Royalty paid by an NR to other NR can't be taxed in India if it arises from patent exploited outside India

The royalty in respect of license granted by a non-resident to another non-resident for manufacturing of CDMA handsets cannot be taxed in India even if these handsets are sold to Indian parties. The source of royalty would be deemed as the place where patent is exploited, viz, where the manufacturing activity takes place, which is outside India.

In the instant case, the appellant was a company incorporated in the USA and was engaged in development and licensing of CDMA technology. The appellant granted license to 'use and sell CDMA technology' to the unrelated Original Equipment Manufacturers ('the OEMs'), who were non-resident and were located outside India, in consideration for royalty. The licenses granted by the appellant to the OEMs were used for manufacturing of handsets and network equipments, which, in turn were sold to various parties located outside India and in India. In respect of taxability of its income in India, the appellant contended that the royalty income earned by it from the OEMs of CDMA mobile handsets and network equipments sold in India was not taxable in India either under Section 9(1)(vi)(c) of the Act or under Article 12(7)(b) of the India-USA DTAA.

Deliberating on the issue, the Tribunal held in favour of assessee as under:

1) The license to manufacture products by using the patented intellectual property of the appellant had not been used in India as the products were manufactured outside India and when such products were sold to parties in India it couldn't be said that OEMs had done business in India;

2) Sale in India without any operations being carried out in India would amount to business with India and not business in India;

3) No patents of the appellant had been used for customization of handsets;

4) The role of appellant ended when it licensed its CDMA technology for manufacturing handsets and when it collected royalty from OEMs on these products;

5) There was no finding that the OEMs had carried on business in India or a part of the sale consideration was attributable to any sale or licensing of software carried out in India. When OEM's itself were not brought to tax, to hold that the appellant was taxable was not correct;

6) The source of royalty was the place where patent was exploited, viz, where the manufacturing activity took place, which was outside India. Hence, the Indian parties would not constitute source of income for the OEMs; and

7) The software was only used with the hardware and was not independent of the equipment or the chipset. Since no separate consideration was paid by Indian parties for licensing of the software and the consideration was paid only for the equipment which had numerous patented technologies, the sale couldn't be bifurcated or broken down into different components.

Thus, the royalty earned by the appellant couldn't be brought to tax in India under Section 9 of the Act or Article 12 of the India-USA DTAA - QUALCOMM INCORPORATED v. ADIT [2013] 30 taxmann.com 30 (Delhi - Trib.)   

Commission as envisaged under Section 194H doesn’t require principal-agent relationship, ITAT rules

TDS under section 194H attracted so long as payment is in the nature of brokerage or commission; Section 194H does not require that relationship between the payer and the payee be necessarily of a principal and agent

Depreciation is not an outgoing expenditure but a statutory deduction.  Therefore, the provisions of section 40(a)(i) are not attracted on such deduction

In the instant case, the moot questions raised before the Tribunal were as follows:
1) Whether Sec. 194H can be invoked in a situation where principal-agent relationship amongst parties is missing?

2) If payment to NR is capitalized in books of accounts and depreciation thereon is being claimed by assessee, whether the depreciation can be disallowed by invoking Sec. 40(a)(ia)?

On first Issue, the Tribunal held in favour of revenue as under:

1) Section 194H talks about the payment to a recipient which is the income by way of commission or brokerage.

2) It does not require that the relationship between the payer and the payee should be of a principal and agent.

3) The Explanation to section 194 elaborates on the terms ‘commission or brokerage’ by including any payment received or receivable directly or indirectly by a person acting on behalf of another person.

4) Thus, it is clear that the provisions of section 194H do not require any formal contract of agency.

