AAR ON TAXABILITY OF A CANADIAN COMPANY, HAVING NO PE IN IND

THE AUTHORITY FOR ADVANCE RULINGS (INCOME TAX) NEW DELHI Anapharm Inc, In re: AAR NO. 746 of 2008 September 11, 2008 RELEVANT EXTRACTS: ** ** ** ** 7. As the case of the Revenue is that the professional fees paid to the applicant for rendering the services in question are in the nature of fees for technical / included services as well as royalty, the relevant provisions of the Act and the DTAA are extracted below. The relevant provisions of the section 9 of the Act are as under : Income deemed to accrue or arise in India. 9. (1) The following incomes shall be deemed to accrue or arise in India:— (i) to (v) x x x x x x (vi) income by way of royalty payable by— (a) the Government ; or (b) a person who is a resident, except where the royalty is payable in respect of any right, property or information used or services utilised for the purposes of a business or profession carried on by such person outside India or for the purposes of making or earning any income from any source outside India ; or (c) a person who is a non-resident, where the royalty is payable in respect of any right, property or information used or services utilised for the purposes of a business or profession carried on by such person in India or for the purposes of making or earning any income from any source in India : Explanation 1 – x x x x x x Explanation 2.—For the purposes of this clause, “royalty” means consideration (including any lump sum consideration but excluding any consideration which would be the income of the recipient chargeable under the head “Capital gains”) for— (i) the transfer of all or any rights (including the granting of a licence) in respect of a patent, invention, model, design, secret formula or process or trade mark or similar property ; (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 trade mark or similar property ; (iv) the imparting of any information concerning technical, industrial, commercial or scientific knowledge, experience or skill ; [(iva) the use or right to use any industrial, commercial or scientific equipment but not including the amounts referred to in section 44BB;] (v) the transfer of all or any rights (including the granting of a licence) in respect of any copyright, literary, artistic or scientific work including films or video tapes for use in connection with television or tapes for use in connection with radio broadcasting, but not including consideration for the sale, distribution or exhibition of cinematographic films ; or (vi) the rendering of any services in connection with the activities referred to in sub-clauses (i) to [(iv), (iva) and] (v). (vii) income by way of fees for technical services payable by— (a) x x x x x x x (b) a person who is a resident, except where the fees are payable in respect of services utilised in a business or profession carried on by such person outside India or for the purposes of making or earning any income from any source outside India ; or (c) x x x x x x Explanation [1] x x x x x Explanation [2].—For the purposes of this clause, “fees for technical services” means any consideration (including any lump sum consideration) for the rendering of any managerial, technical or consultancy services (including the provision of services of technical or other personnel) but does not include consideration for any construction, assembly, mining or like project undertaken by the recipient or consideration which would be income of the recipient chargeable under the head “Salaries”.] Article 12 of DTAA deals with royalties and fees for included services, the relevant provisions of which are being indicated below:- ARTICLE 12 : Royalties and fees for included services 3. The term ‘royalties’ as used in this Article means : (a) payment of any kind received as a consideration for the use of, or the right to use, any copyright of a literary, artistic, or scientific work including cinematograph films or work on film tape or other means of reproduction for use in connection with radio or television broadcasting, any patent, trademark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience, including gains derived from the alienation of any such right or property which are contingent on the productivity, use, or disposition thereof; and (b) payments of any kind received as consideration for the use of, or the right to use, any industrial, commercial, or scientific equipment, other than payments derived by an enterprise described in paragraph 1 of Article 8 from activities described in paragraph 3(c) or 4 of Article 8. 4. For the purposes of this Article, ‘fees for included services’ means payments of any kind to any person in consideration for the rendering of any technical or consultancy services (including through the provision of services of technical or other personnel) if such services : (a) are ancillary and subsidiary to the application or enjoyment of the right, property or information for which a payment described in paragraph 3 is received; or (b) make available technical knowledge, experience, skill, know-how, or processes or consist of the development and transfer of a technical plan or technical design. 12.1 As the main issue in this case is whether by providing its final test reports to Sandoz and Ranbaxy, the applicant ‘makes available’ to them its technical knowledge, experience, know-how, etc., we may first ascertain the true meaning of this expression. 