International Taxation

Case Laws Update

1. Dividend – Dtaa with Malaysia – Art. 11

Deputy Commissioner of Income-tax vs. Turquoise Investment & Finance Limited – (2006) 202 ctr (mp) 395

Dividend income earned in Malaysia by Indian resident is not taxable in India by virtue of the provisions of DTAA between India and Malaysia.

Facts

1. The assessee-company filed its return of income declaring income of Rs.4,30,06,580 from business of investment and finance, which was processed under s. 143 (1) (a) on the same income and demand amounting to Rs.1,07,370 was issued by rejecting the credit claimed by the assessee-company on the basis of deemed credit on dividend received from Pan Century Edible Oils Sdn. Bhd. Malaysia.
    

2. The assessee-company filed an appeal before the CIT(A) who directed that the claim of the appellant for credit of deemed TDS on dividend be allowed towards TDS for the year under appeal. The Department therefore, preferred second appeal and the Tribunal upheld the order of the CIT(A) with the observation that DTAA entered into with any country would override the provisions of I.T. Act, 1961, if they are at variance from the provisions of the Act. It held that from a plain reading of art. XI of the DTAA, it was clear that dividend income would be taxed only in the Contracting States where such income accrued.

Judgment

Aggrieved by the decision of the Tribunal the Department has preferred appeal before the Hon’ble High Court wherein it was held.

1. The core question is with regard to the taxability of the dividend income in Malaysia of the assessee-company in the light of the Agreement for Avoidance of Double Taxation of Income and Prevention of Fiscal Evasion of Tax between the Government of India and the Government of Malaysia.
    

2. It has been observed by Madras High Court in CIT vs. S.R.M. Firm (1997) 208 ITR 400 that art. XI of the agreement provides that dividends paid by the company which is a resident of a Contracting State to a resident of the other Contracting State may be taxed in the first mentioned Contracting State. It was further observed that as far as the taxability of dividends income is concerned, the provisions of ss. 8 and 9 of the IT Act, 1961 deal with the same. But at the same time, art. XI of the agreement provides that dividends paid by a company which is a resident of a Contracting State may be taxed in the first mentioned Contracting State. In this view of the matter, their Lordships answered the question of law in the affirmative and held that the dividend income in Malaysia cannot be subjected to tax in India in view of the said agreement.
    

3. The Supreme Court in CIT vs. P.V.A.L. Kulandagan Chettiar (supra) while considering the effect of the agreement between India and Malaysia, approved the decision in CIT vs. VR.S.R.M. Firm & Ors. (supra). The Department has not been able to dispute that this decision of the Supreme Court squarely upholds the decision of the Madras High Court in CIT vs. VR. S.R.M. Firm (supra). In view of the above decision, it was held that the dividend income earned in Malaysia by Indian resident was not taxable in India.

Cases followed

1. CIT vs. VR. S.R.M. Firm (1994) 120 CTR (Mad) 427 : (1997) 208 ITR 400 (Mad).

2. CIT vs. P.V.A.L. Kulandagan Chettiar (2004) 189 CTR (SC) 193 : (2004) 267 ITR 654 (SC)

3. CIT vs. R.M. Muthaiah (1993) 110 CTR (Kar) 153 : (1993) 202 ITR 508 (Kar).

2. Exemption u/s 10(4)

Where original deposit in NRE account is made in accordance with FERA & Rules and the said Act and rules did not prohibit an individual from earning interest on such deposit, interest on said FDR was exempt u/s 10(4) (ii).

CIT vs. Asandas Khatri – (2006) 152 Taxman 635 (MP)

Facts

1. The assessee claimed exemption of interest earned on the FDRs of Rs.2,39,467 (after accumulation of interest) made from his NRE account under section 10(4)(ii). The Assessing Officer held that the exemption on interest was available on money standing to the credit of NRE account in any bank in accordance with the 1973 Act and this section does not incorporate interest on fixed deposit made out of the NRE account in Indian rupee and, therefore, the exemption claimed by the assessee on interest on Indian fixed deposits could not be allowed.
    

2. On further appeal, the Tribunal held that admittedly the assessee had deposited the foreign currency brought from his NRE account and out of the NRE account the FDRs were prepared in his name and so long as the foreign currency remains with the bank in any account, the interest earned thereon should be allowed to be exempted from income-tax as per the provisions of s. 10(4) (ii) because the object of the introduction of the provisions is to encourage the non-resident Indian to bring foreign currency in India and earn interest thereon without paying any income-tax, and, accordingly, directed the Assessing Officer to delete the interest income earned on NRE FDRs by assessee.

Judgment

On revenue’s appeal to the Hon’ble High Court, it was held

1. The view taken by the Tribunal was correct. The language of the provision of section 10(4)(ii) makes it clear that any income by way of interest on moneys standing to the credit of an individual in a NRE account in any bank in India in accordance with the 1973 Act and the Rules made thereunder, would be excluded from the total income of the individual.
    

