TaxTMI 
TaxTMI 
2015 (2) TMI 458
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....ugust, 2008, ITA No. 120/2008 was admitted for hearing on the following substantial question of law:- "Whether the Income Tax Appellate Tribunal was correct in law in holding that the lump sum payment of Rs. 50,51,050/- ($365,500) by the assessee to M/s Apollo Domain Computers, West Germany, under the agreement dated 11.05.1987 was liable to tax under the Income Tax Act, 1961?" 3. As the issue and the substantial questions of law involved in these two appeals are same, they are being disposed of by this common decision. For the sake of clarity we record that the impugned order passed by the Income Tax Appellate Tribunal (Tribunal, for short) in ITA No. 93/2002 is dated 14th August, 2001 and the impugned order in ITA No. 120/2008 is dated 31st May, 2006. The latter order merely follows the earlier order impugned in ITA No. 93/2002 and, therefore, we will be referring to the facts relevant for the Assessment Year 1989-90. For the sake of clarity and understanding, we have referred to HCL Infosystems Limited as HCL and Apollo Domain Computers, GmbH Germany as ADC in this judgment. 4. Succinctly put, the issue ....
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....ess in the other Contracting State in which the royalties or fees for technical services arise through a permanent establishment situated therein, and the right, property or contract in respect of which the royalties or fees or technical services are paid is effectively connected with such permanent establishment. In such case, the provisions of Article III shall apply. (6) Royalties and fees for technical services shall be deemed to arise in a Contracting State where the payer is that State itself, a land, a political sub-division, a local authority or a resident of that State. Where, however, the person paying the royalties or fees for technical services, whether he is a resident of a Contracting State or not, has in a Contracting State a permanent establishment in connection with which the obligation to make the payments was incurred and the payments are borne by that permanent establishment, then the royalties or fees for technical services shall be deemed to arise in the Contracting State in which the permanent establishment is situated. (7) Where, owing to a special relationship between th....
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....IIA of DTAA being more beneficial than the provisions of the Act, the same would be applicable. The respondent-Revenue has not joined lis on the said score. Explanation 2 to Section 9(1)(vi) of the Act brings within the ambit of royalty a wider range of transactions, which would include payments made for transfer of all or any rights or patents, invention, model designs, etc. The said Explanation which defines the term royalty is, therefore, not restricted to payments based on use of or right to use such right, patent, invention, model, design, secret formula or process or trademark or similar property. Our decision, therefore, does not proceed on Explanation 2 to Section 9(1)(vi) of the Act, but the term "royalty" as defined and covered under Art VIII A of the DTAA. 7. Before we examine the relevant clauses of agreement dated 11th May, 1987 between HCL and ADC, it would be first appropriate to examine the ambit and scope of the term 'royalty' taxable under Article VIIIA of the DTAA. The said article applies to 'royalties' and 'fee for technical services' arising in one contracting State and paid to the resident of the other contracting State. Royalties and fee for technical serv....
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....al property right or know-how, which may be lumpsum, annual or periodical payment. The term 'royalty' is associated with the payment made for grant of the user right. Grant of user right has to be distinguished from transfer of ownership in intangible property or know-how, i.e., sale of intangible property or know-how by the proprietor to a third person. In the latter case, the consideration paid is not for use of or right to use the intangible property or know-how but to acquire full ownership. The consideration paid for transfer of full ownership in the realm of international tax laws is normally taxed as per applicable DTAA either as capital gains or as business income. In the facts of the present case, in case we hold that the payments made by HCL to ADC were for transfer of full ownership in the know-how or intellectual properties, the same would not be taxable under Article VIIIA of DTAA, but would be taxable in the country of residence of ADC, i.e., Federal Republic of Germany, either as capital gains or as business income. However, if we hold that the payments by HCL to ADC were for mere right to use or to use intellectual property rights/know-how and not for transfer of f....
