CIT vs Davy Ashmore India Ltd.

Calcutta High Court

Commissioner Of Income-Tax vs Davy Ashmore India Ltd.

 on 13 December, 1990

Equivalent citations: 1991 190 ITR 626 Cal

1. In this reference under Section 256(1) of the Income-tax Act, 1961, the following question of law has been referred to this court:

"Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was correct in law in holding that the payment of 36,470 made by the assessee-company to the foreign party as consideration for outright sale of drawings and design was not 'royalty' exigible to tax under the Income-tax Act, 1961 ?"

2. Shortly stated, the facts are as follows :

The assessee received a letter of intent from Light Metal Industries Limited (hereinafter referred to as "the LMI") for maintenance and supply of terminal equipment for a secondhand aluminium cold-rolling mill being imported by them for their aluminium-rolled products project at Village Hoera in the District of Hooghly, West Bengal. LMI also issued a purchase order dated March 30, 1984, in terms of which the assessee was to arrange for the import of concept designs and drawings enabling it to prepare the detailed manufacturing drawings for purposes of manufacture of the terminal equipments which were required to be supplied by the assessee as per the letter of intent of LMI.

3. The secondhand rolling mill was to be imported by LMI from Davy Makes (Pools) Ltd., U. K. On receipt of the purchase order and the letter of intent from LMI, the assessee placed an order with Davy Makes (Pools) Limited, U. K., for the supply of one print each of concept designs and drawings for the terminal equipment. In paragraph 2 of the letter of intent, it specifically mentions that the remittance of the purchase consideration as aforesaid was to be made by telegraphic transfer/demand draft in favour of Davy Makes (Pools) Limited, U. K. (hereinafter referred to as "DMPL") subject to the approval of the Reserve Bank of India. Paragraph 6 of the letter mentions that "the concept designs and drawings shall be imported by us in terms of the approval letter dated April 10, 1984, issued by the Secretariat for Industrial Approval, FCI, Department of Industrial Development, Ministry of Industries, and the delivery of the concept designs and drawings for the items mentioned in paragraph 1 of the letter as extracted above were to be made within four weeks from the date of the remittance of the agreed sum of 36,470 in U. K, In the application made to the Secretariat for Industrial Approval, FCI, Department of Industrial Development, Ministry of Industries, the assessee stated that the purpose for which the application was made was that the concept designs and drawings upon import from DMPL would be used by the company for the preparation of detailed manufacturing drawings. The Ministry of Industries, by letter dated April 10, 1981, granted approval to the import of the designs and drawings from DMPL, U. K., for the manufacture of terminal equipments for a lump sum payment of 36,470 net of taxes.

4. On these facts, the Income-tax Officer took the view that the payments made to the non-resident company were in the nature of royalty within the meaning of Explanation 2 to Section 9(1)(vi) of the Income-tax Act, 1961, and accordingly, he applied the rate of tax at 20% on the said sum of 36,470.

On appeal, the Commissioner of Income-tax (Appeals) took the view that the transaction as approved by the Government of India was merely for the import of designs and drawings from the non-resident against a lump sum payment of 36,470. An import licence was also obtained for the purposes as above under the import policy for the year. According to the Commissioner of Income-tax (Appeals), therefore, the payment to a non-resident company would not be a payment in the nature of royalty.

5 The Tribunal, on these facts, confirmed the order of the Commissioner of Income-tax (Appeals) and found that there was a transfer of drawings and designs to the assessee against the lump sum payment of 36,470. In terms of Clause 2 of Article XIII of the Avoidance of Double Taxation Agreement between India and the U. K., such transfer by way of an outright sale by a non-resident party to the assessee cannot be termed as royalty and only the rentals received as consideration for the use and/or the right to use of any patent, trademark, designs or models, plan, secret formula, etc., would be termed as royalty under the said clause. The Tribunal held further that, under Clause 3 of Article XIII of the Avoidance of Double Taxation Agreement between India and the U. K., a different meaning to the term "royalty" has been provided and it is different from the meaning given to the term "royalty" in Explanation 2 to Section 9(1)(vi) of the Income-tax Act, 1961. Therefore, in terms of the Circular No. 333 of the Central Board of Direct Taxes dated April 2, 1982 ([1982] 137 ITR (St.) 1) the provisions contained in Clause 3 of Article XIII of the Avoidance of Double Taxation Agreement between India and the U.K. would prevail. Since there was an outright sale of designs by the foreign company to the assessee-company, the payment of 36,470 cannot be taxed by reference to Explanation 2 to Section 9(1)(vi) of the Income-tax Act, 1961.