2. The Assessing Officer had found that original source of the FDR of Rs.2,39,463 was money deposited by the assessee in the NRE account. The Assessing Officer had not recorded a finding that the money was lying in the said NRE account out of which the FDR of Rs.50,000 was initially prepared was not deposited in accordance with the 1973 Act, and the Rules made thereunder. He had held that section 10(4)(ii) does not exempt interest on fixed deposit made out of NRE account in Indian rupee.
    

3. What the Assessing Officer had failed to appreciate was that the FDR of Rs.2,39,463 comprised of Rs.50,000 which was lying in deposit in the NRE account of the assessee and the accumulated interest thereon and represented moneys standing to his credit in the NRE account in accordance with the provisions of the 1973 Act, and the Rules made thereunder since the original deposit in the NRE account had been made in accordance with the said Act and the Rules and the said Act and the Rules did not prohibit an individual from earning interest on such deposit. The interest on the said FDR of Rs.2,39,463 was, thus, exempted under section 10(4)(ii).

Tribunal decisions

Taxability of fees for professional services rendered by foreign service providers – Scope of “Fees for Technical Services” u/s 9(1)(vii) of the I. T. Act 1961 – Matter remanded to A.O. to examine taxability under the relevant DTAAs

ADIT vs Ess Vee Intellectual Property Bureau [2006] 7 SOT 38 (Mum.) Assessment Years 1999-2000 and 2000-01

The assessee was engaged in business of consultancy in respect of registration and enforcement of intellectual property rights. Services rendered by assessee also included registration and enforcement of intellectual property rights abroad. The assessee had availed services of entities based abroad and made payments to such foreign entities without deduction of tax at source and claimed that since payments were made for professional services, same could not be covered by expression ‘fees for technical services’ under section 9(1)(vii). The claim of assessee was rejected. The payments made in question were taxable in India under section 9(1)(vii)(b). Since neither assessee nor revenue had made any efforts to examine as to what was status of taxability of those foreign entities in terms of provisions of relevant the DTAA, matter required to be considered afresh by Assessing Officer on touchstone of principles set out in relevant DTAA.

Facts

1. The assessee was engaged in the business of consultancy in respect of registration and enforcement of intellectual property rights. The services rendered by the assessee also included registration and enforcement of intellectual property rights abroad.
    

2. The assessee availed services of the entities based abroad. The assessee did not deduct any tax from the payments made to such foreign entities and contended that since the payments were made for the professional services, the same could not be covered by the connotations of the expression ‘fees for technical services’ under section 9(1)(vii).
    

3. The A. O. rejected the contention of the assessee and held that the payments made to foreign entities were taxable under section 9(1)(vii).
    

4. On appeal, the assessee also contended that its case could not be covered by section 9(1)(i) either as those foreign entities did not have any ‘business connection’ in India. The Commissioner (Appeals) accepted both the contentions of the assessee, and, accordingly, deleted the impugned demands raised on the assessee.

Decision

On second appeal, the Tribunal held and directed as under:-

1. Unlike the situations in the cases of tax treaties, where specific provisions are incorporated for the ‘professional services’ and different parameters are laid down for taxability thereof in the source country, the Income-tax Act does not lay down any different treatment for the professional services under section 9(1)(vii). So far as the provisions of section 9(1)(vii) are concerned, merely because a service can be termed as professional service, that fact per se does not take fees for such a professional service outside the ambit of ‘fees for technical services’.
    

2. When one is to examine whether or not a payment to foreign entity can be treated as ‘fees for technical services’ all that is to be examined is whether or not such a payment can be said, subject to exclusion clauses, to be payment for ‘managerial, technical or consultancy services’. Whether the services are professional services or not or legal services or not, would not really be relevant because as long as these services can be said to be technical or consultancy, or even managerial services, the provisions of section 9(1)(vii) would stand invoked.
    

3. When the assessee availed the services for "registration and enforcement of intellectual property rights abroad", these services could not but be treated as technical and consultancy services.
    

4. One is unable to understand the basis of the CIT(A)’s conclusion that "the services rendered by the foreign professionals were neither ‘managerial, technical or consultancy services" and that "it was purely a case of actually rendering professional services, which were neither technical, nor consultancy nor managerial in nature."
    

5. There are overlapping areas in ‘professional services’ and in ‘technical, managerial or consultancy services’ inasmuch as professional service can be rendered in technical managerial or consultancy field. Therefore, a service being a nature of a professional service, in the context of section 9(1)(vii), does not affect the taxability of payment for that service.
    

6. The fees was paid by the assessee, who was a resident in India, and it was not for the purpose of making or earning any income outside India or for the purpose of carrying out any business outside India. The fees was, therefore, taxable in India under section 9(1)(vii)(b).
    

7. Section 90(2) unambiguously provides that in case where India has entered into an agreement with the Government of any country outside India under section 90(1), in relation to the assessee to which such agreement applies, the provisions of the Income-tax Act shall apply only to the extent the same are more beneficial to the assessee. In other words, the taxability in such a case is required to be ascertained on the basis of scheme set out in the relevant agreement and, if there is no tax liability under the said scheme, there is no occasion for reference to the provisions of the Income-tax Act.
    

