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2009 (10) TMI 40

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..... ustice P.V. Reddi (Chairman)and Mr. J. Khosla (Member) Present for the Applicant : Shri G. N. Gupta, Advocate Present for the Department : Shri Mayank Priyadarshi, Addl. DIT (Intl. Taxation), Range-3, Mumbai RULING (By Hon'ble Chairman) - The applicant is a company incorporated in USA having its registered office at San Antonio, USA. The applicant is, inter alia, engaged in the business of supplying advance technology for the manufacture of radial tyres. Being approached by an Indian Company, namely, CEAT Limited, the applicant agreed to grant to the said company a perpetual irrevocable right to use the know-how as well as to transfer the ownership in tread and side-wall designs and patterns required for the manufacture of radial tyres for a lump sum consideration of US $ 7,10,220. The applicant states that the sale and transfer of technology know-how took place in USA and the documents were executed in USA. Technology transfer Agreement was executed on 4th September, 2008 between the applicant and CEAT Limited. The applicant further states that the know-how would be transferred by the applicant to CEAT Limited in the shape of technical documentation and designs .....

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..... its factory being set up at Halol, Gujarat State. It is submitted that the technical document is a chattel or a plant which can be transferred and the sale transaction having taken place in America, the income accrues or arises in America but not in India. Certain decisions have been relied upon to contend that the consideration attributable to the offshore supplies cannot be subjected to Indian income-tax. It is also submitted that income is not in the nature of royalty or fees for technical/included services. In the absence of PE of the applicant in India, the income arising from the transfer of technology cannot be taxed as business profits in view of the provisions of Convention between the Government of United States of America and the Government of Republic of India for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to taxes on income (hereafter referred to as 'Treaty') between India and USA. Technical assistance rendered or training imparted is not liable to be taxed by reason of Article 12(5)(a) of the Treaty. 4. The Revenue has taken the stand that the income received by the applicant is covered under para 3(a) and 4(b) of Article 1 .....

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..... pair of the Machines in the Plant, and for the Commissioning , Start-up, operation and maintenance of the Plant; (d) for the operation of the Process to manufacture the Products in the Plant as identified in this Agreement; (e) for the performance of the Supervision and Training Services; and (f) for design development of the Products covered in Annexure IA and Products falling in the same category." "Know-how Documentation " means the documentation with illustrations containing the Know-how and the Basic Engineering know-how which will be supplied by the transferor as detailed in Annexures IIA, IIB and IIC and any other documentation which may be required for the use of transferee. "Plant" means the manufacturing plant including its test room, laboratories and R D facility to be constructed in Halol, Gujarat by the assembly of 'machines' (all the mechanical and electrical equipment and apparatus required for the manufacture and testing of products) in accordance with the Know-how for the manufacture of products by using the manufacturing process described in Annexure IC. 5.3 Clause 2 speaks of "TRANSFER OF KNOW-HOW AND RIGHT TO USE". It says : "in consideration for .....

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..... ort the tread region, protect the bead/carcass plies from damage, and provide the tyre's ride characteristics …………." 5.5 The consideration for technology transfer and terms of payment is provided for in Cl.4. In consideration for the transfer of Know-how and the grant of right to use the same as well as for the transfer of ownership in TSD, the transferor shall be entitled to receive a lump sum amount of US $ 710, 220 in accordance with the terms of payment set out in Annexure-IX. The said lump sum amount is referred to as consideration for 'Technology transfer'. 5.6 Delivery of know-how documentation is dealt with in cl.5. The time frame for and the mode of delivery, the effect of delay in delivery are all stipulated therein. It is stated in cl.5.3 that the transferee shall be entitled to and have a right to the know-how documentation immediately on receipt of the same. 5.7 Consultancy and assistance and fee in respect of such services are provided for by Clauses 7 and 8 of the Agreement. The method of calculation of fee for consultancy services based on man-day rates and actual number of days worked is given in Cl.8.1. The time and manner of payment is specified in .....

