Treaty definition of royalty prevails; lump sum know-how payments for plant setup were business profits, not taxable as royalty.

Under the India-Italy DTAA, the treaty definition of royalty prevailed over the wider domestic definition in section 9(1)(vi), and the lump sum payments were examined by reference to whether they were consideration for use of a process or for supply of technical know-how and engineering documentation. On the contract terms, the lump sums related to supply of know-how and basic process engineering documentation for setting up the plant, while the running royalty alone was linked to use of the process. As the Italian recipient had no permanent establishment in India, the lump sum receipts were treated as business profits under Article 7 and not taxable as royalty under Article 13.

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Issues: Whether the lump sum payments of US $ 250 lakhs and US $ 35 lakhs payable under the collaboration agreement were royalty within Article 13(3) of the India-Italy DTAA and therefore taxable in India, or constituted business profits not taxable in India in the absence of a permanent establishment.

Analysis: The agreement separately provided for payment for technical know-how and basic process engineering documentation, and also separately provided for running royalty on production. The decisive question was whether the lump sum amounts were consideration for the use of, or right to use, the process or secret formula, or whether they were consideration for supply of know-how and documentation for setting up the plant. The governing principle applied was that, where a DTAA applies, its specific definition controls over the wider domestic definition in section 9(1)(vi), and the provisions of the treaty prevail to the extent they are more beneficial to the assessee. On the facts of the contract, the lump sum payments were held to relate to supply of technical know-how and engineering documentation for creation of the plant, while the running royalty alone was linked to use of the process. Since the Italian company had no permanent establishment in India, the lump sum receipts were treated as business profits under Article 7 and not as royalty under Article 13.

Conclusion: The lump sum payments were not royalty under the India-Italy DTAA and were not taxable in India in the hands of the foreign recipient through the assessee.

Ratio Decidendi: Where a DTAA specifically defines royalty more narrowly than the Income-tax Act, the treaty definition prevails and a lump sum paid for supply of technical know-how and engineering documentation for setting up a plant is taxable as business profits, not as royalty, if the recipient has no permanent establishment in India.

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