Commissioner Of Income-Tax v. Siemens Aktiongesellschaft

F.I Rebello, J.:— This reference has been made by the Tribunal to this court in respect of the assessment year 1979–80. The respondent had entered into agreements with Bharat Heavy Electricals Ltd. (BHEL), Bharat Electronics Ltd. (BEL) and Siemens India Ltd. (Siemens).

2. The first agreement between the assessee-respondent and BHEL was entered into on July 21, 1974, the second was dated July 28, 1975, and the third agreement was entered into earlier on October 28, 1975. Similarly, the assessee entered into agreements with BEL on March 15, 1967, February 23, 1973, and dated July 17, 1975.

3. The assessee had also entered into agreements with Siemens dated February 22/1973, and July 17, 1975.

4. The issue which arises for consideration in the present reference is whether the amounts received under those agreements by the respondent from the three companies were chargeable to tax in India either having regard to the provisions of the Income-tax Act, 1961 (hereinafter referred to as “the Act”) or having regard to the provisions of the Double Taxation Avoidance Agreement (DTAA) entered into between the Government of India and the Federal Republic of Germany (hereinafter referred to as “the German DTAA”).

5. The Income-tax Officer by order of assessment dated September 3, 1983, had assessed these amounts as being liable to tax. In the appeal preferred, for reasons cited by the Commissioner of Income-tax (Appeals), the appeal was dismissed except to the extent of granting relief in the sum of Rs. 49,974 which was by way of commission received from Cable Corporation of India Ltd.

6. The respondent-assessee preferred an appeal to the Tribunal. The Tribunal first dealt with the agreement dated February 23, 1973, between Siemens India Ltd. and the assessee. Under this agreement, the assessee had agreed to provide to Siemens India Ltd. relevant patents, patent applications and utility models, relevant written material, experience and information regarding certain contract products. The assessee was to be paid a royalty of 3 per cent, of the ex factory selling price of each contract product manufactured and sold or otherwise disposed of by the licensee. The learned Tribunal held that it was royalty within the meaning of clause (vi) of section 9(1) of the Income-tax Act. The learned Tribunal, however, was pleased to hold considering the DTAA that the payment under consideration cannot be considered as royalty under the DTAA. It held that royalty under the DTAA has to be held to be income which is non-business and where the return is from business activity it is not royalty but has to be considered as commercial profit. It, therefore, held that it would fall within the expression “commercial profits”, however, as there was no permanent establishment of the assessee in India it could not be brought to tax in India.

7. The next agreement considered was that entered into with BEL on March 15, 1967. By this agreement the assessee had agreed to furnish to the Indian company assistance for the manufacture of x-ray tubes and shields. By clause 4.2 the assessee agreed to give to BEL the complete information for the installation, operation and maintenance of special equipment to be supplied by the assessee. In return as consideration BEL had to pay to the assessee a technical assistance fee of 1 per cent, of the total aggregate of the net selling price of the contract products and royalty of 3 per cent, of the total aggregate of the net selling price. The arguments advanced were similar to what was advanced in respect of the agreement between the assessee and Siemens India Ltd. The Tribunal found that the amount of Rs. 1,93,139 was royalty within the meaning of Explanation 2 to section 9(1)(vi) of the Income-tax Act, but was not royalty under the DTAA, but merely a part of the commercial profits of the assessee and as there was no permanent establishment, it would not be taxable.

8. The agreement with BHEL entered into on June 21, 1974, was next considered. This agreement covered industrial turbines manufactured by BHEL. The assessee was to prepare a technical report covering the requisition of the additional plant, machinery and equipment for manufacturing and testing of the industrial turbines and also to train adequate number of personnel of BHEL and also to delegate its personnel to BHEL and some other requisitions. In consideration BHEL was to pay the assessee 4 per cent, of the selling price of the industrial turbines for the next five years. These payments were described as royalty. Any tax payable was to be paid by BHEL. The learned Tribunal was pleased to hold that the payment is royalty under section 9(1)(vi) of the Act but not royalty within the DTAA but was part of commercial profits but as there was no permanent establishment it would not be taxable.