12.2 DTAA does not define the expression ‘make available’ either in Article 12 or anywhere else. As such, we will have to look to other sources for understanding it. The Indo-US Convention on avoidance of double taxation contains a provision which is pari materia with Article 12(4) of the Indo-Canada DTAA. Though Indo-US Convention also does not define the expression ‘make available’ in the main body, but it has a protocol annexed to it, which was signed along with the said convention. The protocol declares that its provisions shall form integral part of the convention. The Protocol has an MOU attached to it which is intended to give guidance both to the taxpayers and the tax authorities of the two countries in interpreting certain aspects of Article 12 relating to the scope of included services. As regards paragraph 4 (b) of Article 12, the following clarification/interpretation is given in the MOU : “Paragraph 4(b) of article 12 refers to technical or consultancy services that make available to the person acquiring the service technical knowledge, experience, skill, know-how, or processes, or consist of the development and transfer of a technical plan or technical design to such person (For this purpose, the person acquiring the service shall be deemed to include an agent nominee, or transferee of such person.) This category is narrower than the category described in paragraph 4(a) because it excludes any service that does not make technology available to the person acquiring the service. Generally speaking, technology will be considered ‘make available’ when the person acquiring the service is enabled to apply the technology. The fact that the provision of the service may require technical input by the person providing the service does not per se mean that technical knowledge, skills, etc., are made available to the person purchasing the service, within the meaning of paragraph 4(b). Similarly, the use of a product which embodies technology shall not per se be considered to make the technology available”. Example No.7 given therein is also relevant for our purpose. “Example (7) : Facts : The Indian vegetable oil manufacturing firm has mastered the science of producing cholesterol-free oil and wishes to market the product world-wide. It hires an American marketing consulting firm to do a computer simulation of the world market for such oil and to advise it on marketing strategies. Are the fees paid to the U.S. company for included services ? Analysis : The fees would not be for included services. The American company is providing a consultancy service which involves the use of substantial technical skill and expertise. It is not, however, making available to the Indian company any technical experience, knowledge or skill, etc., nor is it transferring a technical plan or design. What is transferred to the Indian company through the service contract is commercial information. The fact that technical skills were required by the performer of the service in order to perform the commercial information service does not make the service a technical service within the meaning of paragraph 4(b)”. 12.6 In the present case, the applicant renders bioanalytical services which, no doubt, are very sophisticated in nature, but the applicant does not reveal to Sandoz / Ranbaxy as to how it conducts those tests or the inputs that have gone into it , so as to enable them to carry out those tests themselves in future. A broad description or indication of the type of test carried out to reach this conclusion does not enable the applicant’s client to derive requisite knowledge to conduct the tests or to develop the technique by itself. The mere fact that the tests in question are highly technical in nature will not make a difference. In its affidavit the applicant affirms that only final results, conclusion of data of bioequivalence tests are provided to the recipient. Clinical procedure, analytical methods, etc., which are proprietary items of the applicant, have neither been nor will they ever be transferred, assigned or handed over to Sandoz or any other Indian client. From the perusal of the relevant agreements, we have not found any provision which would entitle Sandoz/Ranbaxy to know the details of the analytical methods and procedures employed by the applicant in carrying out the bioequivalence tests. The only doubt cast by Clause 15 of the agreement with Sandoz is cleared by Sandoz statement that the said clause which was part of standard format was never given effect to. It seems to be inapplicable also having regard to the actual modalities of the transaction as set out in the application. Then agreement with Ranbaxy says that Ranbaxy shall be the owner of the tested samples and test compounds. Further, the applicant will store tested samples and test compounds for three months and make these available to Ranbaxy at the expiry of that period. Handing over tested samples and test compounds cannot be equated with making technology, know-how, etc., available to Ranbaxy. The agreement also states that Ranbaxy shall be the owner of all intellectual property rights resulting from the services. This would mean that, if on the basis of these results, Ranbaxy is able to acquire patent or other intellectual property rights in respect new generic drugs developed by it, then the applicant shall not claim any interest whatsoever in such right. It is altogether a different aspect. By agreeing to this provision, the applicant has not made its technical expertise, know-how, etc., available to Ranbaxy. It is only natural that Ranbaxy which has developed the generic drug should enjoy the intellectual property rights in relation thereto. The analytical test has not contributed to the development of new generic drug. The test has only shown whether that drug is as efficacious as the reference drug. We would also like to point out here that development of new drug and testing its efficacy are not one and the same thing. By merely acquiring knowledge of the testing methods one does not get any insight as to how a new drug could be developed. 