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....As a guide, certain explanations are given below in order to define the scope of Article 12 in relation to that of other Articles of the Convention, as regards, in particular, the provision of information. 8.5 Where information referred to in paragraph 2 is supplied or where the use or the right to use a type of property referred to in that paragraph is granted, the person who owns that information or property may agree not to supply or grant to anyone else that information or right. Payments made as consideration for such an agreement constitute payments made to secure the exclusivity of that information or an exclusive right to use that property, as the case may be. These payments being payments "of any kind received as a consideration for...... the right to use" the property "or for information", fall under the definition of royalties." The said commentary subsequently elucidates:- "11. In classifying as royalties payments received as consideration for information concerning industrial, commercial or scientific experience, paragraph 2 is referring to the concept of "know-ho....
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.... and even reap intellectual benefits, but the purchaser acquires no right in the literary or intellectual information expressed in the book. Such instances can be multifarious. However, for adjudication of these appeals, we predicate our decision on the following test; where ownership of the rights is alienated and acquired by another party, the consideration is not for use of or right to use and, therefore, not royalty and vice versa. 11. Importantly, paragraph 5 of the exchange of notes between contracting States clarifies that royalty income can consist of lumpsum consideration for transfer even made outside India or imparting of information outside India. Therefore, royalty need not be confined to regular payments such as, yearly, quarterly or monthly or be dependent upon the quantum of production or use of the intellectual property right. 12. The aforesaid ratio is the legal position, which has been applied and accepted in several decisions in India. In Commissioner of Income Tax versus DCM Limited, (2011) 336 ITR 599 (Delhi), DTAA between India and United Kingdom was applicable. DCM Limited, the assessee, had entered into an agreement with one Tate and Lyle Industries Limit....
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....y and / or know-how to other parties did not in our view reduce the right obtained by the assessee under the agreement to one of a mere user of technology and knowhow. The transfer of technology is thus quite often, as in the present case, brought about by executing agreements which give rights far greater than a mere right to use albeit on a non-exclusive basis. The argument made on behalf of the revenue that the transaction does not constitute a sale, misses the point that, for it to fall within the four corners of the provisions of Article XIII(3), the right conferred should be of usage; anything more than that, takes it out of ambit of definition of royalty as provided in the DTAA. We, therefore, agree with the conclusion arrived at by the Tribunal with regard to the terms of the agreement. Having come to this conclusion, it is quite obvious that the remittances made by the assessee to Tate would not fall in the definition of Article XIII(3) of the DTAA." The said decision distinguished decisions relied upon by the counsel for the Revenue, in the following words:- "11. In so far as the judgme....
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....ant portions of the said agreement read as under:- "ARTICLE 2. TRANSFERANCE AND GRANT OF RIGHTS 2.1 Subject to written approval of the appropriate government agencies and departments of the Unites States Export Licensing Authority and all conditions imposed on such approval and compliance therewith, APOLLO hereby conveys and grants to HCL the non exclusive right to manufacture, maintain, use, and sell the Licensed Products in India in accordance with pursuant to and under the Technology. Said conveyance and grant shall encompass all elements of the Technology relating to the manufacture of the Licensed Products in India which is owned by APOLLO as of the Effective Date of this Agreement. 2.2 APOLLO hereby declares that it has the unrestricted right to convey and grant to HCL the rights described in paragraph 2.1 hereof. Sub-Licensing and Sub-Contracting 2.3 Subject to approval by the ....
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....or HCL shall have any further obligation hereunder with respect to such eliminated Licensed Product, except that notwithstanding any such discontinuance and elimination by APOLLO of any Licensed Product, APOLLO shall perform all of its obligations hereunder with respect to all the Licensed Products for a minimum period of at least two (2) years after the effective date of discontinuance. HCL shall not be precluded from continuing to manufacture, use and sell any such eliminated Licensed Products in India on the basis of the Technology already conveyed to HCL at the time of such discontinuance and elimination by APOLLO as provided, however, that HCL shall continue to comply the provisions of this Agreement. "3.1.1 APOLLO shall deliver the tangible Technical Information constituting the Technology, in accordance with Exhibit 3 by prepaid air mail or air freight C.I.F. or by such other means which are reasonable and obtain from HCL acknowledgement of such delivery to HCL's registered office in India or to such other location in India which HCL will designate. APOLLO shall provide two (2) copies o....
