S. 9(1)(vi)/ Article 12: Equipment rental is taxable as “royalty” even if payer does not have control. The retrospective insertion of Explanation 5 to s. 9(1)(vi) is purely clarificatory

Poompuhar Shipping Corporation Ltd vs. ITO (Madras High Court)

 

The High Court had to consider the following issues in the context of a bare-boat charter of a shipping vessel from a foreign party, the income whereof was held assessable as “royalty” u/s 9(1)(vi) & Article 12 in the hands of the foreign party: (i) whether the expression ‘use or right to use‘ in clause (iva) of Explanation 2 to s. 9(1)(vi) & Article 12 of the DTAA requires that there should be a “transfer of effective control for use” in favour of the lessee?, (ii) what is the impact of the retrospective insertion of Explanation 5 to s. 9(1)(vi) on the taxability of equipment royalty?, (ii) whether a ship can be regarded as “equipment”?, (iii) whether if the ship is used for plying between coastal waters, it can be said to be used for “international traffic”?, (iv) whether the two berths reserved for the ships chartered by the assessee can be said to be a “permanent establishment” of the foreign owner? & (v) whether a person who is treated as an “agent” u/s 163 can also be proceeded against u/s 201 for failure to deduct TDS? HELD by the High Court:

(i) The assessee’s argument that in a case where physical possession is not with the transferee or the lessee or the hirer, the payment made for the use of or right to use of equipment would not constitute ‘royalty‘ is not acceptable. Under clause (iva) of Explanation 2 to s. 9(1)(vi) ‘royalty‘ means the consideration paid for “the use or right to use“. Irrespective of whether there is any transfer or not, the consideration paid for use or right to use simpliciter is sufficient for the consideration being called as ‘royalty‘. The presence or absence of possession, effective/general control and custody with the assessee, even though may be matters of agreement, are not of any relevance to decide the character of payment. The same result applies under Article 12 of the DTAA (Gosalia Shipping 113 ITR 307 (SC), OECD Commentary referred);

(ii) Explanation 5, inserted by Finance Act, 2012, w.r.e.f. 01.06.1976 clarifies that irrespective of control or possession or use or location in India such right, property or information with the payer; the payment is taxable as royalty. The Revenue does not need the assistance of Explanation 5 because even if the possession of the ship is with the owner, he has parted with the “right to use” the ship and the consideration thereof constitutes “royalty” even without Explanation 5;

(iii) The assessee’s argument that ship is not an “equipment” for purposes of s. 9(1)(vi) is not acceptable. The word ‘any‘preceding an equipment clearly points out the need for construing ‘equipment‘ widely so as to embrace every article employed by the employer for the purposes of his business. A ship is “plant” u/s 43(3). “Plant” includes ‘all equipment’used by a business man for carrying on his business. As a ship is used to carry on business, it is “equipment”;

(iv) The argument that a ship used for plying between coastal lines on the Indian shore is used in “international traffic”is not acceptable in view of the OECD Commentary;

(v) On the question of permanent establishment, a moving ship is a place of business in the place where the ship is docked. The fact that the ship moved from one point to another is the result of the nature of business contract and the movement is an integrated one having business and geographical coherence. Accordingly, the foreign enterprise has a permanent establishment in India when its ships are in India and the berths are reserved for it. However, the royalties paid are not “effectively connected” or attributable to such permanent establishment. Accordingly, the payment falls for consideration only under Article 12 and not under Article 7;

(vi) The assessee’s argument that a person who is treated as an “agent” u/s 163 cannot be proceeded against u/s 201 for failure to deduct TDS is not correct because the two provisions operate in different spheres. S. 195 casts an obligation on TDS on any person responsible for paying, whereas s. 163 is for assessment purposes. Proceedings u/s 201 has nothing to do with the status of the assessee as an agent u/s 160 and 163 which would assume significance only for assessment purposes (Premier Tyres 134 ITR 17 (Bom) noted)