* IN THE HIGH COURT OF DELHI AT NEW DELHI
+ ITA No. 79/2001 and 80/2001
Reserved on: 23rd July, 2014
% Date of Decision: 30th September, 2014
Commissioner of Income Tax Delhi - I ...Appellant
Through Ms. Suruchi Aggarwal,
Sr.Standing Counsel.
Versus
M/s Voest Alpine A.G. ...Respondent
Through None
CORAM:
HON'BLE MR. JUSTICE SANJIV KHANNA
HON'BLE MR. JUSTICE V. KAMESWAR RAO
SANJIV KHANNA, J.
The present appeals by the Revenue under Section 260A of the
Income Tax Act, 1961 (Act`, for short) pertain to Assessment Years
1989-90 and 1990-91 and stand admitted for adjudication on the
following substantial questions of law:-
ITA No. 80/2001
Whether the Tribunal was correct in law in
holding that a sum of Rs.41,61,083/- received by
the assessee in terms of Article 4.1 of the technical
assistance agreement dated 23 May 1986 was in
the nature of royalty?
ITA No. 79/2001
Whether the Tribunal was correct in law in
holding that a sum of Rs.30,07,889/- received by
the assessee in terms of Article 4.1 of the technical
ITA 79-80/2001 Page 1 of 24
assistance agreement dated 23 May 1986 was in
the nature of royalty?
2. Answer to the aforesaid questions centres on Articles VI and VII
of the Double Taxation Avoidance Agreement (DTAA) between India
and Austria dated 24th September, 1963 and notified on 5th April, 1965.
The said Articles are reproduced below:-
ARTICLE VI
1. Royalties derived by a resident of one of the territories
from sources in the other territory may be taxed only in
that other territory.
2. In this article, the term royalty means any royalty or
other like amount received as consideration for the right
to use copyrights, artistic or scientific works,
cinematographic films, patents, models, designs, plans,
secret processes or formulae, trade marks and other like
property or rights.
ARTICLE VII
Amounts paid by an enterprise of one of the territories for
technical services furnished by an enterprise of the other
territory shall not be subject to tax by the first-mentioned
territory except insofar as such amounts are attributable to
activities actually performed in the first-mentioned
territory. In computing the income so subject to tax, there
shall be allowed as deductions the expenses incurred in the
first-mentioned territory in connection with the activities
performed in that territory.
3. Articles VI and VII delineate that a perspicuous distinction was
endorsed and accepted by India and Austria between royalty` paid as
consideration for right to use copyrights, artistic or scientific works,
designs, secret processes etc.; and consideration paid for technical
services`. The difference between the two Articles has been elucidated
below. However, at this stage, we notice that royalty` derived by a non-
resident as per Article VI, could be subjected to tax in India if received
ITA 79-80/2001 Page 2 of 24
from sources in India and vice versa. Article VI incorporated the source
rule for taxation. On the other hand, under Article VII, technical
services` furnished by a non-resident enterprise, was not taxable in the
country of source, except insofar as such amounts were attributable to
the activities actually performed in the country of source. In such cases,
income could be subjected to tax after allowing deduction of expenses in
the country of source in connection with activities performed in the
source country.
4. However, before we go into detailed discussion on the core aspect
and draw a distinction between royalty` under Article VI and technical
services` under Article VII, we would first like to refer to the relevant
facts in brief.
5. The respondent-assessee, a company incorporated and resident of
Austria had entered into Technical Assistance Agreement for Small
Hydro Power Plants` (Agreement`, in short), dated 23rd May, 1986, with
Punjab Power Generation Machines Limited (PPGML). Austria,
therefore, was the country of residence and India, the country of source.
6. The respondent-assessee as per recitals in the said Agreement was
custodian of advance and valuable technology for producing hydro
power equipment on the basis of information gathered, researched and
developed over years. The respondent-assessee had agreed to furnish to
PPGML, know-how and technical assistance for manufacture of such
equipment and marketing the same on the terms and conditions set out
therein. The information to be made available was set out in the
Agreement in clause 1.1 for the products defined in clause 1.2. For the
completeness, clause 1.1 of the Agreement is reproduced as below:-
ITA 79-80/2001 Page 3 of 24
1.1 Information:
The term "Information" as used herein shall mean any one
or more of the following and the information contained
therein for the manufacture by PPGML of Products as
defined in Section 1.2 of this Article:
i) design manuals, standard and representative
drawings and including input and output data and
computation formulae for typical cases
ii) process specifications
iii) materials specifications
iv) performance specifications including model test
performance charts of runners
v) purchasing specifications
vi) test data (for inspection)
vii) apparatus instructions books
viii) written or otherwise recorded technical assistance
ix) drawings for testing equipment, tools, dies, jigs
and fixtures employed in the manufacture of
Products.
