INTRODUCTION
Intellectual property involves the creations of the mind, such as inventions; literary and artistic works; designs; and symbols, names and images used in commerce. As a form of property right, intellectual property can be considered as assets that can be bought, sold, mortgaged, exchanged, and licensed like physical property. Intellectual property is safeguarded only if rights are given to the producers of intellectual property. IP confers on individuals, enterprises or other entities the right to exclude others from the use of their creations[1]. Economic activities are now increasingly driven by inventions and innovations. When we are paying for a product, a part of that payment goes to the inventor in the form of royalties[2].
Based on their specific nature, intellectual property is often divided into two categories: Industrial property, which includes patents (inventions), trademarks, industrial designs, and geographic indications of source; and Copyright, which includes literary and artistic works such as novels, poems and plays, films, musical works, artistic works such as drawings, paintings, photographs and sculptures, and architectural designs[3].
WTO’s TRIPs Agreement classifies intellectual property rights into following groups[4].
- Copyright and related rights: Copyright is a legal term used to describe the rights that creators have over their literary and artistic works. Works covered by copyright range from books, music, paintings, sculpture and films, to computer programs, databases, advertisements, maps and technical drawings. protects rights related to literary and artistic creations, including: Art and literary works: Books, film, sound recordings, software, designs Performances Radio and TV broadcasters, Technology-based works such as computer programs and databases[5].
- Patents: A patent is an exclusive right granted for an invention. A patent provides the patent owner with the right to decide how – or whether – the invention can be used by others. In exchange for this right, the patent owner makes technical information about the invention publicly available in the published patent document[6].
- Trademarks: A trademark is a sign capable of distinguishing the goods or services of one enterprise from those of other enterprises. We don’t need to register a trademark to have it. You can have a trademark just by regularly using a symbol or design to represent your product. However, it’s important to register your trademark because registration gives you a legal presumption of ownership. A trademark can last forever. When you have a trademark, you have the exclusive rights to make and sell products that use the trademark[7].
- Geographical indications: Geographical indications and appellations of origin are signs used on goods that have a specific geographical origin and possess qualities, a reputation or characteristics that are essentially attributable to that place of origin.
- Industrial designs: An industrial design constitutes the ornamental or aesthetic aspect of an article. A design may consist of three-dimensional features, such as the shape or surface of an article, or of two-dimensional features, such as patterns, lines or colour[8].
Tax on income is a way to finance the public expenditure. With the passage of time as the ways of earning have changed so have the type of taxes levied. The Income Tax Act, 1961 has added certain provisions related to the taxation of the income accrued through Intellectual Property Rights transaction. The basis of tax for IP Rights transactions is different as per the provision of the Act. The nature of the expenditure is of utmost importance. Once the nature is determined it is easy to identify whether the amount paid is taxable or would be allowed as deduction.
But how are intellectual property rights, which are assets of a company, taxed? And what happens when your company licenses and pays royalty to the owner of an intellectual property right but does not own it[9]?
LEGAL ANALYSIS
A. Provisions for taxation of income related to Intellectual Property Rights:
1. As per Explanation 2[10] Act “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).
2. Section 9(1)(VI) of the Income Tax Act, 1961 provides for taxation of income by way of royalties. If the royalty is payable in respect of any right, property or information used or services utilized for the purposes of a business or profession carried on by such person outside India or for the purposes of making or earning any income from any source outside India it is not taxable. Income by way of royalty as a lump sum consideration for the transfer of rights outside India, or the imparting of information outside India in respect of, any data, documentation, drawing or specification relating to any patent, invention, model, design, secret formula or process or trade mark or similar property, if such income is payable in pursuance of an agreement made before the 1st day of April 1976, and the agreement is approved by the Central Government, is not taxable[11].
3. Section 32(1)(ii) of the Income Tax Act, 1961 explains that Depreciation of assets. Depreciations are allowed in the case of know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of a similar nature, being intangible assets acquired on or after the 1st day of April 1998. Deductions are available for expenditure (other than capital expenditure) on scientific research.
4. Section 35A of the Income Tax Act, 1961 explains about expenditure on acquisition of patents and copyrights rights. If they are purchased for a lump sum consideration with an enduring benefit, the purchaser is entitled to claim depreciation over a period of time. If it is paid as periodical payments, then it can be claimed as expenditure fully incurred for the purpose of business. Upon any expenditure which was incurred after the 28th day of February 1966 but before 1st April 1998, on the acquisition of patent rights or copyrights for the purpose of business, deductions will be allowed for each of the previous years on an amount equal to the appropriate fraction of the amount spread over 14 years. In the case of amalgamations, if the amalgamating company sells or otherwise transfers the rights to the amalgamated company (being Indian company) the deductions are not applicable to the amalgamating company[12].
5. Section 35AB of the Income Tax Act, 1961 enumerates that where the assessee has paid in any previous year, any lump sum consideration for acquiring any know-how for the use of his business, one-sixth of the amount so paid shall be deducted in computing the profits and gains of the business for that previous year, and the balance amount shall be deducted in equal installments for each of the five immediately succeeding previous years. It means that the expenditure will be deductible in six equal instalments for six years[13].
