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Judgment
This is a batch of five appeals pertaining to assessment years 2018-19 to 2022-23 and since the issues are largely common, all these five appeals are being disposed of through a single order. The details of the impugned orders and the basic issues involved in each of the years may be summarized from the synopsis of arguments supplied by the assessee:
For the sake of background it needs to be mentioned that the assessee is part of Amphenol Corporation, USA, having multiple production facilities spread in various countries around the world. The assessee earned income from its Indian Associate, being FCI OEN Connectors Ltd./ Amphenol FCI India Pvt. Ltd. For all the years under consideration, the assessee earned royalty income from its Indian AEs out of which royalty on sale made in India has been offered to tax but royalty received from export sales has been claimed to be exempt u/s 9(1)(vi)(b) of the Income Tax Act, 1961 (hereafter as “the Act”). Secondly, management fee has been received and has been claimed as exempt following the beneficial provisions of Article 12 of the DTAA between India and Singapore (hereafter as “DTAA”). For AY 2022-23 an additional issue is regarding the taxability of expenses claimed to be in the nature of reimbursement. It is seen that the main grounds of appeal for assessment years 2018-19 to 2021-22 (4years) are on the taxability of royalty and management fee. For AY 2022-23, in addition to these two grounds the reimbursement of expenses is also a ground. Accordingly, it is proposed to deal with the two issues of royalty and management fee for all the five years and additionally the issue of reimbursement of expenses for AY 2022-23, on a thematic basis for the sake of convenience.
It deserves to be mentioned that the Ld. AR decided not to press the alternative grounds which have been presented in the Form 36, which emanate from the case of Engineering Analysis Centre of Excellence (P.) Limited reported in 432 ITR 471 (SC).
Before us the Ld. AR argued with the help of detailed paper books, case laws and written submissions. It was the request that AY 2018-19 may be taken as the lead case.
Regarding royalty on sales it was the submission that the assessee was offering the sums of monies received under this head from sale of product by Indian Associated Enterprises (hereafter as “AEs”) within India as its income. The Ld. AR stated that section 9(1)(vi)(b) of the Act permitted export sales to not be taxed in India. The Ld. AR elaborated on this point by stating that this apparently exempt income is earned from a source of receipt which is situated outside India, as the payer is outside the country; contract with non-resident is made and concluded outside India; and sales activity leading to income generation also takes place outside India. The Ld. AR explained that in the case of the assessee the sale orders have been procured and concluded outside India by the Amphenol FCI Group. It was claimed by the Ld. AR that the fact of conclusion of sale outside India has been accepted by the AO over the years under consideration. The Ld. AR relied on the case of Aktiengesellschaft Kuhnle Kopp & Kausch W. Germany by BHEL reported in 262 ITR 513 (Madras), for the sake of convenience hereafter referred as the Hon’ble Madras HC case. The Ld. AR stated that this case was totally applicable on the facts of the present case. The Ld. AR also relied on several ITAT cases to canvass the point that export sales, wherever source of receipts was outside India and the contract had been concluded outside India, would render the receipts as not taxable in India considering section 9(1)(vi)(b) of the Act. The Ld. AR read out from the head notes of the Hon’ble Madras High Court case [262 ITR 513 (Madras)] as under: -
“As far as receipts for visit of technicians were concerned, the question regarding taxability of the receipts was considered by the Tribunal in the assessee's own case for the same assessment years and it was held that the receipts were not taxable. The revenue had not challenged that order of the Tribunal, nor was any material produced to show that the earlier order of the Tribunal had not become final. Thus, it was not open to the revenue to reagitate the same question in the instant reference which was the subject-matter in the earlier order of the Tribunal. The Tribunal was correct in holding that the receipts for the visit of experts were not taxable within the meaning of section 9(1)(vi).
As far as receipts for special engineering services were concerned, the issue arose only in the assessment year 1980-81 and there was no doubt that amount was paid under pre-1976 agreement. Since the receipt was a lump sum payment, the amount received was exempt under the proviso to section 9(1)(vi).