x) Typical foundation drawings (including forces)
xi) any other data generally known as engineering and
manufacturing information; and
xii) information furnished under Article III below
7. Clause 1.4 of the Agreement, referred to the term patents`, that it
meant letters patents, utility models, licences, rights and privileges to or
under letters patent and utility models in connection with the product
etc. Article II of the Agreement in clause 2.1 stipulated that PPGML,
during and after the Agreement, was entitled to use the information in
the territory of India, Nepal, Bhutan, Bangladesh and Sri Lanka. Further,
PPGML was entitled to call upon the respondent-assessee to furnish,
ITA 79-80/2001 Page 4 of 24
without additional charge, typical workshop drawings of executed
projects within the product range. PPGML had exclusive right to
manufacture and sell the product within the territory` and use patents
relating to the product owned and controlled by the respondent-assessee
etc. Further, PPGML had the right to export products outside the
territory except Austria and other countries where the respondent-
assessee had entered into arrangements as on the effective date of the
Agreement. Names of the said countries stand mentioned in clause 2.3
of the Agreement.
8. Article III of the Agreement began with heading Engineering
Development/Visitation` and stipulated that the respondent-assessee
would undertake engineering development with respect to products at
the request of the PPGML. Clause 3.1 of the Agreement read as under:-
... Engineering development shall consist of (a) preparing
and supplying to PPGML such manufacturing, enginee-
ring, or other information as is not at the time in current
use by VA in its commercial manufacturing operations or
not at the time available in the records of VA, but which
is specifically prepared at the request of PPGML; (b)
development carried out by VA upon such request; and
(c) furnishing technical experts in connection-with such
requests and for clarification of the information
furnished and assisting in problems encountered by
PPGML. Such technical experts shall be at the services
of PPGML for such time as they may be needed for
attention to specific matters. For such engineering
development and special or additional information,
PPGML shall reimburse to VA the charges including
travelling and living expenses which shall be mutually
agreed and subject to the approval of the Reserve Bank
of India.
9. Clause 3.2 of the Agreement related to visitation and stated that
the respondent-assessee would depute its technical experts to PPGML`s
ITA 79-80/2001 Page 5 of 24
factory to assist them in setting up and commissioning manufacturing
facilities in the design and manufacturing of products. It read as under:-
3.2 Visitation:
Upon prior written request from PPGML, VA shall depute
its technical experts to PPGMLs factory to assist PPGML
in setting up and commissioning manufacturing facilities
and in the design and manufacture of the Products. The
number of such technical experts to be so deputed by VA
and the duration and date of such deputation shall be as
may be mutually agreed by and between VA and PPGML.
PPGML shall reimburse VA all expenses including
travelling and living expenses of its technical experts
visiting India on such deputation which shall be mutually
agreed and subject to the Reserve Bank of India.
VA will permit a reasonable number and not to exceed total
of ten (10) man-months in the first year and thereafter, one
man month per year of collaboration Agreement of vising
representatives of PPGML at PPGMLs expense to visit
such plants of VA in Austria as may be designated by VA
from time to time, and for such periods as may be
necessary; in order to study the design techniques and the
method used by VA in its manufacture of Products. VA
shall make best efforts to make available to such visiting
representatives of PPGML all information relating to the
method [sic, methods] of manufacturing, inspection and
performance testing engineering and design techniques in
respect of Products.
There were certain stipulations on the total manpower, the time period,
the visitations etc. Clause 3.3 was a general provision and for the sake
of completeness is reproduced below:-
3.3 General:
The technical experts, representatives and other
personnel at any time made available or furnished
by either party hereto to the other in accordance
with the provisions of this Agreement shall (unless
otherwise mutually agreed to) at all times be the
employees or representatives of the party
furnishing such personnel or making them
available, and shall not be the employees or
representatives of the party to whom furnished or
made available. Each party shall be responsible for,
ITA 79-80/2001 Page 6 of 24
and shall pay, all such salaries, living allowances,
travelling expenses and other remuneration to
which its said employees or representatives may be
entitled, and shall assume full responsibility for
any and all claims (including personal injury to
such employees or representatives) asserted by or
against any of such employees or representatives
and which arise during the course of their activities
in the plant or offices of the other party or
otherwise under this Agreement. Such employees
or representatives of either party, while on the
property of the other party, shall at all times act in
accordance with the rules and regulations adopted
by the other party with respect to the conduct of its
own employees or representa tives.