6. Section 80QQA of The Income Tax Act, 1961 provides deduction for income from copyrights. “In the case of an individual resident in India, being an author, the gross total income of the previous year relevant to the assessment year commencing on April 1, 1980, or to any one of the nine assessment years next following that assessment year or April 1, 1992 or to any one of the next four assessment years following that assessment year, any income derived by him in the exercise of his profession on account of any lump sum consideration for the assignment or grant of any of his interests in the copyright of any book, or of royalties or copyright fees (whether receivable in lump sum or otherwise) in respect of such book, a deduction to the amount of 25 per cent will be allowed on such amount.”
7. Section 80-O of The Income Tax Act, 1961 provides that where an Indian Company receives any income from foreign state or foreign enterprise in consideration for using any patent, registered Trademark, invention, design etc and the income is received by way of convertible foreign exchange in India or having been received as convertible foreign exchange outside India or having been converted into convertible foreign exchange outside India is brought into India, a deduction of 40% for an assessment year beginning on the 1st day of April, 2001, a deduction of 30% for an assessment year beginning on the 1st day of April, 2002, a deduction of 20% for an assessment year beginning on the 1st day of April, 2003 and 10% for an assessment year beginning on the 1st day of April 2004 should be allowed. But no deduction shall be allowed in respect of the assessment year beginning on the 1st day of April, 2005 and for subsequent years.
8. Section 80 OQA of the Income Tax Act, 1961 provides for that any income derived by the author in exercise of his profession on account of any lump sum consideration for the assignment or grant of any of his interests in the copyright of any of his books or of royalty or copyright fees, a deduction of 25% from that income shall be allowed[14].
9. Article 12 of OECD ARTICLES OF THE MODEL CONVENTION WITH RESPECT TO TAXES ON INCOME AND ON CAPITAL states that “The term ‘royalties’ as used in this Article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience[15]”.
“Royalties arising in a Contracting State and beneficially owned by a resident of the other Contracting State shall be taxable only in that other State”[16]. Exception to this Clause is “The provisions of paragraph 1 shall not apply if the beneficial owner of the royalties, being a resident of a Contracting State, carries on business in the other Contracting State in which the royalties arise through a permanent establishment situated therein and the right or property in respect of which the royalties are paid is effectively connected with such permanent establishment. In such case the provisions of Article 7 shall apply”[17].
Note– GST is applicable only when the owners of an intellectual property rights allows a person to temporarily use the intellectual property in exchange for consideration. However, in case of a permanent transfer of intellectual property right, there is no rendering of service. Hence, the sale of intellectual property services does not come under the purview of taxable services, as the owner no longer remains a owner of the intellectual property right[18]. Thus, a temporary transfer or permission to use or enjoy IPR can be classified as transfer of right to use goods, as it involves transfer of right to use movable property. Therefore, a tax on IPR is in pith and substance a tax on transfer of right to use IPR and not a tax on services.
B. Judicial Decisions:
(i) In Citizen Watch Co. Ltd Vs. IAC[19], the high court held that the definition of the term ‘royalty’ in explanation 2 to section 9(1)(vi) is not a general definition applicable where that term occurs but is applicable to section 9(1)(vi) only.
(ii) In the case of Sicpa India Private Limited[20], the tribunal had to decide whether royalty paid by Sicpa India, to a foreign company in lieu of the exclusive license to use their IP in India should be treated entirely as Revenue Expenditure or a part of it should be considered as Capital Expenditure.
According to the terms of agreement between the assessee and the foreign company who was the holder of the intellectual property rights, the assessee entered into a collaboration agreement with the foreign company for the manufacture of security printing inks for Bank notes and for other securities and the ri ght to sell such products under the terms of agreement. The foreign company had also granted the assessee an exclusive, non-transferable right to manufacture the products in India and a non-exclusive right to sell in India.
The appellants (revenue office) contended that the assessee has misled the authorities by claiming excess expenditure and should have treated 25 per cent of the royalty as a capital expenditure relying the following observations by the Supreme Court of India in the case of Southern Switch Gear Ltd. vs. Commissioner of Income Tax and another[21]:
“The right to manufacture certain goods exclusively in India should be taken to be on independent right secured by the Assessee from the foreign company which was of an enduring nature, that consequently, the entire royalty could not be allowed as a revenue expenditure and 25% of royalty would have to be taken as being Capital in nature.”
The Assessee, on the other hand claimed that as they did not hold any rights over the Intellectual Property other than the license and no part of the royalty paid to the foreign company could come under capital expenditure. Therefore, it was held that “the assessee was right in claiming the royalty paid by them to the foreign company as Revenue Expenditure only”.