As far as royalty on export sales was concerned, that amount was also exempt under section 9(1)(vi). Though the royalty was paid by a resident in India, it could not be said that it was deemed to have accrued or arisen in India as the royalty was paid out of the export sales and, hence, the source for the royalty was the sales outside India. Since the source for the royalty was from the source situated outside India, the royalty paid on export sale was not taxable.”
As against this case law, the Ld. AR assailed the action of Ld. AO in relying on the case of Havells India Ltd. Reported in 352 ITR 376 (Del) (HC) and also the case of Anglo – French Textiles reported in 199 ITR 785 (Mad). It was argued that both these cases are distinguishable on facts, whereas the Madras High Court judgement is squarely applicable in favour of the assessee. In fact, it was pointed out that in the case of MOTIFF India Infotech P. Ltd. reported in 409 ITR 178 (Guj), the Hon’ble Gujarat High Court has distinguished the Havells case and relied on the Hon’ble Madras High Court case to state that royalty income from exports was not taxable in India. It was also argued that the explanation to section 9(2) inserted by Finance Act, 2010, with retrospective effect from 01.06.1976, also did not affect the exemption granted in section 9(1)(vi)(b) of the Act.
Regarding the issue of management fee the Ld. AR placed on record a decision of ITAT in assessee’s own case for AY 2015-16 and our attention was drawn to para 13 of this case [ITA 9659/Del/2019, order dated 21.11.2023] whereby a clear cut finding was given that management support services do not qualify as Fees for Technical Services (FTS) under Article 12(4)(a) of the DTAA. The relevant paragraph may be extracted for ready reference: -
“13.Keeping in perspective these facts, we will proceed to decide the issue. It is observed that the assessee is providing management services to the Indian entity from assessment year 2009-10 onwards. In fact, the Assessing Officer has accepted the aforesaid factual position. For this purpose, the assessee has entered into management services agreement, which was earlier known as support services and consulting agreement. The assessee has entered into a separate agreement with FCI Oen India Connectors Ltd. on 22nd July, 2023, in terms of which, the assessee has granted license for patents, trademark, copyrights, know-how, etc. to the Indian entity and received royalty. The agreement further provides that ancillary to the right and license granted, the assessee will also provide technical assistance, ancillary services to the Indian entity. Payment to be made under the agreement towards royalty also includes the service component. Whereas, the management service agreement has remained in force since the assessment year 2009-10 onwards, though, with insignificant variations in the terms of the agreement. Thus, in our view, technical assistance and the ancillary services rendered by the assessee in connection with licensing of patents, trademarks, copyrights, know-how etc. cannot be equated with fees for management services, as both are governed under different set of agreements and have no connection with each other. Therefore, in our view, the finding of learned DRP that the fee received from management support services would qualify as FTS under Article 12(4)(a) of the tax treaty cannot be accepted.” 2.3 Regarding the issue of taxability of expense reimbursement pertaining to AY 2022-23, it was averred that the DRP has no power to direct the Ld. AO to verify such expenses from the angle of their being any services element. It was argued by the Ld. AR that no show cause notice was issued for this proposed addition and in any case the payments where in the nature of reimbursement of costs with no embedded income or profit. The Ld. AR laid stress on the DRP directions as being violative of section 144C(8) of the Act. The Ld. AR read out the directions as under: -
“6.3The matter has been considered. There appears to be a discrepancy of the figure as proposed in the DAO and as taken in the objections. The AO is directed to consider the correct figure. While claiming exemption of these services on ground of reimbursement, assessee has not established that these were rendered by a third party and assessee was merely a conduit. If these were rendered by a third party, these cannot be treated as services provided by the assessee. However, if these were performed by the assessee himself, these become liable to be taxed as FTS. Being a factual issue, the AO is hereby directed to re-examine this issue in light of directions supra and decide accordingly.”
Without prejudice to the arguments advanced regarding the issues under appeal, the Ld. AR also relied on the case of Vegetable Products Ltd. reported in 88 ITR 192 (SC) to canvass the point that where two views are possible the view favouring the assessee should be adopted.
Per contra, the Ld. DR argued with the help of written submissions and supported the Ld. AO’s order.
