Vildirect: IncomeTax-caselaws-2014-VIL-663--DT

2014-VIL-663--DT

HIGH COURT OF KARNATAKA

IT APPEAL NOS. 208 TO 215 OF 2008 AND 270, 273, 274 & 824 OF 2009

Date: 09.06.2014

COMMISSIONER OF INCOME-TAX

CGI INFORMATION SYSTEMS & MANAGEMENT CONSULTANTS (P.) LTD.

K.V. Aravind for the Appellant.
K.S. Ramabhadran for the Respondent.

BENCH

N. KUMAR AND B. MANOHAR, JJ.

JUDGMENT

N. Kumar, J. - All these appeals are by the revenue challenging the order passed by the Income Tax Appellate Tribunal, Bangalore Bench, holding that the assessee was not liable to deduct tax under Section 195(1) of the Income Tax Act, 1961 (for short hereinafter referred to as 'the Act') from the remittances made to a non-resident.

2. The substantial question of law that arises for consideration in these appeals is as under:-

Whether the Tribunal was correct in holding that the payments made by the assessee for utilizing intranet facilities provided by the non-resident assessee is not liable to tax in India and no TDS need be made as the provisions of Section 195(1) read with section 9(1)(vi) and (vii) read with Article 12 of the DTAA between India and Canada are not applicable?

FACTS IN BRIEF

3. The assessee is engaged in the business of design, development, implementation and support systems for the Information Technology (IT) Sector. The assessee entered into an agreement with CGI Group Inc., a company incorporated in Canada for sharing costs by which the Canada Company would procure licenses from Microsoft and also the communication tool developed by CGI Group Inc., and the costs relating to that would be subsequently invoiced on the assessee. Accordingly, invoice was raised on the assessee by the Canada Company. While making the remittance, the assessee deducted TDS at 20% under Section 195(1) of the Act and also paid the same to Government account. However, according to the assessee, since it is a cost sharing agreement and payments were made by the assesee for reimbursement of cost/expenses, no income is embedded therein. Therefore, the assessee is not liable to deduct tax under Section 195(1) of the Act. The appeals were filed by the assessee before the CIT(A) under Section 248 of the Act. The Appellate Authority sought for a remand report from the Assessing Officer. The claim of the assessee was that the payment was in the nature of reimbursement of expenses. Hence, it was not liable to deduct tax under Section 195(1) of the Act. Further, the payments are not in the nature of royalty. The Appellate Authority held that the payment made by the assessee to the Canada Company cannot be considered as royalty as the assessee was not liable to make deduction in respect of this payment. However, it held the payment made by the assessee is for rendering "any technical or consultancy services" and, therefore, the assessee was liable to deduct tax at source and dismissed the appeal.

4. Aggrieved by the said order, the assessee preferred an appeal to the Tribunal. The Tribunal by a lengthy order, after considering the rival contentions and referring to various judgments held that, the payments made by the assessee are reimbursement of expenses and no income element is embedded therein; therefore, the remittances cannot be considered as fees for technical services. The assessee is liable to deduct tax under Section 195(1) of the Act only on the income embedded in the remittance. Since there was no income element embedded in the remittance, the assessee was not liable to deduct tax from the remittance. It also affirmed the finding of the Appellate Authority that the remittance made by the assessee cannot be treated as royalty and Section 44D is not applicable to the facts of this case. Therefore, the appeals were allowed. The order passed by the Appellate Authority as well as the original authority was set aside. Aggrieved by this order, the revenue is in appeal.

5. The learned counsel for the revenue assailing the impugned order contended that, the Tribunal has proceeded on the assumption that, as the agreement between the parties is a cost sharing agreement, the remittance made by the assessee to the Canada Company is towards such charges and no profit is embedded in the said amount paid to the Canadian Company. Therefore, the said amount was not chargeable to tax under the Act and consequently, there is no liability on the part of the assessee to deduct tax at source. He submits that though the agreement is styled as "cost sharing agreement", a reading of the agreement shows that the Canadian Company had granted a licence to use the facilities which exclusively belongs to them and the consideration paid under the agreement is for the right to use that right and, therefore, it falls within Section 9(1)(vi) of the Act. It constitutes royalty and the Tribunal has not properly appreciated the facts of the case and the material placed on record. Therefore, the order is liable to be set aside.

