2006-VIL-367-ITAT-MUM

Equivalent Citation: [2007] 11 SOT 578 (MUM.)

Income Tax Appellate Tribunal MUMBAI

IT APPEAL NO. 2714 (MUM.) OF 2001

Date: 13.10.2006

KOTAK MAHINDRA PRIMUS LTD.

Vs

DEPUTY DIRECTOR OF INCOME-TAX, TDS CIRCLE 1(1)

BENCH

PRAMOD KUMAR AND MS. SUSHMA CHOWLA, JJ.

JUDGMENT

Pramod Kumar, Accountant Member - The short issue that we are required to adjudicate in this appeal is whether or not the CIT(A) was justified in holding that the assessee before us, i.e., Kotak Mahindra Primus Limited, was required to withhold tax @ 15% from payment of Australian Dollars (A$) 3,25,000 made to M/s. Ford Credit Australia Limited, Australia (Australian company, in short).

2. These developments leading to this litigation before us are as follows. The appellant tax deductor is an Indian company jointly formed by Kotak Mahindra Finance Limited, India, (KMFL, in short) and Ford Credit International Inc., USA (FCII, in short). The appellant is a non-banking finance company and is mainly engaged in the business of providing finance for purchase of cars. On 4th April, 2000, the appellant moved an application to the Assessing Officer for permission to remit A$ 3,25,000 to Australian company without any deduction of withholding taxes. The above payments were made under an agreement dated 30th April, 1997 between appellant and FCII. The relevant provisions of the said agreement were as under :

5.5 On Going Payment Charges

A.The company shall pay to Ford Credit an Annual Maintenance Fee charge of US $ 60,000 for ensuring that system updates are provided as released by Ford Credit as well as permitting the company to have access to Ford Motor Company and/or its affiliates’ overseas based mainframe computer system and its software applications, for the running and operating of the business operations of the company. It will be a requirement that the system solutions being provided, will always be targeted to leverage on Ford Credit’s worldwide automotive financing business at, at the leading edge of the technology, and have specific applicability and competitiveness in operating for the company.

B.In addition, there will be a monthly invoice charge for the costs associated with running the business operations of the company on the Ford Motor overseas based mainframe computer. Such costs will be based upon actual incurred costs for the link to the overseas based mainframe computer, and for the machine run time to process the company’s transaction.

3. As for the break up of the remittance of A $ 3,25,000, between the two segments set out above, the same was as under :

System Annual Maintenance and Licensing Charges

4. The contention of the appellant was that the above amounts were not chargeable to tax in India in the hands of the Australian company, and, therefore, the appellant did not have any liability to withhold tax from the said remittance. Broadly, the contention of the appellant was the sum of A$ 3,25,000 was paid towards data processing costs. This payment was in the nature of business profits in the hands of the Australian company and since Australian company did not have a permanent establishment (PE) in India, the same could not be charged to tax in India in terms of article 7 of the India Australia Double Taxation Avoidance Agreement (the tax treaty, in short). The appellant also submitted that the payment cannot be treated as a royalty in terms of article 12(3)(b) of the tax treaty for the reason that the appellant did not have any physical access to the mainframe computer and that the payment cannot be said to be for use of equipment but rather for consolidated computer processing facilities, It cannot also be covered by the article 12(3)(a) because the appellant has not been granted any right to use any intellectual property rights of the kind referred to in article 12(3)(a). As for the scope of article 12(3)(c), it was contended that the payment cannot said to be for supply of information as it is only the information in the possession of the appellant which is processed by the Australian company. None of these submissions, however, impressed the Assessing Officer. The Assessing Officer noted that the appellant i.e., the Indian company is having access to the mainframe computer of Australian company that software utilized in the CPU of the mainframe computer is that of the Australian company, and that the Australian company has allowed the Indian company to use the same. The Assessing Officer further observed that the mainframe computer is directly accessible to the Indian company and that, to make sure this availability to the Indian company, booking for capacity usage are made in advance. It was thus concluded that the Indian company is thus allowed to use the software, developed and protected by Australian company. The Assessing Officer further observed that there are three main tests to be satisfied for a payment to be classified as royalty payment. These tests according to the Assessing Officer, are as follows :

(1)It is a payment made in return for a right to exercise a beneficial privilege or right.

(2)The payment is made to a person who owns the right.

(3)The consideration payable is determined on the basis of amount of usage.

