Where income is taxable on receipt basis it will be taxed only on actual received and interest under sec 234B and C also have same effect

IN THE INCOME TAX APPELLATE TRIBUNAL

DELHI BENCH: ‘F’ NEW DELHI

BEFORE SHRI R.P. TOLANI, JUDICIAL MEMBER AND

SHRI K.G. BANSAL, ACCOUNTANT MEMBER

I.T.A No. 1656/Del/11

Asstt. Year – 2004-05

Pizza Hut International LLC

C/o Dinesh Mehta & Co. , CAs,

21, Daya Nand Road,

Darya Ganj,

New Delhi.

(Appellant)

Vs

.

Deputy Director of Income Tax,

Circle 2(1),

International Taxation,

New Delhi.

 (Respondent)

I.T.A Nos. 1600 & 1601/Del/11

Asstt. Years – 2003-04, 2004-05

ADIT,

Circle – 2(1),

Intl. Taxation,

New Delhi.

(Appellant)

Vs.

 Pizza Hut International LLC

C/o Yum Restaurant Co. Ltd.

12th Row, Tower-D, Global

Business Park

Gurgaon 122002, Haryana

AACCP3392F

 (Respondent)

Appellant by: Shri Nageshwar Rao, Advocate

Respondent by: Shri N.K. Chand, CIT, DR

Date of hearing: 18-05-2012

Date of pronouncement: 08-06-2012

ORDER

PER K.G. BANSAL, AM:

These three appeals for two different years, consisting of one appeal of the assessee and two appeals of the revenue, were argued in a consolidated manner by the Ld. Counsel for the assessee and the Ld. Sr. DR. Therefore, we find it convenient to pass a consolidated order.

1.1 The assessee has taken up two grounds in its appeal for assessment year 2004-05. Ground No. 1 is that Ld. CIT(A) erred in upholding the taxation of notional royalty income against well established principle that only real income can be taxed. Without prejudice to this ground, in ground No. 2, it is mentioned that assessee follows cash system of accounting and, therefore, it cannot be taxed unless the income is actually received.

1.2 The revenue has taken two similar grounds in its appeal for assessment years 2003-04 and 2004-05. Ground No. 1 is that the Ld. CIT(A) erred in holding that royalty income received by the assessee is taxable @ 15% of the income under the relevant Double Taxation Avoidance Agreement (“DTAA”) instead of 20% under domestic law particularly when the assessee has claimed benefit of the Income Tax Act, 1961, available u/s 10 (6A), on the same income. Ground No. 2 is that the Ld. CIT(A) erred in holding that interest u/s 234B and 234C is not chargeable in the case.

2. The facts of the case for assessment year 2003-04 are that the assessee filed its return on 28.11.2003 showing total income of ` 2,45,83,770/-. The assessee is tax - resident of the USA and it is earning income of the nature of the royalty from Yum Restaurant India Ltd (“YUM” for short) under a technical license agreement. It claimed that its income is taxable @ 15% under the DTAA. In the course of assessment the AO found that it had claimed exemption u/s 10(6A) of the Act in respect of tax on royalty borne by Yum. This claim was considered by the AO after hearing the assessee. He came to the conclusion that the assessment has to be made either in accordance with the provisions contained in the Act or in the DTAA. The assessee cannot avail of the benefit of section 10(6A) and if the same time claimed that tax should be levied @ 15% under the DTAA. Since the assessee has claimed the exemption, the income has been taxed @ 20% as provided in the Act. Thus the additional tax payable has been worked out at ` 1229188/-. Interest under sections 234B and 234C has also been charged.