Regarding the issue of royalty arising from export sales the following was submitted by the Ld. DR: -
“2.Taxability of royalty on account of export sales: The assessee has not disputed the royalty payment on account of sales made to domestic customers; however, the assessee has contended that royalty income on account of export sales is exempt by the assessee u/s 9(1)(vi) (b) of the act. Now this royalty is on account of IPR licensing for the design, use, manufacture, marketing, and sale of products. The royalty is linked to the end sale of products. Page 82 of the paper book contains the IP license agreement. Now, it is clear from the definition that what is being licensed is licensed intellectual property rights (section 1.7), licensed patents (section 1.8), and licensed know-how (section 1.9). So clearly this is the IP relevant to the manufacturing of products, sales IP, and distribution IP that the assessee possesses for the Indian entity. Now in section 1.9, it is clear that the licensor has the right to grant sub-licenses. So it is clear that, effectively, we can say that there is also a transfer of IP. This is not the case of software royalty, and hence this is not covered by the engineering analysis judgement. Instead, this is a case of industrial royalty, where, on manufacturing, the assessee receives a royalty at a certain percentage of sales from the entity manufacturing and distributing in India. Royalty is on account of licensed intellectual property rights, licensed patents, and licensed know-how at 4% of the sales. Now the assessee has also accepted this position, but the only dispute is on the royalty charged for export sales wherein the assessee has disputed that the same is not taxable in India since there is an exemption allowable for the same under section 9(vi)(b) of the Income Tax Act. Now it is already held by the Hon'ble High Court of Delhi in the case of Havells India (2020-21 taxmann.com 476 (Delhi)) that in order to fall within the second exception provided in section 9(1)(vii)(b), the source of income, and not the source of receipt, should be outside India. The relevant portions of the judgement is reproduced below:
13.Section 90(vii)(b) contemplates a source located outside India. It is difficult to conceptualise the place/situs of the person who make payment for the export sales as the source located outside India from which assessee earned profits. The export contracts obviously are concluded in India and the assessee’s products are sent outside India under such contracts. The manufacturing activity is located in India. The source of income is created at the moment when the export contracts are concluded in India. Thereafter the goods are exported in pursuance of the contract and the export proceeds are sent by the importer and are received in India. The importer of the assessee’s products is no doubt situated outside India, but he cannot be regarded as a source of income. The receipt of the sale proceeds emanate from him from outside India. He is, therefore, only the source of the monies received. The income component of the monies or the export receipts is located or situated only in India. We are making a distinction between the source of the income and the source of the receipt of the monies. In order to fall within the second exception provided in Section 9(1)(vii)(b) of the Act, the source of the income, and not the receipt, should be situated outside India. That condition is not satisfied in the present case. The Tribunal, with respect, does not appear to have examined the case from this aspect. Its conclusion that the technical services were not utilized for the assessee’s business activity of production in India does not bring the assessee’s case within the second exception in Section 9(1)(vii)(b) of the Act. It does not bring the case under the first exception either, because in order to get the benefit of the first exception it is not sufficient for the assessee to prove that the technical services were not utilised for its business activities of production in India, but it is further necessary for the assessee to show that the technical services were utilised in a business carried on outside India. Therefore, we cannot also approve of the Tribunals conclusion in para 29 of its order to the extent it seems to suggest that the assessee satisfies the condition necessary for bringing its case under the first exception, Be that as it may, as we have already pointed out, since the source of income from the export sales cannot be said to be located or situated outside India, the case of the assessee cannot be brought under the second exception provided in the Section.”
In this case it is not disputed that the manufacturing activity takes place in India. It is undisputed that the IP is used for manufacturing the products in India, which are then sold abroad. So clearly there is a business connection, and the exemption is only for those wherein the entire business itself is carried outside India, and hence the test of whether it is a source of income or source of receipt becomes important. In this case, the AO has discussed this issue in detail in draft order para 7.2 (page 11 of 29) to para 7.4, where it has held that since the income is generated from manufacturing activities out of export sales, the royalty paid should also be for the export sales and should also be taxable.”
