Justice Syed Shah Mohammed Quadri
.
The Airports Authority of India, a public sector undertaking set up under the Airports Authority Act, 1994, is the applicant in these applications. For Modernisation of Air Traffic Services (MATS) in Delhi and Mumbai, the applicant entered into two contracts - (1) supply contract and (2) service contract - with M/s. Raytheon Company, USA (for short RC) for supply and installation of equipment (together with spares, training, documentation, software etc.) on 19th March, 1993. Pursuant to those contracts, RC handed over equipment software etc. at Delhi in March, 1998 and at Mumbai in June 1999 and thereafter the applicant has been operating and maintaining the equipments on its own without any assistance from RC. Having been in operation for 4-5 years, some assemblies failed, which needed repairs and it was also felt that repairs would be needed from time to time so the applicant entered into two separate contracts with RC on February 4, 2003 for:
(a) Repair of equipment (hardware) of MATS systems â subject matter of AAR/624/2003
(b) Modifications and anomaly resolution of the software of the MATS system. â subject matter of AAR/625/2003
The method and the manner in which RC will discharge its obligations under these contracts are summarized in the paras that follow.
2. In the case of repair of hardware, after detecting default, the applicant has to fill Site Anomaly Report (SAR) form and send the same to RC. The applicant has also to collect and supply additional failure data as and when required by RC. It is the responsibility of the applicant to pack properly and ship the failed parts to RCs facility which is outside India. The failed parts will be repaired by RC subject to certain maximum limit. If they are not repairable, RC would provide a compatible replacement. Repaired hardware part would be sent back to Delhi or Mumbai from RCs facilities. The part has to be checked up within the prescribed time and if found to be successful, SAR will be closed. However, if the part fails in the test, a new SAR will be opened with reference to the old SAR and the same procedure will be repeated.
3. In the case of software maintenance support, on detecting any fault, the applicant has to fill a site anomaly form and send the same to RC with crash data and system sub-data. The applicant is also to collect and supply additional failure data as and when requested by RC. On verification by RCs facilities outside India, if it is noticed that the SAR does not impact the automation system (no change in the software is required), RC would provide explanation for the anomaly and its resolution either by phone or fax or E-mail. But if SAR impacts the automation service (requires change in the software), the System Trouble Report (STR) will be generated and accordingly changes will be made in various modules (each such change is referred to as STR fix). Various STR fixes will be combined to form a software build which, after due verification, will be sent to Delhi or Mumbai by RCs facilities along with a version description document, executive software DAT Tape and source Code DAT Tape. RC software engineers will visit site for a total period of 10 days (5 days at New Delhi and 5 days at Mumbai) for verification of the fixes/software build (which will not exceed 3). After testing the same on a simulator and down loading it on to the operational system, it will be monitored for 48 hours.
4. The Convention between the Government of United States of America and the Government of India for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income was concluded on the 18th December, 1990 (Notified on 20th December, 1990), (for short the âTreatyâ). RC being a tax resident of USA, is entitled to avail the provisions of the treaty. RC does not have a permanent establishment (PE) in India for performing the contract and all activities in connection with the performance of the contract are carried out outside India. The case of the applicant is that the amount paid by it under the said contracts is the business profits of RC and the same will not be liable to tax in India in view of article 7 of the treaty.
In the backdrop of these facts the applicant proposed questions to seek advance rulings of the Authority in AAR/624/2003 and AAR/625/2003, filed under section 245Q(1) of the Income-tax Act, 1961 (for short the âActâ).
In AAR/624/2003 the proposed questions are as follows:-
(i) Whether payment received by M/s. Raytheon company under the transaction mentioned in Annexure I is liable to tax in India in the hands of the recipient non-resident US company?
(ii) If the answer to question No. 1 is in affirmative, at what rate the income-tax will be chargeable in India and at what rate tax at source is deductible by the applicant ?
In AAR/625/2003 the following questions are proposed:
(i) Whether under the facts and circumstances of the case, deputation of an engineer by the M/s. Raytheon Company to India for the purpose of installation and testing of the repaired software will constitute Raytheons permanent establishment in India;
(ii) Whether payment received by M/s. Raytheon Company under the transaction mentioned in Annexure I is liable to tax in India in the hands of the recipient, non-resident US company ?