8. Neither the assessee nor the revenue had made any efforts to examine as to what was the status of taxability of those foreign entities in terms of the provisions of the relevant double taxation avoidance agreement. Hence, the matter required to be remitted to the file of the Assessing Officer for adjudication de novo on taxability of each receipt by the foreign entity on the touchstone of the principles set out in the relevant DTAA wherever such agreements is entered into by the Government of India.

Cases referred to

1. Graphite India Ltd. vs. Dy. CIT [2003] 86 ITD 384 (Kol.)

2. Maharashtra State Electricity Board vs. Dy. CIT [2004] 90 ITD 793 (Mum.)

DTAA between India and Federal Republic of Germany of 1959 – Amendment thereto by Protocol dated 28-06-1984, Ratified on 10-07-1985 and Notified on 26-08-1985 – Cannot adversely affect the rights of the assessee and fasten a tax liability upon the assessee with retrospective effect.

Tata Iron & Steel Co. Ltd. vs. DCIT [1999] 69 ITD 292 (Mum.) /[1998] 62 TTJ (Mum.) 17/ [1998] 100 Taxman 51 (Mum.) Assessment Years 1985-86 to 1986-87

The Tribunal is competent under law to look into vires of a particular notification issued under rule making powers of Central Government and CBDT. While in case of an enactment of Parliament, retrospective effect can be given by making suitable amendment, in case of DTAA, unless the two sovereign parties agree to a certain amendment from a certain date, no effect can be given. As DTAA protocol is an act between two sovereign States, under no circumstances, the notification can take away the rights vested in the tax-payer with the retrospective effect. Retrospectivity of a DTAA adversely affecting the rights of the tax-payer will have no force. Amendment to 1959/60 DTAA between India and Federal Republic of Germany by GSR No. 680(E), dated 26-8-1985 could not be made effective from 1-4-1984. India and Federal Republic of Germany entered into a DTAA in 1959-60. As per Article III of the said agreement royalty and technical know-how fee payable were not taxable. DTAA was amended by protocol dated 28-6-1984 inserting Article VIIIA according to which royalty and technical know-how fee became taxable. Protocol amendment was ratified on 10-7-1985 which was notified on 26-8-1985. Notification, however, stated that amendment came into effect retrospectively with effect from 1-4-1984. Assessee entered into agreement prior to notification and paid royalty and technical know-how fee in question. Notification dated 26-8-1985 giving effect to protocol from
1-4-1984 has to be read down in a manner that it does not adversely affect rights of assessee in a manner so as to fasten it with a liability which under the 1959-60 protocol could not be done. Therefore, assessment had to be made in conformity with protocol of 1959-60 under which certain incomes were exempt from tax in hands of assessee.

Facts

1. The assessee-company, engaged in the business of manufacturing and selling of iron and steel, entered into separate agreements with three West German companies between 1982-85 for supply of technical know-how.
    

2. During the financial year 1984-85, the assessee paid these companies a substantial amount for services rendered by them. The payments made by the assessee to the West German companies were industrial or commercial profits of West German companies; they were not taxable in India as per article III of the DTAA prior to the amendment notified by Notification No. GSR 680 (E), dated 26-8-1985.
    

3. Amendments to the said DTAA were made by protocol dated 28-6-1984 which was ratified on 10-7-1985 and notified on
   26-8-1985. Article XVI of the protocol amending the agreement provided that the protocol shall enter into force one month after the date of exchange of instrument of ratification and shall have effect in India in respect of income and capital assessable for any assessment year commencing on or after 1-4-1984.
    

4. The assessee contended that as agreements between the assessee-company and West German companies for know-how transfer and project study were entered into prior to 26-8-1985, the doctrine of promissory estoppel applied and the payments made by the appellant-company were covered by the provisions of DTAA before amendment.
    

5. The A. O. held that in view of insertion of new Article VIIIA in the DTAA between India and Germany and notification dated 26-8-1985 providing that the amendment would apply retrospectively with effect from 1-4-1984, tax exemptions on technical services contracts were taken back and sum paid by the assessee during the financial year 1984-85 would be taxable.
    

6. On first appeal before the Commissioner (Appeals), it was contended by the assessee that the agreement for transfer of know-how and project study was entered into prior to 26-8-1985; i.e., prior to notification of amendment; therefore, the doctrine of promissory estoppel applied and payments made were covered by the provisions of DTAA before amendment. However, the Commissioner (Appeals) rejected the assessee’s contention and affirmed the order of the Assessing Officer.
    

7. On second appeal, the assessee contended that the notification dated 26-8-1985 having retrospective effect from 1-4-1984 was contrary to the rule-making powers and overrides the terms of the DTAA 1959. Accordingly, it was submitted that the same should be ignored and assessment should be made as if this change had not taken place. The revenue submitted that if the assessee’s case was accepted, the Tribunal would be required to hold that amended article XVI of the treaty which provided that tax would be imposed on such fees, as ineffective and void which the Tribunal cannot do under law as it has no power to do so.