On Second issue, the Tribunal held in favour of assessee as under:

1) The deduction under section 32 is not in respect of the amount paid or payable which is subjected to TDS;

2) Depreciation is a statutory deduction on an asset which is not an outgoing expenditure.  Therefore, the provisions of section 40(a)(i) are not attracted on such deduction;

3) Therefore, where payment, which has been made without deduction of TDS, has been capitalized as part of cost of asset, depreciation in respect of such payment can’t be disallowed by invoking section 40(a)(i) - SKOL Breweries Ltd. v. ACIT [2013] 29 taxmann.com 111

Mere payment of advance tax isn’t sufficient to avoid additions for ‘undisclosed income’ if ROI isn’t filed by due date

On assessee's failure to file IT return by the due date under section 139, payment of advance tax per se cannot indicate his intention to disclose income so as to exclude the applicability of Chapter XIV-B provisions i.e. "Special Provisions for assessment of search cases"

In the instant case, the issue that came for consideration before the Supreme Court was as under:

“Whether payment of advance tax by an assessee would by itself tantamount to disclosure of income for the relevant assessment year and it couldn’t be treated as undisclosed income for the purpose of application of Chapter XIV-B of the Act”?

The Supreme Court held in favour of revenue as under:

1) Chapter XIV-B, find application only in the event of discovery of "undisclosed income" of an assessee. The legislature has defined "undisclosed income" without providing any definition of "disclosure" of income. The only way of disclosing income, on the part of an assessee, is through the filing of a return, as stipulated in the Act;

2) The legislature has clearly carved out two scenarios for income to be deemed as undisclosed: (i) where the income has clearly not been disclosed and (ii) where the income would not have been disclosed. If a situation is covered by any one of the two, income would be undisclosed in the eyes of the Act and hence, subject to the machinery provisions of Chapter XIVB;

3) If the search is conducted after the expiry of the due date for filing return (as in the instant case), payment of advance tax is irrelevant in construing the intention of the assessee to disclose income. Such a situation would find place within the first category carved out by section 158B of the Act i.e. where income has not been disclosed;

4) Payment of advance tax may be a relevant factor in construing intention to disclose income or filing return as long as the assessee continues to have the opportunity to file return of Income;

5) The disclosure of total income by the filing of a return under section 139 of the Act is mandatory even after the payment of advance tax by an assessee, since the "current income" which forms the basis of the advance tax is a mere estimation and not the final total income for the relevant assessment year liable to be assessed; and

6) On failure to file return of income by the due date under section 139 of the Act, payment of advance tax per se cannot indicate the intention of an assessee to disclose his income. As the assessee had not filed its return of income by the due date, the AO was correct in assuming that the assessee had not disclosed its total income and applied provisions of chapter XIV-B – ACIT v. A.R. Enterprises [2013] 29 taxmann.com 50 (SC)

Presumption as to validity of document wouldn’t discharge assessee’s onus to prove ‘source’ and ‘nature’ of receipt evidenced by document

In view of Sec. 292C, if any document is found during the search, such document shall be presumed to be depicting the true position. Even in that case, assessee would be under obligation to prove the ‘source’ and ‘nature’ of receipts to avoid the additions envisaged under provisions of Sec. 68, 69, etc.

In the instant case, the assessee-partnership firm was subject to survey action under section 133A of the Act. Incriminating documents were recovered from its premises. During assessment, the AO had made certain additions based on certain computer printouts. During appellate proceedings before ITAT, the assessee relied on Section 292C, which contains a statutory presumption as to truth of documents found during survey/search, and argued that addition made by AO under Sec. 69A was not justified as the document which was presumed to be true showed that the amount came from the partner and hence, it could not be treated as unexplained money under sections 68, 69A etc.

The Tribunal held in favour of revenue as under:

1) All that section 292C provides for a presumption as to the truth of any document found during search or the moneys recovered from assessee is belonging to the assessee;

2) The same does not contradict, rather compliments and supports the rule of evidence as enshrined in sections 68, 69, etc. The two, therefore, have to be read in conjunction and as complimentary, and not as disjunctive or de hors each other.

