$~
* IN THE HIGH COURT OF DELHI AT NEW DELHI
Reserved on: 30.11.2015
Pronounced on: 08.02.2016
+ ITA 473/2012
DIRECTOR OF INCOME TAX .......Appellant
Versus
NEW SKIES SATELLITE BV ......Respondent
+ ITA 474/2012
DIRECTOR OF INCOME TAX .......Appellant
Versus
NEW SKIES SATELLITE BV ......Respondent
+ ITA 500/2012
DIRECTOR OF INCOME TAX .......Appellant
Versus
SHIN SATELLITE PUBLIC CO. LTD. ......Respondent
+ ITA 244/2014, C.M. APPL.9724/2014
DIRECTOR OF INCOME TAX-II .......Appellant
Versus
SHIN SATELLITE PUBLIC CO. LTD. ......Respondent
Through: Sh. Rohit Madan, Sh. Ruchir Bhatia and
Sh. Akash Vajpai, Advocates, for DIT in ITA
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 1
244/2014, ITA 473/2012, ITA 474/2012 & ITA
500/2012
Sh. M.S. Syali, Sr. Advocate with Sh. Mayank
Nagi and Ms. Bhawna Bakshi, Advocates, for
respondent in ITA 473/2012 and ITA 474/2012.
Sh. T.V.S. Raghavendra Sreyas and Sh. N. Sai
Vinod, Advocates, for respondent in ITA
474/2012.
Sh. F.V. Irani, Sh. Nikhil Nayyar, Sh. Arun. H.
Mehta and Ms. Akansha, Advocates, for
respondent in ITA 500/2012.
CORAM:
HON'BLE MR. JUSTICE S. RAVINDRA BHAT
HON'BLE MR. JUSTICE R.K. GAUBA
MR. JUSTICE S. RAVINDRA BHAT
%
1. The present appeals, by the Revenue, under Section 260A of the
Income Tax Act 1961 ("the Act") are preferred against orders of the Income
Tax Appellate Tribunal ("ITAT"), which upset Assessment Orders that ruled
that the income derived by the assessees through data transmission services
was taxable as royalty under Section 9(1)(vi) of the Act as well as Article 12
of the relevant Double Tax Avoidance Agreements ("DTAA"). The ITAT
however, in the light of the judgment in Asia Satellite Communications Co.
Ltd. V. Director of Income Tax1, interpreting Section 9(1)(vi) in the context
of such services, reversed the said orders. During the pendency of these
appeals, the Finance Act of 2012 amended Section 9(1)(vi) and inserted
Explanations 4, 5, and 6.
2. The substantial question framed by this Court is two-fold;
1
[2011] 332 ITR 340 (Del)
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 2
(1) whether the receipts of the assessees earned from providing data
transmission services, fall within the term royalty under the Income Tax Act,
1961, and
(2) if the answer to the first is in the affirmative, whether the assessees
would be eligible for the benefit under the relevant Double Tax Avoidance
Agreements.
3. In the interest of both brevity and clarity, below is a table of details
with respect to the assessment orders and the orders of the ITAT:
ITA No. Parties Assessment Date of Applicable
Year Assessment Treaty
Order
ITA 500/2012 DIT v. Shin 2007-08 30.09.2010 Indo Thai
Satellite DTAA
ITA 244/2014 DIT v. Shin 2009-10 09.04.2012 Indo Thai
Satellite DTAA
ITA 473/2012 DIT v. New 2008-09 17.08.2011 Indo
Skies Netherlands
DTAA
ITA 474/2012 DIT v. New 2006-07 17.08.2011 Indo
Skies Netherlands
DTAA
Brief Facts: Pre-Finance Act 2012
4. The assessee in ITA 500/12 and 244/14, M/s Shin Satellite Public Co.
Ltd. (hereafter "Shin"), is a company incorporated in Thailand, engaged in
the business of providing digital broadcasting services as well as
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 3
consultancy services to its customers who consist of both residents of India
and non-residents. Shin provides these services through its satellite Thaicom
3, whose footprint covers a large geographical area, including India. In AY
2007-08 and 2009-10, the assessee filed NIL returns. The AO reviewed the
return under Section 143(3) read with Section 144C of the Act and held that
the income was taxable under Explanation 2(iii) and (iva) of Section 9(1)(vi)
of the Act as well as Article 12 of the Indo-Thai DTAA.
5. Likewise, the assessee in ITA 473/2014 and 474/2012 is a company
incorporated in Netherlands, namely M/s New Skies Satellite B.V. (hereafter
"New Skies") that engages in providing digital broadcasting services . On
filing a return of NIL taxable income for the relevant years, the AO again
under Section 143(3) r/w 144C applied Section 9(1)(vi) of the Act to tax the
income of the assessee as royalty.
6. The assessees in the present cases both derive income from the "lease
of transponders" of their respective satellites. This lease is for the object of
relaying signals of their customers; both resident and non-resident TV
channels that wish to broadcast their programs for a particular audience
situated in a particular part of the world. In the present cases, the assessees
were chosen for the simple reason that the footprint of their satellites, i.e. the
area over which the satellite can transmit its signal, includes India. The
process by which the TV programmes reach the viewers in India can be
simply described. The TV channels produce or acquire the tapes of the
programs, which they then uplink to the satellite. The satellite then receives
the content, amplifies it, changes its frequency by undertaking certain
processes, and then downlinks it, scattering the signal over the area of its
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 4
footprint. The cable operators who ultimately relay it to the viewers in their
homes then receive the downlinked signal.
7. These satellites are geostationary satellites placed in an orbit 22240
miles above the surface of the Earth. The repeater section of the satellites
contains antenna systems and microwave electronics that receive, amplify,
modify (in frequency and in polarization) and retransmit the signals received
by it. This antenna section has two reflectors, one for receiving and the
other, for transmitting. The path of each channel between the receiving
antennae to transmitting antennae is called the transponder. The transponder
is used to amplify and shift the frequency of each signal. The uplinked
signal emanates from the uplink earth station and enters the repeater through
the receiving antenna. This antenna on the satellite transforms the wireless
(electromagnetic) signals into an electrical form suitable for amplification in
the Low Noise Receiver (LNR). The signals are modified within the LNR in
frequency to correspond to the relay range and then amplified again before
the individual filters. A microwave type boosts the power of the signal
within each transponder to a high power level such as 100 Watts before
applying it to the transmitting antenna. The latter transforms the electrical
signal from all the transponders into an equivalent electromagnetic form for
radiation into the footprint where the receiving terminals are located.
8. This is the service the assessees provide to their customers, the
income from which is sought to be taxed under Section 9(1)(vi) of the Act.
This section has however, since the time of the first assessment order in this
case, undergone an amendment. Section 9(1)(vi) as it existed then, and on
the basis of which the Assessment Orders were made reads as follows:
"Income deemed to accrue or arise in India.
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 5
9. (1) The following incomes shall be deemed to accrue or arise
in India
(vi) income by way of royalty payable by--
(a) the Government ; or
(b) a person who is a resident, except where the royalty is
payable in respect of any right, property or information used or
services utilised for the purposes of a business or profession
carried on by such person outside India or for the purposes of
making or earning any income from any source outside India ; or
(c) a person who is a non-resident, where the royalty is payable
in respect of any right, property or information used or services
utilised for the purposes of a business or profession carried on by
such person in India or for the purposes of making or earning
any income from any source in India :
Provided that nothing contained in this clause shall apply in
relation to so much of the income by way of royalty as consists of
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, if such income is payable in pursuance
of an agreement made before the 1st day of April, 1976, and the
agreement is approved by the Central Government :
Provided further that nothing contained in this clause shall
apply in relation to so much of the income by way of royalty as
consists of lump sum payment made by a person, who is a
resident, for the transfer of all or any rights (including the
granting of a licence) in respect of computer software supplied
by a non-resident manufacturer along with a computer or
computer-based equipment under any scheme approved under
the Policy on Computer Software Export, Software Development
and Training, 1986 of the Government of India.
Explanation 1.--For the purposes of the first proviso, an
agreement made on or after the 1st day of April, 1976, shall be
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 6
deemed to have been made before that date if the agreement is
made in accordance with proposals approved by the Central
Government before that date; so, however, that, where the
recipient of the income by way of royalty is a foreign company,
the agreement shall not be deemed to have been made before that
date unless, before the expiry of the time allowed under sub-
section (1) or sub-section (2) of section 139 (whether fixed
originally or on extension) for furnishing the return of income for
the assessment year commencing on the 1st day of April, 1977, or
the assessment year in respect of which such income first
becomes chargeable to tax under this Act, whichever assessment
year is later, the company exercises an option by furnishing a
declaration in writing to the Assessing Officer (such option being
final for that assessment year and for every subsequent
assessment year) that the agreement may be regarded as an
agreement made before the 1st day of April, 1976.
