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MANU/IJ/5003/1998

Equivalent Citation: [2000]243ITR60(JP)

IN THE ITAT

ITA No. 378/JP/1997; Asst. yr. 1997-98

Decided On: 30.10.1998

Appellants: Modern Threads (India) Ltd.

Vs.Respondent: Deputy Commissioner Of Income Tax

Coram:Nathu Ram, Pradeep Parikh and R.K. Gupta

Subject: Direct Taxation

Acts/Rules/Orders:Income Tax Act, 1961 - Sections 9(1), 90(2), 195(2) and 255 (4)

ORDER

R.K. Gupta, J.M.

October, 1997

1. This is an appeal filed by the assessee directed against the order of the CIT(A), Jaipurdt. 11th March, 1997. The appellant has taken the following grounds in this appeal :

1. That, on the facts and in the totality of the circumstances and material available, thelearned CIT(A) has erred in law as well as on facts in holding that the lumpsum technicalknow-how fees of USD 250 lakhs and basic process engg. documentation fees of USD 35lakhs were in the nature of 'Royalty' under art. 13(3) of the Double Taxation Avoidanceagreement (DTAA) between India and Italy without appreciating that the consideration ofUSD 250 lakhs and USD 35 lakhs are for acquiring technical know-how and basicprocess engg. documentation and are not the consideration for the use of or right to usesuch Know-how and basic process engg. documentation.


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2. That, on the facts and in the circumstances of the case, the learned CIT(A) has erred inlaw as well as on facts not holding that USD 250 lakhs of which USD 75 lakhs being thefirst instalment is a part and USD 35 lakhs of which USD 10.5 lakhs being the firstinstalment is a part, being lumpsum technical know-how and basic process engg.documentation fees as non-taxable 'business profits' under art. 7(1) of the DTAA between

India and Italy in view of no permanent establishment of M/s. Technimont, S.P.A. ofItaly in India.

3. That the learned CIT(A) has erred in law as well as on facts in holding that theassessee appellant has not made any outright purchase of the exclusive rights over design,secret, formula or process and therefore there is no acquisition of technical know-howwhereas the assessee-appellant did acquire rights over design, secret, formula or processknow-how and technical know-how for that agreed payment is to be made.

2. The brief facts of the case are stated in assessment order as well as in CIT(A)'s order.For the sake of convenience, the facts of the case are briefly stated here also as under.

3. M/s. Modern Threads (India) Ltd. (hereinafter referred to as MTIL) with its principaloffice at A-4, Vijay Path, Tilak Nagar, Jaipur (Rajasthan) entered into a contract dt. 15thDecember, 1995 read with Addendum dt. 15th January, 1996, and 3rd February, 1996,with M/s. Technimont S.P.A. having its principal office at Hilan, Viale Monte Grappa 3,Italy for grant of rights and sub-license to use the 'process and technical know-how' as perart. 2 of the agreement between them. The agreement also provided for supply of basicprocess engg. documentation as per art. 3.2 of the agreement and transfer of technicalknow-how as per art. 1.11 of the said agreement. The agreement was approved by theGovernment of India, Ministry of Industries, Department of Industrial Policy andPromotion, Secretariat for Industrial Approvals, New Delhi vide their letter No. FCII/279/(96)/1310/(95)-Amend dt. 15th July, 1996. The agreement inter alia provided forpayment of lumpsum technical know-how fee of USD 250 lakhs payable in 4 (four)instalments, net of taxes, and royalty payable @ USD 5.00 per metric tonne of products,subject to maximum of USD 50 lakhs and USD 35 lakhs, net of taxes for the supply ofbasic process engg. documentation. The lumpsum payment of USD 35 lakhs, net of taxeswas payable in four instalments. The first instalment of 30 per cent of USD 250 lakhs,USD 75 lakhs and 30 per cent of USD 35 lakhs i.e. 10.5 lakhs USD was payable byMTIL to M/s. Technimont as per the contract agreement and accordingly the appellantfiled an application under s. 195(2) for claiming exemption from taxes of theseremittances. The AO in his order under s. 195(2) dt. 20th December, 1996, held that theconsideration of USD 250 lakhs and USD 35 lakhs to be paid by the appellant to theItalian company was in the nature of royalty and hence liable to tax @ 20 per cent asdetermined under the provisions of Double Tax Avoidance Agreement (DTAA) betweenIndia and Italy. The company preferred an appeal before the learned CIT(A) against thisorder of the AO made under s. 195(2).

4. The learned CIT(A) decided the appeal on 11th March, 1997, upholding the order ofthe AO under s. 195(2). The CIT(A) held that the impugned payments were of royaltytaxable in India under the provisions of DTAA read with various terms of the contract


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agreement. The detailed submissions were submitted before the CIT(A). Reliance wasplaced on a decision of the Tribunal Special Bench Calcutta in the case of GraphiteVicarb (India) Ltd. vs. ITO (1993) 199 ITR 119 (AT) (Cal)(SB). Reliance was alsoplaced on a decision of the CIT(A)-XXII, Bombay, in the case of Gujarat Apar PolymersLtd. dt. 18th November, 1992. After considering the submissions and other materials on

record, the CIT(A) was not satisfied and after giving reasons in detail in her order, theCIT(A) upheld the order of the AO. Now the assessee is in appeal here before us.

5. The learned counsel S/Shri Dinesh Vyas along with Shri P. D. Desai appeared onbehalf of the assessee. Shri Dinesh Vyas, the learned counsel for the assessee reiteratedthe submissions made on behalf of the assessee before the CIT(A). He further submittedthat the assessee entered into an agreement with the Italian company which provided forsupply of basic process engg. documentation as per art. 3.2 of the agreement and transferof technical know-how as per art. 1.11 of the same agreement. The payment was to bemade by the company as net of taxes. He further submitted that if general law is seen thenit may be considered as royalty but as per s. 90 which is about the avoidance of double

taxation, the sum paid by the assessee-company to the Italian company does not fallunder payment as income earned by the Italian company taxable in India. The paymentswere made as per certificate granted by the Government of India as per the agreementbetween the two countries regarding avoidance of double taxation. The learned counselof the assessee also placed a copy of Vienna Convention for guidance purpose wherein itis clearly mentioned that agreement entered between the two countries should befollowed honestly/peacefully by each of the Government.

6. It was further submitted that Italian company has no permanent establishment in thecountry and when a contracting company does not have any permanent establishment inthe country where the payments were effected, no tax is payable on those payments madeby the party of that country. Art. 13.3 of the agreement is very important which isoverriding clause over s. 9(1)(vi). It was further submitted by learned counsel that theassessee company ultimately became the owner of the formula as the term of secrecy wasexpired after 15 years of the agreement date. It was strongly argued that the case of theassessee is merely based on facts of the case which proved that payment of the agreementamount was not taxable in India as per the Avoidance of Double Taxation agreement. Hefurther placed reliance on DCM Ltd. vs. ITO (1989) 29 ITD 123 (Del) wherein similarcase was decided by the Tribunal in favour of assessee.

7. On the other hand the learned Departmental Representative strongly supported theorder of the CIT(A). He further submitted that the assessee was not absolute owner of therights and provisions of s. 9 as per Expln. 2 applicable in the case of the assessee. Hefurther placed reliance on Alembic Chemical Works Co. Ltd. vs. CIT (1989) 177 ITR377 (SC) and N. V. Philips vs. CIT (1988) 172 ITR 521 (Cal). It was further submitted bythe learned Departmental Representative that contract made by the parties wasconditional contract as the assessee became the owner of the products and not of theformula. The learned Departmental Representative also said that Vienna Convention isnot helpful to the assessee as these type of treaties were of the political treaties in nature.The Indian Constitution is not guided by any authority of the world as the Indian


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Constitution is an independent constitution of the country. Therefore, the guidelinesprepared in Vienna Convention is not helpful to the assessee at all. It was further arguedthat legal effect has to be seen and on this aspect reliance was placed on CIT vs.Gillander Arbuthnot & Co. (1973) 87 ITR 407 (SC), CIT vs. B. M. Kharwar (1969) 72ITR 603 (SC) and Pandit Lakshmikanta Jha vs. CIT (1970) 75 ITR 790 (SC).

8. In reply of the submissions made by the learned Departmental Representative, thelearned counsel submitted that no doubt, as per provisions of s. 9(1)(vi) the amount paidcan be treated as royalty but the agreement entered into by the assessee and the Italiancompany was in accordance with the DTAA between the two countries. Therefore, s. 90is overriding s. 9(1)(vi) of the IT Act. He further submitted that the cases relied upon bythe learned Departmental Representative are distinguishable as the facts of the case aredifferent. In case of Alembic Chemical Works vs. CIT (supra) wherein the Hon'bleSupreme Court has held that the amount paid to the company of any other country waspayment of revenue in nature and was not capital in nature. Therefore, the facts of thiscase are distinguishable with the facts of the assessee's case. In case of N. V. Philips vs.