(iii) If the answer to question No. 2 is in affirmative, at what rate the income âtax will be chargeable in India, and at what rate tax at source is deductible by the applicant?
5. The Director of Income-tax (International Taxation) (for short the âCommissionerâ) submitted his comments on August 17, 2004 and additional comments on November 18, 2004. It is stated that contracts entered into in February, 2003 derive substantial strength from the original contracts of 1993. The supply contract is the principal contract and no separate services are envisaged under the service contract. However, separate consideration has been provided for installation, services and training. The original contracts contemplate use and right to use of intellectual properties like patents etc. subject to grant of license to the applicant. Computer software and technical documentations etc. are described as property of the Queen of Canada. Certain limitations have been imposed on the use of technical data and the system which is licensed for use in Delhi and Mumbai cannot be used at other places except by obtaining prior license. There has been no outright sale of the system; only use or right to use of the property has been granted. The contract price is deemed to include royalties and fees for patents etc. RC holds patents in respect of equipment made available to the applicant for use and it would be responsible for defending the patents. Final payment by the applicant is conditioned upon settlement of dispute, if any, in regard to the patents. Though the contract between RC and the applicant is described as a supply contract, in a sense, the applicant is provided modernization of pre-existing air traffic system. Payments made by the applicant to RC under the aforementioned contracts are royalties as defined in article 12(3) of the Treaty. The services provided by RC to the applicant in terms of the contract are ancillary and subsidiary. The exception provided in article 12(5)(a) will not apply to the services provided by RC. Even if the services provided by RC to the applicant under 1993 contracts are construed as sale of property, the exclusion under article 12(5)(a) would not be applicable. The applicant operated the MATS system after its installation till entering into contracts in February, 2003. The original contracts provide for maintenance of spares etc. for the MATS system for a period of 15 years but the services in respect of repairs and maintenance of the hardware and software are not made part of 1993 contracts as they were obviously not considered essential and inextricably linked to the operation of the MATS system. The payments made by the applicant to RC will also fall within the meaning of âfee for included services under article 12(4)(a).
6. Mr. Salil Gupta, Addl. DIT (International), who appeared for the Commissioner raised preliminary objection in regard to the maintainability of the applications on two grounds:
(i) question No.2 in AAR/624/2003 and Question No.3 in AAR/625/2003 are substantial questions which deal with the tax liability of the applicant and not of non-resident, therefore the applications are not maintainable under sec. 245N(a)(ii) of the Act;
(ii) the applicant did not obtain clearance from COD for seeking advance ruling of the Authority.
We shall advert to the preliminary objections presently while dealing with contentions on merits.
Mr. H.P. Aggarwal who appeared for the applicant urged the following contentions: repair of the hardware under the 2003 contract would require despatch of defective parts to RC facilities in USA or Canada where repairs would be done or replacement part will be supplied, so the amount received by the applicant for repairs of parts outside India would be the business income of RC and as it did not have a PE in India, the same would not be chargeable to income-tax in India; the defects in the software would also be attended to outside India and the visit of RCs engineers is only for a short period and would be only incidental and, therefore, the amount payable by the applicant for repair of software would also represent the business income and would not be chargeable to tax in India; even if the amount is treated as fee for included services, having regard to the Memorandum of Understanding appended to the Treaty, the visit would not be covered within the meaning of included services. 8
In any event, if the amount is treated as falling within the meaning of fee for included services, then having regard to the limited number of visits the amount may be apportioned between the fees for included services and business income. Mr. Gupta contended that the amount would not fall within the meaning of business income under article 7 of the Treaty; however, he conceded that RC did not have a PE in India. His main contentions are: the amount falls within the meaning of fee for included services under article 12(4)(a) of the Treaty; the amount would also fall within the meaning of 'âroyalty under article 12(3)(a) of the Treaty as the subsequent agreements of 2003 are only supplementary to the original agreements of 1993.
In the light of the contention of the parties, referred to above, the germane question that arises for consideration is: whether the amount payable by the applicant would be business income or fee for included services of RC within the meaning assigned to those expressions in the treaty.
Before embarking upon an enquiry on this aspect, it would be apposite to dispose of the preliminary objections raised by the Commissioner.
The first objection relates to question No.2 in AAR/624/2003 and question No.3 in AAR/625/2003. Mr.Gupta has submitted that these questions relate to tax liability of the applicant who is resident in India and not to tax liability of RC. However, Mr. Aggarwal has set the controversy at rest by not pressing these questions.
