1990 (12) TMI 51 - HC - Income Tax

Payments for imported designs held consideration for outright sale, not royalty, under Explanation 2 to section 9(1)(vi).

HC held that payments made by the resident assessee to the non-resident for drawings and designs constituted consideration for an outright transfer of ... Double Taxation Avoidance Agreement - payments made to the non-resident company were in the nature of royalty within the meaning of Explanation 2 to section 9(1)(vi) - Whether, the Appellate Tribunal was correct in law in holding that the payment of made by the assessee-company to the foreign party as consideration for outright sale of drawings and design was not 'royalty' exigible to tax under the Income-tax Act, 1961 ? - HELD THAT:- The term 'royalty' has been defined in the agreement to mean, inter alia, the payment of any kind including rentals received as consideration for the use of or the right to use any patent, trademark, design or model, plan, secret formula or process. Therefore, what is important to consider is that, in order that a payment may be treated as royalty for the purposes of article XIII of the Agreement for Avoidance of Double Taxation between India and the U. K., the person who is the owner of such patents, designs or models, plans, secret formula or process, etc., retains the property in them and permits the use or allows the right to use such patents, designs or models, plans, secret formula, etc. In other words, where the transferor retains the property right in the designs, secret formula, etc., and allows the use of such right, the consideration received for such user is in the nature of royalty. Where, however, there is an outright sale or purchase, as in the present case, the consideration is for the transfer of such designs, secret formula, etc., and cannot be treated as royalty. In the case of secret processes, patents, special inventions, etc., where the right of exploitation is given by an owner to a third party instead of an outright sale, then for the right to exploit them, the secret processes, designs, etc., and the amount paid which may be either in lump or a periodic one partakes of the character of royalty. It must be held that the present case is not a case where the non-resident is retaining the property in the designs and drawings. Such designs and drawings are imported under the import policy and with the approval of the Reserve Bank of India on the basis of the letter of intent. The importation of the designs and drawings postulates an out and out transfer or sale of such designs and drawings and the non-resident company does not retain any property in them leaving the grantee to use or exploit them. The consideration paid for transfer, therefore, cannot be treated as royalty falling under article XIII of the Agreement for Avoidance of Double Taxation between India and the U. K. The consideration paid is for an outright transfer of the drawings and designs by the non-resident company and such consideration cannot be termed as royalty. We, therefore, answer the question in this reference in the affirmative and in favour of the assessee. Issues Involved:1. Whether the payment of £36,470 made by the assessee-company to the foreign party as consideration for the outright sale of drawings and design was 'royalty' exigible to tax u/s 9(1)(vi) of the Income-tax Act, 1961.Summary:Issue 1: Nature of Payment - Royalty or Outright SaleThe core issue was whether the payment of £36,470 made by the assessee-company to the foreign party for the outright sale of drawings and designs constituted 'royalty' under the Income-tax Act, 1961. The Income-tax Officer classified the payment as royalty u/s 9(1)(vi) and applied a 20% tax rate. However, the Commissioner of Income-tax (Appeals) and the Tribunal found that the transaction was an outright sale, not a royalty payment. The Tribunal emphasized that under clause 2 of article XIII of the Avoidance of Double Taxation Agreement between India and the U.K., such a transfer by outright sale cannot be termed as royalty. The Tribunal further noted that clause 3 of article XIII provides a different meaning to 'royalty' than Explanation 2 to section 9(1)(vi) of the Income-tax Act, 1961. Consequently, the provisions of the Double Taxation Agreement would prevail over the Act, as per Circular No. 333 of the Central Board of Direct Taxes dated April 2, 1982.Issue 2: Precedence of Double Taxation Agreement Over Income-tax ActThe court addressed the contention that the Income-tax Act should prevail over the Double Taxation Agreement in case of inconsistency. The court held that the Agreement for Avoidance of Double Taxation, entered into u/s 90 of the Income-tax Act, must prevail over the Act's provisions. The court cited the notification enforcing the convention between India and the U.K. and the Andhra Pradesh High Court's decision in CIT v. Visakhapatnam Port Trust [1983] 144 ITR 146, which supported the precedence of the Agreement over the Act. The court concluded that the Agreement's specific provisions regarding 'royalty' would override the general provisions of the Income-tax Act.Issue 3: Definition and Interpretation of 'Royalty'The court examined the definition of 'royalty' in the Double Taxation Agreement, which includes payments for the use or right to use patents, trademarks, designs, models, plans, secret formulas, etc. The court noted that for a payment to be considered royalty, the owner must retain property rights and permit use. In this case, the foreign company did not retain any property rights in the designs and drawings, indicating an outright sale rather than a royalty transaction. The court referenced various judgments, including CIT v. Ahmedabad Manufacturing and Calico Printing Co. [1983] 139 ITR 806 and CIT v. Hindusthan General Electrical Corporation Ltd. [1971] 81 ITR 243, to support its interpretation.Conclusion:The court concluded that the payment of £36,470 was for an outright transfer of designs and drawings, not royalty. Thus, it was not taxable u/s 9(1)(vi) of the Income-tax Act, 1961. The question was answered in the affirmative and in favor of the assessee, with no order as to costs.