The issue for consideration is as to whether the royalty paid by the foreign manufacturers on manufacturing of the goods outside India could also be taxed in India if such goods are sold in India. In terms of section 9(1)(vi)(c), royalty payable by a non-resident, where the royalty is payable in respect of any right, property or information used or services utilised for the purposes of a business or profession carried on by such person in India, is taxable in India because such royalty is treated as ‘deemed’ to accrue or arise in India in the hands of recipient of royalty.
In an interesting recent case (ITA - 3700/D/2009), a US Company granted a non-exclusive and non-transferable worldwide license of its patents developed on CDMA technology to wireless Original Equipment Manufacturers (‘the OEMs’) outside India to make, import, use and sell CDMA handsets and wireless equipment (the ‘Products’) anywhere in the world. In consideration for the grant of licence, the US Company charged a royalty from OEMs.
OEMs who are situated outside India used the patents to manufacture the products outside of India. The OEMs sold the products to wireless carriers worldwide. The OEMs paid royalty to the US company based on net selling price of the product sold worldwide.
Some OEMs sold products manufactured using the patented technology to Tata Teleservices and Reliance Communications, botsh of whom are wireless carriers located in India. The Indian carriers, in turn, sold the products to end users in India.
The tax authorities in India held that the royalty paid by the OEMs to the US company for licensing of patents is also taxable in India to the extent of sales made by OEMs in India. Such royalty was held as ‘deemed income’ of the US Company in India under section 9(1)(vi)( c) of the Income tax Act.
The issue was taken to ITAT. The Hon’ble Tribunal observed that under the deeming provision of Section 9(1)(vi)(c) of the Act, the burden is on the Revenue to prove that the OEMs actually carry on business in India and that they have used US Company’s patents for the purposes of such business in India.
The Tribunal further observed that what is licensed is the use of ‘intellectual property’ owned and patented by the US company for the purpose of manufacture of products. A perusal of the agreements between US Company and OEMs does not demonstrate that the contracts are India specific. In fact they are not specific to any particular country. The OEM’s manufactured products outside India and sold them not only to service providers in India but also in other countries. The licence to manufacture products by using the patented Intellectual Property has not been used in India as the products have been manufactured outside India; and when such products are sold to parties in India, it cannot be said that OEMs have done business in India.
Apart from other technical reasons, the most appealing reason by Tribunal for rejecting the revenue’s case was that proposition taken by the department would lead to a situation where every sale of goods made by any foreign party in India would be considered as if the said foreign party is doing business in India. A sale to India without any operations being carried out in India would amount to business with India and not business in India. For the business to be carried out in India there should be some activity carried out in India. Thus the argument that if manufacturing is done in one jurisdiction and sales in the other jurisdiction, then there is business in another jurisdiction is devoid of merit.
Tribunal finally held as under —
“The role of Taxpayer ends when it licensed its patents on IPR’s pertaining to CDMA products for manufacture and when it collects royalty from OEM’s on these products, when they are shipped out of the country of manufacture.
There is no activity for Taxpayer after this sale and shipment under these 16 agreements. For the OEM’s it is a sale of a product which is the end of the activity. The revenues are generated on sale only. There are no revenues either to the OEM’s or to Taxpayer after the sale of the products. The sale is of a chattel as a chattel.”
In our humble view, a foreign company should be taxed in India only when such company itself is doing business in India. Its business activities should not be linked with the business activities of those whom the foreign company has granted the patent rights.Even if the licensees carry on business activities in India, their business activities cannot fasten any tax liability on the licenser.
Co-authored by Alok Gupta