In the first part of the article published in December 2010
issue of BCAJ, we discussed broadly the issues which arise while making payments
for designs and drawings acquired from foreign entities for diverse business
purposes, definitions of the terms Royalty and Fees for Technical Services (FTS)
under the Income-tax Act, 1961 (the ACT), under Model Conventions and under some
important Indian DTAAs. We also discussed meaning of the terms ‘design’,
technical and plan, as per various dictionaries.
In this part, we will discuss taxability of the payment for
technical plans and technical design with reference to various judicial
pronouncements with a view to understand how the case law has developed over the
years and to cull out guiding principles.
Taxation of Payment for Technical Plan or
Technical Design as explained in various judicial
pronouncements :
Taxation of Payments for Technical Plan or Technical Design
has been examined, explained and applied by various judicial authorities in
India
A gist of relevant cases is given below. It is important to
note that in the gist of cases given below, we have only considered and analysed
the aspect relating to taxation of payments for Technical Plan or Technical
Design. Other aspects relating to royalty, FTS, PE, etc. have not been discussed
or analysed here. For this, the reader should consider and refer the text of the
decisions.
1. CIT v. Davy Ashmore India Ltd. (Cal.)
(1991) 190 ITR 626 (India-UK DTAA) :
Nature of payment :
Import of concept designs and drawings for enabling the
assessee to prepare the detailed manufacturing drawings for purposes of
manufacture of the terminal equipments which were required to be supplied by the
assessee.
Issue :
Whether the payment made to the non-resident company were in
the nature of royalty within the meaning of Explanation 2 to S. 9(1)(vi) ?
Held :
That the non-resident did not retain the property in the
designs and drawings. The designs and drawings were imported under the import
policy with the approval of the RBI on the basis of the letter of intent. The
import of the designs and drawings postulated an out and out transfer or sale of
such designs and drawings. The consideration paid for the transfer was not
assessable as royalty.
2. CIT v. Klayman Porcelains Ltd. (AP)
(1998) 229 ITR 735 (India-Germany DTAA) :
Nature of payment :
Under the agreement, consideration was paid for
construction/installation of a kiln. The amount paid under that memorandum by
the Indian company to the non-resident company was payment for technical
drawings towards engineering for the kiln.
Issue :
Whether the lump sum payment made by the resident company to
the non-resident company for supply of designs and drawings (engineering for the
kiln) did not constitute ‘income’ by way of royalty of the non-resident company,
within the meaning of the provisions of S. 9(1)(vi) ?
Held :
The Tribunal on construing the relevant portion of the
agreement recorded the finding that this was a case of a foreign company
undertaking to supply, erect and commission a kiln in India, the only service
rendered in India being that of supervision by an expert deputed by the foreign
company. The amount was not paid for imparting 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 falling under clause (ii) of
Explanation 2 to S. 9(1)(vi) or for imparting of any information concerning
technical, industrial, commercial or scientific knowledge, experience or skill
within the meaning of clause (iv) of Explanation 2. A close reading of the
second type of work as well as the other items of the memorandum showed that the
consideration was paid for construction/installation of the kiln. Therefore, the
payment made by the assessee to the non-resident company did not constitute
‘income’ by way of royalty of the non-resident company, within the meaning of
the provisions of S. 9(1)(vi) of the Act.
3. Leonhardt Andra Und Partner, GmbH v. CIT
(2001) 249 ITR 418 (Old India-Germany DTAA) :
Nature of payment :
Payment was made to the German company in connection with the
design of the bridge to be built.
Issues :
1. Whether the sums received by the assessee for design and
technical services for the construction work are chargeable to income-tax under
the Act ?
2. Whether the transfer of the drawings, designs and
technical services under the collaboration agreement constituted an out and out
transfer of such rights and as such the sums received therefor could be treated
as royalty for the purpose of the Indo-German DTAA and liable to Indian
Income-tax ?
3. Whether, the sum received by the assessee for the supply
of designs, drawings and technical services constituted ‘industrial and
commercial profits’ for the purpose of the Indo-German DTAA and, as such, the
same is assessable under the Act ?
Held:
Royalty was not defined in the old India-Germany DTAA and was
not included within the term ‘industrial and commercial profits’. The term
‘royalty’ not being defined in the DTAA, the definition in the Act would
prevail. Therefore, the sums received by the assessee for design and technical
services for the construction work were in the nature of royalty within the
meaning of the term in S. 9(1)(vi) of the Act, which was taxable and did not
constitute industrial and commercial profits. The fact that the assessee had no
permanent establishment in India was of little consequence.
Note :
CIT v. Davy Ashmore India Ltd., (1991) 190 ITR 626 (Cal.) was distinguished on the ground that as royalty was not defined in the Old India-Germany DTAA and as such the statutory provision will prevail.