CIT (supra) wherein the payments were held as the character of royalty. That agreementwas as per general clauses of the IT Act and not as per DTAA as per art. 13.3 of theagreement. Therefore, the ratio of this case also does not help to the submission of thelearned Departmental Representative. Likewise, other cases relied upon by the learnedDepartmental Representative are distinguishable on facts. Therefore, they are also nothelpful to the Revenue.

9. We have heard the rival submissions carefully and considered the material on recordalso. According to the AO and CIT(A) the payment made to the non-resident companywas in the nature of royalty within the meaning of Expln. 2 to s. 9(1)(vi) of the Act andaccordingly the tax was properly levied. It is also the contention of the Revenue that ifthere be any inconsistency between the agreement for DTAA and Expln. 2 of s. 9(1)(vi)in that event the Act will prevail over the agreement. First we would like to seeprovisions of s. 9(1)(vi) and Expln. 2 says -

"Explanation 2. - For the purposes of this clause, "royalty" means consideration(including any lumpsum consideration but excluding any consideration which would bethe income of the recipient chargeable under the head "Capital gains") for -

(i) the transfer of all or any rights (including the granting of a licence) in respect of apatent, invention, model, design, secret formula or process or trade mark or similarproperty;

(ii) 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;

(iii) the use of any patent, invention, model, design, secret formula or process or trademark or similar property;


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(iv) the imparting of any information concerning technical, industrial, commercial orscientific knowledge, experience or skill;

(v) the transfer of all or any rights (including the granting of a licence) in respect of anycopyright, 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 notincluding consideration for the sale, distribution or exhibition of cinematographic films;or

(vi) the rendering of any services in connection with the activities referred to in sub-cl. (i)to (v).

Now we will see the s. 90 which says about avoidance of double taxation. Sub-cl. (2) ofs. 90 says where the Central Government has entered into an agreement with theGovernment of any country outside India under sub-s. (1) for granting relief of tax, or asthe case may be, avoidance of double taxation, then, in relation to the assessee to whom

such agreement applies, the provisions of this Act shall apply to the extent they are morebeneficial to that assessee.

10. We would like to define first that which provisions are applicable here in the presentcase i.e. whether provisions of s. 9(1)(vi) or provisions of s. 90 of the IT Act.

11. The definition of 'Royalty' appeared in art. 3 of the agreement for avoidance of doubletaxation made between India and Italy is no doubt different from the definition appearingin Expln. 2 to s. 9(1)(vi) of the Act. In determining the liability of a non-residentcompany, if there is any agreement for avoidance of double taxation entered under s. 90of the IT Act, 1961, the said agreement must prevail over the provisions of IT Act,otherwise, there was no point in entering into any agreement for avoidance of doubletaxation. Whenever any specific arrangement or agreement has been made regarding thetaxability of any income under the agreement of avoidance of double taxation sucharrangement or agreement will necessarily prevail over the provisions of the Statute.

12. In this connection we may usefully refer to the Notification enforcing the Conventionbetween the Govt. of India and the Govt. of Italy which are placed at pages 115 to 134 ofthe Paper Book. This Notification is dt. 25th April, 1996 bearing No. 10075, which readsas follows :

"Whereas the annexed Convention between the Government of the Republic of India andthe Government of the Republic of Italy for the Avoidance of Double Taxation and thePrevention of Fiscal Evasion with respect to Taxes on Income has entered into force on23rd November, 1995 after the exchange of Instruments of ratification by the ContractingStates in accordance with Paragraph 1 of art 30 of the said Convention;

Now, therefore, in exercise of the powers conferred by s. 90 of the IT Act, 1961 (43 of1961), the Central Government hereby directs that all the provisions of the saidConvention shall be given effect to in the Union of India."


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By going through this clarification this is clear that intention of the Government is toavoid the double taxation. All provisions of the said Convention shall be given effect tonotwithstanding the provisions contained in relevant Act or Acts. Therefore, provisionsof s.90 shall prevail upon the provisions of s. 9(1)(vi) of the IT Act. In our view, where

an express provision to the contrary is made in this agreement, the transaction will begoverned by such agreement. Expln. 2 to s. 9(1)(vi) cannot have any applicationinasmuch as the definition of royalty has been specifically provided in the agreement.Thus an express provision to contrary has been made in the agreement. Expln. 2 to s. 9(1)(vi) makes it quite clear that royalty as defined in Expln. 2 is only for the purposes of cl.(vi). The said meaning assigned to royalty cannot be made applicable in an agreementwhich is made under s. 90 of the Act. In this regard we conclude that in case ofinconsistency between the terms of the agreement and the taxation statute, the agreementalone would prevail. We have also seen the Circular No. 333 dt. 2nd April, 1982, a copyof which is placed on record at p. 113 of the paper-book wherein the Board has laid downas follows :

"2. The correct legal position is that where a specific provision is made in the doubletaxation avoidance agreement, that provisions will prevail over the general provisionscontained in the IT Act. In fact that the double taxation avoidance agreements which havebeen entered into by the Central Government under s. 90 of the IT Act, also provide thatthe laws in force in either country will continue to govern the assessment and taxation ofincome in the respective country except where provisions to the contrary have been madein the agreement.

3. Thus, where a double taxation avoidance agreement provides for a particular mode ofcomputation of income, the same should be followed, irrespective of the provisions in theIT Act. Where there is no specific provision in the agreement, it is basic law, i.e., the ITAct, that will govern the taxation of income."

In our view, the circular reflects the correct legal position inasmuch as the Convention oragreement is arrived at by the two contracting Governments in deviation from the generalprinciples of taxation applicable to the contracting States. Otherwise, the double taxationavoidance agreement will have no meaning at all.

13. In case of DCM Ltd. vs. ITO (supra) where the similar issue was involved. In thatcase the question was involved that whether the payments to a foreign company could besaid to amount to royalty. In fact, in that case the assessee M/s. DCM Ltd. has enteredinto an agreement with M/s. Tata & Lyle Industries Ltd., London, who has extensiveknowledge and experience and has been a pioneer in sugar technology for many years.M/s. Tate & Lyle Industries Ltd. manufactures special dosing and control equipment andpossesses valuable and particular know-how in relation to the installation and operationof the special equipment, operation of the processes and use of essential specialitychemical products, which help to eliminate the use of limestone and hardcoke. Theassessee M/s. DCM Ltd. entered into an agreement on 12th October, 1983, for thetransfer of comprehensive technical information and know-how and the supply of


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equipment by M/s. Tate & Lyle (TL) to M/s. DCM Ltd. In consideration of the supply ofdocuments concerning the processes, the DCM had to pay a total amount of Pounds1,55,000 in four instalments. The assessee approached the IAC for no objectioncertificate for these remittances. The IAC issued the certificate with a condition that tax@ 20 per cent was to be remitted by the assessee in its capacity as a representative

assessee, treating the amounts in question as royalty. On appeal, the CIT(A) accepted theposition that the definition of royalty under the DTAA would override the definition ofroyalty under s. 9(1)(vi), but held that the term 'royalty' would include both lumpsum aswell as periodical payments on account of the use of the expression "payments of anykind" in art. XIII(3) of the DTAA between India and UK. He, therefore, held that thetechnical know-how was provided by the foreign enterprise including lending of servicesof foreign technicians, and therefore, the payments in question were of the nature of'royalty'. On second appeal, the Tribunal held that the payment did not constitute 'royalty'as defined in art. XIII of the Convention and it was further held that the aforesaidconsideration constituted business profits for the foreign concern which too could not beassessed through the assessee as per art. VII of the Convention as TL had no permanent

establishment in India. In that case of the case of Citizen Watch Co. vs. IAC (1984) 148ITR 774 (Kar) was followed wherein the similar issue was decided by the Hon'bleKarnataka High Court. The facts in the present case are similar to the case of DCM Ltd.vs. ITO (Del) (supra). In the present case also the assessee entered into an agreement withthe Italian company and payments were made as per the agreement of Avoidance ofDouble Taxation. Therefore, we are not in hesitation to hold that the payments made bythe assessee cannot be held as royalty as per s. 9(1)(vi) as the provisions of s. 90 shallprevail upon.

In the present case the assessee paid amount to Italian company who was not having apermanent establishment in India. A certificate to this effect is placed at p. 112 of thepaper-book wherein the Italian company has confirmed that it has no permanentestablishment in India. It was further mentioned in the said certificate that the provisionsset forth under the Treaty for the Avoidance of Double Taxation in force between Indiaand Italy shall refer to the case of Italian companies without permanent establishment inIndia. We have also seen the provisions of art. VII wherein it is mentioned that the profitsof an enterprise of a contracting State shall be taxable only in that State unless theenterprise carries on business in the other contracting State through a permanentestablishment situated therein. In this case we have already mentioned that there is nopermanent establishment of the recipient company. We have also seen the agreementwhere it is clearly mentioned that technical Know-how fees payable in four instalmentsnet of taxes. It clearly proves that the intention of the agreement was that there should notbe any tax levied in India on the Italian company. We have also gone through ViennaConvention wherein it is mentioned that dispute concerning treaties, like otherinternational disputes should be settled by peaceful means and in conformity with theprinciples of justice and international law.

