SEZ - AUTHORIZED ACTIVITIES WHICH CAN BE UNDERTAKEN BY THE DEVELOPER /APPROVED CO-DEVELOER BY DEFAULT

Instruction no. 20 has been issued to clarify the activities that CAN BE UNDERTAKEN BY THE DEVELOPER APPROVED CO-DEVELOER BY DEFAULT FROM THE DATE OF NOTIFICATION August 2, 2009

Since a time gap exists between the date of notification and actual approval of the authorized operations by the Board of Approval, to avoid delays in the project implementation, the authorized activities were approved by the Board of Approval as default operations which may be carried out by the Developer or Co-Developer, as the case may be, after the SEZ is notified.

The list of default activities has been given to annexure to the instruction.

The list of authorized operations are as under:

(A) Information Technology/Information Technology Enabled Services, Biotechnology
and Gems and Jewellery Special Economic Zone:

1. Roads with Street lighting, Signals and Signage

2. Water treatment plant, water supply lines (dedicated lines up to source), sewage lines, storm water drains and water channels of appropriate capacity.

3. Sewage and garbage disposal plant, pipelines and other necessary infrastructure for sewage and garbage disposal, Sewage treatment plants

4. Electrical, Gas and Petroleum Natural Gas Distribution Network including necessary sub-stations of appropriate capacity, pipeline network etc.

5. Telecom and other communications facilities including internet connectivity

6. Rain water harvesting plant

7. Air conditioning of processing area

8. Fire protection system with sprinklers, fire and smoke detectors

9. Landscaping and water bodies

10. Boundary wall

11. Built up processing area not less than minimum prescribed 1 lakh sq. m.

12. Office space for Customs and Security staff not exceeding 500 sq.m.

(B) Sector Specific Special Economic Zones

1. Roads with Street lighting, Signals and Signage

2. Water treatment plant, water supply lines (dedicated lines up to source), sewage lines, storm water drains and water channels of appropriate capacity.

3. Sewage and garbage disposal plant, pipelines and other necessary infrastructure for sewage and garbage disposal, Sewage treatment plants

4. Electrical, Gas and Petroleum Natural Gas Distribution Network including necessary substations of appropriate capacity, pipeline network etc.

5. Effluent treatment plant and pipelines and other infrastructure for Effluent treatment.

6. Telecom and other communications facilities including internet connectivity

7. Rain water harvesting plant

8. Landscaping and water bodies

9. Wi Fi and / or Wi max Services

10. Drip and Micro irrigation systems.

11. Boundary wall

12. Factory sheds in processing area

13. Office space for Customs and Security staff not exceeding 500 sq.m.

(C) Multi Product Special Economic Zones

1. Roads with Street lighting, Signals and Signage

2. Water treatment plant, water supply lines (dedicated lines up to source), sewage lines, storm water drains and water channels of appropriate capacity.

3. Sewage and garbage disposal plant, pipelines and other necessary infrastructure for sewage and garbage disposal, Sewage treatment plants

4. Electrical, Gas and Petroleum Natural Gas Distribution Network including necessary substations of appropriate capacity, pipeline network etc.

5. Effluent treatment plant and pipelines and other infrastructure for Effluent treatment.

6. Play ground

7. Landscaping and water bodies

8. Wi Fi and / or Wi max Services

9. Drip and Micro irrigation systems.

10. Boundary wall

11. Factory sheds

12. Office space for Customs and Security staff not exceeding 500 sq.m.

No tax on foreign telcos for carrying calls abroad: AAR

FOREIGN telecom firms operating without a permanent establishment in India are no more required to pay any tax on income from carrying international calls and data services in pacts with domestic operators.




A.A.R. NO. 786 OF 2008
Name and Address of Applicant
Cable & Wireless Networks India Private Limited
Unit 2(B) Creator Building, International Tech Park, Whitefiled Road, Bangalore
Commissioner concerned
Director of Income Tax (International Taxation), Bangalore





This application has been filed under section 245Q(1) of the Income-tax Act, 1961 (the Act) by Cable & Wireless Networks India Private Limited. The applicant is a company incorporated in India and is a part of the Cable and Wireless Groups of Companies. It is engaged in the business of providing international long distance and domestic long distance telecommunication services in India. The applicant proposes to enter into an agreement with another group company, namely M/s Cable and Wireless UK (C &W UK) with a view to providing end to end international long distance telecommunication services to its Indian customers. C&W UK is stated to be a leading international telecom company which has a well established international network. The applicant submits that the Indian customers of the applicant would want to transmit their voice/data to places outside India. Under the proposed agreement the applicant would provide the Indian leg of the service by using its own network and equipments and network of other domestic operators, and the international leg of the service would be provided by C&W, UK, using its international infrastructure and equipments. In other words, whereas the applicant will carry the calls and data within the country, C&W UK will further carry those calls and data to the recipients outside India. The network and equipments of C&W UK will not be used in India and the applicant’s network and equipments will not be used outside India. Thus in telecom parlance, domestic half circuit will be provided by the applicant and international half circuit will be provided by C&W UK. In respect of the aforesaid services rendered by C&W UK, the applicant will pay fees to the former.
2. It is in this factual background that the applicant seeks ruling of this Authority on the following questions:
(1) Whether the amounts payable by the Applicant to Cable & Wireless UK (“C&W UK”) under the terms of the proposed agreement/arrangement (the “Agreement”) would be in the nature of “fees for technical services” (“FTS”) within the meaning of the term in Explanation 2 to clause (vii) of section 9(1) of the Act, or not?
(2) Whether the amounts payable by the Applicant to C&W UK under the terms of the Agreement would be in the nature of “royalty” within the meaning of the term in Explanation 2 to clause (vi) of section 9(1) of the Act, or not?
(3) Whether the amounts payable by the Applicant under the Agreement between the Applicant and C&W UK would be in the nature of FTS within the meaning of the term in Article 13 of the Agreement for Avoidance of Double taxation entered into, between the Government of the United Kingdom and the Government of the Republic of India (“Treaty”), or not?
(4) Whether the amounts payable by the Applicant to C&W UK under the terms of the Agreement would be in the nature of “royalty” within the meaning of the term in Article 13 of the Treaty, or not?
(5) Based on the facts of this case, whether C&W UK has a Permanent Establishment (“PE”) in India under Article 5 of the Treaty?
(6) Based on the answers to questions (1) to (5) above, and in view of the facts as stated in Annexure I, whether the income received by C&W UK will be chargeable to tax in India, or not? If the answer is in the negative, would such payments by the Applicant suffer withholding tax under section 195 of the Income Tax Act, 1961, or not, and if yes, at what rate?
3. The applicant has filed a copy of the agreement which it proposes to enter into with C&W UK. This agreement is called ‘Service and Revenue Share Agreement’. It is stated in the recitals that the parties wish to provide to each other on reciprocal basis national and global telecommunications services. Article 1 of the agreement states that the parties shall provide services to each other through bandwidth connectivity and other similar facilities. The bandwidth service will comprise international leased circuit, managed private leased services, managed private lines, etc. Article 3 requires the parties to interconnect their respective networks at Network Access Points. The expression ‘Network Access Points’ has been defined to mean physical points at which the networks of the parties are to be connected. As per article 5, the party availing the service shall pay fees to the party providing the service. The payment shall be on mutually agreed revenue share basis, which shall be calculated with reference to the revenue billed by the party to the customers at the originating point. The revenue share shall be settled on monthly basis. Each party shall bill the other in sterling pounds.

4. The applicant submits that the service to be provided by C&W UK is a standard facility and is not technical in nature. So the payment made for availing this service would not amount to fee for technical services as stipulated in section 9(1)(vii)of the Act. According to the applicant the payment in question would not either be regarded as ‘ fee for technical services’ under article 13(4) of the Convention between the Government of India and the Government of the United Kingdom for the Avoidance of Double Taxation and Prevention of the Fiscal Evasion with respect to Taxes on Income and Capital Gains (the treaty), as C&W UK does not make any technical knowledge, skill or experience available to the applicant. The applicant further submits that the payment made to C&W UK is not for the use of any intellectual property or equipment. Under the proposed agreement, C&W UK will provide two way communication service to the applicant without allowing any right to use its network or equipment. As such, the payment in question would not come within the purview of royalty, either under section 9(1)(vi) or article 13(3) of the treaty. The applicant relies on the Report of the Technical Advisory Group (TAG) constituted by the Organization for Economic Cooperation and Development which lays down certain principles for drawing distinction between transactions for use of equipment and those for rendering of services. The applicant also cites the cases of Neyveli Lignite Corporation Ltd.1 , BSSL vs. UOI2, WIPRO3 and the decision of AAR in Dell International Services India Pvt. Ltd 4. The applicant states that C&W UK has no permanent establishment in India. It has no liaison office, branch office, project office or sales outlet in this country, nor does C&W UK render any services in India through its employees, personnel or agency.