9. It considered the payments described as technical assistance fee but which had been treated as royalties under the extended definition of section 9(1)(vi). The argument advanced on behalf of the respondents that they should be considered under section 9(1)(vii) was rejected. For similar reasons as discussed earlier considering the DTAA it held the same to be commercial profits not assessable to tax in the absence of permanent establishment though they were royalties under section 9(1)(vi) of the Income-tax Act.

10. The Tribunal then dealt with the agreement with BEL dated March 15, 1967, and the payment of Rs. 64,380 under clause 11.1.1 of the agreement which was called technical assistance. These also were held to be royalties within the Income-tax Act. However, under the DTAA would fall under commercial profits and would not be taxable in the absence of permanent establishment.

11. In respect of other payments described as technical assistance fee in so far as ground three and the payment received from BHEL for certain additional assistance and for which the assessee billed BHEL in a sum of Rs. 42,41,884, the Tribunal noted that whether these amounts would be taxable, had already come up for consideration before the Delhi Bench of the Tribunal. The question arose when BHEL was asked to deduct tax under section 195 prior to the remittance of these amounts. The contention of BHEL was that they were not taxable. In the order passed in I.T.A Nos. 4259 and 4260.Delhi/1980, dated November 7, 1981, the Delhi Bench had accepted the contention of BHEL. Similar orders had been passed regarding the taxability of the rest of the amounts. The Tribunal held that they agreed with the finding of the Delhi Bench on the issue and held that these amounts are not taxable in India. The Tribunal further noted that on going through the bills, these payments are not in the nature of royalty, but are merely in the nature of technical fees which are covered by section 9(1)(vii). As the agreements are prior to 1976, even considering section 9 the technical fees cannot be brought to tax. The Tribunal also noted that billing would indicate that amount was charged on the basis of man hours spent on work done in Germany. The Tribunal, therefore, held that these amounts cannot be brought to tax.

12. The next ground considered was the payment of a sum of Rs. 1,71,759 being the fee levied by the assessee for provision of services of technical personnel to BHEL under the agreement dated October 28, 1975. The Tribunal noted that these are also matters decided by the Delhi Bench of the Tribunal in I.T.A No. 2281 of 1979, dated June 3, 1980, and I.T.A No. 2579 of 1979, dated December 6, 1980, for reasons stated in those order cannot be said to be subject to taxation.

13. The last ground considered was the sum of Rs. 64,246 by way of reimbursement of expenditure and whether it could be brought to tax. The Tribunal noted that this is in connection with additional assistance to be rendered by the assessee under the agreement dated October 28, 1975. The Tribunal noted as it had already held that the additional assistance fees of Rs. 42.41 lakhs is not taxable and consequently held that the reimbursement of expenditure also would not be taxable. The Tribunal accordingly partly allowed the appeal.

14. The Revenue moved an application by way of reference. The Tribunal by its order dated May 26, 1987, has referred the following questions of law to this court for its opinion:

“(1) Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in holding that the definition of the term ‘royalty’ in Explanation 2 to section 9(1)(vi) of the Income-tax Act will not apply to the said term as used in article III(3) of the Agreement for Avoidance of Double Taxation of the income between India and the Federal Republic of Germany?

(2) Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in holding that certain sums, namely, (1) the sum of Rs. 20,89,457 due to the assessee from M/s. Siemens (India) Ltd. under the agreement dated February 22, 1973, and dated July 17, 1975, respectively, (2) the sum of the assessee from BEL, under the agreement dated March 15, 1967, and (3) the sum of Rs. 53,844 due to the assessee from BHEL, under the agreement dated June 21, 1974, would not constitute ‘royalty’ within the meaning of the said term as used in article III(3) of the Agreement for Avoidance of Double Taxation of Income between India and the Federal Republic of Germany but would constitute ‘industrial or commercial profits’ for the purpose of article III(1) of the said agreement?

