Taxation On Technical Fees and Royalty

Regarding the taxability of royalty and Technical Fees in India, Section 9(1)(vi) and (vii) of the Income Tax Act, 1961 deal with them. Section 9 mainly deals with the income which is accrued outside India but is taxable. Under this particular Section it clause (vi) and (vii) specifically hold that the royalty or technical fees which also includes reimbursement to professionals is taxable under a specific rates. A fiction is created by which Income accruing outside India is deemed to accrue in India and is made taxable. Section 9 postulates that the income accruing outside India can be deemed to accrue in India and can be made taxable if sufficient territorial nexus is provided. In this particular case, the sufficient territorial nexus is construed as the payment is made by the Indian citizen. This proposition is criticized as being anti economic development and as a deterrent for foreign collaborators in India. In this project the various provisions regarding the taxability of royalty and technical fees are discussed. In what circumstances, the income would be treated as ‘royalty’ or ‘technical fee’ as the case may be in light of the decision of the court in various decided cases. Apart from Section 9 there are various other provisions which deal with this aspect. One of them is Section 115-A which is inserted by the finance Act, 1976. Section 115-A mainly talks about levying a tax on royalties and technical fees in case of foreign companies. It also prescribes the rates at which the taxes are to be levied and also the circumstances under which the concessions on the rates can be provided.

Research Methodology:

The topic of this research is “Taxation on Royalty and Technical Services". For the purpose of this project the researcher has used the doctrinal method of research. The doctrinal method is basically the use of books and other research papers on the same and related topic. The researcher has accessed the books available in the library of the NALSAR University of law; Hyderabad and the latest technology on the form of websites on Internet have also been accessed.

Research scheme:

The researcher has undertaken detailed analysis of the provisions relating to the taxational aspects of royalties and fees on technical services in the Income Tax Act, 1961. The researcher is of the opinion that the importance lies in the interpretation given by the court as to what amounts to royalty and fees on technical services and is thus taxable. The court has interpreted the terms ‘royalties and fees for technical services’ in various cases and has often given varied opinions and while it is clear from the language of the relevant Sections about the rates at which royalty and fees on technical fees are taxable, deliberation has always centered around the fact that what amounts to royalty or fee for technical services. Thus, the researcher has tried to explain the concept of ‘royalty’ and fees for ‘technical services’ from the point of view of case laws and then has proceed on to discuss Section 115-A which taxes royalties and fees for technical services from foreign companies followed finally by the conclusion.

Taxability of Royalty and Technical Fees: Provisions

The Finance Act, 1976 effected three basic changes as regards to assessment on non residents:

i. It inserted clauses (v), (vi) and (vii) in Section 9(1), deeming interest, royalty and technical fees to accrue or arise in India, making a non resident recipient chargeable to tax in cases where there is no tax liability under the pre existing law.

ii. It inserted Sections 44-C and 44-D denying deductions, entirely or part, in respect of expenses wholly and exclusively incurred for the purposes of the non resident’s business or for earning royalty or technical fees.

iii. It inserted Section 115-A prescribing new rates of tax for dividends, royalty and technical fees in the case of foreign companies.

Royalty and fees for technical services:

When Section 9(1) not applicable:

1. The effect of clause (vi) and (vii) is merely to deem income to accrue in India when in fact it accrues abroad, but these clauses of Section 9(1) do not deem any capital receipt to be an income receipt. Therefore, if the amount or royalty or technical fees is on capital account, these clauses would have no application. [1] 

2. The definitions for the term ‘royalty’ and ‘fees for technical services’ are only for the purposes of this section and cannot apply to double taxation avoidance agreements made under Section 90 of the Act unless expressly so provided. [2] 

3. Receipts which are royalty or fees for technical purposes under these clauses would not be chargeable to tax if the relevant treaty provides. Under the provisions of Section 9(1)(vi) and Section 9(1)(vii), royalty and fees for technical services are not deemed to have been accrued or arisen in India if they are payable in pursuance of an agreement made before 1 April, 1976 and approved by the central government. [3] 

4. If an agreement is entered into prior to 1 April, 1976, the amount payable under the agreement is not liable to be taxed under Section 9(1)(vi) and Section 9(1)(vii), irrespective of the date on which the agreement is approved by the central government. In the absence of any indication that the new agreement executed after 1 April, 1976 was in continuation of an earlier agreement entered into before that date the payment made under the later agreement was held to be taxable under Section 9(1)(vii) [4] .

