TaxTMI 
TaxTMI 
2023 (8) TMI 494
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.... a valuation report of an IP expert, one of the leading strategist in the world on IP matters in the wireless industry and mobile communication space. 2. Without prejudice to the above Ground, on the facts and in the circumstances of the case, Cit(A) erred in confirming the action of the Assessing Officer in making an addition of Rs. 156,13,84,785/- to the total income of the appellant by rejecting the valuation carried out by the third party expert valuer without any basis whatsoever, based purely on surmise and conjecture. 2.1 That on the facts and in the circumstances of the case, the CIT(A) erred in confirming the action of the Assessing Officer of making an estimate of the reproduction cost at USD 38,598,890/- on an adhoc and arbitrary basis by doubling the original reproduction cost of USD 19,299,445/- determined by the expert valuer. 2.2 That on the facts and in the circumstances of the case, the CIT(A) erred in upholding the action and order of the Assessing Officer in determining arbitrarily the attribution rate of 80% to the reproduction cost by enhancing the cost attribution/sharing rate to 8% and by further multiplying it for the 10 future yea....
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....d 'net manager'. After developing the software Satyam entered into an assignment agreement with the assessee in the year 1998, where under, Satyam assigned the right, title and interest in the software and Intellectual Property Rights (IPR) and copyright over the software development to the assessee in perpetuity. The assignment agreement also authorized the assessee to seek patent protection for inventions to own all patent applications and letter patent or similar legal protection for such inventions in all countries throughout the world. In terms with the assignment agreement, the assessee filed a professional patent application with the authorities in USA in respect of 'call manager' and 'net manager'. Subsequently, the assessee discovered breach of patent due to certain acts and deeds of the employees of Satyam and accordingly filed a complaint against Satyam in USA. Ultimately, the dispute between the assessee and Satyam was settled through an agreement and in terms of the agreement, Satyam agreed to pay an amount of US $ 70 million (Rs. 361,13,00,000/-) as compensation. As per the terms of the settlement, the assessee granted Satyam a perpetual world royalty free licence in ....
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....e for adjudication before the Tribunal as the AAR has directed the Assessing Officer to examine the taxability under section 9(1)(vi) of the Act. Conceding to the fact that the assessee has not challenged the decision of AAR before any higher court, he, nevertheless, submitted that since, the AAR has not determined the issue, the assessee can raise the issue of taxability of even a part of the compensation received as royalty. He submitted, as per the terms of the settlement agreement, the copyright, propriety in the patent still remains with the assessee and same has not been parted away while granting non-exclusive, non-assignable perpetual licence to use in favour of the Satyam. Thus, he submitted, the receipt will not fall within the ambit of royalty under Explanation 2 to section 9(1)(vi) of the Act. Further, he submitted, Explanation 4 to section 9(1)(vi) of the Act, which provides that transfer of all or any rights in respect of any right, property or information includes transfer of all or any right for use or right to use a computer software including grant of a licence was inserted to the Statute by Finance Act, 2012 with retrospective effect from 01.06.1976. He submitted....
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....illion as capital receipt. After considering, the submission of the assessee, the AAR while accepting that part of the compensation is capital receipt, but does not give rise to capital gain to be taxed in India, however, observed that the compensation also includes the consideration paid by Satyam to the assessee for enabling it to use the particular patent and all subsequent patents. Thus, the AAR held that this right to use the licence/patent is a valuable right acquired by Satyam. Further, referring to the settlement agreement, the AAR held that the right in perpetuity over the licence/patent given to Satyam was a right acquired by the assessee over the software/literary work. Therefore, it cannot be said that the recitals on the settlement agreement that the assignment of right is without consideration can only be viewed as an attempt to avoid payment of tax. Proceeding further, AAR held that a part of the compensation received of US $ 70 million is in the nature of royalty paid by Satyam for obtaining the right to use the patented software for all times to come. The crucial observations of the AAR in this regard are as under: "25. The amount quantified as compensatio....
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.... it properly belongs'. Adopting this approach, we find that at least a portion of the compensation paid by Satyam to the applicant, must be ascribed to or earmarked as consideration for licensing of the right to use the patent and the software comprised therein. This consideration paid for granting of a license in respect of a patent or obtaining the right to use the patent or a process protected by copyright, is royalty as defined in the Income-tax Act. We are therefore satisfied that a part of the $ 70 million paid as compensation by Satyam takes in also royalty paid by Satyam for obtaining the right to use the patented software for all time to come. 27. Then arises the question, as to what part of the compensation paid by Satyam to the applicant ought to be attributed to the license of the right to use the patented software and any improvement to be made on it. Counsel for the applicant while standing firm in his argument that no portion is taxable, suggested, in case we come to the view now taken, that the assessing officer may be directed to determine the portion that may be attributable to 'royalty' and thereafter he may be directed to consider the questi....