14. In our view the principles of Vienna Convention is guidelines for the countries whoare party to this Convention. It is also emphatic to explain that when an agreement isentered between two countries that should be fulfilled by following its terms and


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conditions. In our considered view India and Italian Governments entered into anagreement for avoiding the double taxation in both the countries. Therefore, provisions ofs. 90 are also overriding on provisions to s. 9(1)(vi).

15. We have also gone through the clauses of agreement between the assessee and the

Italian company. Art. VIII is about secrecy. In cl. 8.4 of this agreement it is clearlymentioned that the sub-licensee's secrecy obligations under this art. 8 shall terminate 15(fifteen) years after the effective date. It clearly shows that after 15 years the assessee isnot bound to keep the documents as secret. After the expiry of 15 years the assessee isfree to use the documents as per its will. It can be inferred from this clause that assesseebecame the owner of the rights which he got through agreement. This contention of theRevenue is not tenable that the assessee is not absolute owner of the rights.

16. We have also considered the other case laws relied upon by the learned DepartmentalRepresentative and after perusing the ratios of those decisions, we are of the view thatthose decisions are not helping to the Department. This view of ours finds further support

from that no contradictory decision is available at present on this issue as before us.Therefore, we are of the opinion that assessee is entitled to succeed as the payment madeby the assessee did not constitute royalty as defined in art. 13 of the relevant DTAAbetween India and Italy.

17. In the result, the appeal of the assessee is allowed.

Pradeep Parikh, A.M.

31st December, 1997

18. I have thoroughly perused the proposed order passed by my learned brother. Aftercareful consideration of the said order, I find myself not to be in agreement with theconclusion reached by my learned brother. Hence, I am constrained to make a separateorder on the issue raised in appeal. The grounds of appeal and the facts of the case havebeen mentioned at paras 1 to 4 of the proposed order and hence I need not repeat them forthe sake of brevity.

19. The point in dispute is that whether the consideration of US $ 250 lakhs payable bythe assessee to use the process and technical know-how for the implementation of theplant and use and sell the product so manufactured, as well as the consideration of US $35 lakhs for the supply of basic process engineering, are in the nature of royalty or not.

20. There is no difference of opinion between the Revenue and the assessee that in viewof s. 90, the definition of royalty as given in the Double Taxation Avoidance agreement(DTAA) between India and Italy shall prevail over the definition given in the Act. As amatter of fact, the CIT(A) has decided the issue on these lines only and my learnedbrother has also held that the definition as per DTAA shall prevail. Hence, we have todetermine the issue in the light of the definition of "royalty" given in DTAA. The learnedcounsel, no doubt, while interpreting the term royalty as per the DTAA, did take the help


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of the definition provided in the Act. I repeat, the definition of royalty given in the Actwas merely referred to as an aid to interpret the said term given in the DTAA. In short,there is no dispute that the definition as given in DTAA shall prevail.

21. Art. 13.3 of the DTAA between India and Italy defines the term royalty as follows :

"The term "Royalties" as used in this article means payments of any kind received as aconsideration for the use of, or the right to use, any copyright of literature, artistic orscientific work, including cinematography film or films or tapes used for radio ortelevision broadcasting, any patent, trade mark, design or model plan, secret formula orprocess, or for the use of, or the right of use, industrial, commercial or scientificequipments, or for the information concerning industrial, commercial or scientificexperience."As mentioned earlier, in order to interpret the above clause in its right perspective, thelearned counsel referred to the definition given in the Act which is found in Expln. 2 to s.9(1)(vi). Mainly cls. (i) to (iii) of the said Explanation we referred to, which are as

follows :

"Explanation 2. - For the purposes of this clause, "royalty" means consideration(including any lumpsum consideration but excluding any consideration which would bethe income of the recipient chargeable under the head "Capital gains") for -

(i) the transfer of all or any right (including the granting of a licence) in respect of apatent, invention, model, design, secret formula or process or trade mark or similarproperty;

(ii) 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;

(iii) the use of any patent, invention, model, design, secret formula or process or trademark or similar property;"

22. Referring to the above 3 clauses, Shri Vyas urged the Bench to assume the 3 clausesas three separate boxes. It was submitted that as per the treaty, if the assessee's case wasin the third box, it would certainly be called royalty. However, it was contended that theassessee's case was not in the third box, as according to him, there was something morethan mere right to use, which the assessee received. Similarly, the assessee's case wasalso stated not to be in the first box as there was no outright transfer of the formula or theprocess. Hence, after ruling out the extreme position, it was submitted that the assessee'scase was either somewhere in between box one and box two, or it was a blend of the twoboxes what the assessee received.

23. In other words, what the learned counsel contended was that it was not a mere right touse the process which the assessee acquired, but there was something more. According tohim the assessee acquired a bundle of rights like licence, co-ownership, deferred co-ownership, and so on. To drive home this point, reference was made to several clauses of


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the DTAA entered into between India and Italy. Special references were made to arts.7.1, 7.6, 13.1, 13.2 and 13.3.

24. Reference was then made to the relevant portions of the agreement between theassessee and the Italian company whereby it was tried to establish that the assessee did

not merely acquire the right to use the process in India but also sub-licence under theagreement. For this, reference was first made to the addendum to the contract on pp. 41and 46 of the paper-book. Arts. 1.11 2.1, 2.3, 5, 8, 11 and 12 were specially referred to bythe learned counsel.

25. The contentions of the learned Departmental Representative are not repeated for thesake of brevity as they have been already set out by my learned brother in para 7 of hisorder. The contentions of the learned counsel set out in the preceding paras are only thosewhich, though relevant, have not been set out and considered by my learned brother.

26. At the outset, I would first like to deal with the decision of the Delhi Bench of the

Tribunal in the case of DCM Ltd. vs. ITO (supra), on which much reliance has beenplaced. In that case, DCM entered into a technical collaboration agreement, with a U.K.based company (TL) for the transfer of comprehensive Information and know-how andthe supply of equipment by TL to DCM. In consideration of the supply of documentsconcerning processes, DCM had to pay a total amount of Pounds 1.55 lakhs in 4instalments. The Department treated this amount as royalty. The contention of the DCMbefore the Tribunal was that what the DCM had purchased was equipment and know-howin the form of a packet of documentation akin to video-tape or computer software system.Accordingly it was contended that the case of DCM came under cl. (1) of the Expln. 2 tos. 9(1)(vi) which did not form part of the definition of "royalties" under the DTAAbetween India and UK. Hence, it was submitted that if the case is not governed by articlerelating to Royalty, it would automatically be governed by the article relating to profits,which could not be taxed in India as TL did not have a permanent establishment as afixed place of business in India. On these facts the Tribunal accepted the claim of DCM.

27. The facts in the present case, I am afraid, are certainly distinguishable at least on twocounts. Firstly, in DCM's case there was transfer. In the present case, the Italiancompany, as a sub-licensor has granted the rights and sub-licence to use and practice theprocess in India. Secondly, in DCM's case, DCM had purchased equipment and know-how. In the instant case there is neither the purchase of equipment, nor the know-how butmerely right to use the process is acquired. Moreover, it is also not the case of theassessee, as made out in the case of DCM that the case would be governed by the articlerelating to profits. Thus in my view, the decision in DCM's case cannot be applied in thepresent case.

28. The main thrust of the learned counsel's argument was that it is not merely the right touse the process that the assessee has acquired, but there is something more than that. Infact, according to him, a bundle of rights has been acquired by the assessee. Hence, nowwe shall unfold the bundle and see what it contains as was shown to us by the learned


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counsel. The bundle referred to is nothing but the agreement between the assessee (sub-licensee) and the Italian company (sub-licensor).

29. Firstly, art. 1.11 was referred to in which it is mentioned that both the licensor and thesub-licensor are free to disclose the know-how to the assessee. In this regard, for the sake

of clarification it may be mentioned that INCA International, Italy, is the owner of thetechnical information and know-how which is the subject-matter of the agreement, andhas referred to as licensor. Tecnimont Italy is the sub-licensor who has been authorised togrant such sub-licence to the assessee-company which is referred to as the sub-licensee.In the present appeal the contract is between the sub-licensor and sub-licensee. Thus, nowcoming back to cl. 1.11, the learned counsel submitted that the legal character of the rightacquired by the assessee would remain the same irrespective of the fact whether the sameis provided by the licensor or the sub-licensor. We agree with the learned counsel on thispoint, but it does not add anything beyond the right to use the process.

30. Next, art. 2 was referred to. The said article is titled as "grant of rights and sub-

licence". It was contended that the title itself clinches the issue as the sub-licensor isgranting not only the right but also sub-licence to use the process, technical know-how,product and basic process engineering. It should, therefore, be our endeavour to see whatright the assessee got and in what respect it got sub-licence.