The Ld. DR argued that the case of Havells India (supra) directed taxability on the basis of source of income and not source of receipt. It was the submission that if the source of income was situated inside India, then section 9(1)(vi)(b) of the Act would come to the assessee’s rescue but if only the source of receipt was outside India, then this section would not be of any help to the assessee. The Ld. DR stated that the Hon’ble Madras High Court judgment (supra) relied upon by the assessee, was specifically for assessment years 1978-79 to 1982-83, and it was relevant for the old provisions. It was the submission that since then the said section has evolved with amendments which were not before the Hon’ble Madras High Court at that point of time. It was also pointed out that the Havells case (supra) was a binding precedent since it was from the Hon’ble Jurisdictional High Court.
Regarding the taxability of management service fee, the Ld. DR stated that such services were essentially high-end activities which included payment for R&D expenses and also included services for IT Support and IT Infrastructure. The Ld. DR pointed out relevant portions from the Ld. AO’s order whereby such services have been discussed at length. Thereafter, the Ld. DR concluded his arguments by relying on Article 12(4)(a) and Article 12(4)(b) of the DTAA and the ld. AO’s findings.
We have considered the rival submissions and have carefully perused the case records of all the five years. As discussed earlier, AY 2018-19 is being taken as the lead case and thereafter AY 2022-23 will be dealt with for the issue of reimbursement of expenses.
Regarding the question of royalty the issue before us is whether receipts from exports made by the assessee on items supplied outside India and on the basis of contracts entered into outside India, would result in income exempted u/s 9(1)(vi)(b) of the Act. It is an admitted fact that the manufacturing is taking place in India through AEs of the assessee. The Ld. AR has relied on the Hon’ble Madras High Court case (supra) on the basis of which it has been forcedly argued that the source for the royalty income was the sales made outside India. We find several interesting facts which were before the Hon’ble Madras High Court as far as this case law is concerned. It is seen that this judgment was rendered much prior to amendments in section 9(1) of the Act. Furthermore, a factual issue that keeps on recurring throughout this judgment is that amounts were received under “the Pre-1976 agreement”. This fact appears to have weighed considerably with the Hon’ble Madras High Court in Aktiengesellschaft Kuhnle Kopp & Kausch W. Germany (supra) in arriving at the decision in para 8 of this order. It is also a fact that this case law has been discussed and distinguished in the Havells India case (supra). In fact the Hon’ble Delhi High Court has pointed out that the case of CIT vs. Anglo French Textiles reported in 199 ITR 785 laid down a principle which was contrary to the decision rendered in the Madras High Court case (supra). The entire discussion on the Madras High Court case by the Hon’ble Delhi High Court deserves to be extracted so that its inapplicability on the facts of the present case could be effectively brought out:
“10.In support his this contention, the learned counsel for the assessee drew our attention to a judgment of the Madras High Court in CIT v, Aktiengesellschaft Kuhnle Kopp & Kausch W. Germany By BHEL, [2003] 262 ITR 513 /(2002) 125 Taxman 928 In this case it was held that the exports of goods represented a source outside India. The High Court was concerned with Section 9(1)(vi) which was concerned with payment of royalty by a person resident in India to a non-resident. Though that provision was concerned with royalty, the exceptions provided from taxability of the royalty income in the hands of the non-resident are the same as in the case of fees for technical services dealt with in Section 9(1)(vii)(b) of the Act. In that case the resident company paid royalty to a West German company. The royalty was payable on export sales effected by the resident-assessor The question before the High Court was whether the Tribunal was right in law in holding that the royalty on export sales was not taxable within the meaning of Section 9(1)(vi) of the Act. The High Court held as under:
"As far as royalty on export sales is concerned, that amount is also exempt under section 9(1)(vi) of the Income-tax Act. Though the royalty was paid by a resident in India, it cannot be said that it was deemed to have accrued or arisen in India us the royalty was paid out of the export sales and, hence, the source for royalty is the sales outside India. Since the source for royalty is from the source situate outside India, the royalty paid on export sales is not taxable. The Appellate Tribunal was therefore correct in holding that the royalty on export sales is not taxable within the meaning of section 9(1)(vi) of the Income-tax Act.”