5. All the three tests, according to the Assessing Officer, "squarely cover" the annual maintenance, licensing charges and data processing charges. It was also observed that the payment can also be viewed as payment for the use of scientific equipment i.e., the mainframe computer. The location of the computer is immaterial because the computer could be used from any corner of the world, if it is available on line through any communica-tion system. The Assessing Officer thus concluded that the payments made by the Indian company to the Australian company were covered by the scope of expression ‘royalty’ appearing in section 9(1), Indian Income-tax Act, 1961, as also in article 12(3)(a) of the applicable tax treaty. Reliance was also placed on the ruling given by the Authority of Advance Ruling in Petition No. 30 of 1999, reported as ABC, In Re [1999] 238 ITR 296¹. On this basis, the Assessing Officer directed the Indian company to deduct tax at the rate of 15 per cent of the gross payment. It was also directed that in case the Indian company is to bear the tax liability, the withholding tax will have to be grossed up under section 195A of the Income-tax Act. Not satisfied by the stand so taken by the Assessing Officer, the Indian company carried the matter in appeal before the Commissioner (Appeals) but without any success. The stand of the Assessing Officer was reiterated and confirmed by the Commissioner (Appeals). The assessee is not satisfied and is in second appeal before us.

6. We have heard the rival contentions, perused the material on record and duly considered the factual matrix of the case as also the applicable legal position.

7. We find that the Government of India has entered into a comprehensive Double Taxation Avoidance Agreement with the Government of Austra- lia [in (1992) 194 ITR (Statute) 91], and, as is the settled legal position in view of the provisions of section 90(2) of the Indian Income-tax Act, 1961, the provisions of the tax treaty prevail over that of the domestic law unless the domestic law is more beneficial to the assessee. Therefore, in case we come to the conclusion that the payment in question is not taxable in terms of the provisions of the applicable tax treaty, there is no need to address ourselves to the scope of provisions of the domestic law. We must, therefore, address ourselves to taxability of the impugned payment in the light of the treaty provisions. Learned Departmental Representa- tive, however, submits that first we have to see whether the payment is taxable in India in terms of the provisions of the domestic law, and, if we come to the conclusion that the payment is taxable in India, we may examine whether it is exempt from tax in India in terms of the provisions of the applicable tax treaty. We see no merits in this stand of the revenue. A tax treaty, most importantly, provides for allocation of taxing rights between the contracting States or tax jurisdictions, so far as the persons covered by the scope of the tax treaty are concerned. Once a tax jurisdiction, other than the domicile jurisdiction, has a right to tax that income, a tax treaty further provides the manner in which such an income can be taxed and also the manner in which the corresponding tax credit that such a person will get in the domicile country in respect of the taxes so paid in a country other than domicile country. It cannot be viewed as an exemption regime, as learned Departmental Representative suggests. Therefore, the question of whether or not a particular payment is taxable in a Contracting State, in the hands of a person who is, not domiciled in that Contracting State, is irrelevant unless it is, first established that the Contracting State, as a tax jurisdiction, has a right to tax that payment. We reject the contention of the learned Departmental Representative and proceed to adjudicate upon taxability of impugned payments, in India, in the hands of the Australian company in the light of the provisions of the applicable tax treaty. We have to adjudicate on the taxability of the Australian company in India first. After all, a tax withholding liability is a vicarious or substitutionary liability and it presupposes the existence of a primary and basic tax liability of the person from whose income-tax is to be withheld. Therefore, unless such a tax liability exists, there cannot be any question of any tax withholding liability.

8. It is first necessary to analyze and appreciate correct nature of payment of A$ 3,75,000 made to the Australian company. As preamble to the supplemental investment agreement dated 30th April, 1997, under which the payment is made, sets out, the arrangement "contemplated services to be rendered by Ford Credit and/or their affiliates, and payment therefore to be made by the joint venture company, namely Kotak Mahindra Primus Limited", it was in this background, and upon obtaining the approval of the Government of India, that the Indian company entered into this agreement with the Australian company, which is, beyond any dispute or controversy, an affiliate of the FCII. The relevant provisions of the agreement have already been extracted in second paragraph of this order earlier. The entire payment is in the nature of ‘on going payment charges for data processing’. No doubt, a part of this data processing cost is in the nature of fixed cost, i.e., US $ 60,000 as annual maintenance and licensing charges, whereas the other part of the cost is in the nature of variable cost, i.e., @ A$ 5.041 per unit of processing of contract. However, both these segments, i.e., fixed as also variable, are only payments for processing of data, and cannot be considered in isolation with each other. The ‘annual maintenance fee charge’ does not give any independent rights to the Indian company, as it allows the Indian company only to avail data processing by the Australian company at a specified unit rate. Similarly, per unit cost of data processing is also meaningless unless the fixed annual charge is paid because the Indian company cannot avail this unit cost of processing unless the fixed annual charge is paid. These charges are complementary and can only be considered in conjunction.