6. The short question which falls for determination is whether, on a construction of the collaboration agreement by and between the assessee-company and the non-resident company, i.e., Davy Makes (Pools) Limited, U. K., in the light of the Avoidance of Double Taxation Agreement between India and the U. K., there was an outright transfer of the drawings and designs by the non-resident company to the assessee-company.

7. It has been contended on behalf of the Revenue that the Income-tax Officer was justified in holding that sale of designs and drawings by the foreign company was transfer of all or any of the rights concerning such technical know-how, that is, designs and drawings as covered by the definition of "royalty" in Section 9(1)(vi) of the Income-tax Act, 1961. According to him, the payment made to the non-resident company was in the nature of royalty within the meaning of Explanation 2 to Section 9(1)(vi) of the Act and, accordingly, the tax was properly levied. It is also the contention of the Revenue that if there be any inconsistency between the agreement for avoidance of double taxation and Explanation 2 to Section 9(1)(vi) of the Act, in that event the Act will prevail over the agreement and the Board's Circular laying down to the contrary cannot be and is not binding on the court.

8. We would like to dispose of the second contention first. The definition of "royalty" appearing in Article XIII of the Agreement for Avoidance of Double Taxation made between India and the U. K. is no doubt different from the definition appearing in Explanation 2 to Section 9(1)(vi) of the Act. In determining the liability of a non-resident company, if there is any Agreement for Avoidance of Double Taxation entered into under Section 90 of the Income-tax Act, 1961, the said agreement must prevail over the provisions of the Income-tax Act; otherwise, there was no point in entering into any agreement for avoidance of double taxation. Whenever any specific arrangement or agreement has been made regarding the taxability of any income under the Agreement for Avoidance of Double Taxation, such arrangement or agreement will necessarily prevail over the provisions of the statute.

9. In this connection, we may usefully refer to the notification enforcing the convention between the Government of India and the Government of the United Kingdom of Great Britain and Northern Ireland for the avoidance of double taxation and prevention of fiscal evasion with respect to taxes on income and capital gains. This notification is dated November 23, 1981 (see [1982] 133 ITR (St.) 34), which reads as follows :

"Whereas the annexed convention between the Government of India and the Government of the United Kingdom of Great Britain and Northern Ireland for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital gains has come into force on the notification by both the Contracting States to each other of the completion of the procedures required by their respective laws, as required by Article 27 of the said Convention.

Now, therefore, in exercise of the powers conferred by Section 90 of the Income-tax Act, 1961 (43 of 1961), and Section 24A of the Companies (Profits) Surtax Act, 1964 (7 of 1964), the Central Government hereby directs that all the provisions of the said Convention shall be given effect to in the Union of India.

The Government of India and the Government of the United Kingdom of Great Britain and Northern Ireland ;

Desiring to conclude a Convention for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital gains :

Have agreed as follows."

10. The intention is clear. All provisions of the said Convention shall be given effect to notwithstanding the provisions contained in relevant Act or Acts.

11. Our attention has been drawn to a decision of the Andhra Pradesh High Court in the case of CIT v. Visakhapatnam Port Trust [1983] 144 ITR 146. There, the Andhra Pradesh High Court, while considering the Indo-German Double Taxation Avoidance Agreement, held that in cases of inconsistency between the Agreement and the Act, the Agreement will prevail. In our view, where an express provision to the contrary is made in this Agreement, the transaction will be governed by such Agreement, Explanation 2 to Section 9(1)(vi) cannot have any application inasmuch as the definition of royalty has been specifically provided in the Agreement. Thus an express provision to the contrary has been made in the Agreement. There is also another aspect of the matter. The charging provisions in Sections 4 and 5 of the Act defining "total income" of either residents or nonresidents are expressly made "subject to the provisions of the Act" which will include the Agreement made under Section 90 of the Act. That apart Explanation 2 to Section 9(1)(vi) makes it quite clear that "royalty" as defined in Explanation 2 is only for the purpose of Clause (vi). The said meaning assigned to royalty cannot be made applicable in an Agreement which is made under Section 90 of the Act.