4. Munjal Showa Ltd. v. ITO, (2001) 117
Taxman 185 (Delhi) (Mag.) (India-Japan DTAA)
Nature of payment:
The Japanese company undertook to provide to assessee technical know-how and services in connection with manufacture of shock absorbers. The assessee sought drawings and designs of equipments in order to fabricate plant and machinery in India and the Japanese company charged a sum towards cost of supplying the same.
Issue:
Whether such supply of drawings and designs was an outright sale in the Japanese company’s hands and purchase in the assessee’s hands, and, accordingly, consideration paid was commercial profit of Japanese company within meaning of Article III(1) of DTAA?
Held:
The ITAT held that:
- As per the contract agreement, the assessee-company had received the licence to use the industrial property rights for manufacture of shock absorbers and also technical documents and know-how relating to the process for manufacturing shock absorbers.
- In consideration, the assessee-company had agreed to pay royalty to the Japanese company at the rate of 3% of the ex-factory sale price of the shock absorbers manufactured. The royalty so agreed to be paid was clearly for allowing the assessee-company to manufacture the shock absorbers as per the technical know-how developed by the Japanese company and for supply of technical information, know-how, documentation, etc., relating to the production of shock absorbers and also information and assistance in setting up the manufacturing facilities for production of shock absorbers.
- The agreement, however, did not provide for supply of requisite machinery for the plant. Rather the machinery required had to be procured by the assessee-company, though under the advice and specifications given by the Japanese company.
- The assessee-company instead of importing the required machinery being costlier, decided to get the same fabricated indigenously and as per requirement of the fabricators, the drawings and designs of the machinery were agreed to be obtained from the Japanese company under an arrangement separate from the collaboration agreement for consideration.
- The supply of drawings and designs of the machinery for setting up of the plant was an outright sale in the hands of the Japanese company and purchase in the hands of the assessee-company and, accordingly, the consideration paid was the commercial profit of the Japanese company within the meaning of para 1 of Article III of DTAA.
- Apart from the approval accorded by the Government of India to the collaboration agreement, separate approval was sought and granted for the import of drawings and designs by the Government of India and the payment to be made to the Japanese company for import of drawings and designs had also been approved by the Reserve Bank of India.
- Had there been a provision in the collaboration agreement for supply of such drawings and designs for manufacturing of machinery for the plant, there would have been no necessity of having a separate arrangement and approval of the Government of India.
- There clearly was a distinction between the consideration to be paid for licence and right to use the technical know-how and documentation, etc., for manufacturing of shock absorbers. As per the collaboration agreement, the same was directly linked to the sale of the product and had rightly been termed as ‘payment of royalty’ within the meaning of clauses (e) and (f) of Article X of DTAA and there was no dispute as such about its taxability in India, whereas the payment of US $ 32729 was a consideration for outright purchase of drawings and designs of the machinery required for setting up of the plant and the amount paid was apparently commercial profit of the Japanese company within the meaning of para 1 of Article III of DTAA.
- Admittedly, the Japanese company had no permanent establishment in India within the meaning of para 2 of Article III of DTAA and, accordingly, the payment made of US $ 32729 was not liable to be taxed in India as per Article III of DTAA.
- Hence, the payment made represented business commercial profits of the Japanese company and the Japanese company having no permanent establishment in India, the said payment was not subject to tax in India as per provisions of Article III of DTAA.
5. Pro-Quip Corporation — AAR
(2002) 255 ITR 354 (India-USA DTAA):
Nature of payment:
Linde Process Technologies (India) Ltd. (LPT) received a purchase order from another Indian company for design, engineering technical know-how and erection and commissioning of hydrogen generation plant. As part of execution of the project, LPT was required to obtain and supply the engineering drawings and designs for the setting up of the plant.
The engineering drawings and designs were available with?Pro-Quip?Corporation, USA, the applicant. LPT placed a purchase order with the applicant for the purpose of specified engineering drawings and designs for the construction of hydrogen generation plant for the Indian company.
Issue:
Whether the applicant is liable to tax on the amount received from Linde Process Technologies (India) Ltd. towards consideration for the sale of engineering, drawings and designs received under purchase order of Linde Process Technologies (India) Ltd.?
Held:
The AAR held that:
- This was a case of out and out sale of engineering drawings and designs by the applicant, a non-resident American company to LPT an Indian company to enable LPT to execute an order received by it from another Indian company.
- The payment basically was not made for any service to be rendered by the American company. This was not a case of a licensing agreement or sale being coupled with a restrictive clause.
- The purchaser was entitled to use the engineering designs and drawings as it liked. It was entitled to sell or transfer the properties purchased.
