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 ... Royalty - fees for technical services - industrial or commercial profits - permanent establishment - application of Double Taxation Avoidance Agreement versus domestic law - referential incorporation of domestic tax law into treatyReferential incorporation of domestic tax law into treaty - royalty - application of Double Taxation Avoidance Agreement versus domestic law - Whether the definition of 'royalty' in Explanation 2 to Section 9(1)(vi) of the Income-tax Act applies to the term as used in Article III(3) of the Indo German DTAA. - HELD THAT: - The Court held that Article II(2) requires that terms not defined in the DTAA take the meaning they have under the laws in force in the relevant territory, but rejected the notion that a contracting state may unilaterally amend the treaty by later domestic legislation. The rule of referential incorporation cannot be used to allow unilateral domestic amendment of treaty obligations. Accordingly, the tribunal was correct to examine the treaty text and its scheme rather than treat later domestic definitions as automatically incorporated into the DTAA interpretation. The Court therefore answered the question in the affirmative, finding that the tribunal's approach to the treaty term was correct. [Paras 11, 21, 22, 30, 34]Affirmative; Explanation 2 to Section 9(1)(vi) does not automatically apply to the DTAA term and the tribunal's treaty based approach was correct.Royalty - industrial or commercial profits - permanent establishment - application of Double Taxation Avoidance Agreement versus domestic law - Whether specified receipts from Siemens, BEL and BHEL constitute 'royalty' within Article III(3) of the DTAA or instead form part of 'industrial or commercial profits' under Article III(1). - HELD THAT: - The Court analysed Article III(1) and (3) and the scheme of the DTAA, observing that Article III(3) excludes rents, royalties and certain other heads from the expression 'industrial or commercial profits' where those heads are governed separately by Articles V-XII. The Court held that royalties other than those expressly falling under Article IX (mines, quarries, etc.) can, if relatable to the enterprise's business, be treated as industrial or commercial profits for the purposes of Article III. Consequently the amounts in question, though royalty in domestic law, fall within the expression 'industrial or commercial profits' under the DTAA and thus are taxable in India only if attributable to a permanent establishment in India - which was absent. [Paras 6, 7, 30, 31, 34]The amounts are royalties under domestic law but fall within 'industrial or commercial profits' under Article III and are not taxable in India in the absence of a permanent establishment.Fees for technical services - royalty - Section 9(1)(vii) - Whether the sums of Rs.42,41,884 and Rs.1,71,759 payable by BHEL under the 1975 agreements are 'fees for technical services' within Section 9(1)(vii) of the Income tax Act and not 'royalty' under Explanation 2 to Section 9(1)(vi) or under the DTAA. - HELD THAT: - The Court accepted the tribunal's findings that those payments were consultancy/technical service charges for work performed (largely) outside India and were billed on the basis of man hours spent in Germany; they were not payments for transfer or license of know how falling within the statutory definition of royalty. The Court further treated prior unchallenged coordinate bench tribunal decisions on the same question as conclusive for finality, holding that the Revenue could not relitigate identical issues in respect of the same assessee where the tribunal's view remained unchallenged. Accordingly the tribunal was correct in treating the sums as fees for technical services and not as royalty for DTAA purposes. [Paras 9, 16, 32, 34]Affirmative; the amounts are fees for technical services under Section 9(1)(vii) and not royalty for Income tax Act or DTAA purposes.Industrial or commercial profits - permanent establishment - application of Double Taxation Avoidance Agreement versus domestic law - Whether the payments characterized as technical services would constitute 'industrial or commercial profits' within Article III(1) of the DTAA. - HELD THAT: - The Court held that where income is relatable to industrial or commercial profits it falls under Article III and is taxable in the source territory only if derived through a permanent establishment. As the payments in question were found by the tribunal to be technical fees and the assessee had no PE in India, those receipts would constitute industrial or commercial profits for treaty classification but were not assessable in India. [Paras 27, 30, 34]In the affirmative; such payments would constitute industrial or commercial profits but are not taxable in India in the absence of a permanent establishment.Reimbursement of expenses - revenue receipt - Whether the sum of Rs.84,246 received as reimbursement of expenditure from BHEL is assessable to tax in India. - HELD THAT: - Relying on tribunal findings and High Court precedent, the Court accepted that reimbursements which merely recoup expenses cannot be treated as revenue receipts and are not assessable to tax where no excess over expenses has been received. The tribunal having found that the reimbursed amounts related to additional assistance fees already held not taxable, the reimbursement likewise was not taxable. [Paras 10, 33, 34]The reimbursement is not taxable; reimbursement of expenses cannot be treated as income in the circumstances found.Final Conclusion: The reference is answered against the Revenue: the tribunal was correct to apply the DTAA scheme rather than later domestic definitions; amounts characterized as royalty under domestic law were appropriately treated as 'industrial or commercial profits' under the Indo German DTAA and are not taxable in India in the absence of a permanent establishment; the specified technical service receipts were correctly held to be fees for technical services (not royalties) and not assessable; and the reimbursement is not taxable. 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.