CIT v. Elecon Engg. Co. Ltd., 1987 166 ITR 66; Nippon Electronics (P.) Ltd. v. CIT, 1979 116 ITR 231 (1 Taxman 122) (Kar.) 1. The following two questions have been raised by the applicant Pro-Quip Corporation USA for advance ruling : "1. Whether the applicant is liable to tax on the amount received from Linde Process Technologies India Ltd. towards consideration for the sale of Engineering, Drawings and Designs received under Purchase Order No. 19004, dated 11-12-1998 of Linde Process Technologies India Ltd. 2. Whether the applicant is entitled to the refund of the tax, deducted by Linde Process Technologies India Ltd. calculated at the rate of 15 per cent on the part of the total remittance of US $ 2, 59, 875 together with interest on delayed payment of tax deducted at source already deposited with bank by the said company aggregating to Rs. 17, 10, 525 ?" 2. The case of the applicant is that it is resident in the United States of America. It was incorporated in the State of Oklahoma, United States of America on 25-6-1969 under the name of Pro-Quip Inc. The said corporation filed the Amended and Restated Certificate of Incorporation dated 3-6-1999, which was recorded by the office of the Secretary of State of Oklahoma on 14-6-1999. The name of the applicant was changed to the Pro-Quip Corporation.
3. One of the objects for which the company was incorporated was to engage in general engineering business and in general practice of engineering in all its branches, and in that capacity to make conduct, and supervise research, surveys, design and investigations into all matters and things in the field of science and technology provided this work is accomplished under direct supervision of a person who is registered as a professional engineer under the applicable statutes of the State of Oklahoma.
4. Linde Process Technologies (India) Ltd., (LPT) is a company incorporated in India having its registered office at 806 Meghdoot, 96, Nehru Place, New Delhi, India. The said company is engaged in the business of executing the turnkey projects in India, more particularly the Chemical Process Plants. The said company undertakes the work of executing the projects (jointly with foreign contractors) on behalf of its clients and also, inter alia, source for their clients the technology required for the purpose of establishing the project and supply the same to the clients. LPT received the purchase Order from Nirma Ltd. for design, engineering technical know-how and erection and commissioning of H. Generation Plant of 2200 Nm3/Hr. capacity for a total consideration of Indian Rupees 37, 129 million. As part of execution of the said project, LPT was required to obtain and supply the engineering, drawings and designs for the setting up of the said plant. The said engineering drawings and designs were available with the applicant.
5. LPT, therefore, placed a Purchase Order No. 19004, dated 11-12-1998 with the applicant for the purpose of specified engineering, drawings and designs for the construction of Hydrogen Generation Plant for Nirma Ltd., Ahmedabad as per the specifications in accordance with the inquiry documents of Nirma Ltd. The purchase Order was for the total consideration of US $ 5, 77, 500.
6. In accordance with the said purchase Order the applicant supplied various engineering, drawings and designs from time to time and the payments were made by LPT to the applicant. LPT made a total payment of US $ 2, 02, 125 on 26-3-1999 and US $ 57, 750 on 7-6-1999. The said payments were initially made by LPT without deduction of tax at source.
However, LPT decided to make the payment of the tax by treating the said amount as taxable in India and paid the sum equivalent to US $ 38, 981 to the credit of Government. This amount of US $ 38, 981 from the fourth payment of US $ 1, 15, 500 (net payment being US $ 76, 519) made on 1-9-1999. LPT made the payment to the Government of the amount deducted at source in the following manner :Towards tax deducted at source 16,60,385Towards interest for late payment of TDS 50,140 ----------- However, at the time of remittance of the amount after 7-6-1999, on representation made by the applicant LPT approached the Income-tax Department, through ITO TDS-1, Baroda, Gujarat, India requesting him to issue the no-objection certificate for remittance of the said amount without deduction of tax at source, giving detailed reasons for the same. The said Assessing Officer vide his certificate dated 12-8-1999 granted the no-objection to LPT for remittance of the said amount, without deduction of tax at source. Therefore, the amounts of US $ 28, 875 and US $ 1, 15, 500 was remitted to the applicant by LPT without deduction of the tax at source. Balance amount of US $ 1, 73, 250 was not remitted till the date of this application and will be remitted without deduction of tax at source in accordance with the no-objection certificate issued by the Income-tax Department. The case of the applicant is that it did not have any income from any source in India, other than the income described above and other transactions involving sale of machineries or equipments. In view of the said fact, the applicant was never required to file any return of income in India.