5. The Director of Income-tax (International Taxation), Bangalore, who is the jurisdictional Commissioner in this case, first furnished his comments vide his letter dated 17.11.2008 and later vide letter dated 25.2.2009. He first of all points out that a group company, namely, M/s C&W India Ltd., a company registered in UK, has a branch office in Mumbai, which provides telecommunication networking services, designing and maintaining networks, etc. The Commissioner states that the address of its registered office given by the applicant is the same as that of the branch office of the said UK Company. The Commissioner raises doubt that the applicant may take over the functions of this branch office. On the question of technical services, however, the Commissioner concedes that the services in question cannot be regarded as ‘technical services’ under article 13(4) of the treaty, since no transfer of technology is involved. He further states that the payments made by the applicant to C&W UK would be in the nature of royalty, both under section 9(1)(vi) of the Act as well as article 13 of the treaty. According to the jurisdictional Commissioner the services provided by C&W UK are not in the nature of standard facility as these use secret process. The applicant thus pays for using secret process. The jurisdictional Commissioner relies on Asia Satellite Communication5 case for this proposition. He also submits that as the actual service has not yet started, it cannot be said what equipment will be installed and where and this needs to be verified. The last point raised by the jurisdictional Commissioner relates to PE. He submits that the contract between the applicant and its Indian customers indirectly binds C&W UK. As such, the applicant acts as an agent of C&W UK and so C&W UK has agency PE in India. He also states that it is not clear at this point of time whether C&W UK will be deputing some of its employees for providing connectivity, technical or maintenance support in India. The Commissioner urges that the question of PE may be left open at this stage.

6.

6.1 The Authority, during the course of hearing, on 28.1.2009, directed the applicant to file affidavits clarifying certain technical details relating to the network/system by which connectivity is provided to the customers in India and any other factual information considered relevant by the applicant. The applicant filed two affidavits on 31.3.2009 – a technical affidavit and an affidavit explaining certain relevant factual details.

6.2 In the technical affidavit, the applicant gives the description of a network by which it provides international connectivity between TCS premises located in Mumbai and Equifax located in Alpharetta, USA . The connectivity is provided through a dedicated private leased line. The applicant has installed a router at TCS premises. The voice/data is carried by the applicant in India on its own network and delivered to C&W UK at Marseilles in France from where the latter carries it to Alpharetta, USA. In the Indian leg of the service there is no involvement of the network or equipment of C&W UK. TCS pays one time charge for installation and recurring charges for connectivity services.

6.3 The second affidavit gives clarification about the nature of charges, revenue sharing with reference to the provisions of article 5 of the agreement. It is stated that the applicant charges its customers in India purely for rendition of service. No charges are taken for router which is completely under the control of the applicant. The applicant has by way of illustration stated that if it charges rupees 100 from its customer, it pay Rs. 44 to C&W UK for providing the international leg of the service. This affidavit also gives clarification about the Indian branch of the UK group company

7. We shall first take up the issue whether the applicant pays fees to C&W UK for rendering ‘technical services’ under the Act or under the treaty. Explanation 2 to para (vii) of section 9(1) defines ‘fees for technical services’ to mean any consideration paid for rendering any managerial, technical or consultancy services, including provision of services of technical or other personnel. In the present case, in carrying telecom signals from Marseilles to other countries, C&W UK is not providing any managerial, technical or consultancy services, nor is it providing the services of its technical or other personnel to the applicant. C&W UK performs this part of service itself without the involvement of the applicant. The applicant has thus rightly urged that the fees paid by it to C&W UK is not in the nature of fees for technical services under the Act. So far as article 13(4) of DTAA is concerned, the first part of it defines ‘technical services’ in a manner similar to Explanation 2 to section 9(1)(vii), but it further qualifies this expression in clauses (a), (b) & (c). Clause (c) is relevant for the present consideration. This clause requires that the technical service in question should make available technical knowledge, experience, skill, know-how or process, or consist of the development and transfer of a technical plan or technical design (emphasis supplied). From the description of service presented before us, we do not find that the requirements of clause (c) are fulfilled here. First, no technical service is rendered and secondly, there is no transfer of technology. The Revenue also concedes that this is not a case of payment of fees for technical services.

8.

8.1 The question whether the fees paid by the applicant to C&W UK are in the nature of royalty has been much debated. The revenue vehemently contends that it is royalty income –both under the Act as well as the treaty. Before dealing with the issue, we may extract the provisions of the Act as well as the treaty. The relevant provisions of section 9 read as under:
“Income deemed to accrue or arise in India.

9. (1) The following incomes shall be deemed to accrue or arise in India :—
(i) to (v) xx xx xx xx xx xx xx xx xx
(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 utilized 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 utilized 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 :
xx xx xx xx xx xx xx xx xx
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 section44BB;]”
xx xx xx xx xx xx xx xx xx
The relevant provisions of Article 13 of the treaty are as under:
“ARTICLE 13 -Royalties and fees for technical services –
1. xx xx xx xx xx xx xx xx xx xx
(2) However, such royalties and fees for technical services may also be taxed in the Contracting State in which they arise and according to the law of that State; but if the beneficial owner of the royalties or fees for technical services is a resident of the other Contracting State, the tax so charged shall not exceed :
xx xx xx xx xx xx xx xx xx xx xx xx xx xx xx
3. For the purposes of this Article, the term “royalties” means :
(a) payments of any kind received as a consideration for the use of, or the right to use, any copyright of a literary, artistic or scientific work, including cinematography films or work on films, tape or other means of reproduction for use in connection with radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience; and
(b) payments of any kind received as consideration for the use of, or the right to use, any industrial, commercial or scientific equipment, other than income derived by an enterprise of a Contracting State from the operation of ships or aircraft in international traffic.
xx xx xx xx xx xx xx xx xx xx”
According to the applicant, in the proposed business model, no intellectual property rights are involved; C&W UK has not granted to it any right to use any intellectual property or any equipment. The Commissioner, on the other hand, states that the payment made by the applicant is clearly for using secret process. According to him the technology involved in the process of transmission of voice/data contains proprietary resources. It is not a case of mere rendition of service, but the quality of service and secrecy are also material. It is further stated that the services to be availed by the applicant would amount to the use of a secret process and thus is covered by royalty as stipulated in article 13(3) of the treaty. But, no material has been placed before us to show that C&W UK uses any secret process in the transmission of the international leg of the service, or that the applicant pays towards the use or right to use that secret process. It is well settled that telecom services are standard services. The arrangement between the applicant and C&W UK is for rendition of service and the applicant pays for the same. It is for C&W UK to see how it will provide that service. The applicant is not concerned with the same. This Authority has dealt with this issue in the case of Dell International Services India Pvt. Ltd.(supra). In that case BT America provided two way transmission of voice and data to Dell India between India and USA. For providing this service, BT America had tied up with VSNL in India and other telecom service providers outside India. Dell India had an agreement with BT America for the entire service for which it made payment directly to BT America. One of the issues that arose for consideration was whether the payment made by the applicant to BT America was in the nature of royalty falling either under clause (iii) of Explanation-2 of section 9(1) or article 12(3) of the tax avoidance treaty between India and USA, which is materially similar to the provisions of article 13(3) of the treaty between India and UK. The Authority held –

“14. Whether the payment made by the applicant to BTA is in the nature of royalty falling under clause (iii) of Explanation 2 and/or Article 12(3) of the Treaty?

14.1. It is one of the contentions of the Revenue that the applicant makes use of or is conferred with the right to use a ‘process’ within the meaning of clause (iii) to Explanation (2) to Section 9(1) of the Act. That clause speaks of “the use of any patent, invention, model, design, secret formula or process or trade mark or similar property”. It is contended, relying on the decision of ITAT in the case of Asia Satellite Telecommunications Company Ltd. vs. Deputy Commissioner of IT (ITA No.166/DEL/2001* dated 1.11.2002) that the word ‘secret’ only qualifies the expression ‘formula’ and cannot be read before the word ‘process’. On such interpretation, it is submitted by the Revenue in its comments that the services provided to the applicant are clearly in the nature of a process and not in the nature of standard facility and the applicant has used and has been conferred with the right to use such process. However, this contention has not been urged before us by the learned Counsel for the Department for the obvious reason that the language used in the relevant clause of the Treaty does not support any such interpretation. The expression in Article 12(3) (referred to at para 7.1 supra) is “for the use of or the right to use any copyright, patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience.” It is thus clear that formula/process are part of the same group and the adjective ‘secret’ governs both. The reasoning of ITAT in the aforementioned case, based on the absence of comma after process and the impact of the immediately following word, ‘trade mark’, does not hold good in view of the clear language in Article 12(3) of the Treaty. It has been so pointed out very rightly by another Bench of ITAT in Panamsat International Systems Inc. vs. Dy. Commissioner Income-tax (ITA. No.1796/DEL/2001 dated 11.8.2006) at paragraph 6.18. Going by such interpretation, it cannot be held that there is, in the instant case, the use of or the right to use a secret process. In fact it is nobody’s case that any secret process is involved here and the applicant makes use of it. The use of secret process is alien to the minds of contracting parties. Incidentally, we may mention that it was brought to our notice that similar bandwidth services through private circuits are being provided by many other telecom operators. Hence, the royalty definition under the Treaty relating to secret process is not attracted here. We may mention that the applicant contended that the decision of ITAT in Asia Satellite case (supra) is distinguishable on facts. It is unnecessary to deal with this aspect.”
The Authority also considered in detail the question whether consideration was payable for using or for the right to use any equipment through which connectivity was provided. That question was answered in the negative. We are of the view that on the same reasoning the applicant does not pay for using any secret process in the present case also.