(3) Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in holding that the sums of Rs. 42,41,884 and Rs. 1,71,759 due to the assessee from BHEL under the agreements dated July 28, 1975, and October 28, 1975, respectively, were in the nature of ‘fees for technical services’ within the meaning of section 9(1)(vii) of the Income-tax Act, and not ‘royalty’ either within the meaning of Explanation 2 to section 9(1)(vi) of said Act or within the meaning of the term as used in article III(3) of the Agreement for Avoidance of Double Taxation of Income between India and the Federal Republic of Germany?

(4) Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in holding that the sums referred to in question No. 3 would constitute ‘industrial or commercial profits’ for the purposes of article III(1) of the Agreement for Avoidance of Double Taxation of Income between India and the Federal Republic of Germany?

(5) Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in holding that the sum of Rs. 84,246 due to the assessee from BHEL under the agreement dated July 28, 1975, did not constitute ‘royalty’ either within the meaning of Explanation 2 to section 9(1)(vi) of the Income-tax Act or within the meaning of the said term as used in article III(3) of the Agreement for Avoidance of Double Taxation of Income between India and the Federal Republic of Germany and in consequently holding the said sum is not chargeable to tax in India?”

15. At the hearing of this reference on behalf of the Revenue it is sought to be contended that this court must consider the treaty by applying the ambulatory approach of interpretation and not static interpretation. It is submitted that considering article II(2), the expression “laws in force” as contained in the DTAA, the ambulatory interpretation will have to be accepted and the amounts in issue will have to be held to be “royalty” which is taxable in India. Reliance is placed on rulings on ambulatory approach of the Supreme Court of Netherlands and the Supreme Court of Belgium. We do not propose to deal with the said judgments, in the absence of the full texts of the judgment being made available to the court as such we are not giving the citations.

16. On behalf of the assessee, it is submitted that what will have to be considered are the clauses of the DTAA and not the subsequent amendments. In other words, the static interpretation. Reliance is placed on the ruling of the Supreme Court of Canada. In the alternative, it is submitted that even if it is accepted, that amounts are royalty as defined under section 9(1)(vi) of the Income-tax Act and, therefore, deemed to accrue in India they would not be chargeable to tax in India having regard to the provisions of the DTAA. It is open to an assessee when the provisions of the DTAA are more beneficial considering section 90(2), to contend that the taxability of the income should be governed by the provisions of the DTAA and not by the provisions of the Act. Reliance is also placed on the circular issued by the Central Board of Direct Taxes being Circular No. 333, dated April 2, 1982 (see [1982] 137 ITR (St.) 1). Reliance is also placed on the judgment of the Andhra Pradesh High Court in CIT v. Visakhapatnam Port Trust, [1983] 144 ITR 146, the Calcutta High Court in CIT v. Davy Ashmore India Ltd., [1991] 190 ITR 626 and the Supreme Court in Union of India v. Azadi Bachao Andolan, [2003] 263 ITR 706. Reliance is placed on Bolani Ores Ltd. v. State Of Orissa , (1974) 2 SCC 777 : AIR 1975 SC 17, to contend that when a definition in one statute is incorporated into another statute then any subsequent amendment in the former statute would not effect the definition in the latter statute. In respect of payment received from BHEL, it is submitted that BHEL had made an application under section 195 for the purpose of determining its obligation to deduct tax at source. The Assessing Officer held that the income was chargeable to tax and, therefore, BHEL was obliged to deduct tax at source. In appeal the Tribunal held that the amounts receivable by the respondents were not chargeable to tax in India. These orders of the Tribunal had become final and, therefore, it is not now open to the Revenue to urge to the contrary having accepted the decision of the Tribunal. Reliance is also placed on the case of Berger Paints India Ltd. v. Commissioner Of Income Tax, Calcutta, [2004] 266 ITR 99 (SC). The Tribunal in passing these orders in the case of BHEL it is submitted did not clarify or state that the view they have taken is a prima facie view and that it would have no bearing in the assessment of the respondent.