Decision

The Tribunal held in favour of the assessee as follows:

1. In view of the decision of the Bombay High Court in CIT vs. Bombay State Transport Corp. [1979] 118 ITR 399/1 Taxman 282 and Mahindra & Mahindra Ltd. [1984] 8 ITD 427 it was to be held that the Tribunal has jurisdiction to look into the vires of a particular notification issued under rule-making powers of the Central Government and the CBDT. The DTAA is in the nature of delegated legislation. Section 90 is only an enabling provision. However, unlike most other provisions in the Income-tax Act, it leaves the Executive with a great deal of functional flexibility.
    

2. The only purpose of such treaty should be Avoidance of Double Taxation under the Income-tax law in India and corresponding law in force in the treaty country. Thus, the Central Government is empowered not merely to enter into covenants with the Governments of other countries outside India, but, it has also to be notified in the Official Gazette which is necessary for implementing the decision. If the notification in the Official Gazette makes any provision, which is in direct conflict with the terms of the agreement, then, the terms of the notification will have to be read down as far as the assessee’s rights are affected. In case, the terms of the agreement provide that particular type of income will be exempt from taxation in India or will be taxed by a certain rate, then, unless there is an agreement between the two countries afresh, the Government of India will be in no position to affect the rights of the assessee by mere notification. An interpretation which is not consistent with the provisions of section 90(1) will be tenable in India. Thus, the income-tax authorities in the first place will have to determine income of every person who has any tax liability in India in accordance with the provision of requirements of the Income-tax and thereafter allow him as much relief from the liability so arrived at as the tax treaty of his Government may allow. As per the well-known book of the learned author Philips Baker on Double Taxation Convention and International Tax Law, article XIV, a modern treaty enters into force upon ratification on a day. This will be the same day for both the States. The treaty may well take the effect on different dates in two contracting State usually at the beginning of the financial year of each State and may even take effect on different dates for different taxes.
    

3. A treaty may be retroactive. However, where a treaty is retroactive, it is to provide that the treaty will not have the effect to place a tax-payer in a worst position, than he or she was under the earlier provision of treaty. Thus, no retroactive act can place a tax-payer in a position worse than he or she was in the previous treaty. If in fact a particular treaty is enforced at a particular time, when a particular income was liable to be taxed, then, under a subsequent treaty no effect can be given to a provision making that exempt income as taxable. Any departmental retrospectivity would run counter to the constitutional retrospectivity of the State committed to rule of law. Under such circumstances, the retrospectivity of a DTAA adversely affecting the rights of the tax-payer will have no force.
    

4. By the notification, GSR No. 680 dated 26-8-1985, the agreement between the Government of India and FRG, signed on 18-3-1959, was amended. New article VIII-A was inserted in the new agreement making royalties and fees for technical services arising in the contracting State and paid to resident of the other contracting State as taxable in other State. Thus, there cannot be a dispute in this case that in any case with effect from 10-7-1985, the date on which ratification was exchanged, the royalties and fees for technical services became taxable in India. As far as the prospective taxation is concerned, there is no dispute on that account. In India, the fiscal year starts from 1st of April and ends on 31st of March. Therefore, if, as per article XVI(2)(b), tax had been imposed in respect of income and capital assessable in any assessment year commencing on or after 1-4-1985, there would have been no dispute. The dispute, however, is that under article XVI(2)(b), it is provided that in India, in respect of income and capital assessable in any assessment year commencing on or after the date of 1-4-1984, tax will be imposed. In respect of German tax, the date mentioned is 1-1-1984 because in that country the fiscal year is the calendar year. Thus, as per article XVI(2)(b) of the Protocol the amount which was exempt from taxation earlier under the old protocol was made taxable from the assessment year 1984-85. It seems that it affected the rights of the assessee adversely. A particular income was not taxable under the 1959 Protocol and has been made taxable by the Notification dated 26-8-1985 with effect from 1-4-1984.
    

5. The question is whether by issuing a notification on 26-8-1985 giving effect to the protocol any tax could be imposed on the assessee with effect from 1-4-1984. Whatever may be the date of Protocol, in this case, according to the department, notification was on 26-8-1985. The fact, however, remains that as per the GSR 680, dated 26-8-1985, the Protocol was dated 10-7-1985 only. Thereafter, as per international custom, it comes into effect on 10-8-1985 and the notification is dated
   26-8-1985.
    

6. The date of protocol itself falls in the financial year 1985-86 and not in the financial year 1984-85. The treaty is an act of the Sovereign and any implementation of the same does not require that the same should be placed on the table of the Parliament. However, the fact remains that any authority which has the power to make subordinate legislation cannot make it with retrospective effect unless it is so authorised by the Legislature which has conferred the rule-making power on it. The act of treaty is not an act of Parliament or Legislature. It is an act between two sovereign powers. The terms and conditions prescribed in that treaty have to be strictly followed and any diversion from the same will have to have the stamp of two contracting parties. The assessee, at least till 26-8-1985 when the notification was issued was under a bona fide impression that certain income arising in India will not be liable to be taxed in view of the Protocol and Treaty of 1959. It is only on 26-8-1985 that this notification enforces that its rights are to be adversely affected from 1-4-1984. It is obvious that this notification has tried to do what is not authorised by the treaty represented by the two countries.
    

