(4) Different facets of technical service :
The Supreme Court in Ishikawa jima-Harima Heavy Industries Ltd. reported in 288 ITR 409 (SC) has held that the liability to pay tax under domestic law arises only when there is a live connection or a live territorial nexus between the service and the place where services are rendered. This is a prime condition before applying S. 9(i)(vii), as the said Section itself provides that when an Indian company has availed of any technical service from non-resident in respect of source of income outside India then such payment will not be regarded as accruing in India, since such payment is for earning income from source outside India. The explanation to S. 9(i) (vii) provides a protection in this respect. If a UK company has undertaken a turnkey project or construction project in India, the project is located in India and technical services are provided by the UK company, then such services will be regarded as part and parcel of project and the same will be regarded as project executed by the UK company. The income from execution will be taxed in India. The UK company will be deemed to be having permanent establishment in India.
(5) In many treaties there is not only Article on fees for technical service, but also Article on Independent Personal Service (IPS) say professional service. If in a treaty there is no Article dealing with Fees for Technical Services (FTS),but there is Article on Independent Personal Service, such Article can make a Brazil company liable to domestic tax, if it receives fees from an Indian company, even if there is no fixed base or PE in India.
(6) Where a payment is taxable under one article of treaty, but not under another article of the same treaty, the foreign enterprise may follow beneficial rule.
(7) Fees for Induded Service (FIS) :
This primarily deals with technical service, but its coverage is narrower than fees for technical service (FTS) and is akin to S. 9(i)(vii). Under this Article, tax will be payable by a Brazilian company in India on technical services received from Indian company even though services are not performed in India and it has no PE in India.
A treaty may have two sets of Articles, one dealing with FTS and other with IPS applicable to individual or firm. In a situation where fees for technical services are taxable in India and also under Article with FTS, but not taxable under Article IPS since such FE is not having PE, then FE can follow beneficial rule whereby IPS article will override FTS Article.
(8) Fees for Induded Service (PIS) :
It primarily is applicable to FTS. A technical service becomes included service in circumstances where the person giving service makes available technical knowledge, experience, skill, know-how or process or in addition to service makes available or transfers plan or technical design. The plans of architects or designs for installation and maintenance of machinery are illustrations, which are handed over to the payer of consideration. Similarly, software developed by a technician programmer makes available the software to his customer is another instance of included service.
Where a right to use a patent is acquired by an Indian company and if before effectively putting it to use, in conjunction with it his existing process set-up, and if there is a need for modification which is also provided by FE, then this additional service can be termed as included service. The tax will be payable at the time of making payment as per Article 12(4)(a).
(9) Most-Favoured Nation Clause (MFN Clause) :
Though on plain reading of treaty tax is payable, still there may be certain Articles whereby tax may not become payable, where there is MFN protocol. This clause is generally provided at the insistence of enterprise providing the service to ensure continued patronage of service receiver. However, the receiving company can provide for its freedom to enter into contract with some other service provider in future, whereby present contract will stand modified.
(10) Procurement of designs:
Where intention of receiving enterprise is to buy a product or a customised design and not standard design, the judicial views are divided.
In Abhishek Developers v. ITO, 3719-3722/B/04 (Bang.) and in Indian Hotels Co. Ltd. v. ITO, ITA No. SS3/M/2000 (Mum.), the customised designs were considered as products. As against this, in MRPL v. DCIT, (ITA No. 1826/M/04). In Centex Merchants Pvt. Ltd. v. DCIT, (94 ITD 211 Cal.) and in TAG Report of OECD such supply was treated as technical service.
In all these contracts intent or object behind availing service needs to be looked into. Is the object to buy a service or to buy a product? There can also be a mixed contract. S. USA taxes it at 10% plus Sch. If technical service is connected with a PE, then S. 44D becomes applicable and tax will be 40% plus Sch. after deducting expenses of the P.E. i.e., on net income. The IDS will still be at 10% even if receipt by FE is effectively connected with FE’s PE. One has to keep in view the probable litigation on application of S. 40(a)(i).
(11) Royalties:
This covers payment of royalties for branded products, payment for use of LP.R.s (Intellectual Property Rights).
Traditional view is, when use of intellectual property rights is made available for commercial exploitation, the consideration received is Royalty. Similarly providing use of confidential basis of information or right which is not in public domain gives rise to royalty.
Key question to be asked by recipient of consideration is what does the payer of consideration get in return for such payment, Does he get use of IPR ?