6. Per contra, the learned senior counsel appearing for the assessee submitted that, no right in the intellectual property is transferred under the agreement nor any licence is granted under the agreement. As is clear from the agreement, the Canadian Company developed a tool providing Eportal-intranet facility. It was available only to the members of the Group. The other members of the Group agreed to share the cost of the said tool. Therefore, the assessee agreed to share the cost of the tool. No profit is embedded in the said payment as is clear from the clauses in the agreement. Clause 4.4. provides that the term 'cost' incurred does not include any mark up and is limited to the actual cost. Therefore, the Tribunal was justified in holding that it is neither a payment towards royalty nor payment towards technical services.

7. In the light of what is stated above and the rival contentions, it is necessary for us to look in to the terms of the agreement entered into between the parties, understand the intention of the parties and then find out the nature of transaction. Based on that factual finding, we have to decide whether it falls within the definition of royalty as provided under Section 9(1)(vi) or technical services as provided under Section 9(1)(vii) of the Act. Only if the income is chargeable to tax under the Act under the aforesaid provisions, the liability of the assessee to deduct at source would arise. A copy of the cost sharing agreement is made available to us, which reads as under:-

COST SHARING AGREEMENT

This agreement is made by and between CGI Information Systems and Management Consultants Private Limited (CGI-India), a Company incorporated under the Indian Companies Act having its Registered Office at 38/1, Naganathapura, Singasandra Post, Bangalore - 560 034 and CGI Group Inc. a company incorporated under the provisions of the laws of Quebec and having its registered office at 1130 Sherbrooke Street West, 4th Floor, Montreal, Quebec, H3A 2MB8.

1. CGI Group Inc. has developed an internal telecommunication and communication tool, which is accessible only to the members of CGI worldwide. This is historically known as CGI Information Technology Infrastructure. CGI Group Inc. is the absolute owner of the CGI Information technology Infrastructure facility and holds the Intellectual Property rights (IPR) for the same but no licenses are transferred to CGI- India. This is purely a communication related facility and includes the following:

♦ Network facility

♦ Collaborative facility

♦ Security facility

♦ Eportal-intranet facility

2. CGI-India is providing Information Technology Solutions to companies within the CGI Group and other global customers.

3. As the communication tool developed by CGI Group Inc. is for mutual benefit, the parties propose to enter into a cost sharing agreement by which certain costs as mutually agreed upon, is shared between them.

4. CGI Group Inc. allows CGI-India to use the above facilities subject to the following terms and conditions

4.1 CGI Group Inc. allows CGI-India to use the above facilities as an operational guidance for its day-today business.

4.2 For using the above facilities, CGI Group Inc. shall allocate the cost in respect of the facilities on an agreed basis.

4.3 CGI Group Inc. shall allocate the cost to CGI-India on the basis of number of employees of CGI-India based on the following formula:

Cost incurred *Number of employees of CGI-India

Total number of employees of CGI Group Worldwide

4.4 The term 'cost' incurred under clause 4.3 does not include any mark up and is limited to the actual cost.

4.5 CGI-India shall not have any right to the Intellectual Property rights (IPR) nor have any right to sell or license or lease or in any manner "transfer the right assigned therein" to other parties.

5. Any right in respect of CGI information Technology Infrastructure, or whatsoever in respect of any invention, improvements and other intellectual property rights in respect of CGI Information Technology Infrastructure or products shall vest with CGI Group Inc.

6. Disclosure of information.

6.1 CGI-India agrees to hold all such information in confidence to CGI Group Inc. and not to disclose such information to any other person or organization without the prior written consent of CGI Group Inc.