12. The conclusion is inescapable that, in case of inconsistency between the terms of the Agreement and the taxation statute, the Agreement alone would prevail.

13. The Central Board of Direct Taxes has issued a Circular No. 333 on April 2, 1982 (see [1982] 137 ITR (St.) 1), on the question as to what the Assessing Officers will do when they find that the provisions of the Double Taxation Avoidance Agreement are not in conformity with the provisions of the Income-tax Act, 1961. Then it was laid down by the Board in the said Circular as follows : 

"The correct legal position is that where a specific provision is made in the Double Taxation Avoidance Agreement, that provision will prevail over the general provisions contained in the Income-tax Act, 1961. In fact the Double Taxation Avoidance Agreements which have been entered into by the Central Government under Section 90 of the Income-tax Act, 1961, also provide that the laws in force in either country will continue to govern the assessment and taxation of income in the respective country except where provisions to the contrary have been made in the Agreement.

Thus, where a Double Taxation Avoidance Agreement provided for a particular mode of computation of income, the same should be followed, irrespective of the provisions in the Income-tax Act. Where there is no specific provision in the Agreement, it is the basic law, i.e., the Income-tax Act, that will govern the taxation of income.''

14. In our view, the Circular reflected the correct legal position inasmuch as the Convention or Agreement is arrived at by the two contracting Governments in deviation from the general principles of taxation applicable to the Contracting States ; otherwise, the double taxation avoidance agreement will have no meaning at all.

15. "Royalty" has been defined in the Agreement for Avoidance of Double Taxation between India and the U. K., as follows (sec [1982] 133 ITR (St.) 34, 44) :

"XIII(3) The term 'royalties' as used in this article means payments of any kind including rentals received as 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."

16. It appears, therefore, that the term "royalty" has been defined in the agreement to mean, inter alia, the payment of any kind including rentals received as consideration for the use of or the right to use any patent, trademark, design or model, plan, secret formula or process. Therefore, what is important to consider is that, in order that a payment may be treated as royalty for the purposes of Article XIII of the Agreement for Avoidance of Double Taxation between India and the U. K., the person who is the owner of such patents, designs or models, plans, secret formula or process, etc., retains the property in them and permits the use or allows the right to use such patents, designs or models, plans, secret formula, etc. In other words, where the transferor retains the property right in the designs, secret formula, etc., and allows the use of such right, the consideration received for such user is in the nature of royalty. Where, however, there is an outright sale or purchase, as in the present case, the consideration is for the transfer of such designs, secret formula, etc., and cannot be treated as royalty.

17. In the case of secret processes, patents, special inventions, etc., where the right of exploitation is given by an owner to a third party instead of an outright sale, then for the right to exploit them, the secret processes, designs, etc., and the amount paid which may be either in lump or a periodic one partakes of the character of royalty.

18. Our attention has been drawn to a decision of the Gujarat High Court in the case of CIT v. Ahmedabad Manufacturing and Calico Printing Co. [1983] 139 ITR 806. There, the Gujarat High Court observed as follows (p. 819) :

"A royalty may be a single payment covering the whole use of the patent for the whole term, but the more usual practice is to make periodic payments and to relate the amounts of those payments to the actual use of the patent by the licensee. It is common to charge royalties on the basis of a percentage of the price for which the licensee sells the articles or on the basis of the number of articles made under the patent. Although the amount of royalties is generally a matter of free bargaining between licensor and licensee, in some countries Governments preclude their nationals from paying royalties to foreign patent owners in excess of a certain maximum fixed by the Government. Some Governments also reserve the right to approve the entire licence contract concluded between their nationals and aliens.