3. Aggrieved by this order, the assessee filed appeal before the CIT(A) – XXIX, New Delhi. The main ground taken before him was that the AO was not justified to tax the income @ 20% against the rate of 15% provided in the DTAA on the ground that exemption has been claimed u/s 10(6A). The charge of interest u/s 234C was also challenged. Various averments were made before him. After hearing the case, the Ld. CIT(A) allowed the appeal in respect of ground No. 1. It is mentioned that the royalty income is chargeable u/s 9(i) (vi) of the Act. Section 10 (6A) exempts from taxation the income received by way of tax paid by the payer in India. The assessee is admittedly qualified for such exemption. The assessee has claimed the exemption for assessment year 2003-04 as the agreement has been signed on 15.1.96. This exemption has not been claimed in assessment year 2004-05 as the agreement for this year was signed after 1.6.2002. Therefore, it has been held that he erred in not granting exemption u/s 10(6A) for assessment year 2003-04. The revenue is aggrieved by this order.

4. Before us, Ld. Sr. DR submits that the agreement under which royalty was received in this year was signed on 15.1.1991. This agreement has been placed in the paper book on page Nos. 139 to 162. It is inter-alia mentioned in the agreement that the assessee owns goodwill and enjoys a special and very high reputation in the field of the quick service restaurant industry with respect to its valuable trademark, service marks, trade names, slogans, designs, insignias, emblems, symbols, package designs, distinctive building designs and other architectural features, logos and other proprietary identifying characteristics identifying and distinguishing, used or to be used in connection with its products, business, technology and system (“Trademarks” for short). The agreement is for 7 years. The licence granted under the agreement is renewable after its expiration of the period of five years. The provisions requiring payment of technology licence is subject to the local law. The licensee shall procure all equipments, paper goods and all other products and materials required to be utilised in the operation of business for making approved products from such suppliers etc, as approved by the assessee. In order to maintain and protect uniqueness and uniformity of taste, quality and image of the approved products, the assessee owns and has developed and will continue to develop certain secret blends of herbs, spices and special seasoning and other trade secrets which will be made available to the licensee , which will be purchased at the prevailing international prices in consideration of the license granted to the license, which shall pay licence fees equal to –

(i) 5% of sales per outlet,

(ii) all fees from sub licensees, not in excess of 5% of all of such - licensees’ sales. The fees shall be clear of any tax due including withholding taxes imposed by applicable law.

4.1 It is submitted that the first payment under the agreement was made in the year 2000. It was accounted for on net of tax basis by following cash system of accounting. Two disputes have arisen in these years. The first one is – whether tax of ` 46,55,877/- paid by the licensee is includible or not in the light of provision contained in 10(6A)? The second question arises from the fact that aforesaid agreement ceased to have effect in the last quarter comprising of the period January, 2003, to March, 2003. The licensee had passed the entries in its books of account in respect of royalty payable for this period also, however, no payment was made, therefore, the second question is – whether, the royalty income pertaining to this period is includible or not in the total income ?

4.2 Ld. Sr. DR drew our attention to the new agreement entered into between the assessee and the licensee on 1.7.2003 which, has been placed in the paper book on page Nos. 164 to 180. This agreement came into force w.e.f 1.7.2003. Further, our attention has been drawn towards page No. 200, being press note No. 2 (2003 series) dated 24.6.2003 regarding liberalisation of foreign technology policy and procedures. It is mentioned that at present wholly owned subsidiaries are permitted to make payment of royalty upto 8% on exports and 5% on domestic sales to their offshore parent companies on the automatic route without any restriction on duration of royalty payments. Henceforth, all companies will be permitted on the automatic approval route to make royalty payment @ 8% of exports and 5% on domestic sales without any restriction on duration in respect of the extent of foreign equity in the share holding. The case of the Ld. SR. DR is that the licensee, being a whole at subsidiary of the assessee – company, the old agreement was extendable without any further approval.

4.2. Further, the Ld. Sr. DR drew our attention to notes on accounts of Yum regarding accrual of royalty which mentions that the technology licensee agreements have expired on 14.1.2003 and 31.3.2002 respectively. No royalty has accrued from 1.1.2003 in case of the assessee and 1.4.2002 in case of KFCIH. It has been agreed that no royalty is payable till the renewal of the agreements in notes on accounts for assessment year 2004-05, it is mentioned that the agreements expired on 14.1.2003 and 31.3.2002 respectively. These have been renewed on 1.7.2003. It has been agreed that royalty is not payable for the period in which the agreements were not valid.

