2024 (6) TMI 1457 - AT - Income Tax

Income deemed to accrue or arise in India - taxability of background screening services - Royalty or FTS under the provision of Article 13 of India-USA DTAA - HELD THAT - Co-ordinate Bench Tribunal in 2024 (5) TMI 635 - ITAT DELHI in assessee s own case held that background screening services provided by an assessee does not qualify as royalty. Appeal of the assessee is allowed.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal in the present appeal include:

(a) Whether the Assessing Officer (AO) erred in determining the taxable income of the assessee by making additions based on conjectures and surmises, ignoring the factual matrix and nature of transactions.

(b) Whether the revenue received by the assessee from provision of background screening and investigation services qualifies as 'Royalty' or 'Fees for Technical Services' (FTS) under Article 13 of the India-UK Double Taxation Avoidance Agreement (DTAA).

(c) Whether the reports provided by the assessee are protected by copyright laws, such that their use by clients amounts to royalty income.

(d) Whether the assessee maintains or licenses a database, and if the consideration received is taxable as royalty for use of such database.

(e) Whether the screening reports contain confidential information amounting to commercial experience, the use of which by clients attracts tax as royalty.

(f) Whether the AO erred in treating the revenue as ancillary to royalties and taxable as FTS, ignoring the mutually exclusive nature of these categories.

(g) Whether exemption under Section 10(50) of the Income Tax Act was rightly denied.

(h) Whether the AO erred in not granting credit for equalization levy paid by the assessee.

(i) Whether the AO erred in increasing income based on discrepancies between Form 26AS and books of account.

(j) Whether the AO erred in recovering refund amounts without due appreciation of the facts.

(k) Whether interest under Sections 234A and 234B was rightly levied.

2. ISSUE-WISE DETAILED ANALYSIS

Issue (a): Validity of AO's addition to taxable income

The AO increased the taxable income to INR 7,32,81,530/- despite the assessee declaring nil income. The assessee challenged this addition as being based on conjectures and ignoring the factual matrix and nature of transactions.

The Tribunal noted that this issue was substantially addressed in earlier decisions involving the same assessee and similar facts. The AO's reliance on surmises without appreciating the factual and documentary evidence was found to be erroneous. The Tribunal emphasized the need for additions to be based on concrete evidence rather than mere assumptions.

Issues (b), (c), (d), (e), and (f): Characterization of receipts as Royalty or Fees for Technical Services under Article 13 of India-UK DTAA

The principal legal framework governing these issues is Article 13 of the India-UK DTAA, which defines 'Royalty' and 'Fees for Technical Services' and the conditions under which income may be taxed as such. The Indian Copyright Act, 1957, and relevant judicial precedents, including the Supreme Court decision in Engineering Analysis Centre of Excellence (P) Ltd. vs. CIT, were also considered.

The AO held that the receipts from background screening services fall within the scope of royalty or FTS, on the grounds that:

• The reports are protected by copyright, and their use by clients amounts to royalty.
• The assessee maintains or licenses a database, and the consideration is for use of such database.
• The reports contain confidential information constituting commercial experience, the use of which attracts royalty tax.
• The revenue is ancillary to royalties and taxable as FTS.

The Tribunal relied heavily on prior decisions in the assessee's own case, including orders dated 06.09.2023 and 19.01.2024, and the High Court order dated 26.02.2024, which consistently held that:

• The background screening reports merely summarize factual data and do not qualify as copyrightable works under Section 13(1)(a) of the Copyright Act.
• The clients receive only the right to use the report for internal purposes, without rights to reproduce, distribute, or commercially exploit the report.
• No database access is granted; only specific reports are provided electronically, which does not amount to licensing a database.
• The information contained in the reports is factual and does not involve imparting commercial experience, skill, or know-how.
• The services do not involve transfer or making available any technical knowledge or consultancy, and thus do not qualify as FTS under Article 13(4) of the DTAA.

The Tribunal observed that the AO failed to appreciate these distinctions and relied on irrelevant judicial precedents and agreement clauses that were factually distinguishable. The Tribunal also noted the mutual exclusivity of royalty and FTS provisions under the DTAA, rejecting the AO's attempt to tax the same receipts under both categories.

Issue (g): Denial of exemption under Section 10(50)

The AO denied exemption under Section 10(50) of the Income Tax Act, which relates to income of offshore funds or specified entities. The assessee contended that the factual matrix justified exemption.

