Royalty as per DTAA vs
definition of “Process” in Explanation 6 to section 9(1)(vi) of Income Tax Act
Facts
·
Income Tax Act, 1961
a)
The royalty is being defined in
exhaustive manner under Explanation 2 to section 9(1)(vi), which among other
thing cover royalty as consideration (excluding consideration which would be
income of the recipient chargeable under the head “Capital gains”) for
following transaction:-
S.No
|
Property
involved
|
Transaction
|
1.
|
Patent,
Invention, Model, Design, Secret Formula or Process or Trade Mark or Similar Property
|
a)
Transfer of all or any right
in property.
b)
Imparting any information
concerning the working of property.
c)
Use of Property.
d)
Rendering of any service in
connection with above-mentioned transactions.
|
b)
Explanation 6 to section
9(1)(vi) (hereinafter referred to Explanation 6), which was inserted by Finance
Act 2012 with retrospective effect from 01-06-1976, provide as under:-
For removal of doubts, it is clarified that 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
process is secret.
·
Double Taxation Avoidance Agreement (DTAA)
a)
Both OCED and UN Model
convention on DTAA, defined Royalty under Article 12 as under:-
Payments of any kind
received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific
work including cinematograph films, or films or tapes
used for radio or television broadcasting(not in OECD model)) any
patent, trademark, design or model, plan, secret formula or process,……….
b)
The word “Process” has not been
defined in the DTAA.
c)
Article 3(2) of DTAA (Both
OECD and UN Model) provides that as
regard the application of the convention at any time by a contracting state,
any term not defined therein shall, unless the context otherwise requires, have
the meaning that it has at that time under the laws of that state for the
purpose of the taxes to which the convention applies, any
meaning under the applicable tax laws of that state prevailing over a meaning
given to term under other laws of that state (not in UN model)
Issue
Involved
The
question for consideration is whether the meaning of the word “Process” as used
in Royalty definition under DTAA, has to import from the Explanation 6, in view
of provision Article 3(2) of DTAA.
a)
Before analyzing the issue, let
us considered following:
i)
Suppose a person has purchased
patented product, will it mean that he is using the patent. The obvious answer
will be NO, since he is using the product, which has been patented.
ii)
Similarly, if a person is
availing the transmission services backed by some process, does it mean that
person is using the process? The person is using the transmission services
analogous to above example of use of product.
In both of above examples, the consideration paid for product or
services should not be considered as Royalty in common parlance, as person is
not using the subjected intellectual property in his own right rather he is
using the product/services supported by intellectual property.
However under Income Tax Act,
the definition of Royalty is being extended to cover the consideration paid for
use of transmission services
In this
artifact, honest attempt is made to understand whether definition of Royalty
under DTAA can also be equated with concept of Royalty under Income Tax Act, to
cover within its realm consideration for transmission services.
b)
One may ask what different will
happen, if meaning of the term process under DTAA is treated at par with Explanation 6, in the
sense that upon tax paid being in India
on consideration for transmission service (treating as Royalty), the resident
of other contracting state will get credit of the same in his state under DTAA.
But this is not the case,
explained as under:-
DTAA is an international agreement entered into between two Nations,
where by one Nation agree to waive its sovereign power of taxation in favour of
other state (i.e. Taxation power under DTAA is restricted to either of one
state or where both states have taxation power, residence state gives credit
for tax paid in source state either through credit method or exemption method).
Nation agree to compromise its taxation power under DTAA only when
taxes involved are worked out strictly in terms of provision of DTAA, as
commonly contemplated by both the states. If one state does not cover the
transmission services within the ambit of Royalty, then upon tax paid by its
resident in India, he will not get the credit of same in his state i.e state
will not cede its taxation right on such income under DTAA. Thus there will be juridical double
taxation, which is against the vowed objective of two nations at the time of
entering into DTAA.
Analysis
The solution
to controversy regarding the extension of extended meaning of Royalty in domestic
legislation to DTAA, has been attempted in two spheres:-
1.
To understand and analyze the
way the concept of Royalty is used in DTAA.
2.
