Section 9(1)(vii) – Royalty received by a non resident (NR) from various NR manufacturers of CDMA equipments (which were sold worldwide, including India) is not taxable in India, as the NR manufacturer did not carry on a business in India nor did the customers who purchased the equipment constitute the source of income in India.

Section 9(1)(vii) – Royalty received by a non resident (NR) from various NR manufacturers of CDMA equipments (which were sold worldwide, including India) is not taxable in India, as the NR manufacturer did not carry on a business in India nor did the customers who purchased the equipment constitute the source of income in India.

 A US Company (Taxpayer) had licensed certain intellectual property (IP) relating to the manufacture of Code Division Multiple Access (CDMA) mobile handsets and network equipment to non-resident Original Equipment Manufacturers (OEMs). The OEMs used the licensed IP to manufacture CDMA handsets and wireless equipment outside of India and sold them to customers worldwide, including India. The Indian customers, in turn, sold the handsets to end-users of telecom services in India.

The tax authority assessed a part of royalty, to the extent it related to equipment sold to customers in India by suggesting that part was taxable in India as the IP that was licensed was utilised in a business carried on in India or was for earning income from India sources (the secondary source rule) as per section 9(1)(vii)(c) of the Act. The CIT(A) upheld the order of the tax authority. Aggrieved, the Taxpayer filed an appeal before the Tribunal.

Held

The Tribunal based on the following ruled that the secondary source rule was not applicable to the facts of the case, as the OEMs did not carry on a business in India nor did the Indian customers who purchased the equipment constitute the source of income. Accordingly, the royalty was not taxable in the hands of the taxpayer.

Onus of proof is on tax authority to establish that the non-resident (NR) was carrying on business in India. It is not important whether the right or property is used “in” or “for the purpose of a business”, but to determine whether such business is “carried on by the NR in India”.

Sale to Indian customers without any operations being carried out in India would amount to business ‘with’ India and not business ‘in’ India. For business to be carried out in India, there should be some activity carried out in India.

Further, the IP was not used in India. Use of the products by Indian customers which embed the licensed technology does not amount to use of the IP by the OEMs in India. The OEMs manufactured the products outside India. Hence, the license for the IP of the Taxpayer was used by the OEMs in manufacturing the products outside India. The source of royalty is the place where patent (right, property or information) was exploited, and in the facts of the case, it is where the manufacturing activity took place, which was outside India. Further, as per the agreement, the title of the equipment passed to the Indian customers in high seas before arrival in India. Notwithstanding this, the mere passing of the title with no other activity in India does not result in any income being attributable to the NR for taxation in India.

The clarification inserted to the definition of royalty by the Finance Act, 2012 with regard to taxability of computer software as royalty, has no effect in the present case as the issue on hand was regarding taxability of royalty on patents relating to licensing of IP for manufacture of CDMA handsets and equipment and not on licensing of any computer software.