Royalty characterization under the India-Sri Lanka treaty prevails where restricted software and know-how rights are granted without ownership transfer.
A composite contract granting restricted rights to use proprietary software, installation, perpetual licence, training, support, scientific know-how and equipment was characterised as royalty under Article 12 of the India-Sri Lanka Tax Treaty because it involved payment for use of scientific work, model, plan, equipment and experience without transfer of ownership or intellectual property. In the absence of a specific treaty article for fees for technical services, the residuary article could apply only where income was not otherwise covered, but that issue did not arise once the receipts were classified as royalties. The consideration was therefore taxable as royalty income, not as business profits under Article 7.
Issues: (i) Whether the consideration received under the contract was chargeable as royalties under Article 12 of the India-Sri Lanka Tax Treaty; (ii) whether, in the absence of a specific article for fees for technical services, the receipts could be brought under Article 7 as business profits or under Article 22 as residuary income.
Issue (i): Whether the consideration received under the contract was chargeable as royalties under Article 12 of the India-Sri Lanka Tax Treaty.
Analysis: The contractual arrangement covered not merely consultancy or field work but also transfer of software rights, installation, perpetual licence, training, support, and use of scientific know-how and equipment for the project. The consideration was found to be paid for the use of scientific work, model, plan, equipment, and scientific experience, while ownership and intellectual property in the software were not transferred. The substance of the arrangement showed technology transfer through restricted rights to use proprietary software and associated scientific expertise.
Conclusion: The receipts were held to be royalties under Article 12 of the India-Sri Lanka Tax Treaty and taxable accordingly.
Issue (ii): Whether, in the absence of a specific article for fees for technical services, the receipts could be brought under Article 7 as business profits or under Article 22 as residuary income.
Analysis: Since the treaty did not contain a specific article for fees for technical services, the residuary article applied to such income if it was not otherwise covered by a specific distributive rule. In view of the finding that the consideration was royalties, the question whether the same receipts could alternatively be taxed as business profits under Article 7 did not survive for decision, and the characterization as royalties governed the tax treatment.
Conclusion: The receipts were held not to fall under Article 7 as business profits, and the question of taxing them as fees for technical services was answered by applying the residuary treaty article.
Final Conclusion: The treaty characterization of the entire consideration was determined in favour of the revenue as royalties, leaving the service PE question academic and resulting in taxation under the royalty article rather than as business profits.
Ratio Decidendi: Where a composite contract substantially grants limited rights to use proprietary software and transfers scientific know-how, model-based expertise, and allied rights without transferring ownership, the consideration is taxable as royalties under the treaty's royalty article, and not as ordinary business profits.