Royalty paid by an NR to other NR can't be taxed in India if it arises from patent exploited outside India
The royalty in respect of license granted by a non-resident to another non-resident for manufacturing of CDMA handsets cannot be taxed in India even if these handsets are sold to Indian parties. The source of royalty would be deemed as the place where patent is exploited, viz, where the manufacturing activity takes place, which is outside India. Hence, the Indian parties would not constitute source of income for the OEMs
Qualcomm Incorporated ("the appellant") was a company incorporated in the USA and was engages in development and licensing of CDMA technology. The appellant granted license to 'use and sell CDMA technology' to the unrelated Original Equipment Manufacturers ('the OEMs'), who were non-resident and were located outside India, in consideration for royalty. The licenses granted by the appellant to the OEMs were used for manufacturing of handsets and network equipments, which, in turn were sold to various parties located outside India and in India.
The appellant contended that the royalty income earned by it from the OEMs of CDMA mobile handsets and network equipments sold in India was not taxable in India either under Section 9(1)(vi)(c) of the Act or under Article 12(7)(b) of the India-USA DTAA.
However, the revenue argued that:
(a) The patented technology of the appellant was used by the OEMs to manufacture India-specific products and that the handsets were customized and programmed to include a Code assigned to a specific operator. Hence, there was a certain degree of use of the property for the purpose of carrying on business in India;
(b) The appellant had made available to the OEMs its patented intellectual property relating to CDMA technology in the form of chip sets which were inserted by the OEMs into the handsets, which, in turn, were licensed to Indian operators and, hence, they had a source of income in India. Further, it argued that these chip sets had embedded software which helped in functioning of hardware.
The Tribunal held in favour of assessee as under:
(1) The license to manufacture products by using the patented intellectual property of the appellant had not been used in India as the products were manufactured outside India and when such products were sold to parties in India it couldn't be said that OEMs had done business in India;
(2) Sale in India without any operations being carried out in India would amount to business with India and not business in India;
(3) The patents of the appellant were used for manufacture of handsets and infrastructure equipments which were sold worldwide. No patents of the appellant had been used for customization of handsets;
(4) Technology for manufacturing products was different from products which were manufactured from the use of technology for which the appellant had patents;
(5) The role of appellant ended when it licensed its CDMA technology for manufacturing handsets and when it collected royalty from OEMs on these products;
(6) There was no finding that the OEMs had carried on business in India or a part of the sale consideration was attributable to any sale or licensing of software carried out in India. When OEM's itself were not brought to tax, to hold that the appellant was taxable was not correct.
(7) The provision of Section 9(1)(vi)(c) has two limbs:
(a) The first limb covers cases where the right, property or information has been used by the non-resident payer (OEM) itself and is so used in business carried on by OEM's in India. In the present case, the OEMs had not carried on business in India. The OEMs couldn't be said to have used the appellant's patents for the purpose of business in India;
(b) The second limb covers a case where the right, property or information has not been used by the non-resident payer (the appellant) itself in the business carried on by it, but the right, property and information had been dealt with in a such manner as would result in earning or making income from a source in India. The source of income is the activity that gives rise to the income. In the present case, the right, property or information licensed to OEMs related to the manufacture of the products and, hence, the source was the activity of manufacturing. The source of royalty was the place where patent was exploited, viz, where the manufacturing activity took place, which was outside India. Hence, the Indian parties would not constitute source of income for the OEMs.
(8) On the basis of agreement between OEM's and Indian parties, the ITAT held that it was clear that the software didn't have an independent use and was an integral part of the hardware without which the hardware couldn't function. The software supplied was a copyrighted article and not a copyright right;
(9) The software was only used with the hardware and was not independent of the equipment or the chipset. Since no separate consideration was paid by Indian parties for licensing of the software and the consideration was paid only for the equipment which had numerous patented technologies, the sale couldn't be bifurcated or broken down into different components.
Thus, the royalty earned by the appellant couldn't be brought to tax in India under Section 9 of the Act.