7. The transaction in question is purchase of engineering, drawings and designs. The consideration has been fixed for supply of the engineering, drawings and designs.
8. The contract for the supply of the engineering, drawings and designs having been completed during the previous year ending on 31-3-2000, the income arising there from would be chargeable to tax in the assessment year 2000-01. As per para 1.5 of Annexure 1 to the Purchase Order No.19004 specify that the total price of this purchase Order shall be the sole consideration for the supply of goods as described in this purchase order. The payment schedule was broken up in accordance with the part supply of the various documents. However, the income would accrue only on completion of the contract. The income, therefore, would accrue in the previous year ending on 31-3-2000, irrespective of the fact that part of the payment thereof made on 26-3-2000, i.e., the previous year ending on 31-3-1999.
9. The case of the Commissioner is that the stand taken by the applicant is misplaced. Prima facie, on the basis of the applicant's statement, it is abundantly clear that the payment is to be treated as fee for included service, covered by clause (b) paragraph (4) of Article 12.
10. As per Article 12(4) of India-US Tax Treaty, 'fees for included services' has been defined to mean : "... payments of any kind to any person in consideration for the rendering of any technical or consultancy services (including through the provisions 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 royalty payment within the meaning of the tax treaty is made, 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." 11. Paragraph (4)(a) refers to technical or consultancy services that are ancillary and subsidiary to the application or enjoyment of an intangible asset for which a royalty is received under a licence or sale described in Article 12(3)(a), as well as those ancillary and subsidiary to the application or enjoyment of industrial, commercial or scientific equipment for which a royalty is received under Article 12(3)(b). In addition, the predominant purpose for which the service fees is paid, must be ancillary and subsidiary to the application or enjoyment of the right, property or information, which in turn, has to be determined with reference to the facts of the particular situation.
12. It has been stated that a memorandum of understanding was reached by the negotiators to the India-US treaty indicating how the provisions of the Article are to be understood by the authorities and taxpayers of both the States. This memorandum discusses situations where technology could be said to have been made available. The principle which emerges from an analysis of situation illustrated in the memorandum on this aspect, is that technology would be considered made available when the person acquiring the service is enabled to apply the technology embedded in the services provided to him. The mere fact that the provisions of the service may require technical input by the person providing the service would not per se mean that technology has been made available. Similarly, the use of a product, which embodies technology, shall not per se constitute technology being made available. Training services, which envisage transfer of technical know-how or expertise to the recipient of service and enable application of such know-how independently, are, therefore, covered within the scope of 'make available' 14. Services that involve development of technical plants, designs, drawings (as per deeds of the payer) are covered within this clause and include services such as : 15. The memorandum of understanding to the India-US tax treaty provides illustrations, which are helpful in ascertaining the meaning and import of 'fees for included services'. The memorandum is intended to give guidance both to the taxpayers as well as the tax authorities of the two countries in interpreting the various aspects of this article.
16. Our attention was invited to example (6) of the memorandum of understanding. In that example an Indian vegetable oil manufacturing company wants to produce a cholesterol-free oil from a plant which produces oil normally containing cholesterol. An American company has developed process for refining the cholesterol out of the oil. The Indian company contracts with the US company to modify the formulas, which it uses so as to eliminate the cholesterol, and to train the employees of the Indian company for applying the new formula. Are the fees paid by the Indian company for included services The fees are for included services. The services are technical, and the technical knowledge is made available to the Indian company.
17. Relying on this illustration, it has been contended on behalf of the respondent that the present case clearly falls within Article 12 of the Indo-US Treaty. In our view the argument advanced on behalf of the respondent is misconceived. Here we have a case of out and out sale of engineering drawings and designs by Pro-Quip Corporation, a non-resident American company to LPT which is an Indian company to enable LPT to execute an Order received by it from Nirma Ltd., another Indian company. The payment basically was not made for any service to be rendered by the American company. This is not a case of a licensing agreement or sale being coupled with a restrictive clause. The purchaser was entitled to use the engineering designs and drawings as it liked. It was entitled to sell or transfer the properties purchased.
The agreed price of the sale C.I.F. Mumbai Airport was fixed and not subject to any escalation or variation until complete execution. All costs, taxes and duties were to be borne by the seller. The agreed price included cost of documentation. The total price of the purchase Order was to be the sole consideration for supply of goods as described in the purchase Order placed by LPT and Nirma Ltd. Hydro-Chem agreed to carry out the engineering according to the general standard of engineering profession to enable LPT's customer (Nirma Ltd.) to achieve the performance guarantee. In carrying out this engineering Hydro-Chem had to exercise maximum care and diligence. If there were any deficiencies in engineering, Hydro-Chem had to correct and/or complete such engineering at its own cost so that the LPT's customer (Nirma Ltd.) could reach the minimum performance guarantee.