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....sp; 4. 1 It is understood and agreed by the parties that the Technology and any other information which APOLLO consider proprietary to itself and to its will be conveyed and disclosed by APOLLO to HCL in carrying out the provisions of this Agreement is and shall remain confidential during the terms of this Agreement and after the expiration or termination thereof for any reason whatsoever, until such time as same shall enter the public domain or otherwise become generally known without any material breach of this Agreement by HCL. 4.2 HCL agrees that they shall maintain the confidentiality of the Technology and said other information conveyed and disclosed by APOLLO hereunder and shall not without prior written consent of APOLLO, disclose same or allow same to be disclosed to anyone, except to their management and employees and to any of HCL's sub-licensee (s), subcontractor(s), agents or suppliers and then only to the extent required for the proper and authorized use of the Technology hereunder, unless the Technology and said other information; (a) are contained at the time of disclosure by A....
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....logy, to manufacture, use, sale and maintenance of the Licensed Products by HCL under this Agreement. APOLLO makes no representation or warranty, implied or otherwise, as to whether the Technology conveyed hereunder to HCL and embodied in the Licensed Products, the methods of manufacture the licensed products, the methods of or the maintenance and sale of the Licensed Products in India will infringe the industrial property rights or any other rights of any third party. 5.3 In the event of any suit or threatened suit or claim against HCL by any third party for infringement of industrial property rights or any other rights resulting from the manufacture, use, sale or maintenance of the Licensed Products, HCL shall forthwith, upon receiving knowledge thereof, give written notice of any such suit or threatened suit to APOLLO and APOLLO shall make available to HCL all relevant information, evidence, and particulars in APPOLLO's possession which may assist HCL in defending or otherwise dealing with such suit or threatened suit. 5.4 It is understood and agreed by the p....
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....be paid by a licensee to the inventor of patent as a matter of Indian law. Quality Control 5.8 APOLLO represents that the Technology to be conveyed to HCL hereunder shall be the same Technology on the basis of which APOLLO itself manufactures the Licensed Products and that the Technology, together with the Technical Assistance to be furnished to the HCL hereunder, 'shall by sufficient for the manufacture of the Licensed Products. Therefore, HCL utilising the Technology and the Technical Assistance, should, be able to manufacture the Licensed Products with the same quality as those manufactured by APOLLO. Subject to any approval by the relevant agencies, and department of the U.S. Export Licensing Authorities APOLLO agrees to provide additional Technology, if same is available to APOLLO, and Technical -Assistance to clarify the Technology, if requested by HCL, to facilitate HCL's achieving the standard of quality of the Licensed Products contained in the Technology, at a cost to HCL to be mutually agreed upon by the parties. However, nothing containing in this Agreement shall be construed' as a warranty by APOLLO that HCL, will....
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....f a Receiver, Liquidator or Trustee of any of its' property or assets, or upon the liquidation, dissolution or winding up forthwith be terminated or cancelled by the other party hereto. 14.3 The early termination of this Agreement for any reason shall not affect any accrued rights or obligations of the parties as of the effective date of such termination, nor shall it affect any rights or obligations of the parties under this Agreement which are intended by the parties and agreed herein by them to survive any such termination, especially the secrecy provisions of Article 4 hereof, nor shall it preclude any claim for damages or other remedy of the party effecting such early termination against the other party hereto. 14.4 The HCL agrees that, upon the early termination of this Agreement attributable to material breach by HCL: (a) All rights granted hereunder shall revert to APOLLO; (b) HCL, its sublicensee(s) and subcontractor(s) shall cease to use the Technology and to manufacture, use, and sell the Licensed Products and; (c) the HCL shall forthwith deliver to APOLLO (or its' designated subsidiary or affiliated corporation)all original and copies materials embodyin....
