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Kotak Mahindra Primus Ltd. vs. DDIT [2007] 11 SOT 578 (Mum.)

Assessee, a non-banking finance company, was a joint Venture between an Indian company and an Australian company. Assessee sought for permission to remit certain amount to Australian company without T.D.S. Assessee had to make those payments in consideration of processing of its data. The A.O. held that payments made by assessee to Australian company were covered by scope of expression ‘royalty’ appearing in section 9(1) as also in Article 12(3)(a) of India-Australia DTAA and directed assessee to deduct tax @15% of gross payment. The impugned payment could not be held to be covered by scope of expression ‘royalty’ under Article 12(3) of DTAA. Since Australian company did not have any permanent establishment in India, impugned payment in view of provisions of Article 7(1) of DTAA could not be taxed as a business profit of Australian company in India. Since Australian company did not have any tax liability in India and as tax-withholding liability is only a vicarious and substitutionary liability, the assessee did not have any tax withholding liability so far as impugned payment to Australian company was concerned.

Facts

1. The assessee, a non-banking finance company, was jointly formed by an Indian company and an Australian company.

2. The assessee moved an application to the A. O. for permission to remit certain amount to Australian company without any deduction of withholding tax. It submitted before the Assessing Officer that the said payment was made to the Australian company towards data processing costs and that the payment was in the nature of business profits in the hands of the Australian company; and since Australian company did not have a permanent establishment (PE) in India, the same could not be charged to tax in India in terms of Article 7 of the India Australia DTAA.

3. The assessee also stated that the payment could not be treated as a royalty in terms of Article 12(3)(b) for the reason that the assessee did not have any physical access to the mainframe computer and the payment could not be said to be for use of equipment but rather for consolidated computer-processing facilities.

4. The assessee further submitted that the said payment could not also be covered by Article 12(3)(a) because the assessee had not been granted any right to use any intellectual property rights of the kind referred to in Article 12(3)(a) and that the payment was also not covered by Article 12(3)(c) because the payment could not be said to be for supply of information as it was only the information in the possession of the assessee which was processed by the Australian company.

5. The A. O. held that the assessee was having access to the mainframe computer of Australian company and was allowed to use the software, developed and protected by Australian company. The A. O. further held that three main tests for a payment to be classified as royalty payment, squarely covered the annual maintenance, licensing charges and data processing charges.

6. The A. O. also held that the payment could also be viewed as payment for the use of scientific equipment, i.e., the mainframe computer. The A. O., therefore, held that the payment made by the assessee to the Australian company was covered by the scope of expression ‘royalty’ appearing in section 9(1) as also in Article 12(3)(a) of the DTAA.

7. The A.O., therefore, directed the assessee to deduct tax @ 15% of the gross payment. On appeal, the Commissioner (Appeals) upheld the impugned order.

 Decision

On Second Appeal, the Tribunal held in favour of the assessee as follows:

1. From the reading of the agreement under which the payment was made, it was clear that the entire payment was in the nature of ‘on going payment charges for data processing’. No doubt, a part of this data processing cost was in the nature of fixed cost as annual maintenance and licensing charges, whereas the other part of the cost was in the nature of variable cost per unit of processing of contract. However, both these segments, i.e., fixed as also variable, were only payments for processing of data, and could not be considered in isolation with each other. The ‘annual maintenance fee charge’ did not give any independent rights to the assessee, as it allowed the assessee only to avail data processing by the Australian company at a specified unit rate. Similarly, per unit cost of data processing was also meaningless unless the fixed annual charge was paid because the assessee could not avail this unit cost of processing unless the fixed annual charge was paid. These charges were complementary and could only be considered in conjunction.

2. There are not only good reasons to segregate fixed and variable components for price of one service, but such a method is fully justified and is most appropriate in intra group transactions as in the instant case the consideration for payment was only this data processing work. No part of this payment could be said to be for the use of specialized software on which data was processed or for the use of mainframe computer because the assessee did not have any independent right to use the computer or even physical access to the mainframe computer, so as to use the mainframe computer or the specialized software. The right was for processing of data, and the use of mainframe computer was permitted only for that purpose. The assessee could feed the raw data in the mainframe computer in Australia, with the help of the telecommunication link, and the output data, after due processing was transmitted back to the assessee. There was no privilege or right granted to the assessee by the Australian company. The control of the assessee was only on the input transmission and the right was to get the output processed data back. The actual processing of data was in the exclusive control of the Australian company, and it was for this work that the Australian company was paid. Therefore, the impugned payment was made to the Australian company in consideration of its processing of data belonging to the assessee.

