Critical Taxation Issues in Royalty Income in India

In Depth

Critical Taxation Issues in Royalty Income in India

Dr. D. R. Agarwal | October 2015

The issue relating to taxation of royalty income has undergone different interpretations over the period of time by different taxation authorities, judicial pronouncements, double taxation treaties, advance tax rulings and by the transfer pricing authorities on related party transactions. There are also disputes about taxability of royalty as capital receipt or as revenue receipt. Generally royalty is paid as a consideration for licensing of technology, computer software, publication of books, distribution of films and for various other Intellectual property rights. Sometimes royalty is also paid for various tangible rights such as mining of coal, iron ore etc. However the present article shall deal with payment of royalty in respect of various Intellectual property rights such as patent, invention, design, secret formula and for use of trademark of brands. In United States the Bayh – Dole Act was adopted in 1980 for sharing royalty by the inventors for Federal Funded Projects. A similar legislation is desired in India. However there have been recent amendments in the Copyrights Act, 1957 for sharing of royalty by the film artists.

DEFINITION OF THE TERM ROYALTY

The primary section dealing with the scope of income which is chargeable for tax in India is section 5(2) of Income Tax Act 1961. It provides that a person residing outside India or a non- resident is liable for taxation in India on incomes received or deemed to be received in India and on income which accrue or arise to him in India or are deemed to accrue or arise to him in India as provided in sec. 9(1) (vi) of the Act . If the intellectual property right (IPR) being an intangible capital asset is located in India then the consideration for its use or disposal accrues/arises in India and thus is taxable u/s 5(2) read with 9(1)(i) which states that Income arising out of any property in India or through or from any asset in India shall be deemed to accrue or arise in India.

ROYALTY AS DEEMED INCOME

As per section 9(1)(vi) income by way of royalty payable by:

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 . Under section 115A Royalty is to be taxed at 10% for payments made to non residents.

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—

The transfer of all or any rights (including the granting of a license in respect of a patent, invention, model, design, secret formula or process or trade mark or similar property ;
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 ;
The use of any patent, invention, model, design, secret formula or process or trade mark or similar property ;
The imparting of any information concerning technical, industrial, commercial or scientific knowledge, experience or skill ;

(iva) the use or right to use any industrial, commercial or scientific equipment but not including the amounts referred to in section 44BB;

The transfer of all or any rights (including the granting of a license in respect of any copyright, literary, artistic or scientific work including films or video tapes for use in connection with television or tapes for use in connection with radio broadcasting, but not including consideration for the sale, distribution or exhibition of cinematographic films ; or
The rendering of any services in connection with the activities referred to in sub-clauses (i) to (iv), (iva) and (v).

The above definition is very comprehensive and has done away with several controversies.

Deductions from income: Deduction u/s 80QQB for royalty income to authors of books and u/s 80RRB for royalty on patent is deductible as either the whole of such income or subject to a ceiling of Rupees 3 lakhs.

RELEVANT CASE LAWS

CIT Vs Koyo Seiko Co. Ltd.(1998) 233- ITR-421(AP): Royalty excludes any consideration which would be chargeable under the head “Capital Gains”
Citizen Watch Co. Ltd. Vs IAC [(1984) 148-ITR-774 (Kar.)] The High Court held that definition of the term “ royalty” in Explanation 2 to sec 9(1)(vi) is not a general definition applicable where that term occurs but is applicable to sec 9(1) (vi) only.
Goa Carbon Ltd Vs V.M. Muthuramalingam & Anr. [ () 251-ITR- 348 ( Mum)] High Court held that consideration of services rendered only by sending two persons for a specified period to start the working of the machinery in an agreement for transfer of technology is “Royalty” & not “ Fees for Technical Services”
IMT Labs ( India) Pvt. Ltd. [ (2006) 287- ITR-450(AAR)] Advance authority ruled that payment made for use of software through internet on the server situated in USA. It was held that the software on the server is scientific equipment licensed to be used for commercial purpose and therefore payment was held to be Royalty