Regarding the second objection which relates to obtaining clearance from COD before approaching the Authority, it is evident that there is no lis between the applicant and the Revenue. The applicant is seeking advance ruling in respect of tax liability of RC, a non-resident, within the meaning of section 245N (a) (ii) of the Act. This, in our view, does not require clearance from the COD, having regard to the order of the Honble Supreme Court in Oil and Natural Gas Commission and Another v. Collector of Central Excise (IA Nos.1 and 2 in Civil appeal Nos.2058-59 of 1988, decided on 11th October,1991) and Office Memorandum of Government of India No. 53/3/6/91-Cab. dated 31.12.1991 and No.53/3/10/94-Cab dated the 24th January, 1994.
7. Now reverting to the aforementioned question, it would be useful to refer to the relevant provisions of the Treaty.
Articles 7 and 12 deal with âbusiness profits and âroyalties and âfees for technical services respectively. Paras 1 and 7 of article 7 which are material for our purpose, are as follows:-
Article 7: Business profits
1. The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contacting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to (a) that permanent establishment; (b) sales in the other State of goods or merchandise of the same or similar kind as those sold through that permanent establishment; or (c) other business activities carried on in the other State of the same or similar kind as those effected through that permanent establishment.
2. to 6. x x x x x x x x x x x
7. For the purposes of the Convention, the term âbusiness profitsâ means income derived from any trade or business including income from the furnishing of services other than included services as defined in article 12 (royalties and fees for included services) and including income from the rental of tangible personal property other than property described in paragraph 3(b) of article 12 (royalties and fees for included services).
A perusal of para 1 of article 7, quoted above, shows that the profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable, inter alia, to that permanent establishment. Rest of para 1 is not relevant for our purpose. In other words, with reference to the facts of this case, the contents of para 1 would mean that RC, which is an enterprise of a USA, shall be taxable in USA unless it carries on business through a permanent establishment situated in India. If RC carries on business through a permanent establishment as aforesaid, the profits may be taxed in India but only so much of them as is attributable to the permanent establishment of RC in India.
Mr.Gupta has conceded that RC does not have a permanent establishment in India. The effect of the concession would be that if the amount in question is held to be business profits of RC, it would not be taxable in India. Further this concession will also cover deputation of an engineer by the RC to India for the purpose of installation and testing of repaired software. It follows that such deputation cannot constitute RCs permanent establishment in India.
The expression âbusiness profitsâ is defined in para 7 of article 7, referred to above, to mean income derived from any trade or business including income from the furnishing of services other than included services as defined in article 12 (royalties and fees for included services) and including income from the rental of tangible personal property other than described in paragraph 3(b) of article 12 (royalties and fees for included services). The second limb of para 7 is not relevant for the present discussion. The amount that is being paid by the applicant to RC is for repairs of hardware (including replacement of defective parts) and services for repairing. If such services fall within the meaning of included services as defined in article 12, the amount cannot be classified âbusiness profits. It would, therefore, be necessary to see whether the amount in question satisfies the requirement of âfees for included servicesâ.
Paragraphs 1, 2, 3, 4, 5 and 7 of article 12 which deals with Royalties and fees for included services, are relevant and they may be reproduced here:-
Article 12: Royalties and fees for included services
1. Royalties and fees for included services arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State.
2. However, such royalties and fees for included services may also be taxed in the Contracting State in which they arise and according to the laws of that State; but if the beneficial owner of the royalties or fees for included services is a resident of the other Contracting State, the tax so charged shall not exceed:
(a) to (b) x x x x x x x xx
3. The term âroyaltiesâ as used in this article means:
(a) payments of any kind received as 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 kinds received 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) or 3 of article 8.
4. For purposes of this article, âfees for included servicesâ means payments of any kind to any person in consideration for the rendering of any technical or consultancy services (including through the provision of services of technical or other personnel) if such services:
(a) are ancillary and subsidiary to the application or enjoyment of the right, property or information for which a payment described in paragraph 3 is received; or
(b) make available technical knowledge , experience, skill, know-how, or processes, or consist of the development and transfer of a technical plan or technical design.
