ORDER
Pramod Kumar, A.M.
1. This is an appeal filed by the Revenue and is directed against the order dt. 26th April, 2000, passed by the CIT(A)-IV, Mumbai, in the matter of assessment under Section. 143(3) of the IT Act, 1961 (hereinafter referred to as ‘the Act’), for the asst. yr. 1995-96.
2. The grievance raised by the Revenue is as follows :
“On the facts and in the circumstances of the case and in law, the learned CIT(A) has erred in holding that the payment received by the assessee for supply of technical documentation is not liable to treated as taxable income in its hands and thereby erred in deleting a sum of Rs. 7,88,000 as the income of the assessee from royalty as held by the AO.”
The short issue requiring our adjudication in this appeal, therefore, is whether or not the payment in consideration of supply of technical documentation, on the facts of this case, is to be treated as ‘royalty’ or not.
3. The aforesaid neatly identified legal issue is set out in a narrow compass of undisputed material facts. The assessee, a Russian company, possessing knowledge and experience in the field of manufacturing technique of a product termed as “UR 9168 Polyurethane Wire Enamel”, entered into agreement dt. 8th March, 1994, with an Indian company, by the name of Intec Polymer Ltd. (IPL, in short). Under this agreement, the assessee-company was to provide to IPL a “non-exclusive right to use the ‘know-how’ for the purpose of realisation 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”. The terms of rendering the technical assistance were set out in Article 3 of the agreement which is reproduced below for ready reference :
The technical documentation shall be drawn up in conformity with the norms and standards of the licensor’s country in Russian (1 copy) with translation into English (3 copies) and delivered to the licensee on the terms Ex-Aeroflot Aircraft Board, Moscow, within two months from the date of signing of this agreement.
Under the said agreement, the terms of payments were broadly as follows :
Lump sum fees: US $ 50,000 net of taxes
- first instalment of US $ 20,000 payable within 15 days
of the signing of agreement;
- second instalment of US $ 20,000 payable within 15 days
of the date of delivery of technical
documentation; and
- final instalment of US $ 10,000 payable within 15 days
from the date of signing of successful commissioning
protocol by the parties, but within 12 months from
the date of second instalment, if delay in successful
commissioning is not attributable to the assessee.
Current fees (royalty) : 4 per cent of the selling price of the licensed
product during first five years of the agreement
coming into force.
It was in the above backdrop of facts that the assessee-company received US $ 20,000 as first instalment of the lumpsum fees of US $ 50,000. In the course of assessment proceedings, the assessee’s contention was that since the consideration was for outright sale of technical know-how, it was not liable to be taxed in India. It was contended that the assessee-company did not have a permanent establishment (PE) in India and that in terms of Article 7 of the India Russia Double Taxation Avoidance Agreement, profits on such a sale could only be brought to tax in India when the same is attributable to the PE. It was also contended that the money in question being consideration for sale of know-how, the provisions of Article 12 dealing with ‘royalties’ are not applicable to the present case. The assessee further contended that in any event, the tax is not to be grossed up in view of Section 10(6A) being applicable on the facts of this case. None of these contentions, however, found any favour with the AO. The AO was of the view that the transaction in question was not a case of outright sale of know-how and that provisions of Article 12 of applicable DTAA are applicable. It was thus concluded that the receipt in question is taxable @ 20 per cent as royalty. The AO was further of the view that there is nothing on record to demonstrate that the conditions set out in Section 10(6A) are satisfied. Aggrieved by these actions of the AO, the assessee carried the matter in appeal before the CIT(A). Learned CIT(A) was of the view that in the light of the principles laid down by the Hon’ble Calcutta High Court in the case of CIT v. Davy Ashmore India Ltd. (1991) 190 ITR 626 (Cal), in the case of ‘an outright sale’, the consideration for the transfer of such design, secret formulae, etc. cannot be treated as royalty. It was further observed that since the present case is a case of outright sale of technical know-how, the consideration received by the assessee-company cannot be treated as ‘royalty’ exigible to tax under Article 12 of the India Russia DTAA. The CIT(A) thus reversed the order of the AO and upheld the contentions of the assessee.
