Royalty Payments Under Income Tax Act

Introduction and Importance of Royalty Payments

Royalty means payment of any kind received as consideration for the use of or right to use any intangible property like patent, copyright, design or model, secret formula or process, trademark, trade name or for information concerning industrial, commercial or scientific experience. The essence of ‘royalty’ is that owner of intangible property possessing domain knowledge continues to retain the intangible property and only permits the use or allows the right to use such intangible property. Royalties thus reflect usage-based payments made by one party to another for ongoing use of intangible or tangible assets.

Ownership of intangible can be legal or economic. Where intangible property is legally protected the legal ownership, test applies for transfer of rights in property. But when owner of intangible asset is economic owner the nature of rights enjoyed would depend upon the provisions in domestic law. Although concept of economic ownership is commercial reality it is not recognized in India in the Act or Rules. Royalty contracts are normally made through licensing agreements. The consideration of Royalties can be determined as a percentage of gross or net sales derived from use of the asset or a fixed price per unit sold. Further, there also exist other modes and metrics of compensation.

Transfer pricing regulations provide that the arm’s length character of international transactions involving payment of royalties should be determined by comparing the results or conditions of controlled transactions to the results realized or conditions present in comparable uncontrolled transactions.

Royalty Under Income Tax Act

Finance Act 1976 – Insertion of term “royalty”

Objective –

  • Simplification and rationalization of non-resident taxation

  • Reduce administrative difficulties and uncertainties.

  • Transition from a net income basis of tax for non-residents to gross income basis

Finance Act 2012 inserted following explanations with retrospective from 1 April 1976.

Exempted Royalty

Royalty payable in respect of computer software exempted if-

  • Lump sum payment is made by a resident.

  • For transfer of all or any rights relating to computer software supplied along with a computer or computer-based equipment

  • By a non-resident manufacturer

  • Under any scheme approved under the Policy on Computer Software Export, Software Development and Training, 1986 of the Government of India

“Computer software” means any computer programme recorded on any disc, tape, perforated media or other information storage device and includes any such programme or any customized electronic data

Royalty – Interpretation issues under ITA

Interpretation Issue Point of dispute Resolution Ruling Reference
Meaning of ‘imparting of information concerning technical, industrial, commercial or scientific knowledge, experience or skill’ (‘know-how’) Every information concerning the industries or commercial ventures does not qualify as royalty. Some sort of expertise or skill is required. Some sort of confidentiality/ secrecy & exclusivity is required. It should not be something readily available in the market. (CIT vs. HEG Ltd. (263 ITR 230) (MP)
Allowing access and downloading business Information reports, which is a compilation of publicly available commercial information is not royalty. (Dun & Bradstreet Espana SA (272 ITR 99) (AAR)
Definition of use The application or employment of something; a long-continued possession and employment of a thing for the purpose for which it is adapted (Black Law Dictionary) Criteria for determination of right to use or use of equipment (OECD TAG Report)
  • Customer has physical control / possession over the equipment.
  • Customer has significant interest in the equipment.
  • Provider does not guarantee revenues.
  • Provider does not use the property concurrent to provide services to others.
  • Use or right to use depends on the relation which exists as a matter of fact between the person and the property (Tourapark Pty Ltd v FCT [12 ATR 842])
(Tourapark Pty Ltd v FCT [12 ATR 842])
The expression ‘use’ (of copyright) is not used in a generic and general sense of having access to a copyrighted work. The emphasis is on the ‘use of copyright or the right to use it’. In other words, if any of the exclusive rights, which the owner of copyright, is made over to the customer so that he could enjoy such rights either permanently or for a fixed duration of time and make a business out of it, then it would fall within the ambit of phrase ‘use or right to use the copyright’ (Factset Research Systems Inc [182 Taxman 268])

Exception of capital gain

The definition of royalty excludes any consideration which would be income of the recipient chargeable under the head ‘Capital gains.

  • Clause (i) and (iv) of the definition of royalty provides that transfer of all or any rights in respect of patent, invention, model, design, secret formula or process or trade mark, copyright, literary, artistic or scientific work, etc. would constitute royalty.

  • Definition of ‘transfer’ includes extinguishment of any rights in the asset as per section 2(47) of the Act.

  • Whether the transfer of all or any rights in patent, copyright, etc. can be treated as extinguishment of any right in the asset thereby chargeable under the head ‘Capital gains’.

  • Tests to determine whether transfer of all or any rights in asset would constitute royalty.

    • Ownership of the patent, copyright, etc. is not transferred [HCL Limited (ITA nos. 93/2002 & 120/2008), Delhi Trib.]

    • The asset is appearing in the books of transferor.

    • The income received by the transferor is treated as revenue receipt [Koyo Seiko Co. Ltd 233 ITR 421 (Andhra Pradesh HC)]

    • The transferor does not forego his right to use the patent, copyright, etc. even after the rights are granted/ transferred to the transferee. [Dr. K.P. Karanth 139 ITR 479 (AP High Court)]

    • The transferee does not get enduring benefit out of the rights transferred.

    • The transferee treats the payment made for rights as revenue expenditure.

Deeming rules under the ITA

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:

(a)

(b)

(c)

Summary

Payer of royalty Utilization* Taxable in India
Government - Yes
Indian resident In India Yes
Outside India No
Non-resident In India Yes
Outside India No

Disclaimer:“Information contained herein is for informational purposes only and should not be used in deciding any particular case. The entire contents of this document have been prepared on the basis of relevant provisions and as per the information existing at the time of the preparation. Though utmost efforts have been made to provide authentic information, it is suggested that to have better understanding and obtaining professional advice after thorough examination of particular situation.”

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Prepared By

Muhemmed Anshad

Manager

Date: 13-07-2021