4.3 The Ld. Sr. DR also drew our attention to page Nos. 97 & 98 of the paper book which contain Article 12 of the DTAA regarding royalties and fees for included services. This article, in so far as we are concerned, reads as under:-

“2. However, such royalties and fees for included services may also be taxed in the Contracting State in which they arise and according to the laws of that State; but if the beneficial owner of the royalties or fees for included services is a resident of the other Contracting State, the tax so charged shall not exceed:

(a) in the case of royalties referred to in sub-paragraph (a) of paragraph 3 and fees for included services as defined in this Article [other than services described in sub-paragraph (b) of this paragraph]:

(i) during the first five taxable years for which this Convention has effect,

(a) 15 per cent of the gross amount of the royalties or fees for included services as defined in this Article, where the payer of the royalties or fees is the Government of that Contracting State, a political sub-division or a public sector company ; and

(b) 20 per cent of the gross amount of the royalties or fees for included services in all other cases ; and

(ii) during the subsequent years, 15 per cent of the gross amount of royalties or fees for included services : and (b) in the case of royalties referred to in sub-paragraph (b) of paragraph 3 and fees for included services as defined in this Article that are ancillary and subsidiary to the enjoyment of the property for which payment is received under paragraph 3 (b) of this Article, 10 per cent of the gross amount of the royalties or fees for included services.

3. The term “royalties” as used in this Article mean:

(a) payments of any kind received as a consideration for the use of, or the right to use, any copyright or 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, trade mark, 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 (Shipping and Air Transport) from activities described in paragraph 2 (c) or 3 of Article 8.”

4.4. Paraphrased in the context of this case, paragraph No. 1 provides that royalties accruing to the assessee in India and paid in the USA may be taxed in the USA. Paragraph No. 2 provides that such royalties etc. may be taxed in India also. Paragraph No. 2 also provides for the rate of tax at 15% of the gross amount of royalty. The case of the Ld. Sr. DR is that the article uses the words “gross amounts” which have not been defined under the DTAA. Therefore. these words will have the same meaning as assigned to them under the Act. Section 198 provides that all sums deducted in accordance with the provisions of chapter XVII shall, for the purpose of computing the income of assessee, be deemed to be income received. The exclusionary proviso is not applicable to the facts of this case. Under this provision “gross amounts” will be the amount actually paid to the assessee and the amount of tax deducted at source, for which credit will be available to the assessee. Therefore, both under the Act and the treaty, the tax paid by the licensee on behalf of the assessee will have to be included in the “gross amounts”, chargeable to tax. Therefore, the assessee has an option to be taxed @ 15% of the gross amount or tax rate applicable under the Act on the net amount after claiming exemption u/s 10(6A), which is 20%. Thus, it is argued that the Ld. CIT(A) erred in taxing the net amount @ 15% under the DTAA.

4.5 In regard to the income accruing for three months during which the agreement was not in operation, it is submitted that the assessee is a company and, therefore, it has to perforce follow mercantile system of accounting as mandated under the companies Act. The licensee has made entries in the books of account for the payment and reduced its income accordingly. Therefore, the income arisen or accruing to the assessee in India for these three months will have to be included in the total income.

4.6. Coming to chargeability of interest u/s 234B and 234C, it is submitted that these provisions should be read along with section 209. At the time of receipt of income, the assessee knew that tax is not being deducted at source in respect of income accruing for three months. It was also aware that a wrong calculation was made in respect of the “gross amounts” of income. Therefore, it is urged that the assessee is liable to pay interest under aforesaid provisions.

