Mumbai bench of the Income-tax Appellate Tribunal (the Tribunal) in the case of Siemens Aktiencesellschaft Vs. DCIT [201 1-TII-52-ITAT-MUM-INTL held that royalty received by the Siemens Aktiencesellschaft (taxpayer) was in pursuance of an agreement entered into before 1976 and therefore not covered under Section 115A of the Income-tax Act, 1961 (the Act). Accordingly, the taxpayer was subject to 50 percent tax on such royalties.
Facts of the case
• The taxpayer, a non-resident German company, entered into a 10- year agreement with Bharat Heavy Electricals Ltd (BHEL) in June 1974 (1974 agreement). The taxpayer agreed to transfer technical know-how and to provide BHEL with technical assistance and design information for designing and manufacturing industrial turbines. The parties had agreed that apart from industrial turbines specifically mentioned in the agreement, the taxpayer would be under an obligation for transfer of technology related to other industrial turbines as well.
• Accordingly, the taxpayer agreed to grant BHEL non-transferable, non-exclusive manufacturing rights in India for a lump sum payment, payable as per a time schedule. Royalty would be payable at 4 percent of the selling price of industrial turbines and at the rate of 4.5 percent for export sales.
• In August 1976, BHEL also entered into an agreement with Kraftwerk Union Aktiengesellschaft (KWU), a subsidiary of the taxpayer company, for transfer of technical know- how /innovation /trademark, copy right, patent relating to steam turbines-generators of 200 MW to 1000 MW.
• The taxpayer, KWU and BHEL, agreed to amend the earlier agreements and accordingly entered into a tripartite agreement in July 1981 (1981 agreement). Under the amended agreement, while KWU agreed to supply steam turbines in the range of 100 MW to 200 MW, the taxpayer agreed to supply steam turbines below 200 MW.
• Before the AO, the taxpayer explained that tax on the royalty earned from BHEL should be taxed at the rate of 40 per cent and 30 per cent for the relevant assessment years as per Section 11 5A of the Income-tax Act, 1961 (the Act).
• The AO disallowed the taxpayer’s claim, holding that the royalty was earned following an agreement entered into in June 1974. Therefore, it would not come within the ambit of section 115A of the Act and accordingly was to be taxed at 50 percent.
Section 115 A of the Act was inserted with effect from 1 June 1976. Prior to that royalty income was to be taxed @50 percent
• As per the 1974 agreement, the technology was transferred for the type of Industrial Turbines and designed as mentioned in the “EX- ’A”, whereas the royalty received by the taxpayer was in respect of steam turbines and product below 200 MW as per the 1981 agreement.
• The taxpayer relied on the Special bench decision of the Calcutta Tribunal in the case of Chloride India (2000) 75 ITD 69(CAL)(SB)and contended that when the earlier agreement has expired and a new agreement has been entered into and even all the terms and conditions of the agreement are same, the second agreement would be a new and separate agreement and not the extension of the earlier agreement.
• Reliance was also placed on Mumbai Tribunal’s decision in the case of DCIT v. Glaxo Group ltd, UK (ITA No. 8383 and 8364) (Bom) wherein it was held that even if there is no change in the terms of the subsequent agreement, it would be a new and separate agreement and not an extension of the earlier agreement.
• Further reliance was placed on the Bombay High Court decision in the case of Andheri Bridge View Co-op. Hsg. Society Ltd v. Krishnakant Anandrao Deo and ors (AIR 1991 Bombay 129) wherein it was held that when there are substantial or material changes which go to the root of the agreement then this has to be regarded in law as a new agreement.
• Turbines/generators in the 1974 agreement are different from the 1981 agreement. Therefore the 1981 agreement would be separate and new and not an extension of the existing agreement.
• The 1974 agreement was for a term of 10 years and expired in 1984. Therefore, royalty received by the taxpayer in the relevant assessment years was under the 1981 agreement and in respect of the transfer of technical know-how of a different type of turbines.
Tax department’s contentions
• The 1974 agreement was the umbrella agreement and the 1981 agreement was a mere extension of the 1974 agreement.