10. Article IV of the Agreement dealt with consideration and read as
under:-
ARTICLE IV
CONSIDERATION
In consideration for the Information and services to be
furnished and rendered by VA hereunder:
4.1 PPGML shall pay, subject to deductions at source of
Indian income tax and any other taxes as applicable and
provided in Article A-VIII hereof, to VA as follows:
a) ATS 2,150.000,- within sixty (60 days of the
Effective Date;
b) ATS 2,150.000,- within sixty (60) days from the date of
receipt of the Information; and
c) ATS 2,150.000,- within sixty (60) days from the date of
Commencement of Commercial Production.
4.2 Royalty :
For using Information and Patents furnished or licenced by
VA, PPGNL shall pay to VA, a royalty at the rate of five
percent (5%) of the Net Ex Factory Sale Price of the
Products manufactured and sold by PPGML after
Commencement of Commercial Production and during the
term of this Agreement.
ITA 79-80/2001 Page 7 of 24
4.3 Products shall be considered sold (a) at the time of
billing to a customer, if it is sold; b) at the time of transfer
thereof to a customer, if it is bartered, exchanged for
goods or services or otherwise transferred to such
customer or (c) at the time of transfer thereof for use
anywhere within PPGML.
4.4 The payment of royalty shall be made bi-annually
within ninety (90) days counting from the last day of each
semester, i.e. within ninety (90) days from June 30th and
within ninety (90) days from December 31st respectively.
As to the last royalty payment, PPGML shall make this
payment within ninety (90) days from the termination
of this Agreement.
4.5 Royalty shall be paid by PPGML on the total
annual sales upto the maximum of licenced capacity of
Products plus twenty-five percent (25%) thereof as
allowed by the Government of India. In case of sales in
excess of the aforesaid aggregate of annual licenced
capacity and the aforesaid 25%, prior approval of the
Government of India and Reserve Bank of India will
have to be abtained [sic, obtained] for payment of fee on
such excess sales.
4.6 All amounts which shall become due and payable by
PPGML pursuant to any provisions of the Agreement shall
be paid promptly when due and payable after obtaining
the approval of Reserve Bank of India.
11. A reading of the aforesaid Article of the agreement with PPGML
would indicate that under the heading Consideration`, clause 4.1
delineated and treated lump-sum payment as attributable to information
and services, to be furnished` and clause 4.2 delineated and treated
recurring payments as royalty`. The description in clauses 4.1 and 4.2
under Article IV relating to consideration and method of payment
thereof, was the primary reason for differentiation adopted by the
Tribunal to determine whether the consideration paid was for technical
services` or royalty`. This was the method/mode accepted to bifurcate
ITA 79-80/2001 Page 8 of 24
or divide the consideration received between income treated as exempt
under Article VII and income that was taxable. Thus, primacy stands
accorded to the bifurcation of consideration as made in the agreement.
Whether the said division/bifurcation could be ignored or whether the
division was reasonable and fair have not been elucidated and examined.
Perhaps these aspects were never argued and raised by the Revenue.
12. Now, we come to the assessment order and the order of the first
appellate authority. The Assessing Officer, unfortunately, did not even
notice Article VII of the DTAA, neither did he advert to the distinction
between royalty` and technical services` manifest in the two Articles.
This was inappropriate and undesirable manner of dealing with the issue,
which mandated consideration and answer. The assessment order
records that the respondent-assessee had received consideration in three
installments. Rs.41,61,083/- representing the first two installments in
clause 4.1 were received in the period relevant to the assessment year
1989-90 and the third installment of Rs.30,07,889/- was received in the
period relevant to the assessment year 1990-91. The payments received
were claimed to be exempt or not taxable being consideration for
technical services`. The assessing officer treated the entire amount
received under clause 4.1 as royalty taxable under Article VI of the
DTAA. No elucidation and justification was recorded, why and for what
rationale and reason no part of the consideration could be treated as paid
for rendering technical service`.
