Court Upholds Tax Treatment of Extended Agreement, Orders Reassessment of Deductions

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Case Name:

M/s. Aktiengesellaschaft, Kunhle Kopp & Kausch, Germany Vs The Deputy Commissioner of Income Tax (High Court of Madras)

TC(A). No. 26 of 2005

Date: 25th April 2012

Key Takeaways:

1. When a subsequent agreement is treated as an extension of an original agreement, all consequential benefits should be considered for tax purposes.

2. The court emphasized the importance of considering Double Taxation Avoidance Agreement (DTAA) provisions when assessing international tax cases.

3. The judgment highlights the need for tax authorities to consider all relevant deductions and exemptions when revising assessments.

Issue:

Was the Tribunal correct in treating the 1981 agreement as an extension of the 1973 agreement, and if so, should the consequential benefits be granted to the assessee?

Facts:

1. The assessee, a non-resident company, had an agreement with an Indian company (BHEL) for transferring technical know-how to manufacture industrial boilers and fans.

2. The first agreement was signed on 26.11.1973 for seven years.

3. A second agreement was signed on 21.8.1981, effective retrospectively from 26.11.1980.

4. The assessee received royalties on export sales, indigenous sales, and lump sum royalty during the assessment year 1983-84.

5. The Assessing Officer initially taxed the royalties at different rates (40% for export and indigenous sales, 20% for lump sum).

6. The Commissioner of Income Tax (CIT) initiated proceedings under Section 263 of the Income Tax Act, treating the 1981 agreement as part of the 1973 agreement and applying a 50% tax rate.

Arguments:

Assessee's Arguments:

1. The 1981 agreement was a new agreement, not an extension of the 1973 agreement.

2. If treated as an extension, the assessee should be granted deductions and exemptions as per the original agreement.

Revenue's Arguments:

1. The 1981 agreement was merely an extension of the 1973 agreement.

2. The higher tax rate of 50% should apply as per the Finance Act rates for agreements before 1.4.1976.

Key Legal Precedents:

No specific legal precedents were cited in this judgment. The case primarily focused on the interpretation of agreements and the application of relevant sections of the Income Tax Act and DTAA.

Judgement:

1. The court partially allowed the appeal.

2. It agreed that the 1981 agreement could be treated as an extension of the 1973 agreement.

3. The court directed the Assessing Officer to consider the assessee's claims for:

  a) Relief under the DTAA for expenses towards free training

  b) Exemption under Section 9(i)(vi) of the Income Tax Act for lump sum royalty

  c) Deduction under Section 44D of the Income Tax Act for expenses

FAQs:

1. Q: What was the main dispute in this case?

  A: The main dispute was whether the 1981 agreement should be treated as an extension of the 1973 agreement for tax purposes, and if so, what consequences should follow.

2. Q: Did the court agree with treating the 1981 agreement as an extension of the 1973 agreement?

  A: Yes, the court agreed that the 1981 agreement could be treated as an extension of the 1973 agreement.

3. Q: What did the court order regarding the assessee's claims for deductions and exemptions?

  A: The court directed the Assessing Officer to reconsider the assessee's claims for relief under DTAA, exemption under Section 9(i)(vi), and deduction under Section 44D of the Income Tax Act.

4. Q: Why did the court partially allow the appeal?

  A: The court partially allowed the appeal because while it agreed with treating the 1981 agreement as an extension, it felt that the consequential benefits of this treatment should be reconsidered by the Assessing Officer.

5. Q: What is the significance of this judgment for similar cases?

  A: This judgment emphasizes that when agreements are treated as extensions of earlier agreements for tax purposes, all consequential benefits and provisions, including those under DTAA, should be considered by tax authorities.

1. The assessee is on appeal as against the order of Tribunal for the assessment year 1983-84. The above appeal was admitted on the following questions of law.