17. In so far as sum of Rs. 84,246 it is submitted that this amount is reimbursement by BHEL to the respondents and reimbursement of expenditure can never be regarded as income. Reliance is placed on the judgment in CIT v. Indian Textile Engineers P. Ltd., [1983] 141 ITR 69 (Bom), CIT v. Stewards and Lloyds of India Ltd., [1987] 165 ITR 416 (Cal), CIT v. Dunlop Rubber Co. Ltd., [1983] 142 ITR 493 (Cal) and Commissioner Of Income-Tax v. Industrial Engineering Projects Pvt. Ltd., [1993] 202 ITR 1014 (Delhi).

18. We may now refer to some provisions of the DTAA as also the provisions of the Act to the extent they are required. Before answering the issue we may point out that the Finance Act, 2007, has inserted an Explanation to section 9(2) with retrospective effect from June 1, 1976, and which reads as under:

“For the removal of doubts it is hereby declared that for the purposes of this section where income is deemed to accrue or arise in India under clauses (v), (vi) and (vii) of sub-section (1), such income shall be included in the total income of the non-resident, whether or not the non-resident has a residence or place of business or business connection in India.”

19. The income from receipt of royalties as set out in section 9(1)(vi) are thus now taxable in India whether or not the non-resident has a place of residence, or place of business or business connection in India. In the present appeal though the agreements entered into are before June 1, 1976, income received is for several assessment years.

20. The relevant provisions of the DTAA notified by notification dated September 13, 1960, read as under [1960] 40 ITR (St.) 21:

Article I The taxes which are the subject of the present agreement are:

(a) in India:

the Income-tax,

the super tax,

the surcharge,

imposed under the Indian Income-tax Act, 1922 (11 of 1922) (hereinafter referred to as “Indian tax”) …….

(2) The present agreement shall also apply to any other taxes of a substantially similar character imposed in India or the Federal Republic of Germany subsequent to the date of signature of the present agreement.

(emphasis1 supplied)

Article II

(1) ……

(2) In the application of the provisions of this agreement in one of the territories any term not otherwise defined in this agreement shall, unless the context otherwise requires, have the meaning which it has under the laws in force in that territory relating to the taxes which are the subject of this agreement.

Article III

(1) Subject to the provisions of paragraph (3) above, tax shall not be levied in one of the territories on the industrial or commercial profits of an enterprise of the other territory unless profits are derived in the first mentioned territory through a permanent establishment of the said enterprise situated in the first mentioned territory. If profits are so derived, tax may be levied in the first mentioned territory on the profits attributable to the said permanent establishment ….

(3) For the purposes of this agreement the term “industrial or commercial profits” shall not include income in the form of rents, royal ties, interests, dividends, management charges, remuneration for labour or personal services or income from the operation of ships or aircraft but shall include rents or royalties in respect of cinematographic films.’

Under article V, income derived from the operation of aircraft by an enterprise of one of the territories shall not be taxed in the other territory, unless the aircraft is operated wholly or mainly between places within that other territory.

Article VI deals with shipping operations and how the profits derived shall be taxable. Article VII deals with tax on dividends. Article VIII deals with tax on interest on bonds, securities, notes, debentures or any other form in indebtedness.

Article IX deals with income from immovable property which includes any rent or royalty or other income derived from the operation of a mine, quarry or any other extraction of natural resources. Article X is the matter of capital gains arising from the sale, exchange or transfer of a capital asset, whether movable or immovable. Article XI deals with remuneration from public service. There are other articles which we need not deal with.

21. Royalty has not been defined in the DTAA in question nor at the relevant time was it defined in the Income-tax Act. The German DTAA was amended by notification dated August 26, 1985. Article VIIIA of the amended agreement deals with royalties and fees for technical services which are also explained therein. We are not concerned with the amendment as we are concerned with the assessment year 1979–80.