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.... hold that at this stage, the assessee, through the additional grounds, cannot rake up the issue again that no part of the compensation can be treated as royalty under section 9(1)(vi) of the Act. Accordingly, we decline to admit the additional grounds raised by the assessee. The additional grounds are dismissed. 5. Insofar as, the main grounds are concerned, they relate to the addition made on account of royalty over and above the amount offered by the assessee in the revised return of income. As discussed earlier, in the revised return of income the assessee had offered royalty income of Rs. 3,16,68,603/- as against Rs. 18,83,16,253/- offered in the original return of income. While explaining the reason for revising the royalty income offered to tax, the assessee submitted that while offering the royalty income in the original return of income, the assessee did not have the benefit of exact value of the royalty determined by an expert. Subsequently, based on valuation report of an expert the assessee filed the revised return of income reducing the royalty income. The Assessing Officer was not convinced with the submissions of the assessee. After rejecting the valuation done by....
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.... 6. PCIT Vs. Cinestaan Entertainment Pvt. Ltd., ITA No.1007/2019 (Delhi HC) 7. Urmin Marketing Pvt. Ltd. Vs. DCIT, [2020] 122 taxmann.com 40 (Ahd.) 8. Pramila M Desai, HUF Vs. DCIT, ITA No.04/Ahd./2012 (Ahd. Trib.) affirmed by Gujarat High Court in [2014] 221 Taxman 158 9. CIT Vs. Manjulaben M. Unadkat, 229 Taxman 531 (Gujarat) 10. Shri Rajendra H. Seth Vs. ACIT, ITA No1495/Ahd/2007 (Ahd. Trib.) 11. Sosamma Paulose Vs. JCIT, 79 TTJ 573 (Coch.) 12. Rameshwaram Strong Glass (P.) Ltd. Vs. ITO, [2018] 172 ITD 571 (Jaipur) 5.2 Per contra, learned CIT(DR) strongly relied upon the observations of the Assessing Officer and learned Commissioner (Appeals). He submitted, the expert from whom the assessee has obtained the valuation report may be having some knowledge of telecom sector but that does not make him world renowned. He submitted, royalty is nothing but capture of cost of developing software and the profit margin of IPR owner. He submitted, if the IPR is to be shared in a geography, the value of royalty will be equal to the cost of software multiplied by the share of the IPR which is being transferred to that particular g....
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....exercise may be referred back to the Assessing Officer with a direction to get the value of royalty determined by a second valuer. 6. We have considered rival submissions in the light of decisions relied upon and perused the materials on record. It is a fact on record that to support the value of royalty offered as income in the revised return of income, the assessee had furnished a valuation report from an expert. To appraise the bench about the credentials of the expert, the assessee has taken us through the valuation report and the information available in public domain, which are as under: (a) Mr. Chetan Sharma is one of the leading strategists on JP matters in the wireless industry and has advised clients with biggest patent portfolios in the world and worked with players across the wireless value chain. (b) Mr. Chetan Sharma has been retained as an expert witness and advisor for some of the most prominent legal matters in front of the International Trade Commission (ITC) such as Qualcomm vs. Broadcom and Ericsson vs. Samsung. (c) Mr. Chetan Sharma is a chief curator of the popular Mobile Breakfast Event Series and the Mobile Future Forward Execut....
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.... is not capital gain, hence, not taxable in India. However, the AAR has observed that a part of the compensation received has to be attributed towards royalty for assignment of right to use the patent in perpetuity. However, the AAR has made it clear that the value of such royalty has to be determined through a proper exercise. The assessee, on its part, has furnished a valuation report from an expert to support the value of royalty offered as income. Whereas, the Assessing Officer himself has taken up the task of determining the value of royalty by rejecting the valuation report of the expert. While doing so, the Assessing Officer has proceeded on a purely ad-hoc basis by estimating the reproduction cost to double the amount of reproduction cost taken by the expert valuer. On what basis such a quantum jump in the reproduction cost was arrived at has not been reasoned out by the Assessing Officer. He has also rejected the range of 3 to 5% per annum adopted by the expert valuer towards value of royalty and has applied the rate of 8% per annum on the estimated reproduction cost. The Assessing Officer has also made general observations regarding deficiency in the Valuation Report furn....