Under what circumstances, the
reference can be made to term “Process” under domestic legislation for
application of DTAA, in view of trade-off between ‘Context” and “meaning
defined in domestic legislation”
·
Understanding the concept of Royalty in DTAA
1.
DTAA is a written international
agreement between two states and to apprehend the issue involved, reference is
made to Vienna Convention on law of
treaties (VCLT)
2.
VCLT is considered as Treaty of
Treaties and was an attempt to codify the several aspects of customary
International law.
3.
VCLT is applicable to written
agreement between two states.
4.
Among other things, Article 31
of VCLT provides principles of Interpretation of the Treaty between States.
5.
Since DTAA is a written
agreement between two Nations, the guidance can be drawn from said Article 31
for interpretation of DTAA.
6.
Article 31 provides that “Treaty
shall be interpreted in good faith
in accordance with the ordinary meaning
to be given to the terms of Treaty in their context and in the light of its
objective”
7.
As per Commentary on double
taxation convention by Professor Klaus Vogel, the ordinary meaning for article
31 shall be taken as under:-
The “ordinary meaning” of
the term is not necessarily that of
everyday usage. To the extent that an internationally
uniform legal usage or legal usage
consistent between the contracting states has developed, or to the extent
that a specific technical language has
developed in certain specialized area, such as tax laws, is this “ordinary” usage within the meaning of
Article 31. This is particularly true for those terms which, under the influence of OECD Model convention and its
commentary have since developed into an international language.
8.
The OECD commentary on Article 12, which can be used to comprehend the concept of Royalty in common
parlance, clearly provides that Royalty
is for the use of Asset and not for services, on account of following
reasoning:-
a)
Para 8 provide that definition
of Royalty relates to payment for the
use of, entitlement to use, right or
property …….
b)
Para 8.2 provides that if
payment is in consideration for transfer of full ownership of property or
rights, payment is not royalty. This Para
provide that only use of asset is covered under royalty and not sale of asset.
c)
Para 11.2 provides that
knowhow contract ( contract where one of the parties agrees to impart to other,
so that he use them for his own account, his special knowledge and experience
which remain unrevealed to the public) differs from contracts for provision of
services, in which one of the parties undertakes to use the customary skills of
his calling to execute work himself for other party and such service contract
do fall under Article 12, thus
highlighting the point that Royalty does not consideration for services.
d)
Para 9.1 provides that payments
made by customers under typical “transponder leasing” agreement are payments
made for the use of transponder transmitting capacity and will not constitute
royalties. These payments are not made in consideration for use of, or right to
use property.
9.
Thus in view of interpretative rule of Article 31,
the ordinary meaning of royalty is
payment for use of asset and not for services.
10.
The other point for
consideration is that India, till date, has yet not ratified the Vienna
Convention on law of Treaties, implying that for Interpretation of DTAA, whether
India is required to apply Article 31 of VCLT.
11.
India has entered into DTAA
with 85 countries and out of those, 63 countries has ratified VCLT. Thus, at
this point, the moot question is: how to interpret the India’s standpoint in
the absence of application of Article 31.
12.
Among different principles of
customary International Law, one of them is “silence as consent”. Generally,
sovereign nations must consent in order to be bound by a particular treaty or
legal norm. However, international customary laws are norms that have become
pervasive enough internationally that countries need not consent in order to be
bound. In these cases, all that is needed is that the state has not objected to
the law.
13.
Now if one state is applying
the Article 31 of VCLT to interpret the term Royalty as payment for use of
asset and India has not objected to the same through express provision in DTAA,
it amounts to India’s consent on the same.
14.
The other part of drawing
conclusion on “ordinary meaning” under Article 31 of VCLT is based on legal usage consistent between the
contracting states.
15.
If under the legislation of
both the states, the royalty definition is being extended to cover services
also, and then by entering into DTAA, it means they want to have similar
connotation of royalty in DTAA also.
Thus based on afore-said analysis, the following conclusion can be
drawn on concept of Royalty under DTAA
i)
If states have different
interpretation of Royalty in their domestic legislation, then common meaning of
Royalty, being payment for use of asset, will prevail
ii)
If states have common purport
intending to covering services under Royalty, then same meaning will in flow in
DTAA.