5. Notwithstanding paragraph 4, âfees for included servicesâ does not include amounts paid:-
(a) for services that are ancillary and subsidiary, as well as inextricably and essentially linked, to the sale of property other than a sale described in paragraph 3 (a).
(b) to (e) x x x x x x x x
6. x x x x x x x x x x x x
7. (a) Royalties and fees for included services shall be deemed to arise in a Contracting State when the payer is that State itself, a political sub-division, a local authority, or a resident of that State. Where, however, the person paying the royalties or fees for included services, whether he is a resident of a Contracting State or not, has in a Contracting State a permanent establishment or a fixed base in connection with which the liability to pay the royalties or fees for included services was incurred, and such royalties or fees for the included services are borne by such permanent establishment or fixed base, then such royalties or fees for included services shall be deemed to arise in the Contracting State in which the permanent establishment or fixed base is situated.
(b) Where under sub-paragraph(a) royalties or fees for included services do not arise in one of the Contracting States, and the royalties relate to the use of, or the right to use, the right or property, or the fees for included services relate to services performed, in one of the Contracting State, the royalties or fees for included services shall be deemed to arise in that Contracting State.
A plain reading of para 1 of article 12 discloses that it enables the other Contracting State to tax âRoyalties and âfees for included services arising in a Contracting State and paid to a resident of the other Contracting State. In other words, in terms of para 1 royalties and fees for included services arising in India and paid to RC, a resident of USA, may be taxed in USA. The term âroyaltiesâ is defined in para 3 of article 12. It has two sub paras (a) and (b); only sub-para (a) is material for the present discussion. It is clear from that sub-para that payments of any kind received as consideration for the use of, or the right to use, any copyright of a scientific work, any patent, design or model, 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 (words and expressions not relevant to the present discussion are omitted). If the payment represents consideration for the use of, or the right to use, any copyright or scientific work of any patent design or model or process, it would fall within the meaning of âroyaltiesâ. The expression âfee for included servicesâ as defined in para 4, quoted above, means payments of any kind to any person in consideration for the rendering of any technical consultancy services (including through the provision of services of technical or other personnel) if such services are covered under either sub-para (a) or sub-para (b).
The contention of Mr. Aggarwal is that as the amount in question does not fall within the meaning of sub-para (b) of para 4 so it would be âbusiness profitsâ within the meaning of para 7 of article 7 whereas Mr. Gupta has argued that the amount would fall under sub-para (a) of para 4 of article 12 as such it would not be âbusiness profitsâ. We have noticed above that sub-para (a) of para 4 takes in services which are ancillary and subsidiary to the application or enjoyment of the right, property or information for which a payment described in paragraph 3 is received; sub-para (b) thereof embraces services which make available technical knowledge, experience, skill, know-how or processes, or services which consist of the development and transfer of a technical plan or technical design. The second part of para (b) would not be relevant here. Para 5 which is an adjunct to para 4, commences with a nonobstante clause and says that irrespective of contents of para 4, âfee for included servicesâ does not include amounts paid for services enumerated in sub-paras (a) to (e) and employee of the person making payment referred to in sub-para
(e). We are concerned with sub-para (a) which speaks of amount paid for services that are ancillary and subsidiary as well as inextricably and essentially linked to the sale of property other than a sale described in paragraph 3(a) (definition of royalties). The exclusionary clause, para 5(a), would apply to the amount paid for services that are ancillary and subsidiary as well as inextricably and essentially linked to sale of property which is not in connection with the royalties.
In passing, we may mention that sub-para (a) of para 7 of article 12 incorporates the source rule; it says that royalties and fees for included services shall be deemed to arise in a Contracting State when the payer is that State itself, a political sub-division, a local authority, or a resident of that State. Inasmuch as the payer in the instant case is State within the meaning of Article 12 of the Constitution or at any rate a resident of India, therefore, the payment if construed as âroyaltiesâ and âfees for included servicesâ shall be deemed to arise in India.