13. During the course of hearing before us, we had asked the Senior
Standing Counsel for the appellant-Revenue, whether the income earned
under the head Royalty` in Article 4.2 was subjected to tax in India
under Article VI of the DTAA. She drew out attention to the assessment
ITA 79-80/2001 Page 9 of 24
order dated 19th January, 1993 which records that payments under
Article 4.2 of Rs.1,54,623/- were treated as royalty and therefore, was
taxable income in India. We assume that in the subsequent assessment
years when the production commenced and increased, the payments
received under clause 4.2 of the Agreement were taxed in India as
royalty in the hands of respondent-assessee.
14. The Commissioner of Income Tax (Appeals) deleted the said
addition, observing that the Agreement between the respondent-assessee
and PPGML was a composite one, wherein royalty as well as technical
services had to be paid for. The lump-sum fee payable under clause 4.1
was for technical services furnished in Austria and covered under Article
VII of the DTAA, whereas payments made under clause 4.2 would be
covered under Article VI of the DTAA. Thus, he was of the opinion that
the Assessing Officer was not right in treating Rs.41,61,083/- and
Rs.30,07,889/- as royalty.
15. The Tribunal in the impugned order examined clauses 4.1 and 4.2
and Articles of the DTAA to hold that the payments made under clause
4.1 were for technical service covered by Article VII of DTAA which
were furnished in Austria, whereas clause 4.2 dealt with rights and
consideration covered by royalty under Article VI of the DTAA. The
respondent-assessee did not have place of work in India, and therefore,
payments made under clause 4.1, being lump-sum payments were not
liable to tax in India. Thus, Rs.41,61,083/- and Rs.30,07,889/- could not
be included in the taxable income of the respondent-assessee for the
assessment years 1989-90 and 1990-91, respectively.
ITA 79-80/2001 Page 10 of 24
16. As noticed above, Articles VI and VII of the DTAA, drew a clear
distinction between royalty` and technical services`. Being different
and tax treatment being dissimilar, the two Articles of the DTAA should
be contrasted and dissimilitude marked.
17. Royalty normally means rent or hire charges, but in the context of
Articles VI of the DTAA, it would not be proper to give royalty a
restricted meaning to draw a distinction between Articles VI and VII on
the basis of periodical or lump sum payments. As per Article VI, royalty
meant royalty or other like amount received as consideration. The
Gujarat High Court in Commissioner of Income Tax vs. Ahmedabad
Manufacturing & Calico Printing Co., [1983] 139 ITR 806, has
elaborately and lucidly interpreted the term royalty` making reference to
legal dictionaries, Australian and Canadian law to opine that the term
would mean share of profit reserved by the owner for permitting another
to use his intellectual property. The term is usually and commonly used
in connection with the agreement for use of patents, copyrights, designs,
licences for supply of technical know-how etc. in addition to minerals. It
may be a single payment covering the whole use of the patent, copyright,
trademark etc. for the whole term but the usual practice is to make
periodic payment and the amount relates to actual use of the intellectual
property rights granted under the licence. Thus, it would not be right to
confine royalty to payment like rent or hire charges i.e. charges paid
periodically. Article VI assimilated and encompassed royalty and like
payments, whether paid in lump sum or from time to time. Payment for
royalty` and technical services` could be of recurring nature and this
might not in the facts of a case, be the relevant distinguishing factor.
ITA 79-80/2001 Page 11 of 24
18. Term royalty` in Article VI was defined to mean royalty or like
payments received for right to use copyrights, artistic or scientific works,
patents, models, designs, secret processes and formulae, trademarks and
other property and like. Reference and contextual significance was
accorded on the expression right to use technical know-how, patents,
technical information, and also copyright, trademark etc. Consideration
paid for grant of right to use the stipulated intellectual property/asset
by a resident of one State to a resident of the other State would squarely
fall within the ambit of Article VI of DTAA. Grant of right to use such
intellectual property/asset could be taxed in the source State. Making
available and permission to use technical know-how, information etc. as
such would conceptually fall within the four corners of the expression
right to use`. Contra, in the expression technical service` preeminence
was on the word service` and this, we believe was the substantial and
essential difference between Articles VI and VII of the DTAA. Article
VII would apply if there was obligation to render and provide technical
services.