1. Whether on the facts and in the circumstances of the case the Tribunal was right in holding amended collaboration agreement was an extension of the old agreement which was entered into before 1.4.76 and hence the tax was payable at the rate of 50%?

2. Whether on the fact and in the circumstances of the case the Tribunal was right in not giving specific direction to the Assessing Officer, to grant consequential benefits if the agreement dated 21.8.81 is treated as an agreement entered into before 1.4.76?

2. The assessee herein is a non resident assessee represented through its agency BHEL. The said non resident company had an agreement with the Indian company for passing on technical knowhow to manufacture industrial boilers and fans. The first agreement between the company for transfer of technical knowhow was entered into on 26.11.1973 for a period of seven years. Subsequently, on the expiry of the term, the same was extended under another agreement dated 21.8.1981 having retrospective effect from 26.11.1980. The agreement dated 21.8.1981 related to transfer of technology for three new products and the royalty payable thereon. The agreement dated 26.11.73 was approved by the Government of India on 18.2.1974. The agreement was to remain in force for a period of seven years from the date of signing of the agreement and could be renewed for a further period of six years. Thus, the agreement entered into on 26.11.73 was renewed by an agreement dated 21.8.81 for a further period of seven years from 16.11.80. According to the assessee, the two agreements are separate agreements and the latter agreement dated 21.8.81 would not be construed as an amendment to the agreement dated 26.11.1973.

3. It is seen that during the previous year relevant to assessment year, the appellant received royalty on export sales, indigenous sales and lumpsum royalty. The assessee claimed that the receipt of the royalty on import sales was not taxable as per Section 9(i)(iv) of the Income Tax Act. Thus, the assessee claimed exemption on export sales royalty and 50% of the royalty on indigenous sales as representing payment towards development of patent. The Assessing Officer, however, rejected the said claim and taxed the royalty on export sales and indigenous sales at 40% and the lumpsum royalty at 20%. Treating the agreement dated 21.8.81 for a further period of seven years from 16.11.80, as part of the first agreement dated 26.11.1973, the Commissioner of Income Tax (Appeals) invoked proceedings under Section 263 of the Income Tax Act and held that royalty payments were chargeable at the rate of 50% of the total income determined. Thus, in exercise of power under Section 263 of the Income Tax Act, revisionary proceedings were initiated, treating the assessment as prejudicial to the interest of the Revenue. After giving notice, the proceedings were finalised.

4. The assessee objected to the proceedings contending that the agreement dated 21.8.81 was a new agreement and it was not an agreement extending the period of the agreement. The agreement entered into on 21.8.81 covered new products and the royalty payable thereon. Hence, the agreement dated 21.8.81 entered into after 1.4.76 and the rates as prescribed in Section 115A of the Income Tax Act were correctly applied and the relevant Finance Act rates were not applicable. In the alternative, the assessee contended that if the agreement dated 21.8.81 was to be treated as part of the earlier agreement dated 1.4.76, then the assessee be granted the relief of deduction of 20% towards expenses, further deduction of 20% towards training and exemption in respect of lumpsum royalty and royalty on export sales.

5. The Commissioner of Income Tax however rejected the contention of the assessee as regards the subsequent agreement as a separate agreement, pointing out that the second agreement was entered into only for extending the period of agreement originally prescribed. The Revisional authority thus set aside the order of assessment and confirmed the proposal.

6. As regards the alternative claim of the assessee for deduction of expenditure and exemption in respect of part of royalty, the Commissioner of Income Tax however rejected the plea, holding that granting the relief would be contrary to the provisions of Section 263 of the Income Tax Act. Aggrieved by the same, the assessee went on appeal before the Income Tax Appellate Tribunal, which confirmed the order of the Commissioner of Income Tax. The Tribunal held that the amendment brought forth on 21.8.81 merely extended the period which was originally given under agreement dated 26.11.73. In the circumstances, the Tribunal held that the view of the Commissioner of Income Tax in directing the Assessing Officer to deduct tax at 50% of the total income of the assessee was correct.