31. T. P. Mukerjee's Law Lexicon Vol. 2, (1982 Edn.) describes the term "licence" asfollows :

"In the most natural sense, "licence" is an authority justifying the doing of what otherwisewould be wrongful. In the commonly accepted sense, the term means authority, orpermission to do a thing which the licensor would otherwise have the right to prevent. Alicence confers a right which does not exist otherwise. It is in the nature of a grant orpermission to exercise certain privilege, or to carry on a particular business or to pursue acertain occupation. In the popular as also in the legal sense it is a permission to dosomething which, without the licence, would not be allowable."32. P. Ramanatha Iyer's Law Lexicon (1997 Edn.) describes the term "Licence" asfollows :

"An authority to do something which would otherwise be inoperative, wrongful or illegal,a formal permission from a constituted authority to do something. In the popular as alsoin the legal sense a licence is a permission to do something which, without the licencewould not be allowable. In the secondary sense it denotes a certificate or document whichembodies the permission in question."The above paras, no doubt, explain the meaning of the term licence, whereas the casebefore us is that of sub-licence. Nonetheless, for all practical purpose, the same meaningwould be applicable to the case of sub-licences also as they create rights with the samecharacter.

33. In the present case, the assessee acquired only a right to use the know-how by virtueof a sub-licence granted under a contract between the assessee and the Italian company. I


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fail to understand as to what else the assessee acquired besides the right to use. It has notacquired the ownership of the know-how, as the preamble of the contract makes it clearthat the same is owned by INCA International S.P.A., Italy. Further, the preamble alsomakes it clear that the sub-licensor has the right to sub-licence the technical know-how.No similar right has been acquired by the assessee under the contract. The other relevant

clauses of the contract also do not mince words and are in conformity with the mainobject of the contract that the assessee has only the right to use the know-how andnothing beyond it.

34. Under art. 8, the assessee, as the sub-licensee, is under obligation to maintain strictsecrecy about the process till 15 years, and this is despite the fact that as per art. 12, thecontract is to terminate on completion of 10 years. In this connection it was submitted bythe learned counsel that by getting the right to use the know-how the assessee hadbecome a member of the privileged club, and as a matter of co-operation it was in theassessee's own interest to protect the secrecy. But the same has to be viewed from adifferent angle. The assessee acquired merely the right to use the know-how and nothing

further. Unlike the sub-licensor, the sub-licensee (i.e., the assessee) has no authority todisclose the know-how to anyone.

35. The next is art. 11 of the contract on which much stress has been laid by the learnedcounsel. It would be advantageous to reproduce the same for immediate reference;

ART. 11-"ASSIGNMENT"

"This contract shall inure to the benefit of and be binding upon the parties and shall notbe assignable in whole or in part by either party without the prior written consent of otherparty, provided that such consent shall not be unreasonably withheld. However, thecontract shall be freely assignable to the successor of substantially the entire business ofeither party. In the event of a permitted assignment the assigning party shall remainprimarily liable for the performance of this contract and shall, prior to the assignmentcause the assignee to furnish to the non-assigning party an undertaking to be fully boundby the terms and conditions of this contract. Any purported assignment not fully inaccordance with this art. 11 shall be void."

36. In this connection it was submitted by the learned counsel that besides the sub-licensor, the assessee also had a right to assign this contract to another party. Thoughconsent of the other party was required, the other party could not withhold the consent foran unreasonable cause. Thus, it was contended that if the assessee assigned the contractafter obtaining the consent of the Italian company, the latter was bound by suchassignment. It was vehemently stressed that the truncation of the assigning rights was inmutual interest.

37. It has to be appreciated that truncation of the assigning right is not merely with regardto obtaining the consent of the other party. The truncation is much more. The assignedparty remains primarily liable for the performance of the contract. It is only when forsome good reason the assessee is not in a position to perform its part of the contract, it


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may ask someone else, with the consent of the sub-licensor, to make use of the know-how on its behalf under this very contract. But it can neither grant a sub-licence to use theprocess nor can it divest itself from this contract save as provided in arts. 12 and 13.

38. Then art. 12 was referred to by the learned counsel. It is as follows :

"ART. 12 ..... TERM OF THE CONTRACT

12.1 ... This contract shall come into force on the effective date and, unless soonerterminated as provided for in art. 13, shall continue in full force and effect till the 10thanniversary of the effective date except for secrecy obligations under art. 8 which shallsurvive.

12.2 ... From and after the expiration of the term of contract as specified in art. 12.1, thesub-licensee shall have acquired the fully paid-up right to continue the production of theproduct in the plant and to sell the product anywhere in the world without payment of any

further consideration in addition to those already paid under the contract."

The above article, it was submitted, placed the assessee in a strong position than merelyacquiring the right to use the know-how, and in particular art. 12.2 placed the assessee ina much stronger position after 10 years which fact according to the learned counsel,placed the assessee somewhere in between box one and two as referred to earlier in para22.

38A. I am afraid, the contention of the learned counsel has not convinced me. By virtueof art. 12 also, the assessee has acquired nothing more than a right to use the know-how.It is only after the expiration of the term of contract as per art. 12.1, the assessee acquiresfully paid-up right to continue the product. Hence, before that it does not possess anyright fully except to use the know-how under the terms of contract for which theimpugned payment, as mentioned in para 3 of the order of my learned brother, is to bemade.

39. In the light of the above discussion, I have no hesitation in upholding the order of thelearned CIT(A).

40. It was submitted by the learned counsel that art. 7.1 and 13.1 of the DTAA say thesame thing, but art. 13.2 of the DTAA says something else, and hence it was suggestedthat the said art. 13.2 should be read down. I have considered this aspect but do not seeany force in the suggestion.

41. A reference was made to the commentary by Kanga & Palkhiwala, 8th Edn., p. 2,wherein it is mentioned that if the interpretation of a fiscal enactment is open to doubt,the construction most beneficial to the subject should be adopted, even if it results in hisobtaining a "double advantage". Since I have arrived at the conclusion withoutharbouring any doubt, the question of holding it otherwise does not arise.


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42. A reference was also made to the Vienna Convention on the law of treaties, to whichIndia is a signatory, wherein it is declared that agreements entered into between twocountries should be followed peacefully by each country and the agreements should beinterpreted in good faith. I have certainly kept the principles of the Vienna Convention inmind while interpreting the DTAA between India and Italy, which is an agreement, not

only for the avoidance of double taxation but also for the prevention of fiscal evasion.

43. In the result, the appeal of the assessee is dismissed.

REFERENCE UNDER S. 255(4) OF THE IT ACT, 1961

21st January, 1998.

We, the Members of the Jaipur Bench of the Tribunal have differed in the order to bepassed in ITA No. 378/Jp/1997, in the case of Modern Threads (India) Ltd. vs. Dy. CIT.The question on which we have differed is referred to the Hon'ble President under s.

255(4) of the IT Act, 1961. The said question is as follows :

"Whether, the amount of US $ 250 lakhs and US $ 35 lakhs payable by the assessee toM/s. Tecnimont of Italy is "royalty" as defined in the Double Taxation Avoidanceagreement between India and Italy and hence liable to tax in India ?"We direct the Registry to put the file before the Hon'ble President.

Nathu Ram, A.M. (AS THIRD MEMBER)

1. On account of difference of opinion between the Judicial Member and the AccountantMember of Jaipur Bench of the Tribunal, following question has been referred to me bythe President of the Tribunal as per provisions of s. 255(4) of the IT Act, 1961, foradjudication as a Third Member :

"Whether, the amount of US $ 250 lakhs and US $ 35 lakhs payable by the assessee toM/s. Tecnimont of Italy is "royalty" as defined in the Double Taxation Avoidanceagreement between India and Italy and hence liable to tax in India ?"

2. Though the facts have been discussed elaborately in the orders of the lower authoritiesas well as by brother Members, but for proper appreciation I would like to recapitulatethe facts in brief. M/s. Modern Threads (India) Ltd. (hereinafter referred to as the sub-licencee) entered into a contract on 15th December, 1995 with Technimont S.P.A. ofItaly (hereinafter referred to as sub-licensor) for grant of rights and sub-licence to use theprocess and technical know-how and supply of basic process engineering documentation.The Ministry of Industry in its letter dt. 27th March, 1996, conveyed the approval to theproject. An addendum to the contract agreement executed on 15th December, 1995, wasmade on 15th January, 1996, between both the parties providing for some mutuallyagreed changes in the original contract. The addendum was further amended on 3rdFebruary, 1996. The Ministry of Industry in its letter dt. 15th July, 1996, conveyed theapproval to the changes carried out through addendum in the original contract agreement.


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2.1. Sub-licensor had the availability and access to technical information and know-howof a confidential nature related to the process for the production of purified telephthalicacid ("PTA") owned by Inca International S.P.A. of Italy (hereinafter referred to as"licensor). The licensor authorised the sub-licensor to grant such sub-license and rights

under the know-how to the sub-licensee. The sub-licensor in the contract agreed to grantrights and sub-license to use and practice the process in India and to use and sell theproduct manufactured and also to supply the know-how and documentation for thedesign, construction and operation of the plant on various terms and conditions set out inthe contract agreement. In consideration of the rights and sub-license granted the assessee(sub-licensee) was required to pay to the sub-licensor US $ 250,00,000 net of taxesimposed in India to be paid in the following instalments :

(a) 30 per cent on or before the effective date;

(b) 30 per cent not later than six months from the effective date;

(c) 30 per cent not later than 18 months from the second instalment;

(d) 10 per cent at the plant acceptance date or within 48 months from the effective date,whichever is earlier.

