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In pursuit of knowledge |
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Royalties and Fees for Technical Services in International Trade Direct Taxes Jainee Tushar Shah & Sandeep Bagmar R. Students, Indian Law Society’s Law College, Pune |
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[Editorial Note: 2nd Best Research Paper of 4th Nani Palkhivala Research Paper Competition for the year 2008] Introduction The business of buying and selling or bartering goods or services is called trade1. International trade is the exchange of capital, goods, and services across international borders or territories. In most of the countries, it represents a significant share of gross domestic product (GDP). While international trade has been present throughout much of history, its economic, social, and political importance has been on the rise in recent centuries. Industrialization, advanced transportation, globalization, multinational corporations, and outsourcing are all having a major impact on the international trade system. Increasing international trade is crucial to the continuance of globalization. International trade is a major source of economic revenue for any nation that is considered a world power. Without international trade, nations would be limited to the goods and services produced within their own borders. Bird’s eye view Most of more than 190 countries in the world have not reached the same state of economic advance as have the industrialised countries, which include the United States of America, Canada, Japan and Western Europe. Rather most countries could be classified as having economies that are either (1) Developing, (2) Less developed, and (3) Newly industrialised. In the late 1980s, the more progressive developing countries, particularly in Latin America, began to give up their isolationist policies and to loosen the controls over trade and investment. Today they are trying to attract large sources of new capital for investment, new technologies, new manufacturing techniques and business know-how, improve training for their labour force and organisational and managerial expertise. For example: developing countries are reducing tariffs on most imported products. They are gradually ending burdens on import, licensing schemes and making it easier for local companies and investors to obtain foreign currency. They are reducing many kinds of taxes on business. Some countries are lowering taxes on royalties paid to foreign companies under licensing agreements for modern technology and technical assistance. Gradually developing countries are passing new, more progressive laws – protection of Intellectual property, protection of environment, protection of consumers from fraud and abuse, protection of workers, securities laws to protect investors and increase investment opportunities and many more. Even accounting standards are changing so that investors will be given more information about a company and can better understand its financial health. Government “Red-tape” is being cut allowing a faster and easier flow of paper work through government bureaucracies, which speeds up in application process for investment and eases the way for importers to bring goods into the country. Government agencies are applying laws and regulation to foreign firms in a fairer and more consistent manner2. The business environment of the 1990s has changed dramatically since the end of World War II. To be competitive in the world markets today, the international manager or world trader needs to be familiar with economics, culture, politics and law. Multinational firms have adopted business strategies that see the world and profits in global terms. Even small and medium-sized manufacturing and service firms are important competitors in international markets and will become even more important in future3. India still has some of the most severe restrictions in the world. They have high tariffs and quotas on imports, import licensing requirements a ban on the import of practically all consumer goods and strict control over the import of commodities. Since 1976, India has applied the rule for taxation of royalties and fees for technical services. This has resulted into more foreign collaboration and Indian importers asking for advanced technology and services from other source countries. Meaning of Royalty and Fees for Technical Services Royalty – A payment made to an author on invention for each copy of a work or article sold under a copyright or patent4. As per Income-tax Act, 1961 (hereinafter referred to as the Act) – royalty means consideration (including any lump sum consideration but excluding any consideration which would be the income of the recipient chargeable under the head “capital gains”) for – (i) the transfer of all or any rights (including the granting of a licence) in respect of a patent, invention, model, design, secret formula or process or trademark or similar property; (ii) the imparting of any information concerning the working of, or the use of, a patent, invention, model, design, secret formula or process or trade mark or similar property; (iii) the use of a patent, invention, model, design, secret formula or process or trademark or similar property; (iv) the imparting of any information concerning the technical, industrial, commercial or scientific knowledge, experience or skill; (iva) the use or right to use any industrial, commercial or scientific equipment but not including the amounts referred to section 44BB; (v) the transfer of all or any rights (including the granting of a licence) in respect of any copyright, literary, artistic or scientific work including films or video tapes for use in collection with television or tapes for used in connection with radio broadcasting, but not including consideration for sale, distribution or exhibition of cinematography films; or (vi) the rendering of any services in connection with the activities referred to in sub-clauses (i) to (iv), (iva) and (v)5. The meaning of royalty is not to be restricted to what is mentioned in the Act, even Double Taxation Avoidance Agreements (hereinafter referred to as DTAA) entered with other nations are inclusive of the definition of royalty. Madras High Court in the case of CIT vs. Neyveli Lignite Corp. Ltd.6 has expressed that the term connotes "royalty" which normally connotes the payment made by a person who has exclusive right over a thing for allowing another to make use of that thing which may be either physical or intellectual property or thing. The exclusivity of the right in relation to the thing for which royalty is paid should be with the grantor of that right. Mere passing of information concerning the design of a machine which is tailor-made to meet the requirement of a buyer does not by itself amount to transfer of any right of exclusive user, so as to render the payment made therefore being regarded as "royalty". The term royalty for the purpose of a transaction to be taxable has to be interpreted in the context