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.... 149 @ page 136-137 of the paperbook], the intellectual property rights shall be retained by the appellant on as is basis. Thus, the appellant is the owner of the rights in the patents and is entitled to freely transfer or commercially exploit the same right. Further, the said fact has also been noticed by the AAR. As regards the comment of the assessing officer on the component to the compensation, it would be noticed that the AAR has, after analyzing the nature of damages received having various components, held the same to be capital receipt not liable to tax, except to the portion attributable to royalty free license granted to Satyam. Being so, the observations/comment of the assessing officer qua nature of compensation in contradiction to binding findings of the AAR are not sustainable and are irrelevant. 3. Valuation is based internationally accepted methodologies and is issued after considering all the facts. In para 9.4 (iii) [page 21-22], the assessing officer, inter alia, observed that the valuation report it is not a good indicator of value for following reasons: - The appellant may not be able to recover the cost in normal way so one cannot conclud....
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....d by not amortizing the same, Mahindra Satyam Ltd. has confirmed that the said license did not have any economic value to Satyam and was only a defensive right meant to be used in the event of litigation and not an income generating asset. In this regard, relevant of audited financial statements of Mahindra Satyam Ltd. for FY 2011-12 is placed at pages 308 to 313 @ 311 of paperbook (refer Note 27 of the annual report). Further, the basis of adopting 3-5% cost sharing on part of Satyam has been explained in detail by the expert valuer in the valuation report. Summarily, Satyam's sharing of cost can only be a very small percentage of appellant cost as appellant is the owner and licensor of the software & patents whereas Satyam is only a licensee with no further rights of assignment or sub-license; Satyam's rights are severely truncated and ringfences and is thus of de-minimus value. The issue is discussed in detail infra. 4. The expert valuer has Adoption Cost Method for valuation of patent/ right granted to Satyam over Income and Market approach Method In para 9.4 (iv) [page 22-23], the assessing officer, inter alia, observed that the expert valuer has not given ....
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....ublished on the website of livemint.com. The reference of website is given in the valuation report. Historical cost - Personnel Cost of Development 293,291 Based on management representation. Historical cost - Personnel Cost for Patent Invention 1,088,506 This comprises of cost of the Chairman & CEO - Mr. Simon Joyce and Advisor - Mr. Patrick Nunally for the period 1998 to 2007. The detail of invoices of Mr. Patrick Nunally Along with copies of material invoices placed pages 323to 334 supplementary paperbook Historical Legal cost 1,365,480 Based on the invoices lf Law firm M/s. Staas & Halsey LLP Washington D.C. engaged by the appellant company in relation to registration etc. of patent. Detail of all invoices alongwith copies of material invoices are placed at pages 335 to 382 of supplementary paperbook Opportunity Cost 6,334,89 In accordance with valuation principles and on the basis of various studies e.g., Traditional Intangible Assets Techniques, Weston Anson, The Intangible Assets Handbook - etc. - references given in Valuation report. Further, the internal costs incurred by the apofficer, has not been fully considered for valuation are-....
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....h path breaking and innovative changes in technology and manpower planning. The expert valuer thought it fit to err on the side of caution and take the lower range of productivity level at 3% per annum (refer internal page 20-23 of valuation report at pages 44-47 of paperbook). In so far, the billing rate of USD 21 per hour in 2009 is concerned, the expert valuer has provided his reliable source in his report clearly outlining where he has obtained his research from (refer internal page 23-24 of valuation report at pages 47-48 of paperbook). 8. 2A. Personal Cost Development: - It was doubted as to why the salary of Chairman & CEO has been taken only for the period 1997 - 99 and not thereafter; why salary of Sr. VP- Technology has been, taken only for 2 years and not prior to 1999-00 and after 2000-01; why salary of Chief Platform Architect has not been considered prior to 2000-01; and why salary of Product Development Manager has not been prior to 2001- 02 - The reproduction cost cannot be computed merely adjusting historical cost to inflation especially considering that the salaries in IT industries were at boom till 2009 The IP Expert Valuer ....
