TMI Blog2008 (11) TMI 74X X X X Extracts X X X X X X X X Extracts X X X X ..... and Siemens India Ltd. (Siemens). 2. The first Agreement between the assessee-Respondent and BHEL was entered into on 21 st July, 1974, the Second was dated 28 th July,1975, and the third Agreement was entered into earlier on 28 th October, 1975. Similarly assessee entered into Agreements with BEL on 15th March, 1967, 23rd February, 1973 and dated 17th July, 1975. The assessee had also entered into agreements with Siemens dated 22nd February, 1973 and 17th July, 1975. 3. The issue which arises for consideration in the present reference is whether the amounts received under those Agreements by the Respondent from the three Companies were chargeable to tax in India either having regard to the provisions of the Income Tax Act, 1961 (hereinafter referred to as the Act) or having regard to the provisions of the Double Taxation Avoidance Agreement (DTAA) entered into between the Governments of India and the Federal Republic of Germany (hereinafter referred to as the German DTAA). 4. The Income Tax Officer by order of assessment dated 3 rd September, 1983 had assessed these amounts as being liable for tax. In the Appeal preferred, for reasons cited by the Commissioner of I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Agreement, but merely a part of the commercial profits of the assessee and as there was no PE it would not be taxable. 7. The agreement with BHEL entered into on 21 st June, 1974 was next considered. This Agreement covered industrial turbines manufactured by B.H.E.L. The assessee was to prepare a technical report covering the requisition of the additional plant, machinery and equipments for manufacturing and testing of the industrial turbines and also to train adequate number of personnel of B.H.E.L. and also to delegate its personnel to B.H.E.L. and some other requisitions. In consideration B.H.E.L. was to pay the assessee 4% of the selling price of the industrial turbines for the next five years. These payments were described as royalty. Any tax payable was to be paid by B.H.E.L. The learned Tribunal was pleased to hold that the payment is royalty under Section 9(1) (vi) of the Act but not royalty within DTAA but were part of commercial profits but as there was no PE, it would not be taxable. It considered the payments described as technical assistance fee but which had been treated as royalties under the extended definition of Section 9(1)(vi). The argument advanced on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Tribunal in ITA No.2281 of 1979 dated 3 rd June, 1980 and ITA No.2579 of 1979 dated 6 th December, 1980 for reasons stated in those order cannot be said to be subject to taxation. The last ground considered was the sum of Rs.64,246/- by way of reimbursement of expenditure and whether it could be brought to tax. The Tribunal noted that this is in connection with additional assistance to be rendered by the assessee under the Agreement dated 28 th October, 1975. The Tribunal noted as it had already held that the additional assistance fees of Rs.42.41 lakhs is not taxable and consequently held that the reimbursement of expenditure also would not be taxable. The Tribunal accordingly partly allowed the Appeal. 11. The Revenue moved an application by way of Reference. The Tribunal by its order dated 26 th May, 1987 has referred the following questions of law to this Court for its opinion:- "(1) Whether on the facts and in the circumstances of the case, the Tribunal was correct in law in holding that the definition of the term "royalty" in Explanation 2 to Section 9(1)(vii) of the Income-tax Act will not apply to the said term as used in Article III(3) of the Agreement for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ding the said sum is not chargeable to tax in India.? 12. At the hearing of this reference on behalf of the Revenue it is sought to be contended that this Court must consider the treaty by applying the ambulatory approach of interpretation and not static interpretation. It is submitted that considering Article II(2), the expression "laws in force" as contained in DTAA, the ambulatory interpretation will have to be accepted and the amounts in issue will have to be held to be 'royalty" which is taxable in India. Reliance is placed on rulings on Ambulatory approach of the Supreme Court of Netharlands and the Supreme Court of Belgium. We do not propose to deal with the said judgments, in the absence of the full texts of the judgment being made available to the Court as such we are not giving the citations. On behalf of the assessee it is submitted that what will have to be considered are the Clauses of the D.T.A.A. and not the subsequent amendments. In other words the static interpretation. Reliance is placed on the ruling of the Supreme Court of Canada. In the alternative, it is submitted that even if it is accepted, that amounts are royalty as defined under Section 9(1)(vi) of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ovisions of the Act to the extent they are required. Before answering the issue we may point out that Finance Act, 2007 has inserted explanation to Section 9(1) after Section 9(1)(vii) with retrospective effect from 1 st June, 1976 and which reads as under:- "For the removal of doubts it is hereby declared that for the purposes of this Section where income is deemed to accrue or arise in India under Clauses (v), (vi) and (vii) of sub-section (1) such income shall be included in the total income of the non-resident, whether or not the non-resident has a residence or place of business or business connection in India." The income from receipt of royalties as set out in section 9(1)(vi) are thus now taxable in India whether or not the non-resident has a place of residence, or place of business or business connection in India. In the present appeal though the agreements entered into are before 1 st June, 1976, income have received is for several Assessment Years. 