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....t production facilities of the licensed products under the technology and could disclose the said technology to the sub-licensee or sub-contractor, provided that such disclosure would not confer on the sub-licensee or the sub-contractors any right other than those granted to HCL and shall be subjected to restrictions and confidentiality provisions of Article 4. Clause 2.4 stipulated that subject to necessary approvals, ADC would also convey to HCL improvements, modification or inventions relating to the licensed products during the term of the agreement, which shall become a part of the technology. Thus the rights granted to HCL by ADC were restricted to specified and listed licensed property. Clause 2.6 stipulated that ADC had the absolute rights in its own discretion to discontinue and eliminate manufacture, use of, sale or otherwise stop business in respect of licensed products at any time during the term of the agreement. Notwithstanding, such dis-continuance/elimination, ADC would perform all obligations for a period of two years after the effective date of discontinuance. HCL could continue to manufacture, use and sell such eliminated licenced products, subject to HCL complyi....
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....L all information, evidence and particulars in their possession to them to defend or deal with said suit or threatened suit. The said stipulations were regarding defending a suit or threatened suit. It further stipulated that the HCL could be granted right in India to enforce, enjoin or recover damages on behalf of the ADC for infringement of any registered patent, non-registered trademark etc. regarding licensed products conveyed to HCL. HCL was advised to submit to ADC, copy of patent application or renewal in respect of the licensed products, which was filed or acquired by HCL in India within 30 days of such filing or acquisition. HCL on filing of such patent application or to obtain renewals was required to file corresponding patent application or renewal application at ADC's written request and expense. 19. The agreement was to remain in full force and affect, whether ADC had at any time owned or controlled patents in India covering the licensed products. ADC or its licensors had exclusive right to file any patent application in India relevant to the licensed products and any patent, granted to ADC or its offices in India with respect to the licensed products during the term ....
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....mination nor shall it affect the obligations or rights of the parties under the agreement. Specific reference is made to the secrecy and confidential provision contained in clause/article 4. Thus, irrespective of earlier termination, the confidential or secrecy provision would continue to apply. In categorical terms, it is specified that claim for damages or remedy would not be barred or affected because of earlier termination against either party. In clause/article 14.4, HCL agreed that upon earlier termination of this agreement attributable to material breach on the part of the HCL, all rights granted to them shall revert to ADC and the sub-licencees and sub-contractors of HCL shall cease to use technology, manufacture, and use or sell the licenced products. Lastly, HCL shall forthwith deliver to ADC the tangible material in the form of original copies embodying the technology including but not limited to technical information under Article 31 or at the request of the ADC, destroy the same. 24. Having considered various clauses of the agreement, we do not think the present case is one of absolute or full transfer of ownership in technology made available under Article 3 of the a....
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....ts were rapid, widespread and vigorous. Constant upgradation and improvements were eminent and rule of business. 25. Dias in his work "Jurisprudence" has defined "ownership" as an interest recognize by law, which consists of innumerable number of claims, privileges, powers and immunities with regard to the thing owned. Ownership, therefore, is a bundle of rights, which a person who has title over the property, enjoys and commands. Holland, T.E. in Element of Jurisprudence observed that rights of ownership, conventionally could be arranged under three heads i.e. possession, enjoyment and dispossession. Right of dispossession carries with it right of alienation or destruction. Alienation may be either total when the ownership itself is transferred; or may be partial when a fraction of the rights, is granted or permitted. In cases of immoveable properties, the owner can grant right to use in the form of lease to a third person without transferring the ownership. Similarly, in cases of moveable properties, the owner may grant a license to use. For example, a contract for hire or by way of hire in a contract of bailment. The hirer obtains a right to use the chattel hired in return of p....