8.2 We may now consider the next submission of the Revenue that, since the services are yet to commence, it is premature to say whether C&W UK will install any equipment at the premises of the applicant in India. We notice from the pleadings and averments of the applicant that C&W UK will be providing telecom services to the applicant outside India. The network of the applicant will inter-connect with the network of C&W UK at Marseilles in France. Thus the telecom signal will move on the network of the applicant from India to Marseilles. It is beyond Marseilles that the network and equipment of C&W UK will be used for transmission of the signal. We also notice from the draft agreement that there is neither any stipulation for provision of any equipment nor payment of any fee for the same. On the basis of the records placed before us, we are of the view that no case is made out to presume that any equipment will be installed by C&W UK at the premises of the applicant in India and the applicant will pay for the same. The averment of the Commissioner is based merely on the doubt entertained by him for which he has not shown any basis. The affidavits filed by the applicant after first hearing clarify the factual position in this regard. In the light of the view taken by us, it is not necessary to examine the TAG report.

8.3 The Revenue has thus failed to show how the payments made by the applicant will be royalty income in the hands of C&W UK.

9.
9.1 We may now take up the last issue which relates to permanent establishment. As already pointed out, the Revenue has mentioned about the existence of another group company in India whose address is alleged to have been used by the applicant as its registered office. The applicant has submitted that the Cable and Wireless India Limited which is a company incorporated in UK, has set up a branch office in India under Reserve Bank of India (RBI) permission, a copy of which has been filed. This branch office performs ancillary telecom services, such as network designing , project implementation services and providing network management and maintenance services. This branch has not been granted any licence by the Department of Telecommunication to carry out NLD/ ILD services. The applicant also states that its registered office does not share the premises with the above branch office. We find that the applicant and the branch office of Cable and Wireless India Ltd. are separate legal entities which perform different types of telecom services. The said branch office is not in the business of providing voice / data transmission service.

9.2 The Revenue also states that it cannot be said at this point of time whether C&W UK would be deputing its personnel to provide technical and maintenance support to the applicant. The applicant states that there is no such stipulation in its agreement with C&W UK. From the case presented before us, there is no reasonable basis to entertain the doubt that C&W UK will depute its technical personnel for providing maintenance and support to the applicant.

9.3 The next contention of the Revenue is that the applicant will be entering into an agreement with the Indian customers for providing end-to-end international long distance telecom transmission, the Indian leg of which will be provided by the applicant and the foreign leg will be provided by the C&W UK. Thus the contract between the applicant and the Indian customers would indirectly bind C&W UK, so far as the international leg of the transmission is concerned. As such the applicant would be acting as an agency PE for C&W UK. The applicant states that it does not act on behalf of the C&W UK in India, nor does it conclude any contract on behalf of that company. The applicant in its independent capacity negotiates and concludes contracts with its customers on principal-to-principal basis, to which C&W UK is not a party. Similarly, the agreement with C&W UK is also on principal-to-principal basis, the Indian customer not being a party to the same. The breach of one type of contract does not affect the rights and obligation arising under the other type of contract.

10. In the light of the above discussion, we have come to the conclusion that the payments made by the applicant to C&W UK are in the nature of business profits. In the absence of there being any permanent establishment of C&W UK In India, this income is not at all taxable here. Since this income is not chargeable to tax under the Act, there is no question of making any deduction at source under section 195. In the result, we answer all the questions in negative.
Pronounced in the open Court of the Authority on this 30th day of June, 2009.

AAR on taxability of a US company for allowing use of its database located abroad to customers in India against subscription fees--Not Chargeable

The subscription fee received by the American company from the licensee (user of database) does not fall within the scope of clause (v) of Explanation (2) to section 9(1) of the Income-tax Act, 1961 and the same is not taxable in India as royalty; it is liable to be taxed only as business income if at all it is found by the Revenue that an agency PE exists of the American Company.

THE AUTHORITY FOR ADVANCE RULINGS (INCOME TAX) NEW DELHI

FactSet Research Systems Inc., In re

AAR No. 787 of 2008

June 30, 2009

RELEVANT EXTRACTS:

1.1 The following facts are stated in the application and in the written submissions filed: The applicant maintains a ‘database’ which is located outside India and which contains the financial and economic information including fundamental data of a large number of companies world-wise. The customers of the applicant are mostly financial intermediaries and investment banks which have the need for such data. The databases contain the published information collated, stored and displayed in an organized manner by Fact Set, though the information contained in the database is available in public domain. The applicant, however, through its database enables the customer to retrieve this publicly available information within a shorter span of time and in a focused manner. The database maintains historical information and all the databases of FactSet are maintained at its datacenters in USA. For a customer to access and view FactSet data, the customer need to down-load client interface software (similar to internet browser). The customer can subscribe to specific database as per its requirement. The ‘lion-share’ database provides information on the shareholding by global holders of global equities. The ‘Shark repellent’ database provides information on takeover defence strategies adopted by various U.S. Public companies over a period of time. The Mergerstat database tracks formal transfers of ownership. A Call street database includes transcripts of quarterly conference calls (e.g. analysts’s queries) held by public companies. There are some more databases also. A customer can view the data on their computer screens. The software, tools database and other related documentation are hosted on the FactSet’s main frames and data libraries. Through the tools, any commercial data on FactSet’s database can be easily woven into charts, graphs and spread-sheets. FactSet allows the data to be viewed and used only in the internal documents of its customers. The applicant seeks advance ruling on the following questions formulated by it:

1. Whether, on the facts and circumstances of the case, FactSet Research Systems Inc. (‘FactSet’ or ‘the applicant’) will not be taxable in India under the Income-tax Act, 1961, with respect to the subscription fees?

2. Whether, on the facts and circumstances of the case, the applicant will not be taxable under the Double Taxation Avoidance Agreement entered into between the Government of India and the Government of United States of America with respect to the subscription fees?

3. Whether, on the facts and circumstances of the case, if the applicant is not taxable in India for the subscription fees, its customers in India will be required to withhold taxes under section 195 of the Act on subscription fees paid to the applicant?

4. Assuming that the applicant has no other taxable income in India, whether, on the facts and circumstances of the case, the applicant will be absolved from filing a tax return in India, under the provisions of Section 139 of the Act with respect to the subscription fees?

5. Broadly, the contention of the applicant is that no tax liable to be paid on the subscription fees received from the customers in India as it does not constitute ‘royalty’ or ‘fees for technical services’ either under the provisions of the Income-tax Act, 1961 or the DTAA (Treaty) between India and USA. Moreover, as the applicant does not have permanent establishment (PE) in India, the subscription fees cannot be taxed as business income in view of Article 7 of India-USA Treaty.


6. Let us now notice the material terms of MCL Agreement. The applicant is the Licensor and the Licensee is the subscriber/customer. Clause 1.a declares that the licensor grants to the licensee “limited, non-exclusive, non-transferable rights to use the software, hardware, consulting services and databases”. As regards the consulting service, it is stated that FactSet provides certain consultants who are able to demonstrate the FactSet’s products and its uses to the customers. It is clarified in the rejoinder that consulting services are not really required as FactSet provides helpdesk facilitation free of cost, though at present, there is no such facilitation Centre in India. As regards hardware, it is clarified in the rejoinder that at present no hardware is being provided to the customers in India.

4.1 According to cl. 2.a the licensor provides the services solely and exclusively for licensee’s own internal use and business purposes only in the licensee’s business premises. The licensee’s employees having a password or user ID can access the service. Further, the licensee cannot use or permit any individual or entity under its control to use the services and the licensed material for any unauthorized use or purpose. Clause 1.b makes it clear that all proprietary rights including intellectual property rights in the software, databases and all related documentation (“licensed material”) will remain the property of licensor or its third party data/software suppliers. The licensee is permitted to use licensor’s name for the limited purpose of source attribution of data got from the database in the internal business reports and the like. Licensee is solely responsible for obtaining required authorization from the suppliers for products received through them and in the absence of such authorization the licensor has the right to terminate the licensee’s access to any supplier product.