6.2 All materials received from CGI Group Inc. under this Agreement shall be and remain the property of CGI Group Inc. and shall be returned to CGI Group Inc. upon termination of this agreement.

7. This Agreement is effective 1st October 2001 and shall remain in effect unless terminated by either party as otherwise provided in this Agreement. Termination of this Agreement shall not relieve either party to any obligations, which may have accrued prior to such termination.

8. All payments under this agreement are subject to statutory levies, if any.

9. Any notices permitted or required to be given under this Agreement shall be deemed given upon delivery, if delivered by hand or sent by facsimile followed by registered or certified mail, return receipt requested, to the parties at the address as mentioned in this agreement or other address if the same is notified to the respective parties.

10. The provisions of this agreement shall be construed in accordance with the laws of province of Quebec and applicable laws of Canada and the parties agree to attorn to the jurisdiction of the Courts of Quebec, Canada.

	For CGI information systems and Management Consultants Private Limited	For CGI Group Inc
		Sd/-
	Sd/-	Name: Jacques Roy
	Name: Santosh Bhargava	Title: S.V.P. Finance & Treasury
	Title: Sr. Vice President Date: 24th March 2003	Date: 14th March 2003

8. A reading of the aforesaid agreement shows that the Canadaian Company has developed an internal telecommunication and communication tool at their cost. It could be accessed only to the members of CGI worldwide.

This is historically known as CGI Information Technology Infrastructure. This Canadian Company is the absolute owner of the CGI Information Technology Infrastructure facility. It holds the Intellectual Property rights (IPR) in its name. The Canadian Company has not granted any licenses to the assessee. The tool which they have developed is purely a communication related facility and includes, network facility; Collaborative facility, Security facility and Eportal-intranet facility. The assessee is providing Information Technology Solutions to companies within the CGI Group and other global customers. The tool developed by the Canadian Company is purely for mutual benefit. Therefore, the assessee entered into a cost sharing agreement by which certain costs as mutually agreed upon, is shared between them.

9. Clause (4) of the agreement categorically states that, the Canadian Company allows the assessee to use the above facilities subject to the terms and conditions mentioned therein. Therefore, the Canadian Company has permitted the assessee to use the tool which they have developed. The said tool is required by the assessee as an operational guidance for its day-today business. For using the said facilities, the assessee has allocated the cost in respect of the facilities on an agreed basis as mentioned in clause 4.3. It is made clear the term 'cost' incurred under clause 4.3 does not include any mark up and is limited to the actual cost. In other words, no profit or income is embedded in this cost.

10. Clause 4.5 is of utmost importance. It declares the assessee shall not have any right to the Intellectual Property rights. In other words, though the assessee pays the cost stipulated in the agreement for using the facility it does not confer any right in the intellectual property rights. In other words though the agreement is styled as 'cost sharing agreement', and the cost is paid, the assessee would not get any right in the said tool to any extent whatsoever.

Further, the said clause makes it clear the assessee will not have any right to sell or license or lease the facility which is made available by the Canadian Company to the assessee. That clause does not stop there. It further says "or in any manner transfer the right assigned therein to other parties". It means under the agreement some right is assigned to the assessee. However, the assessee has no right to sell, licence or lease that right. Therefore, it is clear from this agreement, though the word used is "Canadian Company allows the assesee to use the facilities for its day-to-day operational guidance" it has assigned some interest which the Canadian Company possess in the said tool. Therefore, the argument that it is a cost sharing agreement, under this agreement nothing is transferred to the assessee, there is no profit margin and, therefore, the amount paid by the assessee to the Candian Company cannot be construed as royalty or for technical services rendered is ex facie incorrect. Therefore, what follows is, the Candian Company is the absolute owner of the intellectual property. It is making available the said facility to its group Company. For allowing them to use this facility the GroupCompany like the assessee has to pay cost. Though they have paid cost and some right in that is assigned to them, they cannot sell, license or lease that right.

