Payment for non-exclusive Right to Use know how Taxable as Royalty: Authority for Advance Rulings
In the recent case of M/s International Tire Engineering (“Applicant”), the Indian Authority for Advance Rulings (“AAR”) has held that the consideration paid for perpetual and irrevocable right to use of know how should be taxable as royalty under section 9(1)(vi) of the Income Tax Act, 1961 (“ITA”).
The Applicant is a company based in the USA and is engaged in the business of supplying advanced technology (“Knowhow”) for manufacture of radial tyres. The Applicant agreed to grant to an Indian company, CEAT Limited (“Purchaser”), a perpetual, irrevocable and non-exclusive right to use the Knowhow at any place in the world, including India. Further, the Applicant agreed to transfer to the Purchaser, the ownership in certain tread and sidewall designs (“Designs”). The agreement was effectuated outside India for a lump sum consideration of USD 710,220 (“Consideration”). The Applicant approached the AAR for determination as to the taxability of this Consideration and also for consideration receivable in lieu of consultancy and assistance rendered to the Purchaser.
Ruling and Analysis:
The Applicant contended that the Consideration was for the transfer of the technical document which was in the nature of a ‘chattel’ or a ‘plant’, and that such Consideration was received outside India. It was further contended that the Consideration could not be considered as royalty or fees for included services under the India US double tax treaty (“DTAA”), and that under the provisions of the DTAA, that such payments could not be taxable as business profits in the absence of a permanent establishment (“PE”) of the Applicant in India. With respect to the payment towards provision of technical assistance it was contended that the payments were ancillary and inextricably linked to the sale of Knowhow, as a result of which consideration received is in relation to the subject matter sold (i.e. Knowhow and Designs).
It was argued by the revenue authorities that the payments were in the nature of royalty and fees for included services under the Article 12 paragraph (3a) and (4b) of the DTAA and hence taxable in India irrespective of the existence of a PE of the Applicant in India. With regard to the payment for technical assistance it was also submitted that the Applicant would have a service PE in India under the DTAA on account of the proposed presence of personnel for a period exceeding 100 days, under the agreement.
It was held by the AAR that the Consideration paid to the Applicant was for the Purchaser’s right to use the Knowhow. Such right to use was non-exclusive as per the terms of the agreement, and the Applicant retained the right to use the same Knowhow for his own purpose or provide the same rights to other parties to persons other than the Purchaser. Therefore it was held that thepredominant nature of the transaction was that of a right to use Knowhow, as a result of which the Consideration should be in the nature of royalty. With regard to the situs of sale, it was held that transaction cannot be said to have been concluded in USA as the right to use Knowhow would occur on the receipt of document by the Purchaser. As the Purchaser was in India, the AAR presumed that the delivery of the document would have taken place in India and therefore the transaction was not an offshore supply of technical documents as claimed by the Applicant. Proceeding on this a presumption, the AAR held that the Supreme Court ruling in the case of Ishikawajima Harima Heavy Industries, (2007) 288 ITR 408 was not applicable to the facts of the case since here the territorial nexus is present since the communication critical to providing right to use Knowhow was effected in India.
The AAR further held that the technical assistance services should be considered ‘fees for included services’ for the purposes of the DTAA, and that they could not be considered ‘ancillary’ to the ‘sale’. The AAR held that even if right to use Knowhow was an agreement of sale, the provision of services for an extended period and as a vital component of the contract could not be considered ‘ancillary’ to the sale arrangement.
As regard the question of taxability of consideration for transfer of tread and side-wall designs and patterns, the AAR noted that the transfer was absolute and that the consideration could be taxable only in the event that the profits were attributable to a PE of the Applicant in India. It was noted that this consideration was for the manufacture of radial tyres was to be registered in the name of the Purchaser and would be treated as its intellectual property. Therefore, the same could not be treated as royalty and could be taxed in India only if the Applicant had a PE in India. Further, even if the Applicant had a service PE on account of provision of consultancy and technical services, it was held that such PE would not have a connection with the transfer of Designs. Therefore, it was decided that the consideration for Designs was not taxable in India.
Accordingly it was held that withholding tax as provided under section 195 of ITA at a rate of 10% was to be levied on the amounts considered taxable, i.e. the amount receivable under the agreement less the consideration for the transfer of ownership in Designs.
The AAR in this ruling seems to have emphasized on the aspect of whether payments were made for the ‘right to use’ Knowhow, and found it relevant that the perpetual right was non-exclusive in nature and the Applicant had retained rights in the Knowhow. As regards to the taxability of consideration for transfer of tread and side-wall designs and patterns, the AAR applied the same test and held that the Applicant has not held back rights in the same and hence it preferred to treat the payment as business income and not royalty. This ruling will have an impact on the treatment of payments from licensing arrangements.