Explanation 2.--For the purposes of this clause, "royalty" means
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
licence) in respect of a patent, invention, model, design, secret
formula or process or trade mark or similar property ;
(ii) the imparting of any information concerning the working of,
or the use of, a patent, invention, model, design, secret formula
or process or trade mark or similar property ;
(iii) the use of any patent, invention, model, design, secret
formula or process or trade mark or similar property ;
(iv) the imparting of any information concerning technical,
industrial, commercial or scientific knowledge, experience or
skill ;
(iva) the use or right to use any industrial, commercial or
scientific equipment but not including the amounts referred to in
section 44BB;
(v) the transfer of all or any rights (including the granting of a
licence) in respect of any copyright, literary, artistic or scientific
work including films or video tapes for use in connection with
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 7
television or tapes for use in connection with radio broadcasting,
but not including consideration for the sale, distribution or
exhibition of cinematographic films ; or
(vi) the rendering of any services in connection with the
activities referred to in sub-clauses (i) to (iv), (iva) and (v).
9. In ITA 500/2012 the assessee, Shin had on 30.10.2007 filed a NIL
return of income, which was processed under Section 143(1) on 26.03.2009.
In the previous year, the receipts accrued and arising in India to the assessee
had been treated as "royalty". Consequently, the assessee was asked to show
cause why the receipts may not be treated as royalty and taxed accordingly
as had been done in the past. By its letters dated 03.09.2009 and 16.11.2009,
the assessee submitted that the previous treatment of the income as royalty
was in fact, erroneous. The income from the services it provided, the
assessee asserted, were business profits, which in the absence of a
permanent establishment in India, are not subject to tax in India as per
Article 7 of the Indo Thai DTAA. Further, it was submitted, that the relevant
receipts did not partake the character of royalty. The assessee further quoted
the decision of the ITAT in M/s. Pan AmSat International Systems Inc. v.
DCIT, NR Circle, New Delhi2 where in the context of similar facts it was
held that income of such nature is not liable to tax in India. The assessee
also cited the ruling of the Advance Ruling Authority in the case of ISRO
Satellite Centre V. DIT3 where it was held that payment by an Indian
resident to a foreign company, for utilization of transponder centered on a
satellite, is not in the nature of royalty in terms of the provisions of the Act
2
ITA No. 1796/(Del)/2001
3
[2008] 307 ITR 59
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 8
or the DTAA (in that case with the UK); and in the absence of a permanent
establishment in the territory of India not taxable as business profits either.
10. The AO recognised that the operative words in the definition would
be "use" and "process". First, as regards the word "process", the AO held
that the series of acts undertaken within the transponder are done to achieve
a particular result, i.e. to make the signals viewable, and this clearly
qualifies as a "process", the consideration for the "use" of which would
amount to royalty. Noting the nature of the services provided by the
assessee, (as recounted above), the AO observed that the agreements signed
by it with its various customers showed that the agreements were not for the
purpose of satellite hiring, but for the purpose of providing digital channel
services. After enumerating certain clauses of the agreement, the AO held
that it was evident that the assessee was providing complete digital
broadcasting services right from receiving the signals from its customers, to
encoding the signals, feeding them into the uplinking system and to then
transmitting these to the required space segment and that this constituted the
"process" required to bring the income under the fold of Section 9(1)(vi). He
further distinguished the case from the the decision rendered in PanAmSat4.
In that case, the only activity carried out was the processing of the
telecasting signal, whereas here, the assessee carried out a number of critical
processes required for satellite television broadcast and satellite internet
service. Thus, the AO held, that the assessee is receiving payments from its
customers for the "use" as well as the right to use a "process" and not for
hiring the transponder. Consequently it was held that the assessee's receipts
4
supra note 2
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 9
were squarely covered by sub clause (iii) of Explanation 2 to Section
9(1)(vi) which states as follows:
"(iii) the use of any patent, invention, model, design, secret
formula or process or trade mark or similar property"
11. It is also important to note that the AO construed the word "process"
in Section 9(1)(vi) of the Act, and held that the word "secret" qualifies only
the term "formula" and not process. Resultantly, it would suffice that for the
consideration to be termed as royalty, it need only be paid for the use of a
process and not a secret process. In any case, the AO also held that the
process utilized in the present case would qualify as a secret process. The
AO, in doing so, was referring to the transponder as an in-severable part of
the satellite itself. Though the agreement states that the lease is that of the
transponder capacity, in essence, the required roles cannot be performed
without the other essential components of the satellite. In other words, the
use of the transponder necessarily means use of the satellite. To support this,
the AO referred to the price paid by the customer to the assessee and states
that this is disproportionately high in comparison to the cost incurred by the
assessee for the transponder. This according to the AO lead to an inference
that the customers are compensating the assessee for not only the
transponder cost but also the cost of the satellite. The AO did this in an
attempt to establish that the secret process therefore being used is the secret
process of the satellite itself. He stated that while it may be argued that the
theoretical aspects of satellite technology may be available to the interested
off the shelves, the finer practical aspects and critical technologies are kept a
secret. It is important to note that the AO in fact does quote the commentary
of Klaus Vogel where secret formula or process has been defined as one
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 10
which enjoys "at least a relative protection or is capable of being
protected". It was also held that similar to sub clause (iva) of Explanation
2, the receipt would also be royalty under Article 12 for the "use of, or right
to use industrial, commercial or scientific equipment".
12. Second, on the question of whether the royalty received by a non-
resident Telecasting Company is taxable, the AO held that the same would
be taxable only if it had been paid in respect of services utilized for the
purposes of making or earning any income from any source in India. The
source, the AO argues, are the Indian audience, for whom the programs are
created, and thus India becomes the territory of commercial exploitation by
these non-resident Telecasting Companies. Placing reliance on an AAR
Ruling in Steffen, Robertson and Kirsten Consulting Engineers and
Scientists v. CIT5, the AO stated that it had been held that for determining
the place of accrual the important consideration is not the place where the
services for which the payment are being made, but the place where the
services are actually utilized. As a result, the AO held that the receipts from
non resident and non-resident customers were taxable as royalty both under
the Act as well as the Indo Thai DTAA.
13. Having held the receipts as taxable under Section 9(1)(vi) of the Act,
the AO also held that the assessees would not get the benefit of the Indo
Thai DTAA.
14. Briefly, Article 12 of the Treaty states that royalties, which arise in
one of the Contracting States and are payable to a resident of the other
Contracting State, may be taxed in that other State. In other words, the
general rule is that the Resident State has the right to tax royalties
5
[1998] 230 ITR 206 AAR
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 11
irrespective of the fact that they arise in the Source State. However, the
Source State may also choose to tax to a ceratin limit, that limit not
exceeding 15 percent of the gross amount of royalties. Royalties as used in
Article 12 is defined as:
"The term "royalties" as used in this article means payments of
any kind received as a consideration for the alienation or the use
of, or the right to use, any copyright of literary, artistic or
scientific work (including cinematograph films, phonographic
records, and films or tapes for radio or television broadcasting,
any patent, trade mark, design or model, plan, secret formula or
process, or for the use of or the right to use industrial,
commercial or scientific equipment or for information
concerning industrial, commericial or scientific experience."
Since the AO was of the opinion that the definitions were pari materia,
he extended his interpretation of "royalty" under Section 9(1)(vi) to Article
12 under the DTAA.
15. By order-dated 22.07.2011, the ITAT set aside the Assessment Order.
By this time the judgment of this Court in Asia Satellite Telecommunication
Company Ltd.6. The ITAT held that the facts of the case were now squarely
covered by the said judgment. The Court in that case held that the receipts
earned from providing data transmission services through the provision of
space segment capacity on satellites do not constitute royalty within the
meaning of Section 9(1)(vi) of the Act. The Court held that while providing
transmission services to its customers, the control of the satellite always
remains with the satellite operator and the customers are only given access
to the transponder capacity. The customer does not therefore use the satellite
or the process of the satellite itself. Since that is the case, the payment
6
supra note 1
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 12
cannot then be termed as royalty for the use of a process or equipment.
Resultantly, the ITAT allowed the appeal of the assessee. It would be wise
to remember that the judgment in Asia Satellite7 was solely in the context of
Section 9(1)(vi) of the Act, there being no Double Tax avoidance
Agreement in that factual matrix.
16. ITA 244/2014, also in the case of assessee Shin, was preferred by the
Revenue against the order of the ITAT applying the judgment of Asia
Satellite8. Here too the ITAT had overturned the Assessment Order dated
09.04.2012. The order was similar if not wholly identical to the one passed
in ITA 500/2012.
17. ITA 473/2012 and 474/2012 are filed by the Revenue against the
order of the ITAT overturning common assessment order dated 17.08.2011,
in the case of assessee New Skies. Here the return of income for the AY
2008-09 was filed on 10.10.2008 declaring NIL income. For the same
reasons as above, the AO held the income taxable under Section 9(1)(vi).