7. When the treaty and protocol of 1959 was notified and was not amended till
   26-8-1985, the persons who were affected by the said treaty and protocol knew that certain type of income was not liable to be assessed to tax under the said treaty. Later on, on 26-8-1985, an amendment was made to the 1959 protocol and the concessions enjoyed by certain parties till that date were stopped. However, till the notification dated 25-8-1985 the persons enjoying the benefits were given a promise by the State that they would not be liable to be taxed on that type of income. Subsequent to that date, there cannot be any dispute that the exemption was withdrawn and that particular income became liable to be assessed to tax. Therefore, till that date there was a promissory estoppel against the State in acting against the promises given.
    

8. As held by the Supreme Court in the case of Motilal Padampat Sugar Mills Co. Ltd. v. State of UP [1979] 118 ITR 326, it is not necessary that in order to contract the applicability of the doctrine of promissory estoppel, the promissee acting in relying on the terms should suffer any detriment; what is necessary is only that the promisor should have altered his position, the alteration of position need not involve any detriment to the promissee.The detriment in such a case is not the same prejudice suffered by the promissee as by acting on the terms but the prejudice which would be caused to the promise if the promissor were right to go back on the terms. By putting the date having effect from 1-4-1984 the State has gone back on the promise given to the affected assessee. This, the Central Government could not do. Therefore, on this ground itself, the act of notification was bad in law and could not be enforced.
    

9. Though the Central Government, the CBDT and FTD were authorised to issue notification, they could not issue a notification raising a tax liability with effect from the date on which the notification itself was not enforceable in law. Thus, when the notification dated 26-8-1985 was given effect to in India from 1-4-1984, it changed the character of past transactions carried on upon faith and the then existing law that a certain type of income was not assessable to tax in the territory of India. As it is notable that the treaties are not creation of Legislature, but, are creation of a contract between two sovereign parties, they take effect after there is a regular protocol, ratification and notification. The notification has to be under the terms and conditions prescribed in that protocol. Thus, notification dated 26-8-1985 was against the terms and conditions notified in 1959-60 protocol in force till 10-8-1985. While in case of an enactment of Parliament, retrospective effect can be given by making suitable amendment, in case of DTAA, unless the two sovereign parties agree to a certain amendment from a certain date, no effect can be given.
    

10. The notification dated 26-8-1985 giving effect to protocol from 1-4-1984 has to be read down in a manner that it does not adversely affect the rights of the assessee in a manner so as to fasten it with a liability which under the 1959-60 protocol could not be done. If one reads the treaty with the protocol harmoniously, it becomes obvious that the assessee cannot be fastened with any tax liability which was exempt under 1959 treaty and protocol at least till 26-8-1985.
     

11. It is notable that even in the case of the legislative act, an authority that means an executive authority, which has the power to make subordinate legislation, cannot make it with retrospective effect unless it is so authorised by the Legislature which has conferred that power on it. This power of notification given to the executive authority is subordinate to the terms and conditions of the DTAA. It cannot be given retrospective effect unless it is so authorised by the
    sovereign States who entered into such contract.
     

12. In this case, there was only a question of publishing the same in the Gazette. This power of the Central Government, CBDT & FTD cannot prevent the Tribunal from reading down the notification with the protocol treaty so that it does not adversely affect the rights of the tax-payer till the date on which protocol is amended. Notification can have the effect from the date of its publication in the Gazette. This power, however, does not include a power to assign the notification with retrospective effect. In this case, as DTAA protocol is an act between two sovereign States, under no circumstances, the notification can take away the rights vested in the tax-payer with retrospective effect. As per 1985 protocol and all such DTAA protocol no retrospective effect can be given to a particular term of protocol unless the protocol itself authorises so. Under no circumstances, the executive Government exercising the subordinate power can make an item of taxable nature with retrospective effect if the same is not provided in the protocol. Therefore, on reading down the notification with treaty and protocol, it was to be held that the assessment for the assessment year 1985-86 in this case had to be made in conformity with the protocol of 1959-60 under which certain incomes were exempt from taxation in the hands of the assessee.

Cases referred to

1. Motilal Padampat Sugar Mills Co. Ltd. vs. State of U.P. [1979] 118 ITR 326 (SC)

2. Narayan Chandra Chakraborty vs. Union of India [1980] 126 ITR 831 (Cal.)

3. Union of India vs. Godfrey Philips India Ltd. [1986] 158 ITR 574 (SC)

4. Bakul Oil Industries vs. State of Gujarat [1987] 165 ITR 6 (SC)

5. Pournami Oil Mills vs. State of Kerala [1987] 165 ITR 57 (SC)

6. Bombay Conductors & Electricals Ltd. vs. K. Chandramouli [1984] 145 ITR 272 (Delhi) (FB)

7. Bansal Exports (P.) Ltd. vs. Union of India [1984] 145 ITR 642 (Delhi) (FB)

8. Kailashnath vs. State of U.P. AIR 1957 SC 790

9. ITO vs. M.C. Ponnoose [1970] 75 ITR 174 (SC);

10. Bakul Cashew Co. vs. STO [1986] 159 ITR 565 (SC)

11. P. Nageshwarrao vs. Govt. of Andhra Pradesh 1994 Supp. (2) SCC 693

12. Hukumchand vs. Union of India [1973] 1 SCR 896

13. Mahindra & Mahindra Ltd. vs. ITO [1984] 8 ITD 427 (Bom.)

14. CIT vs. Bombay State Transport Corpn. [1979] 118 ITR 399 (Bom.).

[Authors’ note: Though this is an old decision, it is being reported as many DTAAs are reportedly are under revision/renegotiation and this decision would be useful if any such revision is sought to be given retrospective effect to the detriment of the assessee.]