22. The Finance Act, 1976, with effect from June 1, 1976, introduced clauses (v), (vi) and (vii) to section 9(1). Clause (v) deals with income by way of interest. Clause (vi) defines income by way of royalty. Explanation 2 sets out the meaning of “royalty” for the purpose of the clause. Clause (vii) deals with income by way of fees for technical services. The proviso which was inserted by the Finance Act, 1977, with effect from April 1, 1977, provides that nothing contained in this clause shall apply in relation to any income by way of fees for technical services payable in pursuance of an agreement made before April 1, 1976, and approved by the Central Government. Explanation 2 defines fees for technical services.

23. While answering the reference, we have to consider whether (1) income received by way of royalty; (2) income received by way of technical fees; and (3) reimbursement of expenses, are taxable in India considering the provisions of section 9 of the Income-tax Act as amended with effect from June 1, 1976.

24. The Finance Act, 2007, has inserted the Explanation to section 9(1) with retrospective effect from June 1, 1976. The Supreme Court in Ishikawajma-Harima Heavy Industries Ltd. v. Director Of Income Tax, Mumbai., Mumbai, [2007] 288 ITR 408 was dealing with the DTAA entered into between India and Japan. What was in issue was the provisions of section 9(1)(vii)(b) and section 9(1)(vii)(c) and whether the income receivable thereto could be taxed in India. While answering the issue and considering the law the Supreme Court observed that (page 443):

“For attracting the taxing statute there has to be some activities through the permanent establishment. If income arises without any activity of the permanent establishment, even under the DTAA the taxation liability in respect of overseas services would not arise in India. Section 9 spells out the extent to which the income of nonresident would be liable to tax in India. Section 9 has a direct territorial nexus. Relief under a Double Taxation Treaty having regard to the provisions contained in section 90(2) of the Income-tax Act would arise only in the event a taxable income of the assessee arises in one Contracting State on the basis of accrual of income in another Contracting State on the basis of residence. Thus, if the appellant had income that accrued in India and is liable to tax because in its State all residents it was entitled to relief from such Double Taxation payable in terms of the Double Taxation Treaty (sic). However, so far as accrual of income in India is concerned, taxability must be read in terms of section 4(2) read with section 9, whereupon the question of seeking assessment of such income in India on the basis of the Double Taxation Treaty would arise.”

25. The court further observed as under (page 443):

“Therefore, in our opinion, the concepts profits of business connection and permanent establishment should not be mixed up. Whereas business connection is relevant for the purpose of application of section 9, the concept of permanent establishment is relevant for assessing the income of a non-resident under the DTAA.”

26. The court then considering section 9(1)(vii)(c) proceeded to hold as under (page 444):

“Reading the provision in its plain sense, it can be seen that it requires two conditions to be met—the services which are the source of the income that is sought to be taxed, has to be rendered in India, as well as utilized in India, to be taxable in India. In the present case, both these conditions have not been satisfied simultaneously, therefore, excluding this income from the ambit of taxation in India. Thus, for a non-resident to be taxed on income for services, such a service needs to be rendered within India, and has to be part of a business or profession carried on by such person in India. The petitioners in the present case have provided services to persons resident in India, and though the same have been used here, they have not been rendered in India.”

27. Parliament, it appears, took note of this judicial pronouncement as is noted in the Explanatory Notes on Provisions Relating to Direct Taxes for the Finance Act, 2007. It referred to Circular No. 202, dated July 5, 1976 [1976] 105 ITR (St.) 17. With respect to rule for royalty income, it was stated as follows:

“In view of the aforesaid amendment, royalty income consisting of lump sum consideration for the transfer outside India of, or the imparting of information outside India in respect of, any data, documentation, drawings or specifications relating to any patent, invention, model, design, secret formula or process or trademark or similar property, will ordinarily become chargeable to tax in India.”

28. Memorandum explaining the provisions, further notes that the source rule would mean that irrespective of the situs of the service, the situs of the payer and the situs of the utilisation of services will determine the tax jurisdiction. After noting the judicial opinion it observed that:

“Legislative intent for introduction of clauses (v), (vi) and (vii) was to give legal sanctity to the source rule. This source rule is also recognised in India's DTAAs.”

