Payment made to foreign company for outright purchase of plant and know-how cannot be considered as ‘Royalty’

Recently, the Himachal Pradesh High Court in the case of CIT v. Maggronic Devices Pvt. Ltd. [2009-TIOL-568-HC-HP-IT] held that payment made by the taxpayer to a Singapore company for outright purchase of plant and product knowhow cannot be considered as ‘Royalty’ within the provisions of the Income-tax Act, 1961. Accordingly, no tax was required to be deducted while making payment to the Singapore company for acquiring such know-how outside India.

Facts of the Case

• The taxpayer was engaged in the manufacture of audio magnetic sound heads, which are used in various audio appliances like tap recorders, stereos, sound systems, telephone answering systems etc.
• The taxpayer entered into an agreement with a Singapore Company called Sankyo Seiki (Singapore) Pvt. Ltd. (Sankyo) for the purchase of

-plant know-how in the form of technical and engineering data, design data, drawings, sketches, photographs etc., and

-product know-how

for a sum 15 million Yen. The said agreement was approved by the Government of India and the Reserve Bank of India.

• The consideration was payable in three installments i.e. one third was payable on the date of agreement, one third upon the delivery of the documents of designs, machinery and plant and the final installment was to be paid after the commercial production would start. As per the agreement Sankyo also offered to make available the services of trained technicians for setting up the plant and machinery, if required by the taxpayer.
• The two directors of the taxpayer traveled to Singapore for signing the agreement and to purchase the plant know-how including designs, photographs, sketches, etc. and the consideration of 5 million yen was also made in Singapore by the directors to Sankyo.
• The taxpayer applied for No Objection Certificate (NOC) to the Assessing Officer (AO) to pay the consideration to Sankyo without deducting tax at source, on the grounds that no liability to pay tax had accrued in India. However, the AO refused to grant NOC to the taxpayer on the grounds that such payments was in the nature of ‘Fees for Technical Services’ (FTS) within the meaning of section 9(1)(vii) of the Act.
• The Commissioner of Income-tax and the Income-tax Appellate Tribunal (the Tribunal) allowed the claim of the taxpayer and the Tribunal held that since the plant know-how had been purchased by the taxpayer from Sankyo in Singapore, no part of income of the Sankyo was taxable in India. Further, such payments cannot be also considered as royalty even in terms of the extended definition of royalty provided by explanation 2 to section 9(1)(vi) of the Act.

Issues before the High Court

• Whether the payment made by the taxpayer to the Sankyo can be treated as a royalty under the provisions of the Act?

Taxpayer’s Contentions

• The taxpayer had purchased plant know-how which is covered under the definition of ‘plant’ under section 43 of the Act. Accordingly, the payments made cannot be considered as income within the provisions of the Act.
• Payment to Sankyo was towards the outright purchase of plant know-how and does not constitute royalty within the meaning provided by explanation 2 to section 9(1)(vi) of the Act.

Tax Departments Contentions

• The taxpayer had purchased right to utilise the rights in respect of a patent, invention, model from Sankyo for which the taxpayer was liable to make payment and therefore, such payment was royalty within the meaning of Section 9(1)(vi) of the Act.
• The tax department also contended that since the agreement provided that the foreign company would send its technicians, if necessary, the agreement can be said for providing technical services.
• Accordingly, it was an income by way of royalty / FTS payable by the taxpayer who is resident in India as such liable to tax.

Ruling of the High Court

• The High Court after relying on the decisions of the Supreme Court and its own decision in the case of Scientific Engineering House Pvt. Ltd. v. CIT [1986] 157 ITR 86 (SC) and CIT v. Shivalik Hatcheries Pvt. Ltd. [2008] 222 CTR 299 (HP) respectively held that even drawings, designs, processing data, etc. constitute ‘plant’ within the meaning of the Act.
• The High Court further observed that facts of the current case was similar to the case of ITO v. Shriram Bearings Ltd. [1987] 164 ITR 419 (Cal) where the Calcutta High Court had held that no part of the activity or operation related to the sale of trade secrets carried out or took place outside India can be considered as income under section 5(2) of the Act. The High Court also noted that the decision of the Calcutta High Court was also upheld by the Supreme Court in the case of  ITO v. Sriram Bearings Ltd. [1997] 224 ITR 724 (SC).
• Further, the High Court distinguished the ruling of the Calcutta High Court in the case of Leonhardt Andra Und Partner, GMBH v. CIT [2001] 249 ITR 418 (Cal) observed that in the above case the Indian company was not entitled either directly or indirectly to make use of the documents supplied to it by the foreign company beyond the works to which the contract was entered into. However, in the current case there was an outright transfer of know-how in the form of data, drawings, designs, etc. from Sankyo to the taxpayer. Accordingly, in the current case the taxpayer was the owner of the know-how and it was allowed to use the know-how for any purpose albeit after a period of five years.
• Even though the Sankyo had agreed to provide technical assistance to the taxpayer through its technicians, if required, no such technical assistance was required by the taxpayer or provided by the Sankyo.
• The Sankyo neither had business nor any plant in India. The transaction also took place in Singapore and the agreement was entered into between the parties at Singapore and the documents were handed over to the representative of the taxpayer at Singapore. Accordingly, it was a case of outright purchase of plant know-how and not a case of transfer of interest.
• Accordingly, the High Court upheld the decision of the Tribunal holding the payment made by the taxpayer to Sankyo was not royalty within the definition of section 9 of the Act.

Our Comments

In this case the payment was made for purchase of know-how where the entire transaction took place outside India. Based on the above facts the High Court has once again laid down an important principle that payment for outright purchase of know-how is not taxable as ‘royalty’ under the Act. Accordingly, no tax needs to be deducted while making payment to a non-resident for acquiring know-how outside India.

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