• Approval given by the Government of India for acquiring the technical know-how was for amendment of the 1974 agreement which is in the nature of extension and not for any new agreement between the parties.
• It was agreed upon between the parties at the time of the 1981 agreement that the terms and conditions of the 1974 agreement would be applicable even after its expiry.
• The terms and conditions for the turbines which were not included in the EX ”A” were given in EX “D” of agreement of 1974 and therefore the agreement for amendment of the earlier agreement entered into by the parties in the year 1981 is only an extension of the earlier agreements.
• The decision in the case of Chloride India and Glaxo Group ltd, UK was not applicable in the facts and circumstances of the present case because in those cases the new agreement was entered after expiry of the existing agreement whereas in the taxpayer’s case, the amendment agreement was entered into during the validity of the existing agreement of 1974.
• The taxpayer and BHEL agreed for transfer of technology, other information and assistance for the industrial turbines and other specific types of turbines which were mentioned in the EX “A” of the agreement of 1974. It was also agreed by the parties that apart from the industrial turbines as mentioned in the EX “A”, the taxpayer would be under obligation for the transfer of technical know-how of other industrial turbines as per the terms and conditions of the EX “D” of the 1974 agreement.
• Through the 1981 agreement, the parties identified the particular industrial turbines for which the technical know – how was to be transferred, as per the terms and conditions as set out in the EX “D” of the original 1974 agreement. The subject matter of the 1981 agreement was only the performance by the parties in pursuant to the 1974 agreement for transfer of the technology of industrial turbines manufactured by the taxpayer.
• Section 62 of the Contract Act allows novation/ recession/modification and alteration of earlier contract with a new agreement. Novation means the intention of the parties to supersede the old contract by the new one. By virtue of the substituted agreement the original contract gets extinguished and perished.
• In order to determine whether the agreement dated 1981 is a new agreement it has to be seen whether under the new agreement prior rights of the parties are extinguished and new rights and obligation came into existence and as a result the original agreement /contract gets obliterated and wiped out. Further, it has to be examined whether the parties are bound by the terms and conditions mentioned in the amendment agreement and not by the original agreement.
• As per the 1974 agreement, the BHEL was entitled to expand the scope of transfer of technology in terms as agreed between the parties. Accordingly, BHEL has proposed to acquire the technology for industrial turbines less than 200MW which was not transferred initially. The exercise of such right of the BHEL was well within the scope and terms and conditions of the 1974 agreement. Therefore, the 1981 agreement is only an act of exercising the existing rights by the BHEL as per the terms of the 1974 agreement.
• Further, the 1974 agreement was in operation and legally enforceable and had not expired when the parties agreed to enter into the 1981 agreement. The amendment within the scope and the provisions made in the original agreement does not amount to novation or alteration of the original agreement. Therefore, the 1981 agreement was only a written expression of performance of respective part by the parties as per the terms adopted in the original agreement.
• The basic principle behind the concept of novation is the substitution of a contract by new one only through the consent of the parties which may be expressed in the written agreement or implied through their action or conduct. There was no implied or expressed intention or conduct of the parties to terminate the 1974 agreement at the time of the 1981 agreement. Accordingly, the rights under the original agreement were kept alive even after the 1981 agreement and therefore there is no substitution or novation of the original agreement.
• The Tribunal distinguished the cases relied on by the taxpayer on the basis of facts since in the present case the amendment is during the validity of the 1974 agreement.
Accordingly, the Tribunal held that the royalty received by the taxpayer during the relevant assessment years was in pursuance to the 1974 agreement and consequently, subject to tax at 50 percent.
This is an important ruling by the Mumbai Tribunal where it is held that royalty received by the taxpayer was in pursuance to agreement entered into before 1976 and therefore not covered under Section 1 15A of the Act. The Tribunal has meticulously examined concepts such as novation/recession/modification and alteration as provided in the Contract Act to analyze the substance of the agreement and in conclusion rule that the 1981 agreement was an extension of 1974 agreement.
While commercial prudence is essential for any agreement, the judgment brings out the importance of appropriate documentation especially from the tax angle which would have the ultimate bearing on the interpretation and the cost effects of a contract.