ROYALTIES
AND FEES FOR TECHNICAL SERVICES IN INTERNATIONAL TRADE*
Snehal Bade
Introduction
International
trade is the exchange of capital, goods, and services across international
borders or territories. While international trade has been present throughout
much of history, its economic, social, and political importance has been in the
rise in recent centuries. Industrialization, advance transportation, globalization,
multinational corporations, and outsourcing are all having a major impact on
the international trade system. Increasing international trade is crucial to
the continuance of globalization. International trade is a major source of
economic revenue for any nation that is considered as a world power.
I.
Bird’s eye view
In the
late 1980’s, the more progressive developing countries, particularly in Latin
America, began to give up their isolationist policies and to loosen the
controls over trade and investment.
Today
they are trying to attract large sources of new capital for investment, new
technologies, new manufacturing techniques and business know-how, improve
training for their labour force and organizational and managerial expertise.
Some countries are lowering taxes on royalties paid to foreign companies under
licensing agreements for modern technology and technical assistance. Government
“Red-tape” is being cut allowing a faster and easier flow of paper work through
government bureaucracies, and Government agencies are applying laws and
regulations to foreign firms in a fairer and more consistent manner.[1]
India
still has some of the most severe restrictions in the world. They have high
tariffs and quotas on imports, import licensing requirements a ban on the
import of practically all consumer goods and strict control over the import of
commodities. Since 1976, India has applied the rule of taxation of royalties
and fees for technical services. This has resulted into more foreign
collaboration and Indian importers asking for advanced technology and services
from other source countries.
II.
Meaning of Royalty and Fees for Technical Services
Royalty-
A payment made to an author on invention for each copy of a work or article
sold under a copyright or patent.[2] In the Income Tax Act,
1961 (hereinafter referred to as the Act), royalty is not specifically defined
its provided in the Explanation 2 of section 9(1)(vi). The meaning of royalty
is not to be restricted to what is mentioned in the Act, even Double Taxation
Avoidance Agreements (hereinafter referred to as DTAA) entered with other
nations are inclusive of the definition of royalty.
Madras
High court in the case of CIT v. Neyveli
Lignite Corp.Ltd.[3]
has expressed that the term cannotes “royalty” which normally connotes the
payment made by a person who has exclusive right over a thing for allowing
another to make use of that thing which may be either physical of intellectual
property or thing.
Fees
for technical services- fee mean a charge for labour or services, especially for
professional services.[4] In the Act meaning for
fees for technical services is provided in Explanation 2 of Section 9(1)(vi).
Only services of technical nature are taxable as fees for technical services
are not personal, what is technical has to be determined from facts and
circumstances of every transaction. Most of the DTAA’s do not provide for the
meaning of fees for technical services specifically but it is either included
under the term royalty or distinguished from the term personal services.
III.
Basis of Charge
According
to Sec. 4 of the Act, income tax shall be chargeable on every person whose
income in previous year is taxable in the assessment year at any rate or rates.
Income tax at that rate or those rates shall be charged for that year in
accordance with, and subject to provisions of the Act. Sec 4 charges every
person in respect of his ‘total income’, and Sec. 5 defines the gamut of total
income. The principal underlying Sec. 5 is to take the changeability of income
depending upon the locality of accrual of receipt.[5]
IV.
Rate of Taxation
Sec.
115A deals with determination of tax on dividends, royalties and fees for
technical services in the case of foreign companies. In certain cases this
section provides, a special rate of tax on dividends, royalties and fees for
technical services, interest, incomes from units and computer software fees
received by non-resident or non-corporate assesses or foreign company.
The
tax rates mentioned in the Act will not be applicable where a lower rate of tax
is prescribed under an agreement for the avoidance of double taxation entered
into by the Central Government, under S. 90 with any other country or payment
made in pursuance of the agreement approved by the Central Government.
V.
Payment of Income Tax by Assessees in Different Form
A. RESIDENT:
A resident who pays for the use
of royalty does not directly come under the purview of taxation under Sec. 115A of the Act. The resident
merely has to deduct tax at source for such
payments made by him to a non-resident. Sec. 195 provides hat when any person pays to a non-resident, not being
a company or to a foreign company ant interest or any other sum chargeable under the provisions of the Act,
not being income chargeable under the
head ‘salaries’, shall at the time of such payment by any mode deduct income tax thereon at the rates in force.
B. NON-RESIDENT:
Royalty or fees for technical
services paid to a non-resident is always taxable and more so under Sec. 9(1)(vi) & (vii) in
respect of its use for business purposes carried on in India. DTAA would also entitle royalty as mentioned in respective
DTAA’s to be taxed in the country where it arises.
Sec. 44DA provides that the
income by way of royalty or fees for technical services receives from government or an Indian concern in pursuance of an
agreement made by a
non-resident (not being a company) or a foreign company with government of the Indian concern after 31st
March, 2003, shall be computed under the head “profits and gains of business of professions” in
accordance with the provisions of the Act.
C.
FOREIGN COMPANY:
Sec 44D(a) of the Act provides
that in case of foreign company, the deductions admissible under section 28 to
44C of the Act in computing the income by way of royalty or fees for technical
services received from an Indian concern is pursuance of an agreement made with
the Indian concern before 1st April, 1976, shall not exceed 20
percent of the gross amount of such income. Where such agreement is made after
31st March, 1976, Sec. 44D(b) provides that no deduction will be
allowed in respect of any expenditure or allowance under any of the said
sections in computing such income.
