8 Sections – 9(1)(vi)(b), 40(a)(i), 195 of the Act – Royalty paid by an American company tax resident in India to a non-resident company for IPRs which were used for manufacturing products in India was taxable in India even if products were entirely sold outside India.

Dorf Ketal Chemicals LLC vs. DCIT

ITA NO. 4819/Mum/2013

A.Ys.: 2009-10

Date of Order: 22^nd March 2018

Facts       

The Taxpayer was a LLC incorporated in, and tax resident of USA. It was
engaged in the business of trading of specialty chemicals. The Taxpayer was
100% subsidiary of an Indian company (“Hold Co”). The Taxpayer was also treated
as a tax resident of India since its control and management was situated in
India and was filing returns of its income in India as a resident company.
Thus, it was assessed to tax both in USA and India.

The Taxpayer had acquired certain patents and copyrights from an
American company for which it paid royalty computed as a fixed percentage of
sales in USA. The Taxpayer had certain customers in USA. The Taxpayer got the
products manufactured from Hold Co which were sold only in USA, and not in
India. According to the Taxpayer since the royalty was paid to an American
company (“USA Co”) for business carried out in USA, it was not required to
withhold tax from the royalty.

Hold Co had full and unconditional access to technical know-how and
information regarding manufacturing procedure and technology, which was used
for the purpose of manufacture in India. Hence, the AO held that in terms of
section 9(1)(vi) of the Act, the payment of royalty by the Taxpayer to USA Co
constitutes chargeable income, on which, tax was required to be withheld u/s
195 of the Act. Since the Taxpayer had not withheld tax, the AO invoked section
40(a)(i) and disallowed the royalty.

On appeal, the CIT(A) confirmed the order of the AO.

Held:

–   The relationship between the Taxpayer and the
holding company was not merely that of a contract manufacturer. The IPRs were
utilised for manufacturing in India. Export to USA was in conjunction with this
activity and was not isolated. Hence, the CIT(A) was correct that Taxpayer
merely carried out marketing of the products which are exported by it.
Therefore, there was a business connection with India. Further, Hold Co was a
guarantor under the agreement between the Taxpayer and USA Co.

–  Services were rendered in India as well as
utilised in India. Accordingly, the payment did not fall under the exception in
section 9(1)(vi)(b) of the Act. Hence, the CIT(A) was correct in disallowing
royalty paid in terms of section 40(a)(i) of the Act.

–  The decision of the Supreme Court in
Ishikawajima-Harima Heavy Industries Ltd.¹ and that of Madras High
Court in the case of Aktiengesellschaft Kuhnle Kopp and Kausch²  were distinguishable on the facts of this
case.

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1   DIT
v. Ishikawajima-Harima Heavy Industries Ltd. [2007] 158 Taxman 259 (SC)

2     CIT v. Aktiengesellschaft Kuhnle Kopp
and Kausch [2003] 262 ITR 513 (Mad)