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2009 (2) TMI 23 - AAR - Income TaxThe proceedings against the applicant were initiated in 2003. By the date of entering fresh agreement in the year 2006 even the assessments were concluded. All these years the applicant kept quiet perhaps watching the outcome of the assessment and appellate proceedings. Now after the adverse order was passed by the C(A) the appeal was filed before ITAT and application was filed in 2008 before AAR. In view of this AAR refused to give ruling and rejected the application.
1. ISSUES PRESENTED and CONSIDERED
The core legal questions considered by the Authority for Advance Rulings (AAR) in this case are: (a) Whether the payments made by the applicant to MOL Corporation (MOLC) under the license agreement granting manufacturing and distribution rights are in the nature of 'royalty income' arising or sourced in India and hence taxable in India under Section 9(1)(vi) of the Income-tax Act, 1961 (the Act) and/or the provisions of the Double Taxation Avoidance Agreement (DTAA) between India and the USA, requiring tax withholding by the applicant. (b) Whether the payments made by independent Indian distributors to Microsoft Regional Sales Corporation (MRSC) should be regarded as licensing revenues accruing to MOLC and taxable as 'royalty income' under Section 9(1)(vi) of the Act and/or the DTAA, thereby requiring tax withholding by the applicant. (c) Whether the application for advance ruling is maintainable in view of the pendency of appeals before the Income-tax Appellate Tribunal (ITAT) concerning identical or substantially similar questions involving Gracemac Corporation, the predecessor entity merged into MOLC. (d) Whether the application should be rejected under the proviso to Section 245R(2) of the Act on the ground that the question raised is already pending before an income-tax authority or appellate tribunal. (e) Whether the question raised relates to a transaction or issue designed prima facie for avoidance of income tax under clause (iii) of the proviso to Section 245R(2), thereby barring admission of the application. 2. ISSUE-WISE DETAILED ANALYSIS Issue 1: Nature and Taxability of Payments Made by Applicant to MOLC Relevant Legal Framework and Precedents: Section 9(1)(vi) of the Income-tax Act defines income deemed to accrue or arise in India, including royalty income. The DTAA between India and USA, particularly Article 12, governs taxation of royalties and fees for technical services. The Indian Copyright Act defines 'copyright' and the scope of rights therein. Court's Interpretation and Reasoning: The applicant contended that the payments made to MOLC are not 'royalty' since the payments are for purchase of copyrighted articles (software products) and not for the use of copyright or any right therein. The applicant argued that the manufacturing and sale occur outside India, title passes outside India, and no income-generating activity occurs in India. Therefore, Section 9(1)(vi) is not attracted, and withholding tax is not required. Key Evidence and Findings: The license agreement grants non-exclusive rights to manufacture and distribute Microsoft products in Asia, including India. The products are manufactured in Singapore and distributed through MRSC. The applicant pays MOLC based on net sales by MRSC to Indian distributors. The end-users are bound by End-user License Agreements with MS Co. or affiliates to protect intellectual property rights. Application of Law to Facts: The applicant's position is that the payments are for sale of copyrighted articles, not for use of copyright rights, and thus fall outside the definition of royalty income taxable in India. The applicant relies on the DTAA's definition and the Indian Copyright Act's provisions to support this. Treatment of Competing Arguments: The Revenue argued that the payments are in the nature of royalty income as they are consideration for licensing software rights used in India and thus taxable. However, the Authority did not express a view on the merits of this contention as the application was rejected on procedural grounds. Conclusions: The Authority refrained from deciding the substantive issue of whether the payments constitute royalty income taxable in India, as the application was rejected on procedural grounds related to pendency of appeals. Issue 2: Taxability of Payments Made by Indian Distributors to MRSC as Licensing Revenues Accruing to MOLC Relevant Legal Framework and Precedents: Same as Issue 1, involving Section 9(1)(vi) and DTAA provisions on royalty income. Court's Interpretation and Reasoning: The applicant contended that payments by Indian distributors to MRSC are not licensing revenues accruing to MOLC but are sale proceeds of copyrighted articles. The end-users only get the right to use the copyrighted article, not the copyright itself. Key Evidence and Findings: Distribution agreements show MRSC sells to Indian distributors from Singapore warehouses, with title passing outside India. Indian distributors resell to resellers and consumers. The payment obligation of distributors to MRSC is independent of their ability to resell. Application of Law to Facts: The applicant argued that since MRSC holds the title and the transactions are sales of goods, the payments are not royalties but sale consideration, thus not taxable as royalty income in India. Treatment of Competing Arguments: The Revenue disputed this, contending the payments are licensing revenues taxable as royalties. Again, the Authority did not decide on merits due to procedural rejection. Conclusions: No substantive ruling was given on this issue. Issue 3 and 4: Maintainability of Application in View of Pending Appeals and Proviso to Section 