29. It then proceeds to observe as under:

“For the removal of doubts, an Explanation has now been inserted in section 9 to specifically reaffirm the source rule provided in that section, to clarify that where income is deemed to accrue or arise in India under clause (v), (vi) or (vii) of sub-section (1) of section 9, such income shall be included in the total income of the non-resident, regardless of whether the non-resident has a residence or place of business or business connection in India. In such cases, it is not necessary to establish the territorial nexus between the income deemed to accrue or arise to the non-resident under the said clauses and the territory of India.”

30. By the Explanation it appears that the ratio of the judgment in Ishikawajma-Harima Heavy Industries Ltd. v. Director Of Income Tax, Mumbai., Mumbai, [2007] 288 ITR 408 is sought to be overcome by providing that even if any non-resident has no permanent establishment the income from royalty accrued or paid by a resident would be deemed to be taxable in India.

31. We now proceed to consider and answer as to what was taxable under the Indo-German Double Taxation Avoidance Agreement. On a reading of article II(2) it would be clear that if a term is not defined in the agreement and in the instant case royalty was not defined it will have the meaning which it has under the laws in force in that territory relating to the taxes which are the subject-matter of this agreement. Learned counsel for the assessee has placed reliance on the judgment of the Supreme Court of Canada in Her Majesty the Queen v. Melford Developments Inc. (82 DTC 6281). Considering a similar clause in article II(2) of the treaty between Canada and Germany the Supreme Court of Canada was considering the expression “law in force in Canada” relating to the taxes which are the subject of the Convention whether it means the laws as they existed in 1956 or the laws of Canada from time to time in force. The court observed that:

“Laws enacted by Canada to redefine taxation procedures and mechanisms with reference to income not subjected to taxation by the agreement are not, in my view, incorporated in the expression Taws in force in Canada as employed by the agreement. To read this section otherwise would be to feed the argument of the appellant, which in my view is without foundation in law, that sub-section (2) authorizes Canada or Germany to unilaterally amend the tax treaty from time to time as their domestic needs may dictate.”

32. The ratio of that judgment, in our opinion, would mean that by an unilateral amendment it is not possible for one nation which is party to an agreement to tax income which otherwise was not subject to tax. Such income would not be subject to tax under the expression “laws in force”. Income covered by the provisions of the Income-tax Act is subject to tax. The question which calls for consideration is article III and articles V to XII of the Double Taxation Avoidance Agreement. We have already reproduced article III(1) and article III(3). Article III(1) provides that tax shall not be levied in one of the territories on the industrial or commercial profits of an enterprise of the other territory unless profits are derived in the first-mentioned territory through a permanent establishment of the said enterprise situated in the first-mentioned territory. Sub-clause (3) of article III includes only rents or royalties in respect of cinematographic films within the expression “industrial or commercial profits” but does not include income in the form of rents, royalties which are set out therein.

33. On behalf of the assessee what is sought to be contended is that whatever is included in article III(3) and what is taxable is provided from article V onwards. It is submitted that if it does not fall within any of those articles then it would not fall under industrial or commercial profits. Royalty, it is submitted, is covered by article IX and it includes only rent or royalty or other income derived from tax of mine, quarry or any other extraction of natural resources which is to be regarded as income from immovable property. It is, therefore, submitted that royalty in the form which was payable under the agreement was not liable for taxation in terms of article III. Royalty not being defined, the ordinary meaning found in dictionaries can be first considered. In Jowitt's Dictionary of Law, royalty is defined as under:

“Royalty, a payment reserved by the grantor of a patent, lease of a mine or similar right, and payable proportionately to the use made by the right by the grantee. It is usually a payment of money, but may be a payment in kind, that is, a part of the produce of the exercise of the right—See rent.

Royalty also means a payment which is made to an author of each copy of his work which is sold, or to an inventor in respect of each article sold under the patent.”

34. In Black's Law Dictionary royalty to mean:

“Royalty.— (1) A payment made to an author or inventor for each copy of a work or article sold under a copyright or patent.

