Introduction
Taxation of royalty has been a much debated
subject in India. If an Indian company imports concept designs and drawings
from a company incorporated in another country, e.g., the UK, various questions
arise about the taxation of the payment for such designs and drawings. Is such
a payment in the nature of a royalty payment, thereby subjecting it to
withholding tax, or is it a payment for an outright purchase of the designs and
drawings! The answer to this depends on the scope of the term “royalty.”
Definition of “Royalty”
Black’s Law Dictionary defines “[r]oyalty”
as “compensation for the use of property, usually copyrighted material or
natural resource, expressed as a percentage of receipts from using the property
or as an account per unit produced… …” As generally understood, royalty is most
often associated with the fee paid to a patentee for the use of a patent or the
money owed to an author for each copy of a book sold. A Texas court has ruled
that royalty is the share of a product or a profit reserved by the owner for
permitting another to use the property. (Alamo Nat. Bank of San Antonio v.
Hurd, Tex. Civ. App., 485 S. W. Zd. 335, 338) Thus, the salient feature of a
royalty payment is that it is given as a compensation for the use of some
property.
India’s Income-tax Act, 1961 (the “Act”)
defines “royalty” to mean any consideration (including any lump sum
consideration but excluding any consideration which would be the income of the
recipient chargeable under the head “Capital Gains”) for –
(i)
the transfer of all or any rights
(including the granting of a license) in respect of a patent, invention, model,
design, secret formula, process, trademark or similar property;
(ii)
the imparting of any information concerning
the working of, or the use of a patent, invention, model, design, secret
formula, process, trade mark or similar property;
(iii)
the use of a patent, invention, model,
design, secret formula, process, trade mark or similar property;
(iv)
the imparting of any information concerning
technical, industrial, commercial or scientific knowledge, experience or skill;
(v)
the use or right to use any industrial,
commercial or scientific equipment, not including the amounts referred to in
section 44BB;
(vi)
the transfer of all or any rights
(including the granting of a license) in respect of any copyright, literary,
artistic or scientific work including films or video tapes for use in
connection with television or tapes for use in connection with radio
broadcasting, not including consideration for the sale, distribution or
exhibition of cinematographic films; or
(vii) the rendering of any services in connection
with the activities referred to in sub-clauses (i) to (iv), (iva) and (v).
(Explanation 2 to Section 9(1)(vi) of the Act)
Income from royalty is taxable in India
under the Act. However, when designs are imported by an Indian company from a
foreign company, it becomes pertinent to ascertain the definition of royalty
given in the double taxation avoidance agreement (“DTAA”), if any, that India
may have with that foreign country. For example, in the India-UK DTAA, a royalty
payment is a payment of any kind for the
use of, or the right to use:
(a) any patent, trademark, design or model,
plan, secret formula or process;
(b) industrial, commercial or scientific
equipment, or information concerning industrial, commercial or scientific
experience;
(c) any copyright of literary, artistic or
scientific work, cinematographic films,
and films or tapes for radio or television
broadcasting. (Article 13(3) of the DTAA)
As can be seen from the foregoing, royalty
has been defined differently under the Act and the India-UK DTAA. It has been
held that while determining the liability of a non-resident company in India,
if there is any DTAA entered into under section 90 of the Act, the provisions
of the DTAA must prevail over the provisions of the Act. (CIT v. Visakhapatnam
Port Trust [1983] 144 ITR 146)
Does payment for any information constitute
a royalty payment!
To determine the exact nature of the
payment made, the type of information
passed on needs to be verified. Payments
made for all kinds of information given cannot be broadly classified as
royalties. In a recent case, an Indian company paid a certain amount to a US
firm to obtain information concerning certain technical knowledge of the US company.
In this regard, the Madras High Court held that payments made to obtain mere
data or a calculation sheet could not be treated as royalty payments. In order
to withhold tax on payments for information received, the information should
have some special features and should not merely be of a pure commercial
nature. (CIT v. HEG India, 130 Taxman 72)
Purchase of Property v. Right to Use
Property
The Calcutta High Court has ruled that sale
of know-how cannot be taxed as royalty. (CIT v. Davy Ashmore India, 190 ITR
626) In this case, the non-resident company did not retain any property in the
designs and drawings, and the designs and drawings had been imported under
India’s import policy after obtaining the prior approval of the Reserve Bank of
India. A royalty payment must be in respect of a right to use designs and
drawings, and not for the purchase thereof. (Pro-Quip Incorporation v. CIT (255
ITR 354)
Under the India-USA DTAA, payments for
alienation/transfer of property would
be taxable as royalty only if the payments
were contingent on the use or disposition of the property.
Can a one-time payment constitute a royalty
payment!
A one-time payment for the grant of right
to use the property can be classified as royalty. The Gujarat High Court has
held that a royalty may well be a single
payment covering the whole use of the
patent for the whole term, even though the usual practice is to make periodic
payments and to relate the amounts of those payments to the actual use of the patent by the licensee. (CIT
v. Ahmedabad Manufacturing and Calico Printing Co. [1983] 139 ITR 806)
Therefore, a onetime payment or payments
on an ongoing basis may be characterized as royalty, provided that the
payment(s) is made for the right to use the property.
Conclusion
In the light of the above judgments,
various points need to be examined before concluding that a payment is actually
a royalty payment. If there is an outright purchase with no interest remaining
in the seller company, the payment cannot be classified as royalty. Further, if
the right to use certain information is acquired, the payment can only be
considered as royalty if the information has some special features, expertise
or skills. Additionally, payment for information regarding industry or
commercial transactions cannot be treated as a royalty payment.
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