4. Revenue is aggrieved and in appeal before us.
5. We have heard Shri Mohit Kapoor, learned Departmental Representative, and Shri Diveyesh Shah, learned counsel for the assessee. We have also carefully perused the material before us and duly considered factual matrix of the case as also the applicable legal position.
6. We consider it desirable to reproduce Article 12 of the DTAA, dt. 4th Sept., 1989, entered into by India with the Union of Soviet Socialist Republic and which was extended to the Russian Federation vide Government Notification dt. 30th Dec., 1992, for ready reference :
“Article 12
Royalties and fees for technical services :
1. Royalties and fees for technical services arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State.
2. However, such royalties and fees for technical services may also be taxed in the Contracting State in which they arise and according to the laws of that State, but if the recipient is the beneficial owner of the royalties or fees for technical services, the tax so charged shall not exceed :
(a) Fifteen per cent of the gross amount of the royalties relating to copyrights of literary, artistic or scientific works, other than cinematograph films or films or tapes used for radio or television broadcasting; and
(b) Twenty per cent of the gross amount of the royalties in all other cases of fees for technical services.
3. The term “royalties” as used in this article means payments of any kind received as a consideration for the use of, or the right to use any copyright of literary, artistic or scientific work, including cinematograph films or films or tapes used for radio or television broadcasting, any patent, trademark, design or. model, plan, formula or process, or for the use of, or the right to use industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience.
4. The term “fees for technical services” as used in this article means payments of any kind to any person other than payments to an employee of a person making payments, in consideration for the services of a managerial, technical or consultancy nature, including the provision of services of technical or other personnel.
5. The provisions of paras 1 and 2 shall not apply if the beneficial owner of the royalties or fees for technical services, being a resident of a Contracting State, carries on business in the other Contracting State in which the royalties or fees for technical services arise, through a permanent establishment situated therein, 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. In such case the provisions of Article 7 shall apply.
6. Royalties and fees for technical services shall be deemed to arise in a Contracting State when the payer is that State itself, a sub-division, a local authority or a resident of that State. Where, however, the person paying the royalties or fees for technical services, whether he is a resident of a Contracting State or not, has in a Contracting State a permanent establishment in connection with which the liability to pay the royalties or fees for technical services was incurred and such royalties or fees for technical services are borne by such permanent establishment, then such royalties or fees for technical services shall be deemed to arise in the State in which the permanent establishment is situated.
7. Where, by a reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of royalties or fees for technical services paid exceeds the amount which would have been paid in the absence of such relationship, the provisions of this article shall apply only to the last mentioned amount. In such case the excess part of the payment shall remain taxable according to the laws of each Contracting State, due regard being had to the other provisions of this agreement.
7. Learned counsel for the assessee fairly does not dispute that the aforesaid provisions of the India Russia DTAA would apply even to the payments of lump sum consideration for the technical assistance, but he contends that the same shall not apply to the facts of this case because it is a case of outright sale of technical drawings and in view of the Hon’ble Calcutta High Court’s judgment in the case of Davy Ashmore India Ltd. (supra). That is his only defence for the CIT(A)’s order. It is, therefore, important to appreciate as to what principles are laid down by the Hon’ble Calcutta High Court in Davy Ashmore’s case (supra), and perhaps, even more important than that, what principles it has not laid down. In the said case, the Hon’ble High Court has, inter alia, observed as follows :
“……what is important to consider is that, in order that a payment may be treated as royalty for the purpose of Article 13 of the Agreement for Avoidance of Double Taxation between India and the UK, the person who is owner of such patents, designs or models, plans, secret formulae or process, etc. retains the property in them and permits the use or allows the rights to use such patents, designs or models, plans, secret formulae or process, etc. In other words, where the transferor retains the property right in the design, secret formulae, etc. and allows the use of such rights, consideration received for such use is royalty. Where, however, there is an outright sale or purchase, as in the present case (case before Their Lordships), the consideration is for the transfer of such design, secret formulae, etc. and cannot be treated as royalty”.