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..... n Annexures V VI. Annexure IX deals with terms of payment of consideration for technology transfer, the lump sum consideration being USD 710,220. The stages and time schedule for payment are specified in a Chart. The total consideration of USD 710,220 has been split up into two. The first one is consideration for technical documentation such as raw materials specifications, test procedures, standard operating procedures, etc. and it is USD 343,425. The balance amount of USD 366,795 represents consideration for TSD and product development. The break-up is given in a tabular form. 6.1 It is clarified by the learned counsel for the applicant that the know-how documentation except in regard to the TSD can only be used by the transferee (CEAT) in the plant that is being set up and to be set up in future and the same cannot be sold. 7. The Agreement although composite in nature is divisible into three distinct parts, as noticed already. The transfer of know-how i.e. the grant of right to use the know-how is the first part which is dealt with in clause 2 of the Agreement. The second part consists of the transfer of ownership of Tread and Sidewall design/patterns (TSD) which is .....

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..... ces' comes into play in such a situation. In raising the contention that there was sale/transfer outside India, and therefore, the receipts are not liable to be taxed under the provision of the Act, the applicant is evidently inspired by the decisions of the Supreme Court and High Courts rendered in the context of the provisions that were on the Statute book prior to the Finance Act, 1976. By the 1976 amendment to the Act, clauses (vi) and (vii), dealing with 'royalty' and 'fees for technical services', were inserted into Section 9. 9. The argument of the applicant, as noticed earlier, is based on the premise firstly that there was a sale of 'technical documentation' and secondly that the sale took place and concluded outside India. The first premise has to be tested by looking at the essence of transaction. To say that the transaction is nothing more than a sale of technical documents containing the know-how is to oversimplify the issue and to ignore the plain realities. The Agreement speaks of transfer and acquisition of non-exclusive, irrevocable and perpetual right to use the 'know-how' as defined in clause 1.1.16 coupled with an undertaking that the applicant will not gra .....

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..... the outdoor tests of selected products as per the agreed criteria referred in Annex IIIA". Viewed from any angle, it is inappropriate to say that the consideration payable under cl.4 of the Agreement is only the price of technical documents allegedly sold in USA. 9.2 It must be remembered that the deeming provisions embodied in clauses (vi) (vii) of section 9 of IT Act were introduced with a view to reach at the income arising to the non-resident by reason of making available to an Indian enterprise the technical know-how, knowledge and informations. With a similar object in view, Art. 12 has been included in the Treaty. If in all cases of transfer of know-how documents from the State of residence of transferor, the taxing jurisdiction of the other State is to be ousted, there may hardly be any occasion to apply the royalty or FTS provisions. Those provisions would virtually become ineffective if not otiose. 9.3 Secondly, even the assumption or assertion of the applicant that the so-called transaction took place outside India is open to doubt. The Agreement dated 4.9.2008, it may be noted, was executed in India (in Mumbai). In this connection, Clauses 5.1., 5.2. and 5.3 .....

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..... saction having been completed on the high seas, the profits on sale did not arise in India" (vide p.444). But, the fact situation is different in the present case. The contract involving transfer of technology and know-how cannot be equated to the transaction considered by the Supreme Court. 9.5 Reliance has been placed by the applicant on the decision of the Supreme Court in Scientific Engineering House Pvt. Ltd. vs. CIT, Andhra Pradesh 157 ITR 86 in support of the contention that the technical documentation and designs constitute 'plant' and that the plant having been sold in USA, the income is not taxable in India. We do not find any relevance of that decision to the point in issue here. The Supreme Court held in Scientific Engineering case that 'the capital asset acquired by the assessee, namely, the technical know-how in the shape of drawings, designs, charts, plans, processing data and other literature falls within the definition of 'plant' and is, therefore, a depreciable asset and therefore the payment made by the assessee to the foreign collaborator who rendered the documentation service was attributable wholly towards the acquisition of a depreciable asset and de .....