2.2. For the supply of basic process engineering the assessee (sub-licensee) was requiredto pay to the sub-licensor US $ 35 lakh net of any taxes imposed in India in the followinginstalments :

(a) 30 per cent on or before the effective date;

(b) 30 per cent later than four months from the effective date;

(c) 30 per cent not later than 8 months from the effective date;

(d) 10 per cent not later than 18 months from the effective date.

2.3. In addition the assessee (sub-licensee) was required to pay to the sub-licensor arunning royalty payment of US $ 5 per MT of products, manufactured in the plant afterthe plant acceptance date, upto a maximum of US $ 50 lakhs.

2.3.1. As per the terms of the contract agreement the first instalment of 30 per cent of US$ 250 lakhs which worked out to US $ 75 lakhs and 30 per cent of US $ 35 lakhs whichworked out to 10.5 lakhs US Dollar was payable to the sub-licensor. The assessee (sub-licensee), therefore, made an application before the Dy. CIT, Special Range-2, Jaipur, forthe grant of "No objection" to the remittance of the said amount of first instalment to thesub-licensor as per provisions of s. 195(2) of the IT Act. The AO having considered thevarious articles of the contract agreement and art. 13(3) of the Double TaxationAvoidance agreement (DTAA) between India and Italy held that payable amount is


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royalty and the same is taxable in the hands of the assessee (sub-licensee) as an agent ofthe foreign company. He, accordingly, directed to deduct tax at source @ 20 per cent asper provisions of the DTAA. The assessee (sub-licensee) carried the matter in appeal andthe CIT(A) for the detailed reasons given in her order upheld the action of the AO afterduly considering the facts and placing reliance on the decisions of the Tribunal Special

Bench in the case of M/s. Graphite Vicarb (India) Ltd. vs. ITO (1993) 199 ITR 119 (AT)(Cal) (SB) and order of the CIT(A), Bombay in the case of Gujarat Apar Polymers Ltd.

2.4. Before the Tribunal, it was claimed on behalf of the assessee-company that as perterms of the contract the Italian company was to transfer technical know-how and tosupply basic process engineering documentation. The amount payable under the contract,therefore, is not royalty as per art. 13(3) of the DTAA applicable in reference to thegeneral tax law and accordingly no tax at source was required to be deducted therefrom.A reference was also made to the Vienna Convention wherein it is mentioned that theagreement entered into between two countries should be followed honestly andpeacefully by each of the Government. It was also claimed that the Italian company does

not have a permanent establishment in India and as such no tax is payable in India onsuch payments. It was also claimed that the assessee-company ultimately would becomethe owner of the formula as per the terms of the contract agreement on expiry of fifteenyears. It was, therefore, argued that the payments made as per the contract was nottaxable in India as per the DTAA and in support reliance was placed in the case of DCMLtd. vs. ITO (1989) 29 ITD 123 (Del) wherein on similar facts the matter was decided bythe Tribunal in favour of the assessee.

2.5. The learned Departmental Representative on the other hand supported the orders ofthe authorities below placing reliance on Alembic Chemicals Works Co. Ltd. vs. CIT(1989) 177 ITR 377 (SC), N. V. Philips vs. CIT (1988) 172 ITR 521 (Cal) and alsoShyam Lal Prag Narain vs. CIT (1955) 27 ITR 407 (All), CIT vs. B. M. Kharwar (1969)72 ITR 603 (SC) and Pandit Lakshmi Kant Jha vs. CIT (1970) 75 ITR 790 (SC).

2.6. In reply it was claimed by the learned counsel of the assessee that the amount paidcan be treated as royalty under s. 9(1)(vi) of the IT Act but these provisions areoverridden by s. 90 under which the Government of India entered into DTAA with theGovernment of Italy and the payments made are, therefore, governed by the provisions ofthe DTAA. It was further stated that the cases relied upon by the Revenue as quoted in(1989) 177 ITR 377 (SC) (supra) and (1988) 172 ITR 521 (Cal) (supra) aredistinguishable on facts.

3. The learned Judicial Member has taken the view :

(1) That the term "Royalty" has been defined in Expln. 2 to s. 9(1)(vi) of the IT Act butits definition as given in the DTAA between India and Italy executed as per provisions ofs. 90 of the IT Act would prevail over that provided in the IT Act. According to him, inview of decisions in the cases of DCM Ltd. vs. ITO (1989) 29 ITD 123 (Del) and CitizenWatch Co. vs. IAC (1984) 148 ITR 774 (Kar) the amount payable by the assessee isneither royalty under s. 9(1)(vi) of the IT Act nor under DTAA.


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(ii) That as per art. 7 of the DTAA the profits of enterprise of a contracting State wouldbe taxable only in that State unless the enterprise carries on business in the othercontracting State through a permanent establishment situated therein. There is nopermanent establishment of the Italian company in India. The amount payable in

instalments to Italian company being business profit is not taxable in India as perprovisions of DTAA.

(iii) That as per art. 8.4 of the contract agreement, the sub-licensee's secrecy obligationswould terminate fifteen years after the effective date. That shows that after fifteen yearsthe assessee would be free to use know-how as per its will. It is inferred therefrom thatthe assessee became the owner of the rights which he got through contract agreement.

(iv) The case laws relied upon by the Revenue were found to be distinguishable on facts.

(v) The learned J.M. concluded that the payments made did not constitute "royalty" as

defined in art. 13(3) of the DTAA between India and Italy. The appeal of the assesseewas thus held allowable.

3.1. On the other hand, the learned A.M. observed that there is no difference of opinionbetween the Revenue and the assessee that in view of s. 90 the definition of royalty asgiven in DTAA between India and Italy shall prevail over the definition given in s. 9(1)(vi) of the IT Act and accordingly he agreed with the view taken by the learned J.M. inthis behalf. The learned A.M. then considered the facts in the case of DCM Ltd. (supra)and found that the same was distinguishable on two counts-firstly in DCM's case therewas transfer of comprehensive information and know-how whereas in assessee's case theItalian company as a sub-licensor had granted the rights and sub-licence to use andpractice the process in India; secondly, in DCM's case, DCM had purchased equipmentand know-how whereas in the instant case there was neither the purchase of equipmentnor the know-how but merely right to use the process was acquired. Further, it is also notthe case of the assessee, as made out in the case of DCM, that the case would begoverned by articles relating to profits. Accordingly, the decision in the DCM's case hasno application to the facts of the case.

3.2. The learned A.M. further noted that the main thrust of the learned counsel was that itwas not merely the right to use process that the assessee acquired but there wassomething more than that and according to him a bundle of rights had been acquired bythe assessee. He considering the meaning of the term "Licence" as given in T.P.Mukerjee's Law Lexicon Vol. 2 (1982 Ed.) and P. Ramanatha Iyer's Law Lexicon (1997Edn.) and referring to art. 2 of the contract agreement observed that the assessee acquiredonly a right to use the know-how by virtue of a sub-licence granted under the contractbetween the assessee and the Italian company and nothing more than that was acquired.The assessee has not acquired the ownership of the know-how as the preamble of thecontract makes it clear that the same is owned by INCA International S.P.A. Italy and thesub-licensor has only the right to sub-licence technical know-how. The assessee has notacquired similar rights under the contract.


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3.3. The learned A.M. has further noted that as per art. 8 of the contract agreement theassessee is under obligation to maintain strict secrecy about the process till fifteen yearsdespite the fact that the contract is to terminate on completion of ten years. Unlike thesub-licensor the assessee has no authority to disclose the know-how to another party.

3.4. Further, meeting the arguments of the learned counsel on art. 11 of the Contract,about assignment, he observed that the right could be assigned to any other party with theconsent of the sub-licensor. Therefore, under this article, the assessee company couldneither grant a sub-licence to use the process nor could it divest itself from the contractand as such, assigning right with the assessee-company is a truncated one.

3.5. As regards the claim that as per art. 12 of the contract agreement the assessee-company would acquire full right to use the technical know-how after the expiry of tenyears, the learned A.M. has observed that the assessee company has acquired nothingmore than a right to use the know-how and it is only after the expiration of the terms of

contract that the assessee-company would acquire fully paid-up right to continue theproduct only.

3.6. On these considerations, the learned A.M. upheld the order of the CIT(A).

3.7. Thus, as per the finding given by the learned J.M. the payment made to the Italiancompany under the contract is a business profit and not royalty whereas the learned A.M.has upheld the action of the lower authorities in treating the said payments as royalty. It isin this background that the question as set out in para 1 above has been referred, under s.255(4) of the IT Act by the President for decision, to me as Third Member. I have heardboth the parties on the issue involved.

4. The learned counsel of the assessee Shri N. M. Ranka has reiterated the submissionsmade before the lower authorities and has further made a submission that the contractentered into between the assessee company and the Italian company provides forcollaboration for setting up a plant in India as per the technical know-how and basicprocess engineering documentation provided by the Italian company for themanufacturing of PTA. The contract provides for grant of rights and sub-licence to theassessee-company to use and practice the process in India and to supply know-how anddocumentation for the design, construction and operation of the plant as per terms set outin the contract.