- The agreed price of the sale CIF Mumbai airport was fixed and not subject to any escalation or variation until complete execution. All costs, taxes and duties were to be borne by the seller. The agreed price included cost of documentation.
- The total price of the purchase order was to be the sole consideration for supply of goods as described in the purchase order. If any alienation of right or property was made for consideration and such consideration was payable contingent upon productivity, use or disposition, as the case may be, of that property, such payment might come within the expanded definition of royalty. This would not include an out and out sale as in the instant case.
- There was no such contingent clause. Payment received by LPT or the sale of engineering, design or drawing was not contingent upon any of the things mentioned in clause (3) of paragraph (3). Therefore, this payment could not be treated as royalty at all.
- Moreover, drawings and designs which constitute know-how and are fundamental to an assessee’s manufacturing business are treated as ‘plant’ u/s.32 of the Indian Income-tax Act. If the only source of income of the applicant was the consideration for sale of engineering drawings and designs under purchase order, then the applicant would not be liable to pay any tax in India under Article 12.
6. Gentex Merchants (P.) Ltd. v. DDIT(IT)
(2005) 94 ITD 211 (Kol.) (India-USA DTAA):
Nature of payment:
The assessee-company entered into an agreement with a US company for development of water features at premises owned by it. Under this agreement, the US company was not only to provide schematic ideas but also to provide technical designs, drawings and information, on basis of which the assessee was to execute and install water features. Moreover, the US company was to ensure that features executed by contractors at site conformed to drawings, designs specifications provided by it.
Issue:
Whether since the US company was required to deliver technical designs or plan for sole use by the assessee-company in India, payments effected under agreement squarely fell within definition of ‘fees for technical services’ mentioned in Article 12(4)(b) of India-USA DTAA?
Held:
The ITAT held that:
- On reading of the agreement between the parties as a whole, it was noted that various phases contemplated in the agreement were composite and cumulative. Every phase was related to each other and the contract was a single composite contract and the non-resident company was to undertake the work on cumulative basis for which composite non-divisible fee was to be paid.
- It was clear from the agreement that each phase was depended on the other and each phase was carried out in succession and only on completion of all phases the scope of work envisaged in the agreement stood fulfilled. It was, therefore, incorrect to say that the agreement merely provided for giving advice to the assessee and there was no transfer of any design or knowledge.
- The reading of the agreement clearly indicated that the assessee-company was to execute the water features at its premises in accordance with the designs, drawings and technical specifications provided by the non-resident company and the non-resident company was to ensure that the features executed by the contractors at the site conformed to the drawings, designs specifications provided by it.
- From the agreement between the assessee and the foreign company, it was also quite clear that the non-resident company was not only to provide the schematic ideas but also to provide technical designs, drawings and information on the basis of which alone the Indian company was to execute and install the water features. Article 12(4)(b) of DTAA provides that fees for included services shall include ‘services which makes available technical knowledge, experience, skill, know-how or consists of development and transfer of technical plan or technical design’.
- For deciding the issue under Article 12(4) it is not material as to whether the assessee acquired on outright basis any technical knowledge, know-how, technical plan or design. Article 12(4) is attracted the moment a person resident of one state (country) makes available technical knowledge, experience or transfers a technical plan or technical design to the person of other contracting state (country).
- From the agreement between the assessee and the non-resident company it was apparent that the later was to deliver the technical drawings and designs to the former for its own use and benefit in India. The term transfer as used in Article 12(4) does not refer to the absolute transfer of rights of ownership. It refers to the transfer of technical drawing or designs to be effected by the resident of one state to the resident of other state which is to be used by or for the benefit of resident of other state. The said Article 12(4)(b), does not contemplate transfer of all rights, title and interest in such technical design or plan.
- Even where the technical design or plan is transferred for the purpose of mere use of such design or plan by the person of other contracting state and for which payment is to be made, Article 12(4)(b) will be attracted.
- The facts on record clearly indicated that under the agreement the non-resident company was required to deliver such technical designs or plan for the sole use by the assessee-company in India. In fact, the assessee did use those technical plans and drawing for constructing and/or installing the water feature in the premises.
- In the above circumstances, the payments effected under the agreement with the non-resident company squarely fell within the definition of ‘fees for included services’ and therefore, the assessee was liable to deduct tax at the rate of 15% of the amount payable, u/s.195.