4.2 Clause 2.c reads as follows:

Clause 2.c. Except as permitted under this Agreement or under a written agreement with a Supplier, Licensee agrees that it will not copy, transfer, distribute, reproduce, reverse engineer, decrypt, decompile, disassemble, create derivative works from or make any part of the Service, including the data received from the Service available to others. Licensee may use Insubstantial amounts of the Licensed Materials in the normal conduct of its business for use in reports, memoranda and presentations to Licensee’s employees, customers, agents and consultants, but Licensor, its Suppliers and their respective affiliates reserve all ownership rights and rights to redistribute the data and databases.”

4.3 Clause 2.d on which the Revenue placed reliance may also be noticed.
Clause 2.d: Licensor represents and Licensee acknowledges that the Service and its component parts were developed, compiled, prepared, revised, selected and arranged by Licensor, its Suppliers or their respective affiliates through the application of methods and standards of judgment developed and applied through the expenditure of substantial time, effort, money and originality and that they constitute valuable intellectual property and trade secrets of Licensor and its Suppliers. At Licensor’s expense and reasonable request, Licensee agrees to cooperate with Licensor and its Suppliers to protect the proprietary rights in the software and databases during the terms of this Agreement.”

4.4 Coming to the other clauses, the fees is payable within 30 days of receiving the invoice failing which the Licensor may suspend the licensee’s access (vide clause 4). The initial term of the agreement is as set forth in Schedule (A) and thereafter the agreement can be renewed for successive one year periods (vide cl. 5). Clause 5.c stipulates that upon termination of the agreement, licensee will cease using all the licensed material, return any licensor hardware upon request and expunge all data and software from its storage facility and destroy all documentation except such copies of data to the extent required by law. Another restriction placed by cl. 5.d is that the Licensee may not use any part of the services (for eg., Index value) to create a proprietary financial instrument or to list on its exchange facilities. In various schedules relating to different databases, the rates of ‘fixed price service’ and ‘Pay-As-you-Go Service’ are set out.

7. Most of the focus was on ‘royalty’ provision contained in the Act and in the DTAA and the main and substantial question argued was whether the fee received by the applicant could be brought within any of the limbs of ‘royalty’ definition. Section 9(1)(vi) of the Act brings the income by way of royalty within the ambit of deemed income. Explanation 2 to clause (vi) of Section 9(1) defines ‘royalty’ as follows:

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 license) in respect of any copyright, literary, artistic or scientific work including films or video tapes for use in connection with 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).

7.1 Article 12 of the DTAA between India and USA deals with ‘royalty’ and ‘fee for included services’. Such incomes can be taxed in the Contracting State in which they arise and according to the laws of that State (vide Art. 12.2). The term ‘royalty’ is defined in Art. 12.3 as follows:
Article 12.3 3. The term “royalties” as used in this Article means:

(a) payments of any kind received as a consideration for the use of, or the right to use, any copyright of a literary, artistic, or scientific work, including cinematograph films, or work on film, tape or other means of reproduction for use in connection with radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience, including gains derived from the alienation of any such right or property which are contingent on the productivity, use, or disposition thereof; and
(b) payments of any kind as consideration for the use of, or the right to use, any industrial, commercial, or scientific equipment, other than payments derived by an enterprise described in paragraph 1 of Article 8 (Shipping and Air Transport) from activities described in paragraph 2(c) of Article 8.

8. The first question is whether the amounts received by the applicant constitute consideration for the transfer of any rights in respect of the copyright or for the use or right to use any copyright of a literary/scientific work.

8.1 The expression ‘copyright’ is not defined in the Income tax Act. It must be understood in accordance with the law governing copyright in India viz. Copyright Act, 1957. In State of Madras vs. Ganon Dunkrley & Co.*, the Supreme Court held that the expression ‘sale of goods’ in Entry 48 of List II (VII Schedule) of the Govt. of India Act is a nomen juris and shall be construed in its legal sense. The legal sense can only be what it has in the law relating to sale of goods and therefore the said expression shall bear the same meaning as it has in Indian Sale of Goods Act. Looking at the Treaty, we have Art.2.2 which clarifies how the undefined terms shall be understood. In substance, it says that an undefined term shall have the meaning which it has under the taxation law of the State concerned. When the term is not defined in the taxation law (I.T.Act), the definition in the law governing the subject-matter ought to be adopted, more so when there is no basic difference between the statutory definition and the ordinary legal concept. Section 16 of Copyright Act lays down that no person shall be entitled to copyright or any similar right in any work otherwise than under and in accordance with the provisions of this Act or any other law in force.

8.2. Section 14 gives the meaning of copyright. This Section was substituted for the previous one by the Copyright (Amendment) Act of 1994. Section 14 in so far as it is relevant is extracted hereunder:

14. For the purposes of this Act, “Copyright” means the exclusive right subject to the provisions of this Act, to do or authorize the doing of any of the following acts in respect of a work or any substantial part thereof, namely:

(a) in the case of a literary, dramatic or musical work, not being a computer programme –

(i) to reproduce the work in any material form including the storing of it in any medium by electronics means;

(ii) to issue copies of the work to the public not being copies already in circulation;

(iii) to perform the work in public, or communicate it to the public:

(iv) to make any cinematograph film or sound recording in respect of work;

(v) to make any translation of the work;

(vi) to make any adaptation of the work;

(vii) to do, in relation to a translation or an adaptation of the work, any of the acts specified in relation to the work in sub-clause (i) to (vi)
9.3 We are, therefore, of the view that the subscription fee received by the applicant from the licensee (user of data base) does not fall within the scope of clause (v) of Explanation (2) to Section 9(1) of the Act.

10. Even examining from the standpoint of Treaty, we do not think that “the use of or right to use any copyright of a literary or scientific work” is involved in the subscriber getting access to the database for his own internal purpose. It is like offering a facility of viewing and taking copies for its own use without conferring any other rights available to a copyright holder. The expression ‘use’ (of copyright) is not used in a generic and general sense of having access to a copyrighted work. The emphasis is on the “use of copyright or the right to use it”. In other words, if any of the exclusive rights which the owner of copyright (the applicant) has in the database are made over to the customer/subscriber so that he could enjoy such rights either permanently or for a fixed duration of time and make a business out of it, then, it would fall within the ambit of phrase ‘use or right to use the copyright’. What rights of exclusive nature attached to the ownership of copyright have been passed on to the subscriber atleast partially? Is the licensee conferred with the right of reproduction and distribution of the reproduced work to its own clientele? Can it be publicly exhibited or its contents be communicated to the public? Is the applicant given the right to adapt or alter the ‘work’ for the purpose of marketing it? The answer is obviously – no. The underlying copyright behind the data base cannot be said to have been conveyed to the licensee who makes use of the copyrighted product.

13. In the result, the questions are answered as follows :
Qn.Nos.(1) & (2):

The subscription fee is not taxable in India as royalty. It is liable to be taxed only as business income if at all it is found by the Department that an agency PE exists. At present, on the facts stated by the applicant, we must hold that PE is not in existence and therefore the income is not liable to be taxed in India.

Qn.No.(3):
The customers are not required to withhold the tax, until and unless the Department finds the existence of PE after due enquiry.



Qn.No.(4):
At present, there is no obligation to file the return in view of our finding that there is no royalty income and on the facts stated by the applicant, there is no PE


Accordingly, the ruling is pronounced on this 30th day of June, 2009.

No TDS on Sec-195 Payments, as it is a Business Income

ITA No.69 & 70/Bang/2009
Assessment Years : 2000-1 & 2001-02

INCOME TAX OFFICER (INTRNATIONAL TAXATION)
WARD-1(2), BANGALORE

Vs

M/s ITC HOTELS LTD
SANKEY ROAD, BANGALORE-560001



Income tax - Indo-USA DTAA - Assessee is a reputed hotel group - receives certain services from US-based hotel group and makes payment without TDS - Revenue treats it as royalty or fees for technical services u/s 9(1)(vi) or (vii) and also under Article 12(3) of the DTAA - CIT(A) goes by the Delhi HC decision in the assessee's case and treats it as business income and since the non-resident has no PE in India, the payment received is held to be non-taxable - Revenue refers to the Explanation inserted at the end of section 9 by the Finance Act, 2007 with retrospective effect from 1.6.1976 which states that TDS to be deducted under clauses (v), (vi) and (vii) of sub-section (1) of Sec 9 even if there is no PE - held, since the income of the non-resident is held to be business income, this Explanation has no applicability to this case - Revenue's appeal dismissed

ORDER

Per : R V Easwar :

These are two appeals filed by the revenue for the asst.years 2000-01 & 2001-02.