of right to use. There are various types of royalties which are, to mention a few; established royalty, reasonable royalty, haulage royalty, land owners royalty, mineral royalty, overriding royalty, shut-in royalty, royalty interest etc. Though the basic principle of royalty in all of the above mentioned royalties remains the same but they differ on the subject on which royalty is paid. Fees for technical services – fee means a charge for labour or services, especially for professional services7. As per the Act, fees for technical services means any consideration (including any lump sum consideration) for the rendering of any managerial, technical or consultancy services (including the provision of services of technical or other personnel) but does not include consideration for any construction, assembly, mining or like project undertaken by the recipient or consideration which would be income of the recipient chargeable under the head “salaries”.8 The stress is laid on type of service whether it is to be one of technical nature or personal. Only services of technical nature are taxable as fees for technical service and not personal, what is technical has to be determined from facts and circumstances of every transaction. Most of the DTAAs do not provide for the meaning of fees for technical services specifically but it is either included under the term royalty or distinguished from the term personal services. The definitions of the terms ‘royalty’ and ‘fees for technical service’ provided in the Act are only for the purpose of S. 9 and cannot apply to a DTAA made under S. 90 of the Act unless expressly so provided.9 Receipts which are royalty or fees for technical services under clauses (vi) and (vii) of S. 9 would not be chargeable to tax under the Act if the relevant treaty so provides. Basis of charge According to sec. 4 of the Act, income tax shall be chargeable on every person whose income in previous year is taxable in the assessment year at any rate or rates, income tax at that rate or those rates shall be charged for that year in accordance with, and subject to the provisions of the Act. Sec. 4 charges every person in respect of his ‘total income’, and sec. 5 defines the gamut of total income. The principle underlying Sec. 5 is to make the chargeability of income depending upon the locality of accrual or receipt.10 When Royalty and Fees for Technical Service Taxable? Income from royalty and fees for technical services is taxable when it deems to accrue or arise in India. Clause (vi) of Sec. 9(1) was inserted by the Finance Act, 1976. It deals with a specific type of income, namely by way of royalty, whereas clause (i) of sec. 9(1) is a more general provision, which deals with all incomes accruing or arising, whether directly or indirectly, through or from, any business connection in India. Income by way of royalty is a specie or one of the categories of a larger class mentioned in clause (i) of sec. 9(1), and hence, the specific instance having been provided by clause (vi), once the question of royalty arises, the only provision that can be invoked in that is clause (vi) and not the more general provision of clause (i) of sec. 9(1).11 Under clause (vi), income by way of royalty payable by the Government or a person who is a resident, except where the royalty is payable in respect of any right, property or information used for services utilised for the purpose of business or profession carried on by such a person outside India or for the purposes of making or earning any income from any source outside India, shall be deemed to accrue or arise in India. The clause in its main part, deals with the circumstances in which income by way of royalty can be deemed to accrue or arise in India. The proviso to clause (vi) excludes royalties paid in pursuance of agreements made, with the approval of the Central Government, prior to 1st April, 1976, paid up in lump sum as consideration for certain types of transfer or information. Explanation 1 of clause (vi) deals with proposal made before 1st April, 1976 which materialised into agreements made after 1st April, 1976. They will be treated on par with agreements made before 1st April, 1976 if certain conditions are fulfilled. Exceptions Under Explanation 2 to Sec. 9(1)(vi) for the purpose of clause (vi), ‘royalty’ means consideration including any lump sum consideration but excluding any consideration which would be the income of the recipient chargeable under the head ‘Capital gains’,12 though described as royalties, they are in the nature of capital receipts and do not fall within the definition here. They may not be taxable as the deeming here is only in respect of royalty received by way of income, for, (i) the transfer of all or any rights (including the granting of a licence) in respect of a patent, invention, model, design, secret formula or process or trade or similar property; (ii) the imparting of any information concerning the working of, or the use of, a patent invention, model, design, secret formula or process or trade mark for similar property It will be seen that the definition is wide enough to cover both industrial royalties as well as copyright royalties. Further, the definition specifically excludes income which would be chargeable to tax under the “capital gains” and accordingly such income will be charged to tax as capital gains on a net basis under the relevant provisions of the law.13 The definition of the term ‘royalty’ in Explanation 2 to section 9(1)(vi) is not a general definition applicable wherever that term occurs but is applicable to section 9(1)(vi) only.14 Clause (vii) of sec. 9(1) was inserted by the Finance Act, 1976, and a proviso similar to the one in clause (vi) was added to clause (vii) by the Finance (No. 2) Act, 1977, with effect from 1st April, 1977. Under clause (vii), income by way of fees for technical services payable by the Government or a person who is a resident, except where the fees are payable in respect of services utilised in a business or profession carried on by such person outside India, or for the purposes of making or earning any income from any source outside India, is deemed to accrue or arise in India. The expression “fees for technical services” has been defined to mean any consideration (including any lump sum consideration) for the rendering of managerial, technical or consultancy services, including the provision of services of technical or other personnel. It however, does not include fees of the following types namely: (1) any consideration received for any construction, assembly, mining or like project undertaken by the recipient. Such consideration has been excluded from the definition on the ground that such activities virtually amount to carrying on business in India for which considerable expenditure incurred by a non-resident and accordingly it will not be fair to tax such consideration in the hands of a foreign company on gross basis or to restrict the expenditure incurred for earning the same 20% of the gross amount as provided in sec. 44D of the