RULINGS
P. No. 22 of 1996
Decided On: 06.05.1996
Appellants: In Re: P. No. 22 of 1996
Vs.
Respondent:
Hon’ble Judges:
S. Ranganathan, J. (Chairman), D.B. Lal and R.L. Meena, Members
Subject: Direct Taxation
Acts/Rules/Orders:
Income Tax Act, 1961 – Section 9 and 9(1)
RULING
1. This application, made under Section 245Q(1) of the Income-tax Act, 1961 (“the Act”), raises an interesting question regarding the taxability of certain amounts of royalty paid outside India under certain agreements between two groups of companies. On the one side is a Swedish company which can be conveniently described as “A” and its wholly owned subsidiary known as “B” incorporated in the United States of America. On the other side is “C” incorporated in the United States of America, its wholly owned subsidiary known as “CM” and an Indian company, “IC” in which “CM” holds 51 per cent. of the equity capital. As a result of these agreements, “B” has received and “C” has paid to “B”, a one-time royalty of US $ 5,295,756. The question on which “B” seeks the ruling of this authority is :
“Whether the royalty paid outside India amounting to US$ 5,295,756 by ‘C’ to ‘B’ as a consideration for granting the licence and right to ‘IC’, a company in which ‘CM’ has 51 per cent. equity holding, to use the trade mark in India is liable to Indian tax ?”
2. The relevant details of these agreements may now be referred to in order to appreciate the factual background against which the above question arises for consideration.
3. It seems that the Swedish company “A” is the proprietor in India of the trade mark. As already mentioned, “B” is a wholly owned subsidiary of “A”. It seems to have acquired, at some stage, which is not clear, the proprietary interest in the above trade mark. It would seem that in pursuance of a microwave technical assistance agreement followed up by a registered user agreement between “B” and “IC”, the latter had been granted the right to use the trade mark in India in carrying on its business in refrigerators and other articles, subject to the payment of certain royalties by “IC” to “B”. This situation underwent a change with a “trade mark usage and purchase agreement”, entered into on August 15, 1994, between “C”, “A” and “B”. Under this agreement, all the existing trade mark and trade name licences from “B” and/or “A” in favour of “IC”, of whatever nature, including the rights to use any or all trade marks or trade names owned or controlled by “B” and/or “A” were to terminate on the effective date, a date defined in the agreement. The agreement envisages that, notwithstanding the termination of its rights, “IC” would be entitled to the continued use of the trade mark and the trade name during a phase out period of 24 months from the effective date without any further payment but subject to certain restrictions. But, after this period, neither “IC” nor “C” nor any of their affiliates would be entitled to use the trade mark or the trade name in any way whatsoever. The agreement also conferred on “A”, “B” and “C” certain rights which it is not necessary to detail here. Since “IC” was not a party to this agreement it was envisaged that “B” and/or “A”, “C” and “IC” should enter into a “trade mark agreement” covering “IC”s acceptance of the termination of its rights under the earlier agreements coupled with a limited right, without any further payment on its part, to the use of the trade mark during the phase out period. The most important part of the agreement is, however, the provision that, in consideration of the “trade mark agreement”, “C” will pay “B” US$ 5,295,756. The agreement also provided that “C” or its nominee will purchase or cause to be purchased from “B” all the 2,086,796 equity shares held by “B” in “IC” at a price of US$ 10,524,477. It was recited in the agreement that “C” had represented to “B”/”A” that “IC” was also agreeable to this course of action. It must also be mentioned that it was apparently in pursuance of this arrangement that “CM” was incorporated and purchased the 2,086,796 equity shares held by “B” in “IC”. In other words, under this agreement, as finally implemented, (a) “IC” was permitted to continue to use the trade mark during the phase-out period, and (b) “CM” became entitled to the shares held by “B” in “IC”. But neither “IC” nor “CM” paid any consideration under this agreement. The royalty for the licence to “IC” to continue to use the trade mark and the trade name in India during the phase-out period was paid by “C” to “B”, and the purchase price of the shares acquired by “CM” was also paid by “C” to “B”.