19. The word technical` could mean and would include scientific
work, patents, designs or secret processes etc. expressly covered under
Article VI. However, what was not covered and mentioned in the said
Article was services`. The word service` in the context of Article VII
endorses reference to rendering consultation, providing guidance,
imparting skills and technical information relating to implementation
and actual working, in contradiction to grant of right to use technical
know-how, patent, secret processes etc. Making available and
permission/grant of right to use` stood contrasted from rendering of
services` in relation to technology and technical matters. Rendering
service` would be beyond or greater than simply or solely granting
ITA 79-80/2001 Page 12 of 24
right to use` in the goods` specified in paragraph 2 of Article VI. In the
present case, the respondent-assessee provided services to PPGML
which were of technical nature as they were related to and required
special knowledge of applied science, thus would qualify and were
technical services`. Continuing the discussion in the light of DTAA, it
implies that where the foreign entity had provided technical services and
received consideration for the same, it would be covered under Article
VII and not under Article VI of the DTAA.
20. The aforesaid distinction is well recognized and accepted in the
field of International taxation. Klaus Vogel in his work Klaus Vogel on
Double Taxation Conventions`, South Asian Reprint Edition, 2007, at
page 782, paragraph 33 while delving into Article 12 of Organisation for
Economic Co-operation and Development Model Convention (OECD-
MC) has referred to know-how in the following manner:-
11. [`Know-how'] In classifying as royalties
payments received as consideration for
information concerning industrial, commercial or
scientific experience, paragraph 2 alludes to the
concept of know-how`. Various specialist bodies
and authors have formulated definitions of know-
haw which do not differ intrinsically. One such
definition, given by the Association des Bureaux
pour la protection de la Propriete Industrielle`
(ANBPPI), states that know-how` is all the
undivulged technical information, whether capable
of being patented or not, that is necessary for the
industrial reproduction of a product or process,
directly and under the same conditions; inasmuch as
it is derived from experience, know-how represents
what a manufacturer cannot know from mere
examination of the product and mere knowledge of
the progress of technique.' In the know-how
contract, one of the parties agrees to impart to .the
ITA 79-80/2001 Page 13 of 24
other, so that he can use them for his own account,
his special knowledge and experience which remain
unrevealed to the public. It is recognised that the
grantor is not required to play any part himself in the
application of the formulas granted to the licensee
and that he does not guarantee the result thereof.
This type of contract thus differs from contracts for
the provision of services, in which one of the parties
undertakes to use the customary skills of his calling
to execute work himself for the other party. Thus,
payments obtained as consideration for after-sales
service, for services rendered by a seller to the
purchaser under a guarantee, for pure technical
assistance, or for an opinion given by an engineer,
an advocate or an accountant, do not constitute
royalties within the meaning of paragraph 2. Such
payments generally fall under Article 7 or Article
14. In business practice, contracts are encountered
which cover both' know-how and the provision of
technical assistance. One example, amongst others,
of contracts of this kind is that of franchising,
where the franchisor imparts his knowledge and
experience to the franchisee and, in addition,
provides him with varied technical assistance,
which, in certain cases, is backed up with financial
assistance and the supply of goods. The
appropriate course to take with a mixed contract is,
in principle, to break down, on the basis of the
information contained in the contract or by means
of a reasonable apportionment, the whole amount
of the stipulated consideration according to the
various parts of what is being provided under the
contract, and then to apply to each part of it so
determined the taxation treatment proper thereto.
If, however, one part of what is being provided
constitutes by far the principal purpose of the
contract and the other parts stipulated therein are
only of an ancillary and largely unimportant
character, then it seems possible to apply to the
whole amount of the consideration the treatment
applicable to the principal part.
ITA 79-80/2001 Page 14 of 24
(emphasis supplied)
21. In paragraph 49 on page 790, Klaus Vogel has observed:-
49 bb) Imparting of experience: Whenever
the term royalties relates to payments in respect
of experience (know-how`), the condition for
applying Art. 12 is that the remuneration is being
paid for imparting` such know-how (as to that
term, see infra m.nos. 50f.). In this connection, a
distinction between use` and alienation` of the
licensed assets would be irrelevant. Where there
is a mixed agreement, such as one licensing a
patent in connection with imparting know-how,
the patented knowledge must be let` in the
above-described sense, whilst know-how need
only be imparted`. Where the imparting of
experience is of a mere ancillary character under
a patent licence, there need not be any separate
characterization at all (regarding the distinction
between a mixed contract and one that also
involves ancillary services, cf. the concluding
sentence of para 11 MC Comm. Art. 12, supra
m.no. 33; see also BFH BStBl. II 623, 624
(1977).
(emphasis supplied)
22. At this stage, it would be appropriate to refer to Commentary on
Article 12 Concerning the Taxation of Royalties` by OECD, 2010.