18. The basic principle underlying Article 12 appears to be that the licensor's State of residence is entitled to tax royalties received by it. Some difficulty is created in cases where technical assistance is provided by the licensor apart from the property licensed. To get over this difficulty Article 12 of the Indo-US Agreement provides : (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) In the case of royalties referred to in sub-paragraph (a) of paragraph 3 and fees for included services as defined in this Article (other than services described in sub-paragraph (b) of this paragraph).
(i) during the first five taxable years for which this Convention has effect, (A) 15 per cent of the gross amount of the royalties or fees for included services as defined in this article, where the payer of the royalties or fees is the Government of that Contracting State, a political sub-division or a public sector company; and (B) 20 per cent of the gross amount of the royalties or fees for included services in all other cases; and (ii) during the subsequent years, 15 per cent of the gross amount of royalties or fees for included services; and (b) In the case of royalties referred to in sub-paragraph (b) of paragraph 3 and fees for included services as defined in this Article that are ancillary and subsidiary to the enjoyment of the property for which payment is received under paragraph 3(b) of this article, 10 per cent of the gross amount of the royalties or fees for included services.
(a) payments of any kind received as consideration for the use of, or the right to use, any copyright or 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 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, 'fees for included services' means payments of any kind to any person in consideration for the rendering of any technical or consultancy services (including through the provisions of services of technical or to other personnel) if such services : (a) are ancillary and subsidiary to the application or enjoyment of the right, property or information for which a royalty payment within the meaning of the tax treaty is made, 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, 'fees for included services' 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) for services that are ancillary and subsidiary to the rental of ships, aircraft, containers or other equipment used in connection with the operation of ships or aircraft in international traffic; (d) to an employee of the person making the payments or to any individual or firm of individuals (other than a company) for professional services as defined in Article 15 (Independent Personal Services)." 19. Paragraph (6) of Article 12 clarifies that the provisions of paragraphs (1) and (2) will not apply if the beneficial owner of the royalties or fees for included services carries on business in the other Contracting State through a permanent establishment situated therein or renders any independent personal service from a place situated therein. We are, in this case, not concerned with paragraph (6). So we shall examine the scope and effect of paragraphs (1) to (5) of Article 12. It is to be noted that the meaning of royalty as given in paragraph (3)(a) deals with payments as consideration 'for the use of, or right to use' of the things mentioned in clause (a) of paragraph (3). This includes copyright, literary or artistic or scientific work, including cinematograph films, 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. These payments must be for the use of the right to use of the things specified in clause (a) and not for out and out sale thereof. However, there is a clause relating to alienation of property. That clause which are the concluding words of paragraph (3)(a) speaks of "gains derived from alienation of any such right or property which are contingent on the productivity, use or disposition thereof." In other words, if any alienation of right or property is made for consideration and such consideration is payable contingent upon productivity, use or disposition, as the case may be, of that property, such payment may come within the expanded definition of royalty. This will obviously not include an out and out sale as in the case before us.
20. In the instant case, we have not been shown any such contingent clause. Payment received by LPT or the sale of engineering, design or drawing is not contingent upon any of the things mentioned in clause (a) of paragraph (3). Therefore, this payment cannot be treated as royalty at all.
21. The next question is, can this be treated as fees for the included service It is true that paragraph (4) includes in the definition of 'fees for included service' payments which are received for making available technical knowledge, skill, know-how or processes or consists of the development and transfer of a technical plan or technical design. It can be argued that the American company has made available to LPT its technical knowledge, experience, skill, know-how, processes all have developed and transfer technical plant or technical design as contemplated in paragraph (4). But paragraph (5) has specifically excluded from the ambit of paragraph (4) amounts paid for services that are ancillary and subsidiary linked to the sale of property other than a sale described in paragraph (3)(a). But if, as in this case, there is an out and out sale without any contingent clause then even if such sale included rendering of engineering services, those services cannot be anything other than "services that are ancillary and subsidiary as well as inextricably and essentially linked to the sale of property" in paragraph (5). Therefore, such services will clearly fall within the exclusionary clause of paragraph (5).The illustration given in memorandum of understanding on which reliance has been placed is not apposite. In that example (6) of memorandum of understanding which has been set out earlier there is no sale of property involved. The Indian company has requested the US company to modify the formula for refining the cholesterol within the oil and also to trained the employees of the Indian company for the application of the modified formula. The fees are paid for technical services and also technical knowledge made available to the Indian company but no sale of any design or engineering plan or machinery is involved.