7. Indian Hotels Company Ltd. v. CIT [IT Appeal No. 553 (Mum.) of 2000, dated 14-12-2005] India-Singapore DTAA:
[Decision not yet reported. However, the same has been cited with approval in the case of Abhisek Developers v. ITO, (2008) 24 SOT 45 (Bang.) (URO).] The relevant portion cited in the decision of Abhisek Developers is reproduced below. “The facts of the case on hand are identical with the facts of the case dealt by the Mumbai ‘B’ Bench of the Tribunal in IT Appeal No. 553 (Mum.) of 2000, order dated 14-12-2005 in the case of Indian Hotels Co. Ltd. v. ITO, wherein at para 7 it is held as follows: “A careful reading of the above clauses of the agreement between the assessee company and M/s. HBA clearly shows that the fees payable to M/s. HBA are neither fees paid for technical services nor are in the nature of royalty as defined in various articles of the DTAA between India and Singapore. As per the various clauses of the said agreement it is clear that?M/s. HBA has to hand over and transfer all layout plans and interior concepts in regard to the areas defined in the agreement and all the interior design, drawings and presentation material shall become the property of the assessee-company. All design work submitted by M/s. HBA is for the use solely on this project and cannot be used as part of any other design and the transfer of property in the interior design, drawing, presentation material shall take place in Singapore. It is specifically provided in clause 4.5 of the agreement that all interior design, drawing and specifications shall become the property of the client and the same shall be used for any other purpose other than that covered by this agreement by the interior designer. The services were only to create ‘design’ and title in the design, etc. has passed in this case to the assessee-company. In these facts of the case, we hold that the fee payable to M/s. HBA is not a fee for technical services and is not in the nature of royalty as per the articles of DTAA between India and Singapore and therefore, the assessee was not liable to deduct tax from remittances to M/s. HBA (P.) Ltd. The assessee-company has purchased and acquired interior design and drawing from M/s. HBA and the property therein has in fact passed to the assessee-company. In this view of the matter, the issue is decided in favour of the assessee and the grounds of appeal of the assessee are allowed.”
8. DCIT v. All Russia Scientific Research
Institute of Cable Industry, Moscow
(2006) 98 ITD 69 (Mum.)
(India-Russian Federation DTAA):
Nature of payment:
The assessee, a Russian company, possess-ing knowledge and experience in the field of manufacturing technique of a particular product, entered into an agreement with IPL, an Indian company under which the assessee-company was to provide to IPL a “non-exclusive right to use the ‘know-how’ for the purpose of realisation of the process and the technical process and the special process in the territory and sell the licensed product and the special product in the territory and zone of non-exclusive right”. Under this arrangement, the assessee was, upon a request from the IPL, to render ‘technical assistance’.
Issue:
Whether or not the payment in consideration of supply of technical documentation, on the facts of this case, is to be treated as ‘royalty’ or not?
Held:
The ITAT held that:
- An outright sale of designs and drawings essentially implies unfettered right of the assessee to use the same. However, the agree-ment would establish that it was not so in the instant case. Under clause 2.1 of the agreement, the assessee had granted IPL non-exclusive right to use the ‘know-how’ for a specific purpose and that ‘know-how’ included the technical designs and drawings set out in clause 3 of the agreement.
- Under clause 12.2 ‘IPL’ could not assign any rights under the said agreement, including, thus, the right to use the designs and drawings to anyone else. In any event, the right to use the ‘know-how’ was a clearly non-exclusive right and, therefore, the assessee retained property in the same even while the ‘know-how’ was made available to IPL.
- Under clause 7 of the agreement, IPL was under an obligation to maintain the confidentiality, about the designs and drawings. The IPL had an obligation not only to maintain confidentiality, but also to make every effort that it was not divulged to third parties without the assessee’s specific permission.
- Clause 7.2 further provided that in case the drawings and designs were so known to the third parties, IPL would make good the resultant losses incurred to the assessee.
- In the light of that factual position, it could not be said that IPL had outrightly purchased the designs and drawings and that consequent to supply of those drawings and designs, the non-resident assessee did not have any interest in the same.
- The very fact that IPL could be hauled up to pay damages under Article 7.2 of the agreement would clearly show that the non-resident assessee had valuable property and interest in the drawings and designs which were supplied to IPL and in consideration of which were received by the assessee.
- In CIT v. Davy Ashmore India Ltd., (1991) 190 ITR 626 (Cal.), the High Court had categorically observed that where the transferor retains the property right in the designs, secret formulae, etc., and allows the use of such rights, consideration received for such use is royalty.
- It was only in the case of outright sale that the consideration for such sale was not to be treated as ‘royalty’.
- The instant case was not a case of an out-right sale, nor was it a case of importation of drawings under the import policy. It was a case of collaboration of drawings under the import policy. It was a case of collaboration agreement and a case of limited non-exclusive use of certain drawings and designs for that purpose and therefore, consideration in question was taxable as royalty in hands of the assessee.
In the next part of the Article, we shall discuss some more judicial decisions on the subject.
