, like, devising of a methodology to reimburse the actual cost, sharing of cost based on a pre-agreed allocation key reflecting the benefits, direct nexus between the actual cost and cost contribution payment, common benefits, economic ownership, etc. It is, therefore, of utmost important for a multinational company to keep in mind the above key ingredients before entering into a CCA for the activities carried out centrally for its group companies. The AAR has also correctly pointed out that the payments made in pursuance of CCA should also meet the arm’s length standard as per the transfer pricing regulations.

Although the AAR Ruling is applicable only in the case of an applicant who has sought it, it nevertheless carries a persuasive value.