4. The parties also entered into certain subsequent supplemental agreements, the broad terms of which may now be referred to :
(i) A “share sale and purchase agreement” was entered into on December 29, 1994, between “CM”, “C” and “B” which refers to the purchase of the shares by “CM” as well as the payment of the royalty by it.
(ii) A second agreement, also dated December 29, 1994, was entered into between “B” and “C” called a “trade mark license agreement”. The preamble to this document refers to the agreement of August 15, 1994, and the desire of “C” “to use the trade-mark in India, through its majority-owned affiliated company, “IC” ….”. Under article 1 of the agreement “B” grants to “C” “the royalty-bearing and non-transferable right, licence and privilege to use the trade mark in the territory (of India) with the right to grant an additional licence to ‘IC'”. “C” can transfer the rights to “IC” or any related company. Article 7 provides that “as consideration for the trademark rights granted herein, (“C”) shall pay a one-time royalty to (“B”) consisting of US$ 5,295,756″ in accordance with the terms of the purchase agreement of August 15, 1994. Article 8.1 provides that the agreement was to come into force on its execution and continue to be in force and effect for 24 months, unless terminated as provided in article 8.2.
(iii) The third document is a “registered user agreement” between “B” and “IC” providing for continued usage of the trade mark in India by “IC”. Under this agreement, “B” grants “IC” the continuing right to use the trade mark for 24 months from the “effective date”. The pre-payment to “B” of royalties for the use of the trade mark under the agreement dated August 15, 1994, has been referred to in the preamble to this agreement. The agreement makes no other reference to the payment of royalty in respect of the user of the trade mark.
5. The important aspects of the above agreements, in so far as they are relevant for Indian income-tax purposes, are the following :
(i) Royalty is paid in consideration of the right to use the trade mark in India not by “IC” which used the trade mark, but by the parent company of its holding company.
(ii) The purchase of shares held by “B” in “IC” have been paid for by “C” but the transfer of the shares has been got effected in the name of its wholly owned subsidiary “CM”, with the result that any dividends payable on those shares will become payable to “CM” (a company incorporated in Mauritius) and not to “C” (a company incorporated in the United States of America).
6. Of these two aspects, the question posed before the authority is only on the first, namely, whether “B” is liable to Indian income-tax in respect of the royalty paid by “C” to it. It may again be emphasised that “B” and “C” are companies incorporated in the USA. The trade mark rights are being used by “IC” and, in the normal course, “IC” would be liable to pay the royalties therefor. But instead of “IC”, which is an Indian company, the liability has been undertaken by “C” which is an American company.
7. For considering the question that has been posed, it is necessary to refer to a statutory provision contained in the Act and two paragraphs of the “Agreement for avoidance of double taxation and prevention of fiscal evasion with respect to taxes on income” (DTAA) entered into between India and the United States of America which came into force on December 18, 1990.
8. The statutory provision is Section 9(1)(vi) of the Act, the relevant portion of which reads as under :
“9. Income deemed to accrue or arise in India.–(1) The following incomes shall be deemed to accrue or arise in India–. . , .
(vi) income by way of royalty payable by-
(a) the Government ; or
(b) a person who is a resident, except 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 outside India or for the purposes of making or earning any income from any source outside India ; or
(c) a person who is 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 or for the purposes of making or earning any income from any source in India ; . . .”
9. The relevant provisions of the DTAA between India and the United States of America are the following ([1991] 187 ITR (St.) 102, 112) : “Article 10–Dividends :
(1) Dividends paid by a company which is a resident of a Contracting State to resident of the other Contracting State may be taxed in that other State.
(2) However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident, and according to the laws of that State, but if the beneficial owner of the dividends is a resident of the other Contracting State, the tax so charged shall not exceed :
(a) 15 per cent. of the gross amount of the dividends if the beneficial owner is a company which owns at least 10 per cent. of the voting stock of the company paying the dividends ;
(b) 25 per cent. of the gross amount of the dividends in all other cases . . .
