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TMI Blog1999 (4) TMI 612X X X X Extracts X X X X X X X X Extracts X X X X ..... f section 43A of the Companies Act, 1956, on the basis of turnover criteria. It has set up a 100 per cent. EOU and has commenced commercial operations and export from June, 1995, to various countries around the world. The activities/operations of its business in its EOU involve data management, information analysis and control. Its customers currently consist of various "ABC" companies located in different countries. It needs to be mentioned here that "XT" is a wholly owned subsidiary of "Z" of USA. "Y", the applicant-company has, inter alia, a World Wide Information Processing Telecommunication Centre (hereinafter referred to as "WIPT Centre") at USA. It owns and maintains at the said WIPT Centre a huge high-tech computer complex having 15 to 20 mainframe IBM computers and other related hardware and software facilities involving substantial investment and capable of very high volume storage and high speed processing of data. "Y" allows its customers to have access to and to use its Central Processing Unit (CPU) at USA against payment. "XT" is one such entity which uses Y's extensive CPU set up in USA to meet part of its processing needs. The CPU of "Y" at USA is accessed and used ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... India ? (ii) If the answer to question No. 1 is in the affirmative, whether the payment due to the applicant under the transaction mentioned in annexure-B is covered under article 12(3)(a) or article 12(3)(b) of the Double Taxation Avoidance Agreement between India and the USA ? To put the question raised by the applicant in proper perspective, it would be in order to reproduce part of the said annexure-B referred to above : Annexure-B Relevant facts : The application pertains to the liability to tax in India of the charges receivable by the applicant from an Indian company for the use of the applicant's "Central Processing Unit" (CPU) at USA and "Consolidated Data Network" (CDN). A. The applicant : The management and control of the applicant is not situated in India. B. The Indian company (XT) : The Indian company has a 100 per cent. EOU for performing activities of "data management, information analysis and control" for XT's customers. "XT" has its own infrastructure in terms of processors/related computer equipment, own microwave tower, leased circuits and so on. C. Central Processing Unit (CPU) in USA : The applicant, inter alia, has a global "Central Processing Uni ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in India. It is claimed that "XT" is an Indian company and it is not connected with the applicant. The applicant-company receives charges for use of the CPU and CDN by "XT". Since the processing of the data is done in the computers located in Hong Kong and the USA and not in India, no business activity of the applicant arises in India and hence the charges paid by "XT" to the applicant are not taxable in India. "XT" is registered as an Indian company as a 100 per cent. export oriented unit. It provides customer services, mainly, by way of data processing to 13 companies of the ABC group located all over the world, mainly, in Asia and the Pacific. The income of "XT" is, therefore, received in foreign exchange for export of software and hence it is exempted from income-tax under section 80HHE. For doing data processing work pertaining to the travel related services, "XT" accesses the centralised computer of the applicant-company located both in Hong Kong and in USA. As already set out above, "XT" has been authorised by an agreement with the applicant-company to use the applicant's computer system. "XT" also uses the software developed by the applicant-company available in the comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to it from "XT" as business income (other than income by way of "royalty") has to be viewed in the light of the provisions of article 7 of the DTAA (relating to taxation of business income, other than income in the nature of royalty referred to in article 12), read with article 5 of the DTAA which contains an exhaustive definition of the term "permanent establishment" of the enterprise of one of the Contracting States in the other Contracting State. It was submitted that under the provisions of paragraph 1 of article 7 of the DTAA, the business profits of an enterprise of one of the Contracting States shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein and that, in the latter case, only so much of business profit of the enterprise of a Contracting State may be taxed in the other Contracting State as is attributable to the permanent establishment of that enterprise situated in the other Contracting State. It was submitted that the applicant-company did not have any "permanent establishment" in India within the meaning of that term in article 5 of the DTAA. In this connection ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ign", it was submitted that the payments due to "Y" from "XT" for the use of the CPU of "Y" in USA did not involve the rendering of any such services by "Y" to "XT". In this connection, reference was invited to the clarifications regarding the applicability of the provisions of paragraph 4(b) of article 12 of the DTAA contained in the memorandum of understanding concerning royalties and fees for included services, appended to the DTAA. It was also submitted that the payments in question were not taxable in the hands of "Y" in India as income by way of "fees for technical services" as defined in Explanation 2 to section 9(1)(vii) of the Income-tax Act, 1961, as "Y" was not rendering to "XT" any "managerial, technical or consultancy services (including the provision of technical or other personnel)" in allowing "XT" to use its CPU at USA. Finally, it was argued that the payments due to "Y" from "XT" for having access to and for using its CPU at USA were not taxable in the hands of "Y" in India as income accruing or arising or deemed to have accrued or arisen to "Y" or received by it or on its behalf in India. "Y" does not have any "business connection" as such in India as "XT" is no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Indian company, it would be quite clear that the payment has been received as "consideration for use of, or right to use . . . design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience" within the meaning of the term "royalty" as per article 12(3)(a). Article 3(2) of the Double Taxation Avoidance Agreement with USA deals with general definitions. Article 3(2) states that any term not defined in the convention, shall have the meaning which it has under the laws of that State. However, the term "royalty" has been explicitly defined in article 12. That definition would override the definition of "royalty" as appearing in the Income-tax Act, 1961. The Departmental representative further argued that the definition of "royalty" alludes to the concept of "know-how". In classifying as royalties payments received as consideration for information concerning industrial, commercial or scientific experience, the concept of "know-how" comes to play a significant role. Know- how is any undivulged technical information, whether capable of being patented or not, that is necessary for the industrial reproduction of a product or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cessing systems and to act as information technology consultants and to operate a high technology data processing centre, for providing management, processing, analysis, development and accounting, information and data to ABC companies and other companies in Asia and Europe and other countries." It would be relevant to reproduce paragraphs 2 and 3 of article 12 of the DTAA which read as under (see [1991] 187 ITR (St.) 102, 115) : "(2) However, such royalties and fees for included services may also be taxed in the Contracting State in which they arise and according to the laws of that State ; but if the beneficial owner of the royalties or fees for included services is a resident of the other Contracting State, the tax so charged shall not exceed : (a) in the case of royalties referred to in sub-paragraph (a) of paragraph 3 and fees for included services as defined in this article (other than services described in sub-paragraph (b) of this paragraph) : (i) during the first five taxable years for which this convention has effect, (A) 15 per cent. of the gross amount of the royalties or fees for included services as defined in this article, where the payer of the royalties or fee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wn software and is operated by its own personnel in USA. "XT" is retrieving from the CPU the processed data of its customers and "XT" is to make payment to "Y" only for having access to this data and to use the computer system. This clearly establishes that the software used in the CPU is that of the applicant and it has allowed the Indian company to use its software. The same software is also used by various other subsidiaries and group companies of the applicant. The actual use of CPU at USA is not directly accessible to the Indian company. The Indian company accesses the CDN computer system of the applicant at Hong Kong. After having accessed the CDN, it establishes access to the CPU through the CDN. At both the stages, the Indian company is allowed to use the software developed and protected by the applicant-company. As is the practice in Canada, the USA and other developed countries, allowing the use of protected software for a consideration by way of a contract amounts to income by way of royalties covered under article 12(3)(a) of the DTAA. Reference to Klaus Vogel's Commentary on Double Taxation Conventions (page 787, para 27) shows that in Canada, payment for use of soft ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ay-to-day basis. It is well known that globally, enterprises are becoming completely networked, more so in the field of software. "Y", in the present case, is a service-provider, which, inter alia, allows "XT" to use its bandwidth as also its networking-infrastructure for the consideration spelt out in the agreement. In the instant case, though workers are less mobile than the capital and technology, the access to which has been made possible through the CPU and CDN. Undoubtedly, there are millions of transactions which are integrated and processed at a very high speed and every transaction is accounted for in the books of account. For all intents and purposes, "XT" not only collects the data regarding the use of travel documents by the applicant's clients in India and transmits it to the multi-locational electronic set up of the applicant, it also provides various other services such as sending daily and monthly record of bills and payments to its service establishments. On their own admission, after the billing of every card member is completed, the process of collection starts which is captured and recorded in the books. The information is also stored centrally in the CPU which ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e in writing, on a magnetic tape or disc, or on a laser disc. It may be standardised with a wide range of applications or be tailor made for single users. It can be transferred as an integral part of computer hardware or in an independent form available for use on a variety of hardware. The rights in computer software are a form of intellectual property. Research into the practices of OECD member countries has established that all but one protect software rights either explicitly or implicitly under copyright law. Transfer of rights occur in many different ways ranging from the alienation of the entire rights to the sale of a product which is subject to restrictions on the use to which it is put. The consideration paid can also take numerous forms. These factors may make it difficult to determine where the boundary lies between software payments that are properly to be regarded as royalties and other types of payment. 13. Three types of software transfer.-Three situations are considered. The first is of payments made where less than the full rights in software are transferred. In a partial transfer of rights the consideration is likely to represent a royalty only in very limited c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng of the term "royalties" in article 12(3)(a). From the question raised by the applicant, it seems that the applicant is aware of the taxability of the payment received under the head "royalty", but it has also raised the question whether the aforesaid payment could be covered under article 12(3)(b), which speaks of "payment of any kind received as consideration for the use of or the right to use any industrial, commercial or scientific equipment". If the case of the applicant falls under the aforesaid article 12(3)(b), the gross payment would be taxable at 10 per cent. If it falls under article 12(3)(a), the gross payment would be taxable at 20 per cent. for the first five years and thereafter at 15 per cent. In our opinion, the use by "XT" of CPU and CDN of the applicant is not merely use of equipment as evisaged in article 12(3)(b) of the DTAA but is more than that. From the transactions of the applicant with the Indian company as set out in para. 6 above, it is quite clear that CPU/CDN of the applicant are modern technological designs or models involving customised communication and computation with application of sophisticated information-technology requiring constant upkeep ..... X X X X Extracts X X X X X X X X Extracts X X X X
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