9. Learned Departmental Representative submits that this type of pay-ment cannot be for data processing alone, as there cannot be any good reasons to split the data processing cost into two parts. He suggests that what is paid as annual maintenance fees is certainly a royalty payment for right to use of mainframe computer, and the costs per transaction is also a payment for the use of computer as it pertains to actual usage of the computer. In any event, according of the learned Departmental Representative, the payment for annual maintenance fees cannot be said to be for data processing, as it is independent of data processing charges. There cannot be two payments for one task of data processing, according to the learned Departmental Representative. We are, however, not im-pressed by this plea either. This type of pricing of a service, by segregating the fixed and variable price, is not unusual and is fully justified when a business does not seek to make profit, does not seek to maximize the profits or does not seek profits to vary in proportion to scale of operations. That is a typical situation when one of the group concerns has to service the other group concerns, without profit maximization as a primary driving force. Take for example, a situation in which a data processing unit XY has to serve units A, B, C, D and E. Let us assume that this XY unit has fixed costs of $ 5,00,000, incremental or variable cost of $ 1 per unit of data processing, and XY unit expects to process 50,00,000 units of data each year evenly supplied by all the five units it has to serve. Let us further assume that XY unit seeks to make a profit of $ 5,00,000 per year to meet its capital costs. In these circumstances, broadly the pricing options will be as follows :

(* $ 1 is the price per unit transaction when the unit XY seeks to make unit profit entirely insensitive to scale of operations and actual volume of data processed. In case, unit XY seeks to fix unit price so as the profits of the unit are sensitive to the scale of operations to small or marginal degree, which appears more closer to the real life situations even when the unit is servicing other group organisations, the variable price could be fixed say at $ 1.05 per data unit. Either way, the unit XY eliminates the risk of losses, even as it sacrifices, by choice or due to inherent limitation of this model of pricing, profit maximization opportunities.)

B. Overall price per unit of data

$ 5,00,000 + $ 5,00,000 + $ 50,00,000/50,00,000

10. The disadvantage in option B, however, is that the profits of unit XY will vary in case the actual units of data processing are more than or less than the estimated units of data processing. In case the actual data processing units are only 40,00,000, the profit will stand reduced to $ 3,00,000, and if the actual data processing units are less than 25,00,000, the unit XY will incur losses. Similarly, in case the actual data processing units go up to 75,00,000, the profit of XY unit will go up to $ 10,00,000. On the other hand, irrespective of the scale of operations and the actual units of data processed, the profits of XY remain the same in option B. The reason is simple. The variable cost per data processing unit is the actual incremental cost that the unit has to bear for processing of the data unit. The fixed costs and targeted surpluses and profits are taken into account by the fixed prices, and this ensures that the profits do not fluctuate much due to scale of operations.

11. There are therefore, not only good reasons to segregate fixed and variable components for price of one service, but such a method is fully justified and is most appropriate in intra group transactions, as is the case before us. The consideration for payment is only this data processing work. No part of this payment can be said to be for the use of specialized software on which data is processed or for the use of mainframe computer because the Indian company does not have any independent right to use the computer or even physical access to the mainframe computer, so as to use the mainframe computer or the specialized software. All that the right is for processing of data, and the use of mainframe computer is permitted only for that purpose. The Indian company can feed the raw data in the mainframe computer in Australia, with the help of the telecommunication link, and the output data, after due processing, is transmitted back to the Indian company. There is no privilege or right, granted to the Indian company by the Australian company. The control of the Indian company is only on the input transmission and the right is to get the output processed data back. The actual processing of data is in the exclusive control of the Australian company, and it is for this work that the Australian company gets paid. In our considered view, therefore, in essence the impugned payment is made to the Australian company in consideration of its processing of data belonging to the Indian company.

12. Let us now examine the taxability of this payment, in India, in the hands of the Australian company, in the light of the provisions of the India Australia Double Taxation Avoidance Agreement.