3. Article 12(3)(a) of India Australia DTAA covers only a payment for the use of, or the right to use of any copyright, patent, design or model, plan, secret formula or process, trade mark, or other like property or right. The case of the revenue was that the payment was made for the use of specialized software with the help of which data was processed. However, the payment made by the assessee was not for the use of or right to use of software but the payment was for data processing. Even if stand of the revenue was to be upheld and it was to be concluded that the payment was made for software per se that did not lead to taxability of receipt in the hands of the Australian company either. It is now settled that the payment for software is for a copyrighted Article and not copyright per se, and, therefore, is not covered by the scope of payment for copyright. It was not even the revenue’s case that the payment in question was not for the use of, or right to use of, patent, design or model, plan, secret formula or process, or trade mark. In any event, having perused these classifications and having considered the facts that the payment did not fit into any of these classifications, it could not be said that the impugned payment was covered by the residuary clause, i.e., ‘other like property or right’ and also that by making payment of US $ 60,000 per annum, the assessee got a valuable property and right as the payment could not be said to have been made in vacuum and without any consideration. It is not every property or right which can be covered by these expressions appearing in the end of Article 12(3)(a). When that property or right, even if it so exists, is not of the nature of any of the specific categories set out in Article 12(3)(a), it cannot be covered by the general words following those categories either. Therefore, the provisions of Article 12(3)(a) could not be invoked in the instant case.

4. Article 12(3)(b) could apply only when the payment in question could be held to be payment for ‘the use of or the right to use, any industrial, commercial or scientific equipment’. This condition could only be satisfied when it was established that the impugned payment was made for the use of or right to use of, mainframe computer. The assessee did not have any control over, or physical access to, the mainframe computer in Australia. There could not, therefore, be any question of payment for use of the mainframe computer. It is indeed true that the use of mainframe computer is integral to the data processing, but the payment was not for the use of mainframe computer per se; and that the assessee did not have any control over the mainframe computer or physical access to the mainframe computer; and that the payment was for act of specialized data processing by the Australian company; Use of mainframe computer in the course of processing of data was one of the important aspects of the whole activity but that was not the purpose of, and consideration for, the impugned payment being made to Australian company. The payment was for the activity of specialized data processing. Therefore, neither the impugned payment could be said to be towards use of, or right to use of, the mainframe computer, nor was it permissible to allocate a part of the impugned payment, as attributable to use of, or right to use of, mainframe computer. Accordingly, the provisions of Article 12(3)(b) could not have any application in the matter.

5. Article 12(3)(c) provides that where the payment is for ‘the supply of scientific, technical, industrial or commercial knowledge or information’, the same shall be considered as ‘royalty’ for the purposes of Article 12 of the DTAA. By no stretch of logic, it could be said that the payment was made to the Australian company for the supply of any knowledge or information of any nature whatsoever. The information was, in fact, furnished by the assessee, the same was processed in Australia and transmitted back to the assessee. This activity only involved processing and not supply of information. Accordingly, the provisions of Article 12(3)(c) would also not have any application in the matter.

6. It was also not the case of the revenue that remaining parts of Article 12(3), i.e., Article 12(3)(d) to Article 12(3)(L), would have any application in the matter. In any case, these provisions also had no application in the instant situation.

7. Therefore, the impugned payment could not be held to be covered by the scope of expression ‘royalty’ under Article 12(3) of the India-Australia DTAA. Since the Australian company did not have any permanent establishment (PE) in India, this payment could not also be taxed as a business profit of the Australian company in India. Article 7(1) of the DTAA specifically provides that "The profits of the enterprise of one of the Contracting States shall only be taxable in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein". Therefore, the right of Indian tax jurisdiction did not extend to taxing the impugned payment to the Australian company for specialized data
   processing of information furnished by the assessee.

8. Thus, the Australian company did not have any tax liability in India, and as the tax withholding liability is only a vicarious and substitutionary liability, the assessee did not have any tax withholding liability so far as the impugned payment to the Australian company was concerned.

Accordingly, the orders of the lower authorities were set aside and the appeal was allowed.

