February 24, 2010
Characterization issues on assignment of rights to manufacture
Recent times have seen a surge in cases where Indian tax courts have analyzed the provisions of different Indian laws so as to fully appreciate the nature of the transaction undertaken by the tax payer before ruling on their characterizing under domestic tax laws.1 Another example of this approach has been the recent ruling of the Authority for Advance Rulings (“AAR”) in the case of Laird Technologies India Private Limited 2 (“Applicant”). In this the AAR has first examined the principles of contract law before holding that capital gains cannot be said to have arrived unless there is a legal transfer of a capital asset. In the absence of such a legal transfer and the lack of a permanent establishment in India the AAR held that the profits of Laird USA cannot be liable to tax in India.
Facts presented before the AAR:
The Applicant, a group company of Laird Plc. U.K., is engaged in the business of designing and manufacturing antenna and battery facts for the mobile phone industry. On or about June 25, 2003 Laird USA, another group company of Laird Plc. U.K. negotiated a Product Purchase Agreement (“PPA”) with Nokia Corporation, Finland to manufacture and supply products to Nokia Corporation globally. Subsequently, Laird USA entered into an assignment agreement (“Agreement”) with the Applicant to enable the Applicant to supply products to Nokia India. Therefore through this Agreement, Laird USA irrevocably assigned all its beneficial rights, title, interest, obligations and duties under the PPA to the Applicant, in lieu of a consideration of USD 5.3 million.
The AAR was faced with two critical issues, first being of whether the amount receivable by Laird USA under the Agreement was taxable in India and second being whether the Applicant was required to withhold tax under the income tax provisions.
As regards the determination of tax liability of Laird USA under the Agreement the first point considered by the AAR was whether the consideration received under the Agreement was in nature of capital gains. In this regard the AAR held that capital gains cannot be said to have been earned unless there is a legal transfer of a capital asset. For determination of whether there was a legal transfer effected, the AAR drew support from the Supreme Court ruling in the case of Khardah Company Ltd. v. Raymon & Co.,3 to hold that an obligation under a contract cannot be transferred without the consent of a promisee, i.e. Nokia in this case. The AAR observed that there was no evidence to gather Nokia’s consent for transfer of these liabilities and therefore there was no valid assignment under law. Consequently, the capital gains cannot be said to have arisen due to the absence of a valid transfer of capital asset under the Agreement.
Inspite of the AAR questioning the validity of the Agreement, the AAR observed that since Laird USA had in fact received a consideration of USD 5.3 million, this consideration was in nature of business profits. Thereafter, the AAR ventured into the possibility of Laird USA having a Permanent Establishment (“PE”) in India. In this regard the AAR held since Laird USA did not have any fixed place of business in India it did not have any PE under Article 5.1 of the India- US Double Taxation Avoidance Agreement (“DTAA”). Further since the Applicant was actually acting in its independent capacity and dealt with Laird USA on a principal to principal basis it could not be said that it amounted to a dependant agent of Laird USA under Article 5.5 of the aforementioned treaty. Hence, it was concluded by the AAR that Laird USA did not have a PE in India and therefore was not liable to be taxed in India.
Lastly, the AAR held that since the consideration under the Agreement was not taxable in India, the Applicant, being a resident payor, was not liable to withhold tax on the same.
The approach adopted by the AAR in first analyzing the provisions of contract law to fully appreciate the legal validity of the contract entered into between parties before ruling on the characterizing income earned there from must be appreciated. However the AAR has failed to provide proper reasons on the rationale of characterizing the consideration earned by Laird USA under the Agreement as business income. Also, for the consideration of USD 5.3 million, the AAR has failed to consider the effect of Article 23 of the DTAA which could be used in the event the character of income is not covered by any of the articles under the DTAA
The AAR ruling is a refreshing change in light of the ruling of the Karnataka High Court in the case of CIT v Samsung Electronics Co. Ltd, wherein it was held that any payment made to a non-resident which bears a semblance to the character of income, the payor would have an obligation to withhold tax under section 195 of the Income Tax Act, 1961. In this case, inspite of the consideration being in nature of the income the AAR held that since this was not chargeable to tax in India, there was no withholding obligation on the payor. Having said that, since an AAR ruling is not a judgment in rem the aforementioned ruling only would be binding on the transaction in respect of which the ruling is obtained. In this background, this ruling is likely to pave way for many resident payor to apply to the AAR for obtaining clarity on their withholding obligation in addition to obtaining certainty on the tax liability of the non-resident in India.
1 For example the ruling of the AAR in the case of M/s. Dassault Systems. In this the AAR after analyzing the various provisions of Copyright Act, 1957 held that there was no transfer of copyrights but rather a transfer of copyrighted article
2 A.A.R. No. 793/2008
3 AIR 1962 SC 1810
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