7. As regards alternative ground taken by the assessee, the Tribunal confirmed the view of the Commissioner of Income Tax that it would not fall under the purview of Section 263 of the Income Tax Act. Aggrieved by this, the assessee is on appeal before this Court.

8. Learned counsel for the assessee pointed out that when the assessee had taken a specific stand by way of alternative ground for deduction of expenditure and exemption in respect of part of royalty, in the event of treating the agreement dated 21.8.81 as an extension of earlier agreement dated 26.11.73, the Tribunal as well as the Commissioner of Income Tax should have considered the deduction as regards the expenditure under Section 44D of the Act. Thus, without considering the claim as not to be subject matter of revision under Section 263 of the Income Tax Act, the direction given by the Commissioner of Income Tax to the Assessing Officer to deduct tax at 50% of the total income of the assessee is contrary to the rates prescribed under the Act. Further, when the assessee is entitled to the benefit of Double Taxation Avoidance Agreement, the same should have been considered by the Tribunal. Learned counsel for the assessee pointed out that when the Tribunal and the Commissioner of Income Tax (Appeals) had treated the agreement of the year 1981 as part of earlier agreement entered in the year 1973, the relief on the expenditure towards free training under Section 44D of the Act and exemption under Section 9(1)(vi) in respect of lumpsum royalty ought to have been considered as a logical sequence to the above finding. In the circumstances, the Tribunal committed a serious error in its view that granting of such relief would not fall within the jurisdiction of Section 263 of the Income Tax Act.

9. Per contra, learned standing counsel for the Revenue supported the order of the Tribunal.

10. Heard learned counsel for the assessee as well as learned standing counsel for the Revenue.

11. As regards the first question of law raised on the character of the second agreement as to whether the same was extension of the original agreement or not, learned counsel appearing for the assessee submits that the assessee is not making serious dispute on the view taken by the Tribunal as well as by the Commissioner of Income Tax. Learned counsel for the assessee pointed out that on the above admitted fact that 1981 agreement has to be treated as amendment to the agreement of the year 1973, and hence, part of it, the consequential relief should have been considered.

12. In the light of the admitted fact position, we agree with the contention of the assessee that once 1981 agreement is treated as part of 1973 agreement, then the consequences of treating the second agreement as part of the original agreement should have been considered for applying the relevant statutory provisions under the Income Tax Act and in consonance with the Double Taxation Avoidance Agreement.

13. On the short ground that the assessee does not dispute the first question of law, we agree with the assessee that in the matter of computing the taxable income, deductions which are otherwise available under the provisions of the Act ought to have been considered as logical sequence to the finding on the first question of law. In the circumstances, we hold that the Tribunal should have considered this aspect of the matter while giving necessary directions to the Assessing Authority to work out the taxable income in accordance with law. It is seen that the assessee felt prejudiced about this aspect only by reason of the fact that the alternative ground taken before the Commissioner of Income Tax was rejected. Thus, it preferred further appeal before the Tribunal. In paragraph 7 of the order of the Tribunal, it is stated that the above stated relief would not fall under Section 263 of the Income Tax Act. The Tribunal however viewed that the assessee was not precluded from raising this issue before the Assessing Officer for his consideration.

14. As already pointed out when the Tribunal confirmed the view of the Commissioner of Income Tax on the merits of the revision, as regards the alternative relief, we feel that the proper course herein would be to direct the Assessing Officer to consider the claim of the assessee on the relief under DTAA agreement in respect of expenses towards free training, exemption under Section 9(i)(vi) in respect of lumpsum royalty as well as the claim for deduction under Section 44D towards expenses.

15. In the result, the above Tax Case (Appeal) is partly allowed. No costs.

To

1. The Deputy Commissioner of Income Tax Special Range, Tiruchy

2. The Income Tax Appellate Tribunal, Chennai C Bench