A perusal of the contracts of February, 2003, shows that in the preamble as well as in the introduction to statement of work (Annexure A) there is reference to supply of MATS-BD system as well as supply of hardware and software to the applicant by RC for the Delhi site in March 1998 and for the Mumbai site in June 1999. It is also clear that the said contracts of 2003 relate to repair of the hardware and to resolve the anomalies and to modify the software, outside India, which were supplied under the aforementioned contracts of 1993. Having regard to the contentions of Mr. Gupta, we shall notice pertinent aspects of the supply contract executed by the applicant and RC in March, 1993. Preamble (para 2) of the contract shows that RC offered to supply the equipment and services for ATS in accordance with the Price Adjustment Bid 7th July, 1992 and the applicant agreed thereto. The scope of the agreement contained in clause (2) thereof shows that Air Traffic Control System (ATS) would be provided by RC thereunder as specified in Ex (A), statement of work; Table 5A contains list of items under the head âequipment descriptionâ, which are to be supplied by RC. It is provided that property in the equipment/sub-system to be supplied under the contract shall pass to the applicant when the same are despatched for delivery and thereafter RC will be in possession and custody of the same for the purpose of transportation to site, its installation and site acceptance testing. It shall hold the same for or on behalf of the applicant and shall not deal with them in any manner except for the purposes of the contract. This averment does indicate that the property in the goods, namely, equipments etc. had passed to the applicant. The fact that customs duty of Rs.43 crores levied on the equipment and spares was paid by the applicant support the case of outright sale of the property in question to the applicant.
However, Mr. Gupta invited our attention to clause 1.15 of the supply contract of 1993 to show that supplies means equipments, material, software and services, specified in the contract including spares and documentation and contended that what was transferred was only the right to use the goods and that the property in the goods did not pass to the applicant. Para 2.18 of the contract deals with reproduction and license. Para 2.18.2(a) and (b) shows that documents furnished by the contractor to the applicant which were in the possession of RC, were developed on the basis of proprietary concepts contained in those documents which shall be the property of RC. Clause (c) relates to computer software and technical documentation required to operate equipment to be sold under the Contract. It is provided therein that the contractor shall grant license to the applicant to use such computer software and technical documentation on the ATS. The license would indicate that the computer software and technical documentation are: (1) the property of Her Majesty, the Queen in Right of Canada; (2) they are to be used or copied only for the purpose of operating the article or thing in which they are contained. Para 2.18.4 contains the stipulation by the applicant agreeing that the technical data as referred to in para 2.18.1 shall only be used, reproduced, adapted or otherwise modified by the applicant for the purposes of Delhi and Mumbai ATS systems. It further provides that the license agreement shall be entered into with RC or other relevant proprietors of such rights for use at other locations of the applicant.
The above discussion leads us to the conclusion that insofar as software and documentation are concerned, the applicant acquired a right to use the same subject to certain conditions but the hardware and other equipment were subject matter of outright sale in favour of the applicant. It follows: that in regard to repair of hardware the payment received by RC does not fall within the meaning of income from the furnishing of services as defined in article 12. The payment, would, therefore, be business profits within the meaning of para 7 of article 7. Inasmuch as admittedly RC has no permanent establishment in India the payment will not be taxable in India in view of the provisions of article 7 of the treaty.
In regard to repair of software, payment received by RC answer the description of fees for included services within the meaning of sub-para (a) of para 4 of article 12. Mr. Aggarwal is correct that it does not fall within the meaning of sub-para (b) of para 4 of article 12 if understood in the light of the Memorandum of Understanding and the examples annexed to the treaty. However, it falls under sub-para (a) of para 4 of article 12, it would be fees for included services. Sub-paras (a) and (b) are alternative. The descriptions in sub-paras (a) and (b) are not cumulative. In view of this description the payment made for repair of software will be outside the purview of para 7 of article 7. Having regard to provisions of para 2 of article 12 the same shall be taxable in India.
For the above mentioned reasons, we rule:
in AAR/624/2003 on question
(i) that the payment received by M/s Raytheon Company under the transaction mentioned in Annexure I is not liable to tax in India in the hands of the recipient, non-resident US Company;
(ii) as the question is not pressed by the applicant we decline to pronounce advance ruling on it.
in AAR/625/2003 on question
(i) that under the facts and circumstances of the case, deputation of an engineer by M/s Raytheon Company to India for the purpose of installation and testing of the repaired software will not constitute Raytheons permanent establishment in India;
(ii) that payment received by M/s Raytheon under the transaction mentioned in Annexure I is liable to tax in India in the hands of the recipient, non-resident US company;
(iii) as the question is not pressed by the applicant we decline to pronounce advance ruling on it.
Pronounced by the Authority in the presence of the parties on this 15th day of December, 2004.