However, in addition to this, the AO also went into the difference between
the definition of royalty under Section 9(1)(vi) and the treaty, in that case,
the Indo-Netherlands DTAA. Here, the definition of royalty under Article
12(4) is as follows:
"The terms "royalties" as used in this Article means payments of
any kind received as a consideration for the use of or the right to
use, any copyright of literary, artistic or scientific work including
cinematograph films, any patent, trademark, design or model,
plan, secret formula or process, or for information concerning
industrial, commercial or scientific experience."
7
Supra note 1
8
supra note 1
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 13
Compared to the definition in Explanation 2(iii) of 9(1)(vi) the only
distinction between the two was one of punctuation, specifically, the
existence of a single "comma" following the word "process" in Article
12(4), a comma which is absent from the definition under domestic law. The
only question was whether this comma dictated a particular consequence,
namely whether its presence would mean that the word secret did qualify the
word process in Article 12(4), and that its absence under domestic law
would mean that it did not. In other words, if the comma was allowed to
influence the interpretation of Article 12(4), it would mean that for the
purposes of consideration to be termed as royalty under the DTAA, the
process utilized would necessarily have to be a "secret process", whereas the
position under domestic law is that the secrecy or not of the process utilized
is irrelevant. After delving into a list of case law which lay down the rules
for when punctuation is not to be taken seriously while interpreting an act or
treaty, the AO decided that the presence of the comma was inconsequential.
Here too, without prejudice to its above finding, the AO held that the
process of providing the transponder would still qualify as a secret process.
Quoting the Oxford Dictionary, the AO held that secret means kept or meant
to be kept private, unknown or hidden from all but a few. It was held that the
process was within the exclusive knowledge of the assessee. The customer is
neither in the know nor is it empowered to use the process in its own way.
Post Finance Act 2012
18. It can be seen, therefore, that while the assessment orders consistently
held that the income from data transmission services shall be taxable under
Section 9(1)(vi) as royalty, the Tribunal equally consistently, set aside these
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 14
orders applying, as it is bound to do so, on the basis of Asia
Satellite9.However, as it has been noted, the Finance Act of 2012 amended
Section 9(1)(vi) inserted Explanation 4, 5, and 6. The inclusion of these
Explanations, clarificatory as they claim they are, have attempted to undo
the implications of Asia Satellite.10Explanations 4, 5, and 6 are reproduced
below:
"Explanation 4.--For the removal of doubts, it is hereby
clarified that the transfer of all or any rights in respect of any
right, property or information includes and has always included
transfer of all or any right for use or right to use a computer
software (including granting of a licence) irrespective of the
medium through which such right is transferred.
Explanation 5.--For the removal of doubts, it is hereby clarified
that the royalty includes and has always included consideration
in respect of any right, property or information, whether or not--
(a) the possession or control of such right, property or
information is with the payer;
(b) such right, property or information is used directly by the
payer;
(c) the location of such right, property or information is in India.
Explanation 6.--For the removal of doubts, it is hereby clarified
that the expression "process" includes and shall be deemed to
have always included transmission by satellite (including up-
linking, amplification, conversion for down-linking of any
signal), cable, optic fibre or by any other similar technology,
whether or not such process is secret;"
Contentions of parties
9
supra note 1
10
supra note 1
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 15
19. The Revenue argues in their appeals that with the insertion of the
three explanations to Section 9 (1)(vi) of the Act, the matter has been settled
beyond controversy. Consequently, the impugned orders, based as they are,
on the reasoning in Asia Satellite11., cannot stand, because the basis of that
ruling has been undone. It was argued that it matters little as to whether the
amendment is held to be declaratory or clarificatory, because it imperatively
suggests that if there were any doubts as to whether the activity was taxable,
those stood removed. Necessarily, the amendment therefore, applied to all
transactions- past and present. Asia Satellite12, therefore, was statutorily
overborne. For this simple reason alone, argued counsel, the impugned
orders are to be set aside and the matters remitted to the AO to give tax
effect and work out the assessee's liabilities.
20. It was submitted that as far as the second question, i.e. whether the
DTAA applied and resulted rendering the activity non-taxable was
concerned, the question should not arise. Here, learned counsel stated that
the DTAA predated the amendment. Consequently, the interpretation placed
in Asia Satellite13, which was in relation to Section 9, could not be said to be
an authority on treaty interpretation. Furthermore, argued counsel for the
Revenue, the terms of the treaty and the terms of the pre-amended Act being
similar, the subsequent amendment rendered the reasoning in Asia Satellite
academic. Therefore, the assessees could not take shelter under the DTAA,
which was cast in identical terms with the pre-amended statute. Since the
11
supra note 1
12
supra note 1
13
supra note 1
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 16
same has subsequently been amended, the Courts are bound to give effect to
it.
21. Learned counsel for the assessees contended that the matter is no
longer res integra. It was submitted that having regard to the structure of
Section 92 of the Act, there is little elbow room for the Revenue; it cannot
be contended that any change in the substantive law would automatically
result in a like change in respect of taxability of a transaction or service,
which is otherwise tax exempt in terms of a DTAA or which is subject to a
lower rate of taxation mandated by a treaty. Counsel relied on the judgment
of the Bombay High Court in Commissioner of Income Tax v. Seimens
Aktiongessellschaft14and the Andhra Pradesh High Court in M/s Sanofi
Pasteur Holding SA v. Department of Revenue.15.
22. Learned counsel, most importantly stressed upon the decision of this
Court, in Director of Income Tax v Nokia Networks16which had dealt with a
similar issue, with respect to applicability of the amended Section 9 (1) (vi)
in the light of insertion of the Explanations, the context being the efficacy of
the interpretation given to the statute vis-à-vis a double taxation avoidance
treaty. In that case, this Court had rejected that any amendment could
change the situation and render the service or activity taxable.
23. Taking the argument to its logical end, counsel further argued that it
is not possible for one nation to, by way of a unilateral amendment to tax
income which otherwise was not subject to tax under the treaty. In other
words, argued counsel, the rule of referential incorporation cannot be
14
[2009] 310 ITR 320
15
(2013) 354 ITR 316 (AP)
16
2013 (358) ITR 259
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 17
applied in dealing with a DTAA between two Sovereign Nations. Though it
is open to a Sovereign Legislature to amend its Laws, a DTAA entered into
by the Government has to be reasonably construed.
Analysis and Conclusions:
24. International double taxation typically occurs when two jurisdictions
claim the right to tax the same tax entity or subject with respect to the same
income for the same period. Indisputably, taxation of income twice over by
two different jurisdictions has an adverse impact on the movement of goods
and services across international borders. For this purpose, jurisdictions with
concurrent taxing rights enter into Double Tax Avoidance Agreements,
which set rules that attempt, at the very least, theoretically, to eliminate a
double incidence of tax. The States therefore limit their legitimate taxing
powers in favour of the other State, by either agreeing not to tax a certain
income, which has been reserved for the other Contracting State, or taxing
that income to a limited extent. These treaties therefore have the effect of
restraining the operation of the domestic taxing laws of a Contracting State.
Justifiably, the balance between the domestic law of the Contracting State
and its obligations under the treaty is a delicate matter worthy of critical
consideration and is often the subject of Parliamentary legislation. In this
context, Section 90 of the Act of 1961, which is law relatable to Article 253
of the Constitution, read with Entries 13, 14 and 82 of List 1 of the Seventh
Schedule holds the field. It states that where the Central Government has
entered into a Double Tax Avoidance Agreement, then in relation to the
taxpayer who is contemplated by such agreement, the provisions of the Act
shall apply to the extent that they are more beneficial to the assessee.
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 18
25. The underlying presumption of a DTAA being that in the absence of
such agreement, the income in question is taxable in both jurisdictions as
under their domestic laws, whenever Courts are confronted with taxability of
an income in the context of such an agreement, they must as a matter of
course, first decide whether the income in issue is taxable under domestic
legislation, specifically the Act. It is only when that issue is answered in the
affirmative that the Court turns its attention to the tax convention in issue, to
ascertain primarily whether the terms of the convention exempt that
particular income from being taxed under the Act.
26. Section 9(1)(vi) is, aside from changes made by the Finance Act,
2012, a long and winding provision, subject to several explanations and
provisos. It will therefore be prudent to undertake a systematic approach to
it, whereby each stage of the section is examined. The opening words of
Section 9; "the following incomes shall be deemed to accrue or arise in
India" indicate at the outset that the provision is a deeming one whereby,
income otherwise not accruing in India, will be deemed to have accrued in
certain cases. Until 1922, various provisions enumerated cases under which
income accruing to an assessee abroad was deemed to accrue in India. The
1961 Act collects these provisions and covers them under the ambit of
Section 9. One of such deeming provisions is Section 9(1)(vi), which states
that income by way of royalty, shall be deemed to have accrued in India. For
income of such nature to be taxable under the Act, two aspects must be
examined, first, whether the income partakes the character of royalty as
defined in Explanation 2, and second, depending on who it is payable by,
whether the conditions governing payment by such person have been met.