Act. Consideration for any construction, assembly, mining or like project will, therefore, be chargeable to tax on net basis, i.e., after allowing deduction in respect of costs and expenditure incurred for earning the same and charged to tax at the rates applicable to the ordinary income of the non-resident as specified in the relevant finance Act. (2) Consideration which will be chargeable to tax in the hands of the recipient under the head “salaries”. If the case falls under clause (vi) of section 9(1) and is exempted from the operation of clause (vi) by virtue of the proviso, then one cannot refer to clause (vii) which is a general clause.15 Rate of taxation As per the Act Sec. 115A deals with determination of tax on dividends, royalties and fees for technical services in the case of foreign companies. The section was inserted by the Finance Act, 1976 with effect from 1st June, 1976 and has been amended several times. In certain cases this section provides, a special rate of tax on dividends, royalties and fees for technical services, interest, incomes from units and computer software fees received by non-resident or non-corporate assessee or foreign company. Sec 115A(1) deals with all individuals whether non-resident Indian or foreign nationals.16 The salient features of this section are as follows:– (a) The section covers in certain cases, dividend (other than that referred to in Sec 115O), interest on loans or debts in foreign currency defined in Sec. 10(15)(iv)(g), income in respect of units of a mutual fund specified under sec. 10(23D) purchased in foreign currency, income referred to in clauses (vi) and (vii) in sec. 9(1) in the nature of royalty and technical fees as defined therein, and income from computer software as defined in sec. 80HHE. (b) No deduction will be allowed in respect of any expenditure or allowance under sec. 28 to 44C and Sec. 57 on such income.17 (c) Deduction under chapter VI – A will not be allowed on dividend, interest and income from units included in the gross total income. (d) Where a non-resident, non corporate assessee or the foreign company has such income only, and tax is deducted at source thereon as per Chapter XVII–B, a return is not required to be filed under sec. 139(1). The tax rates mentioned below will not be applicable where a lower rate of tax is prescribed under an agreement for the avoidance of double taxation entered into by the Central Government, under S. 90 with any other country or payment made in pursuance of the agreement approved by the Central Government. Rates of income-tax on Royalties and Fees for Technical Services as per the Act
As per DTAAs As already mentioned, receipts which are royalties or fees for technical services under clauses (vi) and (vii) of section 9(1) could not be chargeable to tax if the relevant DTAA so provides. Payment of income-tax by assessees in different form A. RESIDENT A resident who pays for the use of royalty does not directly come under the purview of taxation under sec. 115A of the Act. The resident merely has to deduct tax at source for such payments made by him to a non-resident. Sec. 195 provides that when any person pays to a non-resident, not being a company or to a foreign company any interest or any other sum chargeable under the provisions of the Act, not being income chargeable under the head ‘Salaries’, shall at the time of such payment by any mode deduct income tax thereon at the rates in force. Where deduction is denied on any payment under the sec. 195 for any year on the ground that the tax thereon has not been paid or deducted, the proviso enables the assessee to claim deduction in a later previous year in which the tax is paid or deducted. Presumably, such deduction can be claimed in more than one previous year if the tax thereon is paid in instalments over a number of years. B. Non-resident Royalty or fees for technical services paid to a non-resident is always taxable and more so under sec. 9(1)(vi) & (vii) in respect of its use for business purposes carried on in India. DTAA would also entitle royalty as mentioned in respective DTAAs to be taxed in the country where it arises. Sec. 44DA provides that the income by way of royalty or fees for technical services received from government or an Indian concern in pursuance of an agreement made by a non-resident (not being a company) or a foreign company with government or the Indian concern after 31st March, 2003, shall be computed under the head “Profits and gains of business or professions” in accordance with the provisions of the Act. However the provisions of the said section shall apply only if the non-resident (not being a company) or a foreign company carries on business in India through a permanent establishment situated in India, or performs professional services from a fixed place of profession situated in India, and the right, property or contract in respect of which the royalties or fees for technical services are paid is effectively connected with such permanent establishment or fixed place or profession, as the case may be. It has also been provide that no deduction shall be allowed – (i) In respect of any expenditure or allowance which is not wholly and exclusively for the business of such permanent establishment or fixed place of profession in India; and (ii) In respect of amounts, if any, paid (otherwise than towards reimbursement of actual expenses) by the permanent establishment to its head office or to any of its other offices. With a view to harmonize the provisions relating to income from royalty or fees for technical services attributable to a fixed place or profession or a permanent establishment in India with similar provisions in the various DTAAs, section 44DA was inserted. The section also requires that non-resident (not being a company) or a foreign company shall keep and maintain books of account and another documents in accordance with the provisions of sec. 44AA and get the accounts audited and furnished along with return of income, the report of such audit. Non-resident having a business connection – Whether there is a business connection or not, any income by way of fees for technical services should be taken to have been covered by the provision in section 9(1)(vii).18 C. Foreign company Sec. 44D(a) of the Act provides that in case of a foreign company, the deductions admissible under sections 28 to 44C of the Act in computing the income by way of royalty or fees for technical services received from an Indian concern in pursuance of an agreement made with the Indian concern before 1st April, 1976, shall not exceed 20 per cent of the gross amount of such income. Where such agreement is made after 31st March, 1976, sec. 44D(b) provides that no deduction will be allowed in respect of any expenditure or allowance under any of the said sections in computing such income. In other words gross amount is taxable under sec. 115A(1)(b), as mentioned earlier. Where income is assessable as royalty or fees for technical services, deductions under sections 28 to 44C and 57 would have no