14. The relevant provisions of DTAA notified by Notification dated September 13, 1960, read as under:- Article (1) The taxes which are the subject of the present Agreement are:- (a) in India: the income-tax, the sup ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er movable or immovable. Article XI deals with remuneration from public service. There are other Articles which we need not deal with. 15. Royalty has not been defined in the DTAA in question nor at the relevant time was it defined in the Income Tax Act. The German DTAA was amended by Notification dated August 26, 1985. Article VIII(A) of the amended Agreement deals with Royalties and fees for technical services which are also explained therein. We are not concerned with the amendment as we are concerned with the assessment year 1979-80. 16. The Finance Act 1976 with effect from 1 st June, 1976 introduced clauses 5, 6 and 7 to Section 9(1). Clause 5 deals with income by way of interest. Clause 6 defines income by way of royalty. Explanation 2 sets out the meaning of royalty for the purpose of the clause. Clause 7 deals with income by way of fees for technical services. The proviso which was inserted by Finance Act, 1977 with effect from 1 st April, 1977 provides that nothing contained in this clause shall apply in relation to any income by way of fees for technical services payable in pursuance of an agreement made before the 1 st day of April, 1976 and approved by the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt establishment is relevant for assessing the income of a non-resident under the DTAA." The Court then considering Section 9(1)(vii)(c) proceeded to hold as under:- "Reading the provision in its plain sense, it can be seen that it requires two conditions to be met the services which are the source of the income that is sought to be taxed, has to be rendered in India, as well as utilized in India, to be taxable in India. In the present case, both these conditions have not been satisfied simultaneously, therefore, excluding this income from the ambit of taxation in India. Thus, for a non-resident to be taxed on income for services, such a service needs to be rendered within India, and has to be part of a business or profession carried on by such person in India. The petitioners in the present case have provided services to persons resident in India, and though the same have been used here, they have not been rendered in India." 19. Parliament, it appears, took note of this judicial pronouncement as is noted in the Explanatory notes on provisions relating to direct taxes for the Finance Act, 2007. It referred to Circular No.202 dated 5 th July, 1976. With respect to rule fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Her Majesty The Queen (Appellant) vs. Melford Developments Inc.(Respondent) 82 DTC 6281. Considering a similar clause in Article II(2) of the Treaty between Canada and Germany the Supreme Court of Canada was considering the expression "law in force in Canada" relating to the taxes which are the subject of the Convention" whether it means the laws as they existed in 1956 or the laws of Canada from time to time in force. The Court observed that:- "Laws enacted by Canada to redefine taxation procedures and mechanisms with reference to income not subjected to taxation by the Agreement are not, in my view, incorporated in the expression "laws in force" in Canada as employed by the Agreement. To read this section otherwise would be to feed the argument of the Appellant, which in my view is without foundation in law, that subs. (2) authorizes Canada or Germany to unilaterally amend the tax Treaty from time to time as their domestic needs may dictate." The ratio of that judgment, in our opinion, would mean that by an unilateral amendment it is not possible for one nation which is party to an Agreement to tax income which otherwise was not subject to tax. Such income would not be subjec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mineral lease, in exchange for the lessee's right to mind or drill on the land.- also termed (in sense 2) override." In that context reference was made by learned Counsel for the Assessee to the judgment of the House of Lords in Rolls-Royce Ltd. vs. Jeffrey (Inspector of Taxes), (1962) W.L.R. 425. In that case the company was engaged in metallurgical research and the discovery and development of engineering techniques and secret process. As a result it acquired in the course of the years a fund of technical knowledge, or "know-how", of which only a comparatively small part was capable of forming the subject matter of patent rights. For some years the company, as a general rule, used its "know-how" only in its own trade, but subsequently entered into a number of agreements whereby in consideration of lump sum payments and royalties, it undertook to supply the foreign government or company with technical knowledge, plans, a licence and facilities for the interchange of staff to enable them to manufacture specified types of aircraft engines. The Agreements were for various periods. The question was whether in computing the company's profits or gains, the lump sums paid to it under ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ould be the law as was applicable or as defined when the D.T.A.A. was entered into. The question however, would still remain, whether the income by way of royalties other than those included in Article III(3) are subject to tax in India considering the D.T.A.A. when there is no permanent establishment. We may also note at this stage that the rule of referential incorporation or incorporation cannot be applied when we are dealing with a Treaty (D.T.A.A.) between two Sovereign Nations. Though it is open to a Sovereign Legislature to amend its Laws, a D.T.A.A. entered into by the Government in exercise of the powers conferred by Section 10(1) while considering Section 10(2) have to be reasonably construed. 