As to the second aspect, Section 9(1)(vi) begins with the following words:
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 19
"(vi) income by way of royalty payable by--
(a) the Government ; or
(b) a person who is a resident, except where the royalty is
payable in respect of any right, property or information used or
services utilised for the purposes of a business or profession
carried on by such person outside India or for the purposes of
making or earning any income from any source outside India ; or
(c) a person who is a non-resident, where the royalty is payable
in respect of any right, property or information used or services
utilised for the purposes of a business or profession carried on by
such person in India or for the purposes of making or earning
any income from any source in India"
Three categories are intended here, namely, (i) the Government, (ii)
residents of India and (iii) non-residents. Once it is established that the
income accruing to the assessee is in fact, royalty under the second
Explanation, the individual conditions annexed to each of the three above
must be met. In the present case, both residents as well as non-residents have
paid the income purported to be taxed by the Revenue, which argues that the
conditions for both have been satisfied. Briefly, royalty paid by a resident is
taxable as long as it is not paid for the purpose of a business or profession
carried on outside India or for the purposes of making or earning income
from any source outside India. In the case of a non-resident, royalty paid
shall be taxable when it is paid for the purposes of a business or profession
carried on in India or for the purposes of making or earning any income
from any source in India. In other words, for both residents as well as non-
residents, either of two situations must occur; (i) the business or profession
for the purpose of which the royalty is paid must be carried on by such
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 20
person in India or (ii) the royalty must be paid for the purposes of making or
earning any income from any source situated in India.
27. Since the underlying premise is that the payment is "royalty", the
Court must first deal with Explanation 2, most pertinently to sub-clause (iii)
and (iva) under which the income in the present case is sought to be taxed.
"(iii) the use of any patent, invention, model, design, secret
formula or process or trade mark or similar property ;
(...)
(iva) the use or right to use any industrial, commercial or
scientific equipment but not including the amounts referred to in
section 44BB"
28. The two clauses as applicable to data transmission services have been
the subject of debate in courts as well as business circles. The debate was
finally settled by the judgment delivered in Asia Satellite17. In Asia
Satellite18this Court held that income from data transmission services would
not qualify as royalty in order for it to be taxable under the Act. The Court
first recognized that the definition of royalty in the section is with respect to
permission granted to use the right in respect of the patent, invention,
process, etc., all essentially forms of intellectual property. This permission
restricts itself merely to the letting of the licensed asset. The permission does
not go so far as to allow alienation of the asset itself. That being said, it is
not so restricted as to qualify as a case where the licensor uses the asset
himself, albeit for the purposes of his customers. The Court took note of the
features of the agreements between the assessee in that case, which was a
17
supra note 1
18
supra note 1
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 21
foreign company, incorporated in Hong Kong, and its customers, which
were TV channels. The agreement was essentially one of allocation of the
transponder capacity available on the satellite to enable the channels to relay
their signals. The customers had their own relaying facilities. No different
from the case at hand, the transponder receives the signal, amplifies it, and
downlinks it to facilitate transmission of the signals. Quoting the judgment
of the AAR in ISRO19, the Court held that it becomes clear that all the
customer gets through the agreement with the assessee is mere access to a
broadband width available in the transponder. The control over the parts of
the satellite and naturally the transponder remains with the assessee. At no
point does the assessee cede control over the satellite to the customers.
Logically therefore, since the transponder is a part of the satellite that cannot
be severed from it, there can be no independent control of the transponder
without control of the satellite itself. The AAR had specifically rejected the
revenue's contention that in substance there is use of equipment; that being
the transponder. The fact that the transponder automatically responds to the
data commands sent from the ground station network and retransmits the
same data over a wider footprint area does not mean that control and
operation of the transponder is with the customer. Interestingly, this has not
escaped the notice of the AO, except that the Assessment Order
conveniently employs the in-severability of the transponder from the
satellite to assert that that the technology of the satellite would qualify as the
"secret process" but conveniently divorces the transponder from the satellite
while trying to prove that there is use of the transponder as an equipment.
However, equipment as envisaged in the section must be capable of
19
supra note 3
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 22
functioning independently, or in other words, must be able to perform an
activity by itself without material reliance on another. Essentially therefore,
Asia Satellite20, held that the presence of control was a critical factor in
adjudging whether there was "use" of a particular process. On the question
of whether the "process" so used must be a secret process or not, the
judgment did not return any finding specifically, other than quoting with
approval the OECD Commentary which alludes to the indispensability of
the secrecy of the process.
29. The Revenue argues that critical aspects of this judgment, primarily
that the function performed by the transponder could not be categorized as a
"process" and that even in the event it could be, there was no "use" of this
process since there was no control exercised by the customers, is no longer
good law in light of the inclusion of Explanations 4-6 by the Finance Act,
2012. In other words the Revenue contends that a mere reading of
Explanation 4-6 will go to show that they are clarificatory and are therefore
automatically retrospective. By this reason, as clarificatory amendments do,
these explanations relate back to the time when the main provision of
Section 9(1)(vi) first came into force. By logical extension, the judgment in
Asia Satellite21was based on a misinterpretation of the section and thus no
longer holds the field or corresponds to the correct interpretation of the
definition of royalty.
30. Undoubtedly, the legislature is competent to amend a provision that
operates retrospectively or prospectively. Nonetheless, when disputes as to
their applicability arise in court, it is the actual substance of the amendment
20
supra note 1
21
supra note 1
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 23
that determines its ultimate operation and not the bare language in which
such amendment is couched. Two judgments of note have succeeded the
Finance Act, 2012 in this context. In Director of Income Tax v. TV Today
Network Limited22 , a Division Bench of this Court was confronted with the
question of taxability of income from data transmission services. Answering
the question in favour of the Revenue, the Court held that as far as the
domestic taxability of the said income is concerned, the Finance Act 2012
mandates it to be as such. Interestingly however, the Court did not rule out
any relief that the assessees may be entitled to by virtue of the DTAA
between India and the United States for the simple reason that the ITAT had
not rendered any finding in that regard. Resultantly, the Court remitted the
matter to the ITAT to decide that question.
"In an appeal under Section 260A of the Act, we are not required
to consider the constitutional validity and vires of the said
amendments but have to apply the amended provision. In view of
the said statutory amendments, the reasoning given by the
Tribunal cannot be sustained is has to be reversed.
Learned counsel for the respondent assessee has however rightly
drawn our attention to the assessment order in which the
assessee had also pleaded and submitted that the payments made
cannot be considered as royalty or fee for included services as
defined in the Double Taxation Avoidance Agreement (DTAA)
between India and United states of America. It is submitted that
the payments were business profit and accordingly not taxable or
chargeable to tax under the Act. The tribunal has not referred to
and examined the effect of the DTAA between India and the USA
and whether the assessee is entitled to benefit or advantage
under the said agreement and therefore, payments made were not
taxable in India in the hands of the recipient. Accordingly while
answering the question of law in favour of the Revenue we pass
22
ITA 600/2012 decided on 12.11.2013
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 24
an order of remit and ask the tribunal to decide the other
contention raised by the respondent assessee; whether the
payments made nevertheless remain untaxable in view of the
provisions of the DTAA."
31. In a judgment by the Madras High Court in Verizon Communications
Singapore Pte Ltd. V. The Income Tax Officer, International Taxation I23,
the Court held the Explanations to be applicable to not only the domestic
definition but also carried them to influence the meaning of royalty under
Article 12. Notably, in both cases, the clarificatory nature of the amendment
was not questioned, but was instead applied squarely to assessment years
predating the amendment. The crucial difference between the judgments
however lies in the application of the amendments to the DTAA. While TV
Today24recognizes that the question will have to be decided and the
submission argued, Verizon25cites no reason for the extension of the
amendments to the DTAA.
32. Explanations 4-6 are designed as clarificatory amendments.
Unarguably they have all the apparent characteristics of one. The words "for
the removal of doubts, it is hereby clarified...includes and has always
included" qualify the interpretation in Explanation 5. In Explanation 6, the
same words have been modified and they state "includes and has always
deemed to have always included". This is the standard language used to
communicate an intended retrospective effect.
33. There is a general presumption against retrospectivity of an
23
[2014] 361 ITR 575 (Mad)
24
supra note 22
25
supra note 23
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 25
amendment. This is the principle of lex prospicit non respicit which implies
that unless explicitly stated, a piece of legislation is presumed not be
intended to have retrospective operation.
34. Most recently in Commissioner of Income tax (Central)-1, New Delhi
v. Vatika Township Private Limited26, the Constitution Bench, while quoting
Govind Das v. Income Tax Officer27and CIT Bombay Scindia Steam
Navigation Company Ltd. 28held as follows:
"31. Of the various rules guiding how a legislation has to be
interpreted, one established rule is that unless a contrary
intention appears, a legislation is presumed not to be intended to
have a retrospective operation. The idea behind the rule is that a
current law should govern current activities. Law passed today
cannot apply to the events of the past. If we do something today,
we do it keeping in view the law of today and in force and not
tomorrow's backward adjustment of it. Our belief in the nature of
the law is founded on the bed rock that every human being is
entitled to arrange his affairs by relying on the existing law and
should not find that his plans have been retrospectively upset.