2. The assessee is a public limited company engaged in the running of hotels. It made payments of Rs.2,52,93,968/- and Rs.1,11,35,305/- respectively for the two years to Sheraton International, USA, a non-resident company. The question whether the assessee was liable to deduct tax from the above payments came up before the Assessing Officer. The Assessing Officer held that the assessee was liable to deduct the tax and since it had not done so, he passed an order u/s.201(1) and section 201(1A) of the IT Act on 31.7.2001 holding the assessee to be in default and directing it to pay the taxes which it ought have deducted and also charging interest. The tax amount came to Rs.33,47,733/- and Rs.15,02,609/-. The interest charged came to Rs.10,00,935/- and Rs.2,57,918/-. This order reached the Bangalore Bench of the ITAT in ITA Nos.145 to 148/Bang/2004 and by order dt.11.11.2005, the issue was restored to the file of the Assessing Officer with the following directions :

"Since the chargeability or otherwise is yet to be decided we think it fit not to prejudge the issue so as to hamper the judicial decision to be arrived at by the Assessing Officer in view of the remand by the Tribunal at New Delhi. The Assessing Officer, after determination of the taxability or otherwise of the payee, may appropriately pass order in the case of the present assessee. The matter is therefore restored back to the file of the Assessing Officer. The Assessing Officer shall determine the nature of payment as well as the amount taxable therein."

3. The Assessing Officer appears to have contacted his counterpart in New Delhi where Sheraton International, USA was being proceeded against as recipient of the aforesaid payments made by the assessee. The latter seems to have sent to the Assessing Officer all the relevant papers including the order of the Delhi Bench of the Tribunal in the case of Sheraton International which is reported in (2007) 293 ITR (AT) 68 = (2007-TIOL-288-ITAT-DEL). In this order it was held that the payments made by the present assessee under the agreement to Sheraton International did not amount to royalty or fees for technical services or fees for included services and that the payments represented business profits in the hands of Sheraton International and since Sheraton did not have any permanent establishment in India, the profits were not taxable in India in terms of Article 7 of the DTAA between India and America. The issues have been elaborately dealt with by the Tribunal but suffice to note paragraph 87 of the said order (page 152 of the report) which is as under :

"As such, considering all the facts of the case, the relevant provisions of the income-tax Act, 1961 as well as that of the Double Taxation Avoidance Agreement between India and USA and keeping in view the legal position emanating from various judicial pronouncements discussed above, we are of the opinion that the amount received by the assessee from the Indian hotels/clients for the services rendered under the relevant agreements was not in the nature of "royalties" within the meaning given in section 9(1)(vi) read with Explanation 2 thereto of the Income tax Act, 1961 or as given in article 12(3) of the Indo-American DTAA. The same was also not "fees for technical services" or "fees for included services" as defined in section 9(1)(vii) read with Explanation 2 thereto of the Income-tax Act, 1961 or article 12(4) of the Indo-American DTAA respectively. Having regard to the integrated business arrangement between the assessee-company and the Indian hotels/clients as evident from the relevant agreements as well as the nature of the assessee's own business, the said amount clearly represented its "business profit" which was not liable to tax in terms of article 7 of the Indo-American DTAA. We, therefore, allow the relevant grounds raised in the assessee's appeals on this issue and dismiss the additional grounds raised by the Revenue in its appeals."

4. On receipt of the aforesaid order of the Tribunal the Assessing Officer in the present proceedings held that the order of the Tribunal did not have any bearing on the question of the assessee's liability to deduct tax from the payments. He, accordingly, directed the assessee to deduct tax from the payments and reiterated the earlier order passed on 31.7.2001, by order passed on 30.11.2006.

5. On appeal, the Commissioner of Income-tax (Appeals) accepted the assessee's plea based on the order of the Tribunal cited above and held as follows :

"7.5. I have considered the submissions made by the AR on behalf of the appellant and perused the order passed by the Hon'ble ITAT, Delhi Bench in the case of Sheraton referred to above. It is an undisputed fact that the liability for TDS is a vicarious liability. The principal liability is of the recipient of income as provided u/s.191 of the Act. Since, in the instant case, the recipient i.e., Sheraton is assessed to tax in India, the interest of the revenue would be amply protected because upon conclusion of the litigation, the tax due on remittances, if any, will be liable to be paid or otherwise recovered from Sheraton direct. It is observed that proceedings u/s.201(1) were initiated against the appellant on receipt of information that the appellant had paid various amounts to Sheraton without deduction of tax as required u/s. 195. I find that the impugned order was passed by the ITO concerned at Bangalore as per direction of ITAT, Bangalore Bench after taking into account the findings contained in the order of his counterpart dated.28.11.2003 in the case of Sheraton. Since the said order of the Assessing Officer in the case of Sheraton has been set aside by the Hon'ble IT AT, Delhi Bench vide its order referred to above, there is no justification for the continuance of the impugned order. Once it has been held by the Hon'ble Tribunal that the services rendered by Sheraton to Indian hotels including the appellant are not chargeable to tax in India, there is no valid reason to hold the appellant to be an assessee in default ufs.201(1) of the Act for not deducting tax at source u/s.195 on remittances made towards availing the said services. Respectfully following the said order of the Hon'ble ITAT, Delhi Bench referred to above, I hold that as the very foundation of the impugned order has ceased to exist by virtue of the said order of the Hon'ble Tribunal, the impugned order cannot be sustained anymore. The impugned order is accordingly set aside. This ground of appeal is, therefore, decided in favour of the appellant."

As regards interest u/s.201(lA) the CIT(A) deleted the same consequential to his decision on the applicability of section 201(1).

6. The revenue is in appeal challenging the order of the CIT(A) as above. At the time of the hearing it was pointed out on behalf of the assessee that the order of the Delhi Bench of the Tribunal in the case of Sheraton International has been affirmed by the Hon'ble Delhi High Court in Director of Income tax v. Sheraton International Inc. by judgement dt.30.1.2009 reported in (2009) 221 CTR 752 (Del) = (2009-TIOL-57-HC-DEL-IT). A copy of the judgement was also filed. We find from paragraph 13 of the judgement of the High Court it has been observed as under :

"13. In view of the aforesaid findings of the Tribunal that the main service rendered by the assessee to its client-hotels was advertisement, publicity and sales promotion keeping in mind their mutual interest and, in that context, the use of trademark, trade name, or the stylized "S" or other enumerated services referred to in the agreement with the assessee were incidental to the said main service. It rightfully concluded, in our view, that the payments received were neither in the nature of royalty under s.9(1)(vi) r/w Expln. 2 or in the nature of fee for technical services under s.9(1)(vii) r/w Expln. 2 or taxable under art. 12 of the DTAA. The payments received were thus, rightly held by the Tribunal, to be in the nature of business income. And since the assessee admittedly does not have a PE under the art. 7 of the DTAA "business income" received by the assessee cannot be brought to tax in India. The findings of the Tribunal on this account cannot be faulted. The Tribunal pointedly observed that there was no evidence brought on record by the Revenue to enable them to hold that the agreement was a colourable device, in particular, that the payments received were for use of trademark, brand name and stylized mark "S". We agree with reasoning adopted by the Tribunal. Moreover, these are findings of fact which could be gone into only if a question was proposed impugning the findings of the Tribunal as perverse. We find that no such question has been proposed in the appeal."

Thus, after the judgement of the Hon'ble Delhi High Court, the argument of the revenue that the payments made by the assessee are to be treated either as royalty u/s.9(1)(vi) or as fees for technical services u/s.9(1)(vii) of the Income tax Act cannot be upheld. The Delhi Bench of the Tribunal has applied the Indo-US DTAA and held that the payments cannot be considered as royalty or fees for technical services as per the Act or as per the DTAA. It has further found that the payments represented business profits in the hands of Sheraton assessable as such but because of the fact that Sheraton had no permanent establishment in India, the payments cannot be taxed by the Income-tax department in India as per Article 7 of the DTAA. The Tribunal has also found that the agreement between the parties cannot be considered as a colourable device. All these findings of the Tribunal have been upheld by the Hon'ble Delhi High Court in the judgement cited supra. In this view of the matter and respectfully following the High Court's judgement, we hold that the Commissioner of Income-tax (Appeals) was right in cancelling the orders passed by the Assessing Officer on 30.11.2006 u/s.201(1) and 201(lA)of the Act.

7. The learned DR however submitted that the Explanation inserted at the end of section 9 by the Finance Act, 2007 with retrospective effect from 1.6.1976 makes a difference. The Explanation reads as under :

Explanation.—For the removal of doubts, it is hereby declared that for the purposes of this section, where income is deemed to accrue or arise in India under clauses (v), (vi) and (vii) of sub-section (1), such income shall be included in the total income of the non-resident, whether or not the non-resident has a residence or place of business or business connection in India.