13. We consider it appropriate to reproduce the provisions of article 12(3) of India Australia Double Taxation Avoidance Agreement, which have been pressed into service by the revenue authorities. This Article reads as follows :

Article 12 : Royalties

1 & 2. ******

3. The term "royalties" in this article means payments or credits, whether periodical or not, and, however described or computed, to the extent to which they are made as consideration for :

(a)the use of, or the right to use, any copyright, patent, design or model, plan, secret formula or process, trade mark, or other like property or right;

(b)the use of, or the right to use, any industrial, commercial or scientific equipment;

(c)the supply of scientific, technical, industrial or commercial knowledge or information;

(d)the rendering of any technical or consultancy services (including those of technical or other personnel) which are ancillary and subsidiary to the application or enjoyment of any such property or right as is mentioned in sub-paragraph (a), any such equipment as is mentioned in sub-paragraph (b) or any such knowledge or information as is mentioned in sub-paragraph (c);

(e)the use of, or the right to use :

(i)motion picture films;

(ii)films or video tapes for use in connection with television; or

(iii)tapes for use in connection with radio broadcasting;

(f)total or partial forbearance in respect of the use or supply of any property or right referred to in sub-paragraphs (a) to (e); or

(g)the rendering of any services (including those of technical or other personnel) which make available technical knowledge, experience, skill, know-how or processes or consist of the development and transfer of a technical plan or design; but that term does not include payments or credits relating to services mentioned in sub-paragraphs (d) and (g ) that are made;

(h)for services that are ancillary and subsidiary, and inextricably and essentially linked, to a sale of property;

(i)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;

(j)for teaching in or by an educational institution;

(k)for services for the personal use of the individual or individuals making the payments or credits; or

(l) to an employee of the person making the payments or credits or to any individual or firm of individuals (other than a company) for professional services as defined in article 14.

14. As far as the scope of article 12(3)(a) is concerned, we find that it covers only a payment for the use of, or the right to use of, any copyright, patent, design or model, plan, secret formula or process, trade mark, or other like property or right. The case of the revenue is that the payment is made for the use of specialized software with the help of which data is processed. We are not persuaded. As we have concluded earlier in this order, on the facts of this case, the payment made by the Indian company, is not for the use of, or right to use of, software, the payment is for data processing. Be that as it may, even if stand of the revenue is to be upheld and it is to be concluded that the payment is made for software per se, that does not lead to taxability of receipt in the hands of the Australian company either. It is also by now settled that the payment for software is a for a copyrighted article and not copyright per se, and, therefore, is not covered by the scope of payment for copyright. The authority for this proposition is contained in Special Bench decision in the case of Motorola Inc. v. Dy. CIT [2005] 95 ITD 269 (Delhi) (Mag.) Samsung Electronics Co. Ltd. v. ITO [2005] 94 ITD 91 (Bang.) and Lucent Technologies Hindustan Ltd. v. ITO [2005] 92 ITD 366 (Bang.) It is not even the revenue’s case that the payment in question is not for the use of, or right to use of, patent, design or model, plan, secret formula or process, or trade-mark. In any event, having perused these classifications and having considered the facts before us, we are of the considered view that the payment does not fit into any of these classifica-tions. It is, however, contended that the impugned payment is covered by the residuary clause i.e., "other like property or right". It is contended that by making payment of US $ 60,000 per annum, the Indian company gets a valuable property and right as the payment cannot be said to have been made in vacuum and without any consideration. This plea also does not impress us. It is not every property or right which can be covered by these expressions appearing in the end of article 12(3)(a), because, following the principles of ejusdem generis meaning of the general words following the specific words have to take colour from the specific words preceding it. When that property or right, even if it so exists, is not of the nature of any of the specific categories set out in article 12(3)(a), it cannot be covered by the general words following those categories either. For all these reasons we are of the considered view that provisions of article 12(3)(a) cannot be invoked on the facts of the case before us.

15. That takes us to the question whether the provisions of article 12(3)(b), as relied upon by the revenue authorities, can be invoked on the facts of the present case. Article 12(3)(b) can apply only when the payment in question can be held to be payment for "the use of, or the right to use, any industrial, commercial or scientific equipment". This condition can only be satisfied when it is established that the impugned payment is made for the use of, or right to use of, mainframe computer. The Indian company does not have any control over, or physical access to the mainframe computer in Australia. There cannot, therefore, be any question of payment for use of the mainframe computer. It is indeed true that the use of mainframe computer is integral to the data processing but what is important to bear in mind is the fact that the payment is not for the use of mainframe computer per se, that the Indian company does not have any control over the mainframe computer or physical access to the mainframe computer, and that the payment is for act of specialized data processing by the Australian company. Use of mainframe computer in the course of processing of data is one of the important aspects of the whole activity but that is not the purpose of, and consideration for, the impugned payment being made to Australian company. The payment, as we have observed earlier, is for the activity of specialized data processing. It is neither practicable, nor permissible, to assign monetary value to each of the segment of this economic activity and consider that amount in isolation, for the purpose of deciding character of that amount. Therefore, neither the impugned payment can be said to be towards use of, or right to use of, the mainframe computer, nor is it permissible to allocate a part of the impugned payment, as attributable to use of, or right to use of, mainframe computer. Accordingly, the provisions of article 12(3)(b) cannot have any application in the matter.

