2008 (11) TMI 74 - HC - Income Tax

Royalties under domestic law count as 'industrial or commercial profits' under Article III of India-Germany DTAA; no tax without PE

HC held that payments characterized as royalties under domestic law fall within 'industrial or commercial profits' under Article III of the India-Germany ... Taxability of the income - deemed to accrue in India - Nature of 'fees for technical services' - definition of the term 'royalty' in Explanation 2 to Section 9(1)(vii) of the Income-tax Act Or 'industrial or commercial profits' for the purpose of Article III(1) of Double Taxation Avoidance Agreement (DTAA) entered into between the Governments of India and the Federal Republic of Germany (German DTAA) - Whether the amounts received under those Agreements by the Respondent from the three Companies were chargeable to tax in India either having regard to the provisions of the Income Tax Act, 1961 - HELD THAT:- In our opinion, even in the absence of royalty being defined under the Clauses of the Agreement, if it amounts to any industrial or commercial profit it would be taxable under Clause III provided there is a permanent establishment in India unless we hold that considering the explanation to Section 9 brought by the Finance Act, 2007 the requirement of P.E. is now of no consequences. While considering the D.T.A.A. the expression 'law in force' would not only include a tax already covered by the Treaty but would also include any othertax as taxes of a substantially similar character subsequent to the date of the agreement as set out in Article I(2). Considering the express language of Article I (2) it is not possible to accept the broad proposition urged on behalf of the assessee that the law would be the law as was applicable or as defined when the D.T.A.A. was entered into. The question however, would still remain, whether the income by way of royalties other than those included in Article III(3) are subject to tax in India considering the D.T.A.A. when there is no permanent establishment. We may also note at this stage that the rule of referential incorporation or incorporation cannot be applied when we are dealing with a Treaty (D.T.A.A.) between two Sovereign Nations. Though it is open to a Sovereign Legislature to amend its Laws, a D.T.A.A. entered into by the Government in exercise of the powers conferred by Section 10(1) while considering Section 10(2) have to be reasonably construed. In our opinion the correct interpretation of the D.T.A.A. would be to include the royalties from Patents, copyrights or trade marks and the like within the expression 'industrial' or 'commercial' profits. The learned Tribunal, therefore, has correctly taken a view that though this income would not be royalties within the meaning of D.T.A.A. but would fall under the expression 'commercial or industrial profits'. In the absence of a PE such income would not be taxable in India. Once in respect of the same assessee the issue was in issue before the Tribunal of Competent jurisdiction and the Tribunal having answered the issue and that having not been challenged it will not be open to the revenue to raise the said issue again in respect of the same assessee. The only exception would be if the statute expressly provides that such findings are not conclusive. This is not the case here. The income would be royalty but fall within the expression 'industrial or commercial profits' within the meaning of Article III of D.T.A.A. Issues Involved:1. Taxability of amounts received under agreements as 'royalty' or 'industrial or commercial profits' under the Double Taxation Avoidance Agreement (DTAA) between India and Germany.2. Interpretation of 'royalty' under Section 9(1)(vi) of the Income Tax Act, 1961, and its applicability under the DTAA.3. Taxability of 'fees for technical services' under Section 9(1)(vii) of the Income Tax Act.4. Taxability of reimbursement of expenses.Detailed Analysis:1. Taxability of Amounts Received as 'Royalty' or 'Industrial or Commercial Profits':The Tribunal considered several agreements between the assessee and companies like Siemens, BEL, and BHEL. The Tribunal held that payments described as royalties under these agreements fell within the meaning of 'royalty' under Section 9(1)(vi) of the Income Tax Act but were not considered royalties under the DTAA. Instead, they were classified as 'industrial or commercial profits.' As the assessee had no permanent establishment (PE) in India, these amounts were not taxable in India under the DTAA.2. Interpretation of 'Royalty' Under Section 9(1)(vi) and DTAA:The Tribunal and the High Court examined whether the definition of 'royalty' in Explanation 2 to Section 9(1)(vi) of the Income Tax Act applied to the term as used in Article III(3) of the DTAA. The court noted that the term 'royalty' was not defined in the DTAA at the relevant time. The court concluded that the income received by the assessee, though classified as 'royalty' under the Income Tax Act, should be treated as 'industrial or commercial profits' under the DTAA, provided there was no PE in India.3. Taxability of 'Fees for Technical Services':The Tribunal considered payments under agreements dated 27th July 1975 and 28th October 1975 as 'fees for technical services' under Section 9(1)(vii) of the Income Tax Act. The Tribunal held that these payments were not 'royalty' under the Income Tax Act or the DTAA but were part of 'industrial or commercial profits.' As the assessee had no PE in India, these amounts were not taxable in India.4. Taxability of Reimbursement of Expenses:The Tribunal held that reimbursement of expenses, such as the sum of Rs. 84,246/- received from BHEL, was not taxable. The court cited judgments from the Delhi and Calcutta High Courts, which held that reimbursement of expenses could not be regarded as revenue receipts and, therefore, were not assessable to tax.Conclusion:The court answered the reference questions as follows:1. The definition of 'royalty' in Explanation 2 to Section 9(1)(vi) of the Income Tax Act does not apply to the term as used in Article III(3) of the DTAA.2. The sums received from Siemens, BEL, and BHEL would constitute 'industrial or commercial profits' under Article III(1) of the DTAA.3. The sums due from BHEL under the agreements were in the nature of 'fees for technical services' within Section 9(1)(vii) of the Income Tax Act and not 'royalty.'4. These sums would constitute 'industrial or commercial profits' under Article III(1) of the DTAA.5. The reimbursement of expenses did not constitute 'royalty' and was not chargeable to tax in India.The court emphasized that the provisions of the DTAA, being more beneficial to the assessee, would prevail over the Income Tax Act, provided there was no PE in India. The court also noted that the explanation inserted by the Finance Act, 2007, to Section 9(1) could not override the DTAA provisions.