It may be seen that the Explanation applies only where the income is deemed to accrue or arise to the non-resident company under clauses (v), (vi) or (vii) of section 9(1). These clauses speak of interest, royalty and fees for technical services, respectively, payable to the non-resident. We have already seen that the Delhi High Court has affirmed the finding of the Delhi Bench of the Tribunal in the case of Sheraton International that the character of the payments made by the assessee to Sheraton was that of business profits and not either royalty or as fees for technical or included services. The Explanation will apply only if the payments can be characterized as interest or royalty or fees for technical services. Therefore, we are of the opinion that the Explanation has no application to the present case. The argument of the learned DR cannot be upheld.

8. In the result the appeals of the department are dismissed with no order as to costs. Order pronounced in the open court on this 1st day of May, 2009.

Non-compete fees constitute depreciable intangible assets--Chennai Tribunal

The Chennai Income Tax Appellate Tribunal (ITAT) has issued three rulings addressing the contentious issue of whether noncompete fees paid by the acquirer of a business constitute a tax deductible expenditure, and concluding that such fees are tax-depreciable intangible assets (Radaan Mediaworks India Ltd (2007), Real Image Technologies (Pvt.) Ltd (2008) and
Medicorp Technologies India Ltd (2009)).

Overview

Taxpayers historically have taken the position that non-compete fees paid are revenue expenditure that are deductible for tax purposes, whereas the tax authorities have treated such fees as capital expenditure. These divergent views have led to the matter being referred to the Special Bench of the Tribunal. While the decision of the Special Bench has not yet been issued, the Chennai ITAT has added another dimension to the debate with its holdings in the three rulings treating the fees as intangible assets.

Section 32 of the Indian Income Tax Act, 1961 (ITA) allows depreciation on both tangible and intangible assets. Intangible assets for this purpose include know-how, patents, copyrights, trademarks, licenses, franchises and any other business or commercial rights of a similar nature, acquired on or after 1 April 1998. Depreciation on such intangible assets is allowed at
a rate of 25% per annum.

The issue before the Chennai Tribunal was whether non-compete fees fall within the scope of “any other business or commercial rights of a similar nature.” The Tribunal unanimously concluded that non-compete fees are a business or commercial right within the meaning of Indian income tax law and, therefore, may be depreciated for tax purposes.

The facts of the three cases were very similar:

• In acquiring a “business” (e.g. line, unit or entity, among others) from the seller, the taxpayer also paid a noncompete fee that restrained the seller from competing with the taxpayer.
• Separate non-compete agreements were entered into in two cases and, in the third, the agreement for the transfer of the business included a separate clause containing the non-compete obligation.
• The taxpayer claimed that the non-compete fee was an intangible asset entitled to depreciation (this was made as an alternative claim in two of the three cases).
• The tax authorities rejected the claim on the ground that a non-compete fee is not an “asset” and so no depreciation is allowed.

In all three cases, the first appellate authority (i.e. the Commissioner of Income-tax (Appeals)) found merit in the taxpayers’ arguments and held that the non-compete fee is tax depreciable. The tax authorities then appealed to the second appellate authority, the ITAT.

Real Image Technologies (Pvt.) Ltd – In arriving at its conclusion that a non-compete fee is tax depreciable, the Tribunal provided an informative explanation of its rationale in Real Image Technologies (Pvt.) Ltd, separating the issues before it into the following questions:

1. Whether the payment of a non-compete fee can be construed as a commercial right; and
2. If so, whether a non-compete fee is a business or commercial right similar to other rights that may be depreciated.

On the first issue, the Chennai ITAT held that the payment made by the acquirer to the seller was for restraining the seller from competing with the acquirer and, thus, gave the acquirer the right to operate the business without concern over competition. A non-compete fee is generally paid for a limited period of time (usually five years), during which the business
becomes more stable and better equipped to withstand competition. As a result, the ITAT held that the non-compete fee is a commercial right.

Having concluded in the affirmative on the first question, the ITAT then examined whether a non-compete fee is a right similar to know-how, patents, copyrights, trademarks, licenses and franchises. The Tribunal applied the ejusdem generis principle for the definition of intangible assets, which requires that words of a general nature following specific and particular words be construed as limited to things that are of the same nature as those specified. The ITAT consequently ruled that, if the business or commercial right of a patent, trademark, license, franchisee, etc., fulfilled the condition of being intangible assets, then a business or commercial right acquired by payment of INR 18.79 million also fulfilled the
condition by way of a logical corollary. The non-compete right was therefore held to be eligible for depreciation under ITA section 32(1)(ii).

Medicorp Technologies India Ltd – The Chennai ITAT’s views in Medicorp Technologies were along similar lines. However, responding to the tax authorities’ contention that a non-compete fee was not an “asset” at all because it lacks a market value and it cannot be transferred, sold or licensed, the Tribunal also examined the concept of depreciation in the ITA.

The ITAT considered the difference between the concept of depreciation under the ITA and under normal accounting principles. Under the ITA, depreciation is a statutory allowance, which is not confined to the diminution in value of an asset by wear and tear but also contains an “incentive” element and is governed by fiscal policies and considerations. The ITAT
observed that depreciation under the ITA does not reflect purely economic criteria. The ITAT gave as an example items for which the rate of depreciation provided under the ITA is 100% and observed that this does not mean that the effective life of the items is only one year. According to the ITAT, the logic for such differences in treatment could be that the Indian
government wanted to encourage the use of certain types of assets.

As another example, the ITAT referred to the fact that depreciation is allowed on computer software, which, once loaded, cannot be resold, loses its assignability and transferability, and has practically no market value. The ITAT noted that the depreciation provisions do not necessarily follow the traditional concept of an “asset” and an accountant’s approach to
“depreciation,” reiterating that the tax law sometimes implements the government’s economic and/or fiscal policies.

Conclusion

Through its analyses in the rulings, the ITAT concluded that a non-compete fee is an intangible “asset” that may be depreciated. The rulings should provide a boost to merger and acquisition activities in India, allowing taxpayers and their advisors to better plan for the tax consequences of non-compete fee arrangements in drafting takeover contracts

Source:Deloitte

Maintenance of software is not capital expenditure

Maintenance of software is not capital expenditure


SHV ENERGY INDIA PVT LTD HYDERABAD

Vs

ASSISTANT COMMISSIONER OF INCOME TAX CIRCLE 3(1) HYDERABAD


The assessee is in appeal before us against the order of the learned CIT(A) dated 17-11-2004 for assessment year 2001-02. First four grounds in the appeal relate to the disallowance of 60% the unshared expenses.

2. The assessee company is engaged in the business of trading in raw materials, distribution of liquid petroleum gas (LPG), establishment of LPG terminals, blending and bottling plants, manufacturing of cylinders and developing LPG network. It has wholly owned subsidiaries as well as joint ventures for the aforesaid purpose. For the year under consideration it declared a business loss of Rs.2,11,35,329 and long-term capital loss of Rs.17,57,95,625. The assessee has entered into agreement with each of its subsidiaries known as ‘Shared Service Agreement', as per which the services rendered by the assessee company to the subsidiaries are to be charged to the respective subsidiaries. In this connection, the assessee showed a recovery of Rs.3,00,34,000 from the subsidiaries. The details revealed that the total cost of shared services is Rs.5,93,42,541. Thus, it was seen that the subsidiaries had shared about 51% of the total cost. The Assessing Officer scrutinised in detail the structure of the conglomerate and their activities. He found that the control of the companies was in the hands of the assessee company with common management, common public relations, common purchases, common sharing of services and data processing. Therefore, the question the Assessing Officer posed to himself was as to what was the basis of allocation of costs incurred by the assessee amongst the subsidiaries. The details on record revealed that the assessee had recovered the aforesaid sum of Rs.3,00,34,000 only from four of its subsidiaries and that too at a fixed rate of 20 or 30%. It was further noted that there was no correlation between capital employed in each of these four subsidiaries and the capital expenditure recovered from them. According to the Assessing Officer, allocating the expenditure on the basis of turnover would have been more scientific but that too was not done by the assessee. The next question the Assessing Officer posed to himself was as to why the total expenditure was not allocated to all the subsidiaries. He noted that whereas six subsidiaries did not have any activity, three were in the business of maintenance of storage terminals which involved lot of expenditure. The Assessing Officer compared the total capital employed in the four subsidiaries from whom recoveries were made with the capital employed in the three companies maintaining storage terminals and was of the view that on proportionate basis a sum of Rs.86,13,278 should have been recovered from these three companies. However, it was submitted by the assessee that the three companies were not its subsidiaries but were joint ventures and had little control over them. The Assessing Officer having noted the absence of a proper method of allocation of expenditure, fell back upon assessment year 1997-98 in which year 60% of the expenditure was disallowed and which was also confirmed by the CIT(A) by his order dated 20-3-2002 . Accordingly, for the year under consideration, the Assessing Officer followed the same pattern and disallowed Rs.1,75,85,124 out of the total expenditure.