4.1. He further submitted that as per Law Lexicon the word "Grant" is described :

"Grant. - An operative word of conveyance, particularly appropriate to deeds of grant,properly so called, but used in other conveyances also, such as deeds of bargain and sale,and leases.

1. The action of granting or bestowing; an authoritative bestowal or conferring of a right,a gift or assignment of money, etc., out of a fund (s. 13, Industrial Development Bank of


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India Act); 2. the thing granted or bestowed; 3. to bestow by a formal Act [s. 24A(a)Companies (Profits) Surtax Act and s. 42, Prov. Plantations Labour Act); 4. to accede tos. 432(2), CrPC].

"This word is taken largely where any thing is granted or passed from one to another.

And in this sense it doth comprehend feoffments, bargains and sales, gifts, leases,charges, and the like; for he that doth give, or sell, doth grant also and thus it issometimes in writing or by deed, and sometimes it is by word without writing, But theword being taken more strictly and properly, it is the grant, conveyance, or gift, bywriting of such an incorporeal thing as lieth in grant, and not in livery, and cannot begiven or granted by word only without deed. Or it is the grant by such persons as cannotpass anything from them but by deed, as the king, bodies corporate, & c. And this albeit itmay be made by other most proper to this purpose."

4.1.1. It is therefore, contended that the word "Grant" includes transfer of right, interest,title and possession and accordingly the assessee has acquired the right to the process and

technical know-how and also right to transfer them after the specified period as per termsof the contract. Moreover, the Italian company also supplied technical know-how anddocumentation for design, construction and operation of the Plant and it amounted toacquisition in the hands of the assessee-company for a consideration. The payment madefor providing technical know-how and documentation was, therefore, not royalty butbusiness profit of the Italian company and it having no permanent establishment in India,the amount payable therefor is not taxable in India. In support he has cited the followingdecisions :

(a) DCM Ltd. vs. ITO (supra);

(b) Citizen Watch Co. Ltd. vs. IAC (supra);

(c) Rolls Royce Ltd. vs. IRC (1965) 56 ITR 580 (HL);

(d) CIT vs. Gilbert and Barker Manufacturing Co. USA (1978) 111 ITR 529 (Bom);

(e) Swedesi Polytex Ltd. vs. ITO (1991) 38 ITD 328 (Del);

(f) Graphite Vicarb Ltd. vs. ITO (supra); and

(g) CIT vs. Koyo Seiko Co. Ltd.

4.2. The learned counsel further placing reliance on art. 11 of the contract submitted thatprovision made therein has not been properly appreciated. The technical know-howreceived is assignable in whole or in part to another party with the written consent of thesub-licensor and such consent is not to be unreasonably withheld. In support of thisproposition he has placed reliance on the decision of the Hon'ble Supreme Court in thecase of Kamala Ranjan vs. Vaijnath Bajoria AIR 1951 SC 1 and Shankar Prasad Goyanka& Anr. vs. State of Madhya Pradesh AIR 1965 MP 153 (Vol. 52-c.48).


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4.3. The learned counsel has further pointed out that the contract provides for grant ofsub-licence and assignment of the technical know-how. The expression of these terms inthe contract make it clear that the technical know-how and related documentation havebeen transferred to the assessee-company by the sub-licensor and there is nothing in the

contract that the same have not been provided, supplied or transferred to the assessee-company. He further made a submission that the provisions of s. 195 read with terms ofthe contract and DTAA and required to be construed and interpreted liberally andbeneficially in favour of the assessee-company and in support of such proposition, he hasplaced reliance on the following decisions :

(i) CIT vs. J. K. Hosiery Factory (1986) 159 ITR 85 (SC);

(ii) Man Singh Bros. (P) Ltd. vs. CIT (1984) 147 ITR 361 (Raj);

(iii) CIT vs. Gwalior Rayon Silk Manufacturing Co. Ltd. (1992) 196 ITR 149 (SC);

(iv) Bajaj Tempo Ltd. vs. CIT (1992) 196 ITR 188 (SC);

(v) CIT vs. Dharm Chand (1993) 204 ITR 787 (Raj);

(vi) CIT vs. Trinity Hospital (1997) 225 ITR 178 (Raj) and

(vii) CIT vs. Shaan Finance (P) Ltd. (1998) 231 ITR 308 (SC).

4.4. The learned counsel arguing further submitted that the Revenue authorities have notexamined and considered the provisions of the contract as a whole but they have beencarried away by the words "right to use" in the contract. He submitted that it is not theform but the substance of the transaction that matters and in support he placed reliance onthe decisions reported in the following :

(a) Devidas Vithal Das & Co. vs. CIT (1972) 84 ITR 277 (SC);

(b) CED vs. Aloke Mitra (1980) 126 ITR 599 (SC);

(c) Associated Hotels of India Ltd. vs. R. N. Kapur AIR 1959 SC 1262 (Vol. 46); and

(d) Ram Niwas vs. Municipal Board Nawabganj AIR 1976 All 241.

4.5. The learned counsel of the assessee has further made a submission that the sub-licensor under the authority of licensor was the owner of the technical know-how andbasic process engineering documentation and on supply of the same to the assesseecompany was entitled to receive the consideration. The tax liability would, therefore, lieon the sub-licensor being the recipient of the said amount and in support of suchproposition the learned counsel placed reliance on the decision of the Hon'ble SupremeCourt in the case of CIT vs. Poddar Cement (P) Ltd. & Ors. (1997) 226 ITR 625 (SC).


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4.6. The learned counsel of the assessee, therefore, contended that the payment made wasbusiness income of the Italian company as paid in consideration of supply of technicalknow-how and documentation and the Italian company admittedly having no permanentestablishment in India no tax thereon was liable to be paid on its remittance by the

assessee-company as an agent as per terms of DTAA. He, therefore, pleaded that theview taken by the learned J.M. is justified on facts as well as in law and the samedeserves to be endorsed.

4.7. The learned Departmental Representative Shri N. S. Dayam on the other hand reliedupon the orders of the AO as well as the CIT(A). He also carried me through the relevantarticles of the contract and further submitted that Italian company provided thedocumentation data and right to use the secret formula or process for the manufacture ofPTA. This also included the right to use the design of the plant necessary for manufactureof the PTA. The assessee-company otherwise has not made any out-right purchase ofexclusive rights over the technical know-how. The amount paid of US $ 250 lakhs and

US $ 35 lakhs as consideration for the use of or right to use the secret formula or process.Moreover, the assessee-company cannot transfer the technical know-how to any otherperson and this right has been retained by the foreign company. He also argued to showthat the facts of the case of M/s. Graphite Vicard India Ltd. (supra) are distinguishable.The learned Departmental Representative further adopting the reasoning given by theCIT(A) in para 2.5 of the appellate order contended that the payment made is a royaltyand the same is taxable in India as per art. 13 of the DTAA. In support he has also placedreliance on the following decisions :

(a) N. V. Philips vs. CIT (1988) 172 ITR 521 (Cal); and

(b) CIT vs. Krebs & Co. (1998) 229 ITR 615 (MP).

4.8. In reply the learned counsel of the assessee pointed out that arts. 11, 8.4 and 5.6 ofthe contract which were material to the issue involved have not been considered by theCIT(A) and, therefore, the conclusion reached by the CIT(A) is vitiated. Moreover, onexpiry of the contract period of ten years, the assessee will have full right to transfer thetechnical know-how received as per terms of the contract agreement. This aspect hasbeen totally overlooked by the CIT(A).

4.9. The learned counsel has further submitted that the case reported in (1988) 172 ITR521 (Cal) (supra) is distinguishable on facts and the another case cited by the learnedDepartmental Representative in (1998) 229 ITR 615 (MP) (supra) being not under DTAAis also not applicable to the facts of the present case.

5. I have carefully considered the facts, rival submissions and have also gone through theorders of the lower authorities. Orders of the learned J.M. and learned A.M., provisionsof contract, double taxation avoidance agreement, etc. and also the various case law citedfor and against. Before I advert to the question whether the said amount payable isroyalty or not, I would like to discuss and consider the nature and scope of the contract


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agreement entered into by the assessee-company with the Italian company for properappreciation.

5.1. The preamble of the contract agreement mentions that the assessee-company wasinterested in building in India a plant for the production of PTA and wanted to be granted

the rights and sub-license to use and practice the process and to be supplied withtechnical documentation in accordance with the process and technical assistance for theimplementation of the plant. The sub-licensor under the authority from the licensoragreed to grant to the assessee-company the rights and sub-license to use and practice theProcess in India and to use and sell the product so manufactured and was willing tosupply the assessee-company with know-how and the documentation for the design,construction and operation of the plant as per the terms and conditions set out in thecontract agreement.

