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Treaty between India and Thailand – Indian decision on taxability of sale of designs and drawings, and whether tax treaty can give rise to taxing right

The Indian Income Tax Appellate Tribunal (ITAT) delivered a ruling dated 4 July 2008 in the case of Parsons Brinckerhoff India Pvt. Ltd. v. Assistant Director of Income Tax (2008-TIOL-375-ITAT-DEL) on whether the payment for an outright sale/supply of drawings and designs would be taxable in India as "royalty" and whether the payment can be taxed in India under a tax treaty even if such payment is not taxable under India's domestic tax laws.

(a) Facts. The Taxpayer (i.e. Parsons Brinckerhoff India Pvt. Ltd.) was an Indian company which entered into a contract with Parson Brinckerhoff Asia Pvt. Ltd (PBAT), a Thailand company. The Taxpayer was engaged to render engineering consultancy services and was awarded a contract in India for rendering such services. The scope of the work required preparation of certain drawings and designs. The Taxpayer entered into an agreement with PBAT which had the requisite expertise in preparation of required designs for the project.

The agreement between the Taxpayer and PBAT was styled as a "service agreement" for the provision of drawings and designs in return for an agreed consideration. The Taxpayer made an application to the Indian tax authorities for a "nil" rate withholding tax certificate for payments that were to be made to PBAT in Thailand for providing the drawings and designs.

The Tax Authorities took the view that the payment to PBAT was in the nature of "royalty" under Art. 12 of the India-Thailand tax treaty (the Tax Treaty) and not really in the nature of payment for outright supply of designs and drawings.

On appeal, the Commissioner of Income Tax (Appeals) rejected the Taxpayer's argument and held that the payment was "royalty" taxable in India and hence subject to withholding tax in India. The Taxpayer appealed to the ITAT.

(b) Issues. The issue before the ITAT was whether the payments to PBAT for the supply of designs and drawing were taxable in India under the Indian Income Tax Act 1961 (ITA) read with the Tax Treaty.

(c) Decision. The ITAT held that the payment to be made to PBAT for the supply of drawings and designs was not "royalty" and therefore not subject to withholding tax in India. The ITAT observed that:

-   The "service agreement" between the Taxpayer and PBAT was for the supply of drawings and designs on an outright basis. As such, the payment would fall under Art. 7 of the Tax Treaty as business profits and would not be taxable unless PBAT had a permanent establishment in India.

The payment cannot be regarded as "royalty", as wrongly held by the Tax Authorities, under the ITA as the words "model" and "design" mentioned in the ITA (i.e. in Sec. 9) are to be understood in the context of intellectual property like patents, invention etc and cannot be applied literally.

The ITAT further observed that even if the payment can be regarded as "royalty" income under Art. 12(3) of the Tax Treaty, it will still not be taxable in India since a Tax Treaty is not a taxing enactment. If PBAT is not taxable in India under India's domestic tax laws, it cannot be subjected to tax under a tax treaty. A tax treaty cannot create a tax burden on a non-resident which is not created under India's domestic tax law. If no tax liability is fastened on a non-resident by the terms of the domestic tax law, then it is not legally necessary or permissible to examine the provisions of the tax treaty to find out whether the non-resident (in this case, PBAT) is liable to pay tax in India

The ITAT further held that the visits of PBAT employees to India were only to effectively explain the drawings and designs to the Taxpayer, and the procurement of the drawings and designs was not a service agreement but an agreement for outright sale of such drawings and designs.

Accordingly, the ITAT concluded that payment to PBAT was not taxable in India as "royalty" and there was no need for the Taxpayer to withhold any tax.

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