3. The CIT(A), by and large agreed with the action of the Assessing Officer except to the extent that he directed to disallow 60% of the total expenditure after reducing the salary paid to the Managing Director and the expenditure incurred on software as these expenses were considered separately for disallowance.

4. At the outset, the learned counsel drew our attention to the basic fact and the quantum of disallowance. The assessee incurred total staff costs of Rs.2,98,70,096 and establishment costs of Rs.2,94,72,445 aggregating to Rs.5,93,42,541. The above two amounts appear debited in the profit and loss account. Out of the aggregate, the assessee distributed Rs.3,00,34,000 to the subsidiaries and the credit for which is found in the profit & loss account. Thus, the balance amount of Rs.2,93,08,541 (5,93,42,541-3,00,34,000) was claimed by the assessee as its own expenditure. However, the Assessing Officer disallowed 60% of Rs.2,93,08,541 on the ground of not having recovered any expenditure from the three storage companies and against which the assessee is aggrieved. Since the Assessing Officer made the disallowance in the light of the finding in assessment year 1997-98, the learned counsel drew our attention to the order of the Tribunal for that year in ITA No.670/Hyd/2002 dated 28-2-2007. In this connection, it was pointed out that according to the finding of the Tribunal, except Government of India's letter dated 12-10-1995 , there was no other material to suggest that the assessee provided any service to the other companies where investments were said to have been made. In a miscellaneous application filed by the assessee against the said order of the Tribunal, the amended approval of the Government of India in the form of its letter dated 19-2-1996 was placed on record to show that the formation of the new company was to implement the project. However, since this evidence was filed for the first time, the Tribunal vide its order dated 25-5-2007 in M.A.No.27/Hyd/2007 held that there was no mistake apparent on record. Thus, for the present appeal the emphasis of the learned counsel was on the letter dated 19-2-1996 to which our attention was drawn to impress that the assessee company was established to implement the project. In view of this, it was submitted that the order of the Tribunal in assessment year 1997-98 should not be followed and that the matter requires a fresh look. It was also argued that there was absolutely no basis to make a disallowance of 60%. It could well have been 6% or even 80%. It was also submitted that no disallowance could be made unless the expenditure was of a personal nature or capital nature and it was not the case of the revenue claiming to be either of this. It was also not unconnected with the business, it was submitted. The learned counsel relied on the following judgments:
(a) CIT v. Walchand And Co. Pvt. Ltd. – 65 ITR 381 (SC)
(b) J.K. Woollen Manufacturers v. CIT – 72 ITR 613 (SC)
(c) Aluminium Corporation of India Ltd. v. CIT – 86 ITR (SC)

5. At the outset, the learned Departmental Representative did not dispute about the new fact being brought on record in the form of Government's letter dated 19-2-1996 . However, according to her this did not make any material difference. Referring to paragraph 4 in the letter dated 12-10-1995 , it was contended that the legal mandate to the parent foreign company was to set up a company for the main object to carry on the business of trade in LPG, setting up and operation of LPG terminals and so on. Setting up of subsidiaries was not the business of the assessee and hence all activities other than the business in LPG were incidental only. The learned Departmental Representative likened the case of the assessee with that of a kirana dealer whose business is to trade in kirana but setting up of shops cannot be said to be his business. The submission was that the expenditure incurred by the assessee for the subsidiaries had no nexus with its own business and that the business of the subsidiaries was independent of the assessee. It was not the business of the assessee to run the business of the subsidiaries and she also raised a question as to why the recovery was from four companies only and not from all fourteen subsidiaries. The learned Departmental Representative also questioned the basis of allocation adopted by the assessee and submitted that though the allocation was stated to have been made on the basis of a careful study, no details of such study were placed on record. She further questioned the responsibility of the assessee's own assessment of time spent and resources utilised on behalf of the subsidiaries for allocating the expenditure in different propositions. Referring to the Shared Services Agreement (SSA), it was submitted that there was no payment of fees as stipulated in clause 2 of the agreement and hence it could not be said that the SSA was sacrosanct. Further, if some companies had not begun operations, it means they did not have employees and it further means that their activities were undertaken by the assessee. If that were so, the assessee should have been reimbursed for the same. According to the learned Departmental Representative, the subsidiaries were the fiefdom of the assessee and hence recoveries were effected only from them leaving out the Joint Ventures (JVs). It was submitted that the assessee did have some stake in the JVs and it was irrelevant that because they were JVs, no recoveries could be made from them. Finally, the learned Departmental Representative summed up her arguments by reiterating that the only difference from assessment year 1997-98 was the amended approval of FIPB, but the basic mandate to carry on the business of LPG did not undergo any change and hence the disallowance made this year on the basis of assessment year 1997-98 was justified and should be upheld.

6. We have duly considered the rival contentions and the material on record. First let us ascertain the raison d'etre of the assessee company. It is supposed to have been set up as a wholly owned subsidiary of SHV energy NV, Netherlands for operation of LPG terminals, blending and bottling plants, and manufacture of gas cylinders, regulators, valves and ancillary equipment and development of a LPG dealer network throughout the country. This is as per the approval letter dated 12-10-1995 . Clause 4 of this letter is also relevant. It reads as follows:
“It is noted that the proposed holding company would route the investments in downstream joint ventures, would coordinate them and provide managerial and technical assistance wherever required.”
The question is as to which is the holding company which is to route its investments in downstream joint ventures and also provide managerial and technical assistance. Well, we need not venture to interpret the clause as the Tribunal has already done so in its order for assessment year 1997-98 cited supra. As per paragraph 6 of the said order, the assessee appears to be a wholly owned subsidiary company of SHV Energy Mauritius Pvt. Ltd. which in turn is a subsidiary of SHV Energy NV, Netherlands . The Tribunal, therefore, held that the holding company was SHV Energy NV, Netherlands , and not the assessee company. The Tribunal further observed that the assessee company has nothing to do with the approval granted by the Government of India for setting up of another wholly owned subsidiary company by SHV Energy NV, Netherlands . Therefore, it may not be correct to say that the assessee company was providing any managerial and technical assistance. In the light of these findings, the Tribunal held that unless and until it is shown that the assessee is making investment in an organized and systematic manner, it cannot be said that the assessee was in the business of investment. Admittedly, it was also not in the business of money lending. In the light of these findings, the Tribunal held that the interest income is not the business income of the assessee but income from other sources. Further, in the light of these findings the Tribunal also upheld the disallowance of expenses by observing that there was no material available on record to suggest that the assessee had provided managerial or technical services to the subsidiaries. This is the factual position so far as assessment year 1997-98 is concerned. Now let us come to the present year.

7. The dispute in the present year is, by and large the same. Facts also, by and large are the same except the new evidence placed on record in the form of Government of India's letter dated 19-2-1996 . In the light of the new evidence on record, we shall try to approach the problem by posing to ourselves the following questions:
(a) are the expenses of Rs.5,93,42,541 incurred by the assessee for the purpose of its business ? if the answer to this question is in the affirmative, then obviously, the expenses would be allowable. However, if the expenses are held to be not for the purpose of the business, then the next question that arises is,
(b) whether the said expenses are incurred on behalf of the subsidiaries/JVs, and if so, was the assessee under an obligation to recover the same from them?
Let us consider the first question in the light of the new evidence placed on record. The crucial content of the letter after referring to the earlier approval is that “a new company in the name and style of M/s. SHV Energy India Private Limited has been formed to implement the project.” The implication of this letter is that the Netherland company is not to set up other subsidiaries or joint ventures but it is the assessee company which will set up subsidiaries and joint ventures in future. This is strengthened by two aspects in the original approval dated 12-10-1995 . Clause 4 uses the expression “proposed holding company”. The word ‘proposed' itself is indicative of the fact that it refers to the company which is to be established and not to the one which is already in existence. However, in absence of proper clarification in the form of the letter dated 19-2-1996, the tribunal was constrained to hold in assessment year 1997-98 that the assessee is not the holding company but only a subsidiary company. Second aspect which strengthens our view is clause 5 of the letter. It says that “for setting up further joint ventures/subsidiaries in India for downstream activities, you shall require prior approval of the Govt. of India.” Now it is common sense that if the proposed company is going to be the holding company as mentioned above, and if it has to implement the project as envisaged in the letter dated 19-2-1996 , obviously that company only will have to obtain the approval of the Government before setting up joint ventures/subsidiaries. Therefore, we are of the firm view that with the clarification coming in, in the form of the letter dated 19-2-1996, it is the assessee company which is to be the holding company which would route the investments in downstream joint ventures, would coordinate them and provide managerial and technical assistance wherever required. This fact is tacitly accepted by the Tribunal in its order in the Miscellaneous Application also when it is observed that the learned counsel very fairly conceded that the letter dated 19-2-1996 was not on record at the time of hearing the appeal, and the Tribunal could not take cognizance of the said letter in the proceedings u/s 254(2) of the Act.

