2012 (6) TMI 328 - AT - Income Tax

DTAA between India and USA - Royalty income - taxability on gross basis or net basis - assessee opted for the provision contained under article 12 of DTAA contemplating taxation @ 15% of the gross amounts of royalties - Held that - Term Gross amounts has not been defined in the treaty. In common parlance, these words mean the amount received alongwith tax deducted etc. at source. Also, section 198, provides that all sums deducted in accordance with the provisions of chapter XVII shall be deemed to be income received for computing the income of an assessee. Thus, expression gross amount includes within its ambit the actual payment and tax deducted at source. Therefore, CIT(A) erred in taxing the net amount @ 15% under the DTAA - Decided in favor of Revenue. Whether, the income by way of royalty is taxable on cash basis or mercantile basis - Held that - Initial point of taxation is the arising of the royalty in India, but it is finally taxed on the basis of amount of royalty paid to the non-resident. Therefore, irrespective of the system of accounting, royalties are taxable on cash basis. Accordingly it is held that the amount provided by the licensee in its books of account but not paid to the assessee is not taxable. Matter restored to the file of AO to decide about chargeability of interest u/s 234B & 234C.

Summary

Issues Involved:
1. Taxation of notional royalty income.
2. Applicability of DTAA rate vs. domestic law rate for royalty income.
3. Chargeability of interest under sections 234B and 234C.
4. Basis of accounting for royalty income (cash vs. mercantile).

Detailed Analysis:

1. Taxation of Notional Royalty Income:
The assessee argued that only real income could be taxed, and as they followed a cash system of accounting, income should be taxed only when received. The Tribunal found that the royalty income for the period January 2003 to March 2003, during which no payment was made, should not be taxed as it was not received. The Tribunal cited a precedent where royalties are taxable on a cash basis, not accrual basis.

2. Applicability of DTAA Rate vs. Domestic Law Rate for Royalty Income:
The revenue contended that the royalty income should be taxed at 20% under domestic law since the assessee claimed an exemption under section 10(6A) of the Income Tax Act. The Tribunal noted that Article 12 of the DTAA prescribes a 15% tax rate on "gross amounts" of royalties. The term "gross amounts" includes the actual payment and the tax deducted at source. The Tribunal concluded that the assessee should be taxed at 15% of the gross amount under the DTAA, reversing the CIT(A)'s decision that allowed taxation at 15% on a net basis.

3. Chargeability of Interest Under Sections 234B and 234C:
The revenue argued that the assessee should pay interest under sections 234B and 234C for not paying advance tax on the royalty income. The Tribunal decided that since the royalty income is taxable on a cash basis, there was no liability for advance tax, and hence no interest under sections 234B and 234C should be charged. The matter was remanded to the AO for verification and final decision based on facts and law.

4. Basis of Accounting for Royalty Income (Cash vs. Mercantile):
The Tribunal upheld that the royalty income should be taxed on a cash basis, as per the DTAA, which takes precedence over domestic law. The Tribunal referenced previous cases to support that royalties are taxable on a payment basis, not on an accrual basis. The Tribunal noted that the royalty for the period when the agreement was not in force was not paid, and hence, should not be taxed.

Conclusion:
The Tribunal allowed the assessee's appeal for AY 2004-05, and the revenue's appeals for AY 2003-04 and 2004-05 were allowed for statistical purposes. The Tribunal emphasized that royalty income should be taxed on a cash basis at 15% of the gross amount under the DTAA, and no interest under sections 234B and 234C should be charged if there was no liability for advance tax.