application. Element of profit is not an essential ingredient of taxability.19 where a flat rate is applied on the income from royalty and fees for technical services under section 115A, the salary paid to the employees for rendering such technical service is not deductible. Sec. 44D has no application to such cases.20 The question of deduction of head office expenses under section 44D arises only in computation of business income attributable to permanent establishment in India. The flat rate at a lower rate of tax assumes that all expenses are allowed. It is for this reason, no separate deduction is possible. Sections 44D and 44DA are special provisions; it takes precedence over sections 28 to 44C.21 In view of treaty override, a more liberal inference under the agreement, if any, in favour of the tax payer may require to be accepted. Consequences of failure to deduct tax or pay Any person, who fails to deduct tax at source, does not deduct or does not pay, or after so deducting fails to pay, the whole or any part of the tax, as required by or under this Act, then such person shall be deemed to be an assessee in default in respect of such tax. Assessee in default is liable to pay simple interest at one per cent for every month or part of a month on the amount of such tax from the day on which such tax was deductable to the date on which such tax is actually paid. The assessing officer has the right to create charge on the assets of the assessee in default for the purpose of sec. 201 on amount of tax and simple interest thereon. If assessee fails to deduct a tax at source as required by or under the provision of Chapter XXVII; then, such person shall be liable to pay, by way of penalty a sum equal to the amount of tax which such person failed to deduct or pay as aforesaid. Such penalty shall be imposed by the Joint Commissioner.22 Transactions chargeable as royalty 1. Right to use of technical know-how or trademark as royalty and not capital received 23 2. Grant of licence to be one of the conditions to treat supply of equipment or drawing or manufacturing and equipment as royalty24 3. When right of exploitation is given by the owner to a third party instead of outright sale, then, for the right to exploit the invention, secret processes, some amount may be paid and the amount paid may be correlated to the extent of exploitation. Such payments are royalties, even though termed something else and would be deemed to accrue or arise in India25 4. As a non-resident does not retain the property in designs and drawings which are sold outright, the consideration paid for transfer of designs and drawings was assessable as royalty26 5. Lease rent payable for use of a transponder located abroad for relay of programme in Indian channels should give rise to royalty taxable in India27 6. An information agreed to be supplied in respect of working methods and manufacturing processes of a product are exclusive information and knowledge available to the assessee and not generally disseminated an payment in respect thereof would bear the character of royalty.28 Transactions not chargeable as royalty 1. A non-resident company reputed and expert to supervise the construction and installation of a kiln in India and not for imparting any information, the payment to it was held not to be income by way of royalty.29 2. Where the foreign company entered into a single contract for designing, engineering, manufacturing, testing and supplying machinery, it was held that it was not possible to apportion the consideration for the design on one part, and the other activities on the other part, and hence, the consideration for the transfer of design did not come under the purview of royalty.30 3. Merely providing of
information unless it is a secret or confidential one cannot by itself lead to
the inference that the amount received would constitute royalty31
Transactions chargeable as
Fees for Technical Services 1. Technical or consultancy
services paid in the form of success fee32 2. Fees received from foreign
company for preparatory studies conducted abroad33 3. Training by a non-resident
company in India34 4. Profits from installation,
testing and training services35 5. Supervisory services for
erection, commissioning and start-up of the plant36 6. Fees paid to assist in
achieving desired quality and optimum production37 7. Telecom bandwidth for
two-way transmission of voice38 Transactions not chargeable
as Fees for Technical Services 1. Service provided through use
of electronic gadgets or instruments to make life easier39 2. Payment made to foreign
employees by way of remuneration for the services rendered in India40 3. Rendering of services by two
foreigners for just 15 days to set up a plant in India under an agreement for
transfer of technical know-how41 Tax duplication Tax duplication, also known as
‘double taxation’, occurs when income is assessed twice, either by the same tax
jurisdiction or by two competing tax jurisdictions. International Double
Taxation Overlapping of tax
jurisdictions of two (or more) sovereign countries with respect to the same base
is said to occur when both (or all) the sovereign countries in question have
legitimate claims as to competency to levy such tax, for instance, when a
tax-payer is subject to taxation on income from a cross-border transaction in
more than one jurisdiction. Competence of a country to
impose taxes: The following principles govern
the right of a country to impose tax on income from royalty and fees for
technical services: 1. Use Rule: According to this
rule, the source country is the country where the intangible property is
utilized. 2. Pay Rule: According to this
rule, the source country is the country of residence of the payer of royalties
and/or technical fees. Methods to alleviate
International Double Taxation The problem of international
double taxation could have substantially been avoided if all the countries
followed either the source rule or the residence rule. In practice however, most
countries exercise their tax jurisdiction based on both the rules. Generally, a country taxes its
residents for their foreign income, and non-residents for their income
originating within its territorial borders. International double taxation thus
arises when both, the home country, as well as the source country claim tax
jurisdiction as to the income arising from a cross-border transaction occurring
between those two countries. Double taxation of this kind hinders free
international movement of goods and services, and thus hinders international
trade and commerce. In order to alleviate or even
eliminate double taxation of foreign income of their residents, countries may
adopt any of the following methods: Tax exemption method – A
country may voluntarily and unilaterally waive off its claim to tax foreign
income of its residents by granting tax exemption on the same. Foreign tax credit method – The
objective of this mechanism is to reduce tax on foreign income of a resident to
the extent that income has already been taxed in that foreign jurisdiction.
