Section 245R(2) of the Indian Income Tax Act, 1961 (‘ITA’)
provides for situation wherein application filed before the
Authority for Advance Ruling (“AAR”) may be
rejected at the stage of admission. The matter of Microsoft
Operations Pte. Ltd., Singapore (the “Applicant”),
a wholly owned subsidiary of Microsoft Corporation US
(“MS Co.”) is one such instance.
FACTS
Gracemac Corporation (“Gracemac”), a wholly
owned subsidiary of MS Co., had been granted the proprietary and
ownership rights with respect to licensing and IPR of
Microsoft products in Asia by MS Co., with effect from 1.1.1999.
Gracemac had further entered into a license agreement with the
Applicant whereby the Applicant was granted, for a consideration
as provided in the agreement, a non-exclusive license to
manufacture, reproduce and distribute Microsoft products in Asia
including India. For the purposes of distribution of the
software, the Applicant appointed Microsoft Regional Sales
Corporation (“MRSC”), which in turn entered
into agreements with third party distributors for the sale of
the Microsoft products in India.
In the year 2006, Gracemac merged with MOL Corporation (“MOLC”);
after which the Applicant entered into a fresh license agreement
on similar terms with MOLC.
The Applicant approached the AAR to adjudicate upon whether the
payments received by MOLC from the Applicant under the license
agreement as well as those received by MRSC from the Indian
distributors be characterized as ‘royalty income’ under the ITA and/or the
India-US tax treaty and hence accordingly, whether tax is
required to be withheld by the Applicant.
ADMISSIBLITY OF THE APPLICATION: CONTENTIONS BEFORE THE
AAR
The primary contention of the Revenue was with respect to the
non-maintainability of the present application, on grounds that
the Applicant had an appeal pending before the Income Tax
Appellate Tribunal, Delhi (“Tribunal”).
The Revenue based its contention on Section 245-R(2) of ITA,
whereby the AAR is granted wide discretion to accept an
application, except in certain circumstances, which includes a
situation where the question raised before the AAR is pending
for adjudication before any tax authority or Tribunal and
accordingly claimed that the aforesaid section clearly prevented
the AAR from adjudicating on the merits of the application at
hand.
It is important to note that for the assessment years 1999-2000
to 2005-06, the Tribunal had held, after analyzing inter-alia
agreements (similar to those referred to in the present
application) entered into by Gracemac with MS Co., Applicant and
the end-users, that the license fee received was in the nature
of royalty income and thus, liable to be taxed in India.
The Applicant had counterclaimed that the appeals at the
Tribunal were Gracemac’s appeals; however, this application was
filed with respect to the agreement with MOLC and thus, no
proceedings in relation to the Applicant in respect of the same
transaction can be said to be pending. The Applicant further
contended that proceedings at the AAR with regard to withholding
of taxes cannot be equated to proceedings at the Tribunal with
respect to determination of Gracemac’s liability to pay taxes in
India.
RULING
The AAR rejected the contentions of the Applicant and thereby
the application made by the Applicant on the ground that the
matter in question was ‘already pending’ before the Tribunal. The AAR
noted that as a result of merger with MOLC, MOLC itself becomes
the appellant in the pending appeals and that the obligation of
the Applicant to withhold the tax at source cannot be decided de
hors the issues raised concerning the tax liability of MOLC.
Further, the AAR noted that if the Tribunal and the AAR rule
differently, it would give rise to an anomalous situation and
having allowed the proceedings thus far, the Applicant cannot as
a matter of right seek the ruling from the AAR. The AAR
also referred to the ruling delivered in the case of Airports
Authority of India, wherein the application was allowed even
though it concerned tax withholding obligations and appeals
against assessment orders were still pending. The AAR
distinguished the facts of the Airports Authority case by
pointing out that in that case the assessing officer had created
uncertainty by departing from AAR’s earlier ruling on the same
subject matter and further, the AAR was approached by the
aggrieved applicant at the earliest opportunity. However, in the
present case, the Applicant had taken its chances at the time of
the assessment and the first appellate proceedings and
thereafter approached the AAR. Thus, the applicant had no
grounds to pursue the AAR to exercise its discretion and
adjudicate upon the questions raised.
ANALYSIS
This ruling sends out a clear message that notwithstanding the
discretion conferred on the AAR, it is not open to the AAR to
ignore the legal bar created by the proviso to Section 245R(2)of
the ITA.
Further, it is evident that AAR restrains from exercising its
discretionary powers to admit applications wherein the applicant
has tried to make out its case at various levels and thereafter,
on receiving an adverse order from all counters, approach the
AAR. The sanctity of the process for advance ruling is required
to be respected and strictly adhered to.
It may be recollected that as per various media reports in the
recent past, tax authorities have alleged that Gracemac is
liable to pay income tax on its gross royalty income earned out
of licensing of software to Indian customers and had alleged
that payments made for use of shrink wrap software are royalty
income. Pertinently, the AAR did not discuss the case on merits
and therefore, the question with respect to payments in lieu of
software still remains to be decided by the Tribunal.