This principle of law is known as lex prospicit non respicit : law
looks forward not backward. As was observed in Phillips vs.
Eyre (1870) LR 6 QB 1, a retrospective legislation is contrary to
the general principle that legislation by which the conduct of
mankind is to be regulated when introduced for the first time to
deal with future acts ought not to change the character of past
transactions carried on upon the faith of the then existing law."
35. This presumption against retrospectivity stems from an indispensible
need for each rule of law to answer to the principle of fairness. L'Office
Cherifien des Phosphates v. Yamashita-Shinnihon Steamship Company
26
(2015) 1 SCC 1
27
[1976] 1 SCC 906
28
[1962] 1 SCR
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 26
Ltd.29. This presumption can be displaced in either of two situations, (i)
where the words of the amendment specifically indicate the retroactivity of
the law or (ii) in the case of declaratory or clarificatory amendments.
Clarificatory amendments are a special class of amendments the object of
which is self-evident, that is to say, it purports to "clarify" law that has
already been legislated, essentially an Act to remove doubts existing as to
the meaning or effect of a statute. Naturally therefore, they must be read as
intrinsic and implicit, but overlooked elements of the original section itself.
They thus dictate the interpretation of law since the time it was first drafted
or brought into force. However, in order for such clarificatory amendments
to be sustained as retrospective, they must answer to this description.
36. A clarificatory amendment presumes the existence of a provision the
language of which is obscure, ambiguous, may have made an obvious
omission, or is capable of more than one meaning. In such case, a
subsequent provision dealing with the same subject may throw light upon it.
Yet, it is not every time that the legislature characterizes an amendment as
retrospective that the Court will give such effect to it. This is not in
derogation of the express words of the law in question, (which as a matter of
course must be the first to be given effect to), but because the law which was
intended to be given retrospective effect to as a clarificatory amendment, is
in its true nature one that expands the scope of the section it seeks to clarify,
and resultantly introduces new principles, upon which liabilities might arise.
Such amendments though framed as clarificatory, are in fact transformative
substantive amendments, and incapable of being given retrospective effect.
29
[1994] 1 AC 486
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 27
In R. Rajagopal Reddy and Ors. v. Padmini Chandrasekharan30, it was held
that the use of the words "it is declared" is not conclusive that the Act is
declaratory because it may be used to introduce new rules of law. If the
amendment changes the law it is not presumed to be retrospective
irrespective of the fact that the phrase used is "it is declared" or for the
removal of doubts". In determining, therefore, the nature of the Act, regard
must be had to the substance rather than to form. While adjudging whether
an amendment was clarificatory or substantive in nature, and whether it will
have retrospective effect or not, it was held in CIT v. Gold Coin Health
Food (P) Ltd.31 and CIT v. Podar Cement (P) Ltd.32that, (i) the
circumstances under which the amendment was brought in existence, (ii) the
consequences of the amendment, and (iii) the scheme of the statute prior and
subsequent to the amendment will have to be taken note of.
37. An important question, which arises in this context, is whether a
"clarificatory" amendment remains true to its nature when it purports to
annul, or has the undeniable effect of annulling, an interpretation given by
the courts to the term sought to be clarified. In other words, does the rule
against clarificatory amendments laying down new principles of law extend
to situations where law had been judicially interpreted and the legislature
seeks to overcome it by declaring that the law in question was never meant
to have the import given to it by the Court? The general position of the
courts in this regard is where the purpose of a special interpretive statute is
to correct a judicial interpretation of a prior law, which the legislature
30
(1995) 2 SCC 630
31
(2008) 9 SCC 662
32
(1997) 5 SCC 482
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 28
considers inaccurate, the effect is prospective. Any other result would make
the legislature a court of last resort. United States v. Gilmore 8 Wall33,
Peony Park v. O'Malley34. It does not mean that the legislature does not
have the power to override judicial decisions which in its opinion it deems
as incorrect, however to respect the seperation of legal powers and to avoid
making a legislature a court of last resort, the amendments can be made
prospective only (Ref. County of Sacremento v. State35, In re Marriage of
Davies36).
38. The circumstances in this case could very well go to show that the
amendment was no more than an exercise in undoing an interpretation of the
court which removed income from data transmission services from taxability
under Section 9(1)(vi). It would also be difficult, if not impossible to argue,
that inclusion of a certain specific category of services or payments within
the ambit of a definition alludes not to an attempt to illuminate or clarify a
perceived ambiguity or obscurity as to interpretation of the definition itself,
but towards enlarging its scope. Predicated upon this, the retrospectivity of
the amendment could well be a contentious issue. Be that as it may, this
Court is disinclined to conclusively determine or record a finding as to
whether the amendment to 9(1)(vi) is indeed merely clarificatory as the
Revenue suggests it is, or prospective, given what its nature may truly be.
The issue of taxability of the income of the assessees in this case may be
resolved without redressal of the above question purely because the assessee
has not pressed this line of arguments before the court and has instead stated
33
(75 US) 330, 19 L Ed 396 (1869)
34
223 F2d 668 (8th Cir. 1955)
35
134 Cal App 3d 428
36
105 Ill App 3d 661
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 29
that even if it were to be assumed that the contention of the Revenue is
correct, the ultimate taxability of this income shall rest on the interpretation
of the terms of the DTAAs. Learned Counsel for the assessee has therefore
contended that even if the first question is answered in favour of the
Revenue, the income shall nevertheless escape the Act by reason of the
DTAA. The court therefore proceeds with the assumption that the
amendment is retrospective and the income is taxable under the Act.
39. It is now essential to decide the second question i.e. whether the
assessees in the present case will obtain any relief from the provisions of the
DTAAs. Under Article 12 of the Double Tax Avoidance Agreements, the
general rule states that whereas the State of Residence shall have the
primary right to tax royalties, the Source State shall concurrently have the
right to tax the income, to the extent of 15% of the total income. Before the
amendment brought about by the Finance Act of 2012, the definition of
royalty under the Act and the DTAAs were treated as pari materia. The
definitions are reproduced below:
Article 12(3), Indo Thai Double Tax Avoidance Agreement:
"3. The term "royalties" as used in this article means payments
of any kind received as a consideration for the alienation or the
use of, or the right to use, any copyright of literary, artistic or
scientific work (including cinematograph films, phonographic
records and films or tapes for radio or television broadcasting),
any patent, trade mark, design or model, plan, secret formula or
process, or for the use of, or the right to use industrial,
commercial or scientific equipment, or for information
concerning industrial, commercial or scientific experience."
Article 12(4), Indo Netherlands Double Tax Avoidance Agreement
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 30
"4. The term "royalties" as used in this Article means payments
of any kind received as a consideration for the use of, or the right
to use, any copyright of literary, artistic or scientific work
including cinematograph films, any patent, trade mark, design or
model, plan, secret formula or process, or for information
concerning industrial, commercial or scientific experience."
Section 9(1)(vi), Explanation 2, Income Tax Act, 1961
"(iii) the use of any patent, invention, model, design , secret
formula or process or trade mark or similar property"
40. In Asia Satellite37the Court, while interpreting the definition of royalty
under the Act, placed reliance on the definition in the OECD Model
Convention. Similar cases, before the Tax Tribunals through the nation,
even while disagreeing on the ultimate import of the definition of the word
royalty in the context of data transmission services, systematically and
without exception, have treated the two definitions as pari materia. This
Court cannot take a different view, nor is inclined to disagree with this
approach for it is imperative that definitions that are similarly worded be
interpreted similarly in order to avoid incongruity between the two. This is,
of course, unless law mandates that they be treated differently. The Finance
Act of 2012 has now, as observed earlier, introduced Explanations 4, 5, and
6 to the Section 9(1)(vi). The question is therefore, whether in an attempt to
interpret the two definitions uniformly, i.e. the domestic definition and the
treaty definition, the amendments will have to be read into the treaty as well.
In essence, will the interpretation given to the DTAAs fluctuate with
successive Finance Act amendments, whether retrospective or prospective?
37
supra note 1
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 31
The Revenue argues that it must, while the Assessees argue to the contrary.
This Court is inclined to uphold the contention of the latter.
41. This Court is of the view that no amendment to the Act, whether
retrospective or prospective can be read in a manner so as to extend in
operation to the terms of an international treaty. In other words, a
clarificatory or declaratory amendment, much less one which may seek to
overcome an unwelcome judicial interpretation of law, cannot be allowed to
have the same retroactive effect on an international instrument effected
between two sovereign states prior to such amendment. In the context of
international law, while not every attempt to subvert the obligations under
the treaty is a breach, it is nevertheless a failure to give effect to the intended
trajectory of the treaty. Employing interpretive amendments in domestic law
as a means to imply contoured effects in the enforcement of treaties is one
such attempt, which falls just short of a breach, but is nevertheless, in the
opinion of this Court, indefensible.