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..... cientific work including films or video tapes for use in connection with television or tapes for use in connection with radio broadcasting, but not including consideration for the sale, distribution of exhibition of cinematographic films; or (vi) the rendering of any services in connection with the activities referred to in sub-clauses (i) to (iv), (iva) and (v). 11. In order to find the answer to the question whether the royalty provisions in the Act and the Treaty are attracted, we have to consider the substance and essence of the transaction. As noticed earlier, the nature and content of the right transferred is the right to use the technology or the technical know-how supplied by the applicant for setting up the plant for the manufacture of radial tyres and to adopt the know-how in relation to the products that may be developed or manufactured in future in any manufacturing unit of the transferee-CEAT. Not only that, the applicant will provide to CEAT technical service assistance and train CEAT's personnel for making use of the know-how supplied by it on proper lines. Otherwise, the know-how and underlying technology will only remain on paper. In fact, it has been expres .....

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..... e of royalty. The technical know-how embodied in various documents is received by the applicant in India from time to time and is put to use in India with the assistance and advice offered by the technical personnel of the applicant deputed to India. The role played by the applicant is perceivable at every stage till the plant is set up and the goods are manufactured. No doubt can possibly arise from the stand point of territorial nexus. 11.2 Apart from clause (vi) of Section 9(1), the services contemplated in clause 7 of the Agreement would also fall within the ambit of clause (vii) of Section 9(1) of the Act as they are in the nature of technical or consultancy services. 12. We shall now turn our attention to Art.12 of the Treaty which deals with 'royalties' as well as 'included services'. The opening para of Article 12 lays down the first rule that royalty and fees for included services arising in a contracting State (India in the present case) and paid to a resident of the other contracting State (the applicant in the present case) may be taxed in that other State (i.e. USA which is the State of residence of the recipient of royalty). However, the next para preserves the p .....

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..... for technical services'). 12.3 Though there is substantial similarity between Art.12 and Section 9(1)(vi) of the Act, the definition of 'royalties' under the Treaty is more restrictive in scope than the definition contained in Explanation 2 to S.9(1)(vi). In contrast with the wider expression used in Explanation 2 to S.9(1)(vi), it is seen that para 3(a) of the Treaty uses the expression "consideration for the use of or the right to use". The use or right to use is related to the various items enumerated in clause (a) of para 3. The design, plan and secret formula or process is among the enumerated items. Moreover, the information concerning industrial, commercial or scientific experience is another item mentioned in para 3(a) of Art.12. Thus the know-how transfer contemplated by clause (2) of the Agreement squarely falls within the definition of 'royalties' in para 3(a). The learned counsel has not been able to point out how para 3(a) of Art.12 is not attracted. His emphasis was more on para 5 which has bearing on the consultancy and assistance services. We have no doubt that the consideration which the applicant receives for the right to use the know-how as per clause 2.1 r .....

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..... eme Court in a short order and it is reported in 224 ITR 724. The Supreme Court observed, thus: "The agreement is in two parts. It is true that the two parts are interdependent but yet the consideration for the sale of trade secrets and consideration of technical assistance is separately provided for and mentioned under separate sections. So far as the consideration for the technical assistance is concerned, its taxability is not in doubt. The only controversy is with respect to the taxability of 1,65,000 US dollars which is stipulated as the consideration for sale of trade secrets. The agreement specifically says that the said sale is effected in Japan. We are unable to see on what basis it can be said that any part of the said amount has been earned in India." 13.1 Another case cited by the counsel for the applicant is the decision of the Supreme Court in Corborandum Co. vs. CIT 108 ITR 335. That was also a case in which the foreign company entered into an agreement with Indian company for rendering technical and know-how services in the form of furnishing technical information and know-how with reference to manufacturing of certain products, providing factory and des .....

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..... ter of the sole agreement was not in India, the receipts were not chargeable to tax under Section 5(2) or section 9(1)(i) of the Income-tax Act, 1961. The question whether the transaction in the instant case amounts to transfer of capital assets situated outside India has not been raised in the present case. Whether or not the payment received by the applicant amounted to 'royalty' was not decided in that case. The scope and essential features of the contract in the present case are vastly different. Hence, the Pfizer ruling does not help the applicant. 14. In the light of the foregoing discussion, we reach the conclusion that the sum of USD 343,425 representing consideration for the transfer of know-how and the grant of right to use the know-how can be subjected to tax in India under the Income-tax Act, 1961, treating the same as deemed income by way of royalty. 15. The balance consideration of 366,795 USD is for transfer of ownership of Tread and Sidewall design/patterns, designed by the transferor and approved by the transferee. It should be noted that a part of that consideration is charged for supplying technology for full tyre development. The details are found in A .....

