Commissioner Of Income Tax ... vs D.C.M. Limited
2011 Latest Caselaw 1411 Del

     IN THE HIGH COURT OF DELHI AT NEW DELHI
%
                         Judgment reserved on : 14.02.2011
                         Judgment delivered on: 10.03.2011

                     ITR Nos.87-89/1992


COMMISSIONER OF INCOME TAX                       ..... PETITIONER
CENTRAL-II, NEW DELHI


                                  Vs


D.C.M. LIMITED                                  .... RESPONDENT

Advocates who appeared in this case:

For the Appellant : Ms. Prem Lata Bansal, Sr. Advocate with Mr. Deepak Anand, Advocate For the Respondent : Mr. S.K. Aggarwal, Advocate

CORAM :-

HON‟BLE MR. JUSTICE SANJAY KISHAN KAUL HON'BLE MR JUSTICE RAJIV SHAKDHER

1. Whether the Reporters of local papers may Yes be allowed to see the judgment ?

2.     To be referred to Reporters or not ?              Yes

3.     Whether the judgment should be reported           Yes
       in the Digest ?

RAJIV SHAKDHER, J

1. The captioned references arise out of the orders passed

in ITC No.95-97/1990. We were informed that only question

of law which was to be answered is as follows :-

"Whether on the facts and in the circumstances of the case, the Tribunal was right in law in holding that no tax was to be deducted at source under the Act on payment of 38750 pounds, 77500 pounds, 23250 pounds and 15500 pounds to M/s. Tate and Lyle

Industries Ltd., London under the Technical Collaboration Agreement, dated 12.10.1983?"

1.1. As a matter of fact, we had recorded the same, after

confabulation with the counsels for parties, in our order

dated 10.02.2011.

2. The question of law detailed out above arises in the

background of the following facts as culled out from the

orders of the authorities below:-

2.1 The assessee which is in the business of manufacture

of sugar had entered into an agreement dated 12.10.1983 (in

short „agreement‟) for transfer of comprehensive technical

information, know-how and supply of equipment with one

Tate & Lyle Process Technology; a division of Tate & Lyle

Industries Limited, London (hereinafter referred to as „Tate‟).

2.2 The said agreement envisaged payment of a sum

of £1,55,000 in four (4) instalments towards supply of

documents concerning, what was known as "TALO

processes".

2.3 It appears that Tate being a pioneer in sugar

technology; was not only engaged in the manufacture of

specialized equipment but was also in possession of know-

how required for installation and operation of specialized

equipment, processes and use of essential specialty chemical

products, which assisted in elimination of use of lime stone

and hard coke while, greatly conserving energy bringing

about reduction in pollution as well as loss of sugar during

manufacture of plantation white sugar.

2.4 The assessee wanting to adopt the "TALO processes"

for its factory at Daurala, in India entered into the

aforementioned agreement.

2.5 The first, of the four (4) instalments, was to be remitted

to Tate on the execution of the aforementioned agreement.

Accordingly, the assessee, in its capacity as a representative

assessee for Tate, applied to the Inspecting Assistant

Commissioner (in short, „IAC‟) for permission to remit the first

instalment in the sum of £ 38750. The IAC accorded its no

objection vide certificate dated 27.03.1984 albeit with a

caveat that the assessee would have to deduct tax at source

at the rate of 20% towards tax on the gross amount of

remittance. Resultantly, the assessee could remit to Tate the

amount only after deduction of tax at source. A similar no

objection certificate was issued by the IAC vide its certificate

dated 17.05.1984 in respect of the second remittance in the

sum of £1,16,250.

2.6 It is pertinent to note that, in the two certificates issued

by the IAC, no reasons were supplied as to why the assessee

had been called upon to deduct tax at source at the rate of

20%.

2.7 The assessee being aggrieved by the said action of the

IAC preferred an appeal to the Commissioner of Income Tax

(Appeals) [in short, CIT(A)]. Several grounds were raised in

the appeal by the assessee. The principle ground being that

the remittance to Tate was not in the nature of royalty; the

remittances in the hand of Tate constituted industrial or

commercial profits and since Article VIII of the Double

Taxation Avoidance Agreement (in short „DTAA‟) obtaining

between India and the United Kingdom was applicable, the

said remittances could be taxed only if Tate was shown to

have a permanent establishment in India.