The Tribunal, however, did not elaborate extensively on this ground, implicitly finding that the issue was subsumed within the broader determination of the nature of income, which was resolved in favour of the assessee.

Issue (h): Non-grant of credit for equalization levy

The assessee claimed credit for equalization levy paid during the relevant assessment year. The AO did not follow the directions of the Dispute Resolution Panel (DRP) to grant such credit.

The Tribunal noted the failure of the AO to adhere to DRP directions and implicitly upheld the assessee's contention that credit should be granted, although detailed reasoning was not provided.

Issue (i): Addition based on difference between Form 26AS and books

The AO made an addition of INR 23,45,986 based on discrepancies between receipts shown in Form 26AS and the assessee's books of account.

The assessee argued that the difference arose due to genuine reasons and did not warrant addition. The Tribunal accepted this explanation, holding that the AO failed to appreciate the nature of the difference and erred in making the addition.

Issue (j): Erroneous recovery of refund

The AO recovered a refund amounting to INR 70,37,551 without appreciating that no refund had been granted due to absence of a bank account in India.

The Tribunal found this recovery to be erroneous and unsupported by facts.

Issue (k): Levy of interest under Sections 234A and 234B

The AO levied interest under Sections 234A and 234B for delay in filing and payment of tax. The assessee challenged this levy.

The Tribunal did not provide detailed reasoning on this point in the order but, given the allowance of the appeal on substantive grounds, implicitly held that the interest levy was not justified.

3. SIGNIFICANT HOLDINGS

The Tribunal's crucial legal reasoning is encapsulated in the following verbatim extract from its prior order dated 06.09.2023, which was followed in the present case:

"As regards the impugned receipts being in the nature of royalty, in our considered view, none of the requisites under Article 13(3) of the India-UK DTAA are satisfied so as to qualify such receipts as 'royalty'. What assessee is providing to the clients in India is merely a report summarizing its findings with respect to the background check undertaken by the assessee which is primarily a factual data and cannot per se qualify as literary or artistic or any other copyrightable work. Such a report cannot be copyrighted as it does not fulfill the requirements enlisted under section 13(1) (a) of the Indian Copyright Act, 1957. Also, none of the rights as mentioned in Section 14(a) of the Indian Copyright Act, 1957 have been rested with the client by the assessee while rendering its services. Income from provision of the services rendered by the assessee cannot be characterized as royalty for use of copyright in the report as the client merely has the right to use the findings in the report for its own internal consumption. The client does not have any rights to publicly display, sell/ distribute, copy, edit, modify or undertake any other commercial exploitation of the said report. It is thus evident that the consideration received by the assessee under the terms of its agreement with its client is purely towards provision of background screening services and does not include any consideration for use or right to use any copyright or a literary, artistic or scientific work, patent, trademark, design, model, plan, secret formula, or process or information. Thus, the impugned receipts of the assessee from its clients in India cannot be regarded as 'Royalties' under the provisions of Article 13 of the India-UK DTAA."

Further, the Tribunal held:

"The services rendered by the assessee do not involve any technical skill/knowledge or consultancy or make available any technical knowledge, experience, skill, know-how or processes to the clients. Assessee's role is restricted to the verification of information provided by various candidates proposed to be hired by its clients. It involves seeking information from various sources that is accessible on specific requests and no advice/guidance on the credentials of the candidate is provided by the Assessee to its client. The role of the assessee is limited to validation of data provided by the candidate and provide relevant facts captured during the course of validation. The clients make an independent decision to hire the candidate. Hence, in our view the services should not be considered as FTS under Article 13(4) of the India-UK DTAA."

The Tribunal also affirmed the binding nature of these principles by reference to the High Court's decision, which dismissed the Department's appeal and held:

"The mere undertaking of background checks of an employee or the verification of testimonials cannot possibly be recognized as entailing the use of any technical knowledge, experience or skill as provided under Article 13(4) of the India-UK DTAA. The assessee is merely verifying disclosures and which activity cannot be recognized as being imbued with any technological characteristic. There is also a complete absence of a transfer of data or information which could be described as 'technical' as the word is commonly understood."

On other grounds, the Tribunal concluded that additions based on Form 26AS discrepancies and erroneous recovery of refunds lacked merit and that the AO's levy of interest was unjustified in light of the overall findings.

Accordingly, the Tribunal allowed the appeal of the assessee, setting aside the impugned assessment order and holding that the income from background screening services is neither taxable as royalty nor as fees for technical services under the India-UK DTAA.