3) Sec. 68, 69A etc. casts an obligation on assessee to explain both the nature and source of the money, and not its source alone;

4) It was revealed during proceedings that the basic facts had been withheld by the assessee. Therefore, the deeming fiction of Section 69A validly applied by the Revenue in the facts and circumstances of the case as the assessee's explanation was silent as to the nature of receipts - Alliance Hotels v. ACIT [2012] 28 taxmann.com 277 (Mumbai - Trib.)

TP adjustments to be governed by SAAR as contained in sec. 92; Sec.40A(2) can’t be imported for such adjustments

Anti-avoidance provisions of Act, override all other provisions of Act; hence, disallowance made under section 40A(2) is not required to be made for TP adjustments

In the instant case, the Tribunal held as above on the basis of following reasonings:

1) The TP provisions in Chapter X are special provisions and section 92(1) thereof mandates that any income arising from an international transaction shall be computed having regard to the arm's length price (ALP);

2) Chapter X being brought in as an anti-avoidance measure to protect the tax base of the country, provisions thereof would override the other provisions of the Act, including section 40A(2); and

3) The Explanation to section 92(1) clarifies that the allowance for any expense or interest arising from an international transaction shall also be determined having regard to the ALP, and, therefore, the disallowance should be made under section 92(1) and not under section 40A(2) - Toyota Kirloskar Motors (P.) Ltd. v. ACIT [2012] 28 taxmann.com 293 (Bangalore - Trib.)

HC held regulatory function of a State Agency an economic activity and denied it registration; BIS's verdict contradicted

As the activity of the State Seed Certification Agency assists the sale of certified seeds and is "in relation to any trade, commerce or business", its activity cannot be held to be a "charitable purpose" in terms of section 2(15).

The petitioner-assessee was registered under the State Society Registration Act to carry on the functions of the certification agency under the Seeds Act, 1966 in the Andhra Pradesh State. The petitioner used to certify the Seeds which met the minimum seeds certification standards as per the Indian Minimum Seed Certification Standards, 1988. The petitioner collected a fee for providing certification as the process of certification involved technical and scientific evaluation of the seeds, although the fee collected by it was enough to enable it to sustain its activities and did not result in much profit to it. However, CCIT rejected the approval in his case for exemption under section 10(23C)(iv).

On appeal, the High Court held in favour of revenue as under:

1) The term "advancement of any other object of general public utility" used in Section 2(15) of the Act includes all objects to promote the welfare of the public, particularly when the object is to promote or protect the interest of a particular trade or industry;

2) The activity of the petitioner would fall within "advancement of any other object of general public utility" but in view of the fact that certification of seeds by the petitioner facilitated trade, commerce or business in the certified seeds by the client of the petitioner, the proviso to section 2(15) would come into operation; and

3) The petitioner's activity assisted the sale of certified seeds and was "in relation to any trade, commerce or business", therefore, its activity couldn’t be regarded as "charitable purpose".

In view of the above, the rejection by CCIT of the petitioner’s application for approval under section 10(23C)(iv) was upheld - Andhra Pradesh State Seed Certification Agency v. CCIT [2012] 28 taxmann.com 288 (Andhra Pradesh)

Editor’s Note – In a recent ruling of Bureau of Indian Standards vs. DGIT(E) [2012] 27 taxmann.com 127 (DELHI), the Delhi High Court held otherwise - that performing any regulatory function can’t be enfolded within the proviso to Section 2(15) to construe it as service ‘in relation to trade, commerce or business’ so as to exclude it from the scope of "charitable purpose". The ruling in Bureau of Indian Standards (Supra) has not been considered in the instant case.