5.1.1. The material terms used have been defined in art. 1 of the contract agreement asunder :

(1) Basic process engineering shall mean the process engineering documentation inaccordance with the process and the technical know-how to be provided by the sub-licensor. The documentation includes the items listed in Exhibit 1 to the contract such as;

(a) Process giving details and description of raw material; auxiliary materials; catalystsand chemicals, characteristics of utilities; necessary information concerning raw material,chemicals and catalysts including physical property, list of major manufacturers orvendors; consumption rates of all raw materials, chemicals and catalysts at differentlevels of production; plant capacity; information on plant effluents and wastes includingrecommended treatment; process flow-sheets; preliminary material balance withcomposition and operating conditions of process fluids including flow rates, composition,phrase, temperature, pressure, operating and standard specific gravities, densities andmolecular weights for gases and vapors, heat content, final material balance; utilitiesrequirements for operation of plant such as steam, cooling, water and demi-water,nitrogen, oxygen and hydrogen, equipment list; supervisory operating manual; Analyticalmethods and procedures; general safety information for the operation of the plant;prescriptions and/or suggestions concerning particular process requirements to the effectof instrumentation, electrical system, ventilation, air-conditioning, lighting, type andmaterials of civil works, insulation, painting;

(b) Piping;

(c) Instrumentation;

(d) Electrical;

(e) General layout and plot plan;


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(c) Process for the recovery of the solvent and of the by product methylacetate in thesynthesis of terephthalic acid.

(d) Method for catalyst preparation in the terephthalic acid synthesis process.

5.1.3. Art. 2 of the contract provides that subject to the terms and conditions of thecontract the sub-licensor grants to the sub-licensee the non-exclusive right and sub-license :

(a) to use the process and the technical know-how for the implementation of the plant tothe extent required to erect and operate the plant and to manufacture thereby the product;and

(b) to use and sell the product so manufactured in the territory which includes; allcountries of the world except Europe, former USSR countries, all American countries andMiddle East countries including Turkey and Iraq;

(c) for the purpose of practising the sub-license granted, sub-licensor shall disclose to thesub-licensee, process and technical know-how in the manner prescribed.

(d) the sub-licensor grants to the sub-licensee the rights to use the basic processengineering for the design, engineering, construction and operation of the plant only.

5.2. Art. 3 of the contract provides for supply of basic process engineering and technicalassistance and promptly after the effective date, a design conference shall be held inMilano, Italy between the sub-licensor and the sub-licensee to establish the design basisrequired by the sub-licensor for the preparation of the basic process engineering to beused by the sub-licensee in the engineering, construction and operation of the plant.

5.3. The sub-licensee shall select a engineering contractor to be approved by the sub-licensor for the preparation of the engineering and construction drawings andspecifications for the plant based on the basic process engineering under the supervisionof the sub-licensor.

5.4. The sub-licensor shall provide training services relating to the operation andmaintenance of the plant safely and efficiently in order to make them adequately familiarwith the process. Such training shall be carried out by the sub-licensor at its office and atsub-licensor's plant or at any other licensed plant using the same process. The trainingenvisages for theoretical part about the main process features and a practical part on theselected plant.

5.5. Sub-licensor shall make available its technical representatives skilled in the processto assist and advice sub-licensor at the site, in the plant check-up, pre-commissioning,commissioning, start-up and initial operation of the plant and to supervise the test runsfor an agreed period.


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5.6. Art. 4 of the contract provides for guarantees about design and construction of theplant; selection of equipments employed in the plant, type and regular operation of theplant; steady and sufficient supply of proper raw materials, auxiliary materials andutilities process performance, etc. and in case of any defect or problem found the sameare to be rectified by the sub-licensor to the extent prescribed.

5.7. The financial liability if any in putting the plant to proper operation as per terms ofthe contract after removing designing, engineering, structural etc. defects, if any, is to beborne by the sub-licensor to the extent of 40 per cent of the amount to be paid under art.5.1 of the contract i.e., US $ 250 lakhs for supply of technical know-how.

5.8. Art. 5 provides for consideration to be paid for supply of technical know-how, basicprocess engineering and payment of royalty as per details given above.

5.9. In addition the assessee-company is required to pay for the travelling, boarding andlodging expenses of its personnel to be trained at the selected plant. For training facilities

the assessee-company is to pay to the trainers of the sub-licensor at net rate of US $ 720per day for training services carried out in Italy and of US $ 800 per day for trainingservices carried out outside Italy. The assessee-company is also to pay to the technicalpersonnel of sub-licensor deputed at site at daily rate of US $ 800/720.

5.10. Art. 6 of the Contract provides for mode of payment to the sub-licensor.

5.11. Art. 7 of the Contract provides for future co-operation in the updating of the processand technical know-how in manufacturing of TPA.

5.12. Art. 8 provides for secrecy. The assessee-company undertakes not to disclose and tobind its personnel having access to the technical know-how not to disclose to other all orany part of the technical know-how, basic process engineering and/or any otherinformation supplied by the sub-licensor to the sub-licensee under the contract.

5.13. The assessee-company agrees that it will use the technical know-how and basicprocess engineering only to design, construct and operate the plant.

5.13.1. The assessee-company's secrecy obligations under art. 8 shall terminate fifteenyears after the effective date.

5.14. Art. 9 provides for protection against patent infringement.

5.15. The maximum financial liability of the sub-licensor for all expenses,indemnification, reimbursements, costs of plant modifications to avoid infringement,legal cost relevant to the defence and disposal of suit or action including claims underarts. 4 and 9 shall be to the extent of 80 per cent of the amount to be paid under art. 5.1i.e. US $ 250 lakhs for supply of technical know-how.


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5.16. Art. 10 of the contract provides for liabilities of the sub-licensor to the extent of 80per cent of the total amount received of US $ 250 lakhs.

5.17. Art. 11 of the contract provides that the contract shall inure to the benefit of and bebinding upon the parties and shall not be assignable in whole or in part by either party

without the prior written consent of the other party, provided that such consent shall notbe unreasonably withheld. However, the contract shall be freely assignable to thesuccessor of substantially the entire business of either party. In the event of permittedassignment the assigning party shall remain primarily liable for the performance of thiscontract and shall, prior to the assignment, cause the assignee to furnish to the non-assigning party an undertaking to be fully bound by the terms and conditions of thiscontract. Any purported assignment not fully in accordance with this art. 11 shall be void.

5.18. Art. 12 of the contract provides that the contract shall come into force on theeffective date, and shall continue in full force and effective till the 10th anniversary of theeffective date except for secrecy obligations under art. 8 which shall survive upto fifteen

years. On expiry of the terms of contract the assessee company shall have acquired thefully paid-up right to continue the production of the product in the plant and to sell theproduct anywhere in the world without payment of any further consideration in additionto those already paid under the contract.

5.19. Art. 19 provides that the following seven exhibits shall form an integral part of thecontract.

Exhibit-1 Basic process engineering;Ext. 2 Terms and conditions for technical assistanceExt. 3 technical specifications and process performance

guarantees.Ext. 4 Process description.Ext. 5 Patent listExt. 6 Form of secrecy agreement.Ext. 7 Battery limits.5.20 On close reading of the contract agreement as a whole following position emerges :

(a) That the contract agreement provides for collaboration with the Italian company forsetting up a plant in India for production of PTA;

(b) That the sub-licensor has granted to the assessee company the right and sub-licence touse the process for production of PTA.

(c) That the Italian company, as the preamble indicates, would supply the technicalknow-how and basic process engineering documentation for designing, construction andoperation of the plant;

(d) That the assessee-company would pay US $ 250 lakhs for supply of technical know-how and the sub-licensor is liable to bear the loss to the assessee-company on account of


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defect in designing, construction or operation of the plant or on account of litigation, ifany, relating to the technical know-how used to the extent of 80 per cent of US $ 250lakhs payable.

(e) That the assessee-company has undertaken to pay US $ 35 lakhs for supply of basic

process engineering documentation for designing, construction and operation of the plantas per the technical know-how and this payment is not subject to any restrictions as in thecase of amount payable for supply of technical know-how.

(f) That the assessee-company would pay royalty of US $ 5 per metric ton of product toItalian company subject to maximum of US $ 50 lakhs.

(g) That the Italian company would provide technical personnel for supervision oferection, construction and operation of the plant and they would be paid at the ratesprescribed.

(h) That the Italian company would also train the technical personnel of the assessee-company in its own office or in the plants outside India and the cost of the training is tobe borne by the assessee-company as prescribed;

(i) That the assessee-company has right to assign the contract to its successor also to athird party with the prior written consent of the sub-licensor and such consent is not to bewithheld unreasonably on expiry of contract period, the assessee-company would haveabsolute right to transfer the technology acquired.

(j) That the contract agreement provide for payment of consideration separately forsupply of technical know-how and basic process engineering documentation and royaltypayment for use of process/secret formula for manufacturing of PTA and this has beenduly approved by the Govt. of India. Thus, such separate payments provided are not ofthe same character.

5.21. Under the contract agreement, the assessee-company has been granted the right andsub-licence to use the process and technical know-how. The word "grant" has beendefined in Venkataramaiya's Law Lexicon Second Edn. (4th Vol.) to mean : that the workis taken largely where anything is granted or passed from one to another. And in thissense it does comprehend feoffments, bargains and sales, gifts, lease, charges and thelike, for he that does give or sell, does grant also.

5.22 The word "Grant" has also been defined in K. J. Aiyer's Judicial Dictionary (4thEdn. 1980) : Liberally permission and thus a gift, the implication being that such a giftcarries with it a privilege of some kind. It is thus used especially in law where it meansthe conveyance of property from one person to another by deed.

