Taxability of Payment for assignment of contractual rights in connection with the supply of products to foreign company not having PE

Recently, the Authority for Advance Rulings (AAR) in the case of Laird Technologies India Pvt. Ltd. [2010-TIOL-06-ARA-IT]  has held that the fees received by the USA company for assigning contractual rights to the applicant for supply of products in India is taxable as business profits and in the absence of a Permanent Establishment (PE) such consideration is not taxable in India under the India- USA tax treaty (the tax treaty). Accordingly, tax is not required to be deducted under section 195 of the Income Tax Act, 1961 (the Act) while making remittance outside India.

Facts of the case

• The applicant is a group company of a UK based company. It is engaged in the business of designing and manufacturing of antenna and battery packs for the mobile phone industry.
• Laird Technologies Inc, a USA company (Laird USA) is a globally known designer and manufacturer of antennae, EMI, data communications, etc. The Laird USA entered into a Product Purchase Agreement (PPA) with Nokia Corporation globally, including India to supply products in relation to Nokia’s manufacturing requirements in India.
• In connection with the supply of products to Nokia India Pvt Ltd (Nokia India), the Laird USA entered into an Assignment Agreement (the Agreement) with the applicant for a period of five years for a lump sum consideration. Under the Agreement, the Laird USA assigned all its beneficial rights, title, interest, obligations and duties in connection with supply to Nokia India under the PPA in favour of the applicant.

Issues before the AAR

• Whether the amount received by the Laird USA as assignment fees from the applicant is taxable under the Act or the tax treaty?
• Whether the applicant is required to withhold tax even if the assignment fee is not taxable in the hands of Laird USA?

Applicant’s contentions

• Section 55 of the Act specifically recognises “right to manufacture, produce or process any article or thing” or “right to carry on any business” as capital asset. PPA entered into by Laird USA with Nokia constitutes capital asset since Laird USA had acquired the right to manufacture and supply the specified products to Nokia Corporation globally.
• The situs of PPA contract is outside India where it was entered into and signed by the parties. Further, the Agreement was executed outside India and Laird USA received assignment fees outside India. Thus, the capital gains was arising to Laird USA on transfer of a capital asset which was situated outside India. Therefore, no tax can be levied on the taxpayer in India.
• Further, even if the consideration received by Laird USA under the Agreement is construed as business profits, the tax cannot be levied in India in the absence either business connection between Laird USA and the applicant within the meaning of section 9(1 )(i) of the Act or any PE of Laird USA in India.
• The applicant is not acting as an agent of the Laird USA and it has been carrying on its business operations by itself without any direction or instructions from Laird USA, bearing the risk and responsibility of its business transactions. Further, the applicant was supplying products to Nokia India on a principal to principal basis and not on behalf of Laird USA.

Tax department’s contentions

• Laird USA 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.. Therefore, the question of assignment of rights and obligations under the PPA to its affiliate does not arise.
• The PPA only casts a host of obligations upon Laird USA without any consideration flowing to it and any legal right derived by it. In the absence of any legal right accruing to Laird USA under the PPA, there is no question of assignment of any rights in favour of the applicant. Hence, no asset can be said to have been transferred to the applicant outside India.
• Under the Agreement, there can be assignment only of the rights and benefits under the contract but not the burden and obligations.
• Assignment of obligations alone is not recognised by law and such assignment of obligations of Laird USA under the PPA to the applicant requires a novated tripartite agreement between Laird USA, applicant and Nokia Corporation.
• As per clause 5 of the PPA, Laird USA 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. Therefore, the business network of LSP who would import goods on behalf of Laird and deliver them to Nokia at site constitutes the PE of Laird USA.
• The applicant is wholly dependent on Laird USA for its business of supplies of products to Nokia. Further, as per the Agreement Laird USA continues to have legal commitments in respect of guarantee of risks of volume of sales and minimum insurance cover.