HIGHLIGHTS - COMPANIES BILL, 2012

On 18th December, 2012 the Companies Bill, 2011 had been passed by the Lok Sabha. However, it was passed with certain modifications as recommended by the Parliamentary Standing Committee on Finance. Some of the amendments to the Companies Bill (as passed by the Lok Sabha) are as under:

1) Definition of 'key managerial personnel'(KMP) in clause 2(51) amended to include ‘Whole-time director' within its realm. Further, the pre-condition of CFO’s appointment by BOD to treat him as KMP was deleted;

2) As per amended clause 3, in case of One Person Company, nominee mentioned in Memorandum of Association would become member not only on subscriber's death but also in the case of subscriber's incapacity to contract due to insanity, etc.;

3) Words ‘of money’ omitted from Sec. 2(64) to cover bonus shares in paid-up share capital;

4) As per amended clause 2(40), the ‘statement of changes in equity’ should form an integral part of the financial statements of companies governed by Ind-AS;

5) Clause 23 amended to allow a private company to make rights and bonus issues;

6) Members are empowered to offer whole of their holdings of shares to public in offer for sale; earlier this was restricted to part shareholdings only;

7) In accordance with the Supreme Court's interpretation of section 67 of the Companies Act, 1956 in Sahara India Real Estate Corpn. Ltd. v. SEBI [2012] 115 SCL 478/25 taxmann.com 18, clause 42 was amended to define 'private placement' in order to curb public issues in the garb of private placement;

8) Time-limit for filing annual return in clause 92(4) relaxed from 30 days to 60 days from the date of AGM or due date of AGM, if the AGM wasn’t convened;

9) Corporate Social Responsibility spending has been made mandatory;

10) As per amended clause 139 appointment of auditors for five years needs to be ratified by members at every Annual General Meeting;

11) Clause 152(6) provides that not less than two-thirds of the total number of directors of a public company shall be liable to retire by
rotation and be appointed by the company in general meeting. The independent directors are being excluded from the "total number of directors" for computing the proportion, nonetheless they are appointed under this Act or any other law;

12) As per newly inserted clause 245(2), where members or depositors seek any other suitable action from or against an audit firm, the liability shall be of the firm as well as of each partner who was involved in making any improper or misleading statement of particulars in the audit report or who acted in a fraudulent, unlawful or wrongful manner;

13) Provisions relating to voluntary rotation of auditing partner (in case of audit firm) modified to provide that members may rotate the partner at such interval as may be resolved by members instead of every year.

Tribunal applied ‘force of attraction rule’ to tax income indirectly connected to PE in India

The basic philosophy underlying the ‘force of attraction’ rule is that when an enterprise sets up a PE in another country, it brings itself within the jurisdiction of that another country to such a degree that such another country can properly tax all profits that the enterprise derives from such country- whether the transactions are routed and performed through the PE or not

In the instant case, the moot question that arose for consideration before the Tribunal was “Whether services rendered by PE in India to Indian project could only be made taxable and similar services rendered by general enterprise of such PE outside India will not be taxable as the same doesn’t amount to income indirectly attributable to PE in India”

The Tribunal held in favour of revenue as under:

1) It held that not only the profits directly attributable to the work performed by the PE but the entire profits whether “directly” or “indirectly” attributable to the PE could be made taxable;

2) The connotations of “profits indirectly attributable to permanent establishment” do indeed extend to incorporation of the ‘force of attraction’ rule embedded in Article 7(1);

3) In addition to taxability of income in respect of services rendered by the PE in India, any income in respect of the services rendered to an Indian project, which is similar to the services rendered by the PE, should also to be taxed in India in the hands of the assessee irrespective of the fact whether such services are rendered through the PE, or directly by the general enterprise;

4) This indirect attribution, in view of the specific provisions of India UK tax treaty, was enough to bring the income from such services within ambit of taxability in India. The twin conditions to be satisfied for taxability of related profits are: (i) the services should be similar or relatable to the services rendered by the PE in India; and (ii) the services should be ‘directly or indirectly attributable to the Indian PE’, i.e., rendered to a project or client in India. In effect, thus, entire profits relating to services rendered by the assessee, whether rendered in India or outside India, in respect of Indian projects are taxable in India;

5) The Tribunal has taken a considered view on interpretation of the aforesaid article that the entire profit relating to services rendered by the assessee whether rendered in India or outside India, in respect of Indian Project are taxable in India and it was not permissible to review the decision of the Tribunal in the guise of rectification under section 254(2) - Linklaters & Paines v. ITO, International Taxation [2012] 28 taxmann.com 250 (Mumbai - Trib.)