42. It takes little imagination to comprehend the extent and length of
negotiations that take place when two nations decide to regulate the reach
and application of their legitimate taxing powers. In Union of India v. Azadi
Bachao Andolan,38where the Indo Mauritius Double Tax Avoidance
Convention was before the Supreme Court, the Court said the following of
the essential nature of these treaties,
"132. An important principle which needs to be kept in mind in
the interpretation of the provisions of an international treaty,
including one for double taxation relief is that treaties are
negotiated and entered into at a political level go ahead and
have several considerations as their bases. Commenting on this
38
(2003) 263 ITR 706 (SC)
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 32
aspect of the matter, David R. Davis in Principles of
International Double Taxation Relief , David R. Davis,
Principles of International Double Taxation Relief , Pg.4
(London Sweet & Maxwell, 1985)points out that the main
function of a Double Taxation Avoidance Treaty should be seen
in the context of aiding commercial relations between treaty
partners and as being essentially a bargain between two treaty
countries as to the division of tax revenues between them in
respect of income falling to be taxed in both jurisdictions. It is
observed (vide para 1.06):
"The benefits and detriments of a double tax treaty will
probably only be truly reciprocal where the flow of trade and
investment between treaty partners is generally in balance.
Where this is not the case, the benefits of the treaty may be
weighted more in favour of one treaty partner than the other,
even though the provisions of the treaty are expressed in
reciprocal terms. This has been identified as occurring in
relation to tax treaties between developed and developing
countries, where the flow of trade and investment is largely
one way.
Because treaty negotiations are largely a bargaining process with
each side seeking concessions from the other, the final agreement
will often represent a number of compromises, and it may be
uncertain as to whether a full and sufficient quid pro quo is obtained
by both sides."
43. The Vienna Convention on the Law of Treaties, 1969 ("VCLT") is
universally accepted as authoritatively laying down the principles governing
the law of treaties. Article 39 therein states thegeneral rule regarding the
amendment of treaties and provides that a treaty may be amended by
agreement between the parties. The rules laid down in Part II of the VCLT
apply to such an agreement except insofar as the treaty may otherwise
provide. This provision therefore clearly states that an amendment to a treaty
must be brought about by agreement between the parties. Unilateral
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 33
amendments to treaties are therefore categorically prohibited.
44. We do not however rest our decision on the principles of the VCLT,
but root it in the inability of the Parliament to effect amendments to
international instruments and directly and logically, the illegality of any
Executive action which seeks to apply domestic law amendments to the
terms of the treaty, thereby indirectly, but effectively amending the treaty
unilaterally. As held in Azadi Bachao Andolan39these treaties are creations
of a different process subject to negotiations by sovereign nations. The
Madras High Court, in Commissioner of Income Tax v VR. S.RM. Firms
Ors40 held that "tax treaties are...... considered to be mini legislation
containing in themselves all the relevant aspects or features which are at
variance with the general taxation laws of the respective countries".
45. At the very outset, it should be understood that it is not as if the
DTAAs completely prohibit reliance on domestic law. Under these, a
reference is made to the domestic law of the Contracting States. Article 3(2)
of both DTAAs state that in the course of application of the treaty, any term
not defined in the treaty, shall, have the meaning which is imputed to it in
the laws in force in that State relating to the taxes which are the subject of
the Convention.
"Indo Thailand DTAA:
"ARTICLE 3: GENERAL DEFINITIONS
2. In the application on the provisions of this Convention by
one of the Contracting States, any term not defined herein shall,
unless the context otherwise requires, have the meaning which it
39
supra note 36
40
[1994] 208 ITR 400 (Mad)
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 34
has for the purposes of the laws in force in that State relating to
the taxes which are the subject of this Convention.
Indo Netherlands DTAA:
ARTICLE 3: GENERAL DEFINITIONS
2. As regards the application of the Convention by one of
the States any term not defined herein shall, unless the context
otherwise requires, have the meaning which it has under the law
of that State concerning the taxes to which the Convention
applies.
The treaties therefore, create a bifurcation between those terms, which have
been defined by them (i.e the concerned treaty), and those, which remain
undefined. It is in the latter instance that domestic law shall mandatorily
supply the import to be given to the word in question. In the former case
however, the words in the treaty will be controlled by the definitions of
those words in the treaty if they are so provided.
46. Though this has been the general rule, much discussion has also taken
place on whether an interpretation given to a treaty alters with a
transformation in, or amendments in, domestic law of one of the State
parties. At any given point, does a reference to the treaty point to the law of
the Contracting States at the time the treaty was concluded, or relate to the
law of the States as existing at the time of the reference to the treaty? The
former is the `static' approach while the latter is called the `ambulatory'
approach. One opportunity for a State to ease its obligations under a tax
convention comes from the ambulatory reference to domestic law. States
seeking to furtively dodge the limitations that such treaties impose,
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 35
sometimes, resort to amending their domestic laws, all the while under the
protection of the theory of ambulatory reference. It thereby allows itself an
adjustment to broaden the scope of circumstances under which it is allowed
to tax under a treaty. A convenient opportunity sometimes presents itself in
the form of ambiguous technical formulations in the concerned treaty. States
attempting to clarify or concretize any one of these meanings,
(unsurprisingly the one that benefits it) enact domestic legislation which
subserves such purpose.
47. In this context, recently in M/s Sanofi Pasteur Holding SA v.
Department of Revenue41, the Andhra Pradesh High Court discussed and
subscribed to the ratio of the Supreme Court of Canada in R. v. Melford
Developments Inc.42 with respect to the applicability of domestic
amendments to international instruments. In R v. Melford43, the Canadian
Supreme Court in a first, held that the ambulatory approach is antithetical to
treaty obligations:
"There are 26 concluded and 10 proposed tax conventions,
treaties or agreements between Canada and other nations of the
world. If the submission of the appellant is correct, these
agreements are all put in peril by any legislative action taken by
Parliament with reference to the revision of the Income Tax Act.
For this practical reason one finds it difficult to conclude that
Parliament has left its own handiwork of 1956 in such
inadvertent jeopardy. That is not to say that before the 1956 Act
can be amended in substance it must be done by Parliament in an
Act entitled "An act to Amend the Act of 1956". But neither is the
converse true, that is that every tax enactment adopted for
whatever purpose, might have the effect of amending one or more
41
supra note 15
42
36 DTC 6281 (1982)
43
supra note 40
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 36
bilateral or multilateral tax conventions without any avowed
purpose or intention so to do."
48. In Commissioner of Income Tax v. Seimens Aktiongessellschaft44, the
Bombay High Court citing R v. Melford Developments Inc. held that
"The ratio of the judgment, in our opinion, would mean that by a
unilateral amendment it is not possible for one nation which is
party to an agreement to tax income which otherwise was not
subject to tax. Such income would not be subject to tax under the
expression "laws in force".
********** ********* *********
While considering the Double Tax Avoidance Agreement the
expression "laws in force" would not only include a tax already
covered by the treaty but would also include any other tax as
taxes of a substantially similar character subsequent to the date
of the agreement as set out in article I(2). Considering the
express language of article I(2) it is not possible to accept the
broad proposition urged on behalf of the assessee that the law
would be the law as applicable or as define when the Double Tax
Avoidance Agreement was entered into."
49. It is essential to note the context in which this judgment was
delivered. There, the Court was confronted with a situation where the word
royalty was not defined in the German DTAA. Following from our previous
discussion on the bifurcation of terms within the treaty, in situations where
words remain undefined, assistance is to be drawn from the definition and
import of the words as they exist in the domestic "laws in force". It was in
this context that the Bombay High Court held that they were unable to
accept the assesse's contention that the law applicable would be the law as it
existed at the time the Double Tax Avoidance Agreement was entered into.
44
[2009] 310 ITR 320 (Bom)
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 37
This is the context in which the ambulatory approach to tax treaty
interpretation was not rejected. The situation before this Court however is
materially different as there is in fact a definition of the word royalty under
Article 12 of both DTAA, thus dispensing with the need for recourse to
Article 3.
50. There are therefore two sets of circumstances. First, where there exists
no definition of a word in issue within the DTAA itself, regard is to be had
to the laws in force in the jurisdiction of the State called upon to interpret the
word. The Bombay High Court seems to accept the ambulatory approach in
such a situation, thus allowing for successive amendments into the realm of
"laws in force". We express no opinion in this regard since it is not in issue
before this Court. This Court's finding is in the context of the second
situation, where there does exist a definition of a term within the DTAA.
When that is the case, there is no need to refer to the laws in force in the
Contracting States, especially to deduce the meaning of the definition under
the DTAA and the ultimate taxability of the income under the agreement.