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....ior to 2002. 50% of time is not considered in reproduction costs as the same was for patent litigation and enforcement strategy which is not pertaining to development of software. In relation to advisor - Mr. Patrick Nunally, details of his invoices as considered by the expert valuer is placed at pages 323 to 334 of supplementary paperbook. 10 3. Legal Cost: - Historical Cost Method: Professional fee paid by Upaid for the year 2000 to 2007 has been taken in report without elaborating the person to whom it was paid and if the amount captures the full value. The amount captured is understated for the reason that the material on record suggests that litigation with Satyam continued even after 2007 and the initial settlement agreement was arrived on 18.07.2009. - Reproduction cost: same as 2A above 4. Opportunity Cost: - The rate applied should have been with reference to Indian perspective where the software was developed rather than the US Treasury Bond Rates. It needs no elaboration that the Bond yields in India are historically higher than that the USA These amounts were paid to a law firm, M/s Staas & Halsey LLP in Washington D.....
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....by factual cases. The value derived by Satyam was the right granted was de-minimus (minimal value) because of the following factors: -The limited right to use appellant patent is not a valuable right for Satyam. - Right granted to Satyam was not assignable or transferable. -Satyam could not have commercially exploit the licenses given to it. Should they choose to do so, their ultimate client would be infringing the appellant's patents. - No revenue could be generated by Satyam from the right granted to it by the appellant. -Satyam' s rights of the license granted is severely truncat appellant was the owner of the patent and had substantially superior rights to that of Satyam. -The license was granted to Satyam merely as a protection right again future litigation and not as a generator of revenue (which is the primary basis of deriving the value). - In fact, Satyam did not recognize the license granted as income generating asset; rather it expensed off the amount paid to the appellant thus proving that the license granted by the appellant to Satyam was of no economic value to the latter. Mahindra Satyam Ltd. would have, in terms of man....
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....idering that the said software / patent will be used without any limit, it would be fair and reasonable to multiply it by at least ten. This multiple of ten will take care of onetime lump sum payment for say about fifteen years and will also account for the discounting for down payment by Satyam to the assessee. Thus, the rate applied would be 80% of the estimated reproduction cost of USD 38,598,890. It is submitted that the contention of the assessing officer is absurd on the face itself as the assessing officer has attributed 20% of the value of the license to the owner of the IP, i.e., the appellant and 80% to the licensee whose rights are severely truncated. The reasoning adopted by the assessing officer is that the license granted by the appellant to Satyam is a very valuable right for Satyam which the latter can use in perpetuity and forever. This fundamental premise is completely flawed for the reasons explained above summarized hereunder: - The right cannot be transferred or assigned by Satyam; -It cannot be commercially exploited or lead to generation of revenue as opined by the valuer; Satyam's admission that the license granted by appellant h....
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....ing officer is completely baseless. The valuation was conducted by the expert valuer in March 2014 as has been confirmed by the valuer himself in certificate placed at page 259 of paperbook. The: valuer had mentioned that he was engaged by the appellant in December 2013 for valuation, which was completed around 25th March 2014 which was communicated to the management on the same date as it was needed to filed tax return in India. The signed report was, on request, sent in. November 2014. Being so, there cannot be any basis to doubt the action of the assessee in relying on the valuation report for filing the revised return. Be that as it may, even if the report is stated to be post facto, no adverse inference could be drawn on the valuation determined by the expert valuer on sound and logical basis. 15 Expert valuer has given a range of value - US $5,78,983 to US $9,64,972. The assessee has adopted a value of US $6,13,810 Assessing officer has, After applying, 80% to reproduction cost of USD 38,598,890 worked value of license granted as $30,879,112 (-30 million) As explained above, the reproduction cost doubled by the assessing officer on adhoc basis; and rate of 80% app....
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.... neither the Assessing Officer, nor learned first appellate authority is competent to assume the role of an expert valuer. In case, the Assessing Officer was not satisfied or convinced with the Valuation Report of the expert valuer, proper course for him would have been to seek opinion of a second valuer on the Valuation Report furnished by the assessee. Instead of doing that, the Assessing Officer has taken it upon himself to undertake the exercise on valuation of the royalty. This, in our view, is totally erroneous and against settled legal principles. The Assessing Officer cannot reject the Valuation Report done by an expert in the field, when he has no such expertise. The decisions relied upon by learned counsel appearing for the assessee clearly support this view. It is evident, after rejecting the Valuation Report of the expert on flimsy grounds, the Assessing Officer eventually has proceeded to value the royalty on purely estimate basis without bringing on record any cogent material to support such estimate. There is no valid reason, why he estimated the reproduction cost to twice the amount determined by the expert valuer. Further, the data relied upon by the Assessing Offi....