12.7. In the light of the above discussion interpreting the expression ‘make available’, it follows that clause (b) of Article 12(4) relied upon by the Revenue does not come into play and the services in question cannot be considered to be “fees for included service” within the meaning of this provision. The second limb of clause (b) refers to “development and transfer of a technical plan or technical design”. Obviously, that has no application here. 13. We may now come to the submission of the learned counsel of Revenue that the payment of fees in this case can also be regarded as royalty income under Article 12 of DTAA, for which he places reliance on paragraph 11 of OECD Commentary and page 790 of Klaus Vogel on Double Taxation Conventions. Paragraph (3) of the said Article 12 states that royalty is payment of consideration for the use of, or the right to use any, copyright, patent, secret formula, process, information concerning industrial, commercial or scientific experience. We find that paragraph (2) of Article 12 of OECD Model Convention also defines royalty in a manner similar to paragraph (3) of Article 12 of DTAA. While discussing paragraph (2) of Article 12 of the OECD Model Convention, OECD Commentary at paragraph 11 states that information concerning industrial, commercial or scientific experience alludes to the concept of know-how which is all the undivulged technical information that is necessary for the industrial reproduction of a product or process directly. Know-how represents what a manufacturer cannot know from mere examination of the product and mere progress of the technique. The Commentary further states that a know-how contract differs from contracts for the provision of services, in which one party undertakes to use the customary skills of his calling to execute the work himself for the other party. Payment made under the latter contract generally come in the category of business income. We find that in the present case the agreements of the applicant fall in the latter category, as the applicant uses its experience and skill itself in conducting the bioequivalence tests, and provides only the final report containing conclusions, to the applicant. The information concerning scientific or commercial experience of the applicant or relating to the method, procedure or protocol used in conducting bioequivalence tests is not being imparted to the pharmaceutical companies and the consideration is not paid for that purpose. On the basis of the final report, the pharmaceutical companies will not be able to find out what method, procedure or protocol was used in conducting the tests. Moreover, the test reports are drug specific as stated at para 4 above. Hence the material furnished by the applicant will not in any way help the customers to facilitate further research and development of new drugs as contended by the Revenue. As such, the fees received by the applicant are to be treated as business income and not royalty income. Klaus Vogel at page 790 of his commentary on Double Taxation Conventions states that what distinguishes a contract for provision of know-how from a contract for rendering advisory services is the concept of ‘imparting’. An adviser or consultant, rather than imparting his experience, uses it himself. All that he imparts is the conclusion that he draws from his own experience. His obligation to observe secrets, or even, his own interest in retaining his means of production, will prevent a consultant from parting with his experience. The above observation of Klaus Vogel also rather than advancing the case of Revenue, goes against it. 14. We are of the view that since the applicant is in the business of providing bioanalytical services to various pharmaceutical companies, the consideration received by it from them would be its business income. In view of Article 7 read with Article 5 of DTAA, such income can be taxed in India only if the applicant has a Permanent Establishment in this country. We observe that the applicant has denied the existence of any PE here and there is nothing on record to indicate anything to the contrary. On the facts stated, the existence of PE in India cannot be inferred also. 15. In the light of the above discussion, we rule that the fee paid by Sandoz Private Limited, Ranbaxy Research Laboratories to the applicant in respect of bioequivalence test conducted by it is in the nature of ‘business profits’ under article 7 of the DTAA and the same is not taxable in India as the applicant does not have a permanent establishment situated in this country.