That is not to say that the Court may be inconsistent in its interpretation of
similar definitions. What that does imply however, is that just because there
is a domestic definition similar to the one under the DTAA, amendments to
the domestic law, in an attempt to contour, restrict or expand the definition
under its statute, cannot extend to the definition under the DTAA. In other
words, the domestic law remains static for the purposes of the DTAA. The
Court in Sanofi (supra)45 had also held similarly:
"We are in agreement with the petitioners and in the light of our
preceding analyses, discern no textual, grammatical or syntactic
45
supra note 43
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 38
ambiguity in Article 14(5), warranting an interpretive recourse.
In the circumstances, invoking provisions of Article 3(2) by an
artificial insemination of ambiguity (to accommodate an
expanded meaning to the DTAA provision), would be contrary to
good faith interpretation. A further problematic of contriving an
ambiguity to unwarrantedly invite application of domestic law of
a contracting State would be that while India would interpret an
undefined DTAA provision according to the provisions of the Act,
France could do so by reference to its tax code. As a
consequence, the purpose of entering into a treaty with a view to
avoiding double-taxation of cross-border transactions would be
frustrated."
51. Pertinently, this Court in Director of Income Tax v Nokia Networks46
specifically dealt with the question of the effect of amendments to domestic
law and the manner of their operation on parallel treaties. The Court
delivered its judgment in the context of the very amendments that are in
question today; the Explanations to Section 9(1)(vi) vis a vis the
interpretation of a Double Tax Avoidance Agreement. This Court rejected
that any amendment could change the situation and render the service or
activity taxable, in the following observations:
"He, thus submitted that the question of "copyrighted article" or
actual copyright does not arise in the context of software both in
the DTAA and in the Income Tax Act since the right to use
simpliciter of a software program itself is a part of the copyright
in the software irrespective of whether or not a further right to
make copies is granted. The decision of the Delhi Bench of the
ITAT has dealt with this aspect in its judgment in Gracemac Co.
Vs. ADIT 134 TTJ (Delhi) 257 pointing out that even software
bought off the shelf, does not constitute a "copyrighted article" as
sought to be made out by the Special Bench of the ITAT in the
present case. However, the above argument misses the vital point
namely the assessee has opted to be governed by the treaty and
46
2013 (358) ITR 259
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 39
the language of the said treaty differs from the amended Section
9 of the Act. It is categorically held in CIT Vs. Siemens
Aktiongesellschaft, 310 ITR 320 (Bom) that the amendments
cannot be read into the treaty. On the wording of the treaty, we
have already held in Ericsson (supra) that a copyrighted article
does not fall within the purview of Royalty. Therefore, we decide
question of law no.1 & 2 in favour of the assessee and against
the Revenue."
52. Thus, an interpretive exercise by the Parliament cannot be taken so far
as to control the meaning of a word expressly defined in a treaty. Parliament,
supreme as it may be, is not equipped, with the power to amend a treaty. It is
certainly true that law laid down by the Parliament in our domestic context,
even if it were in violation of treaty principles, is to be given effect to; but
where the State unilaterally seeks to amend a treaty through its legislature,
the situation becomes one quite different from when it breaches the treaty. In
the latter case, while internationally condemnable, the State's power to
breach very much exists; Courts in India have no jurisdiction in the matter,
because in the absence of enactment through appropriate legislation in
accordance with Article 253 of the Constitution, courts do not possess any
power to pronounce on the power of the State to enact a law contrary to its
treaty obligations. The domestic courts, in other words, are not empowered
to legally strike down such action, as they cannot dictate the executive
action of the State in the context of an international treaty, unless of course,
the Constitution enables them to. That being said, the amendment to a treaty
is not on the same footing. The Parliament is simply not equipped with the
power to, through domestic law, change the terms of a treaty. A treaty to
begin with, is not drafted by the Parliament; it is an act of the Executive.
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 40
Logically therefore, the Executive cannot employ an amendment within the
domestic laws of the State to imply an amendment within the treaty.
Moreover, a treaty of this nature is a carefully negotiated economic bargain
between two States. No one party to the treaty can ascribe to itself the power
to unilaterally change the terms of the treaty and annul this economic
bargain. It may decide to not follow the treaty, it may chose to renege from
its obligations under it and exit it, but it cannot amend the treaty, especially
by employing domestic law. The principle is reciprocal. Every treaty entered
into be the Indian State, unless self-executory, becomes operative within the
State once Parliament passes a law to such effect, which governs the
relationship between the treaty terms and the other laws of the State. It then
becomes part of the general conspectus of domestic law. Now, if an
amendment were to be effected to the terms of such treaty, unless the
existing operationalizing domestic law states that such amendments are to
become automatically applicable, Parliament will have to by either a
separate law, or through an amendment to the original law, make the
amendment effective. Similarly, amendments to domestic law cannot be
read into treaty provisions without amending the treaty itself.
53. Finally, States are expected to fulfill their obligations under a treaty in
good faith. This includes the obligation to not defeat the purpose and object
of the treaty. These obligations are rooted in customary international law,
codified by the VCLT, especially Article 26 (binding nature of treaties and
the obligation to perform them in good faith); Article 27 (Internal law and
observance of treaties, i.e provisions of internal or municipal law of a nation
cannot be used to justify omission to perform a treaty); General rule of
interpretation under Article 31 (1) ( i.e that it shall be interpreted in good
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 41
faith, in accordance with ordinary meaning to be given to the terms of a
treaty) and Article 31 (4) (A special meaning shall be given to a term if it is
established that the parties so intended).
The expression "process" and treaty interpretation in this case
54. Neither can an Act of Parliament supply or alter the boundaries of the
definition under Article 12 of the DTAAs by supplying redundancy to any
part of it. This becomes especially important in the context of Explanation 6,
which states that whether the `process' is secret or not is immaterial, the
income from the use of such process is taxable, nonetheless. Explanation 6
precipitated from confusion on the question of whether it was vital that the
"process" used must be secret or not. This confusion was brought about by a
difference in the punctuation of the definitions in the DTAAs and the
domestic definition. For greater clarity and to illustrate this difference, we
reproduce the definitions of royalty across both DTAAs and sub clause (iii)
to Explanation 2 to 9(1)(vi).
Article 12(3), Indo Thai Double Tax Avoidance Agreement:
3. The term "royalties" as used in this article means
payments of any kind received as a consideration for the
alienation or the use of, or the right to use, any copyright of
literary, artistic or scientific work (including cinematograph
films, phonographic records and films or tapes for radio or
television broadcasting), any patent, trade mark, design or
model, plan, secret formula or process, or for the use of, or the
right to use industrial, commercial or scientific equipment, or for
information concerning industrial, commercial or scientific
experience." (emphasis supplied)
Article 12(4), Indo Netherlands Double Tax Avoidance
Agreement
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 42
"4. The term "royalties" as used in this Article means
payments of any kind received as a consideration for the use of,
or the right to use, any copyright of literary, artistic or scientific
work including cinematograph films, any patent, trade mark,
design or model, plan, secret formula or process, or for
information concerning industrial, commercial or scientific
experience."
(emphasis supplied)
Section 9(1)(vi), Explanation 2, Income Tax Act, 1961
(iii) the use of any patent, invention, model, design , secret
formula or process or trade mark or similar property; (emphasis
supplied)
55. The slight but apparently vital difference between the definitions
under the DTAA and the domestic definition is the presence of a comma
following the word process in the former. In the initial determinations before
various ITATs across the country, much discussion took place on the
implications of the presence or absence of the "comma". A lot has been said
about the relevance or otherwise of punctuation in the context of statutory
construction. In spoken English, it would be unwise to argue against the
importance of punctuation, where the placement of commas is notorious for
diametrically opposite implications. However in the realm of statutory
interpretation, courts are circumspect in allowing punctuation to dictate the
meaning of provisions. Judge Caldwell once famously said "The words
control the punctuation marks, and not the pun ctuation marks the words."
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 43
Holmes v. Pheonix Insurance Co.47. It has been held in CGT v. Budur 48and
Hindustan Const v. CIT49 that while punctuation may assist in arriving at the
correct construction, yet it cannot control the clear meaning of a statutory
provision. It is but, a minor element in the construction of a statute,
Hindustan Const50.
56. The courts have however created an exception to the general rule that
punctuation is not to be looked at to ascertain meaning. That exception
operates wherever a statute is carefully punctuated. Only then should weight
undoubtedly be given to punctuation; CIT v. Loyal Textile51; Sama Alana
Abdulla vs. State of Gujarat52; Mohd Shabbir vs. State of Maharashtra53;
Lewis Pugh Evans Pugh vs. Ashutosh Sen54; Ashwini Kumar Ghose v.