What constitutes “outright sale” of Technical know how – Article 12 of DTAA between India and USSR – Taxability of impugned payments as royalt

DCIT vs. All Russia Scientific Research Institute of Cable Industry [2005] 145 Taxman 1 (Mum.) (Mag.)/92 TTJ 74

It is only in case of outright sale that consideration for such sale is not to be treated as ‘royalty’. Assessee, a Russian company, entered into an agreement with IPL, an Indian company, under which assessee-company was to provide to IPL a "non-exclusive right to use ‘know-how’ for purpose of realization of process and technical process and special process in territory and sell licensed product and special product in territory and zone of non-exclusive right". Assessee-company received lump sum fees in US dollars. It claimed that since said receipt was for outright sale of know-how, it was not liable to be taxed in India and that provisions of Article 12 of DTAA dealing with ‘royalties’ were not applicable to its case. A.O. look the view that transaction in question was not a case of outright sale of know-how and brought receipt to tax @ 20% as royalty. The CIT(A) treating it as ‘outright sale’ reversed A.O.’s order. The agreement showed that assessee had granted IPL non-exclusive right to use ‘know-how’ for a specific purpose and this ‘know-how’ included technical designs and drawings; that IPL could not assign any rights under said agreement, including, right to use designs and drawings to anyone else; that IPL had an obligation not only to maintain confidentiality about designs and drawings supplied by assessee but also to ensure that same was not divulged to third parties. On facts, it could not be said that Indian company had out rightly purchased said designs and drawings and that consequent to supply of those drawings and designs, non-resident assessee did not have any interest in same. The very fact that Indian company could be hauled up to pay damages under agreement would clearly show that non-resident assessee had valuable property and interest in drawings and designs supplied to IPL. The instant case was not a case of an outright sale but it was a case of collaboration agreement and a case of limited non-exclusive use of certain drawings and designs and, therefore, consideration in question was taxable as royalty in hands of assessee.

Facts

1. The assessee, a Russian company, possessing knowledge and experience in the field of manufacturing technique of a particular product, entered into an agreement with IPL, an Indian company under which the assessee-company was to provide to IPL a "non-exclusive right to use the ‘know-how’ for the purpose of realization of the process and the technical process and the special process in the territory and sell the licensed product and the special product in the territory and zone of non-exclusive right". Under this arrangement, the assessee was, upon a request from the IPL, to render ‘technical assistance’.
    

2. It, accordingly, received US $ 20,000 as first instalment out of the lump sum fees agreed to be paid by IPL.
    

3. The assessee’s contentions were that since that consideration was for outright sale of technical know-how, it was not liable to be taxed in India; that it did not have a permanent establishment (PE) in India and that in terms of Article 7 of the DTAA, profits on such a sale could only be brought to tax in India when the same was attributable to the PE; that the money in question, being consideration for sale of know-how, the provisions of Article 12, dealing with ‘royalties’, were not applicable to its case; and that, in any event, the tax was not to be grossed up in view of section 10(6A) being applicable on the facts of its case.
    

4. The Assessing Officer, however, while rejecting the said contentions, opined that the transaction in question was not a case of outright sale of know-how; that provisions of Article 12 of said DTAA were applicable; and that there was nothing on record to demonstrate that the conditions set out in section 10(6A) were satisfied. Thus, he came to the conclusion that the receipt in question was taxable @ 20% as royalty.
    

5. On appeal, the Commissioner (Appeals), allowed the assessee’s appeal.

Decision

On second appeal, the Tribunal held in favour of the Revenue as follows:

1. An outright sale of designs and drawings essentially implies unfettered right of the assessee to use the same. However, the agreement would establish that it was not so in the instant case.
    

2. The assessee had granted the IPL non-exclusive right to use the ‘know-how’ for a specific purpose and that ‘know-how’ included the technical designs and drawings. IPL’ could not assign any rights under the said agreement, including, the right to use the designs and drawings to anyone else. In any event, the right to use the ‘know-how’ was a clearly non-exclusive right and, therefore, the assessee retained property in the same even while the ‘know-how’ was made available to the IPL. IPL was under an obligation to maintain the confidentiality about the designs and drawings. IPL had an obligation not only to maintain confidentiality but also to make every effort that it was not divulged to third parties without the assessee’s specific permission. The agreement further provided that in case the drawings and designs were so known to the third parties, the IPL would make good the resultant losses incurred to the assessee.
    

3. In the light of the factual position, it could not be said that the IPL had outrightly purchased the designs and drawings and that consequent to supply of those drawings and designs, the non-resident assessee did not have any interest in the same.
    