11.The judgment of the Madras High Court certainly supports the contention of the learned counsel for the assessee. In an earlier judgment in CIT v. Angle French Textiles (1993) 199 ITR 785, a Division Bench of the Madras High Court had occasion to consider a somewhat similar question arising under Section 9 of the Act. In that case the assessee was a company incorporated under the French laws which were applicable to possessions in Pondicherry in India. It had a textile mill in Pondicherry and its activity consisted in the manufacture of yarn and textiles as well as export of textiles from Pondicherry. The entire business operations were confined to the territory of Pondicherry. After the merger of Pondicherry with India in August, 1962, the Income Tax Act was extended to Pondicherry w.e.f. 1.4.1963. Till then, the French law relating to income tax was in force in Pondicherry. During the period when the French tax law was in force, the assessee surrendered certain raw cotton import and machinery import entitlement and received payments from the Textile Commissioner (Bombay). The question arose as to the taxability of the income referable to the import entitlements. While the income tax department took the stand that the income accrued to the assessee outside Pondicherry and was therefore texalite (sic) under the Act, the assessee maintained that the receipts were only in Pondicherry and since the exports were made from Pondicherry, the income accrued or arose to the assessee in the territory of Pondicherry which was outside the purview of the Act. The Madras High Court observed that the import entitlements arose out of the export activity which was carried on by the assessee only in Pondicherry, that no part of the manufacturing or selling activity of the assessee was carried on outside Pondicherry, that the import entitlements were relatable only to the export performance which took place in Pondicherry and that on the fulfilment of the export activity, a right to receive the export incentive accrued in favour of the assessee in the territory of the Pondicherry. The argument of the department was that the incentive was quantified and sent from Bombay from it the export activity, a right to receive the export incentive accrued in favour of the assessee in the territory of the Textile Commissioner and, therefore, the income arose within the taxalite (sic) territories. This argument was rejected by the Madras High Court by holding that "the right to receive the import entitlements arose when the export commitment was fulfilled by the assessee in Pondicherry, though such amount was subsequently ascertained or quantified. It was also argued on behalf of the Revenue before the High Court that the import entitlement should be regarded as a source of income in the taxable territories and under Section 9(1) of the Act, the income arising out of the encashment of the import entitlements should be deemed to accrue or arise in the taxable territories. This argument was also rejected by the Madras High Court which held:-
"Equally, it is difficult to regard the import entitlements as a source of income which should be looked at from a practical view-point and not merely as an abstract legal concept. We are, therefore, unable to agree with the contention of the learned counsel for the Revenue that the import entitlements constituted a source of income within the meaning of Section 9 of the Act as to deem the import entitlements as having accrued or arising in India"
This earlier judgment of the Madras High Court does not appear to have been brought to the notice of the Division Bench which decided the later case [Emphasis added].The observations of the Madras High Court in the earlier case, which we have quoted above, clearly suggest that the export activity or export sales were the source of the import entitlements and the export activity took place in Pondicherry and it was only on fulfilment of the export activity that a right to receive the import entitlement/incentive accrued in favour of the assessee. Since the export activity was fulfilled in Pondicherry, the source of income was located in Pondicherry. Applying this judgment to the facts before us in the present case, we have to conclude that the export activity having taken place or having been fulfilled in India, the source of income was located in India and not outside [Emphasis added]. Moreover, just as in the Madras case it was held that the mere fact that the import entitlements which had their source in Bombay, did not constitute a source of income within the meaning of Section 9 of the Act, we have also to hold in the present case that the mere fact that the export proceeds emanated from persons situated outside India did not constitute them as the source of income.”