Further, Clause (vi) is a specific clause dealing with royalty and therefore, if royalty covered by the substantive part of the clause is excluded by the proviso, the department cannot seek to bring it under clause (i) or (vii) [5] . Similarly, if ‘fees for technical services’ covered by the substantive part of clause (vii) are excluded by the proviso to that clause they cannot be brought under Clause (i). [6] On the other hand, the clauses would apply even when there is no business connection under Clause (i).

What Constitutes Royalty and Technical Fees:

The question whether a payment under an agreement is royalty or technical fees must be decided strictly in accordance with the definition. It is also to be determined on the facts and circumstances of the case and terms of agreement. [7] It is true nature of the consideration and not the nomenclature of an agreement that determines whether a particular receipt is ‘royalty’ or ‘fees for technical services’ or not. The contractual obligation contained in an agreement must be examined against the backdrop of the definitions so as to ascertain the true nature of payments [8] . The entire agreement and not merely the preamble should be examined to ascertain the true nature of consideration [9] .

It is for the revenue to establish that the payment is covered under the clauses (vi) and (vii) and therefore, taxable, but the burden to prove that the case falls under exclusionary parts of explanation 2 in both the clauses, and hence, the amount is not taxable, is on the assessee [10] . In the case of composite contract for supply of equipment and for providing technical services, if the terms and conditions are demarcated, the consideration for the technical services would remain independent of the consideration for supply of equipment and would be taxable as fees for technical services [11] and in the absence of such demarcation, an estimated allocation would be justified. [12] 

a. Royalty: The courts have time and again deliberated into the question of what constitutes royalty because this fundamental question has to be decided before Income Tax Act, and its relevant Sections can be applied. The approach of the case has been elucidated with the help of case laws available [13] .

The court has held that a lump Sum consideration which is in the nature of income chargeable under the head ‘capital gains’ is excluded from the meaning of the term ‘royalty’. Where a non resident company deputed an expert to supervise the construction and installation of a kiln in India (and not for imparting any information), the payment to it was held not to be income by way of royalty under clause (vi) [14] .

In the case of Leonhardt Andra Und Partner, GMBH v. CIT, [15] the assessee foreign company entered into a contract in 1974 with an Indian company to construct a bridge. The agreement came to an end and a fresh agreement was entered in 1980, without indicating that it was in continuation of the earlier agreement. It was held that it was evident from the contract, entered into after the gap of two years without any intention regarding continuation of the earlier agreement and remittances there under were taxable as ‘royalty’ in India. Admittedly, royalty was not defined in ‘double taxation avoidance agreement’ between India and Germany, and hence definition in the Act, had to prevail. Thus, the sums received by the assessee were in the nature of ‘royalty’ under Section 9(1)(vi) [16] .

In another case of IAC v. Daimler Benz AG West Germany [17] , The assessee, a non resident company incorporated abroad, entered into an agreement with Telco, an Indian Company, whereby it licensed Telco to manufacture diesel engines and spare parts thereof. The assessee agreed to provide to Telco all technical information etc. relating to improvements in licensed products and to make available all the technical personnel for service in India in an advisory capacity in the area of their specialization. Telco was the sole selling agent for all products in India for the period of 5 years. In consideration of the aforesaid services to be rendered by the assessee, Telco agreed to make Rs. 15 million in 5 equal installments. Regarding the nature of the receipts in the hands of the assessee, the tribunal held that the entire receipt fell under the definition of ‘royalty’ and had to be taxable and should be considered as income accrued in India [18] .

In CIT v. Neyveli Lignite [19] , the foreign company supplied machinery to the Indian company and incidentally also supplied the design of the manufacturing machinery and information concerning the working of the machinery. The design was not supplied to enable the Indian company to manufacture the machinery, nor was any licence of any patent involved in the transaction. The Madras High Court held on these facts that the payment to the foreign company was not covered by either Clause (vi) or (vii) of Section 9(1) and therefore, not taxable. Similarly, where a foreign company received payments in consideration of it foregoing exports in various markets and transferring certain export orders in favor of an Indian company, it was held that such payments did not amount to ‘royalty’ or ‘technical fees’ [20] .

However, payments received for the supply of drawings and designs for the construction of a bridge [21] , or for providing specialized knowledge for manufacturing a particular commodity [22] , or for the supply of know how and information necessary for setting up a plant [23] or for a license to manufacture and sell certain products and use of patents [24] were held to be payments by the way of royalty and therefore taxable.