Arbinda Bose55; Pope Alliance Corporation v. Spanish River Pulp and
Paper Mills Ltd.56. An illustration of the aid derived from punctuation may
be furnished from the case of Mohd. Shabbir v. State of Maharashtra57
where Section 27 of the Drugs and Cosmetics Act, 1940 came up for
construction. By this section whoever "manufactures for sale, sells, stocks
or exhibits for sale or distributes" a drug without a license is liable for
punishment. In holding that mere stocking shall not amount to an offence
under the section, the Supreme Court pointed out the presence of comma
47
98 F 240 (1899)
48
103 ITR 189
49
208 ITR 291
50
supra note 46
51
231 ITR 573
52
AIR 1996 SC 569
53
AIR 1979 SC 564
54
AIR 1929 Privy Council 69
55
AIR 1952 SC 369
56
AIR 1929 PC 38
57
AIR 1979 SC 564
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 44
after "manufactures for sale" and "sells" and the absence of any comma
after "stocks" was indicative of the fact "stocks" was to be read along with
"for sale" and not in a manner so as to be divorced from it, an interpretation
which would have been sound had there been a comma after the word
"stocks". It was therefore held that only stocking for the purpose of sale
would amount to an offence but not mere stocking.
57. However, the question, which then arises, is as follows. How is the
court to decide whether a provision is carefully punctuated or not? The test-
to decide whether a statute is carefully (read consciously) punctuated or not-
would be to see what the consequence would be had the section been
punctuated otherwise. Would there be any substantial difference in the
import of the section if it were not punctuated the way it actually is? While
this may not be conclusive evidence of a carefully punctuated provision, the
repercussions go a long way to signify intent. If the inclusion or lack of a
comma or a period gives rise to diametrically opposite consequences or
large variations in taxing powers, as is in the present case, then the
assumption must be that it was punctuated with a particular end in mind.
The test therefore is not to see if it makes "grammatical sense" but to see if
it takes on any "legal consequences".
58. Nevertheless, whether or not punctuation plays an important part in
statute interpretation, the construction Parliament gives to such punctuation,
or in this case, the irrelevancy that it imputes to it, cannot be carried over to
an international instrument where such comma may or may not have been
evidence of a deliberate inclusion to influence the reading of the section.
There is sufficient evidence for us to conclude that the process referred to in
Article 12 must in fact be a secret process and was always meant to be such.
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 45
In any event, the precincts of Indian law may not dictate such conclusion.
That conclusion must be the result of an interpretation of the words
employed in the law and the treatises, and discussions that are applicable
and specially formulated for the purpose of that definition. The following
extract from Asia Satellite58 takes note of the OECD Commentary and
Klaus Vogel on Double Tax Conventions, to show that the process must in
fact be secret and that specifically, income from data transmission services
do not partake of the nature of royalty.
"74. Even when we look into the matter from the standpoint of
Double Taxation Avoidance Agreement (DTAA), the case of the
appellant gets boost. The Organisation of Economic Cooperation
and Development (OECD) has framed a model of Double
Taxation Avoidance Agreement (DTAA) entered into by India are
based. Article 12 of the said model DTAA contains a definition of
royalty which is in all material respects virtually the same as the
definition of royalty contained in clause (iii) of Explanation 2 to
Section 9(1) (vi) of the Act. This fact is also not in dispute. The
learned counsel for the appellant had relied upon the
commentary issued by the OECD on the aforesaid model DTAA
and particularly, referred to the following amendment proposed
by OECD to its commentary on Article 12, which reads as under:
`9.1 Satellite operators and their customers (including
broadcasting and telecommunication enterprises) frequently
enter into transponder leasing agreements under which the
satellite operator allows the customer to utilize the capacity
of a satellite transponder to transmit over large
geographical areas. Payments made by customers under
typical transponder leasing agreements are made for the
use of the transponder transmitting capacity and will not
constitute royalties under the definition of paragraph 2;
these payments are not made in consideration for the use of,
or right to use, property, or for information, that is referred
58
supra note 1
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 46
to in the definition (they cannot be viewed, for instance, as
payments for information or for the use of, or right to use, a
secret process since the satellite technology is not
transferred to the customer). As regards treaties that
include the leasing of industrial, commercial or scientific
(ICS) equipment in the definition of royalties, the
characterization of the payment will depend to a large
extent on the relevant contractual arrangements. Whilst the
relevant contracts often refer to the lease of a transponder,
in most cases the customer does not acquire the physical
possession of the transponder but simply its transmission
capacity: the satellite is operated by the lessor and the
lessee has no access to the transponder that has been
assigned to it. In such cases, the payments made by the
customers would therefore be in the nature of payments for
services, to which Article 7 applies, rather than payments
for the use, or right to use, ICS equipment. A different, but
much less frequent, transaction would be where the owner
of the satellite leases it to another party so that the latter
may operate it and either use it for its own purposes or offer
its data transmission capacity to third parties. In such a
case, the payment made by the satellite operator to the
satellite owner could well be considered as a payment for
the leasing of industrial, commercial or scientific
equipment. Similar considerations apply to payments made
to lease or purchase the capacity of cables for the
transmission of electrical power or communities (e.g.
through a contract granting an indefeasible right of use of
such capacity) or pipelines (e.g. for the transportation of
gas or oil).
75. Much reliance was placed upon the commentary written
by Klaus Vogel on Double Taxation Conventions (3rd Edition)'.
It is recorded therein:
`The use of a satellite is a service, not a rental (thus
correctly, Rabe, A., 38 RIW 135 (1992), on Germany's DTC
with Luxembourg); this would not be the case only in the
event the entire direction and control over the satellite, such
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 47
as its piloting or steering, etc. were transferred to the user.'
76. Klaus Vogel has also made a distinction between letting
an asset and use of the asset by the owner for providing services
as below:
`On the other hand, another distinction to be made is letting
the proprietary right, experience, etc., on the one hand and
use of it by the licensor himself, e.g., within the framework
of an advisory activity. Within the range from services', viz.
outright transfer of the asset involved (right, etc.) to the
payer of the royalty. The other, just as clear-cut extreme is
the exercise by the payee of activities in the service of the
payer, activities for which the payee uses his own
proprietary rights, know-how, etc., while not letting or
transferring them to the payer.'
77. The Tribunal has discarded the aforesaid commentary of
OECD as well as Klaus Vogel only on the ground that it is not
safe to rely upon the same. However, what is ignored is that
when the technical terms used in the DTAA are the same which
appear in Section 9(1)(vi), for better understanding all these very
terms, OECD commentary can always be relied upon. The Apex
Court has emphasized so in number of judgments clearly holding
that the well-settled internationally accepted meaning and
interpretation placed on identical or similar terms employed in
various DTAAs should be followed by the Courts in India when it
comes to construing similar terms occurring in the Indian
Income Tax Act....
***** ********** *****
78. There are judgments of other High Courts also to the same
effect.
(a) Commissioner of Income Tax Vs. Ahmedabad Manufacturing
and Calico Printing Co., [139 ITR 806 (Guj.)] at Pages 820-822.
(b) Commissioner of Income Tax Vs. Vishakhapatnam Port Trust
[(1983) 144 ITR 146 (AP)] at pages 156-157.
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 48
(c) N.V. Philips Vs. Commissioner of Income Tax [172 ITR 521]
at pages 527 & 538-539."
59. On a final note, India's change in position to the OECD Commentary
cannot be a fact that influences the interpretation of the words defining
royalty as they stand today. The only manner in which such change in
position can be relevant is if such change is incorporated into the agreement
itself and not otherwise. A change in executive position cannot bring about a
unilateral legislative amendment into a treaty concluded between two
sovereign states. It is fallacious to assume that any change made to domestic
law to rectify a situation of mistaken interpretation can spontaneously
further their case in an international treaty. Therefore, mere amendment to
Section 9(1)(vi) cannot result in a change. It is imperative that such
amendment is brought about in the agreement as well. Any attempt short of
this, even if it is evidence of the State's discomfort at letting data broadcast
revenues slip by, will be insufficient to persuade this Court to hold that such
amendments are applicable to the DTAAs.
60. Consequently, since we have held that the Finance Act, 2012 will not
affect Article 12 of the DTAAs, it would follow that the first determinative
interpretation given to the word "royalty" in Asia Satellite59, when the
definitions were in fact pari materia (in the absence of any contouring
explanations), will continue to hold the field for the purpose of assessment
years preceding the Finance Act, 2012 and in all cases which involve a
Double Tax Avoidance Agreement, unless the said DTAAs are amended
jointly by both parties to incorporate income from data transmission services
as partaking of the nature of royalty, or amend the definition in a manner so
59
supra note 1
ITA 473/2012, 474/2012, 500/2012 & 244/2014 Page 49
that such income automatically becomes royalty. It is reiterated that the
Court has not returned a finding on whether the amendment is in fact
retrospective and applicable to cases preceding the Finance Act of 2012
where there exists no Double Tax Avoidance Agreement.
61. For the above reasons, it is held that the interpretation advanced by
the Revenue cannot be accepted. The question of law framed is accordingly
answered against the Revenue. The appeals fail and are dismissed, without
any order as to costs.
S. RAVINDRA BHAT
(JUDGE)
R.K. GAUBA
(JUDGE)
FEBRUARY 08, 2016
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