(iii) In Director of Income Tax, (International Taxation) v/s IBM World Trade Corporation[22], the HC held that “Assessee, a foreign company, depending on date of agreement i.e. before 1-6-2005 or on or after 1-6-2005, was entitled to adopt rates of tax payable on royalty income as per provisions of section 115A(1)(b) or provisions of Article 12 of Indo-US DTAA, which were more beneficial to assessee”.
(iv) In Honda Motorcycle and Scooter India Pvt. Ltd. v/s Deputy Commissioner of Income-tax, Circle 2(1), Gurgaon[23] the tribunal held that “Where lumpsum royalty was capitalized in assessee’s books of account and same was also not claimed as an expenditure in return of income, since amount expended was in relation to running royalty, once manufacturing process had began, same could be allowed as business expenditure”.
(v) In ARA Law v/s Assistant Commissioner of Income Tax-16(2), Mumbai[24], the tribunal held that “Where assessee-firm carrying profession of Advocates & Solicitors, paid royalty to its founder partner for use of brand name, logo or trademark owned by him, amount so paid was to be allowed as deduction under sec. 37(1)”.
Note-Patent Box regime was introduced in India by Finance Act, 2016 by enacting new Section 115BBF. Further, patent is being ‘boxed’ off from others and hence justifying the nomenclature well. The Government decided to put in place a concessional taxation regime for income from patents. The aim of the concessional taxation regime is to provide an additional incentive for companies to retain and commercialise existing patents and to develop new innovative patented products which in turn encourages companies to locate the high-value jobs associated with the development, manufacture and exploitation of patents in India. Section 115BBF provides concessional rate of taxation at 10% on royalty income in respect of exploitation of patents. Applicability of Section 115BBF is not mandatory and eligible taxpayer has an option to avail Section 115BBF benefit[25].
CONCLUSION
Taxation of income is necessary in a developing country like India as it is the main source of financing the public expenditure. Intellectual Property Rights are of great value and the holder of these rights has to invest a great amount of labour and money in creating these rights. Regarding, how to charge the money invested and the value of these rights for taxation purpose is a question, whose answer depends upon the nature of the transaction. Once the nature is determined then it is easy to charge the income or expenditure according to the various provision of the Income Tax Act. For charging tax it is necessary to determine whether the transaction is revenue or capital in nature. All the decisions will depend upon the facts and circumstances of each case.
[1] What is Intellectual Property, https://m.esa.int/About_Us/Law_at_ESA/Intellectual_Property_Rights/What_is_intellectual_property
[2]What is Intellectual Property, https://www.wipo.int/about-ip/en/
[3] Tojo Jose, What is Intellectual Property Rights? https://www.indianeconomy.net/splclassroom/what-is-intellectual-property-rights-iprs/
[4] Overview: The TRIPS Agreement, World Trade Organization, https://www.wto.org/english/tratop_e/trips_e/intel2_e.htm
[5] Techopedia, Intellectual Property, https://www.techopedia.com/definition/5521/intellectual-property-ip
[6]Oxford University Innovation, What is Intellectual Property, https://innovation.ox.ac.uk/university-members/commercialising-technology/ip-patents-licenses/intellectual-property/
[7] Intellectual Property India, http://www.depenning.com/intellectual.htm
[8]Legal Career Path, What is Intellectual Property Law, http://legalcareerpath.com/intellectual-property-law/
[9]INTELLECTUAL PROPERTY SERVICES IN INDIA & SERVICE TAX REGIME, https://www.lawteacher.net/free-law-essays/international-law/intellectual-property-services-in-india-international-law-essay.php
[10] Sec. 9(1)(vi) of Income Tax
[11]Bijal Ajinkya, Legal and Tax Issues in structuring Cross-Border IPR transactions with case studies, https://ctconline.org/documents/international/Bijal%20Ajinkya%20-%20Cross%20Border%20IP.pdf
[12]R.Kumar, Intellectual Property Rights -Taxation Aspect, https://taxguru.in/income-tax/intellectual-property-rights-taxation-aspect.html
[13]K.D Raju, Intellectual Property Taxation: Need for a Comprehensive Policy and Law in India, http://nopr.niscair.res.in/bitstream/123456789/2431/1/JIPR%2013%286%29%20563-573.pdf
[14]Himanshu Sharma, India: Taxing Provision Related To IP Right In India: A Brief Look,
http://www.mondaq.com/india/x/623230/Income+Tax/SA+IPTechAugust+2017
[15] Clause 2 of Article 12
[16] Clause 1 of Article 12
[17] Clause 3 of Article 12
[18]Service Tax on Intellectual Property Services, https://www.indiafilings.com/learn/service-tax-intellectual-property-services/
[19](1984) 148-ITR-774 (Kar)
[20] 2013 (8) TMI 315
[21] (2000) 10 SCC 501
[22] [2020] 120 taxmann.com 151 (Karnataka)
[23] [2021] 124 taxmann.com 81 (Delhi – Trib)
[24] [2018] 90 taxmann.com 395 (Mumbai)
[25]Tax on Income from Patents – Patent Box Regime, https://cleartax.in/s/patent-tax-treatment#sec
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