TMI Blog2015 (2) TMI 458X X X X Extracts X X X X X X X X Extracts X X X X ..... mination thereof, until the same entered public domain or was otherwise generally known. HCL could not have breached the said confidentiality clause. A material breach by HCL would have resulted in an earlier termination of the agreement and reversion of all rights granted to HCL. It entailed ceasure of right to manufacture, use or sell the licensed products. Tangible technical information was to be returned. The agreement permitted HCL to disclose the said confidential intellectual property rights to the sub-contractors or sub-licensees only to the extent required for proper and authorised use of technology.Clause 2.3 was similarly worded and stated that HCL might sub-licence or sub-contract in whole or in part production of the licensed products and might disclose the technology provided that such disclosure would not confer upon the sub-contractor or the sub-licencee any rights other than those accorded to HCL. As noticed above, lump-sum payments are covered under the term ‘royalty’. The agreement postulated grant of permission to use or right to use intellectual property rights or knowhow and it is not a case of outright sale. Mode and manner is not determinative, but nature ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... we have referred to HCL Infosystems Limited as HCL and Apollo Domain Computers, GmbH Germany as ADC in this judgment. 4. Succinctly put, the issue raised in the present appeals is whether payments of ₹ 1,11,38,650/- and ₹ 50,51,050 made by HCL to ADC in terms of the inter se agreement dated 11th May, 1987 was royalty under Article VIIIA of the Double Taxation Avoidance Agreement (DTAA, for short) between India and the then Federal Republic of Germany. The aforesaid DTAA was notified on 13th September, 1960. Article VIIIA was inserted subsequently after protocol was signed on 28th June, 1984 and ratified on 10th July, 1985. As the said article arises for consideration, we deem it appropriate to reproduce the entire Article:- ARTICLE VIIIA (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 insofar as the fees for technical services are concerned, the tax so c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eeds for whatever reason 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 that case the excess part of the payments shall remain taxable according to the law of each Contracting State, due regard being had to the other provisions of this Agreement. 5. In order to appreciate the ambit and scope of term royalty and what would be taxable under Article VIIIA of DTAA, there was exchange of notes between the contracting States on 28th June, 1984 and the relevant portion reads:- 3. Notwithstanding the provisions of paragraph (3) of Article III of the Agreement, no deduction shall be allowed in respect of amounts paid or charged (otherwise than towards reimbursement of actual expenses) by the permanent establishment to the head office of the enterprise or any of its other offices, by way of- (a) royalties, fees or similar payments in return for the use of patents or other similar rights; (b) commission for specific services performed or for management; and (c) interest on moneys lent to the permanent establishment, except in the cas ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ere payments arose and knowhow was utilized, in accordance with the laws in India but the tax so charged cannot exceed 20% of the gross amount of such fee. To this extent also, the parties are ad idem and there is no dispute. The dispute is whether the payments made under the agreement dated 11th May, 1987 are royalty within the meaning of clause (3) of Article VIIIA of the DTAA. The term royalty has been defined in the said clause to mean payments of any kind received as a consideration for use of, or right to use any copyright of literary, artistic or scientific work including cinematographic films or films or tapes used for radio or television broadcasting, any patent, trade mark ,design or model, plan, secret formula or process, or for use of, or the right to use, industrial, commercial or scientific equipment or for information concerning industrial, commercial or scientific experience. The said Article is in consonance with the UN Model Tax Treaties rather than OECD Model. The use of the words right to use industrial, commercial or scientific equipment expands the ambit and scope of the term royalty in Article VIIIA. The term royalties in 1963 draft convention and t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f property referred to in the definition, the payment is not in consideration for the use of, or the right to use that property and cannot therefore represent a royalty. As noted in paragraphs 15 and 16 below as regards software, difficulties can arise in the case of a transfer of rights that could be considered to form part of an element of property referred to in the definition where these rights are transferred in a way that is presented as an alienation. For example, this could involve the exclusive granting of all rights to an intellectual property for a limited period or all rights to the property in a limited geographical area in a transaction structured as a sale. Each case will depend on its particular facts and will need to be examined in the light of the national intellectual property law applicable to the relevant type of property and the national law rules as regards what constitutes an alienation but in general, if the payment is in consideration for the alienation of rights that constitute distinct and specific property (which is more likely in the case of geographically-limited than time limited rights), such payments are likely to be business profits within Artic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nterprise and from the disclosure of which an economic benefit can be derived. Since the definition relates to information concerning previous experience, the Article does not apply to payments for new information obtained as a result of performing services at the request of the payer. 11.1 In the know-how contract, one of the parties agrees to impart to the other, so that he can use them for his own account, his special knowledge and experience which remain unrevealed to the public. It is recognised that the grantor is not required to play any part himself in the application of the formulas granted to the licensee and that he does not guarantee the result thereof. 