Factors Impacting the Characterisation of Payments

The ambiguity in taxation of such payments in the nature of subscription charges/fees etc. for data retrieval/access to database needs to be redressed both, on domestic as well as international front. While the commercial terms used for access to database may vary across business models, the facts and substance of the transactions in each case shall have to be examined to ascertain the true character of the payments. Few of the factors which may be relevant in determining the taxability of such payments are illustrated as under:-

  1. The nature of rights granted reading rights, downloading rights, commercial exploitation of rights etc.
  2. Exclusivity of rights for use of database or otherwise
  3. Nature of content of the database
  4. Right to use the process/use or right to use, any industrial, commercial or scientific equipment.
  5. Whether access to data/information requires specific software or hardware or regular internet connection would suffice.
  6. Content of information being accessed, whether raw data is compiled and provided or it intends to impart any information concerning technical, commercial or scientific knowledge.

This list is only illustrative and not exhaustive, and some of these factors may not be relevant in a particular case. All relevant facts having a bearing on the substance of the transaction should be taken into account while determining the true character of the payments so as to determine the taxability, if any, of the payments. As we go along in this article, we shall briefly deliberate upon the taxability of payments in the nature of access to database, fees for data retrieval, subscription fees etc. along with an analysis of the Indian jurisprudence dealing with the contentious issue of treatment of such payments. It may be pertinent to note that there are numerous factors associated with characterisation of payments as Royalty or otherwise and it is in itself a fact intensive exercise.

Royalty- The Indian Tax Scenario

The concept and scope of the expression “royalty” has been subject matter of prolonged litigation and reason for consequential amendments to the relevant provisions of the Act. India taxes royalties on the basis of source rule of taxation. Identifying the true nature of income sourced by a non-resident from India, is of critical importance for the purposes of determining the exigibility of such income in India.

The term ‘royalty’ has been defined in Explanation 2 to Section 9(l)(vi) of the Act’. Under the present definition in Section 9(l)(vi) of the IT Act, 1961 royalty includes (a) transfer of all or any rights in respect of patent, invention, model design, secret formula, etc. (b) imparting of any information in respect of (i) above (c) use of patent, invention, model design, secret formula, etc. (d) imparting technical, industrial, commercial or scientific knowledge (e) transfer of all or any rights in respect of copyright, literary, artistic or scientific work etc. (f) any services in connection with all the activities mentioned above.

The Finance Act, 2012 w.r.e.f. 1-6-1976 clarified the definition of royalty so as to include within its scope the payment made for use of any right in property, or information, irrespective of whether such right in property, or information was directly used by the payer, whether the possession or control of such right is with payer or whether the location of such right in property, or information was in India or not. In other words if there was a use, then, irrespective of possession, control with the payer or use by someone else on behalf of payer, or the location of right in property or information in India, the consideration would nevertheless be treated as ‘royalty’. The net result was that if there was a use of any right in property, or information in India, the payment would be held as royalty.

Thus, for holding a payment as royalty, it was earlier considered necessary to find out where the services were rendered or where the equipments/ patent/invention were used. If they were used outside India, the payment was held as not taxable in India. The amendments were made to the Income-tax Act by the Finance Act, 2012 with retrospective effect from 1-6-1976 so as to do away with the condition of rendering of services in India or use of property or information etc. in India, so long as situs of such property or information etc. was in India or services rendered were utilised in India.

 

It may also be pointed that the Memorandum to the Finance Act, 2012 stated that there are certain judicial pronouncements which have created doubts about the scope and purpose of Sections 9 and 195 of the Act. It also stated that there are conflicting decisions of various judicial authorities on certain issues in respect of income deemed to accrue or arise in India. Though it was stated in the Memorandum that the changes made were clarificatory in nature intending to provide certainty in law, the said amendments has far reaching consequences as it has overturned a number of existing judicial pronouncements favouring the assessee.

The phrase ‘royalty’ has, thus been very widely defined under the Act and hence, based on the above definition, one would need to analyse whether payments made in the nature of subscription/fees/ charges etc. for data retrieval/access would fall under any of the above clauses of royalty definition i.e. (i) to (vi) to Section 9(1) of the Act.

Indian Jurisprudence-An Analysis

  1. Whether payments for use of Electronic Database fall within the ambit of Royalty? Issue:

The issue before the Karnataka High Court was whether payment made to foreign company for providing access to information, available in the data base maintained by the said company in foreign country is to be regarded as royalty?

Nature of payments/transactions:

The assessee paid subscription to a foreign company to access the business data collated, collected and maintained by it. Data pertaining to the technology/software area of business was published periodically through web and was available on subscription as well.

