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New dimension to the definition of 'royalty'

HP Agrawal 

The Hon’ble Delhi High Court has recently delivered a historical judgement in case of CIT v. D.C.M. Ltd. 336 ITR 599 in respect of meaning of the term “royalty”. An Indian company which is engaged in manufacturing of sugar entered into an agreement with a UK company for transfer of comprehensive technical information and know-how. The Indian company agreed to pay the specified amount towards supply of documents relating to technology.

The agreement between the parties envisages transfer of “comprehensive technical know-how and also supply of equipment” by UK company to the Indian company in order to enable the later to adopt the special process owned by the UK company.

The Indian company contended that the payment was not in the nature of royalty; the remittance in the hands of UK company constituted industrial or commercial profits. Such profits could be taxed only if UK company was shown to have a permanent establishment in India.

It was commonly agreed by both the parties that UK company did not have any permanent establishment in India. Therefore, in terms of Agreement for Avoidance of Double Taxation between India and UK (DTAA) the remittance to be made to UK company could be taxed in India if the nature of remittance was “royalty” because while business profits of a foreign company can be taxed in India if the foreign company has a permanent establishment in India, but royalty received by a foreign company can be taxed in India even if foreign company does not have any permanent establishment in India.

Therefore, the issue to be considered by the High Court was whether the remittance to UK company constituted “royalty” or the same was “business profits”.

The Tribunal after analysing the agreement between the parties had come to the conclusion that the remittance concerned would be “royalty” if section 9(1)(vi) of the Income Tax Act is considered. But the definition of the term “royalty” is narrower in DTAA. The said payment will not be covered within the definition of royalty if the provisions of DTAA are considered. Therefore, in the absence of permanent establishment in India the remittance is not taxable in India.

It may be pointed out that the fundamental difference between the DTAA and Income Tax Act on this issue is while under the DTAA an amount is considered as “royalty” if it is received as a consideration for the use of, or the right to use intellectual properties. On the other hand, in the Income Tax Act payment will be royalty if made for “transfer of all” or “any rights” in intellectual properties. In other words, while under DTAA, an amount for the use of an intellectual property is royalty, under Income Tax Act payment for “transfer of all or any rights” will amount to royalty.

In the instant case the payment by the Indian company was held not to be the payment for “use” of or “right to use” any intellectual property. The payment infact was for “transfer” of the rights relating to the intellectual property. Therefore, the Hon’ble Delhi High Court held that the remittance made to UK company would not fall in the definition of “royalty” under DTAA.

The Hon’ble High Court observed that “the transfer of technology is quite often, as in the present case, brought about by executing agreements which give rights far greater than a mere right to use albeit on a non exclusive basis”. In order to fall within the definition of royalty, the “right conferred should be of usage; anything more than that takes it out of ambit of the definition of the royalty as provided in DTAA”.

As the UK company did not have a permanent establishment in India, the remittances made by the Indian company to UK which constituted “business profit” could also not be taxed in India.

The above case opens a flood gate of opportunities for foreign companies if their agreements for transfer of technology are properly drafted.

H.P.Agrawal (Author is a Sr. Partner inSS Kothari Mehta & Co.)  

First Published: Mon, September 19 2011. 00:35 IST