9. A reading of the aforesaid quotations would exposit that the taxable event would depend upon the nature of rights acquired by the payer under a particular arrangement. In case payment is made for acquisition of a partial right in the intangible property or know-how without the transferor fully alienating as the ownership rights, the payment received would be treated as royalty . Where, however, full ownership rights are alienated as intellectual property of the transferee, the payment made is not roy ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oyalty in somewhat different manner as it was based on the OECD Model, but this to our mind would not be entirely relevant and the distinguishing factor. The Delhi High Court rejected the appeal of the Revenue in the said case after referring to the various clauses of the agreement to hold that there was absolute or full transfer of technology and know-how, albeit on non-exclusive basis, which was confined to the factories of the assessee in India and with conditional right to sub-lease, as sub-licensing of technology or know-how required consent of the UK party. The exact reasoning given by the High Court in the said case reads:- 8.1 In our view, it is quite clear by virtue of the aforementioned agreement what the assessee obtained was a complete transfer of technology and know-how albeit on a non exclusive basis which was confined to its factories in India with a conditional right to sub-licence it to third parties. The sub-licencing of technology and/or know-how had to have, however, the consent of Tate and also the approval of the Government of India. The obligation of Tate to update the technology and/or know-how transferred to assessee based on research and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ty only on the grounds of insolvency of the parties. There is no general right of termination obtaining in the agreement in the present case. Likewise, the judgment in the case of N.V. Philips Vs. CIT (1988) 172 ITR 521 is not applicable since what was transferred was use of technology. In this regard, specific reference may be made to clause (c) appearing at page 524 which provided that any information disclosed by the assessee to the Indian company under the agreement would remain confidential and would not become the property of the Indian company until such time and to the extent that such information had become public by application and user. The judgment of the Supreme Court in the case of Alembic Chemical Works Co. Ltd. (supra) would also not be applicable on a similar rationale. The decisions noted, were cases in which there was no absolute or full transfer of intellectual property rights or know-how, but only grant of right to use or permission to use intellectual property rights or know-how. 13. Having elucidated on the legal position, we would now proceed to examine the agreement between HCL and ADC styled as Technology Transfer and Technical As ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... developments, improvements, modifications, or inventions concerning the Licensed Products made by APOLLO during the term of the agreement may become part of the Technology and may be disclosed and conveyed by APOLLO to the HCL at no additional...........in accordance with the terms and conditions of the Agreement promptly after APOLLO s use of same in its commercial manufacture of the Licensed Products. 2.5 It is understood and agreed that neither party shall be required to convey or disclose to the other party any developments, improvements, modifications, or inventions unless same are directly related to the Licensed Products, in the manner described in this Article 2. Discontinuance of Manufacture 2.6 The parties hereby agree that APOLLO shall have the absolute right, in its sole discretion, to discontinue the manufacture, use, sell, or otherwise do business with respect to any of the Licensed Products, at any time during the term of this Agreement and in such eventuality APOLLO shall have the discretion to eliminate said Licensed Product, from the Agreement upon such elimination from prior written notice of same to HCL. Upon such elimination herefro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fficient delivery of Technology under the Agreement. 3.1.2 It is hereby expressly agreed that the Technical Transfer for the consideration set forth in article 6.2.1 is for a total of three future versions of the Licensed Products to be developed for manufacture or marketing by APOLLO in addition to the DN 3000 series as set forth in Exhibit 2. Said Licensed Products to be Products within the product space of the first Licensed Product (to wit: DN 3000). A version is a family of engineering workstations or any significant enhancement or upgrade to said family and shall not be understood to be in any way linked to a specific product model number as used by APOLLO. For example, all products set forth in Exhibit 2 known as DN 3000 series, will constitute one version. It is further agreed that the further three versions covered under this agreement will be agreed and defined, from time to time by HCL and APOLLO and will be subject to the approval of the appropriate US Government agencies. ARTICLE 4. CONFIDENTIALITY. 4. 1 It is understood and agreed by the parties that the Technology and any other information which APOLLO consider proprietary to its ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... its business. ARTICLE 5. INDUSTRIAL PROPERTY RIGHTS, WARRANTIES AND QUALITY CONTROL. 5.1 HCL shall not at any time or in any manner question, content or dispute the right, title, interest of APOLLO, and its Licensors in and to, or the validity of, any of the patents, patent applications, un-patented inventions, or other industrial property rights including but not limited to any registered or unregistered trade mark or trade names and copyright of APOLLO and its Licensor covering the Licensed Products and constituting the Technology, and shall not aid or encourage others to do so. 5.2 APOLLO hereby declares that, to the best of its knowledge the rights, of any third parties will not be infringed by the parties performance of this Agreement and by HCL's use of the Technology, to manufacture, use, sale and maintenance of the Licensed Products by HCL under this Agreement. APOLLO makes no representation or warranty, implied or otherwise, as to whether the Technology conveyed hereunder to HCL and embodied in the Licensed Products, the methods of manufacture the licensed products, the methods of or the maintenance and sale of the Licensed Products ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ducts. Any patents which may be granted to APOLLO and/or its Licensors in India with respect to the Licensed Products during the term of this Agreement shall be considered part of the Technology and shall be promptly conveyed to the HCL in accordance with the terms and conditions of this Agreement. 