Article 12–Royalties and fees for included services :
(1) Royalties and fees for included 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 included services may also be taxed in the Contracting State in which they arise and according to the laws of that State . . .
(7) (a) Royalties and fees for included services shall be deemed to arise in a Contracting State when the payer is that State itself, a political sub-division, a local authority, or a resident of that State. Where, however, the person paying the royalties or fees for included services, whether he is a resident of a Contracting State or not, has in a contracting State a permanent establishment or a fixed base in connection with which the liability to pay the royalties or fees for included services was incurred, and such royalties or fees for included services are borne by such permanent establishment or fixed base, then such royalties or fees for included services shall be deemed to arise in the Contracting State in which the permanent establishment or fixed base is situated.
(b) Where under sub-paragraph (a) royalties or fees for included services do not arise in one of the Contracting States, and the royalties relate to the use of, or the right to use, the right or property, or the fees for included services relate to services performed, in one of the Contracting States, the royalties or fees for included services shall be deemed to arise in that Contracting State …”
10. The argument urged on behalf of the applicant is very simple. It proceeds on the assumption (it was, indeed, even conceded) that the royalty in question would be one deemed to accrue or arise in India under Article 12(7)(b) of the DTAA. It was, however, contended that income by way of royalty payable by a person who is a non-resident could, under Section 9(1)(vi)(c) of the Act, be deemed to accrue or arise in India only if it is payable in respect of any right, property or information used for the purposes of a business, profession or vocation carried on by such person in India. So, it is said, if “C” had paid the royalty in respect of its utilisation of trade mark in any business carried on by it in India, it could have been said that the royalty accrues or arises in India to “B” and hence is taxable in the hands of “B”. But since the utilisation of the trade mark in India is by “IC” and not by “C”, it is said that this clause is not attracted. It is then argued that, though the DTAA renders the royalty taxable in the hands of “B”, the statutory provision which is more favourable to the applicant, will prevail. For this contention, reliance is placed on the enabling provision contained in Section 90(2) of the Act which reads as under :
“Where the Central Government has entered into an agreement with the Government of any country outside India under Sub-section (1) for granting relief of tax, or, as the case may be, avoidance to double taxation, then, in relation to the assessee to whom such agreement applies, the provisions of this Act shall apply to the extent they are more beneficial to that assessee.”
11. The Departmental representative sought to repel this contention in two ways. He first contended that the applicant’s case falls under Clause (b) and not Clause (c) of Section 9(1)(vi). He argues that as the trade mark is utilised by “IC”, the royalty in respect thereof is payable by “IC” which is a person resident in India, a situation attracting Clause (b). This argument cannot be accepted. It is true that normally royalty is paid by the person who uses the right, information or property in question. But it is open to the parties to arrange the transaction differently. The arrangement between the parties is that “B” grants a licence to “C” and “IC” to use the trade mark for the phase out period but agrees to receive the royalties therefor in advance from “C”. As a result of the various agreements entered into between the parties royalty in respect of such user is payable by “C”, a non-resident, not by “IC”. These arrangements and their legal effect cannot be ignored and any conclusion reached on the assumption that the royalty is payable by “IC”.
12. An argument has been put forward by the Department that the agreement between “B” and “C”, is void since “B” has furnished no consideration to “C” in return for the large amount of royalty received from the latter. This argument has no merit. “B” is the owner of the trade mark in India and it has permitted “C” to use the trade mark “with the right to grant an additional licence to “IC”. By agreement of August 15, 1994, the rights granted earlier by “B” to “IC” to use the trade mark in India have been terminated. There are recitals in the agreement which show that “C” is anxious to come into the Indian market with like products and wants to take over the mantle of the “IC” as a step-in-aid to introduce its own brands in the Indian market. These recitals have not been extracted here but they show beyond doubt that it is with a view to achieve the above end that “C” had acquired shares in “IC” and was planning to introduce its products in the Indian market by making use of “IC” and the TM also in a limited manner during the phase out period. Thus it cannot be said that “C” had nothing to gain as a result of the agreement and the royalty amount was paid gratuitously on behalf of “IC”.