Paragraph 2 thereof contains the sub-paragraphs that read as under:-
11. In classifying as royalties payments received as
consideration for information concerning industrial,
commercial or scientific experience, paragraph 2 is
referring to the concept of "know-how". Various
specialist bodies and authors have formulated definitions
of know-how. The words "payments ... for information
concerning industrial, commercial or scientific
experience" are used in the context of the transfer of
certain information that has not been patented and does
not generally fall within other categories of intellectual
ITA 79-80/2001 Page 15 of 24
property rights. It generally corresponds to undivulged
information of an industrial, commercial or scientific
nature arising from previous experience, which has
practical application in the operation of an enterprise and
from the disclosure of which an economic benefit can be
derived. Since the definition relates to information
concerning previous experience, the Article does not
apply to payments for new information obtained as a
result of performing services at the request of the payer.
11.1 In the know-how contract, one of the parties agrees to
impart to the other, so that he can use them for his own
account, his special knowledge and experience which
remain unrevealed to the public. It is recognised that the
grantor is not required to play any part himself in the
application of the formulas granted to the licensee and that
he does not guarantee the result thereof.
11.2 This type of contract thus differs from contracts for
the provision of services, in which one of the parties
undertakes to use the customary skills of his calling to
execute work himself for the other party. Payments made
under the latter contracts generally fall under Article 7.
11.3 The need to distinguish these two types of payments,
i.e. payments for the supply of know-how and payments
for the provision of services, sometimes gives rise to
practical difficulties. The following criteria are relevant
for the purpose of making that distinction:
-- Contracts for the supply of know-how concern
information of the kind described in paragraph 11 that
already exists or concern the supply of that type of
information after its development or creation and include
specific provisions concerning the confidentiality of that
information.
-- In the case of contracts for the provision of services, the
supplier undertakes to perform services which may require
the use, by that supplier, of special knowledge, skill and
expertise but not the transfer of such special knowledge,
skill or expertise to the other party.
-- In most cases involving the supply of know-how, there
would generally be very little more which needs to be done
by the supplier under the contract other than to supply
existing information or reproduce existing material. On the
other hand, a contract for the performance of services
would, in the majority of cases, involve a very much
ITA 79-80/2001 Page 16 of 24
greater level of expenditure by the supplier in order to
perform his contractual obligations. For instance, the
supplier, depending on the nature of the services to be
rendered, may have to incur salaries and wages for
employees engaged in researching, designing, testing,
drawing and other associated activities or payments to sub-
contractors for the performance of similar services.
11.4 Examples of payments which should therefore not be
considered to be received as consideration for the provision
of know-how but, rather, for the provision of services,
include:
-- payments obtained as consideration for after-sales
service,
-- payments for services rendered by a seller to the purchaser
under a warranty, -- payments for pure technical
assistance,
-- payments for a list of potential customers, when such a
list is developed specifically for the payer out of
generally available information (a payment for the
confidential list of customers to which the payee has
provided a particular product or service would, however,
constitute a payment for know-how as it would relate to
the commercial experience of the payee in dealing with
these customers),
-- payments for an opinion given by an engineer, an
advocate or an accountant, and
-- payments for advice provided electronically, for electronic
communications with technicians or for accessing, through
computer networks, a trouble-shooting database such as a
database that provides users of software with non-
confidential information in response to frequently asked
questions or common problems that arise frequently.
11.5 In the particular case of a contract involving the
provision, by the supplier, of information concerning
computer programming, as a general rule the payment
will only be considered to be made in consideration for
the provision of such information so as to constitute
know-how where it is made to acquire information
constituting ideas and principles underlying the program,
such as logic, algorithms or programming languages or
techniques, where this information is provided under the
ITA 79-80/2001 Page 17 of 24
condition that the customer not disclose it without
authorisation and where it is subject to any available trade
secret protection.
11.6 In business practice, contracts are encountered which
cover both know-how and the provision of technical
assistance. One example, amongst others, of contracts of
this kind is that of franchising, where the franchisor imparts
his knowledge and experience to the franchisee and, in
addition, provides him with varied technical assistance,
which, in certain cases, is backed up with financial
assistance and the supply of goods. The appropriate course
to take with a mixed contract is, in principle, to break
down, on the basis of the information contained in the
contract or by means of a reasonable apportionment, the
whole amount of the stipulated consideration according to
the various parts of what is being provided under the
contract, and then to apply to each part of it so determined
the taxation treatment proper thereto. If, however, one part
of what is being provided constitutes by far the principal
purpose of the contract and the other parts stipulated
therein are only of an ancillary and largely unimportant
character, then the treatment applicable to the principal part
should generally be applied to the whole amount of the
consideration.