16. We now come to the provisions of article 12(3)(c) of the India Australia tax treaty. It provides that where the payment is for "the supply of scientific, technical, industrial or commercial knowledge or information", the same shall be considered as ‘royalty’ for the purposes of article 12 of the treaty. By no stretch of logic, it could be said that the payment is made to the Australian company for the supply of any knowledge or information or any nature whatsoever. Learned Departmental Representative could not point out any legally sustainable reasons on the basis of which the payment can be said to be covered by article 12(3)(c). We have also carefully considered factual matrix of the case and are of the considered view that the payment in question cannot be said to be for the supply or any knowledge or information. The information is in fact furnished by the Indian company, the same is processed in Australia and transmitted back to the Indian company. This activity only involves processing, and not supply of information. Accordingly, the provisions of article 12(3)(c) will also not have any application in the matter.

17. It is not also the case of the revenue that remaining parts of article 12(3), i.e., article 12(3)( d) to article 12(3)(l), will have any application in the matter. No specific arguments are advanced in this regard in any event, we have also carefully considered these provisions as also the facts of the case before us, and we are of the considered view that these provisions also have no application in the present situation. The impugned payment cannot be said to be for consultancy services, in terms of the provisions of article 12(3)(d). This payment cannot also be said to be for making available any technical knowledge, experience, skill, know-how or processes etc. in the sense that recipient of services, i.e., Indian company, is not enabled to make use of technical knowledge on its own, without recourse to the provider of service, which is sine qua non for making available’ technical knowledge, experience, skill, know-how etc. in terms of provisions of article 12(3)(g). It is also not covered by any other clause of the article 12 either. As regards learned Departmental Representative’s reliance on the ruling given, by the Hon’ble Authority for Advance Ruling in the case of ABC ( supra), in the light of the detailed reasons set out above, we see no need to deal with the same separately. The Assessing Officer had adopted the reasoning approved by the Hon’ble Authority for Advance Ruling and we have dealt with the same in the course of our consideration to the matter. The prescription of section 245S is unambiguous. Section 245S of the Act provides that the Advance Ruling pronounced by the Authority under section 245R will be binding only on the applicant who had sought it, in respect to the transaction in relation to which the ruling had been sought, on the Commissioner, and the income-tax authorities subordinate to him, in respect to the applicant and the said transaction. It is, therefore, obvious that, apart from whatever its persuasive value, it would be of no help to us. We are not inclined to disturb our conclusions merely because the conclusions arrived at above, and in the light of detailed reasons set out earlier in the order, are at variance with the conclusions arrived at in the said ruling. We have carefully perused the esteemed views of the Hon’ble Authority for Advance Ruling, and, with respect but without hesitation, we are not persuaded.

18. In view of the above discussions, in our considered view, the impugned payment cannot be held to be covered by the scope of expression ‘royalty’ under article 12(3) of the India Australia Double Taxation Avoidance Agreement. Since the Australian company admittedly does not have any permanent establishment (PE) in India, this payment cannot also be taxed as a business profit of the Australian company in India. It is so in view of the fact that article 7(1) of the applicable tax treaty specifically provides that, "The profits of the enterprises of one of the Contracting States shall only be taxable in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein". This leads us to the conclusion that the right of Indian tax jurisdiction does not extend to taxing the impugned payment of A$ 3,25,000 to the Australian company, i.e., FCAL, for specialized data processing of information furnished by the Indian company.

19. Having held that the Australian company, i.e., FCAL, did not have any tax liability in India, and as the tax withholding liability is only a vicarious and substitutionary liability, we also hold that the appellant before us, i.e., Indian company by the name of Kotak Mahindra Primus Limited, did not have any tax withholding liability so far the payment of A $ 3,25,000 to the Australian company was concerned. The plea of the appellant is accepted.

20. For the reasons set out above, we vacate the orders of the authorities below. We also direct the Assessing Officer to refund the taxes deposited by the appellant company, after verifying that the appellant company has not issued tax deduction at source certificate under section 203 and, accordingly, the credit for the tax deduction at source has not been given to the Australian company in its income-tax assessment in India. The appellant will get the relief, if so admissible in law, accordingly.

21. In the result, the appeal is allowed.

 

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