5.23 The term "Licence" has been described in T. P. Mukherjee's Law Lexicon Vol. 2(1982 Edn.) an authority justifying the doing of what otherwise would be wrongful. In thecommonly accepted sense, the term means authority, or permission to do something


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specified, leave to do a thing which the licensor would otherwise have the right toprevent.

5.24. The term "Licence" has further been described in P. Ramnatha Aiyer's "LawLexicon" 1997 Edn. as an authority to do something which would otherwise be in

operative wrongful or illegal; a formal permission from a constituted authority to dosomething. In the popular as also in the legal sense, a licence is a permission to dosomething which without the licence would not be lawful.

5.25. The word "Right" has been defined in K. J. Aiyer's Judicial Dictionary (8th Edn.1980) to mean claim a thing. That which is so directed for the protection and advantageof an individual is said to be his right. It is the liberty of doing or possessing somethingconsistently with law. A right is an interest which is recognised and protected by law.

5.26. Looking to the judicial meaning of the word "Grant", "Right" and "Licence" asdescribed above, the act of the sub-licensor in granting the right and sub-licence to use

the process and technical know-how amounts to transfer of the right, interest, title andpossession of the process for the production of PTA as per the technical know-howdeveloped by the licensor to the assessee-company. However, simple grant of such rightand licence is meaningless unless necessary facility for production of PTA as per theProcess and technical know-how is created and for this purpose the sub-licensor agreed tosupply necessary technical know-how and basic process engineering documentation fordesigning, construction and operation of the plant for consideration. The word "supply"as per T. P. Mukherjee's Law Lexicon (Vol. 2 1982 Edn.) is merely a form of sale anddespatch, and unless there was sale there was no supply of goods. [Karamchand Thapar& Bros. vs. State of Bihar (1956) 7 STC 58 (Pat)]. The words sale and supply gotogether. Since the sub-licensor has supplied the technical know-how and basic processengineering documentation for a consideration the transaction amounts to sale in thehands of sub-licensor and purchase in the hands of the assessee-company. It is also notedthat the consideration charged for supply of technical know-how is subject to the liabilityon account of loss suffered, if any, by the assessee-company on account of rectification ofthe fault, if any, in designing, construction and operation of the plant and also on accountof litigation with a third party for infringement of patent right, etc. to the extent of 80 percent of the consideration charged. The claim of such liability in the hands of the sub-licensor against the consideration received could be claimed only if the amount receivedis taken as a business profit in the hands of the sub-licensor and income therefrom isassessed in Italy, as the sub-licensor having no permanent establishment in India is nottaxable on such business profit in India. Moreover, intent of the contract agreement has tobe construed and interpreted liberally in favour of the sub-licensee as per ratio of variousprecedents cited.

5.27. I would now advert to the main controversy whether the remittance made by theassessee-company, sub-licensee is a royalty or business receipt of sub-licensor. It is notedin this regard that as per provisions of s. 90, the Government of India entered into anagreement with the Government of Italy for Double Taxation relief as per NotificationNo. 10075 dt. 25th April, 1996. As per art. 7 of the DTAA, the profit of an enterprises of


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a contracting state shall be taxable only in that State unless the enterprise carries onbusiness in the other contracting State through a permanent establishment situatedtherein. As per sub-cl. (6) of art. 7, where profits include items of income which are dealtwith separately in other articles of the convention, then the provisions of those articlesshall not be affected by the provisions of art. 7. Art. 13 of the DTAA provides for mode

of taxation of royalties and fees for technical services. The term "Royalty" as per cl. (3)of art. 13 of DTAA means payments of any kind received as a consideration : (i) for theuse of, or the right to use any copyright of literary, artistic or scientific work, includingcinematography film or films or tapes used for radio or television broadcasting, anypatent, trade mark, design, or model, plan, secret formula or process; or (ii) for the use of,or the right to use, industrial, commercial or scientific equipment, or for informationconcerning industrial, commercial or scientific experience.

5.28. The term "Royalty" in the DTAA has been given a restricted meaning as comparedto the term "Royalty" defined in Expln. 2 to s. 9(1)(vi) of the IT Act reproducedhereunder :

"Explanation 2. - For the purposes of this clause, "royalty" means consideration(including any lump sum consideration but excluding any consideration which would bethe income of the recipient chargeable under the head "Capital gains") for -

(i) the transfer of all or any rights (including the granting of a licence) in respect of apatent, invention, model, design, secret formula or process or trade mark or similarproperty;

(ii) the imparting of any information concerning the working of, the use of, a patent,invention, model, design, secret formula or process or trade mark or similar property;

(iii) the use of any patent, invention, model, design, secret formula or process or trademark or similar property;

(iv) the imparting of any information concerning technical, industrial, commercial orscientific knowledge, experience or skill;

(v) the transfer of all or any rights (including the granting of a licence) in respect of anycopyright, literary, artistic or scientific work including films or video tapes for use inconnection with television or tapes for use in connection with radio broadcasting, but notincluding consideration for the sale, distribution or exhibition of cinematographic films;or

(vi) the rendering of any services in connection with the activities referred to in sub-cls.(i) to (v)."

5.29. However, as per Board's Circular No. 333 (F. No. 506/42/81-FTD) dt. 2nd April,1982, where a DTAA provides for a particular mode of computation of income, the sameshould be followed irrespective of the provisions in the IT Act. Since the DTAA with the


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Government of Italy provides for mode of computation of income the question oftaxability of the amount of payment has to be considered in accordance thereof and thereis also no dispute in respect thereof. It is, therefore, required to be examined whether theamount of payment to the Italian company as per the terms of the contract agreement fallwithin the term "Royalty" or "business profit" under DTAA.

5.30. As per cl. (2) of art. 13 of the DTAA, such royalties and fees for technical servicesmay be taxed in the contracting State in which they arise and according to the laws of thatState but if the recipient is the beneficial owner of the royalties or fees for technicalservices the tax so charged shall not exceed 20 per cent of the gross amount of royaltiesor fees for technical services.

5.31. As per art. 2 of the contract agreement the sub-licensor has granted a right and sub-licence to use the process for manufacturing of PTA. The payment made for use of theprocess or secret formula for manufacture of PTA would obviously fall within thedefinition of the term "royalty" under DTAA.

5.32. The term "Royalty" has been defined in K. J. Iyer's Judicial Dictionary according towhich "Royalty" has several meanings :

"(a) percentages or dues payable to land-owners for mining rights;

(b) sums paid for the use of a patent;

(c) percentages paid to an author by a publisher on the sales of a book.

"Royalty" was a payment to the owner of minerals for the right of working the same, andthat the charging was based on produce. [Sethi Marblestone Industries vs. State ofRajasthan AIR 1958 Raj 140].

Royalty is payment which the Government may demand for the appropriation ofminerals, timber or other property belonging to the Government. Two important featuresof royalty have to be noticed; they are, that the payment is made for the privilege ofremoving the articles in proportion to the quantity removed, and the basis of the paymentin an agreement.

5.33. The word "Royalty" has also been described in Black's Law Dictionary (Fifth Edn.)to mean compensation for the use of property; usually copyrighted material or naturalresources, expressed as a percentage of receipts from using the property or as an accountper unit produced. A payment which is made to an author or composer by an assignee,licensee or copyright holder in respect of each copy of his work which is sold, or to aninventor in respect of each article sold under the patent. Royalty is share of product orprofit reserved by owner for permitting another to use the property in its broadest aspect,it is share of profit reserved by owner for permitting another the use of property.


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In mining and oil operations, a share of the product or profit paid to the owner of theproperty.

5.34. It is clear from the meaning of the word "Royalty" described that the royaltypayment is linked to the production or profits earned through use of process or secret

formula, patent, copyright, etc. In the present case art. 5.6 of the contract agreementprovides for payment of a running royalty to the sub-licensor of US $ 5 per metric ton ofproduct manufactured in the plant upto maximum of US $ 50 lakhs. The payment of theroyalty amount is directly linked to the product and the same, would no doubt be taxed asroyalty as per art. 13 of the DTAA. There is no dispute either about the taxability of theroyalty payment as per cl. 5.6 of the contract agreement in the hands of the assessee-company as agent of the Italian company.

5.35. The controversy however relates to the payment to be made in instalments to thesub-licensor for supply of technical know-how of US $ 250 lakhs and also for supply ofbasic process engineering documentation of US $ 35 lakhs for designing, construction

and operation of the plant. This payment thus relates not to the use of any process, secretformula or patent for production of any commodity but for creating an asset in the shapeof a plant, designed, constructed and operated as per the technical know-how developedby the licensor and basic process engineering documentation provided by the sub-licensorand this payment is required to be made in instalments by the date of completion and startof the plant for production of PTA. Such payment thus made to the sub-licensor as perthe contract agreement. In my considered opinion, does not fall within the term "Royalty"as defined in cl. 3 of art. 13 of the DTAA. Moreover, as mentioned above, the paymentmade as per cl. 5.1 of the contract agreement for supply of tec

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