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Royalty Paid Outside India Not Taxable

Published on Thu, Feb 21,2013 | 16:12, Updated at Fri, Feb 22 at 14:23Source : Moneycontrol.com 

By: Mital Patel, Senior Manager, Deloitte Haskins & Sells

The Income-tax Appellate Tribunal Delhi recently, in the case of a non-resident taxpayer (“taxpayer”), engaged in the business of telecom sector, held that the royalty received by the taxpayer from another non-resident outside India would not be taxable in India, if the source of income of the non-resident payer is not in India.

This decision lays down important principles relating to the meaning of ‘carrying of business in India’, ‘passing of title of goods in India’, ‘source of royalty’, ‘sale of equipment where the software is embedded in the hardware’. The above principles would be relevant for understanding the taxability of a non resident taxpayer in India in respect of the royalty income earned from licensing of patented technology.

The facts of the case are as under:

Business of the Taxpayer:

• The taxayer was engaged in the design, development, manufacture, marketing and licensing of digital wireless telecommunication products and services based on Code Division Multiple Access (CDMA) technology. Worldwide, the taxpayer’s extensive portfolio has more than 6200 US patents and patent applications for CDMA and other technologies.

• The taxpayer developed key patents in resepct of CDMA, a method for transmitting simultaneous signals over a shared spectrum, most commonly applied to digital wireless technology.

Licensing transaction with another Non-Resident and receipt of Royalty income:

• The taxpayer granted a non-exclusive and non-transferrable worldwide license of its patents developed on CDMA technology (“patented techonology”) to unrelated wireless Original Equipment Manufacturers (‘OEMs’) to make, import, use and sell CDMA handsets and wireless equipment in consideration for a royalty based on sales.
 
• The OEMs are non-resident of India and use the patents to manufacture the products outside India. The OEMs sell the products across the world.

• Royalty is payable by the non-resident OEMs to the taxpayer for use of patented technology in the manufacture of products and is determined with reference to the net selling price of the product sold to unrelated wireless carriers worldwide.

• The products manufactured by the OEMs outside India were purchased by the Indian carriers from the OEMs. The Indian carriers, in turn, sold the products to end users in India. The products are used by customers of the Indian carriers in India.

A dispute arose whether the royalty income received by the taxpayer from the OEM was taxable in India under Section 9(1)(vi)(c)  of the Income-tax Act, 1961 (ITA).

Contention of the Tax Payer

The taxpayer contended that the right, property or information licensed to the OEMs relates to manufacture of the products and hence the source is the activity of manufacturing. The manufacturing activitiy is not carried out in India. The source for the taxpayer is only the patented technology agreement entered with OEMs which has no reference to India.

Section 9(1)(vi)(c) [1] of the ITA itself draws a distinction between the term ‘use’ and ‘utilised’. In so far as royalty for right to use the property or information is concerned the word  in the statute is ‘used’ and not ‘utilised’. The CDMA technology is not utilised in India; what is utilised in India is the product of that technology.  It further emphasised that technology for manufacturing product is different from product which is manufactured from the use of the technology.  The ultimate use of a product manufactured by the OEMs using the patent licensed by the taxpayer, in India, cannot be said to be a source in India.

Contention of the Revenue

The revenue on the other hand contended that the taxpayer is taxable in India. The OEMs (i.e. the payers of royalty) are found to have used the property either for carrying on busines in India or for earning income from a source in India. For the purposes of Section 9(1)(vi)(c) of the ITA it is not necessary to look at the arrangements between the taxpayer and OEMs. The use of technology by the OEMs for the purpose of carrying on business in India is sufficient nexus for the purpose of section 9(1)(vi)(c) of the ITA. The licencse for use of technology embedded in a handset/equipment is granted to specific operators in India under the agreement and hence it is used by the OEMs for manufacturing India specific supplies. On a reading of certain clauses of the agreement entered between OEMs and the Indian carriers, it was submitted that the intent of the parties was that the title to equipment passes in India at the site where the deliveries are made.

The taxpayer has made available to the OEMs its patented intellectual property relating to CDMA technology in the form of chip sets and that OEMs have inserted these chip sets into the handsets/network equipment manufacture by them and these have been licensed to Indian operators for which OEMs have received consideration and hence OEMs have a source of income in India.

Observation and Ruling of the Hon’ble Delhi Tribunal

After considering the arguments of the taxpayer and the tax department, the Hon’ble Delhi ITAT observed and ruled as under:

Burden of Proof for applicability of Section 9(1)(vi)(c) of the ITA

• The onus lies on the Revenue authorities to prove that royalty payable by a non-resident is for the purposes of business carried on by that non-resident in India.

• What is important is not whether right to property is used “in” or “for the purpose of” a business, but to determine whether such business is “carried on by such person in India”.

Carrying on business in India

• The agreements were entered into long before CDMA technology was introduced in India and that the agreements were not specific to India. OEMs were free to sell handsets anywhere across the world.

• The license to manufacture the product by using the patented Intellectual Property of the taxpayer has not been used in India as the products are manufactured outside India. When such products are sold to parties in India it cannot be said that OEMs have carried on business in India.

• The  technology for manufacturing products is different from products which are manufactured from the use of the technology for which the taxpayer had patents. The role of the taxpayer ended when it licensed its patents pertaining to manufacture of CDMA products and when it collects royalty from OEM’s on these products on shipment out of the country of manufacture.

• The patents of the taxpayer are admittedly for manufacture of handsets and infrastructure equipment which are sold worldwide. There are no patents of taxpayer which are used for customisation of handset with respect to CDMA connectivity. There is no customisation of handset qua the CDMA connectivity.

• For the OEM’s it is a sale of a product which is the end of the activity. The revenues are generated on sale of handsets only.

Passing of the title in goods

• There is no evidence with the Revenue to show that the title of the goods passed in India and that certain further activity was done by the OEMs in India after the sale. The Tribunal  relied on the decision of the Delhi High Court in the case of Ericsson AB and Nokia Networks.

• It was further held that mere passing of title in goods imported into India at the port of destination cannot lead to a conclusion that the OEMs carry on business in India. The same amounts to  business with India and not business in India. The mere passing of the title with no other activity does not result in any income being attributable in India.

Source of Royalty

• The source of royalty is the place where the patent is exploited viz. where the manufacturing activity takes place, which is outside India.

Software embedded in Hardware

• The software embedded in the hardware sold to Indian carriers by OEMs belongs to the OEMs which may have been self generated or procured from outside India and is not part of the CDMA agreement with OEMs. The software is embedded in the hardware and what is sold is the equipment. The total price is fixed for the equipment as a whole and there is no separate consideration for the licensed material.

• The software is embedded in the chipset and the chipset is part of the equipment.  The use of such equipment cannot result in a source of income as it is sale of the equipment  which is as a “Chattel”, the title of which gets transferred.

Conclusion

• The Hon’ble Tribunal finally held that royalty paid by OEMs to the taxpayer outside India would not be taxable in India as OEMs did not carry on business in India and the customers who purchased the equipment did not constitute the source of income.

Under Section 9(1)(vi)(c) of ITA income by way of royalty payable by a person who is a non-resident will be taxable in India where the royalty is payable in respect of  any right, property or information used or services utilized or 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.

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