This article is written by Arunesh Roy, pursuing a Diploma in Entrepreneurship Administration and Business Laws from LawSikho.com. Here he discusses “Royalty and Technical Fees Payable to Foreign Nationals”.
Historical Perspective
In Post liberalization era India has seen a lot of cross border transactions leading to payments of technical fees and royalties to foreign nationals/ foreign companies. With the increase in globalization coupled with the tremendous growth of Information technology and related aspects, import of technical knowhow, import of software and technology services and other intellectual property, has voluminously increased. With the increased focus of the government on the socio-economic development coupled with all-round development of various sectors, the country is faced with more challenges to import the necessary intellectual property and this has resulted in increased outflow of payments in the form of royalties and technical fees.
Time and again various government have taken varied stands with regards to the ease and access to the cross-border transactions depending upon the requirements of the situation and also on the socio-economic requirement. Accordingly, there have been varied rules and regulations depending upon the scenario. Need has been felt by the varied government to keep such transactions easy to use and hence nominal taxes have been charged on such transactions.
Thus over a period of time things have been broadly evolved and now we may see a lot of technical and Intellectual property being used across various aspects which were unheard of before.
Definitions – “Royalty”/“Fees for Technical Services”
“Royalty”
The term “Royalty” refers to the amount of consideration paid to the proprietor or Licensor of intellectual property rights against the benefits derived or sought to be derived by the Licensee or the user. The term Royalty may be paid against the use of copyright, patent, trademark, industrial design, Trade Secret, know-how or combinations of them. However, it may also cover mining royalties, art royalties etc.
The exclusivity of the right in relation to the intellectual property must be with the grantor of the right. Just by passing off the information related to a design of the tailor-made machine to the buyer does not amount to “Royalty”- held in “CIT vs Neyveli Lignite Corporation Ltd (2007). It has also been ruled out by a Texas court that royalty is the share of a product or profit reserved by the owner of the property for permitting another to use it- held in Alamo Nat. Bank of San Antonio Vs Hurd, Tex Civ. App.)
As per section 9 of the Income Tax Act the term “Royalty” means either of the following:
(i) Transfer of any right or the granting of a license, in respect of a Patent, design, process, formula or any kind of similar property.
(ii) Consideration for the transfer of any rights (includes the granting of a license) in respect of a patent, model, design, invention, formula, process, trademark or any kind of similar property.
(iii) The imparting of any information related to the working of or the use of any Intellectual property;
(iv) The use of any patent, invention, model, design, formula, process, trademark or any similar kind of property;
(v) The imparting of any information concerning technical, commercial, scientific, industrial knowledge, experience, skill or any similar kind of property;
(vi) the use or right to use of any equipment such as industrial, commercial, scientific etc;
(vii) The transfer of all or any rights in respect of any copyright, literary, artistic, or scientific work or knowhow including films, or videotapes
(ix) The rendering of any services in connection with the above would also be treated as part of royalty payments
“Fees for Technical Services”
As per Income Tax Act it means any consideration for the rendering of any managerial, technical or consultancy services (including provision of services of other personnel) but does not include the consideration for any construction, assembly, mining or like project undertaken the recipient of the consideration, which would be treated as Salaries in the hands of the recipient.
Thus the terms have been properly elaborated by various acts.
Issues cropped up in making payments of Royalties and Technical Fees to Foreign Nationals
The payments of royalties and technical fees to foreign nationals have led to creeping up of various issues such as type of product or services received a transfer of technology issues, right to commercially exploit the product or services, transfer of limited rights in the product or services transferred etc. Thus numerous challenges have arisen on the basis of final usage of the products/ services and also on the nature of the intellectual property being transferred and the extent of the transfer.
These challenges need to be dealt with properly at various levels by the taxation departments so that the level of taxes levied are minimal and all such transactions may be easily continued without any hassles.
Thus it has led to the evolution of easier systems, rules, regulations, tax rates and continuous involvement of various governments/ departments to keep them easy for entrepreneurs/ aspiring entrepreneurs.
Issues cropped up in Taxation due to Income Categorization
The underlying principle which needs clarity with regards to such matters is whether the transaction involves a transfer of “intellectual property involved” or transfer of the “ product/ services”. This would lead to clarity of the taxation aspect as well as the structure involved.
There is no direct rule in the Income Tax Act categorizing such transactions and payments to foreign nationals against the transactions. It entirely depends upon the nature of transactions. Any payment made by a “resident” to a “non-resident”/ Foreign company towards such transactions could be treated as Royalty, technical fees, capital gains or business income depending upon the nature of the transaction.
Hence various court in India has predominantly depended upon various precedents and other judgements that the category of Income would depend upon the “ Purposes for which the consideration is paid in a transaction”. Broadly in case, the consideration has been paid towards procurement of the “Product”, it would be treated as “Business Income”. However, in case the consideration has been paid towards the right to “Commercially exploit the intellectual property in the product” the same could be treated as royalty and treated accordingly. In case full rights relating to the product have not been transferred, then the income might be treated as “business income” or “Capital Gains”.
The category “ Technical Fees” is less contentious and is generally recognized as any payment for technical services, which involves the application of technical knowledge, experience, skill, know-how, or processes availed by a “resident” from a “ Foreign Company”
Thus usage of various precedents, Court rulings, various judgements, interpretations have let to simplification of understanding the category as well as the nature of the product/services and ultimately has lessened the disputes involved.
Applicability of Tax under Income Tax Act
Section 115A of the IT Act prescribes a tax rate of 10% on the payment of “Royalty” or “Technical Fees” to non-residents. The rate is exclusive of any surcharges or cess applicable to it. Though tax rates have been amended a lot many times finally government realized that a lower tax rate would encourage the budding entrepreneurs and facilitate introducing new technologies as well as Intellectual property leading to faster development of the economy.
However the non-residents need to have a PAN (Permanent account number) as per section 206AA of the IT Act, else tax deduction @ 20% would be required. Further, all such payments arising to a foreign company have also been excluded from the provisions of MAT (Minimum alternate tax), even if the final taxes being levied on such transactions is less than 18.5%.
Though the silver lining is that such nonresidents are not required to file any returns of income, thus leading to lesser hassles and procedural compliances on the part of the income recipients.
Conflict Between Income Tax Act and DTAA (Double Tax Avoidance agreement)
Provisions relating to the taxation of income received by nonresidents of other jurisdictions are generally contained in the DTAA signed off between both the Jurisdictions. The rates of taxation under DTAA are either higher or equal to the rates prescribed under the IT Act. As per section 90 (2), either of the rates of DTAA or rates under the Income Tax act may be chosen by the nonresident, whichever is beneficial to him.
Section 90 (2) also prescribes that PAN is not mandatory for a non-resident even though the rates of taxes applicable are lesser under DTAA. Though certain other documentation formalities need to be completed eg (i) Tax Residency certificate issued by the home country (ii) Declaration in Form 10F as prescribed by IT rules (iii) Self-declaration by non-resident in relation to a permanent establishment in India etc.
Conclusion
The overall aspect of payments of “ Royalty” and “ Technical Fees” to nonresidents have clearly evolved over time. The evolution has taken place through various phases bringing more clarity on the usage, understanding, clarity of terminology, clarity of the nature depending on its use and various technical aspects. Clarity has also been achieved through various precedents, Court judgements, interpretation across the country and from other countries, rules, regulations etc.
Thus we see the changing aspect in terms of the finality of the various underlying usages.
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