Double taxation avoidance
agreements (tax treaties) method – A tax treaty is an agreement entered into by
countries for the avoidance of double taxation of income, and the division of
tax revenue amongst those countries inter se in respect of income falling within
the tax jurisdictions of those countries concurrently. A tax treaty may be
multilateral or bilateral. 1. Multilateral tax treaties: There are three notable
multilateral tax agreements in international tax legislation – the ANDEAN
Pact42, the CARICOM Conventions43, and the Nordic Convention44. Multilateral tax
treaties, though considered at different times in various contexts, have not
gained acceptance for being complex.45 It is difficult to administer and apply a
multilateral tax treaty as compared to a bilateral one. 2. Bilateral tax treaties: Most tax treaties are
bilateral46. Model tax treaties drawn up by international organizations like the
OECD47 and the United Nations48, have helped to harmonize the approach of
countries to double tax relief with respect to international transactions. These
model treaties have facilitated the negotiation of tax treaties by eliminating
the need for elaborate analysis and protracted discussion of every issue
involved in each treaty.49 India’s Bilateral Tax
Treaties The Income-tax Act, 196150
empowers the Government of India to enter into an agreement with the Government
of any country outside India for the following purposes: a. the granting of relief in
respect of: i. Income on which have been
paid both income tax under this Act and income tax in that country; or ii. Income tax chargeable under
this Act and under the corresponding law in force in that country to promote
mutual economic relations, trade and investment, or b. for the avoidance of double
taxation of income under this Act and the corresponding law in force in that
country, or c. for the exchange of
information for the prevention of evasion or avoidance of income tax chargeable
under this Act or under the corresponding law in force in that country, or
investigation of cases of such evasion or avoidance, or d. for the recovery of income
tax under this Act and under the corresponding law in force in that country. Implications under India’s
Tax Treaties for tax on income from royalty and fees for technical services This paper purports to analyze
India’s double taxation avoidance agreements (hereinafter “DTAAs”) with USA, UK,
UAE and Mauritius with respect to taxability of royalties and fees for technical
services. Indo-usa Double Taxation
Avoidance Agreement The Indo-USA DTAA provides for
limited source country taxing right as regards income from royalty and fees for
technical services. It seeks to tax such income along the lines of the UN Model. Article 12 thereof applies to
royalties and technical fees. It provides for taxation of ‘royalties’ and ‘fees
for included services’ in the country where they arise.51 during the first five
taxable years during which the convention has effect, the tax on ‘royalties’ or
‘fees for included services’ is not to exceed 15% of the gross amount of
royalties or fees for included services, where the tax-payer is the Government
of a contracting country, a political sub-division thereof or a public sector
company, and 20% in all other cases.52 At the expiry of the said period of five
years, the rate of tax is 15% in all cases.53 There is a separate 10% rate
(maximum limit) for certain royalties and ancillary fees derived from use or
enjoyment of proprietary rights in industrial, commercial or scientific
equipment.54 ‘Fees for included services’
include payments for technical or consultancy services, if they are: a) ancillary and subsidiary to
the application or enjoyment of the rights for which payment for royalties
definition is received, or b) make available technical
knowledge, plans or designs.55 ‘Fees for included services’ do
not include amounts paid: a) for services ancillary but
linked to the sale of certain property; b) for services related to ship
and aircraft rental in international traffic; c) for teaching in or by
educational institutions; d) for personal services used
by the payer; or e) to employees or for
professional services (other than to a company).56 Indo-uk Double Taxation
Avoidance Agreement This DTAA also provides for
limited source country taxing right as regards income from royalty and fees for
technical services, following the UN Model. Article 13 of the Indo-UK DTAA
applies to royalties and technical fees. It provides for taxation of ‘royalties’
and ‘technical fees’ in the country where they arise.57During the first five
years during which the convention has effect, the tax on ‘royalties’ or ‘fees
for included services’ is not to exceed 15% of the gross amount of royalties or
fees for included services, where the tax-payer is the Government of a
contracting country, a political sub-division thereof, and 20% in all other
cases.58 At the expiry of the said period of five years, the rate of tax is 15%
in all cases.59 There is a separate 10% rate (maximum limit) for certain
royalties and ancillary fees derived from use or enjoyment of proprietary rights
in industrial, commercial or scientific equipment.60 ‘Technical fees’ include
payments for technical or consultancy services, if they are: a) ancillary and subsidiary to
the application or enjoyment of the rights for which payment for royalties
definition is received, or b) make available technical
knowledge, plans or designs.61 ‘Technical fees’ do not include
amounts paid: a) for services ancillary but
linked to the sale of certain property; b) for services related to ship
and aircraft rental in international traffic; c) for teaching in or by
educational institutions; d) for personal services used
by the payer; or e) to employees or for
professional services (other than to a company).62 Indo-UAE DTAA Following the UN Model, the
Indo-UAE DTAA also provides for limited source country taxing rights as regards
income from royalty. Article 12 of the said DTAA provides for taxation of income
from ‘royalty’. Unlike the Indo-USA and Indo-UK DTAAs, the provision does not
define technical fees. Under this provision63, royalties are taxable at a rate
not to exceed 10% of the gross amount of royalties. Indo-Mauritius DTAA The Indo-Mauritius DTAA also
follows the UN Model, and provides for limited source country taxing rights with
respect to ‘royalty’. The DTAA does not define ‘technical fees’. Article 1264 of
the said DTAA provides for taxation of royalties at a rate not to exceed 10% of
the gross amount of royalties. ‘Royalty’ or ‘Technical
Fees’? Neither the UN Model65 nor the
OECD Model66 expressly defines ‘technical fees’. However, ‘royalty’ has been
defined under both the aforesaid conventions to include payments of any kind as
consideration for the right to use any patent, trade mark, design or model,
plant, secret formula or process, or right to use any industrial or commercial
equipments or even information. India’s DTAAs do not have a separate provision
for taxing ‘technical fees’. These are taxed at the same rate as ‘royalties’,
and therefore the DTAAs do not purport to draw a distinction between ‘royalties’
and ‘technical fees’. Such distinction must, however, be drawn where the
domestic law of one of the countries sets different rates of taxation for