VI.
A Magnified View over the Intellectual Property Right- Software’s
There
are three categories of software that may be distributed, namely, specialist
bespoke programs, general commercial software and mass marketed software. The
first is an unlikely candidate for distribution, while commercial programs with
a general application are more suited for distribution. Mass marketed software
has been beleaguered by the greater number of problems and is subjected to the
same affliction that plagues the music industry- copyright infringement on
commercial scale. For the purposes of copyright law, computer programs are
treated as “literary works”.
Notwithstanding
all of these hazards, the efficiently and technical advances underlying
licensing makes it a rapidly expanding and highly profitable form of doing
business abroad. It is, however, an endeavor that must be pursued cautiously.
One
of the questions faced by the foreign companies which supply the Intellectual
property or advanced technology such as software is whether the payment made
thereof takes the character of ‘royalties’ or leads to business profits?
In
view of Tata Consultancy Services v.
State of A.P[6],
computer software put in the medium of disk are “goods” and its purchase
constitutes the “Purchase” of a tangible asset and the assessee becomes the
“owner” thereof, though the content on such medium is intangible asset. The
fact that the computer software is obtained by way of “ownership” or on
“license” is not determinative. The functional test is more important. If the
tests of ownership and enduring benefit are satisfied, the question whether
expenditure incurred on computer software is capital or revenue has to be seen
from the point of view of its utility to a businessman and how important an
economic or functional role it plays in his business.[7]
Under
the Act, right to use software is ‘royalty’ irrespective of the fact that it is
on a CD. Treating payments to acquire software as royalties could imply more
revenues for the tax department in India. However, revenues may not be
guaranteed for the tax department if they are treated as business profits due
to ‘permanent establishment’ issues for multinational software companies.
The
high-profile Microsoft case, involving about Rs. 700 crore, is an example of
differing interpretations on the “characterization’ of the payments made for
software. Transfer of all or any rights of software including granting of a
license in respect of a patent, invention, model, design, secret formula or
process or trade mark or similar property would fall under the term royalty. Thus,
to conclude, only those transactions wherein there is a transfer of all or any
rights of the computer software would fall within the definition of royalty
under explanation 2 of Sec 9(1) (vi) and not those transactions of commercial
nature.
VII.
Interpretation- is it Complex?
Controversies
relating to international taxation are about the provisions of domestic law,
the treaties and the conventions concerning double taxation avoidance. Tax
treaties may give rise to various tax disputes, which domestic tax forums and
courts have to deal with. The main problem before such courts would be that
there are often no precedents to be followed, since international tax law is
still in its infancy. Most of the cases are being decided keeping the law aside
and depending upon facts and circumstances of the case.
In
interpreting a section in a taxing statute, according to Lord Simons, “the
question is not at what transactions the section is according to some alleged
general purpose aimed, but what transaction its language according to its
natural meaning fairly and squarely hits.”[8] It is, therefore, not the
function of a court of law to give to words a strained and unnatural meaning to
cover loopholes through which the evasion tax-payer may find escape or to tax transactions
which, had the legislature thought of then, would have been covered by
appropriate words.[9]
If there is any ambiguity in respect of the subject of the tax, person liable
to pay the tax and the rate at which the tax is levied,[10] and such ambiguity is not
removable by reasonable construction then there will be no tax in law till the
defect is removed by legislature.[11]
VIII.
Conclusion
With
respect to the Act, Sec 115A where it provides concessional rate of tax for
royalty where the agreement is in respect of industrial policy or approved by
the Central Government. It is an option available that if the subject is not
included in the industrial policy then the person who makes such payment shall
try and get the approval of the Central Government for a concessional rate of
tax. The situation is not very clear on what basis the Government grants
approval for such agreement, whether it is being based on industrial policy or
it is a matter administrative policy. And when such payments are made by the
Government itself the rule is not much clear whether it has to be presumed that
it is approved by the Central Government.
*Awarded Second Best Paper at the 4th
Nani A. Palkhivala Memorial Research Paper Competition,2009. This is an abridged
version of the same.
[1] Richard Schaffer, Berverley Earle& Filiberte Agusti,
International Business Law and its Environment, 4th Ed. (1999), West
Education
[2] Bryan a. Garner, Black’s Law Dictionary, 7th Ed. (1999),
West Group
[3] CIT V. Neyveli Lignite Corp. Ltd. 243 ITR 459
[4] Supra note 2
[5] Kanga Palkhivala; Vyas, The Law and Practice of Income tax, 9th
Ed. (2004), LexisNexis Butterworths
[6] Tata Consultancy Services v. State of AP 271 ITR 401 (SC)
[7] Amway India Enterprises v. DCIT 301 ITR 1 (Delhi)
[8] St. Aubhya (LM) v. A.G. (1951) 2 ALL ER 473
[9] IRC v. Wolfson (1949) 1 ALL ER 865
[10] State of Kerala v. Alex George (2005) 1 SCC 299
[11]Mathuram Agarwal v. State of Madhya Pradesh AIR 2000 SC 109
