2008 (7) TMI 456 - AT - Income Tax

Summary

Issues Involved:
1. Nature of Payment: Whether the payment made by the assessee to PBAT is business income or royalty.
2. Applicability of Section 195(2) of the IT Act: Whether the assessee is required to deduct tax at source before remitting the amount to PBAT.
3. Interpretation of the Double Taxation Avoidance Agreement (DTAA) between India and Thailand.
4. Permanent Establishment (PE): Whether PBAT has a PE in India.

Detailed Analysis:

1. Nature of Payment:
The primary issue is whether the payment made by the assessee to PBAT for the supply of designs and drawings is to be treated as business income or royalty. The assessee contended that the payment represents consideration for the sale of drawings and designs, which were prepared outside India, and thus constitutes business profits. Since PBAT does not have a PE in India, the profits are not taxable in India. The AO, however, classified the payment as "royalty" under Article 12 of the DTAA between India and Thailand, arguing that the payment was for the use of designs and drawings developed by PBAT.

The Tribunal examined the agreement between the parties, noting that although it was titled a "service agreement," the substance of the agreement indicated an outright sale of drawings and designs. The agreement provided for the supply of detailed design services, including preparation and submission of drawings and data. The Tribunal concluded that the agreement was for the sale of tangible movable property and thus the consideration should be treated as business profits, not royalty.

2. Applicability of Section 195(2) of the IT Act:
The assessee made an application under Section 195(2) of the IT Act to remit the amount without any deduction of tax, arguing that the payment was not taxable in India. The AO directed the assessee to deduct tax at 15% before remitting the amount, considering it as royalty. The CIT(A) upheld the AO's decision, stating that the payment fell within the definition of royalty under Explanation 2 to Section 9(1)(vi) of the IT Act.

The Tribunal disagreed with the AO and CIT(A), stating that the payment represented business profits from the sale of drawings and designs, which were prepared outside India. Since PBAT did not have a PE in India, the profits were not taxable in India, and thus, the assessee was not required to deduct tax at source.

3. Interpretation of the Double Taxation Avoidance Agreement (DTAA) between India and Thailand:
The Tribunal emphasized that the DTAA should be interpreted to provide relief from double taxation and not as a taxing enactment. Article 12.3 of the DTAA defines "royalty" and includes consideration for the alienation of any design or model. However, the Tribunal applied the rule of noscitur a sociis, interpreting the terms "design" and "model" in the context of intellectual property rights. The Tribunal concluded that the outright sale of drawings and designs does not fall within the definition of royalty under the DTAA.

4. Permanent Establishment (PE):
The assessee argued that PBAT did not have a PE in India, and thus, the business profits from the sale of drawings and designs were not taxable in India under Article 7 of the DTAA. The CIT-Departmental Representative contended that the assessee might not be aware of whether PBAT had a PE in India. However, the Tribunal held that it was open to the assessee to raise this plea and noted that the AO and CIT(A) did not dispute the assessee's statement that PBAT had no PE in India.

Conclusion:
The Tribunal concluded that the payment made by the assessee to PBAT was for the outright sale of drawings and designs, constituting business profits and not royalty. Since PBAT did not have a PE in India, the profits were not taxable in India. Consequently, the assessee was not required to deduct tax at source under Section 195(2) of the IT Act. The orders of the AO and CIT(A) were set aside, and the appeal of the assessee was allowed.