·
Reference to domestic meaning in view of Context of Treaty
For application of Article 3(2) of DTAA, one needs to look into two
aspects:-
I.
Whether meaning of term used in
DTAA is defined under Domestic legislation of contracting state applying the
treaty?
II.
Whether using the meaning of
term under domestic law, is in consonance with Context of treaty?
Ø
Meaning of term used in domestic legislation
Whether the term “Process” as explained by Explanation 6,
can be taken as meaning of term “Process” as contemplated under Article 3(2),
is also not free from doubt on account of
following:-
I.
The Explanation 6 was inserted
by Finance Act 2012 with retrospective effect from 01-06-1976
II.
In CAgIT vs. Planation Corporation of Kerala Ltd (2001) 247 ITR 155,
161-62 (SC), it was held that an
Explanation is intended to either explain the meaning of certain phrases and
expression contained in statutory provision or depending upon its language it might
supply to take away something from contents of provision and at times even, by
way of abundant caution, to clear any mental cobweb surrounding the meaning of
a statutory provision spun by interpretative process to make the position
beyond controversy or doubt.
III.
The Memorandum explaining the
provision of Finance Bill 2012 provide the following rationale for introduction
of Explanation 6 – “… doubts have been raised regarding the meaning of the term
process. Considering the conflicting decisions of various courts in respect of
income in the nature of royalty and to restate the legislative intent, it is
further propose to amend the Income tax Act
IV.
In view of afore-said, one
would appreciate that Explanation 6 was introduced on the statue to clarify the
implied meaning of the term process (which was disputed at judicial forum) since time, definition of Royalty in
explanation 2 was bought in statue i.e 01-06-1976
V.
Thus whether implied meaning of
term process under Income Tax Act can be considered as meaning of term under
domestic legislation from perspective of Article 3(2) is questionable.
VI.
However for our analysis
purpose, the said explanation 6 is taken as meaning of term process for the
purpose of Article 3(2)
Ø
Context of Treaty
I.
What exactly should be taken as
context of treaty has not been codified in express terms in either domestic
statutes or legislation of foreign countries.
II.
To apprehend the same, one has
to refer the commentaries on Double taxation Convention and one of them is by
learned Professor Klaus Vogel.
III.
According to this commentary,
the context of treaty should be arrived at after considering the following:-
a)
Objective of Treaty – to
prevent/avoid double taxation
b)
Text of the treaty – any
special meaning of term/concept apparent from treaty.
c)
Any supplementary instrument
attached to treaty –any special meaning of term/concept assigned in supplementary
instrument executed by contracting states.
d)
The relevant provision of two
national legal systems.
Article 3(2)
which is interpretative clause for other Articles of DTAA, should in itself be
interpreted according to Article 31 of VCLT i.e. in good faith and accordingly the reference to domestic
meaning in view of context of treaty, should be referred in following cases:
a)
The other contracting state
also convey similar meaning to term as assigned by one contracting state.
b)
If above case does not hold
true, the reference to domestic meaning will not lead to double taxation.
Conclusion
In my
opinion, the meaning of word “Process” as used in definition of Royalty in
Article 12, should be carry from Explanation 6 in following cases:-
a)
We should need to ascertain whether
other contracting state also intend to cover the transmission services under
the definition of Royalty in their domestic legislation. If yes, then meaning
of term “Process” in definition of Royalty in Article 12 should be interpreted
accordingly. This approach will in consonance with article 31 of VCLT (ordinary meaning as per legal usage consistent between the contracting states) and Article
3(2) of DTAA (Context is taken in harmony with provisions of two national legal
system).
b)
If other contracting state
considered Royalty as payment for use of asset, then meaning of words “Process”
in definition of Royalty in article 12 should not treated at par with the
definition of term process. This approach will be in synch with Article 31 of
VCLT (ordinary meaning of Royalty is per
specific
technical language that has developed in certain specialized area, such as tax
laws (OECD commentary)) and Article 3(2) of DTAA (Context is taken in
terms of objective of prevention of double taxation)