2.8 In support of the aforesaid stand, it was argued that

Tate had no permanent establishment in India. It appears, in

this regard, a reference was made to a certificate dated

02.03.1984 to establish that Tate had no establishment in

India in terms of Article V of the DTAA

2.9 The CIT(A), however, came to the conclusion that the

remittances made to Tate by the assessee fell within the

purview of the expression "payments of any kind" appearing

in Article XIII (3) of the DTAA The CIT (A), however, accepted

the position that the provisions of Section 9(1)(vi) of the

Income Tax Act, 1961 (in short, „I.T. Act‟) would be

overridden in view of the provisions of Article XIII (3) of the

DTAA. The CIT (A) was of the view that the term „technical

know-how‟ was wide enough to include not only outright

sales of design or know-how but also any other provision of

technical assistance. He also went on to hold that for a

payment to be construed as royalty under the provisions of

Article XIII(3) of the DTAA, it made little difference whether

the payments made were lump-sum or, were made

periodically or, even on a recurring basis. For these reasons,

the CIT(A) concluded by holding that: "in the present case, it

is clear that technical know how was provided by the foreign

enterprise including lending of services of foreign

technicians. The payment was clearly in the nature of royalty

and it could not be said that payment had to be treated as

commercial or industrial profits."

2.10 Consequently, the CIT (A) sustained the order of the IAC

even while noting that there was no reasoning contained in

the certificate issued by the IAC mandating the deduction of

tax at source at the rate of 20% in respect of the remittances

in issue. The CIT(A) was of the view that a reading of the

order would show that the impugned certificate issued by the

IAC was otherwise in accordance with law.

3. Aggrieved by the order of the CIT (A), the assessee

carried the matter in appeal to the Income Tax Appellate

Tribunal (hereinafter referred to as the „Tribunal‟). The

Tribunal, in the impugned judgment, noted the difference in

the definition of royalty as contained in Article XIII(3) of the

DTAA and that which obtained in explanation 2 to Section

9(1)(vi) of the I.T. Act. The Tribunal opined that the definition

of royalty as appearing in the DTAA was narrower than that

under the Income Tax Act. The Tribunal also noted the fact

that the CIT(A) had correctly construed the position in law,

which is that, the provisions of DTAA would override those of

the I.T. Act. In these circumstances, the Tribunal examined

the agreement dated 12.10.1983 in the light of the provisions

as contained in the DTAA. On examination of the

aforementioned agreement, the Tribunal observed as

follows:-

"A perusal of the Technical Collaboration Agreement shows that the amount of £1,55,000 was to be paid by DCM to TL once for all as consideration for the grant of licence and the disclosure of the know-how. Para 2 of the said Agreement provided that TL was to grant DCM the right and full but non-transferable licence to practice the TALO Processes at its existing factories. The DCM could sub-licence its rights to another Indian party with the consent of TL and with the approval of the Government of India. Para 3 of the said agreement provides for the disclosure of the know-how, of which the details appear from paras 3.1 to 3.9. We find that the definition of „royalty‟ under Explanation 2 to section 9(1)(vi) of the Income Tax Act, 1961 is not the same as the definition of the term under Article XIII(3) of the double taxation avoidance agreement. As rightly submitted on behalf of the assessee, the definition under the double taxation avoidance agreement is a truncated one i.e., it is narrower than the definition under the Income Tax Act. A comparative look at the two definitions shows that the following part of the definition which occurs in Explanation 2 to section 9(I)(vi) of the Income Tax Act, 1961 does not figure under Article XIII(3) of the double taxation avoidance agreement :-

(i). The transfer of all or any rights (including the granting of the 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.

The know-how is intellectual property and excluded clauses referred to above pertained to the know-how of secret formula or process and the imparting of any information concerning the working thereof. The assessee, in our view, is right in submitting that the things for the transfer of which DCM agreed to pay to TL 81,55,000 as such squarely fell within these two exclusionary clauses which do not form part of the definition of the term „royalty‟ under Article XIII(3) of the double taxation avoidance agreement. The Income Tax authorities in our view, were not right in being influenced by the term „payments of any kind‟ preceding the definition of this term under the double taxation avoidance agreement."