Cases Referred to

1. ABC, In re [1999] 238 ITR 296/105 Taxman 240 (AAR),

2. Motorola Inc. vs. Dy. CIT [2005] 95 ITD 269/147 Taxman 39 (Delhi) (Mag.) (SB),

3. Samsung Electronics Co. Ltd. vs. ITO [2005] 94 ITD 91 (Bang.) and

4. Lucent Technologies Hindustan Ltd. vs. ITO [2005] 92 ITD 366 (Bang.).

[Note: This decision contains an excellent discussion on whether payment for Computer Software or Data Processing Services constitutes "Royalty" under various clauses of Article 12(3) of the Treaty.]

IBM India Ltd. vs. CIT (Appeals) [2007] 105 ITD 1 (Bang.) Assessment Year 1998-99

Facts

1. The assessee claimed that while computing its tax liability, the credit in respect of income-tax paid in USA was to be allowed as per law and as per Article 25(2)(a) of the DTAA between India and USA.

2. The Commissioner (Appeals) directed the A. O. to allow the credit as per law subject to condition that the claim was to be allowed if the same was made in the return or during the assessment proceedings.

3. On appeal, the assessee contended that the claim was to be entertained whether or not such claim was made either in return or during assessment proceedings.

Decision

The Tribunal agreed with the assessee and held that the A. O. should allow the credit for the taxes paid in USA as per the provision of section 90 read with Article 25(2)(a) of the DTAA, whether or not such claim was made in the return or during the assessment proceedings. There could not be any embargo on entertaining the claim even if such claim was not made in the return or during assessment proceedings.

DCIT, vs. Vinarom Ltd. [2007] 104 ITD 234 (Bang.) Assessment Years 1998-99 to 2002-03

Assessee-company entered into a licence agreement with a foreign company ‘GRISA’ for some technology and know-how against payment of royalty. The A. O. noticed that ‘GRIL’, which was wholly owned subsidiary of ‘GRISA’, held 76 per cent shares in assessee-company, and disallowed payment of royalty holding that transaction was not at arm’s length. Since foreign company had provided know-how on which assessee-company had commercial benefit and payment was required to be made, mere fact that said foreign company might be holding shares in assessee did not make that company and assessee one and same. Whether further, since payment to foreign company by way of royalty was not proved to be excessive or more than market value for know-how provided and it was also not proved that said payment was only a make believe, payment being a legitimate business expenditure was required to be allowed under section 37(1).

Facts

1. The assessee-company was engaged in manufacture of perfumery compounds. It entered into a licence agreement with a foreign company ‘GRISA’, pursuant to which the know-how was made available to the assessee-company and in consideration of the rights granted and the services provided under that agreement, the assessee was required to pay a royalty to GRISA at certain percentage of the net sales value of the products manufactured and sold by it.

2. The assessee paid the royalty and claimed deduction thereof u/s 37(1).

3. The A. O., however, noticing that GRIL, which was a fully owned subsidiary company of GRISA, owned 76% of the shares of the assessee-company, held that though the assessee received know-how necessary for advancement of its business and though it was benefited commercially, yet the transaction was not at an arm's length. Consequently, he disallowed the royalty payment treating it to be a colourable device. On appeal, the Commissioner (Appeals) upheld the impugned disallowance.

Decision

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

1. A transaction is said to be at an arm's length when one is compensated for the benefit received. Conversely, if it is not so done, it can be considered as a transaction ‘hands in glove’. In the instant case, what the assessee did was precisely a transaction at arm's length. While paying for the technology received, the assessee had paid precisely the price payable for the same. Had it not paid the same, it would have been considered as a transaction ‘hands in glove’ and not at arm's length. Even though the share capital of assessee was held by GRIL, which itself was a subsidiary of GRISA, GRISA, was under no obligation whether legally or morally, to part with its confidential information, experience, know-how, trade secret and formula relating to the products manufactured by the assessee. The two companies were different legal identities and not bound to supply the technology free of cost.

2. On the contrary, if the technology was transferred free of cost, it would have been held to be a transaction not at arm's length. By entering into agreement and by paying the fees, the transaction was to be treated at arm's length and but for payment, the inference could have been otherwise. The assessing authority and the appellate authority failed to appreciate the fact that since the foreign company had provided the knowhow on which the assessee had commercial benefit, the payment was required to be made. The fact that the foreign company might be holding the shares in the assessee did not make the foreign company and the assessee one and the same. They were two different legal entities capable of entering into a contract. Further, they were also not in the susceptible capacity as provided under section 40A(2).