245R(2) Relevant Legal Framework and Precedents: Section 245R(2) of the Income-tax Act provides that the Authority shall not allow an application if the question raised is already pending before any income-tax authority, appellate tribunal, or court. The proviso to Section 245R(2) is a legal bar to entertaining applications involving questions pending adjudication. Court's Interpretation and Reasoning: The Revenue contended that identical questions are pending before the ITAT in appeals filed by Gracemac Corporation, the predecessor of MOLC, arising from assessments for earlier years. The applicant's rights and obligations flow from agreements assigned to MOLC post-merger. The Authority noted that the questions raised in the present application are intimately connected and substantially identical to those pending before the ITAT. The Authority held that the term 'question' in the proviso should be understood broadly to prevent conflicting decisions and avoid duplication of litigation. The pendency of Gracemac's appeals, now effectively MOLC's appeals after merger, bars admission of the application. Key Evidence and Findings: The appellate orders and appeal memoranda show that the issues raised in this application are no different from those pending before the ITAT. The applicant did not dispute the identity of issues or facts. Application of Law to Facts: The Authority applied the proviso to Section 245R(2)(i) strictly, concluding that the application must be rejected since the question is pending adjudication. Treatment of Competing Arguments: The applicant argued that the tax withholding issue is separate from substantive tax liability and can be decided independently. The Authority acknowledged that tax deduction at source is a separate issue but emphasized that the obligation to withhold tax depends on the substantive tax liability of MOLC, which is under adjudication. Conclusions: The Authority rejected the application under Section 245R(2) for being barred by pendency of identical questions before the ITAT. Issue 5: Whether the Application Relates to a Transaction Designed Prima Facie for Avoidance of Income Tax Relevant Legal Framework: Clause (iii) of the proviso to Section 245R(2) bars admission of applications relating to transactions designed prima facie for tax avoidance. Court's Interpretation and Reasoning: The Revenue alleged that the restructuring of licensing and distribution arrangements post-1999 was designed primarily to avoid tax in India by artificially reducing taxable royalty income. The applicant countered that there were genuine commercial reasons for the arrangements, including manufacturing and distribution rights granted to the applicant in Singapore. Key Evidence and Findings: The Revenue's assertion was based on the complexity of agreements and the shifting of income streams among group companies. The applicant pointed out that the Department treated Gracemac and MRSC as independent commercial entities and subjected them to tax, indicating recognition of commercial substance. Application of Law to Facts: The Authority held that on the material before it, it could not infer prima facie tax avoidance. The mere effect of the transaction is not determinative of intent to avoid tax. Since the Department did not raise tax avoidance in assessments, the Authority overruled this objection. Treatment of Competing Arguments: The Authority balanced the Revenue's suspicion against the absence of explicit findings of tax avoidance in prior proceedings. Conclusions: The Authority found no prima facie case of tax avoidance barring admission under the proviso. 3. SIGNIFICANT HOLDINGS The Authority did not express any substantive view on the merits of the taxability or withholding tax questions posed. Instead, the application was rejected on procedural grounds under Section 245R(2) of the Income-tax Act. The crucial legal reasoning includes: "The word 'question' occurring in the proviso to Section 245-R(2) should be understood in a manner which sub-serves the object of the proviso. It should not be construed too narrowly or technically. An intimate and direct connection between the question raised in the application and the question pending is what is contemplated by the proviso. It should arise out of identical if not the same transaction." "The Authority is precluded from 'allowing' the application if the application is hit by any of the embargoes laid down in the proviso to Section 245-R(2). On the basis of the facts stated in the application and the other documents forming part of the record as well as on the basis of the comments/objections filed by the Revenue, the Authority should first address itself to the question whether any of the three clauses is attracted. Once the conclusion is reached that the application is hit by one or all of the embargoes laid down in the proviso to Section 245-R(2), the Authority has no option but to reject the application in limine." "The obligation of the applicant to withhold the tax at source cannot be decided de hors the issues raised concerning the liability of MOLC. The findings of the appellate authority in Gracemac's appeals and the outcome of further appeal to the Tribunal will have inevitable bearing on the questions raised in the present application." "On the basis of the facts presented before us, it is not possible to draw an inference on a prima facie consideration that the question raised in the application 'arises out of a transaction designed prima facie for the avoidance of income tax'. The resultant effect of transaction by itself is not determinative of the applicant's design to avoid tax." Core principles established include:
Final determinations:
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