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..... product development specified in Columns (C) and (D) of Sr.No. 2 of Annexure-9, totaling 148,390 USD stands on the same footing as transfer of know-how and is liable to be taxed under the Income-tax Act. 16. The third question is whether the fee for consultancy and assistance payable to the applicant under the Agreement is liable to be taxed in India. 16.1 Consultancy and assistance and the fee in respect of such services are provided for by Clauses 7 and 8 of the Agreement. Under Cl.7.1, the transferor agrees to provide to the transferee during the term of the Agreement, the technical assistance as set out in Annexure-V "only in relation to the transfer of Know-how so as to enable the transferee to use the Know-how and manufacture the product in the plant in accordance with the terms of the Agreement." It is specifically stated that the transferor acknowledges that the transferee will not be able to use the know-how unless the transferor trains the transferee's personnel in the plant "in order to be capable of designing, developing and manufacturing the products in accordance with the Know-how". 'Consultancy Services' include the supervision service and training service .....

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..... of the right, property or information for which the payment described in paragraph 3 is received; and (b) make available technical knowledge, experience, skill, know-how, or processes, or consist of the development and transfer of a technical plan or technical design. 16.3 Whether or not the first limb applies, undoubtedly, the second limb is attracted in the instant case. The consultancy, assistance and training services make available to CEAT the technical knowledge, experience, Know-how and processes so that the transferee-CEAT will be able to derive full advantage from the Know-how supplied by the applicant and to equip itself with the requisite knowledge and expertise so that the transferee will be able to utilize the same even in the future ventures on its own and without reference to the transferor. The importance of consultancy and assistance services is highlighted by an express declaration in the Agreement which we may, at the risk of repetition, notice at this stage. The "transferor acknowledges that the transferee will not be able to use the Know-how unless the transferor trains the transferee's personnel in the plant in order to be capable of designing, developin .....

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..... dum of Understanding concerning fees for services (Art.12) appended to US-India Tax Treaty, while referring to the expression "ancillary and subsidiary" occurring in paragraph 4(a) of Art.12, it has been clarified that "the clearly dominant purpose of the arrangement under which the payment of the service fee and such other payments are made must be the application or enjoyment of the right, property or information described in paragraph 3". One of the relevant factors that could be taken into account for this purpose is "whether the amount paid for the services (at arm's length) is an insubstantial portion of the combined payments for the services and the right, property or information described in paragraph 3". "The extent to which such services are customarily provided in the ordinary course of business arrangements involving royalties described in paragraph 3" is another relevant factor. For the purpose of explaining paragraph 5 of Art.12, certain examples are given after the following prefatory remarks: "Paragraph 5 of Article 12 describes several categories of services which are not intended to be treated as included services even if they satisfy the tests of paragraph 4. .....

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..... e, the ingredient of inextricable link will also be missing, if the applicant's contention is to be accepted. If what had happened in the present case is mere sale of technical documentation as contended by the applicant, then, it cannot be said that there is an inextricable link between such sale and the magnitude of post-sale services to be rendered as per clause (7) and (8) of the Agreement. They are no doubt the services allied or consequential to the alleged sale but they cannot be characterized as 'inextricable' or 'inseparable' from sale. In the case of ITO vs. Shri Ram Bearings (supra), as seen from the judgement of Calcutta High Court, the rendering of technical assistance and training was considered to be independent of the sale of trade secrets though the Agreement was a composite one. 17.4 Thus, for more than one reason, we hold that para 5 of Art. 12 of the Treaty cannot be invoked by the applicant. In the view we have taken, it is not necessary to consider whether the payments received by the applicant towards consultancy and assistance and training could be taxed as business profits under Art.7 even if they are not fees for included services. In fact, such alter .....

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