R. Kumar, B.Com. MBA (Finance)
Whether or not the royalty/fees for technical services is taxable in India in the hands of the non-resident, will depend on provisions of Income Tax Act, 1961 (‘Act’) and the relevant Double Taxation Avoidance Agreement, if any. Further whether such royalty/ fees for technical services will also be taxed in the home country of the recipient will depend upon the provisions of the tax laws of such home country.
The Article on royalty and fees for technical services in a treaty assumes significance, since the assessee in view of provisions of section 90 (2) has an option to opt for taxation either under the Act or under the treaty, whichever is beneficial to him. It has been held that while determining the liability of a non-resident company in India, if there is any DTAA entered into under section 90 of the Act, the provisions of the DTAA must prevail over the provisions of the Act. CIT Vs. Visakhapatnam Port Trust [(1983) 144-ITR-146].
Meaning & Definition:-
Royalties, sometimes simply referred to as ‘royalty’, is typically the sum of money paid to the proprietor or Licensor of Intellectual Property (IP) Rights for the benefits derived, or sought to be derived, by the user (the Licensee) through the exercise of such rights. Royalties may be paid for the use of copyright, patent, trademark, industrial design, procedural knowledge or a combination of them. However, the term has also a much wider application and can cover mining royalties, performance of art royalties, etc.
The exclusivity of the right in relation to the thing for which royalty is paid should be with the grantor of that right. Mere passing of information concerning the design of a machine which is tailor-made to meet the requirement of the buyer does not by itself amount to transfer of any right of exclusive user so as to render the payment made therefore being regarded as royalty. That was what Mr. Justice Jayasimha Babu observed in a ruling in CIT Vs. Neyveli Lignite Corporation Ltd (2007) 243-ITR-459.
Black’s Law Dictionary defines “[r]oyalty” as “compensation for the use of property, usually copyrighted material or natural resource, expressed as a percentage of receipts from using the property or as an account per unit produced … …” As generally understood, royalty is most often associated with the fee paid to a patentee for the use of a patent or the money owed to an author for each copy of a book sold. A Texas court has ruled that royalty is the share of a product or a profit reserved by the owner for permitting another to use the property. (Alamo Nat. Bank of San Antonio Vs. Hurd, Tex. Civ. App., 485 S. W. Zd. 335, 338) Thus, the salient feature of a royalty payment is that it is given as a compensation for the use of some property.
Sec. 9 of the income-tax (I-T) code deals with income deemed to accrue or arise in India. Royalty is dealt with in Sec. 9(1)(vi). Explanation 2 to Sec. 9(1)(vi) defines the term royalty in a fairly exhaustive way — it means, inter alia, the transfer of any right or the granting of a licence in respect of a patent, design, process, secret formula or similar property. It also takes in the imparting of any information concerning technical, industrial, commercial or scientific knowledge or skill and the use of the patent, design, and so on.
Explanation 2.—For the purposes of this clause, “royalty” means consideration (including any lump sum consideration but 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 trade mark 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 or 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).
The rendering of any services in connection with these will also be part of royalty payments. In a contract for the design, manufacture, supply, erection and commissioning of machinery, not involving licence of the patent concerning the machinery or copy right of its design, mere supply of drawings before commencement of manufacture and the supply of diagram and other details can only be incidental to the performances of the total contract which included design, manufacture and supply of the machinery.
Fees for Technical Services:-
The expression “Fees for Technical Services” is defined in Explanation 2 in section 9(1)(vii) of the Income -tax Act as under:
“For the purposes of this clause, ‘fees for technical services’ means any consideration (including any lump sum consideration) for the rendering of any managerial, technical or consultancy services (including the provision of services of technical or other personnel) but does not include consideration for any construction, assembly, mining or like project undertaken by the recipient or consideration which would be income of the recipient chargeable under the head “Salaries”.
Technical word has been defined by The Oxford Dictionary- 2nd Edition [Vol. XVII] published by Clarendon press- Oxford at page 703 defines ‘technical’ as follows:-
“….3.a. Belonging or relating to an art or arts: appropriate or peculiar to, or characteristic of, a particular art, science, profession, or occupation; also, of or pertaining to the mechanical arts and applied sciences generally, as in technical education, or technical college, school, university.”
In the case of Skycell Communication Ltd. [(2001)251-ITR-53(Mad)], “The popular meaning associated with “technical” is “involving or concerning applied and industrial science”. In the modern day world, almost every facet of one’s life is linked to science and technology in as much as numerous things used or relied upon in every day life is the result of scientific and technological development. Every instrument or gadget that is used to make life easier is the result of scientific invention or development and involves the use of technology. On that score, every provider of every instrument or facility used by a person cannot be regarded as providing technical service.”