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....ngle act, restricted to a location or for a limited period of time or duration. It may be a one-time act or there can be stipulations as to upgradation or right to access future technological advances. One of the important attributes of intellectual property rights in cases of technology, patent etc. is confidentiality. It is confidentiality, which gives the owner the commercial edge, competitive position and superiority. Confidentiality enforces monopoly. Confidentiality and monopoly are the most valuable rights which the owner possesses and commercially exploits. License to use know-how or technology is, therefore, and often given with riders and condition to maintain confidentiality to ensure that the valuable asset of the licensor is preserved and secured. Thus, the owner can grant a trail of licenses to third parties with identical or similar limited rights of use with the confidentiality clause and without assignment or transfer of ownership. The price agreed, between the licensor and the licensee for right to use, could depend upon several factors. The commitment by the licensee not to disclose the know-how or technology to third parties, except under certain conditions or w....
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....from 'services', via 'letting' to 'alienation', outright alienation is the one clear-cut extreme, viz. outright transfer of the asset involved (right, etc.) to the payer of the royalty. The other, just as clear-cut extreme is the exercise by the payee of activities in the service of the payer, activities for which the payee uses his own proprietary rights, know-how, etc., while not letting or transferring them to the payer (for more details regarding the distinction between licensing and the provision of services, see infra m.nos. 54ff., in connection with the various subjects of licences). Neither extreme comes under Art. 12, all that does is the central category, viz. 'letting'." 31. This is indeed the true and appropriate test, which has to be applied. Paragraph 11 DCM Limited (supra) specifically makes reference to the decision of the Calcutta High Court in N.V. Philips versus Commissioner of Income Tax (No. 1), (1988) 172 ITR 521 and it was held that the said decision was related to transfer or use of technology as it provided that the information disclosed under the agreement would remain confidential and would not become property of the Indian company till such time and to ....
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.... in the aforesaid restricted manner. This secret knowledge in this case is as much its capital asset as is a patent, a monopoly and a capital asset of the patentee as observed by Romer L.J. in the case of Handley Page [1935] 19 TC 328. This secret process which the non-resident assessee-company is parting with in this case is analogous to the parting of a monopoly right of the patentee and, therefore, the remuneration received by the assessee for the same should be treated as royalty and for the reasons as aforesaid, the answer to the question referred should be in the affirmative and in favour of the Revenue." 32. In Shriram Pistons and Rings Limited versus Commissioner of Income Tax, (2008) 307 ITR 363 (Delhi) a clear distinction was made between outright sale and a right to use and the effect thereof. Reference was made to the decision of the Supreme Court in CIT versus Ciba India Limited, (1968) 69 ITR 692 (SC) to the effect that the technology agreement was to remain in force for a period of five years and there was a provision for earlier termination and Indian company could not have assigned the benefits and obligations without taking consent of the foreign party. What had ....
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.... it has been held that intellectual property rights in scientific processes, technology etc. have limited time scale benefit and have invariably a short life span, due to rapid progress and advancement in such fields. In Alembic Chemicals Works Co. Ltd. vs. CIT (1989) 177 ITR 377 (SC) with reference to rapid advances and research in micro biology, it was observed that it would not be correct to attribute a degree of durability and permanence to technical knowhow in medical sciences. The same principle would be equally applicable, as it has not been shown or indicated that the right to use technology had an enduring or long term commercial benefit. The clause relating to upgradation, elimination and discontinuance of manufacture by ADC, reflects the fleeting and momentary life span of the technical information. In Alembic chemical (supra) elucidating the said facets, it was held that acquisition in such fields with rapid and fast strides indicate grant of right to use of knowhow, rather than ownership acquisition. This aspect, when read cumulatively with restrictions on the right of the assessee in dealing with knowhow and conditions as to non-partibility, confidentiality and secrec....