5.7 Any patents principally which may be granted to the HCL outside India with respect to the Licensed Products during the term of this Agreement shall be licensed to APOLLO and/or its Licensors outside India on an exclusive basis (other than for HCL themselves) and at no charge to APOLLO, except for the royalty which must be paid by a licensee to the inventor of patent as a matter of Indian law. Quality Control 5.8 APOLLO represents that the Technology to be conveyed to HCL hereunder shall be the same Technology on the basis of which APOLLO itself manufactures the Licensed Products and that the Technology, together with the Technical Assistance to be furnished to the HCL hereunder, 'shall by sufficient for the manufacture of the Licensed Products. Therefore, HCL utilising the Technology and the Technical Assistance, should, be able to manufacture the Licensed Pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... enever any of the following events occur: (a) the terms and conditions of this Agreement are materially breached by either party and said material breach is not cured within ninety (90) days from the receipt by the breaching party of written notice of such breach from the non-breaching party; or (b) In the event that either party be adjudged insolvent or bankrupt, or upon the institution of any proceedings by or against it seeking relief, reorganization or arrangement under any laws relating to insolvency, or upon any assignment for the benefit of creditors, or upon the appointment of a Receiver, Liquidator or Trustee of any of its' property or assets, or upon the liquidation, dissolution or winding up forthwith be terminated or cancelled by the other party hereto. 14.3 The early termination of this Agreement for any reason shall not affect any accrued rights or obligations of the parties as of the effective date of such termination, nor shall it affect any rights or obligations of the parties under this Agreement which are intended by the parties and agreed herein by them to survive any such termination, especially the secrecy provisions of Article 4 hereof, nor shall ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... In the impugned order, clause 2.1 has been quoted as if an exclusive right was granted to the HCL, an assertion which is also made in the grounds of appeals. Albeit, it was accepted during the course of arguments that HCL was granted non-exclusive right by ADC and not an exclusive right. ADC had agreed to convey such technical data and know-how and grant to HCL non-exclusive right to manufacture, sell etc. the licenced products in India only pursuant to and for applying the technology. Clause 2.3 is important and stipulated that HCL could sub-licence or sub-contract in India in whole or in part production facilities of the licensed products under the technology and could disclose the said technology to the sub-licensee or sub-contractor, provided that such disclosure would not confer on the sub-licensee or the sub-contractors any right other than those granted to HCL and shall be subjected to restrictions and confidentiality provisions of Article 4. Clause 2.4 stipulated that subject to necessary approvals, ADC would also convey to HCL improvements, modification or inventions relating to the licensed products during the term of the agreement, which shall become a part of the techn ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ded and not disclosed to an unauthorised person during and even after the expiration or termination of the agreement. 18. Article 5 stated that the HCL would not at any time or in any manner question, contest or dispute ADC s patent, patent application, unpatented inventions or industrial property rights and would not encourage or aid others to do so. In the event a third party filed a suit or threatened to file a suit for infringement of industrial property, HCL was required to inform ADC and make all relevant information, evidence, etc. available to ADC. ADC was obliged to make available to HCL all information, evidence and particulars in their possession to them to defend or deal with said suit or threatened suit. The said stipulations were regarding defending a suit or threatened suit. It further stipulated that the HCL could be granted right in India to enforce, enjoin or recover damages on behalf of the ADC for infringement of any registered patent, non-registered trademark etc. regarding licensed products conveyed to HCL. HCL was advised to submit to ADC, copy of patent application or renewal in respect of the licensed products, which was filed or acquired by HCL in India ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t was 5 years commencing from effective date and in case the agreement was not terminated earlier, HCL could after the termination continue to manufacture, use or sell the licenced products under the rights granted therein, without obligation to pay additional consideration to ADC provided HCL did not make any claim against them in respect of the licensed products. The agreement could be terminated as on the stipulations stated in clause 14.2. 