Airport Authority isn’t a ‘municipality’; agriculture land in its limit but beyond municipal limit isn’t a cap. asset

As Hyderabad Airport Development Authority (“HADA”) can’t be treated as a ‘municipality’, agricultural land situated within its jurisdiction isn’t a ‘capital asset’ by virtue of exclusion u/s 2(14)(iii) and capital gains resulting from sale of such land aren’t taxable as capital gains

In the instant case, the moot question that arose before the Tribunal was whether HADA could be considered as municipality and agricultural land situated within its jurisdiction could be considered as capital asset under section 2(14)(iii)(a)/(b).

The Tribunal held as under:

1) It was  clear from section 2(14)(iii)(a)/(b) that the gain on sale of an agricultural land would be exigible to tax only when the land transferred was located within the jurisdiction of a municipality;

2) HADA was basically and essentially a creation of the Act of the State Legislature consisting of persons appointed by the State Government on salary basis. The Board Members were not elected by the people and there was no element of people’s choice being represented in any manner in the constitution of the Board. The Board functioned strictly under the supervision and control of the State Government and did not hold or possess a “local fund”. Being so, HADA couldn’t be called as a local authority;

3) HADA was only entrusted with the responsibility of preparing draft Master Plans and granting technical approval for any proposed construction or development in its jurisdiction. It didn’t have any power or ability to collect taxes nor was it responsible for provision of civic amenities which would be within the exclusive domain of the local authorities;

4) HADA, being a Development/Special Area Authority constituted under the said Act, couldn’t be either equated with a distinct municipality or considered as a complete substitute of a municipality or any other local authority;

5) HADA couldn’t be treated as a 'Municipality' and, as such, the agricultural lands situated within the jurisdiction of HADA wouldn’t constitute capital asset. Thus, gains consequential to sale of such land wouldn’t be chargeable to tax - Smt. T. Urmila v. ITO [2012] 28 taxmann.com 222 (Hyderabad - Trib.)

A perpetual sole occupancy right given to a shareholder in a flat is deemed dividend

Transferable occupancy rights of a flat given to shareholders by a company on perpetual basis subject to deposit of a meagre sum, are deemed dividend under section 2(22)(a)
In the instant case, HPPL, a company had constructed a building and given occupancy rights of flats in the said building to its shareholders. The assessee ( i.e. one of the shareholder) got occupancy right of flat on deposit of certain sum towards proportionate cost of land and cost of construction. The AO held that distribution of occupancy rights should be considered as dividend under section 2(22)(a), and made addition under section 2(22)(a). However, the CIT (A) treated same as perquisite under section 2(24)(iv).

On appeal, the Tribunal held in favour of revenue as under:

1) The CIT (A) was not justified to hold that it was perquisite given by HPPL to its shareholders and not the transfer of occupancy rights to its shareholders. Hence, the provisions of section 2(24)(iv) would not apply to grant of occupancy rights by HPPL;

2) The assessee had got the occupancy rights in perpetuity as assessee could transfer his occupancy rights of the premises under consideration by way of sale to a third party subject to condition that transferee was to deposit the required amount of interest free security deposit with HPPL;

3) The consideration to be received by the assessee on transfer of his occupancy right was not to be refunded to HPPL. HPPL would have no objection for creating third party rights in the occupancy rights given to assessee; and

4) The AO had rightly held that the value of flats received was nothing but dividend given in the form of assets by HPPL. Hence, the decision of the AO, that said occupancy rights of the premises allotted by HPPL to assessee amounted to deemed dividend under section 2(22)(a), was upheld - Shantikumar D. Majithia v. Dy.CIT [2012] 28 taxmann.com 149 (Mumbai - Trib.)