Having set out the principles thus, Their Lordships came to the following conclusions on the particular facts of that case as follows :
“Having regard to the facts and circumstances of this case, it must be held in the present case that the present case is not a case where the non-resident is retaining the property in designs and drawings. Such designs and drawings are imported under the import policy with the approval of the Reserve Bank of India and on the basis of the letter of intent. The importation of the designs and drawings postulates an out and out transfer or sale of such designs and drawings and non-resident company does not retain any property in them leaving the grantee to use or exploit them…..”
It was in this backdrop that Their Lordships concluded that the consideration for such ‘out and out transfer or sale’ of designs and drawings cannot be treated as ‘royalty’.
8. It is thus clear that Davy Ashmore decision (supra) merely lays down the proposition that in the case of an outright sale or transfer of designs and drawings and in a situation where non-resident does not retain any property in such drawings and designs, the consideration for such an outright sale and transfer cannot be regarded as in the nature of payment for use of, or right to use of, such patents, designs or models, plans, secret formulae or processes, etc. Accordingly, it cannot be treated as ‘royalty’, as are the normal connotations of this expression in DTAAs including India Russia DTAA. However, this decision does not lay down the general proposition that consideration for transfer of designs and drawings in all cases is to be treated as consideration for outright sale of such designs and drawings. Let us now go back to the facts of the case before us.
9. An outright sale of designs and drawings essentially implies unfettered rights of the assessee to use the same. However, a plain reading of the agreement would establish that it is not so in the present case. Under Clause 2.1 of the agreement, the assessee had granted the IPL non-exclusive right to use the ‘know-how’ for a specific purpose and this ‘know-how’ included the technical designs and drawings set out in Clause 3 of the agreement. Under Clause 12.2, IPL could not assign any rights under the said agreement, including thus the right to use the designs and drawings, to anyone else. In any event, the right to use the ‘know-how’ is 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. Under Clause 7 of the agreement, the IPL was under an obligation to maintain the confidentiality about the designs and drawings. The IPL had an obligation not only to maintain confidentiality but also to make every effort that it is not divulged to third parties without assessee’s specific permission. Clause 7.2 of the agreement further provided that in case the drawings and designs are so known to the third parties, the IPL shall make good the resultant losses incurred to the assessee. In the light of this factual position, in our considered view, it could not be said that the IPL had outrightly purchased the designs and drawings and that consequent to supply of these drawings and designs, the non-resident assessee did not have any interest in the same. The very fact that the IPL can be hauled up to pay damages under Article 7.2 of the agreement would clearly show that the non-resident assessee had valuable property and interest in the drawings and designs which were supplied to the IPL and in consideration of which the US $ 20,000 were received by the assessee. In Davy Ashmore’s case (supra), the Hon’ble Calcutta High Court has 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 case before us is not a case of an outright sale nor is it a case of importation of drawings under the import policy. It is a case of collaboration of drawings under the import policy. It is a case of collaboration agreement and a case of limited nonexclusive use of certain drawings and designs for that purpose. Accordingly, the case of the assessee did not have any support from the Hon’ble Calcutta High Court’s judgment. We are, therefore, unable to approve CIT(A)’s reliance on the Hon’ble Calcutta High Court’s judgment in Davy Ashmore’s case (supra). No other argument was raised before us in defence of CIT(A)’s order.
10. For the reasons stated above, we vacate the relief granted by the CIT(A) and disapprove his impugned order. Resultantly, order of the AO stands restored.
11. In the result, Revenue’s appeal is allowed.