1988 (10) TMI 76 - AT - Income Tax

Business Profits Collaboration Agreement Foreign Enterprise Representative Assessee Tax At Source

Summary

Issues Involved:
1. Definition and applicability of "royalty" under the Income-tax Act, 1961.
2. Definition and applicability of "royalty" under the Double Taxation Avoidance Agreement (DTAA) between India and the UK.
3. Determination of whether the payments made by the assessee to the foreign entity constitute "royalty" or "business profits."
4. Consideration of the permanent establishment status of the foreign entity in India.

Issue-Wise Detailed Analysis:

1. Definition and Applicability of "Royalty" under the Income-tax Act, 1961:
The primary issue involves whether the payments made by the assessee to the foreign entity (TL) can be classified as "royalty" under the Income-tax Act, 1961. The term "royalty" is defined in Explanation 2 to section 9(1)(vi) of the Act, which includes consideration for:
- Transfer of all or any rights in respect of a patent, invention, model, design, secret formula or process, or trademark.
- Imparting information concerning the working or use of such intellectual properties.
- Use of any patent, invention, model, design, secret formula or process, or trademark.
- Imparting information concerning technical, industrial, commercial, or scientific knowledge.
- Transfer of rights in respect of any copyright, literary, artistic, or scientific work.
- Rendering of services related to the above activities.

The IAC (Asst.) treated the payments as "royalty" under the Income-tax Act, 1961, and issued certificates for tax remittance at 20%.

2. Definition and Applicability of "Royalty" under the Double Taxation Avoidance Agreement (DTAA) between India and the UK:
The DTAA between India and the UK defines "royalties" in Article XIII, para 3, as payments for the use of, or the right to use:
- Any patent, trademark, design, model, plan, secret formula, or process.
- Industrial, commercial, or scientific equipment or information.
- Any copyright of literary, artistic, or scientific work, cinematographic films, and films or tapes for radio or television broadcasting.

The DTAA definition is narrower than the Income-tax Act, excluding certain elements such as the transfer of rights and imparting information concerning the working of patents or processes.

3. Determination of Whether the Payments Made by the Assessee Constitute "Royalty" or "Business Profits":
The assessee argued that the payments were for the purchase of equipment and know-how, akin to a video tape or computer software system, and did not constitute "royalty" under the DTAA. The CIT (A) initially held that the payments were for technical know-how and thus classified as "royalty." However, the Tribunal found that the payments fell within the exclusionary clauses of the DTAA definition, which does not cover the transfer of rights in respect of patents or processes or the imparting of information concerning their working.

The Tribunal concluded that the payments were for the transfer of drawings, designs, and know-how, which constituted business profits for the foreign entity (TL) and not "royalty."

4. Consideration of the Permanent Establishment Status of the Foreign Entity in India:
Article VII of the DTAA states that business profits of an enterprise can only be taxed in the state where the enterprise is resident unless it has a permanent establishment in the other state. Article V defines "permanent establishment" and includes various categories, none of which applied to TL. TL provided a certificate stating it had no permanent establishment in India.

The Tribunal agreed with the assessee that TL had no permanent establishment in India and thus, the payments constituted business profits, not taxable in India under Article VII of the DTAA.

Conclusion:
The Tribunal allowed the appeals, holding that the payments made by the assessee to TL did not constitute "royalty" under the DTAA but were business profits, not taxable in India due to the absence of a permanent establishment of TL in India. The definition of "royalty" under the DTAA prevailed over the broader definition under the Income-tax Act, 1961.