(i) Outright sale of documentation pertaining to plant supplied does not constitute royalty, either u/s.9(1)(vi) or under Article 12. 572 (ii) Mere shareholding by foreign supplier of plant in purchaser Indian company does not result in business connect

16 ADIT (IT) v. Zimmer AG

The assessee was a German company engaged in manufacture of
plant and machineries. It had entered into three separate agreements — Equipment
Supply Agreement, Engineering and Know-how Supply Agreement and Technical
Assistance Agreement — with an Indian company, which proposed to set up a plant
for manufacture of certain petrochemicals products. Under the Engineering and
Know-how Supply Agreement, the German company had undertaken to supply a fully
integrated plant. Under Engineering and Know-how Supply Agreement, the German
company agreed to sell engineering information, drawings and designs to Indian
company on outright basis. The transfer of ownership and title in the
documentation took place in Germany. The payment was also made by remittance to
Germany. Thereafter, the Indian company imported these in physical form into
India. These were required for installation and commissioning of the plant.

The Indian company’s contention was that: the import of the
documentation was similar to the import of plant; it was purchase on outright
basis of a capital asset on which depreciation was permissible and not a case of
mere right to use of engineering information and know-how; the technical
documentation formed integral part of the plant since in its absence, the Indian
company could not have set up, operated or maintained the plant; and as such the
consideration payable under the Engineering and Know-how Supply Agreement did
not constitute royalty and therefore it was not taxable either u/s. 9(1)(vi) of
the Income-tax Act or under Article 12 of the India-Germany DTAA.

The Department’s representative contended that under the
Engineering and Know-how Supply Agreement, the Indian company paid lump sum
consideration for transfer of technical know-how, design and secret process and
therefore, the payment was taxable in India (which was the country of source of
income) as royalty, not only u/s.9(1)(vi) of the Income-tax Act, but also under
Article 12(3) of the India-Germany DTAA. He also referred to the secrecy clause
in the said agreement which prohibited the Indian company from disclosing the
confidential information to any person and submitted that this made it apparent
that the German company had not sold these on outright basis, but allowed mere
use and hence, the payment was royalty u/s.9(1)(vi) of the Income-tax Act as
well as under Article 12(3) of the India-Germany DTAA. He, then, referred to the
order of the AO and argued that the German company was one of the promoters of
Indian company and therefore, there was a business connection between the German
company and the Indian company and hence, the income should be taxable
u/s.9(1)(i) itself. He also referred to the decisions in N. V. Philips’
Gloeilempenfabrieken v. CIT, (1988) 172 ITR 541(Cal.) and N. V. Philips
v. CIT, (1988) 172 ITR 521 (Cal.) to substantiate that even lump sum
payments were taxable in India as royalty.

The Tribunal referred to various relevant clauses of the
Engineering and Know-how Supply Agreement and found that : ownership, title and
risk in documentation was transferred in Germany; consideration was also paid
outside India; documentation was imported into India; the engineering supplied
by the German company was limited to designs of plant supplied by it; and supply
of engineering, drawings and designs was incidental to sale of plant which was
tailor-made to suit specific requirements of the Indian company. Considering
these factors, the Tribunal observed that supply of engineering, drawings and
designs was integral part of supply of plant and it could not be viewed in
isolation and therefore, the payment was not for acquiring mere right to use,
which would constitute royalty. The Tribunal found that even under Article 12(3)
of the India-Germany DTAA, it could not be considered as royalty. It then
referred to the decision in Scientific Engineering House P. Ltd. (1986) 157 ITR
86 (SC) wherein the Supreme Court had held that lump sum payment made to acquire
technical know-how to facilitate operations and process amounted to acquisition
of capital asset and technical drawings, designs, charts, processing data and
other literature fell within the definitions of ‘plant’. In light of that it
agreed with the German company’s contention that what was acquired was ‘plant’,
it was acquired outside India and therefore, the payment could not be taxed as
royalty in India. The Tribunal, thereafter, referred to and discussed the
following decisions and observed that these decisions squarely supported the
contention that the consideration received by the German company under the
Engineering and Know-how Supply Agreement was not in the nature of royalty,
either u/s.9(1)(vi) of Income-tax Act or under Article12 of India-Germany DTAA.