5. In reply, Ld. Counsel referred to the provisions contained in section 90(2) of the Act which grants option to non-resident companies to opt for beneficial tax treatment under the Act. It however does not provide that if such a provision is availed of the rate provided in the treaty will cease to have effect. Article 12 prescribes that income in the nature of royalty is taxable @ 15% of the “gross amounts”. It provides only for the rate of tax. The term “income” or “gross amounts” has not been defined in the DTAA and, therefore, the computation – provision under the Act will come into force as mentioned in Board Circular No. 333 of 1982 dated 2.4.1982, in which it is mentioned that where a DTAA provides for a particular mode of computation of income, the same should be followed, irrespective of provisions in the Income Tax Act. However where there is no specific provisions in the agreement, it is basic law, i.e., the Act, which will govern the taxation of income ; (1982) 137 ITR (Statute)I. Therefore, it is urged that the income of the assessee is taxable @ 15% of the amount actually paid by the licensee to it. Coming to the inclusion of the royalty income of three months during which the agreement was not in force, our attention has been drawn towards the DTAA. In paragraph No. 1, it is provided that royalties and fees for included services arising in a contracting state and paid to a resident of the other Contracting State may be taxed in that other State (emphasis supplied by the Ld. Counsel). On the basis of this provision it is argued that the taxation of royalty under the DTAA is based on cash system of accounting and not mercantile system of accounting.

5.1. Finally, it is argued that the whole of the income of the assessee was subject to tax deduction at source, therefore, the assessee had not incurred any liability for payment of advance tax u/s 209. Sections 234B and 234C are in the nature of machinery provisions, which cannot over- ride the charging provision. Thus, it is argued that since there is no liability to pay advance tax, there will also be no liability to pay interest in respect of default for payment of advance tax or deferment of such tax.

6. We have considered the facts of the case and submissions made before us. The first question to be decided by us is – whether, income by way of royalty is taxable on gross basis under the DTAA @ 15% or on a net basis @15% ? We have seen that the assessee has opted for the provision contained under article 12 of DTAA as taxation under the Act is not more beneficial to it. Prargraph No. 2 of Article 12 of the DTAA contemplates taxation @ 15% of the “gross amounts” of royalties. The term “Gross amounts” has not been defined in the treaty. In common parlance, these words mean the amount received alongwith tax deducted etc. at source. If the intention was to tax only that amount which is actually paid to the assessee, then the word “amount” only would have been used. Therefore, it is clear that the intention is to tax the gross amount and not the net amount of the royalty. We also find that this term has not been defined in the DTAA. Therefore, the guidance will have to be sought, if available, from the Act. We find that the Act, in section 198, provides that all sums deducted in accordance with the provisions of

chapter XVII shall be deemed to be income received for computing the income of an assessee. This section embodies in itself the principle that tax deducted at source , for which credit is available to the payee, is nothing but payment of income, utilised for payment of tax on behalf of

the payee. Therefore, this section also embodies the principle of ascertaining the gross amount paid by the payer to the payee. In terms of this provision also, the gross amount would mean the actual payment by way of royalty and tax deducted at source or paid to the Central Government on behalf of the payee. The Ld. CIT(A) has mentioned that the benefit of computational provision would be available to the assessee and, therefore, the amount of tax deducted at source would be excluded from the total income u/s 10(6A) of the Act. We do not agree with him in this behalf for the simple reason that no computation is required for finding the gross amount of royalties paid to the assessee. As mentioned earlier, as a matter of common understanding, this expression includes within its ambit the actual payment and tax deducted at source, paid to the Central Government on behalf of the assessee. In this light, the provision in section 198 is in the nature of definition only. Therefore, the order of the Ld. CIT(A) is reversed on this issue. Consequently ground No. 1 in both the appeals of the revenue is allowed.

7. The second question is – whether, the income by way of royalty is taxable on cash basis or mercantile basis? We find that this issue has been decided by ‘B’ Bench of Delhi Tribunal in the case of CSC Technology Singapore Pte. Ltd. in ITA No. 5604/Del/2010 dated 17.2.2012. This decision takes care of the submissions of the Ld. Sr. DR and the Ld. Counsel in our case. The Tribunal considered the decision in the case of DCIT vs. Uhde Gmbh. (1996) 54 TTJ 355 (Bom), National Organic Chemical Industries Ltd. vs. DCIT (2005) 96 TTJ 765 (Bom.) and CIT vs. Standard Triumph Motor Co. Ltd. (1979) 119 ITR 573. In the decision it has been mentioned that paragraph No. 1 uses the words “ royalties and fees for included services arising in a contracting state and paid to a resident of the other contracting state” . Thus the initial point of taxation is the arising of the royalty in India, but it is finally taxed on the basis of amount of royalty paid to the non-resident.