AAR’s ruling

On the taxability as capital gains

• The AAR observed that it was not clear whether Nokia had consented to or ratified the Agreement and therefore there is no valid assignment in the eyes of law. Mere fact that the 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 backed up by an express or necessarily implied consent of Nokia Corporation, the AAR rejected the contention of the applicant that there was legal transfer of capital asset and that the consideration shall be deemed to be the capital gain. However, irrespective of the validity of the assignment and the fact that there is no transfer of capital asset, the consideration received by Laird USA would still be income in the nature of business profits in the hands of the recipient.

On the formation of PE

• The AAR observed that the Laird USA actively assisted the applicant in setting up the manufacturing facility in India within the framework of the understanding reached between Laird USA and Nokia India. However, there is nothing on record that Laird USA had any other role to play in the manufacturing and business activities of the applicant thereafter. Further, once the necessary authorisation to manufacture and supply the products to Nokia India has been given by Laird USA, Laird USA cannot carry on the same business in India or interfere with the business carried on by the applicant.
• LSP was never appointed or provided by Laird USA to fulfill its obligations of delivery of products to Nokia. Accordingly, it is unreasonable to draw inference that the business profits representing the consideration paid under the Agreement is attributable to the PE in the form of LSP, or any other place of business.
• As regards the tax department’s contention that the applicant is wholly dependent on Laird USA for its business of supplies of products to Nokia, the AAR after referring the various clauses of the Agreement held that the agency PE was not formed within the meaning of article 5(5) of the tax treaty. Further, the tax department has also failed to elaborate as to how and in what manner the applicant depends on Laird USA which has already assigned its rights.
• The clauses relating to guarantee of risks of volume of sales is meant in the business interests of both the parties to the Agreement and it cannot be construed to mean that the applicant acts as an agent much less as a dependent agent of Laird USA in supplying the products to Nokia India. The AAR after relying on its own ruling in the case of ABC Limited, In re [2006] 289 ITR 438 (AAR) also observed that these provisions by themselves do not militate against the relationship of principal to principal between Laird USA and the applicant.

On taxability and withholding tax

• The AAR held that the amount of consideration received by Laird USA from the applicant is in the nature of business profit. However since the Laird USA has no PE in India the consideration received by it is not liable to tax in India. Since Laird USA has not derived any income chargeable to tax in India, the applicant is not required to withhold tax under section 195 of the Act while making remittance to Laird USA.

Our Comments

This is a welcome decision by the AAR holding that since no income is chargeable to tax in India, the applicant is not required to withhold tax under section 195 of the Act while making remittance to the foreign company. Further, it also reaffirms that the consideration received for assignment of contractual rights should be treated as business profits and it will be taxable only if the recipient is having a PE in India.

It is important to refer to the decision of the Karnataka High Court in the case of CIT v Samsung Electronics Co Ltd and others [2009] 185 Taxman 313 (KAR), wherein it was held that any payment made to a non-resident which bears a semblance to the character of income, the payer would have an obligation to withhold tax under section 195 of the Act.

Subsequently, the Delhi High Court in the case of Van Oord ACZ India (P) Ltd. v. CIT [2010-TIOL-187-DEL-IT] held that under section 195 of the Act the taxpayer is required to deduct tax while making payments to the non-resident only when such payment is taxable in India in the hands of non-resident. However, the Delhi High Court has also observed that in case the taxpayer contends that the deduction of tax is required to be made at a rate lower than prescribed rate or there is no need for deduction of tax, the taxpayer is required to file an application to the AO under section 195(2) of the Act.

Recently, the AAR in the below-mentioned rulings have also held that the taxpayers are not required to deduct tax under section 195 of the Act on the payments made to non-residents if such sum is not taxable in India.

It is not clear from the stated facts whether the decision has examined fully the question raised before it that whether the amount receivable by Laird USA as per the assignment agreement is taxable in India having regard to the provisions of the Act and the tax treaty? The AAR could have examined the applicability of the “other income” clause as per the tax treaty..

Please note that an AAR ruling is binding on the applicant, in respect of transaction in relation to which the ruling is sought and on the tax authorities. However, it carries persuasive value before the tax tribunals/ courts.

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NF