Royalty excludes sale of drawings and designs

By Sumes Dewan and Shradha Puri, KR Chawla & Co
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The Income Tax Appellate Tribunal (ITAT), in a recent judgment (Parsons Brinckerhoff India (P) Ltd v Assistant Director of Income-tax, International Taxation, Circle (2) (1), Delhi 24 SOT 341 Delhi) held that income deemed to accrue or arise in India from proceeds of an outright sale of drawings and designs could not be treated as royalty.

In this case, an Indian company entered into a contract with PB Asia (PBAT).

Sumes Dewan Partner KR Chawla & Co
Sumes Dewan
Partner
KR Chawla & Co

The company had been awarded a contract for rendering such services to Larsen & Toubro in connection with the Second Vivekananda Bridge Tollway (SVBT) project. PBAT had to supply detailed design services for the project and receive consideration from the company.

The drawings and designs were sold to the company, which made an application under section 195(2) of the Income Tax Act, 1961 (ITA) to remit the consideration to PBAT in Thailand for the supply of designs and drawings without the deduction of tax at source.

The assessing officer took the view that the amount paid to PBAT represented “royalty” within the meaning of article 12 of the double taxation avoidance agreement between India and Thailand (DTAA).

The company objected to the view, stating that what was received by PBAT constituted its business profits, since the responsibility of PBAT came to an end once the designs and drawings were supplied.

The company therefore argued that it could not be a case of royalty. The assessing officer did not accept the contention and held that the payment in question was covered under the definition of royalty under article 12 and was therefore taxable in India at the rate of 15% on gross basis.

On appeal, the commissioner held that the payment made to PBAT for the supply of designs and drawings was also covered under explanation 2 to section 9(1)(vi) of the ITA as royalty, since the provision used the wide expression – “transfer of all or any rights” – and was not restricted to the mere use, or right to use the property.

The commissioner further held that under article 12.3 of the DTAA, considerations for the alienation of any design or model would also be taken as royalty, since even under the DTAA, the definition of royalty included a consideration for the transfer of the designs and drawings.

Because the company was based in India, what it paid to PBAT would be taxable in India if it fell within the definition of royalty under Explanation 2 to section 9(1)(vi) of the ITA. Thus, it was held that the payment was royalty both under the ITA and the DTAA.

The company filed an appeal before the ITAT. The commissioner of income tax (CIT) before the ITAT argued its case by placing reliance on clause (i) of Explanation 2 to section 9(1)(vi) of the ITA, which states that the consideration for the transfer of all or any rights, (including the granting of a licence) in respect of a patent, invention, model, design, secret formula or process or trade mark or similar property shall be treated as royalty and taxed in India.

Shradha Puri Senior associate KR Chawla & Co
Shradha Puri
Senior associate
KR Chawla & Co

It also relied on clause (vi) under the same explanation, which treats the consideration for the rendering of any services in connection with the activities referred to in clause (i) as royalty.

Strong reliance was placed by the CIT on the words “model” and “design” used in the clause and it was argued that the drawings and designs sent by PBAT fell within these categories. Since there was a transfer of all the rights in the drawings and designs, the consideration would thus be treated as royalty.

The ITAT held that the words model and design, had to be taken into consideration from the words surrounding them, such as “patent”, “invention” and “secret formula”. The words could not refer to drawings and designs which were sold outright and could not fall within the definition royalty under explanation 2 to section 9(1) (vi) of the ITA.

Further, the ITAT stated that the basic issue in such cases is whether the non-resident assessee is taxable. Only if they are taxable should one look into the treaty for any beneficial provisions to exempt the assessee from taxation or reduce the rigours of domestic law.

If there is such a provision in the treaty, the assessee is entitled to claim that it should be given the benefit of the treaty provisions.

Since the outright sale of drawings and designs by PBAT does not give rise to income by way of royalty, PBAT is not chargeable to tax in India under section 9(1)(vi) of the ITA. If there is no liability fastened on the non-resident by the terms of the ITA, then it is not legally necessary or permissible to examine the terms of the DTAA to determine whether a foreign company is liable to pay tax in India.

Sumes Dewan is a partner and Shradha Puri is a senior associate at KR Chawla & Co Advocates & Legal Consultants. The firm is headquartered in New Delhi and has offices in Chennai, Bangalore and San Francisco, as well as a representative office in Singapore.

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