3.1 In view of the aforesaid observations, the Tribunal

came to the conclusion that the consideration paid by the

assessee for transfer of drawings, designs, etc., outside India

by Tate to the assessee did not constitute royalty "as

contemplated under Article XIII of the DTAA". It went on to

observe that the consideration received by Tate constituted

business profits of Tate, which could not be taxed through

assessee in India as Tate did not have a permanent

establishment in India.

4. Being aggrieved, the Department sought a reference to

this court. As noticed hereinabove, we are called upon to

decide the references in the light of the question of law

framed.

5. Mrs. Bansal, learned senior counsel appearing on behalf

of the revenue has confined her submissions to the

interpretation of the clauses of the agreement executed

between Tate and the assessee. Mrs. Bansal drew our

attention to various clauses of the agreement, and

consequently, contended that a reading of the provisions

would demonstrate that what had been obtained by the

assessee was a mere use of the know-how and the

technology owned by Tate. In other words, Mrs. Bansal

contended that there was no transfer of technology and / or

know-how by Tate to the assessee. Mrs. Bansal, however,

fairly conceded that the issue at hand would have to be

looked at only in the light of the definition of royalty

obtaining in Article XIII(3) of the DTAA, and also the fact that

it was no longer res integra that in case of a conflict between

the provisions of the I.T. Act and the DTAA, the provisions of

DTAA would override. In support of her submissions, the

learned senior counsel cited the following judgments :-

N.V. Philips Vs. CIT (1988) 172 ITR 521; Alembic

Chemical Works Co. Ltd. Vs. CIT (1989) 177 ITR 377;

Shriram Pistons and Rings Ltd. Vs. CIT(Del.) (2008) 307

ITR 363; and CIT Vs. J.K. Synthetics Ltd. (2009) 309 ITR

371.

6. Mr. Agarwal appearing for the assessee refuted the

contentions of the revenue. Mr. Aggarwal largely relied upon

the order of the Tribunal in support of his plea. A particular

emphasis was laid by Mr. Aggarwal on the terms of the

aforementioned agreement executed between Tate and the

assessee. It was Mr. Aggarwal‟s say that a reading of the

agreement would show that Tate had sold the technology

and / or know-how in issue (i.e., the „TALO‟ processes) albeit

based on certain conditions. The learned counsel submitted

that it was a case of conditional sale and not a mere use of

technology and know-how as was sought to be contended by

the learned senior counsel for the revenue. Mr. Aggarwal in

support of his contention relied upon the judgment in the

case of CIT Vs. Davy Ashmore India Ltd. (1991) 190 ITR 626.

7. We have heard learned counsel for the parties and also

perused the documents on record. In our view, the answer to

the question framed would largely depend upon our being

able to ascertain the intent of the parties based on the

language employed in the agreement. For this purpose, the

agreement in issue will have to be read as a whole and not in

a piecemeal fashion. The first recital i.e., recital „A‟ suggests

that Tate was in possession of the necessary expertise i.e.,

the technical know-how, which is, broadly referred to as the

„TALO‟ processes used in the sugar industry. Recital „B‟

indicates that the assessee was „desirous of acquiring‟

technical know-how offered by Tate for its existing sugar

factories in India.

7.1 Clause 1 specifies that the agreement envisages

transfer of „comprehensive technical know-how and also

supply of equipment‟ by Tate to the assessee in order to

enable it to adopt the „TALO‟ processes. The said clause

clearly provides that the term „know-how‟ used in the clause

(1) shall include the following:-

".... all trade secrets and technical information, tangible and intangible, including documents, process description, process flow diagrams, specification of speciality chemicals and TL‟s standards of purity and performance for these chemicals, equipment specifications, equipment layout, design, drawings, piping drawings, laboratory testing methods, operation and use of analytical instruments, and all other related technical information as are or may be available from and used by TL on the date hereof with regard to the TALO processes."

7.2 Moving further, in particular, clause 2.1 and 2.2 confer

on the assessee full rights in the form of non-transferable

licences to practice „TALO‟ processes at the assessee‟s

existing factories, with an added right to sub-licence the

rights conferred to another Indian party provided the terms

and conditions of sub-licence were previously agreed to by

both parties. This right was, however, subject to a caveat,

which was, to obtain necessary approval in that regard, of

the Government of India.

7.3 Under clause 3.2, the assessee was required to

maintain confidentiality of any drawings, specification or

technical information forming part of the know-how received

by it.