royalties and technical fees. Should not the Indo-UAE and Indo-Mauritius DTAA
explicitly define ‘technical fees’? ‘Royalty’ or ‘Business
Income’? A question may arise whether a
particular income falls under the category of ‘income by way of royalty’ or
under ‘business income’. A payment of royalty may be encompassed within
‘business income’ when the lessor or the licensor has a permanent establishment
in the source country. ‘Technical Service’ or
‘Commercial Service’? It is to be seen whether a
service rendered by a non-resident is technical in content or only a commercial
service. Even where such service is of technical nature, it may form a part of
an integrated business package wherein the said service is rendered from a fixed
base situated in the source country, thus rendering it assessable only as
‘independent personal service’. ‘Consultancy Services’ The use of the word
‘consultancy services’ in a service agreement between parties has proved to be
misleading to income tax authorities including appellate authorities.67 In such
cases, what is material is the nature of the consultancy agreement. It should
make available technical knowledge, experience, skill, know-how or processes, or
consist of development and transfer of technical plan or design.68 It should
ordinarily impart knowledge and supply solutions.69 A magnified view over the
Intellectual Property Rights – Softwares In general, licensing provides
to a firm with intellectual property a means for increasing the returns yielded
by that property by permitting someone else to exploit it. In the international
context, this capability is particularly useful: a United States concern with
little or no experience in Nepal can contract with someone with such experience
to exploit the Nepalese market. In the normal course, licensor and licensee will
negotiate over matters such as condition and extent of use, compensation and
confidentiality. Many countries seek to assist local licensees in their efforts
to acquire advanced technology. Local legislation may supersede contractual
provisions in order to permit host-country nationals to process the intellectual
property more rapidly. Tax enforcement of local legislation may provide a
further source of mischief. Under some approval systems, nothing is likely to
happen without co-operation of a local licensee.70 There are three categories of
software that may be distributed, namely, specialist bespoke programmes, general
commercial software and mass marketed software. The first is an unlikely
candidate for distribution, while commercial programmes with a general
application are more suited for distribution. Mass marketed software has been
beleaguered by the greatest number of problems and is subjected to the same
affliction that plagues the music industry – copyright infringement on
commercial scale. For the purposes of copyright law, computer programmes are
treated as “literary works”. Notwithstanding all of these
hazards, the efficiency and technical advances underlying licensing makes it a
rapidly expanding and highly profitable form of doing business abroad. It is,
however, an endeavour that must be pursued cautiously. One of the questions faced by
the foreign companies which supply the Intellectual property or advanced
technology such as software is whether the payment made thereof takes the
character of ‘royalties’ or leads to business profits? In view of Tata Consultancy
Services vs. State of AP71, computer software put in the medium of disk are
“goods” and its purchase constitutes the “purchase” of a tangible asset and the
assessee becomes the “owner” thereof, though the content on such medium is
intangible asset. The fact that the computer software is obtained by way of
“ownership” or on “license” is not determinative. The functional test is more
important. If the tests of ownership and enduring benefit are satisfied, the
question whether expenditure incurred on computer software is capital or revenue
has to be seen from the point of view of its utility to a businessman and how
important an economic or functional role it plays in his business72. A transaction for the sale of
computer software is clearly a sale of "goods" within the meaning of the term as
defined in the Indian Sale of Goods Act, 1930. The term "all materials, articles
and commodities" includes both tangible and intangible/incorporeal property
which is capable of abstraction, consumption and use and which can be
transmitted, transferred, delivered, stored, possessed etc. The software
programmes have all these attributes. Under the Act, right to use software is
‘royalty’ irrespective of the fact that it is on a CD. Treating payments to
acquire software as royalties could imply more revenues for the tax department
in India. However, revenues may not be guaranteed for the tax department if they
are treated as business profits due to ‘permanent establishment’ issues for
multinational software companies. AMCHAM, a body representing the
interests of US companies in India, have made a call for clarity and certainty
in tax treatment on software payments. Mr. Sanjiv K. Chaudry, Chairman, Taxation
Committee, AMCHAM, told Business Line “we have urged the Finance Ministry to put
down in a circular on how payments made for software should be characterized.
They could treat it as royalties or as payments leading to business profits. But
they should some view on this. It should not be left to the interpretation of
assessing officers. Absence of clarity is only leading to a plethora of
litigation and uncertainty in business environment.”73 The high-profile Microsoft
case, involving about Rs. 700 crore, is an example of differing interpretations
on the “characterization” of payments made for software. Transfer of all or any rights
of software including granting of a licence in respect of a patent, invention,
model, design, secret formula or process or trade mark or similar property would
fall under the term royalty. Thus, to conclude, only those transactions wherein
there is a transfer of all or any rights of the computer software would fall
within the definition of royalty under Explanation 2 of sec. (9)(1)(vi) and not
those transactions of commercial nature. Interpretation – Is it complex?
Controversies relating to
international taxation are about the provisions of domestic law, the treaties
and the conventions concerning double taxation avoidance. It has been settled
that the provisions of the DTAA will prevail over the domestic law and the
Explanation to s. 90 that the charge of tax in respect of a foreign company at a
rate higher than the rate at which a domestic company is chargeable, shall not
be regarded as less favourable charge or levy of tax in respect of such foreign
company. In spite of this, the amount of litigation over the conflicts over the
provision of domestic law and the treaties and conventions concerning DTAA is
never ending. Tax treaties may give rise to various tax disputes, which domestic
tax forums and courts have to deal with. The main problem before such courts
would be that there are often no precedents to be followed, since international
tax law is still in its infancy. Most of the cases are being decided keeping the
law aside and depending upon facts and circumstances of the case. As said by Mr. Swatanter Kumar.