(emphasis supplied)
23. The aforesaid paragraphs eloquently interpret the differentiation
between technical know-how` and technical services`. In know-how or
under a know-how contract, one party agrees to grant right to use` or
simply provide to the other special knowledge and experience not
revealed to the public. In such cases, the granter may not guarantee the
result of the formulae, information and for which licence for use is
granted. Such contracts differ from contracts for services which require
one of the parties to undertake customary skills to execute the work for
other, impart skills to the recipient, provide guidance or render
assistance of technical nature to the recipient. This service` element
goes beyond mere providing of technical know-how. The said distinction
is clearly made out in sub-paragraphs 11.3 and 11.4 of the Commentary
ITA 79-80/2001 Page 18 of 24
on Article 12 Concerning the Taxation of Royalties` (supra). The
aforesaid elucidation is relevant to distinguish consideration, which
would get covered under Article VI or Article VII of the DTAA.
24. In the earlier portion of the judgment, we have elaborately dealt
with the different parts of the Agreement with PPGML. The said
Agreement would fall in the category of contract involving supply of
technical know-how etc. as well as technical services. Thus, Articles VI
and VII of the DTAA would both be applicable. The respondent-
assessee provided tangible/intangible property in the form of know-how
like design manuals, data, computation formula, process specification,
material specification etc. But, obligation of the respondent-assessee
was not restricted to make the said technical information available. The
service element was equally significant and given due importance.
Implementation and rendering of service was an integral and significant
obligation of the respondent-assessee. Implementation and help in
adopting, habituating and converting the know-how/information, was a
crucial contractual term. The respondent-assessee was to furnish services
such as rendering advice and information on manufacturing, engineering
and other aspects, even when the information or technology was not in
use in the respondent-assessee`s commercial manufacturing operations.
These were to be specifically prepared at the request of PPGML. The
Agreement mandated providing service of development, clarification,
furnishing information, assistance in rectifying problems encountered by
PPGML and providing technical experts in connection with PPGML`s
request. PPGML was to reimburse charges etc. as per the Agreement that
included travelling and living expenses subject to the approval of
Reserve Bank of India. Thus, clauses 3.1 and 3.2 demonstrated the
expansive and comprehensive scope of the Agreement and commitment
ITA 79-80/2001 Page 19 of 24
accepted. Clause 3.2 referred to visitation right in Austria by
representatives of PPGML. Technical experts of the respondent-
assessee were to be deputed to come to India to assist PPGML in setting
up and commissioning of manufacturing activities, design and
manufacture of products. The technical experts required, their duration
and date of deputation were subject matter of the Agreement. No doubt
PPGML was to reimburse all expenses including travelling and living
expenses subject to the approval of the Reserve Bank of India but
reimbursement of expenses would not account for consideration paid
towards proprietary rights and earning/profit for technical services to be
rendered. Expenses were distinct and should not be equated with income
or profits and question would arise whether the consideration mentioned
in clauses 4.1 and 4.2 included the consideration for providing technical
services? The answer clearly is that the Agreement was for both,
furnishing and grant of right to use` technical
specifications/information/know-how; and technical services`.
25. Under Article VII, technical services component would be taxable
in India in so far as such amounts were attributable to the activities
actually performed in India i.e. the country of source. For the activities
performed in Austria and not in India, the payments towards technical
services would not be taxable in India. The word attributable` is much
wider than the expression derived from` and, therefore, all activities
which were performed by the respondent-assessee in India as technical
services would be taxable in India but activities performed in Austria
would not be taxable in India. In respect of activities in India, deductions
of expenditure incurred in India by the respondent-assessee had to be
allowed.
ITA 79-80/2001 Page 20 of 24
26. In view of the aforesaid discussion, it has to be held that the
consideration paid for right to use technical know-how etc. under the
Agreement would be taxable in India as royalty` under Article VI and
consideration paid for technical services would be taxable in India to the
extent of such amounts were attributable to the activities actually
performed in the country of source, after allowing deduction of
expenditure incurred in India. However, payments made for technical
services furnished by the non-resident assessee outside India would not
be taxable in India.