1. New Skies Satellites vs. ADIT[(2009) 30-DTR-289 (TDELS)]
The assessee, a foreign company, was engaged in operating geostationary telecommunication satellites with transponder capacity which were provided to telecasting companies in India for a fee. The question arose whether the said fee was “consideration for … the use of any … secret formula or process …” so as to constitute “royalty” under Expl. 2 to s. 9 (1)(vi) and corresponding definition under the DTAA.
In Asia Satellite Telecommunications Co. Ltd. Vs. Deputy Commissioner of Income tax [(2003)85-ITD-478(TDEL)] the Tribunal held that the said receipts were taxable as `royalty’ having been paid in respect of a “process”. However, in DCIT Vs. PanAmSat [(2006) 9-SOT-100] it was held that as in the term “royalty” in Art. 12 of the India-USA DTAA there was a `comma’ after the words “secret formula or process”, it was only a `secret process’ which would qualify as royalty and not what was provided by the assessee. To resolve the conflict, the issue was referred to the Special Bench. HELD, reversing PanAmSat:
(i) The provision of the transponder through which the telecasting companies are able to uplink the desired images/data and downlink the same in the desired area is a “process”. To constitute “royalty”, it is not necessary that the process should be a “secret process”. The fact there is a `comma’ after the words “secret formula or process” in the DTAA does not mean that a different interpretation has to be given to the DTAA as compared to the Act;
(ii) The argument that there is no “use” of the satellite by the payer as it has no control or possession of the satellite is not acceptable. To constitute “royalty”, it is not necessary that the instruments through which the “process” is carried on should be in the control or possession of the payer. The context and factual situation has to be kept in mind to determine that whether the process was “used” by the payer. In the case of satellites physical control and possession of the process can neither be with the satellite companies nor with the telecasting companies. The fact that the telecasting companies are enabled to telecast their programmes by uplinking and downlinking the same with the help of that process shows that they have “use” of the same. Time of telecast and the nature of programme, all depends upon the telecasting companies and, thus, they are using that process;
(iii) The consideration paid by telecasting companies to satellite companies is for the purpose of providing “use of the process” and consequently assessable as “royalty” under the Act and the DTAA.
2. Pintsch Bamag Antriebs-und Verkehrstechnik , in Re. [(2009) 184-Taxman-122]
Held that It is not possible to hold that the place of manufacture of the sub-contractor situated far away from the installation site should notionally be regarded as part of the applicant’s PE; occasional or brief visit by some of the employees of the applicant right from the beginning does not give rise to inference of the existence of PE; hence, its business profits arising from the periodical payments made by TPT as a consideration for the contract cannot be subjected to tax under the Income-tax Act, 1961 in view of Article 7.1 of DTAA between India and Germany.
3. DDIT (IT) Vs. Pipeline Engineering Gmbh [(2009) 28-SOT-121 (BOM)]
Any amount received by a non-resident in pursuance of an agreement made before 1-4-2003 is to be governed by the provisions of section 44D of the Income-tax Act; the words `according to the domestic law of the contracting State in which the PE is situated’ appearing in Article 7(3) of DTAA between India and Germany are the words of significance which, would only mean that the expenditures incurred by the non-resident assessee for the purpose of business of the PE in India would be allowable in accordance with the provisions of domestic law i.e., Income-tax Act, 1961; consequently, no deduction is to be allowed against the receipts by way of royalties or fees for technical services in case of non-resident company, even if the business profits in respect of such income are to be computed under Article 7 of the DTAA.
4. Commissioner of Income Tax Vs. Samsung Electronics Co. Ltd. [(2009) 185-Taxman-313 (Kar.)]
The Authority for Advance Ruling (“AAR”) has, in its recent ruling in the case of Dassault Systems K.K. (“Applicant”), now provided some succor to the software industry. In a very well reasoned and detailed ruling, the AAR held that payments received from import of software products cannot be characterised as “royalties” but should be characterised as “business profits”. Therefore, in the absence of a Permanent Establishment (“PE”) of the non-resident supplier in India, such payments would not be taxable in India.