C.J. Bombay High Court in his speech “International taxation has become too
complex an issue. It has made the legal circles rethink the jurisprudence of the
jurisdiction. Innovation in applying settled legal dictum is the need of the
hour.”74 In interpreting a section in a
taxing statute, according to Lord Simonds, “the question is not at what
transaction the section is according to some alleged general purpose aimed, but
what transaction its language according to its natural meaning fairly and
squarely hits.”75 It is, therefore, not the function of a court of law to give
to words a strained and unnatural meaning to cover loopholes through which the
evasive tax-payer may find escape or to tax transactions which, had the
legislature thought of then, would have been covered by appropriate words.76 The
object of enactment is to frustrate legitimate tax avoidance devices for moral
precepts are not applicable to the interpretation of revenue statute.77 When it comes to fiscal
treaties dealing with double taxation avoidance, different countries have
varying procedures. In the United States of America such a treaty becomes a part
of municipal law upon ratification by the Senate. In United Kingdom such a
treaty would have to be endorsed by an order made by the Queen-in-Council. Since
in India such a treaty would have to be translated into an Act of Parliament, a
procedure which would be time consuming and cumbersome, a special procedure was
evolved by enacting Sec. 90 of the Act.78 In the case of Padmasundara Rao
(Deed.) vs. State of Tamil Nadu79 it was held that Courts should not place
reliance on decisions without discussing as to how the factual situation fits in
with the fact situation of the decision on which reliance is placed.
Circumstantial flexibility, one additional or different fact may make a world of
difference between conclusions in two cases. If there is any ambiguity in
respect of the subject of the tax, person liable to pay the tax and the rate at
which the tax is levied,80 and such ambiguity is not removable by reasonable
construction then there will be no tax in law till the defect is removed by the
legislature.81 Conclusion With respect to the Act, sec.
115A where it provides concessional rate of tax for royalty where the agreement
is in respect of industrial policy or approved by the Central Government. It is
an option available that if the subject is not included in the industrial policy
then the person who makes such payment shall try and get the approval of the
Central Government for a concessional rate of tax. The situation is not very
clear on what basis the Government grants approval for such agreements, whether
it is being based on industrial policy or it is a matter administrative policy.
And when such payments are made by the Government itself the rule is not much
clear whether it has to be presumed that it is approved by the Central
Government. Exclusion of payments made
which are in nature of capital expenditure though such payments are made to
acquire a right or right to use, defeats the whole purpose of charging income
under royalty and fees for technical services, and so does when such income is
chargeable under the head Capital gains. DTAAs do not provide for a
fixed rate of taxation for the purpose of royalty and fees for technical
services they only set an upper limit, and define the conflict of laws rules for
determining the tax jurisdiction as regards taxation of the same. Moreover tax
treaties do not have any precondition for the taxation of royalty and technical
fees at concessional rate, comparing it to that of the Act, like the industrial
policy and approval by the Central Government and do not specifically
differentiate between what constitutes royalty or technical services. And the
provisions of the Act have different meaning of the term royalty and technical
services, and provides for different rate of taxation for the same purpose as
per the preconditions. It is hoped that the Revenue would tax income by a
hard-headed approach. Bibliography Books referred 1. Kanga, Palkhivala and Vyas,
The Law and Practice of Income Tax, 9th Ed., LexisNexis Butterworths, 2004 2. S. Rajaratnam, Sampath
Iyengar’s Law of Income Tax, 10th Ed., Bharat Law House, 2005 3. Chaturvedi and Pithisaria’s,
Income Tax Law, 5th Ed., Wadhwa & Co., 1998 4. Richard Schaffer, Beverley
Earle and Filiberte Agusti, International Business Law and Its Environment, 4th
Ed., West Education, 1999. 5. S. V. Joga Rao, Computer
Contracts and Information Technology Law, 2nd Ed., Wadhwa & Co., 2005 6. Roy Rohatgi, Basic
International Taxation, 2nd Ed., Taxmann, 2005 7. S. Rajaratnam, B. V.
Venkatramaiah, Commentary on Double Taxation Avoidance Agreements, 3rd Ed.,
Taxmann, 2007 8. M. M. Sury, Income Tax in
Theory and Practice, 1st Ed., New Century, 2002 9. G. P. Singh, Principles of
Statutory Interpretation, 11th Ed., Wadhwa & Co., 2008 Cases referred 1. CIT vs. Neyveli Lignite
Corp. Ltd. 243 ITR 459 2. Cf Leonhardt vs. CIT 249 ITR
418 3. Citizen Watch Co. Ltd. vs.
IAC 148 ITR 774 4. Meteor Satellite Ltd. vs.
ITO. 121 ITR 311 5. 234 ITR 335 6. Erricsson Telephone vs. CIT
224 ITR 203 7. CIT v, Copes Vulcan Inc. 167
ITR 884 8. In re Timken India Ltd. 273
ITR 67 9. In re DHV Consultants BV 277
ITR 97 10. DCIT vs. ONGC as agent of
Foramer France 70 ITD 468 11. Atlas Copco AB of Sweden
vs. DCIT (1995) 53 TTJ (Bom.) 91 12. CIT vs. Neyveli Lignite
Corp. Ltd. (2000) 243 ITR 459 (Mad.) 13. CIT vs. Ahmedabad Mfg. &
Calico Printing Co. 139 ITR 306 (Guj.) 14. CIT vs. Davy Ashmore India
Ltd. 190 ITR 626 (Cal.) 15. Asia Satellite
Telecommunication Co. Ltd. vs. DCIT 85 ITD 478 (Del.) 16. NV Philips
Gloeilempenfabrieken vs. CIT (1988) 172 ITR 541 (Cal.) 17. CIT vs. Klayman Porcelains
Ltd. (1998) 229 ITR 755 (A.P.) 18. CIT vs. Mitsui Engineering
259 ITR 248 19. CIT vs. HEG Ltd. 263 ITR
230 (M.P.) 20. G. V. K. Industries Ltd.
vs. ITO (1997) 228 ITR 564 (A.P.) 21. Sahara Airlines Ltd. vs.