11. It is in this background, we have to find out whether the right which is transferred or conferred on the assessee under the cost sharing agreement falls within the definition of 'royalty' or 'technical services' in order to chargeable to tax under the Act.

12. In order to appreciate the argument of the assessee that no licence is granted and amounts paid under the cost sharing agreement do not constitute licence fee, it is necessary to understand what is 'licence'. This Court had an occasion to consider the said question in the case of CIT v. Synopsis International Old Ltd. [ITA Nos. 11 to 15/2008 & 17/2008] decided on 3.8.2010. At para 40 what is a 'licence' has been explained as under:—

"40. A licence is a grant of authority to do a particular thing. It enables a person to do lawfully what he could not otherwise lawfully do. A licence does not, in law, confer a right. It only prevents that from being unlawful which, but for the licence, would be unlawful. It amounts to a consent or permission by an owner of copyright that another person should do an act which, but for that licence, would involve an infringement of the copyright of licensor. A licence gives no more than the right to do the thing actually licensed to be done. It transfers an interest to a limited extent, whereby the licensee acquires an equitable right only in the copyrighted article."

It was further held as under:—

"43. A licence is a permission to do something that would otherwise be unlawful. The question arises, therefore, as to what legal permission is granted by a software licence. The answer is, briefly, that in some cases the licence will be a permission to use confidential information, and in virtually in all cases it will be a permission to copy a copyright work. If the software has been kept secret by the producer, or only supplied on conditions of confidentiality and has not been published too widely, then the software licence will be akin to a licence of confidential information or know-how. The owner or licensor of a copy right, has a right to grant permission to use the software or a computer programme, in respect of which they have a copy right, without transferring the right in copy right. It is one of the rights of a copy right owner or licensor. Without such right being transferred, the end user has no right to use the software or computer programme. If he uses it, it amounts to infringement of copy right. For transfer of such right if consideration is paid, it is not a consideration for transfer of a copy right but for use of intellectual property embedded in the copy right, and therefore it is for transfer of one of those rights of the owner of the copy right. It is not a right in copy right but it is in respect of a copy right. When a copy righted article is sold also, the end user gets the right to use the intellectual property embedded in the copy right and not a right in the copy right as such. Therefore the mode adopted or the terminology given is not decisive to decide the nature of transfer. Ultimately, it is the substance which has to be looked into."

13. In the background of the aforesaid legal position, if we look at Cost Sharing Agreement, it is clear that without entering into an agreement, the assessee was not permitted or allowed to use the facility which exclusively belongs to the Canadian Company. The cost is paid for use of the said facility. By use of such facility, a right is conferred on the assessee. But a restriction is put on the assessee to sell or license or lease or in any manner transfer the right so conferred. The assessee was given the right to use the said facility for its purposes on payment of cost stipulated therein. Therefore, the terminology of the said agreement would not conclusively decide the nature of transaction between the parties. Once we read the entire agreement as a whole, it is clear that the Canadian Company under the said agreement has permitted or allowed the assessee to use the facilities which they have developed at considerable cost to be paid. Merely because the agreement provides that the term 'Cost' does not include any mark-up and is limited to the actual cost, it makes no difference in the eye of law. But one thing that clearly emerges from the said agreement is that in developing the facility or tool, it is the Canadian Company which has invested the entire money. Prior to the development of the said facility, there was no agreement between the Canadian Company and the assessee for sharing the cost of development of the said tool. Further, the agreement expressly states that the Canadian Company is the absolute owner of the CGI Information Technology Infrastructure facility and they hold the intellectual property rights. It has not transferred any licenses to the CGI- India i.e. the assessee. Therefore, even after payment of cost, the said product used would absolutely vests with the Canadian Company. If really, the agreement was to share the cost of developing the facility, the assessee also would become a co- owner. That is not the intention between the parties. The assessee under no circumstances, would get any title to any extent in the facility developed by the Canadian Company and the right conferred is only for its user. Therefore, it is nothing but a license though it is styled as the Cost Share Agreement.