23. The next question that we have to answer is, if the provisions of Double Taxation Avoidance Agreement are more beneficial to the assessee whether the taxability of the income should be governed by the provisions of that Agreement and not by the provisions of I.T. the Act as amended. In other words would the D.T.A.A. prevail over the provisions of the I.T. Act. 24. In Commissioner of Income-tax, A.P.I vs. Visakhapatnam Port Trust, 144 ITR 146 a learned Division Ben ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tation of the terms of a double taxation avoidance agreement. When that happens, the provisions of such an agreement, with respect to cases to which where they apply, would operate even if inconsistent with the provisions of the Income-tax Act. We approve of the reasoning in the decisions which we have noticed. If it was not the intention of the Legislature to make a departure from the general principle of chargeability to tax under section 4 and the general principle of ascertainment of total income under section 5 of the Act, then there was no purpose in making those sections "subject to the provisions" of the Act. The very object of grafting the said two sections with the said clause is to enable the Central Government to issue a notification under Section 90 towards implementation of the terms of the DTAs which would automatically override the provisions of the Income-tax Act in the matter of ascertainment of chargeability to income-tax and ascertainment of total income, to the extent of inconsistency with the terms of the DTAC. Referring to the Circular the Court held that the Circular shall prevail even if inconsistent with the provisions of the Income-tax Act, 1961, in so f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The royalty which is the subject matter of this appeal can only be taxable under Article III provided the predicates therein, are satisfied namely that there is a permanent establishment. Learned Counsel for assessee had raised the point before the Tribunal and have also reiterated the same before this Court, that Article III (3) has to be read in consonance with Articles V to XII as they are relevant for understanding the D.T.A.A. 30. We have earlier reproduced parts of Article III of the D.T.A.A. Article III (3) sets out that the term "industrial or commercial profits" shall not include income in the form of rents, royalties, interests, dividends, management charges, remuneration for labour or personal services or income from the operation of ships or aircraft but shall include rents or royalties in respect of cinematographic films. A reading of this Article may prima facie indicate that only royalties from cinematographic films form a part of industrial or commercial profits and all other incomes by way of royalty would not be taxable except to the extent which may be provided by the D.T.A.A. This must also be seen in the context of Articles V to XII where the income from th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... III(3) makes it clear where income is dealt with separately under other articles then those provisions will apply. A new Article VIIIA has been inserted which explains the expression royalties to include payments of any kind received as consideration for the use of, or the right to use amongst other payments received as consideration for the right to use any copyright, patent, trade mark, etc. Though the word "royalty" was also not defined under the Income Tax Act as it then stood, the expression would have to be understood in its ordinary grammatical meaning which we have already set out earlier. The conclusion would be that royalty other than royalty for mine, quarries, etc., if relateable to industrial or commercial profits would be taxable under Article III(1) provided there was a permanent establishment of the enterprise in India. 32. That leaves us with the second question in respect of the payments have been held by the Tribunal to be by way of technical services. Reference by the Tribunal is whether the payment under the Agreement dated 27 th July, 1975 and 28 th October, 1975 were in the nature of fees for technical services within the meaning of Section 9(1)(vii) o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e assessee. The only exception would be if the statute expressly provides that such findings are not conclusive. This is not the case here. 33. That leaves us with the last contention as to whether the amount by way of reimbursement are liable to tax. To answer that issue, we may gainfully refer to the judgment of a Division Bench of the Delhi High Court in Commissioner of Income Tax vs. Industrial Engineering Products Pvt. Ltd. 202 ITR 104. The learned Division Bench of the Delhi High Court was pleased to hold that reimbursement of expenses can, under no circumstances, be regarded as a revenue receipt and in the present case the Tribunal had found that the assessee received no sums in excess of expenses incurred. A similar issue had also come up for consideration before the Division Bench of the Calcutta High Court in Commissioner of Income-tax, West Bengal-IV vs. Dunlop Rubber Co. Ltd. The learned Division Bench was answering the following questions:- "Whether, on the facts and in the circumstances of the case, the amounts received by the assessee (English company) from M/s. Dunlop Rubber Co. (India) Ltd. (Indian company) as per agreement dated 29 th January, 1957, con ..... X X X X Extracts X X X X X X X X Extracts X X X X
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