Where a lump sum amount was paid to the foreign company for providing technical know how, the entire amount was held to be royalty, notwithstanding the fact that the services were rendered in India by the two personnel of the foreign company for fifteen days to set up the plant. [25] 

Where the foreign company entered into a single contract for designing, engineering, manufacturing, testing and supplying machinery, it was held that it was not possible to apportion the consideration for the design on one part, and the other activities on the other part, and hence, the consideration for the transfer of design did not come under the purview of Clause (vi) [26] 

Fees for technical services

The term fees for technical services could only be meant to cover such things technical as are capable of being provided by the way of service for a fee, having regard to the fact that the term is required to be understood in the context in which it is used [27] ; in Clause (vii), it contemplates rendering of a ‘service’ to the payer of the fee and cannot include providing cellular mobile telephone facility to the subscribers [28] .

In the case of Cochin Refineries ltd. v. CIT, (1996) 135 CTR 193: Cochin refineries requested a foreign company ,F, to evaluate whether the coke produced from a blend of vacuum bottoms and clarified oil from the Bombay High Crude was suitable for making anodes for the aluminum industry. The tests were carried out in U.S.A in regard to which the payment of around 7 lakhs 60 thousand. The assesses also paid around 1.2 lakhs and also 38000 which were payments in the nature of reimbursements of the payment made to the personnel of the said consultant F. All these payments were assessed under Section 9(1)(vii) and this was also upheld by the tribunal. On a reference: it was held that the services which are rendered by a foreign company, F, would be in the nature of technical services and would, therefore, consequently, be covered fully by the explanation to Section 9(1)(vii). Even, with regard to the payments of Rs. 1.2 lakhs and Rs. 38000 in the nature of reimbursement of payments made to the personnel, no different situation would be available because these payments would be part and parcel of advice of technical character and would fall for coverage only within the meaning of the above explanation.

Cluases (vii) (b) and (c) use the expression ‘fees for services utilized’ in India and not ‘fees for services rendered’ in India and accordingly if the fees are paid for the services utilized by the Indian company in its business carried on by it in India, irrespective of the place where the services are rendered, the amount of fess would be deemed to accrue in India [29] .

Fees for technical services include consideration for the rendering of services by an assesse through its employees [30] ,But not where the payment is made to the foreign employees by way of the remuneration for the services rendered in India [31] .

Where the technical services are rendered by a non resident who has not undertaken any construction, assembly, mining or the like project in India, but has undertaken merely to supervise the erection, commissioning and start up of the plant, the payment for the supervisory services is taxable under Clause (vii) because the exclusionary clause contained in explanation 2 does not apply in such a case [32] . Similarly, the fees paid to assist in achieving the desired quality and optimum productions are taxable [33] , but rendering of services by two foreigners for just 15 days to set up a plant in India under an agreement for transfer of technical know how was held not to be covered under Clause vii. [34] .

Where a foreign company rendered services as a financial advisor to an Indian company in raising finances for its power generating business and was paid a ‘success fee’ based on the total debt financing, it was held that the success fee was a fee for technical and consultancy services and hence taxable under Clause (vii) [35] .

Section 115-A

Dividends received by a foreign company, as also income by way of royalty or fees for technical services received by them form Indian Concerns in pursuance of approved agreements made or on after 1st April, 1976, are charged to tax at flat rates applicable on the gross amount of such income. The rates of income tax to be applied in respect of such income have been specified in new Section 115-A of the Income Tax Act, 1961 and are as follows:

i. Income by way of royalties received under the approved agreements made on or after 1st April, 1976, will be charged to tax at 40% on gross basis, except that so much of such income as represent lump sum consideration for the transfer outside India of, or the imparting of information outside India in respect of, any data, documentation, drawing or specification relating to any patent, invention, model, design, secret formula, or process or trade mark or similar property will be charged to tax at the rate of 20% of the gross amount of such lump sum consideration.

iii. Income by way of fees for technical services received by a foreign company form an Indian concern in pursuance of an approved agreement made on or after the 1st April, 1976, will be charged to tax at the rate of 40% on the gross amount of such fees.

The flat rates specified above will, however, not be applicable in relation to royalties approved by a foreign company in pursuance of the approved agreement made after the 1st April , 1976, if such agreement is regarded as an agreement made before the said date under Section 9(1)(vi) of the Income Tax Act. Such royalties will be charged to a tax on net basis at the rates specified in the annual finance Act in respect of Income by way of royalties and technical fees received by foreign companies from Indian concerns under approved agreements made before the 1st April, 1976 [36] .