7.4 Clause 3.5 obliged Tate to send its engineer and

technologists, and also specialists, as and when the assessee

sought its assistance, in that regard.

7.5 Under clause 3.9, Tate was obliged to inform the

assessee of any research and development and, as such,

improvements in the „TALO‟ processes which became

available commercially, from time to time. The obligation,

however, was confined to a period of 5 years from the

effective date of the contract.

7.6 Under clause 4.1, Tate was required to supply the

necessary control equipment required for the „TALO‟

processes. The terms with respect to the supply of such

equipment were required to be contained in a separate

agreement.

7.7 The manner of payment of the once-for-all

consideration in the sum of £ 1,55,000 was contained in

clause 6 of the agreement.

7.8 Performance Guarantee was provided for in clause 7.

7.9 Similarly, warranties were required to be furnished by

Tate with respect to its know-how in terms of clause 8 of the

aforesaid agreement.

7.10 Under clause 12, parties were prohibited from assigning

or transferring rights under the agreement to any third party

directly or indirectly without the written consent of the other

party.

7.11 Clause 13 of the agreement provided for termination on

the grounds of insolvency. The right in this was conferred on

both the „Tate‟ and the assessee.

7.12. Clause 18 which dealt with the validity of the

agreement provided that the terms and conditions contained

in the agreement are conditional upon commissioning of the

„TALO‟ processes before 01.01.1987.

8. As is noticed above, we have only referred to what

according to us, were the essential clauses of the agreement.

A reading of the aforementioned clauses would show that

what was intended by the parties was as follows :-

(i) Tate would transfer to the assessee technical know-how

for a lumpsum consideration of £ 1,55,000 to be paid in the

manner provided in clause 6 of the agreement. The

agreement provided for transfer of "comprehensive technical

information" and know-how, which included all trade secrets

and technical information, designs and drawings, etc.;

(ii) The transfer of technical know-how was on a non-

exclusive basis, in order to enable the assessee to adopt

„TALO‟ processes, in respect of its existing factories in India.

(iii) In addition to the above, the assessee had also the

right to sub-licence the technology and/or the know-how

transferred to it, to another Indian party, subject to the terms

and conditions of sub-licence being agreed to by both „Tate‟

and the assessee.

8.1 In our view, it is quite clear by virtue of the

aforementioned agreement what the assessee obtained was

a complete transfer of technology and know-how albeit on a

non exclusive basis which was confined to its factories in

India with a conditional right to sub-licence it to third parties.

The sub-licencing of technology and/or know-how had to

have, however, the consent of Tate and also the approval of

the Government of India. The obligation of Tate to update

the technology and/or know-how transferred to assessee

based on research and development carried out by it, had

obviously to be restricted in point of time, bearing in mind

that it was a transaction which dealt with complete transfer

of technology. The time span provided was 5 years from the

effective date of the contract.

8.2. It was not, according to us, therefore, as contended by

the learned counsel for the revenue, a mere use of the

technology and/or know-how owned by Tate. Therefore, the

mere fact that Tate retained with it the right to transfer

technology and / or know-how to other parties did not in our

view reduce the right obtained by the assessee under the

agreement to one of a mere user of technology and know-

how. The transfer of technology is thus quite often, as in the

present case, brought about by executing agreements which

give rights far greater than a mere right to use albeit on a

non-exclusive basis. The argument made on behalf of the

revenue that the transaction does not constitute a sale,

misses the point that, for it to fall within the four corners of

the provisions of Article XIII(3), the right conferred should be

of usage; anything more than that, takes it out of ambit of

definition of royalty as provided in the DTAA. We, therefore,

agree with the conclusion arrived at by the Tribunal with

regard to the terms of the agreement. Having come to this

conclusion, it is quite obvious that the remittances made by

the assessee to Tate would not fall in the definition of Article

XIII(3) of the DTAA.

8.3 Another argument raised before us was that the

definition of the term of royalty was very wide as it brought

within its wings payments of any kind. To deal with this

submission it would be appropriate to extract the relevant

portion of Article XIII(3) of the DTAA.