14. Section 9 provides for the income deemed to accrue or arise in India. It reads as under:

"9(1) The following incomes shall be deemed to accrue or arise in India-

(i) all income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India or through the transfer of a capital asset situate in India.

(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 utilised 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 utilised 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: Provided that nothing contained in this clause shall apply in relation to so much of the income by way of royalty as consists of lump sum consideration for the transfer outside India of, or the imparting of information outside India in respect of, any data, documentation, drawing or specification relating to any patent, invention, model, design, secret formula or process or trade mark or similar property, if such income is payable in pursuance of an agreement made before the 1st day of April, 1976 , and the agreement is approved by the Central Government:

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;

(vi) the rendering of any services in connection with the activities referred to in sub-clauses (i) to (iv), (iva) and (v)

Explanation 4 - For the removal of doubts, it is hereby clarified that the transfer of all or any rights in respect of any right, properly or information includes and has always included transfer of all or any right for use or right to use a computer software (including granting of a licence) irrespective of the medium through which such right is transferred.

Explanation 5 - For the removal of doubts, it is hereby clarified that 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 prayer;

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

Explanation 6. - For the removal of doubts, it is hereby clarified that the expression "process" includes and shall be deemed to have always included transmission by satellite (including up-linking, amplification, conversion for downlinking of nay signal), cable, optic fibre or by any other similar technology, whether or not such process is secret;]

15. Explanations 4, 5 and 6 were inserted by the Finance Act, 2012, which came into retrospective effect from 1-6-1976.

16. The facility which is provided by the Canadian Company used by the assessee is the intranet facility. Therefore, it is necessary for us to understand what "Intranet" facility means. An intranet is a computer network that uses Internet Protocol technology to share information, operational systems, or computing services within an organization. This term is used in contrast to extranet, a network between organizations, and instead refers to a network within an organization. Sometimes, the term refers only to the organization's internal website, but may be a more extensive part of the organization's information technology infrastructure, and may be composed of multiple local area networks. The objective is to organize each individual's desktop with minimal cost, time and effort to be more productive, cost efficient, timely, and competitive.

17. An intranet may host multiple private websites and constitute an important component and focal point of internal communication and collaboration. Any of the well known Internet protocols may be found in an intranet, such as HTTP (web services), SMTP (e-mail), and FTP (file transfer protocol). Internet technologies are often deployed to provide modern interfaces to legacy information systems hosting corporate data. An intranet can be understood as a private analog of the Internet, or as a private extension of the Internet confined to an organization. The first intranet websites and home pages were published in 1991, and began to appear in non-educational organizations in 1994. Intranets are sometimes contrasted to extranets. While intranets are generally restricted to employees of the organization, extranets may also be accessed by customers, suppliers, or other approved parties. Extranets extend a private network onto the Internet with special provisions for authentication, authorization and accounting.

18. Explanation-4 inserted by the Finance Act, 2012 has puts at rest all the controversies and doubts. It expressly states that transfer of all or any rights in respect of any right, property or information includes and has always included transfer of all or any right for use or right to use a computer software including granting of a licence irrespective of the medium through which such right is transferred. Therefore, the terms of Cost Sharing Agreement explicitly mention that the Canadian Company has developed internal telecommunication and communication tool which is accessible only to the members of CGI worldwide. Therefore it is an intranet facility. Further it declares that the Canadian Company holds the intellectual property rights in the said CGI Information Technology Infrastructure facility. It has allowed the assessee to use the said facility subject to the terms and conditions stipulated in the said agreement. Clauses 4.2 and 4.3 deal with the payment of cost to be paid for using the said facility. Clause 4.4 declares that the cost does not include any mark up and is limited to the actual cost. Further, Clause 4.5 declares the permission granted to the assessee to use the facility on payment of cost does not extend to confer on the assessee any right to sell or licence or lease or in any manner "transfer the right assigned therein to other parties". Therefore, it is clear that some right is assigned to the assessee under the agreement on payment of cost. That right is a right to use the facility notwithstanding the fact that the cost is paid. Clause 5 declares the rights of such facility vest with the Canadian Company only. Therefore, it is clear that the cost is paid for using the computer software. When the assessee is allowed to use the said facility, it is nothing but a license to use the said facility. If really the cost paid represents the assessee's share of cost for developing the internal telecommunication and communication tool, on such payment, the Canadian Company can never claim to be the absolute owner of the said intellectual property. If CGI group companies were to pay costs for using the said facility, then the title of the said facility i.e. intellectual property should equally vest proportionate to the cost share by this group companies. That is not the intention behind this agreement. Therefore, we have no hesitation to hold that this Cost Sharing Agreement is only a device to avoid payment of tax as contemplated under the aforesaid provision. It is nothing but a royalty. Therefore, the order passed by the Tribunal is erroneous and requires to be set aside.