Concessional Taxation of royalties in respect of books on scientific, technical and educational subjects in case of foreign companies-Section 115-(1A):

Under Section 115-A(1) of the Income Tax Act, 1961, income by way of royalty(other than lump sum royalty for transfer outside India of, or the imparting of information outside India in respect of data, documentation, drawings, etc, in relating to any patent, invention etc.) received by a foreign company form an Indian concern in pursuance of an agreement made on or after 1st April, 1976, is charged to tax at the rate f 40%, on the gross amount of such income, if the agrrement is apporoved by the central government. The finace (No.2) Act, 1977, has inserted a new sub Section (1-A) in section 115-A to provide that the aforesaid condition, namely, that the agreement between the foreign comoany anf the Indian concern should have been approved by the central government will not apply in cases where the royalty is paid in consideration for the transfer of any rights(including the granting of any licence) in respect of copyright of any book, if the book is on a subject the books on which are permitted, according to the Import Trade Control Policy of the government of India for the financial year 1977-78, to be imported into India under an open general licence [37] .

Uniform rate of Tax on royalty and fees for technical services in the case of foreign companies (The Finance Act, 1986):

Under the existing provision of Section 115-A of the Income Tax Act, the amount of Income Tax payable on the gross amount of income by way of royalty or technical fees received by a foreign company form an Indian concern or from the government is as under:

i. 20% of such income as consists of lump sum consideration for the transfer outside India of the technical know how.

ii. 40% on the balance of such income.

It may be mentioned that when the provisions of Section 115-A were enacted, it was felt that it might be difficult to segregate the royalty payment relating to the supply of know how simpliciter from the payment relatable to the technical service. This is because of the fact that a number of our technical collaboration agreement envisage composite situation where the collaborator tenders various types of services of technical nature apart form making available patents and know how. It had been apprehended at that time that a higher rate of tax on royalty might result in inflating fees for technical services. Hence, Uniform rate of tax of 40% for both royalty and technical services was prescribed. It may appear to be ironical that with the passage of time, the lower rate of tax at 20% applicable to lump sum payments for supply of technical know how abroad has given rise to the problems which had been apprehended relating to royalty viz a viz fees for technical services [38] . It has been found that the foreign collaborators tend to take more by way of lump sum which attracts lower rate of tax than by way of royalty and in some cases payments for grant of license for use in India of technical process are camouflaged in lump sum payments abroad. This is also not in the interest of absorption and adoption of imported technology. An agreement for transfer of technology in India is more conducive, when compared to an agreement for lump sum payment, to self reliance in our industrial production.

Conclusion

The parliament of India can legislate only for the territory of India. As far as foreigners are concerned, the well established principle is that given a sufficient territorial connection or nexus between the person sought to be charged and the country seeking to tax him, the income tax may properly extend to that person in respect of his foreign income. The connection must be a real one and the liability sought to be imposed must be pertinent to that connection. [39] 

Clauses (i) to (iv) of Section 9(1), which deem foreign income to accrue in India, are intra vires the powers of parliament, since they proceed upon the sufficient territorial nexus. But Clauses (vi) and (vii) which deal with royalty and technical fees respectively seek to charge a foreigner in respect of his income outside India only because the payment is made by an Indian resident, even when it arises under a contract which is made and performed entirely outside India and neither the income not the contract has any connection with India. Unlike the residence of the assessee himself, the residence of the person from whom the income is received can never afford a sufficient, a real or pertinent territorial nexus to justify the levy of income tax on a foreigner in respect of his income which has nothing to do with India. Under these clauses, the foreigner is made liable to Indian Income Tax in every case in respect of interest, royalty or technical fees received abroad from an Indian resident for services or other consideration rendered wholly abroad, the only exception being the case where the payment is made for the purposes of the Indian resident’s business, profession or source of income abroad. If the Indian parliament can cast the net wide enough to collect tax in such cases where the foreigner’s income has no nexus with India, only because the income is derived from a transaction with an Indian, it can equally levy a tax on a hotel in a foreign country where the Indian goes to stay or dine, or on a foreign store where an Indian buys shirts or grocery, or on a foreign physician whose services are sought by an Indian while abroad. Not only are these clauses contrary to the well settled international norms of taxation on a foreigner in respect of his income accruing, arising and received outside the taxing state, but they are against the letter and the spirit of the various tax treaties entered into by India with foreign countries, though they do not, and cannot, supersede those treaties [40] . Further, it is difficult to conceive of more powerful fiscal deterrents to keep away foreign collaborators.