"The term „royalties‟ as used in this Article means payments of any kind including rental received as a consideration for the use of, or the right to use:

(a). any patent, trademark, design or model, plan, secret formula or process;

(b). industrial, commercial or scientific equipment, or information concerning industrial, commercial or scientific experience;

(c). any copyright of literary, artistic or scientific work, cinematographic films, and films or tapes for radio or television broadcasting;

But does not include royalties or other amounts paid in respect of the operation of mines or quarries or of the extraction or removal of natural resources."

9. A bare perusal of Article XIII(3) would show that the

expression „payments of any kind‟ is circumscribed by the

latter part of the definition which speaks of consideration

received (including in the form of rentals) for "use of" or

"right to use" intellectual properties. The Tribunal, in our

view, rightly observed that the CIT(A) had erred in coming to

the conclusion that the expression „payments of any kind‟

was broad enough to include even an outright sale. To drive

home this point the Tribunal, once again, has correctly drawn

a distinction between the definition of royalty as appearing in

the DTAA and that which finds mention in explanation 2 to

section 9(1)(vi) of the I.T. Act. A perusal of the provisions of

the said explanation would show that it bring within the

ambit of royalty a wider range of transactions which would

include payments made for "transfer of all" or "any right" in

patents, inventions, model, design, etc. apart from payments

based for use of such right, patent, innovation, model,

design, secret formula or process or trade mark or similar

property. As a matter of fact, a perusal of clause (i) of

explanation 2 of section 9(1)(vi) of the I.T. Act would show

that "transfer of all" or "any right" could take place by

execution of licences as well, which was the methodology

adopted by Tate and the assessee in the present case. For

the sake of convenience and in order to draw a distinction

between the definition of royalty as appearing in Article XIII

(3) and that which obtains in the I.T. Act: the relevant portion

of explanation 2 of Section 9(1)(vi) of the I.T. Act is extracted

hereinbelow :-

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, formula or process or trade mark or similar property;

(iii). ....

(iv). ....

(v). ....

(vi). The rendering of any services in connection with the activities referred to in sub-clauses (i) to

(v)."

10. As is obvious, what is contended by the revenue, if at

all falls within clause (i) of explanation 2 of section 9(1)(vi).

Since the definition of royalty in DTAA has a limited scope,

the remittances in issue cannot be construed as royalties,

therefore, as is correctly concluded by the Tribunal, against

the remittances in issue, tax at source could not have been

deducted. We are also in agreement with the Tribunal that

these payments could only constitute business profits of

Tate. Mrs. Bansal during the course of the arguments, has

fairly conceded that there is no permanent establishment of

Tate in India. She had, therefore, accordingly confined her

arguments to that aspect of the matter, which is discussed

hereinabove by us. Given the fact that Tate did not have a

permanent establishment in India, the remittances which

constitute business profits cannot also be taxed in India.

11. In so far as the judgments cited by Mrs. Bansal are

concerned, the same are distinguishable on facts. CIT Vs.

J.K. Synthetics Ltd. (supra), turned on its own facts.

Significantly it did not involve interpretation of the provisions

of the DTAA as is the situation in the present case. Similarly,

the Shri Ram case is also distinguishable. A reading of various

clauses would show that there was no transfer of technology

and know-how. In this regard, reference may be had to

clause 11 of the agreement which specifically prohibited the

right of the transferee to manufacture products based on the

transferors technology after its determination. No such

limitation exists in the present case. As a matter of fact, in

the instant case, the termination clause provides for such an

eventuality only on the grounds of insolvency of the parties.

There is no general right of termination obtaining in the

agreement in the present case. Likewise, the judgment in

the case of N.V. Philips Vs. CIT (1988) 172 ITR 521 is not

applicable since what was transferred was use of technology.

In this regard, specific reference may be made to clause (c)

appearing at page 524 which provided that any information

disclosed by the assessee to the Indian company under the

agreement would remain confidential and would not become

the property of the Indian company until such time and to the

extent that such information had "become public" by

application and user. The judgment of the Supreme Court in

the case of Alembic Chemical Works Co. Ltd. (supra) would

also not be applicable on a similar rationale.

12. For the aforementioned reasons, we are of the view

that the question of law framed, has to be answered in favour

of the assessee and against the revenue. Accordingly, the

captioned references are dismissed. However, in the given

circumstances, parties shall bear their own cost.

RAJIV SHAKDHER, J.

SANJAY KISHAN KAUL, J.

MARCH 10, 2011 yg