Royalty payments may be in exchange for something in addition to the mere use of the invention.

The most common example is that wherein the licensor not only grants the right to use the invention but also undertakes to supply the licensee with technical "know-how", that is to say, information from his own experience on the most efficient and economical way of working the patent. It is estimated that more than 50% of licence contracts include "know-how" provisions.

When applied to industrial designs, the meaning of the word "royalty" is roughly the same as in the case of patented inventions. Designs, depending on their nature or the various national laws, may be protected by patents, copyright or registration. The form of legal protection, however, does little to change the system of royalty payment as described in regard to patents.

It is thus clear that in the case of secret processes, patents, special inventions, when right of exploitation is given by the owner of the inventions, patents, etc., to a third party, instead of outright sale, then for the right to exploit these inventions, secret processes, some amount may be paid and the amount paid may be co-related to the extent of exploitation. It is in this sense, -as pointed out by the Encyclopaedia Britannica, that licence agreements for the exploitation of patents, inventions, etc., are being entered into in the modern commercial world and as" part of such agreements, even knowledge derived from his own experience and technical know-how for the most economical and efficient user of the patents, inventions, etc., are parted with by the licensor to the licensee."

19. The Karnataka High Court, in the case of Citizen Watch Co. Ltd. v. IAC of I. T. [1984] 148 ITR 774, observed that the term "royalty" is referable to payments to be made for the use of patents by the Government or H. M. T. and it does not include the fee payable for supply of documents and information.

20. This court, in the case of CIT v. Hindusthan General Electrical Corporation Ltd. [1971] 81 ITR 243, held that royalties usually are periodical payments for continuous enjoyment of certain benefits under a contract.

21. Our attention has also been drawn to the decision of this court in the case of N.V. Philips v. CIT (No. 1) [1988] 172 ITR 521, where this court observed as follows (p. 538) :

"From the dictionary meaning of the term 'royalty', it appears that the said term connotes payments periodic or at a time for user by one person of certain exclusive rights belonging to another person.

Examples of such exclusive rights are rights in the nature of a patent, mineral rights or rights in respect of publications. It appears to us that the person who grants the user of the exclusive right might have the sanction of law which guarantees such exclusiveness. Such sanction may be obtained by taking out a patent in respect of an invention. In other cases, such exclusive right would arise from the ownership of mineral rights and is protected by the laws relating to property. In respect of books and publications, the exclusive right of the author is protected and sanctioned by the laws of copyright.

It is possible that a person who invents may not take out a patent for his invention but unless some other inventor independently and by his own efforts comes to duplicate the invention, the original invention remains exclusive to the inventor and it is conceivable that such an inventor might exploit his invention permitting some other person to have the user thereof against payment. Similarly, it is possible for a person carrying out operations of manufacture and production of a particular produce to acquire specialised knowledge in respect of such manufacture and production which is not generally available. A person having such specialised knowledge can claim exclusive right to the same as long as he chooses not to make such specialised knowledge public. It is also conceivable that such a person can exploit and utilise such specialised knowledge in the same way as a person holding a patent or owning a mineral right or having the copyright of a publication to allow a limited user of such specialised knowledge to others in confidence against payment.

There is no reason why payment for the user of such specialised knowledge, though not protected by a patent, should not be treated as royalty or in the nature of royalty."

22. Having regard to the facts and circumstances of this case, it must be held that the present case is not a case where the non-resident is retaining the property in the designs and drawings. Such designs and drawings are imported under the import policy and with the approval of the Reserve Bank of India on the basis of the letter of intent. The importation of the designs and drawings postulates an out and out transfer or sale of such designs and drawings and the non-resident company does not retain any property in them leaving the grantee to use or exploit them. The consideration paid for transfer, therefore, cannot be treated as royalty falling under Article XIII of the Agreement for Avoidance of Double Taxation between India and the U. K. The consideration paid is for an outright transfer of the drawings and designs by the non-resident company and such consideration cannot be termed as royalty. We, therefore, answer the question in this reference in the affirmative and in favour of the assessee.

23. There will be no order as to costs.