THE STORY OF ROYALTY TAXATION IN INDIA


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MEANING OF ROYALTY

royalty is a payment made by one party (the licensee or franchisee) to another that owns a particular asset (the licensor or franchisor), for the right to ongoing use of that asset. Royalties are typically agreed upon as a percentage of gross or net revenues derived from the use of an asset or a fixed price per unit sold of an item of such, but there are also other modes and metrics of compensation.

Meaning of Royalty – Wikipedia

SECTION 9(1)(VI) OF THE INCOME TAX ACT

The royalty income is deemed to accrue or arise in India when-

  • royalty is payable by the Govt. to the NR recipient;
  • royalty is payable by a resident to the NR recipient (except where the royalty is payable in respect of services utilized in 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)
  • royalty is payable by a NR to the NR recipient, only when royalty is payable in respect of services utilized in 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

Provided that royalty payments in respect of computer programme are excluded from above provisions if –

  • lumpsum payment is made by resident
  • for transfer of all or any rights relating to computer software supplied as integrated within computer or computer-based equipment
  • by a NR manufacturer
  • under scheme approved by Govt of India, if any.

Explanation 3 – Computer software means any computer programme recorded on any disc, tape, perforated media, or other information storage device and includes any such programme or any customized electronic data.

Explanation 4 – the transfer of all or any rights in respect of any right, property or information includes and has always included the transfer of all or any right for use or right to use computer software (including granting of a license) irrespective of the medium through which such right is transferred.

The Govt wants to tax the payments for software and to settle the issue of copyright and copyrighted article by inserting a special provision in respect of payments for software, but unfortunately, the matter of the dispute is still alive.

Explanation 5 – The royalty includes and has always included consideration in respect of any right, property or information, whether or not—

(a) the possession or control of such right, property or information is with the payer;

(b) such right, property or information is used directly by the payer;

(c) the location of such right, property or information is in India.

It seeks to clarify that once the software is included under the royalty, it will continue to be taxable in India irrespective of possession or control of the right or property, usage of the right, property or information, and location of such right, property or information.

Explanation 6 – the expression “process” includes and shall be deemed to have always included transmission by satellite (including up-linking, amplification, conversion for down-linking of any signal), cable, optic fibre or by any other similar technology, whether or not such process is secret

It seeks to nullify the requirement of the process being secret.

Although, as per Calcutta HC, once specialized knowledge becomes public; the person loses the exclusivity in respect of such special knowledge and hence, loses the right to receive royalty in respect of the same. [MV Phillips [1988] 172 ITR 521 (Cal HC))

Explanation 4 to 6 is introduced by the Govt by making retrospective amendments in Finance Act 2012 with effect from 01.06.1976. The Govt was adamant of taxing payment for the purchase of software or software licenses from outside India and therefore it brings a retrospective amendment.

Further, Royalty will be deemed to accrue or arise in India, whether or not –

  • the NR recipient has residence or place of business or business connection in India.
  • the NR recipient has rendered services in India.

BENEFICIAL TREATY (DTAA) PROVISIONS

As per above provisions payments for the sale of the license of software will be taxable in India, however, the assessee can take benefit of beneficial treaty provisions and it will still be possible to contend that payment of software is payment for copyrighted article and not for use of copyright and thus, not taxable in India. Payment for software is taxable only in treaty with Russia, Turkmenistan, Malaysia, and Tobago.

MEANING OF ROYALTY AS PER INCOME TAX ACT

As per Explanation 2 to Section 9(1)(vi) of the Act, 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 –

  • Use
  • Transfer of all or any rights
  • Granting of license
  • Imparting any information concerning working or use;

with respect to patent, invention, model, design, secret formula or process or trademark or similar property.

  • Imparting of any information

With respect to technical, industrial, commercial or scientific knowledge, experience or skill

  • Use;
  • Right to use

With respect to any industrial, commercial or scientific equipment (excluding matter covered in Section 44BB of the Act).

  • Transfer of all or any rights;
  • Granting of license

With respect to 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)

  • Payments for rendering services in connection with any of the above activities.

Point to Remember

Every case of imparting of information concerning technical, commercial, industrial, or scientific knowledge, the expertise of skill by itself has not been brought into the definition of royalty. (Haldor Topsoe [2014] 369 ITR 453 Bombay HC)

 Providing any information in the course of advisory services from own knowledge and experience will not amount to imparting of any information to be covered under royalty. (Sundaram Asset Management Co Ltd [2015] 67 SOT 67 (Chennai Tribunal))

Payment can be a consideration for the use or right to use of the defined property, only when such property is in existence at the time of use. [Marriot International Licensing Company BV [2013] 144 ITD 333 (Mumbai ITAT))

Things to be kept in mind while examining characterization of income as Royalty

  • The recipient must be the owner/license holder of the underlying asset.
  • The purpose for which the payment is made (sale or use of rights)
  • The substance of the arrangement
  • Classification of the payment in Import Policy, RBI Approvals, Government Approvals, etc, if any.

MEANING OF ROYALTY AS PER UN MODEL CONVENTION

Royalty means payments of any kind received as a consideration for the use of, right to use, any copyright of literary, artistic, or scientific work including cinematographic films, any patent, trademark, design or model, plan, secret formula or process, or for the use of, or the right to use, industrial, commercial or scientific equipment, or for information concerning the industrial, commercial or scientific experience.

MEANING OF ROYALTY AS PER OECD MODEL CONVENTION

Royalty means payments of any kind received as a consideration for the use of, right to use, any copyright of literary, artistic, or scientific work including cinematographic films, any patent, trademark, design or model, plan, secret formula or process, or for information concerning the industrial, commercial or scientific experience.

The definition of royalty in OECD is narrower than the definition in the Income Tax Act and the UN Model, thus beneficial provisions in treaties can rescue the taxpayers from software taxation.

COPYRIGHT VS COPYRIGHTED ARTICLE

Copyright: Meaning of copyright is neither available in the Income-tax Act nor in any Double Tax Avoidance Agreement. We can follow the definition of copyright from the Copyright Act, 1957 (Definition of Copyright)

Copyrighted Article: The copyright in a computer programme remains with the originator of the programme, but the moment copies are made and sold in the market, they become goods. (Tata Consultancy Services vs. State of Andhra Pradesh (SC)). However, this case was in the context of Sales Tax but still, this case was referred by judges in income tax cases also to resolve the distinction between copyright and copyrighted article.

CONDITIONS TO QUALIFY AS USE OF COPYRIGHT

If a person acquires a copy of a computer programme but does not acquire any of the four below listed copyright rights, he gets only a copyrighted article but no copyright:

  1. The right to make copies of the computer programme for the purpose of commercial exploitation.
  2. The right to prepare derivative computer programme based upon the copyrighted computer programme.
  3. The right to make the public performance of the computer programme.
  4. The right to publicly display the computer programme.

There are a number of judicial precedents on both sides favoring the assessee’s and against the assessee’s and every transaction need to be evaluated by looking into the facts of the case, position in relevant tax treaty until this issue was resolved either by the Government or any ruling from the Supreme Court of India.

Disclaimer: The above analysis of Royalty Taxation is done on the basis of provisions of current law and judicial precedents. This article is written for understanding and educational purposes only and it does not contain any opinion. (Picture-Copyright: transfer-pricing.in)

For any query, suggestions or opinions, please feel free to reach out at info@taxstreaming.com

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