13. But the authority is of opinion that the applicant’s case is bound to fail even on the language of Clause (c) of Section 9(1)(vi). The applicant’s contention misses the second part of that clause which deems royalty to accrue or arise in India where it is payable in respect of the right, property or information used for the purposes of making or earning any income from any source in India. Here there is no reference to the person who is liable to pay the royalty or a business carried on by him in India. Here it is sufficient that the property–in this case the trade mark–in respect of which royalty is payable is used to earn income from any source in India. The applicant’s representative submitted that the trade mark is not so used but it is difficult to accept this submission. The licence agreement itself recites that “C” desires to use the trade mark in India, through “IC”, in respect of refrigerators and other licensed products the sale of which constitutes the source of income to “IC” in India. There is, therefore, no doubt that, even in terms of Clause (c) the royalty in question must be deemed to accrue or arise to the applicant in India and is, hence, taxable.
14. The statutory provisions being clear, what is the position under the DTAA ? As mentioned earlier, the applicant’s representative assumed and even conceded that the position would be the same under sub-paragraph (b) of para. 7 of Article 12 of the DTAA. The authority is of the opinion that the provisions of this sub-paragraph are somewhat ambiguous and that it is not easy to get at the real purport of this sub-paragraph. It is clear that two conditions have to be attracted for invoking sub-paragraph (b) : (i) that the royalties in question do not arise in one of the Contracting States under sub-paragraph (a), and (ii) that the royalties relate to the use of, or the right to use, the right or property in one of the Contracting States, The difficulty is in understanding the precise meaning of the first few words of the sub-paragraph which spell out the first condition.
15. The opening words of sub-paragraph (b) are susceptible to two interpretations. One is that the sub-paragraph is applicable only if it is not possible to ascribe a locale for the royalties under the sub-paragraph (a). Where it is clear, as here, that under sub-paragraph (a), the royalties should be deemed to arise in the U.S., it cannot be said that this is a case in which, under sub-paragraph (a), the royalties do not arise in one of the Contracting States. This being so, the criterion mentioned in sub-paragraph (b) is not attracted at all. The second way of construing the provision is this. In the present case, applying the provisions of sub-paragraph (a), it is seen that the royalties in question accrue in the United States because the payer of the royalties is resident there and do not arise in India because the payer has no permanent establishment or fixed base in India. In other words, under sub-paragraph (a), the royalties do not arise in India, i.e., one of the Contracting States. Again the royalties relate to the use of or the right to use, the trade mark in one of the Contracting States (namely, in India). Both the conditions mentioned in sub-paragraph (b) are, therefore, fulfilled and the royalties must be taken or deemed to arise in India by virtue of sub-paragraph (b) even though they may arise in the United States on the criteria of sub-paragraph (a).
16. It is not easy to decide which one of these interpretations is correct. However, after considerable thought, the authority has come to the conclusion that the second of the above interpretations should be preferred for a number of reasons :
(i) The first of the above interpretations leads to the result that sub-paragraph (b) will be attracted only where the payer of the royalties is neither resident nor has a permanent establishment in any of the two Contracting States. This is a somewhat unusual situation for a DTAA which contemplates relief in respect of a person who is a resident in one of the Contracting States and outlines a method of determining accrual of profits on the basis of a permanent establishment or fixed base being in one of the two States.
(ii) The above interpretation will also mean that the country with which the payer has a nexus will alone determine the suits of accrual of the royalty irrespective of the State in which it actually accrues or arises by reason of the use of, or right to use, the property in question. This does not seem to be correct.