22. More apposite would be Example (8) of the memorandum of understanding.
"Facts : An Indian company purchases a computer from a U.S. computer manufacturer. As part of the purchase agreement, the manufacturer agrees to assist the Indian company in setting up the computer and installing the operating system and to ensure that the staff of the Indian company is able to operate the computer. Also, as part of the purchase agreement the seller agrees to provide, for a period of 10 years, any updates to the operating system and any training necessary to apply the update. Both of these service elements to the contract would qualify under paragraph (4)(b) as an included service. Would either or both the excluded from the category of included services, under paragraph (5)(a), because they are ancillary and subsidiary, as well as inextricably and essentially linked, to the sale of the computer Analysis : The installation assistance and initial training are ancillary and subsidiary to the sale of the computer, and they are also inextricably and essentially linked to the sale. The computer would be of little value to the Indian purchaser without these services, which are most readily and usefully provided by the seller. The fees for installation assistance and initial training, therefore, are not fees for included services, since these services are not the predominant purpose of the arrangement. The services of updating the operating system and providing associated necessary training may well be ancillary and subsidiary to the sale of computer, but they are not inextricably and essentially linked to the sale. Without the updates, the computer will continue to operate as it did when purchased, and will continue to accomplish the same functions. Acquiring the updates, cannot, therefore, be said to be inextricably and essentially linked to the sale of the computer." 23. The example is in two parts. Firstly, it deals with the purchase of a computer from US computer manufacturer. The second part relates to updating the operating system and training personnel for the purpose of application of the updated technology over a period of ten years.
24. We are not concerned, in this case, with any long-term contract for updating technology. But the first part of the example squarely applies to the facts of this case. In that example an Indian company purchased a computer from an US manufacturing company. In the case before us, drawings and designs have been purchased from a German company.
Engineering service has also been given in connection thereof.
25. The facts of this case are very similar to the facts of the first part of Example (8). The engineering services were being rendered as a part of the purchase agreement as a composite whole. This service was essentially linked with the sale of drawings and designs. It is not an agreement for long-term service to be rendered after the sale of the machinery.
26. It has also to be borne in mind that drawings and designs which constitute know-how and are fundamental to an assessee's manufacturing business are treated as 'plant' under Section 32 of the Income-tax Act, 1961 the nature of the designs, drawings and patterns has been examined by the Supreme Court in the case of CIT v. Elecon Engg. Co. Ltd. 1987 166 ITR 66. In the case of Nippon Electronics (P.) Ltd. v. CIT 1979 116 ITR 231 (1 Taxman 122) (Kar.), it was observed by Venkatramaiah, J. (as His Lordship then was), "it is not only tangible assets that depreciate but also intangible assets like technical knowledge become obsolete as progress is made with scientific research". There is a well-known distinction between the out and out sale of property and allowing use of the property or technical know-how. In the former case property, which may include person's business transferred unconditionally and becomes property of the purchaser. In the latter case the purchaser only gets the right to use the property. The payment in the latter case may be treated as licensing fee or royalty but the payment in the first category of cases cannot be treated as royalty unless there is a special definition making such payments 'royalty'. The case before us is a case of out and out sale of property. We have carefully examined Article 12 and the facts of this case. We are not persuaded to hold that the payments made by the LPT to the American company will fall within the ambit of Article 12 of the Indo-US Treaty for Double Taxation. The first question is answered in the negative and in favour of the applicant.
27. The second question, however, relates to the refund of tax deducted by LPT at source. The applicant will be entitled to claim refund of the tax deducted at source along with the amount of interest paid for belated payment of advance tax. Refund is to be availed in the manner laid down in the Act and following the prescribed procedure. For this purpose, a return of income will have to be filed claiming refund in accordance with law. It is to be seen whether there is any other source of income of the applicant in India. If the only source of income of the applicant is the consideration for sale of engineering drawings and designs under Purchase Order No. 19004, dated 11-12-1998 then the applicant will not be liable to pay any tax in India under Article 12.
In such a situation, it may be entitled to get refund of the amount deducted at source. If the amount has been paid with interest the applicant-company may claim that the amount be paid back to it along with that interest and also interest, if any, in accordance with the provisions of Chapter XVII of the Act.