We also find that the Ld.AO has discussed the inapplicability of this case in para 7.2 at page 11 of the impugned order (AY 2018-19), on somewhat similar lines as has been discussed by the Lordships of the Hon’ble Delhi High Court in the Havells case (supra). Thus, we are unable to subscribe to the arguments advanced by the Ld. AR that the Hon’ble Madras High Court case (supra) applies perfectly to the facts of this case. At this point it also needs to be mentioned by way of a caveat that there would not be many case laws in the entire body of judicial literature which could be perfectly applied on the facts of any case being adjudicated by any judicial authority. This matter is no difference, whether its the Hon’ble Madras High Court case (supra) or the Havells case (supra). However, the broad principle that emanates from the Havells case is worthy of consideration. In that case, it has been a clear directive that the importer of the assessee’s product is no doubt situated outside India, but he cannot be regarded as a source of income. The importer of the assessee’s product is merely the source of the receipts. The income component of the export receipts is located or situated in India. In this manner, the lordships of the Delhi High Court have distinguished between the source of income and the source of receipts. In this case also, we find that the source of receipts are outside India but the income is firmly arising from manufacturing activity within India. Thus, the situs of income, as against the receipts, could be considered to be the deciding factor in case any taxability u/s 9(1) of the Act has to be determined. However, we feel considerably constrained due to absence of fact finding by the Ld. AO regarding the place of signing of contracts, both for sales within Indian and sales outside. While the assessee has made a blanket statement that contracts for export outside India have been concluded outside as well, however, it is not clear what is implied by exports being concluded outside India, i.e. to say what are the modalities for conclusively showing that such contracts are concluded outside India and contrarily the contracts for royalty income offered to tax in India have been contracted within the country only. This fact may have critical bearing on the issue since in para 13 of the Havells case (supra) it is mentioned that the contracts in that case were concluded in India only. We hasten to add that this would be one of the deciding factors and not the essential deciding factor when we are dealing with the situs of income vis-a-vis the situs of receipts. To this extent, we deem it fit to set aside the relevant portion of the impugned order for remanding this issue back to the file of Ld. AO for examining to what extent the contracts have been signed outside or inside India. The Ld. AO is also expected to examine where exactly such “exempt” royalty income is taxed. We find an interesting discussion on page 16, para 9 of the draft order (AY 2018-19), where a rhetorical question has been put forth by the Ld. AO to the extent that where exactly have the receipts claimed as exempt in India are being offered to tax. The Ld. AO has even speculated on the possibility of tax evasion. We would direct the Ld. AO to obtain the necessary details from the assessee regarding the offering, or otherwise, to tax of such “exempt” receipts in any other geography around the world. The result of this enquiry should also be used to determine the taxability of such receipts in India. We are also not impressed by the Ld. AR’s argument that for AY 2015-16 the Ld. AO had accepted the assessee’s contention regarding the non-taxability of export receipts. We find that such acceptance of the assessee’s position would not be a binding precedent in later years since each assessment year has to be examined in the light of facts available with the Assessing Officer at that point in time. We are also unable to persuade ourselves that this is a case where the Vegetable Products judgment (supra) would apply. We would refrain from trivializing the directive in that case law by applying the same to virtually all matters before us since invariably the Revenue and the assessee are contesting whatever issue may present itself. In any case more fact finding can determine if at all the balance of convenience can be regarded to be in favour of the assessee.
Regarding the reimbursement of management services, we find that this issue has been decided in favour of the assessee through the ITAT’s order for AY 2015-16 (supra) and from a passage extracted (supra), it is clear that the assessee deserves to succeed on this issue for all the years under consideration before us.
Regarding the issue of reimbursement of expenses, being an issue only for AY 2022-23, we are persuaded by the Ld. AR’s argument that section 144C(8) of the Act does not authorize the DRP to set aside any proposed variation or issue any direction under sub-section (5) of 144C for any further enquiry and thereafter passing of the assessment order. Even the explanation to section 144C(8) of the Act, inserted w.e.f. 01.04.2009, does not come to the rescue in this regard. Accordingly, it deserves to be held that the DRP had no power to delegate verification of the nature etc. of such expenses. Accordingly, there is no hesitation in holding that such directions are beyond the power of the DRP and hence are invalid in the eyes of law. The same are directed to be deleted. However, we refrain from commenting on the nature of such receipts on merits, as has been canvassed by the Ld. DR.
As mentioned earlier, the issues of royalty income on export sales and management fee income are running through all the five years under consideration, thus, on the basis of finding given for AY 2018-19 regarding both these issues the decision rendered therein shall, mutatis mutandis, apply to the remaining four years also. The issue of reimbursement of expenses is exclusive to AY 2022-23 and thus, it deserves to be held that the grounds pertaining to that addition are allowed in favour of the assessee.
In the result, all the appeals are partly allowed.