3. Further, the payment to the foreign company by way of royalty was not proved to be excessive or more than the market value for the know-how provided. It was also not proved that the payment was only a make believe. On the other hand, the royalty payments were actually being made. Therefore, the payment being a legitimate business expenditure was required to be allowed under section 37(1).

4. The other argument, that the device was colourable, was also without merit. It was an undisputed fact that the foreign company had supplied know-how but for which the company could not have expanded its business. The performance of the company was again proved on account of the various customers, which could gain by applying the know-how provided by the foreign company. Had the foreign company not provided the know-how and directly dealt with the various esteemed customers of the assessee, the assessee would nowhere be in the market. On the other hand, the assessee, having reaped the benefit for obtaining the know-how, was providing the fraction of the profit by way of royalty to the foreign company. By no stretch of imagination, the agreement might be held to be colourable.

5. The expenses were claimed under section 37(1). It is not open to the department to adopt a subjective standard of reasonableness and disallow a part of business expenditure as being unreasonably large, or decide what type of expenditure the assessee should incur and in what circumstances. The jurisdiction of the Assessing Officer is confined to deciding the reality of the expenditure, namely whether the amount claimed as deduction was factually expended as laid down and whether it was wholly and exclusively for the purpose of the business; the reasonableness of the expenditure can be considered only for the purpose of determining whether in fact, the amount was spent; once it is established that there was a nexus between the expenditure and the purpose of the business, the department cannot justifiably claim to put itself in the armchair of a businessman or in the position of the board of directors and assume the said role to decide how much is a reasonable expenditure having regard to the circumstances of the case. But this principle is now subject to express provisions of section 40A(2). No effort had been made to find out as to what was the market value of service provided and to what extent the amount was excessive or unreasonable. On the contrary, from the order under section 92CA, for the assessment year 2002-03, it was seen that the transaction was treated at arm's length and even as per the amended provisions of section 92, no adjustment in respect of such international transaction had been
   made.

6. In view of the discussion above, the amount paid by way of royalty to GRISA could not be disallowed. In the result, the appeal of the assessee was allowed.

ONGC vs. ACIT [2007] 12 SOT 584 (Delhi) assessment years 1998-99 and 1999-2000

Consideration paid for rendering all services like imparting of training and carrying out drilling operations for exploration or exploitation of oil and natural gas will not be treated as ‘fees for technical services’ for purpose of Explanation 2 to section 9(1)(vii) and so payment of such services to a foreign company would, therefore, be income chargeable to tax under provisions of section 44BB and not under provisions of taxation of fees for technical services contained in section 115A, read with section 44D.

Facts

1. ONGC was engaged in exploration, extraction and production of mineral oil.

2. ONGC appointed the assessee, a non-resident company, for imparting training on ‘Ceased Hole and Production Log Evaluation’ and on ‘Ceased Hole and Production Log Analysis’ to its officers and paid certain consideration to the assessee.

3. The assessee claimed that since the impugned consideration for providing training was not fee for technical services, the same was covered under the provisions of section 44B as per the CBDT Instruction No. 1862, dated 22-10-1990.

4. The A. O. rejected the assessee’s claim and held that the services and activities by the assessee were technical in nature and were covered under the provisions of section 44D, read with section 115A. On appeal, the Commissioner (Appeals) upheld the impugned order.

Decision

On Second Appeal, the Tribunal held in favour of the assessee, as under:

1. The assessee non-resident company was engaged by ONGC for imparting training. As per Instruction No. 1862, the CBDT with regard to the definition of fee for technical service in Explanation 2
   to section 9(1)(vii) made some clarifications.

2. From the clarification made by the CBDT, it is clear that the consideration paid for rendering all services like imparting of training and carrying out drilling operations for exploration or exploitation of oil and natural gas will not be treated as ‘fees for technical services’ for the purpose of Explanation 2 to section 9(1)(vii) and so payment of such services to a foreign company would be income chargeable to tax under the provisions of section 44B and not under the provisions of the taxation of fees for technical services contained in section 44D, read with section 115A,

3. The amount received by the assessee for imparting training was not covered within the meaning of technical services, and, hence, the A. O. was not justified in assessing the income of the assessee under section 44D, read with section 115A against shown by the assessee under section 44BB. The orders of the lower authorities were set aside.

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