5. Commissioner of Income Tax Vs. Neyveli Lignite Corporation Ltd. [(2007) 293-ITR-362 (Msd)]
Neyveli Lignite Corporation (NLC) acquired steam generating plants with auxiliaries. It entered into an agreement with a Hungarian company, Trans Electro. The Hungarian supplier undertook the design, manufacture and supply of all imported equipment and components as well as supervision of erection, testing and commissioning of the machinery. It provided an engineer for the guarantee period. The agreement covered supervision of erection, testing and commissioning of the plant. NLC applied for a no-object ion certificate under Sec. 195 for remittance of fees for design and engineering. The income-tax officer (ITO) took the view that the amounts payable for design and engineering had accrued to the foreign contractor in India in the assessment year 1981-82 and was assessable under the Indian I-T Act. The matter reached the High Court.
The court went into the details of the terms of the contract and explained the provisions of Sec. 9. It noted that the contract nowhere referred to any specific patent owned by Trans Electro and there was no question of NLC exploiting such patent. Only a n indemnity was provided against third party action in respect of the patent in the equipment supplied. None of the sub-clauses in and Explanation 2 under Sec. 9(1)(vi) can be regarded as covering the design and engineering carried out by Trans Electro a broad.
Information concerning the working of the machine was incidental to its supply. The amount paid as part of the total contract price towards design and engineering was not royalty under Sec. 9(1) and the amount paid did not result in the accrual of the in come to Trans Electro.
6. Commissioner of Income Tax Vs. Ruti Machinery Works Ltd.[(2000)109-Taxman-407 (Mad.)]
Ruti Machinery Works Ltd, a company incorporated in Switzerland, had a record of 130 years in the manufacture of weaving machines. It entered into a collaboration with Lakshmi Automobile Loom Works Ltd. There was an Indian subsidiary in which Ruti was a 25 per cent shareholder. On the products manufactured by the Indian company and marketed in India and abroad, royalty was payable. All the documents relating to the manufacture were to be handed over in Switzerland only and consideration was payable in c ash in Switzerland. Royalty was to be paid at the rate of 5 per cent on domestic sales. Obviously, the collaboration agreement involved both know how and royalty. The Madras High Court held (in 243 ITR 442) that consideration for documentation handed over in Switzerland was not exigible to the Indian income-tax. That income did not accrue or arise in India.
However, in respect of the royalty payment, the court came to the conclusion that the business was carried on in India under licence and that there was business connection between the assessee and the Indian company; and the income by way of royalty from the Indian company had accrued or arisen in India and was taxable.
7. CIT Vs. HEG India, [(2003) 130-Taxman-72 (MP)]
To determine the exact nature of the payment made, the type of information passed on needs to be verified. Payments made for all kinds of information given cannot be broadly classified as royalties. In a recent case, an Indian company paid a certain amount to a US firm to obtain information concerning certain technical knowledge of the US Company. In this regard, the Madras High Court held that payments made to obtain mere data or a calculation sheet could not be treated as royalty payments. In order to withhold tax on payments for information received, the information should have some special features and should not merely be of a pure commercial nature.
8. Pro-Quip Incorporation Vs. CIT [(2002)122-Taxman-588(AAR)]
The Calcutta High Court has ruled that sale of know-how cannot be taxed as royalty. CIT Vs. Davy Ashmore India, 190-ITR-626 In this case, the non-resident company did not retain any property in the designs and drawings, and the designs and drawings had been imported under India’s import policy after obtaining the prior approval of the Reserve Bank of India. A royalty payment must be in respect of a right to use designs and drawings, and not for the purchase thereof.
Under the India-USA DTAA, payments for alienation/transfer of property would be taxable as royalty only if the payments were contingent on the use or disposition of the property.
9. CIT Vs. Ahmedabad Manufacturing and Calico Printing Co. [(1983) 139-ITR-806]
A one-time payment for the grant of right to use the property can be classified as royalty. The Gujarat High Court has held that a royalty may well be a single payment covering the whole use of the patent for the whole term, even though the usual practice is to make periodic payments and to relate the amounts of those payments to the actual use of the patent by the licensee. Therefore, a onetime payment or payments on an ongoing basis may be characterized as royalty, provided that the payment(s) is made for the right to use the property.
10. Bovis Lend Lease (India) Pvt. Ltd. Vs. ITO [(2009) TIOL-666-ITAT (Bang.)]
The Income Tax Appellate Tribunal, Bangalore Bench (“ITAT”) has expended the scope of ‘fees for technical services’ to include services are rendered by a group company for assistance with day-to-day operations, where such services are in the nature of administrative, accounting and legal services. However, on grounds that the services was rendered offshore, the ITAT held that payments were not taxable in India and hence not liable to deduction of tax at source in India.
In the light of the above judgments, various points need to be examined before concluding that a payment is actually a royalty payment/ Fees for technical services.
(Author can be reached at [email protected])
(Republished With Amendments)