(12) Inherent features of IPR Grants:
(a) IPR is the result of owner’s skill, effort, exertion, intellect and/ or suffering.
(b) Owners possession usually constitutes his tool of trade.
(c) IPR’s are not in public domain, but are possessed secretly.
(d) Such IPRs mayor may not be registered or protected.
(e) Grantee is permitted to do what otherwise may be infringement.
(f) Grantee is enabled to do what owner could have done.
(g) Grantee can commercialise the product.
(13) Illustrative rights of copyright holder:
(a) Literary work is protected by the Indian Copyright Act (ICA)
(b) Literary work includes computer programme [So2(0) of the Indian Copy-right Act (ICA)]
(c) Exclusive rights of copyright holder are described in S. 14 of LCA. and they are,
(i) To reproduce work
(ii) To issue copies to public
(iii) To make translation
(iv) To make adaptation
(v) To sell or offer for sale.
(14) The learned speaker then illustrated and displayed a chart illustrating the exact nature of receipts in the hands of grantor & grantee of licence, is Product v. Underlying IPR.
Apprehended confusion ….Product v. Underlying IPR:
(15) Definition of Royalty – Expl. 2 to S. 9(i)(vi) :
This is to be viewed from point of view of payer When payer gets any of the following rights, then it is payment of royalty.Where payer is getting any right for use any patent, invention, secret formula or secret process or similar property or for use of any copyright of any scientific, literary, artistic book, (It covers music drama, software or IPR) then such payment is royalty.
(16) There are subtle differences in definition, scope of royalty including exceptions under the Income-tax Act and the definition under UN Model. The speaker elucidated those differences through display of studies. The same are as follows :
As per Explanation Z’to S. 9(1)(vi) the royalty takes in its fold consideration received for
(a) any transfer of all or any right (including the granting of a licence in respect of films or video tapes for telecast or radio broadcasting)
(b) transfer of any right to use equipment
(c) disclosure of any knowledge, experience or skill on technical, industrial, commercial matter popularly known as undivulged know-how;
Exceptions : The following is not covered
(a) Payment is for business or source of income outside India.
(b) Consideration for sale, distribution or exhibition of cinematographic films.
(c) Capital gain income from sale, transfer of IPR.
(17) U.N. Model definition:
Definition of royalties per S. 9(I)(vi) is very wide. Treaty definitions normally are more beneficial under U.N. Model, definition of royalty:
The term ‘royalties’ as used in this Article means payment of any kind received as a consideration for the use of or right to use, any copyright of literary, artistic or scientific work including cinematograph films, any patents trademark, design or model, plan, secret formula or process or for the use of or right to use industrial, commercial or scientific equipment or for information concerning industrial, commercial or scientific experience. Therefore what is not royalty is business income taxable in the country of residence.
(18) Judicial development in taxation of royalty:
(a) Asian Satellite Decision: In this case, payment was made for use of service from equipment service provider who had server and equipment at his disposal, satellite transponder was used. The payment received from such user, whether a royalty ? According to the assessee he was using only a commercial service, but per Dept. it was payment for use of process since the words in S. 9(i)(vi)are use of secret formula or process. Per the Tribunal, a formula may be secret, but process need not be secret. By use of process, the data becomes available to user, hence it is covered by term royalty. The other cases are of Grindwel Ltd. & Kotak Mahindra, holding that use of server, the consideration par-takes colour of royalty. According to speaker, these decisions require reconsideration.
(19) Equipment hire v. Service:
As definition of royalty includes consideration for use of or right to use industrial, commercial or scientific equipment, the user has to ask two questions to himself, namely:
(a) Am I requiring the use of equipment, or
(b) Am I acquiring service of the equipment?
In the former case he needs physical possession, custody and control of property. There should be no concurrent user by other and thirdly the risk of operation is with him as user.
In the latter case, treaties are not uniform e.g., the India-USA DTAA covers equipment rental also. But in India-Netherlands DTAA, it does not. Impact of MFN clause. In Belgium treaty, the scope was amended due to favourable treaty with Sweden.
(20) TDS compliance:
TDS compliance assures great importance due to rigours of S. 40(a)(i). It is advisable to take certificate u/s. 195(2) to overcome chances of disallowance of expense and also to avoid litigation on failure to deduct, confrontation on interest and penalty for non-deduction and paying tax out of own pocket. The assessee payer has no authority to decide whether tax is deductible or not. It is advisable to follow safer course of withholding tax before payment to non-resident.
The meeting terminated with a vote of thanks to the learned speaker.