DCIT (2002) 83 ITD 11 (Del.) 22. International Airport
Authority of India Ltd. vs. DCIT (2005) 95 TTJ (Delhi) 1075 23. Clouth vs. CIT 238 ITR 861 24. International Operating
Services Ltd. vs. CIT 228 ITR 599 25. Dell International Services
India Pvt. Ltd. vs. CIT MANU/AR/0002/2008 26. Skycell Communications Ltd.
vs. DCIT (2001) 251 ITR 53 (Mad.) 27. CIT vs. Bharat Electricals
252 ITR 218 28. Goa Carbon vs.
Muthuramalingam 251 ITR 348 29. 271 ITR 401 (SC) 30. Amway India Enterprises vs.
DCIT 301 ITR 1 (Delhi) 31. St. Aubya (LM) vs. A.G.
(1951) 2 All ER 473 32. IRC vs. Wolfson (1949) 1
All ER 865 33. Owen Thomas Margin vs. IRC
(1971) 2 WLR 39 (PC) 34. Union of India and Anr. vs.
Azadi Bachao Andolan and Anr. (2004) 10 SCC 1 35. Padmasundara Rao vs. State
of Tamil Nadu 255 ITR 147(SC) 36. State of Kerala vs. Alex
George (2005) 1 SCC 299 37. Mathuram Agarwal vs. State
of Madhya Pradesh AIR 2000 SC 109 Treaties and Conventions 1. The OECD Model Double
Taxation Convention, 1977 Dictionary 1. Bryan A. Garner, Blacks Law
Dictionary, 7th Ed., West Group, 1999 Articles 1. Royal Biz: Microsoft case
exposes opaque tax policy, The Economic Times, 7th April, 2008 WEBSITES 1. WWW.incometax.gov.in
Bryan A. Garner, Blacks Law Dictionary, 7th Ed., West Group,
1999
Richard Schaffer, Berverley Earle & Filiberte Agusti,
International Business Law and its Environment, 4th Ed., 1999.
Bryan A. Garner, Blacks Law Dictionary, 7th Ed., West Group,
1999
Bryan A. Garner, Blacks Law Dictionary, 7th Ed., West Group,
1999
Citizen Watch vs. IAC 148 ITR 794, CIT vs. Davy Ashmore 190
ITR 626, Cf Leonhardt vs. CIT 249 ITR 418
Kanga. Palkhivala and Vyas, The Law and Practice of Income
tax, 9th Ed. 2004
S. Rajaratnam, Sampath Iyengar’s Law of Income Tax, 10th Ed.,
p 1231
CIT vs. Neyveli Lignite Corp. Ltd. (2000) 243 ITR 459 (Mad.)
CIT vs. Ahmedabad Mfg. & Calico Printing Co. 139 ITR 306 (Guj.)
Asia Satellite Telecommunication Co. Ltd. vs. DCIT 85 ITD 478
(Del.)
NV Philips Gloeilempenfabrieken vs. CIT (1988) 172 ITR 541
(Cal.)
Steffen, Robertson & Kristen Consulting Engg. & Scientists v.
CIT (1998) 230 ITR 206 (AAR)
International Airport Authority of India Ltd. vs. DCIT (2005)
95 TTJ (Delhi) 1075
Dell International Services India Pvt. Ltd. vs. CIT
MANU/AR/0002/2008
Skycell Communications Ltd. vs. DCIT (2001) 251 ITR 53 (Mad.)
This multilateral tax treaty was concluded between the
member-countries of the ANDEAN Group, namely, Bolivia, Columbia, Ecuador,
Peru, and Venezuela.
There exists a multilateral tax treaty between the CARICOM
member-countries, namely, Antigua and Barbuda, Bahamas, Barbados, Belize,
Dominica, Grenada, Guyana, Haiti, Jamaica, Montserrat, St. Kitts and Nevis,
St. Lucia, St. Vincent and Grenadines, Surinam, and Trinidad and Tobago.
A multilateral tax treaty exists amongst the Nordic
countries, namely, Denmark, Finland, Faeroes Islands, Iceland, Norway and
Sweden.
M. M. Sury, Income Tax in Theory and Practice, 1st Ed., New
Century, 2002, at p. 62
The OECD in 1977 issued a Model Double Taxation Convention
based on the experience of OECD member-countries.
In 1980, the United Nations issued its Model Double Taxation
Convention between Developed and Developing Countries based on the report of
its expert committee set up to study the special problems that arise when a
tax treaty is concluded between a developed and a developing country.
The United Nations Model Double Taxation Convention between
Developed and Developing Countries, 1980
S. Rajaratnam, B. V. Venkatramaiah, Commentary on Double
Taxation Avoidance Agreements, 3rd Ed., Taxmann, 2007, § 25.20
S. V. Joga Rao, Computer Contracts and Information Technology
Law, 2nd Ed., Wadhwa & Co., 2005
K. R. Srivats, Are software payments royalty or business
income, ask foreign cos., 20th May, 2008
International Tax Conference, organized by International
Fiscal Association, India and the OECD, Mumbai
Union of India and Anr. vs. Azadi Bachao Andolan and Anr.
(2004) 10 SCC 1
Mathuram Agarwal vs. State of Madhya Pradesh AIR 2000 SC 109 |