27. Now comes the difficult part, not interpretative or legal but
equitable, virtuous and just i.e. bifurcation of the consideration into non-
exempt under Article VI and VII and exempt under Article VII of the
DTAA. To some extent, it refers to the principle of good governance.
The assessment order has been critically disapproved for failure to refer
and examine Article VII of the DTAA. The entire amount paid including
the periodical payments were treated as royalty, ignoring Article VII of
the DTAA and the relevant clauses of the Agreement. Ignorance and
nescience was not due to lack of awareness, but attributable to failure to
understand and deal with the issue inspite of the submission/contention.
It was propelled with the desire to ensure 100% taxation of the entire
consideration. No attempt was made to elucidate, and painstakingly
answer the objections with facts and to bifurcate and divide the
consideration in a reasonable manner between right to use technical
information or know-how etc. and the consideration paid for services.
Again, in respect of services, differentiation regarding services rendered
in the source state, i.e. India, the amount attributable to the activities
actually performed in India and expenses incurred, was not undertaken.
Consideration paid for technical services outside India had to be
ITA 79-80/2001 Page 21 of 24
examined and excluded. The assessment order records that the payments
received under clause 4.2 of the Agreement were offered for taxation as
royalty` under Article VI of the DTAA. The Commissioner of Income
Tax (Appeals) and the Tribunal have primarily gone by the heading of
clauses 4.1 and 4.2 to draw distinction between the consideration paid
for services and consideration paid for royalty. They have not, examined
the question of bifurcation of consideration or drawn distinction between
the services which were actually rendered in India and services which
were rendered outside India. The findings/division of the appellate
authorities may not, therefore, be in terms of the reasoning and finding
recorded by us. Option to remit the matter to the Assessing Officer for
fresh determination may not be appropriate as the assessment years in
question are 1989-90 and 1990-91, and in doing so we would be setting
the clock back by about 25 years. Evidence and material, by passage of
time would have disappeared and desiccated. As noticed above, in the
present case, the respondent-assessee offered and stands taxed on 5%
commission under clause 4.2. In case we ignore and reject the heading in
clauses 4.1 and 4.2 as determinative as to taxability under Articles VI
and VII of the DTAA, possibly the respondent-assessee would be
entitled to partial relief for payments under clause 4.2 but a part of
consideration under clause 4.1 would be taxable. In the facts of the
present case, thus, we are not inclined to remit the case on the ground
that the bifurcation/division made should be ignored and on a reasonable
basis after ascertaining full facts, the amounts should be bifurcated and
amounts covered under Article VI should be taxed in India and the
amounts covered under Article VII should be taxed in India only if they
were attributable to activities actually performed in India, after
deducting expenditure. It does appear that the respondent-assessee
ITA 79-80/2001 Page 22 of 24
stands taxed on payments under clause 4.2 in India and therefore, has
paid tax in India.
28. In view of the aforesaid position, we are not inclined to pass an
order of remand for fresh determination.
29. Accordingly, the questions of law mentioned above, are answered
in the following manner:-
a) Consideration paid for technical services would be taxable under
Article VII of the DTAA, to the extent the amounts were
attributable to the activities performed by the respondent-assessee
in India. Deduction of expenses would be made.
b) Consideration paid for right to use technical information and
know-how would be taxable under Article VI of the DTAA.
c) The consideration paid for furnishing technical services outside
India, shall not be taxable in India.
30. Before we close, two caveats and a note of caution; firstly, we
have not examined or interpreted the expression the right to use` in the
present decision as the said aspect was not raised before the authorities,
including the Tribunal and there was no appearance on behalf of the
respondent-assessee before us. Secondly, the difference between the
expression royalty` under Article VI, as distinct from what wa s covered
under the words technical service` under Article VII has been
interpreted in relation to the applicable DTAA. The observations and
findings in this judgment have been made with reference to the express
language of the two Articles to draw the distinction. The expression
royalty` and the other similar expressions used in other DTAAs or
ITA 79-80/2001 Page 23 of 24
under Section 9(1)(vi) of the Act may not or may warrant same
interpretation.
31. Thus, the questions of law are partly answered in favour of the
appellant-Revenue and against the respondent-assessee, but we do not
disturb the figures/income which has been held to be not taxable in view
of the reasons as stated above. The appeals are disposed of. No costs.
-sd-
(SANJIV KHANNA)
JUDGE
-sd-
(V. KAMESWAR RAO)
JUDGE
September 30, 2014
vkr/kkb
ITA 79-80/2001 Page 24 of 24
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