8. In another words, irrespective of the system of accounting, royalties are taxable on cash basis. The findings are contained in paragraph No. 6.4 which is reproduced below:-

“We find that the ld. Senior DR has primarily relied upon the provision contained in section 5(2). The decision in the case of Standard Triumph Motors Co. Ltd. (supra) also deals with harmonious interpretation of the provisions contained in sections 145 and 5(2). The decision and the submissions do not take into account the provisions of the DTAA as probably none existed at that time. These have been considered by the Tribunal in the case of Uhde Gmbh and National Organic Chemical Industries Ltd. (supra). It has been mentioned that in case of conflict between the provisions of the DTAA and Act, the provisions contained in the treaty shall prevail.

Consequently, it has been held that the taxation of royalty/FTS is on receipt basis. In other words, the amount which has accrued as income to a foreign company cannot be taxed in the source country, being India in this case, unless the amount has been received by the foreign company. It is also the case of the Ld. Senior DR that such an interpretation can lead to deferment of payment of tax for some time or for indefinite time. We have considered this matter also. This issue has to be decided on the basis of conduct of the two parties, which are associated enterprises (AEs) in this case. It is no doubt true that the provision may be used as a device to defer the tax for any length of time by mutual understanding of the parties. However, to come to such a conclusion in a particular case, the conduct of the parties has to be seen and thereafter a conclusion has to be arrived at that deferment of payment was a device used for the purpose of delaying the payment of tax. No such finding has been recorded in this case. Such is also not the case of ld. Senior D.R. Therefore, even if there is force in the argument that the interpretation may lead to delay in payment of tax, it will be useful only in such cases where the AO makes out a case that the delay was with a view to defer the payment of tax. In absence of such a finding by the AO, it is held that the argument is not applicable to the facts of this case. Accordingly, it is held that royalty and FTS are taxable on payment basis and not on accrual basis.”

8.1. Coming to the fact of this case, the payee had provided for the payment of royalty in the books of account of this year but such royalties were not paid to the assessee in absence of any agreement approved by the RBI or for which it could be deemed that the approval has been granted. What is important to note is that royalty for this period has not been paid. Since royalties are taxable on cash basis, it is not necessary for us to go into press note No. 8 (2000) relied upon by the Ld. Counsel and press note No. 9 (2000) relied upon by the Ld. Sr. DR. Accordingly it is held that the amount provided by the licensee in its books of account but not paid to the assessee is not taxable.

9. In regard to the ground No. 2, in the appeals of the revenue, the Ld. Counsel has mentioned that if royalties are taxed on receipts basis, there will be no liability to pay interest u/s 234B and 234C even on the basis of interpretation canvassed by the Ld. Sr. DR. This is a matter of verification. The other argument has been that there was no liability to pay advance tax. This is a matter on which amendment has been proposed in Finance Bill, 2012. In the circumstances, we think it fit to restore the matter to the file of AO to decide the same on the basis of facts, and in accordance with law after hearing the assessee. The result is that this ground in both the appeals is treated as allowed for statistical purposes.

10. In the result:-

(i) the appeal of the assessee for asstt. year 2004-05 is allowed ; and

(ii) the appeals of the revenue for assessment years 2004-05 and 2003-04 are treated as allowed for statistical purposes.

                                                  Sd/-                                 Sd/-

                                       [R.P. TOLANI]             [K.G. BANSAL]

                                   JUDICIAL MEMBER  ACCOUNTANT MEMBER

Veena

Copy forwarded to: -

1. Appellant

2. Respondent

3. CIT

4. CIT (A)

5. DR, ITAT

TRUE COPY

By Order,

Deputy Registrar, ITAT