Ruling:

Bangalore ITAT in the case of Wipro Ltd.1 had held that the payments to the web based publishing house giving access to the data was not covered as Royalties under Article 12(3)(a) of the Double Taxation Avoidance Agreement between India and USA and therefore not amenable to tax in India. The arguments supporting the said ruling were:

  1. Access given is to all those who are willing to pay towards publications obtaining market data.
  • It is a copyrighted information and cannot be

passed on to anyone else and is not a transfer of right in the copyright material.

  1. Access is restricted to specific individuals named by the assessee and fees is payable even if no service is utilised.
  2. It is more like an entry fee and not for imparting of information.
  3. The transaction is similar to purchase of a book, which allows use of information contained therein but does not transfer the copyright therein

On Revenue’s appeal before the Karnataka High Court, it was held[1] that the payments were in the nature of royalty. The High Court held that the mere fact that in the instant case, the issue does not pertain to shrink wrapped software or off-the shelf software and access to database is granted online, would not make any difference in holding such payments to be in the nature of Royalty. It also held that the right to access the database amounted to transfer of right to use the copyright. Further, the payment made by the taxpayer to the foreign publisher was for the license to use the said database and therefore it should be treated as royalty.

Our Comments

It appears that the Karnataka High Court has simply equated the nature of transaction of access to Electronic Database with purchase of shrink wrapped or off-the-shelf software. Enormous reliance was also placed on its own judgment in the case of Samsung Electronics Co. Ltd.[2] where it has been held that the payment for shrink wrapped software is in the nature of royalty. It may be noted that as on date, the assessee’s appeal against the earlier judgment (in Samsung’s case) is pending before the Supreme Court. It may be pertinent to note that the nature of transaction is of pivotal importance in determining its taxability. It seems that while classifying the payments as Royalty, the High Court has neither emphasised on the nature of transactions nor distinguished the same with shrink- wrapped or off-the-shelf software.

  1. Whether payments for use of Online Data Processing fall within the ambit of Royalty? Issue:

The issue before the Tribunal was whether payment made to foreign company towards processing of data in foreign country is to be regarded as royalty for use of‘equipment’ or ‘process’?

Nature of payments/transactions:

The assessee entered into a hubbing agreement with foreign company for availing data processing support. The foreign company had a data centre in Singapore and it made available certain disc space for exclusive use of the assessee. The assessee transferred raw input data through application usage, the data was then processed at the data centre in Singapore as per the assessee’s requirements and subsequently the processed data was transmitted electronically to the assessee.

Ruling:

Mumbai ITAT in case of Standard Chartered Bank[3] held that the nature of payments could neither be construed towards use or right to use industrial, commercial or scientific equipment nor towards use or right to use a process. The Tribunal held that since the assessee did not have any right to access the mainframe, it could only send data to the mainframe and receive back processed data in a particular form and therefore use or right to use a process was not present in this transaction. Similarly, the assessee had no possessory rights in relation to the computer mainframe and just because it took advantage of use of a facility or use of sophisticated equipment, it could not be said that it used’ the equipment as such. In view of the above, the Mumbai Tribunal concluded that payment for use of disc space in hardware cannot be termed as Royalty (within the meaning of Article 12(3)(b) of the India-Singapore Treaty) in guise of use of a process or towards use of industrial, commercial or scientific equipment.

Our Comments

On the basis of the ruling of the Tribunal, it can be opined that the payments shall not be classified as Royalty for use of a facility on the basis of control over such facility by the user. Moreover, in order to consider a payment as royalty, there must be a positive act of use or possession or use of that property or

The concept and scope of the expression “royalty”
has been subject matter of prolonged litigation and
reason for consequential amendments to the relevant
provisions of the Act. India taxes royalties on the basis
of source rule of taxation. Identifying the true nature
of income sourced by a non-resident from India is of
critical importance for the purposes of determining
the exigibility of such income in India.

equipment. Mere data processing charges cannot be construed as royalty, nature of services rendered is very important to come to a conclusion as to whether the payment is in the nature of royalty or not. It is imperative that there should be a real access to the whole process or to the equipment.

  1. Whether payments for information available from website fall within the ambit of Royalty? Issue:

The issue before the Authority for Advance Rulings (AAR) was whether payment made for electronic purchase of Business Information Reports (BIR’s) to foreign company will be taxable in India?

[1] CIT vs. Wipro Ltd [2011] 16 taxman 275 (Kar)

[2] CIT vs. Samsung Electronics Co. Ltd. ITA No 2808/2005

[3] Standard Chartered Bank vs. DDIT [2011] 14 taxman 4(Mumb)

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