23. Clause/Article 14.3 of the agreement in clear terms records that earlier termination would not affect accrued rights and obligations effective on the date of termination nor shall it affect the obligations or rights of the parties under the agreement. Specific reference is made to the secrecy and confidential provision contained in clause/article 4. Thus, irrespective of earlier termination, the confidential or secrecy provision would continue to apply. In categorical terms, it is specified that claim for damages or remedy would not be barred or affected because of earlier termination against either party. In clause/article 14.4, HCL agreed that upon earlier termination of this agreement attributable to material breach on the part of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sub-contractors and sub-licencees intellectual property rights. Clause 2.3 specifically refers to the confidentiality clause in article 4 and the binding effect. The clause relating to further technology or information in addition to technology already transferred is illustrative that it was not a case of complete or full transfer, but only a case of right to use or permission to use the technology by HCL. Thus, the provision for upgradation. The stipulation also reflects acceptance and recognition that the technology in the said field was transient and transitory and not lasting. Developments and improvements were rapid, widespread and vigorous. Constant upgradation and improvements were eminent and rule of business. 25. Dias in his work Jurisprudence has defined ownership as an interest recognize by law, which consists of innumerable number of claims, privileges, powers and immunities with regard to the thing owned. Ownership, therefore, is a bundle of rights, which a person who has title over the property, enjoys and commands. Holland, T.E. in Element of Jurisprudence observed that rights of ownership, conventionally could be arranged under three heads i.e. possession, en ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or it can be assigned/transferred, mortgaged or licensed. Transfer of intellectual property rights by way of sale or assignment when complete or absolute, results in exclusive rights being conferred on the transferee or the assignee, who becomes the new owner and is entitled to exercise all rights as an owner. The owner, however, need not transfer complete ownership and can grant a license or permission to use to a third party, one or more acts. The license granted amounts to permission to use, the intellectual property rights. The rights conferred on the licensee may vary. The right to use may be in respect of a single act, restricted to a location or for a limited period of time or duration. It may be a one-time act or there can be stipulations as to upgradation or right to access future technological advances. One of the important attributes of intellectual property rights in cases of technology, patent etc. is confidentiality. It is confidentiality, which gives the owner the commercial edge, competitive position and superiority. Confidentiality enforces monopoly. Confidentiality and monopoly are the most valuable rights which the owner possesses and commercially exploits. Licen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... A distinction must be made between letting the licensed asset for use on the one hand and transferring its substance by alienation (regarding the deviation of US MC, see infra m. no. 63). The decisive difference in this connection is the degree of change in the attribution of the asset from licensor to licensee. On the other hand, another distinction to be made is letting the proprietory right, experience, etc., on the one hand and use of it by the licensor himself, e.g., within the framework of an advisory activity. Within the range from services , via letting to alienation , outright alienation is the one clear-cut extreme, viz. outright transfer of the asset involved (right, etc.) to the payer of the royalty. The other, just as clear-cut extreme is the exercise by the payee of activities in the service of the payer, activities for which the payee uses his own proprietary rights, know-how, etc., while not letting or transferring them to the payer (for more details regarding the distinction between licensing and the provision of services, see infra m.nos. 54ff., in connection with the various subjects of licences). Neither extreme comes under Art. 12, all th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... his is really a permission granted to use the secret process exclusively in a particular manner and it is meant only for the Indian company and not to be disclosed to any third parties. Therefore, it is clear that the non-resident assessee itself treated the method of manufacturing process carried on by it as its exclusive secret process over which it had exclusive domain and wanted the same to be kept a secret and not meant for the public and granted the company right to utilise the same only in the aforesaid restricted manner. This secret knowledge in this case is as much its capital asset as is a patent, a monopoly and a capital asset of the patentee as observed by Romer L.J. in the case of Handley Page [1935] 19 TC 328. This secret process which the non-resident assessee-company is parting with in this case is analogous to the parting of a monopoly right of the patentee and, therefore, the remuneration received by the assessee for the same should be treated as royalty and for the reasons as aforesaid, the answer to the question referred should be in the affirmative and in favour of the Revenue. 32. In Shriram Pistons and Rings Limited versus Commissioner of Income Tax, (200 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... under the term royalty . The agreement postulated grant of permission to use or right to use intellectual property rights or knowhow and it is not a case of outright sale. Mode and manner is not determinative, but nature and character of the right acquired is definitive and decisive criteria. 34. The period of five years cannot be read in isolation and would necessarily have reference to the commercial life of the intellectual property rights for which permission or right was granted. Repeatedly it has been held that intellectual property rights in scientific processes, technology etc. have limited time scale benefit and have invariably a short life span, due to rapid progress and advancement in such fields. In Alembic Chemicals Works Co. Ltd. vs. CIT (1989) 177 ITR 377 (SC) with reference to rapid advances and research in micro biology, it was observed that it would not be correct to attribute a degree of durability and permanence to technical knowhow in medical sciences. The same principle would be equally applicable, as it has not been shown or indicated that the right to use technology had an enduring or long term commercial benefit. The clause relating to upgradation, elim ..... X X X X Extracts X X X X X X X X Extracts X X X X
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