4. In CIT vs. Davy Ashmore India Ltd.’s [1991] 190 ITR 626 (Cal.), the High Court had categorically observed that where the transferor retains the property right in the designs, secret formulae, etc., and allows the use of such rights, consideration received for such use is royalty. It was only in the case of outright sale that the consideration for such sale was not to be treated as ‘royalty’. The instant case was not a case of an outright sale nor was it a case of importation of drawings under the import policy. It was a case of collaboration agreement and a case of limited non-exclusive use of certain drawings and designs for that purpose.
    

5. In view of the above, the relief granted by the Commissioner (Appeals) was to be vacated and his impugned order had to be disapproved and the order of the Assessing Officer had to be restored.

Eligibility to access a DTAA – Meaning of the expression "Liable to tax" – Assessee a tax Resident of UAE but not actually paying tax in UAE – Denial of benefits of India – UAE DTAA – Whether justified? – Held Assessing Officer was not justified.

ADIT vs. Green Emirate Shipping & Travels [2006] 6 SOT 329 (Mum.) Assessment Year
1998-99

Assessee, a shipping line, based in United Arab Emirates [UAE], had certain taxable income from shipping operations in India. It claimed that in terms of Article 8, its income was liable to tax only in country of domicile; i.e., UAE. Assessing Officer (AO) rejected the claim on ground that provisions of DTAA did not come into play unless it was established that assessee was paying tax in both the countries in respect of the same income, and that assessee failed to produce any evidence that it was liable to pay tax in UAE. Commissioner (Appeals) held that assessee had not been allowed benefit of DTAA only because assessee had not produced any evidence before A.O. that it was a tax resident of UAE. Having found that assessee had submitted xerox copy of tax residency certificate issued by Ministry of Finance and Industry in UAE, CIT(A) directed the A.O. to allow benefit of the DTAA to assessee. Taxability in one country is not a sine qua non for availing relief under treaty from taxability in other country. All that is necessary for this purpose is that person should be ‘liable to tax in contracting State by reason of domicile, residence, place of management, place of incorporation or any other criterion of similar nature’ which essentially refers to fiscal domicile of such person. Being ‘liable to tax’ in contracting State would not necessarily imply that person should actually be liable to tax in that contracting State by virtue of an existing legal provision. Words ‘liable to tax’ would also cover cases where other contracting State has right to tax such persons irrespective of whether or not such a right is exercised by contracting State. Therefore, A.O. was not justified in rejecting assessee’s claim that its income was liable to tax only in UAE .

Facts

1. The assessee-company, a shipping line based in United Arab Emirates (UAE), had certain taxable income from shipping operations. It claimed that in terms of Article 8 of the Indo-UAE Double Taxation Avoidance Agreement (India-UAE DTAA), its income was liable to tax only in the country of domicile; i.e., UAE.
    

2. The A.O. rejected the claim of the assessee on the ground that the assessee was not paying taxes in UAE. The Assessing Officer relied upon the decision of the AAR in the case of Cyril Eugene Pereria, [1999] 239 ITR 650/105 Taxman 275 in support of the proposition that the provisions of the DTAA did not apply to any case in which the same income was not liable to be taxed twice by the existing laws of both the contracting States.
    

3. The Assessing Officer also held that the assessee had failed to furnish proof/evidences in support of the claim of being eligible for benefit of India-UAE DTAA and, consequently, the assessee had failed to discharge the onus on it to prove that it was liable to pay tax in UAE.
    

4. On appeal, the Commissioner (Appeals) held that the assessee had not been allowed the benefit of DTAA only because the assessee had not produced any evidence before the Assessing Officer that it was a tax resident of UAE. Having found that the assessee had submitted the xerox copy of the tax residency certificate issued by the Ministry of Finance and Industry in UAE, the CIT(A) directed the Assessing Officer to allow the benefit of DTAA to the assessee.

Decision

On second appeal, the Tribunal held in favour of the assessee, as follows:

1. The judgments of the Supreme Court are binding on the Tribunal under Article 141 of the Constitution of India; the rulings of Authority for Advance Ruling, whatever be their persuasive value, are not. The Supreme Court in the case of Union of India vs. Azadi Bachao Andolan [2003] 263 ITR 706/132 Taxman 373, had an occasion to deal with the ruling given by the Authority for Advance Ruling in Cyril Eugene Pereria’s case. Undisputedly, in Cyril Eugene Pereria’s case, the Authority for Advance Ruling, deviating from the stand taken by it in the earlier rulings including ruling in Mohsinally Alimohammed Rafik, [1995] 213 ITR 317/79 Taxman 75, concluded that an individual who is not liable to pay tax under the UAE law cannot claim any relief from the tax on income which is payable in India under the agreement and that the provisions of the Double Taxation Avoidance Agreement do not apply to any case where the same income is not liable to be taxed twice by the existing laws of both the Contracting States. However, in the case of Azadi Bachao Andolan, the Supreme Court after referring to the said ruling and after elaborate discussions on the various aspects of this issue concluded that ‘it is . . . not possible for one to accept that the avoidance of double taxation can arise only when tax is actually paid in one of the Contracting States’. Clearly, therefore, there is no meeting ground between the ruling given by the Authority for Advance Ruling in the case of Cyril Eugene Pereria and the judgment delivered by the Supreme Court in Azadi Bachao Andolan’s case. Therefore, the Assessing Officer’s reliance upon the ruling given by the Authority for Advance Ruling in the case of Cyril Eugene Pereria, could not be approved.
    

