Section 9(1)(vi) – Royalty paid by one NR to another NR would be
taxable in India if it is paid in respect of patents used for the
purpose of carrying on business in India or for earning any income from a
source in India. On facts and in the context of CDMA technology , where
it can be shown that royalty is paid for license used in manufacturing
products specific to India, such license may be treated as used in
carrying on business in India.
Facts:
The
Taxpayer, a company incorporated in the US, was engaged in the business
of designing, developing, manufacturing and marketing digital wireless
communication products and services based on “Code Division Multiple
Access” (CDMA) technology. The Taxpayer owned certain patents pertaining
to CDMA technology.
The Taxpayer granted a non-transferable and
non-exclusive, worldwide patent licence to NR Original Equipment
manufacturers (OEMs) outside India to manufacture and sell CDMA
handsets/ infrastructure equipment (CDMA products).
For
exploitation of patent license, OEMs were required to pay a
non-refundable licence fee and an on-going royalty based on sale of CDMA
products. Royalties were to be computed as a percentage of the selling
price of the products manufactured by the OEMs. As per the agreement
between the taxpayer and OEM, royalty would become due as and when the
CDMA product was invoiced, shipped, sold, leased or put to use,
whichever was earlier.
OEMs manufactured CDMA products outside
India and sold them to telecom operators/service providers (SP)
worldwide, including India.
The issue before the Tribunal was
whether the royalty paid by NR OEMs to the Taxpayer (relating to
handsets /equipment sold/ used by OEMs in India) were taxable in India.
In other words, whether the royalty payment will be taxable in the
jurisdiction where the handsets/equipment are manufactured or in the
jurisdiction where they are used.
Held:
Under the Act
The
determining factor in royalty taxation is the place where the
intellectual property (IP) is used. i.e., the emphasis is on the situs
of use of the IP.
In connection with the patents, the event
triggering taxation is (i) granting of a right, licence or sub licence
in a patent, or (ii) sharing of information concerning use or working of
a patent. It is thus taxation of income of the person owning the
patents and it is taxation in the jurisdiction of end use of patents.
The emphasis is on the “situs of use” of the patent rather than “situs of the entity” making payment for the royalty.
If
a patent is used in a manufacturing process, royalty taxation should be
in the jurisdiction where manufacturing takes place. However, where
patent is used by the end consumer and the manufacturing is only a
conduit for collection of royalty for use from the end customer, it
should be taxable in end use jurisdiction.
As per the royalty
source rule u/s. 9(1)(vi), the situs is in India if the usage of patent
is for the purpose of (i) carrying on business or profession in India
(first limb) or (ii) earning income from a source in India (second
limb).
On carrying on a business or profession in India
Carrying
on business wholly in India or exclusively in India is not a sine qua
non for attracting taxability u/s. 9(1) (vi)(c). Even when business is
partly carried out in India but the royalties are payable in respect of
such part of the business as is carried on in India, it would be taxable
in India.
When an entity has a PE in a jurisdiction it would
imply that such an entity is carrying on business in the jurisdiction in
which such PE is situated.
Where the core manufacturing
activity with respect to CDMA products is carried out in one
jurisdiction but the sales and marketing activity in respect of the same
product is carried out in another jurisdiction (India), it cannot be
said that the business is not carried on in that other jurisdiction
(India).
Thus even where OEM do not manufacture CDMA products in
India, but makes India-specific products and carries out a part of his
business operation in India, it would be sufficient for section
9(1)(vii) to apply.
The principle that sale to customers in
India would amount to business with India and not business in India (as
observed in earlier ruling of ITAT ) would hold good only where there
was no material to suggest that any activity is carried on in India.
Thus by analogy even where NR has some operations in India, it can be
said to carry on business in India.
Thus, whether or not the OEMs carried on business in India would depend on two questions;
-Whether the CDMA handsets were made India specific and
-Whether OEM, as a part of his business, was carrying on any operations in India.
The
Andhra Pradesh High court (HC) in the case of Asifuddin [(2005)
Criminal Law Journal 4314 AP] had examined the working of the CDMA
technology and concluded that CDMA handsets are service provider
specific. However, it was argued by the Taxpayer that the CDMA handsets
sold in India were not service provider specific.
The issue was
remanded back to Tax Authority for a fresh examination on the aspects of
whether the OEMs made India specific products, whether OEMs had PE in
India.
On earning income from a source in India
The
expression ‘for the purpose of making or earning any income from any
source in India’ not only involves active earnings such as a business in
India but also a passive earning by exploiting an asset (both tangible
and intangible) in India.
The taxation of royalties for use of a
patented technology will have the situs where the technology is used.
Accordingly, when the royalty is for use of a technology in
manufacturing, it is to be taxed at the situs of manufacturing the
product, and, when the royalty is for use of technology in functioning
of the product so manufactured, it is to be taxed at the situs of use.
In
the present case, taxpayer owns the patent and royalty is for use of
patented technology, while the point of its collection, as a measure of
convenience and in consonance with the industry practice, is from
manufacturer when the patented product is put into use by sale.
Whether
or not patents are used in the manufacturing of the handset or for the
use of the patented technology embedded in the CDMA handsets is a highly
technical aspect requiring opinion of technical expert. The matter was
remitted back to Tax Authority for further examination.
Under the DTAA
Article
12(7)(b) of the India-USA DTAA provides that royalty shall arise in
India if it relates to the use of or the right to use the right or
property in India.
Patents can be said to be used in India only
when royalty is paid for the use of patents in CDMA products sold in
India and not for the use of CDMA technology for the manufacture of CDMA
products outside India.
The Tribunal abstained from ruling on
Article 12(7)(b) as this issue was remanded back for consideration based
on opinion of technical expert.