(iii) That the first interpretation may lead to anomalies may be highlighted by an example. If, in the present case, “C” had been the owner of the trade mark and had entered into an arrangement of the present type with “A”, under which “A” is to pay royalty to “C” for using the trade mark in India, the provisions of sub-paragraph (a) will not apply, since the person who pays the royalties is neither a resident nor has a permanent establishment or a fixed base in that country or in India. Sub-paragraph (b) will, therefore, be attracted and the royalties will attract Indian income-tax. If sub-paragraph (b) could apply to such a case, there is no logical reason why the position should be different in the present case. If, in the former case, the locus of the use of or the right to use the trade mark is relevant for determining the situs of accrual, it is difficult to see why it should not be equally relevant in the latter case. It is necessary that the first interpretation which gives rise to such an anomaly should be avoided.
(iv) The second interpretation is in line with the language of Section 9(1)(vi) of the Income-tax Act. The concept of deemed accrual or arisal of royalties under Section 9 is that it is related to the residence of the person paying the royalties or, irrespective of such residence, the place where the right to use the property in question is exercised. As far as possible, Double Tax Avoidance Agreements should be interpreted consistently with the statutory provisions prevalent in the country unless the contrary can be clearly read into the provisions of the agreement as the parties must have had them in mind when drafting the DTAA. Where the terms of the agreement are absolutely clear, no doubt, they will prevail and even if there is a contrary provision in the statute the assessee can opt for the beneficial provision in the agreement. But where there is an ambiguity as in the present case in the provisions of the treaty and the terms of the treaty are susceptible to both interpretations, the interpretation which is harmonious with the provisions of the statute should be adopted.
17. For the reasons abovestated, in the opinion of the authority, the two sub-paragraphs of Article 12(7) are not mutually exclusive. Sub-paragraph (b) says that where under sub-paragraph (a) the royalties do not arise in one of the Contracting States (i.e., India), they can be deemed under sub-paragraph (b) to arise in India because that is the State where the right giving rise to the royalties is used or exercised. In other words, the combined effect of sub-paragraphs (a) and (b) is to deem royalty to arise in a State-
(a) if the person paying the royalty is a resident of that State ; or
(b) if the person paying the royalty has a permanent establishment or a fixed base there in connection with which the liability to pay royalty is incurred and the liability is borne by such establishment or base ; or
(c) if the royalty relates to the use of, or the right to use, the property which gives rise to the royalty in that State. In this case, the third of these requirements is fulfilled vis-a-vis India and hence the royalties in question arise only in India even on the terms of the DTAA.
18. For the reasons discussed above, the authority is of the opinion that the answer to the question raised should be in the affirmative. In this view of the matter, it is unnecessary to discuss whether, in case the authority had come to the conclusion that the royalty is not liable to tax, it should have rejected this application in limine under Clause (c) of Section 245R(2) of the Act on the ground that the question raised by it relates to a transaction which shifts the liability to pay royalty from “IC” to “B” in an effort to shift the locus of its accrual to the USA so as to avoid the impact of Indian tax and which, therefore, should be treated as a transaction designed for the purpose of avoidance of Indian income-tax. It is also unnecessary to touch upon the point made by the Departmental representative that the transaction by which “CM” of Mauritius became the shareholder of “IC” in place of “C” is also a transaction intended to avail of the reduced rate of tax on dividends received from an Indian company by a foreign company under the DTAA with Mauritius in contrast to the higher rate at which it would have been levied on “C” as a US company and is thus a transaction designed to avoid the incidence of Indian income-tax in this manner as well, as the question raised in the application does not relate to this transaction.
19. For the reasons discussed above, the authority pronounces the following :
ruling
Question
Answer
Whether the royalty paid outside India
amounting to US$ 5,295,756 by ‘C’ to ‘B’ as a
consideration for granting the licence and right to “1C”, a company in which ‘CM’ has 51 per cent, equity holding, to use the trade mark in India is liable to Indian tax ?”
Yes
