2025 (4) TMI 1561 - 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 - Hon ble Tribunal in assessee s own case for AY 2021-22 2024 (6) TMI 1457 - ITAT DELHI while relying on aforesaid orders held that the background screening services provided by the assessee does not quality as royalty Thus background screening services provided by an assessee does not qualify royalty and no additions can be made on account of royalty and decided the appeals in favour of the assessee.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal in these appeals are:

(a) Whether the Assessing Officer (AO) erred in determining taxable income by treating receipts from background screening and investigation services as 'Royalty' under Explanation 2 to Section 9(1)(vi) of the Income-tax Act, 1961 ("the Act") and Article 12 of the relevant Double Taxation Avoidance Agreements (DTAA) (India-UK and India-USA respectively);

(b) Whether the reports provided by the assessee qualify as copyrightable works, and whether the use of such reports by clients amounts to use of copyright attracting tax as royalty;

(c) Whether the consideration received by the assessee is for use or right to use a database maintained by the assessee, thereby constituting royalty;

(d) Whether the screening reports contain confidential information or impart commercial experience, skill, or know-how to clients, thus constituting royalty or fees for technical services (FTS);

(e) Whether the services rendered by the assessee qualify as FTS under Article 13(4) of the DTAA;

(f) Whether the AO erred in levying interest under Sections 234A, 234B, and 234C of the Act;

(g) Whether the AO erred in initiating penalty proceedings under Section 270A of the Act;

(h) In the case of the appeal involving India-USA DTAA, whether the recovery of common internet and IT-related costs from the Indian associate enterprise amounts to royalty;

(i) Whether exemption under Section 10(50) of the Act was rightly denied by the AO.

2. ISSUE-WISE DETAILED ANALYSIS

Issue (a) & (b): Taxability of Background Screening Services as Royalty under DTAA and Copyright Law

Legal Framework and Precedents: The AO relied on Explanation 2 to Section 9(1)(vi) of the Act and Article 12 of the India-UK and India-USA DTAA, which define 'Royalty' to include consideration for the use of or right to use copyright of literary, artistic or scientific work, including computer software. The Indian Copyright Act, 1957, defines copyrightable works and the rights conferred under Section 14.

Court's Interpretation and Reasoning: The Tribunal referred extensively to its earlier orders in the assessee's own cases for AY 2021-22 and 2022-23, where it was held that the background screening reports are factual data summarising findings of verification and do not qualify as literary or artistic works protected under copyright law. The reports do not fulfill the requirements under Section 13(1)(a) of the Copyright Act and no rights under Section 14(a) were transferred to clients. The client's right is limited to internal use of the report findings without rights of reproduction, distribution, or commercial exploitation.

Key Evidence and Findings: The assessee demonstrated that the reports contain factual information such as employment and education verification, which is not copyrightable. No evidence was produced by the revenue to establish that the reports are copyrightable or that rights were transferred.

Application of Law to Facts: The Tribunal applied the legal tests for royalty and copyright and found that the receipts are consideration for services rendered, not for use of copyright. The Supreme Court decision in Engineering Analysis Centre of Excellence (P) Ltd. vs. CIT was relied upon to support this interpretation.

Treatment of Competing Arguments: The AO's view was based on surmises and assumptions that reports are copyrightable and that database rights were transferred. The Tribunal rejected these on the basis of factual matrix and legal principles. The revenue did not contest the binding precedents.

Conclusions: The Tribunal concluded that the receipts from background screening services do not constitute royalty under the Act or DTAA.

Issue (c): Whether Consideration is for Use or Right to Use Database

Legal Framework and Precedents: Royalty under DTAA includes consideration for use of or right to use a database. The AO alleged that the assessee maintained a database and provided access to clients.

Court's Interpretation and Reasoning: The Tribunal found that the assessee only provided reports electronically and did not grant access to any database. The access was limited to specific reports requested by clients, not to the database itself.

Key Evidence and Findings: The assessee's submissions and records showed no access to database but only to discrete reports. The revenue failed to produce contrary evidence.

Application of Law to Facts: Since no database access was granted, the receipts cannot be treated as royalty for use of database.

Conclusions: The Tribunal held that no royalty arises from database use.

Issue (d): Whether Screening Reports Contain Confidential Information or Impart Commercial Experience

Legal Framework and Precedents: Royalty also includes consideration for use of industrial, commercial, or scientific experience. Fees for technical services (FTS) under Article 13(4) of DTAA cover services involving technical knowledge or skill.

Court's Interpretation and Reasoning: The Tribunal observed that the information in the reports is factual data about candidates, such as educational and professional details, which is publicly available or verifiable and does not amount to imparting commercial experience. The assessee does not transfer any skill, knowledge, or know-how to clients.

Key Evidence and Findings: The reports merely validate information and do not provide advice or consultancy. The clients independently decide on hiring based on the reports.

Application of Law to Facts: The Tribunal applied the legal tests to conclude that the services are not FTS and do not involve transfer of commercial experience or technical knowledge.

Treatment of Competing Arguments: The AO's characterization of the receipts as royalty or FTS was rejected as legally untenable.

Conclusions: The Tribunal held that the receipts are not taxable as royalty or FTS.

Issue (e): Taxability of Recovery of Common Internet and IT-Related Costs

Legal Framework and Precedents: The AO treated reimbursements of common internet and IT costs recovered from the Indian associate enterprise as royalty under the Act and DTAA.

Court's Interpretation and Reasoning: The assessee did not press this ground in one appeal, leading to its rejection. The Tribunal did not find merit in this claim in the other appeal, holding it as cost-to-cost reimbursement without transfer of rights.

Conclusions: This ground was rejected against the assessee.

Issue (f) & (g): Levy of Interest and Penalty Proceedings

Legal Framework: Interest under Sections 234A, 234B, and 234C is levied for defaults in filing returns and payment of advance tax; penalty under Section 270A is for concealment or misreporting of income.

Court's Interpretation and Reasoning: Since the primary additions were disallowed and the income was correctly returned as nil, the levy of interest and penalty was held to be erroneous.

Conclusions: The Tribunal allowed the appeals on these grounds in favor of the assessee.

Issue (h) & (i): Exemption under Section 10(50) and Taxability under India-USA DTAA

Legal Framework: Section 10(50) provides exemption to certain income of non-resident entities; the India-USA DTAA provisions were invoked by the AO to tax receipts as royalty.

Court's Interpretation and Reasoning: The Tribunal applied the same reasoning as in the India-UK DTAA cases, holding that the receipts are not royalty and that the exemption under Section 10(50) was wrongly denied.

Conclusions: The Tribunal partly allowed the appeal, except the ground relating to recovery of IT costs.

3. SIGNIFICANT HOLDINGS

"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 summarising 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."

"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."

"The information obtained by the assessee from various sources is in the nature of factual data about the prospective candidates proposed to be hired by the clients. This information is not an information which involves imparting of any kind of commercial experience, skill or expertise."

"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. 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."

"In our considered opinion, 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."

"No addition on account 'Royalty' is warranted in this case."

Final determinations:

- The receipts from background screening and investigation services do not constitute royalty under the Act or DTAA.

- The reports provided are not copyrightable works and do not transfer copyright rights to clients.

- No database access or use/right to use database was granted to clients.

- The services do not impart commercial experience or constitute FTS.

- Interest and penalty levied on the basis of erroneous additions were not justified.

- Recovery of common internet and IT costs on cost-to-cost basis was not pressed and rejected.

- Exemption under Section 10(50) was wrongly denied and should be allowed.