8. What transpires from the foregoing discussion is that one vital additional fact has changed the status of the assessee company and hence, the complexion of the matter. It was in the case of Padmasundara Rao (decd.) v. State of Tamil Nadu (255 ITR 147) at page 153 of the report, the Supreme Court observed that circumstantial flexibility, one additional or different fact may make a world of difference between conclusions in two cases. The same is the case here. Thus, to fulfill its objects, mandated both by the memorandum of association as well as the FIPB, the assessee company set up certain wholly owned subsidiaries and invested in some joint ventures. It entered into agreements with these companies for sharing of services and charges therefor. It was also to provide managerial and technical assistance to these companies. Therefore, the assessee incurred business development costs, stewardship costs and service related costs. The first two types were not charged to the subsidiaries but were born by the assessee company itself. So far as service related costs re concerned, the assessee incurred staff costs and establishment costs. As regards staff costs, the assessee has given details of the employees and the description of the services rendered by them. Referring to these details, it was pointed out by the learned Departmental Representative that some employees were shown to have worked for all the companies. The question raised by her was as to why there were no recoveries from the JVs and according to her there was hardly any difference between the JVs and the subsidiaries. Well, undoubtedly these are insignificant trivialities which have no bearing on the actual matter of fact. De hors that, firstly, it cannot be disputed that all the companies, whether JVs or subsidiaries are distinct legal entities. The assessee has stake in both. However, the difference is that in JVs there is another party who maybe equally interested but in subsidiaries no one except the assessee company is interested. In that sence, if the subsidiaries are the fiefdom of the assessee as the learned Departmental Representative has described it, it may not be wrong but the assessee company certainly has control over it and it has an agreement for sharing services amongst themselves. The objects of subsidiaries and JVs would obviously be different. Generally speaking, in the context of the assessee's business, subsidiaries would act in furtherance of the object of the holding company whereas the JV would be undertaking a distinct business by itself. As it appears from the overall business spectrum of the assessee, the JVs are to be kept independent and the subsidiaries are to be subservient to the holding company. In short, how the assessee has to run its business, how it has to be structured and how it has to be organized, it is all assessee's own lookout and the revenue officers need not take upon themselves the role of a business consultant. Even if there is a deviation from the SSA, it makes no difference and does not prejudice the interests of the revenue unless it is specifically shown to be so. There is no allegation or even a doubt that the expenses are fictitious or that they are of capital nature or having personal element. All the expenses incurred by the assessee are for the purpose of business and shared by some of the subsidiaries which are nothing but special purpose vehicles to smoothen the business operations of the assessee. We may also clarify that there cannot be a business of floating and winding up of subsidiaries as the learned Departmental Representative had argued. Even if the kirana dealer opens several shops, it cannot be said that he is in the business of opening shops. His business remains that of kirana only. Therefore, we do not find the comparison with the kirana dealer to be apt. In the ultimate analysis, we hold that all the expenses incurred by the assessee are wholly and exclusively for the purpose of business and no disallowance is called for. Therefore, the disallowance of 60% of Rs.2,93,08,451 is deleted.

9. Second ground in the appeal is against the disallowance of royalty of Rs.4,71,317. The impugned amount was paid to the parent company towards maintenance of Kernel Software. Since TDS was not deducted from the said payment, the Assessing Officer disallowed the same u/s 40(a)(i) of the Act. The CIT(A) confirmed the same.

10. The contention of the learned counsel is that the said amount represents credit and not actual payment. It is pointed out that as per rule 30(1)(b)(i)(1) of the Income tax Rules, if the amount is credited on 31 st March, then the tax in respect of the said amount should be deducted and paid before 31 st May. It is also submitted that the payment of tax was in fact made on 31-5-2001 . In view of the said rule, we delete the disallowance subject to the verification of the payment by the Assessing Officer.

11. Third ground in the appeal is against restricting the remuneration allowable to Rs.51 lacs paid to the managing director. The assessee paid a salary of Rs.75,50,264 to its managing director. The Assessing Officer observed that though the remuneration paid to the managing director was approved by the shareholders, the same was subject to the approval of the Central Government, which was awaited. Therefore, he disallowed the entire salary paid to him. In the course of appellate proceedings, the assessee produced the approval of the Central Government, as per which salary of Rs.4,25,000 per month was approved. Therefore, the Assessing Officer was directed to allow deduction to the extent of Rs.51 lacs and the disallowance of the balance amount of Rs.24,50,264 was confirmed.

12. The contention of the learned counsel is that the expenditure is for the purpose of business and hence is allowable. The learned Departmental Representative relied on the orders of the lower authorities.

13. On due consideration of the matter, we allow the claim of the assessee. It is not disputed that the expenditure is incurred wholly and exclusively for the purpose of business. It is also not a capital expenditure nor an expenditure of a personal nature. Therefore, all the conditions required under the Income tax Act for the allowance of the expenditure are fulfilled. The Act does not lay down any condition that remuneration to the managing director will be allowed only to the extent approved by the Central Government. Thus, the disallowance sustained by the CIT (A) is not in accordance with law and hence we delete the same.

14. Last ground in the appeal is against treating the expenses of acquiring computer software as capital expenditure. The assessee incurred expenditure of Rs.14,21,002 for purchase of software, MS Technet and Norton licences. According to the Assessing Officer it was an enduring benefit acquired by the assessee and hence proposed to treat it as capital expenditure. It was explained by the assessee that major portion of the expenses i.e. Rs.14,06,402 was towards maintenance charges/licence fees of the MS Office Enterprise and anti-virus software. However, the Assessing Officer was not convinced with the explanation and hence disallowed Rs.14,06,402. The CIT(A) confirmed the action of the Assessing Officer and also directed him to grant depreciation thereon. We do not detain ourselves for long on this issue as in several cases the Tribunal has taken the stand to hold that in the rapidly changing technological environment, nothing is of enduring nature and more so in the field of software. Moreover, in the present case, the expenses are mainly for the maintenance of the software and hence it is of revenue nature. Accordingly we delete the disallowance.

15. In the result, the appeal of the assessee is allowed.
The order was pronounced in the court on 4-12-2008 .

Estimated expenditure towards warranty is allowable u/s 37 (1): Supreme Court

Rotork Controls vs. CIT (Supreme Court)

The assessee sold valve actuators. At the time of sale, the assessee provided standard warranty that if the product was defective within the stated period, the product would be rectified or replaced free of charge. For AY 1991-92, the assessee made a provision for warranty at Rs.10,18,800 at the rate of 1.5% of the turnover. As the actual expenditure was only Rs. 5,18,554, the excess provision of Rs.5,00,246 was reversed and only the net provision was claimed. The Tribunal allowed the claim on the basis that the provision had been consistently made and on a realistic manner. The High Court reversed the Tribunal on the basis that the liability was contingent and not allowable u/s 37 (1). HELD, reversing the High Court that:

(1) A provision is a liability which can be measured only by using a substantial degree of estimation. A provision is recognized when: (a) an enterprise has a present obligation as a result of a past event; (b) it is probable that an outflow of resources will be required to settle the obligation; and (c) a reliable estimate can be made of the amount of the obligation. If these conditions are not met, no provision can be recognized;

(2) A Liability is defined as a present obligation arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits;

(3) A past event that leads to a present obligation is called as an obligating event. The obligating event is an event that creates an obligation which results in an outflow of resources. It is only those obligations arising from past events existing independently of the future conduct of the business of the enterprise that is recognized as provision. For a liability to qualify for recognition there must be not only present obligation but also the probability of an outflow of resources to settle that obligation. Where there are a number of obligations (e.g. product warranties or similar contracts) the probability that an outflow will be required in settlement, is determined by considering the said obligations as a whole;

(4) In the case of a manufacture and sale of one single item the provision for warranty could constitute a contingent liability not entitled to deduction u/s 37 of the said Act. However, when there is manufacture and sale of an army of items running into thousands of units of sophisticated goods, the past event of defects being detected in some of such items leads to a present obligation which results in an enterprise having no alternative to settling that obligation;

(5) On facts, the assessee has been manufacturing and selling Valve Actuators in large numbers since 1983-84 onwards. Statistical data indicates that every year some Actuators are found to be defective. The data over the years also indicates that being sophisticated item no customer is prepared to buy the Valve Actuator without a warranty. Therefore, warranty became integral part of the sale price of the Valve Actuator(s). In other words, warranty stood attached to the sale price of the product and a reliable estimate of the expenditure towards such warranty was allowable.