2. The Supreme Court in the case of Azadi Bachao Andolan had also held that a ruling given by the Authority for Advance Ruling is not even binding on the Commissioner and authorities subordinate thereto, in any case except in the case of that very assessee in which such a ruling is given and even in such a case, it is binding in respect of transaction in respect of which the ruling is given. Whatever be the respect and deference judicial authorities indeed have for the rulings given by the authority, the Authority for Advance Ruling, not being a part of the judicial hierarchy, cannot lay down a binding precedence for anyone — the revenue, the assessees or the appellate authorities. By no stretch of logic, therefore, a ruling given by the Authority of Advance Ruling has any precedence value in general. Therefore, the revenue’s reliance on the ruling given by the Authority for Advance Ruling in the case of Abdul Razak A. Menan, In re [2005] 276 ITR 306/146 Taxman 115, by itself was not sufficient to decide the matter one way or the other. Further, since the very contention which had been raised by the revenue in the instant case was successfully challenged by the Union of India before the Supreme Court in the case of Azadi Bachao Andolan, it could not be open to the Tribunal to take any other view of the matter than the view so taken by the Supreme Court.
    

3. Although the Assessing Officer’s objection to applicability of India-UAE tax treaty was only on the ground that the provisions of double taxation avoidance agreements did not come into play unless it was established that the assessee was paying tax in both the countries in respect of the same income, in the grounds of appeal, it was also contended that the assessee failed to produce any evidence to the effect that it was liable to pay taxes in UAE. The question then would arise whether an existing liability to pay taxes in UAE is a sine qua non to avail the benefit of India-UAE tax treaty in India. On this issue also, one finds guidance from the judgment of the Supreme Court in the case of Azadi Bachao Andolan. It is clear from the observations made by the Supreme Court in the case of Azadi Bachao Andolan, that a tax treaty not only prevents ‘current’ but also ‘potential’ double taxation. Therefore, irrespective of whether or not the UAE actually levies taxes on non-corporate entities, once the right to tax UAE residents in specified circumstances vests only with the Government of UAE, that right, whether exercised or not, continues to remain exclusive right of the Government of UAE. However, the exemption agreed to under the ‘assignment’ or ‘distributive’ rule is independent of ‘whether the Contracting State imposes a tax in the situation to which exemption applies’. It is, thus, clear that taxability in one country is not sine qua non for availing relief under the treaty from taxability in the other country. All that is necessary for this purpose is that the person should be ‘liable to tax in the Contracting State by reason of domicile, residence, place of management, place of incorporation or any other criterion of similar nature’ which essentially refers to the fiscal domicile of such a person. In other words, if fiscal domicile of a person is in a Contracting State, irrespective of whether or not that person is actually liable to pay tax in that country, he is to be treated as resident of that Contracting State. The expression ‘liable to tax’ is not to be read in isolation but in conjunction with the words immediately following it; i.e., ‘by reason of domicile, residence, place of management, place of incorporation or any other criterion of similar nature’. That would mean that merely a person living in a Contracting State should not be sufficient, that person should also have fiscal domicile in that country. These tests of fiscal domicile which are given by way of examples following the expression ‘liable to tax by reason of; i.e., domicile, residence, place of management, place of incorporation, etc., are not more than examples of locality-related attachments that attract residence type taxation. Therefore, as long as a person has such locality-related attachments which attract residence type taxation, that ‘person’ is to be treated as resident and this status of being a ‘resident’ of the contracting State is independent of the actual levy of tax on that person. Therefore, being ‘liable to tax’ in the Contracting State does not necessarily imply that the person should actually be liable to tax in that Contracting State by virtue of an existing legal provision but would also cover the cases where other Contracting State has the right to tax such persons — irrespective of whether or not such a right is exercised by the Contracting State. Therefore, the plea taken by the revenue that the assessee was not liable to tax was also not sustainable in law either.

Cases referred to

1. Cyril Eugene Pereria, In re [1999] 239 ITR 650/105 Taxman 273 (AAR),

2. Union of India vs. Azadi Bachao Andolan [2003] 263 ITR 706/132 Taxman 373 (SC),

3. Asstt. Collector of Central Excise vs. Dunlop India Ltd. [1985] 154 ITR 172 (SC),

4. Mohsinally Alimohammed Rafik, In re [1995] 213 ITR 317/79 Taxman 75 (AAR),

5. Abdul Razak A. Menan, In re [2005] 276 ITR 306/146 Taxman 115 (AAR), and

6. John N. Gladden vs. Her Majesty the Queen 85 TC 5188.

[Authors’ Note: Prof. (Dr.) Klaus Vogel has favourably commented on this Tribunal Decision in his column "Tax Treaty Monitor" in IBFD Bulletin.]