19. Learned Senior Counsel for the assessee contended that reimbursement is permissible in law. The agreement is nothing but an agreement for reimbursing the cost of development of internal telecommunication and communication tool. In support of this contention relied upon several judgments. When we looked into the Cost Sharing Agreement, there is no whisper about reimbursement of cost. On the contrary, under the agreement, the assessee has agreed to share the cost. In that view of the matter, the question of considering the case of the assessee for reimbursement of cost would not arise. Accordingly that argument of the learned Senior Counsel in our opinion, does not arise for consideration in the facts of this particular case.

20. The case of the Canadian Company is that it has obtained the intellectual property right by way of license from Microsoft and license fee is paid. After acquisition of the said property by licence, that facility was permitted to be used by its group members, one of which is the assessee. In law, it makes no difference, whether Canadian Company acquired intellectual property either by way of lease or it independently developed the same. The question for consideration in this case is whether what is paid by the assessee to the Canadian Company represents royalty payable for the licence granted to use the said facility or is it a cost of acquisition of the said intellectual property rights. Similarly in one of the cases, what is provided by the Canadian Company to the assessee was not intranet facility and it is only leased line charges. The same reasoning holds good even in respect of the said facility made available to the assessee.

21. It was also contended that this Court has already held in the case of CIT v. Ranka And Ranka 352 ITR 0121 that Instruction No.3/2011 dated 9-2-2011 is retrospective in operation and equally applied to the proceedings pending even prior to 9-2-2011 notwithstanding the fact that Circular expressly states that it is only prospective and therefore, on that basis, relief has to be granted in the case where tax liability is less than Rs. 10.00 lakhs. We do not find any substance in the said contention. The question of extending the benefit of Instruction No.3 would arise only in cases where the tax liability is admitted and the tax payable is less than Rs. 10.00 lakhs. It has no application to the case, where the very liability is disputed. Therefore, in this case, we have held that the assessee is liable to pay tax. In fact, the assessee had paid the tax and therefore, in the facts and circumstances, we are satisfied that the said judgment has no application to the facts of the cases where the tax liability is less than Rs. 10.00 lakhs. It is placed on record that the assessee had no doubt paid the tax, after, deducting the tax at source as contemplated under Section 195(1) of the Act after making payment to the Canadian Company. It is after making the payment, the assessee wanted to test the legality and preferred an appeal before the CIT(A) under Section 248 of the Income Tax Act. When we have held that the tax liability exists and the assessee had already discharged the tax liability by paying the money within the time stipulated, the question of Revenue proceeding against the assessee for recovery of the tax would not arise.

22. Hence, we pass the following order:-

(a) Appeals are allowed.

(b) Impugned orders passed by the Tribunal are set aside.

(d) No costs.

DISCLAIMER: Though all efforts have been made to reproduce the order accurately and correctly however the access, usage and circulation is subject to the condition that VATinfoline Multimedia is not responsible/liable for any loss or damage caused to anyone due to any mistake/error/omissions.