(2) A share of the product or profit from real property, reserved by the grantor of a mineral lease, in exchange for the lessee's right to mine or drill on the land also termed (in sense 2) override.”

35. In that context reference was made by learned counsel for the assessee to the judgment of the House of Lords in Rolls-Royce Ltd. v. Jeffrey (Inspector of Taxes), [1962] 1 WLR 425 : [1965] 56 ITR 580. In that case, the company was engaged in metallurgical research and the discovery and development of engineering techniques and secret process. As a result it acquired in the course of the years a fund of technical knowledge, or “know-how”, of which only a comparatively small part was capable of forming the subject-matter of patent rights. For some years the company, as a general rule, used its “know-how” only in its own trade, but subsequently entered into a number of agreements whereby in consideration of lump sum payments and royalties, it undertook to supply the foreign Government or company with technical knowledge, plans, a licence and facilities for the interchange of staff to enable them to manufacture specified types of aircraft engines. The agreements were for various periods. The question was whether in computing the company's profits or gains, the lump sum paid to it under the agreements should or should not be included. The House of Lords held that the sum should be so included as being part of the receipts of the company's trade; the company was not parting with its assets but trading in them as part of the development of its general trade. In this context, we may refer to the observation of Lord Radcliffe (page 585 of 56 ITR):

“‘Know-how’ is an ambience that pervades a highly specialised production organisation and, although I think it correct to describe it as fixed capital so long as the manufacturer retains it for his own productive purposes and expresses its values in his products, one must realise that in so describing it one is preceding by an analogy which can easily break down owing to the inherent differences that separate ‘know-how’ from the more straightforward elements of fixed capital.”

36. Proceeding further the court observed as under (page 586 of 56 ITR):

“… although ‘know-how’ is properly described as fixed capital by way of analogy, it is the kind of intangible entity that can very easily change its category; according to the use to which its owner himself decides to put it.”

37. The amounts received were described in the agreement as royalties. The court observed that they were only royalties in the sense that the measure of these recurrent payments is taken to be so many pounds/sterling per engine manufactured in China.

38. This aspect really need not detain us as admittedly, by the Finance Act, 1976, the expression “royalty” has been explained for the purpose of section 9 of the Income-tax Act and the issues being considered are for the assessment year 1979–80.

39. In our opinion, even in the absence of royalty being defined under the clauses of the agreement, if it amounts to any industrial or commercial profit it would be taxable under article III provided there is a permanent establishment in India unless we hold that considering the Explanation to section 9 brought by the Finance Act, 2007, the requirement of permanent establishment is now of no consequence.

40. While considering the Double Taxation Avoidance Agreement the expression “law in force” would not only include a tax already covered by the treaty but would also include any other tax as taxes of a substantially similar character subsequent to the date of the agreement as set out in article I(2). Considering the express language of article I(2) it is not possible to accept the broad proposition urged on behalf of the assessee that the law would be the law as was applicable or as defined when the Double Taxation Avoidance Agreement was entered into. The question however, would still remain, whether the income by way of royalties other than those included in article III(3) are subject to tax in India considering the Double Taxation Avoidance Agreement when there is no permanent establishment.

41. We may also note at this stage that the rule of referential incorporation or incorporation cannot be applied when we are dealing with a treaty (Double Taxation Avoidance Agreement) between two sovereign nations. Though it is open to a sovereign Legislature to amend its laws, a Double Taxation Avoidance Agreement entered into by the Government in exercise of the powers conferred by section 90(1) while considering section 90(2) has to be reasonably construed.

42. The next question that we have to answer is, if the provisions of Double Taxation Avoidance Agreement are more beneficial to the assessee whether the taxability of the income should be governed by the provisions of that agreement and not by the provisions of Income-tax Act as amended. In other words would the Double Taxation Avoidance Agreement prevail over the provisions of the Income-tax Act.

43. In CIT v. Visakhapatnam Port Trust, [1983] 144 ITR 146 a learned Division Bench of the Andhra Pradesh High Court considering the German Double Taxation Avoidance Agreement and section 9 of the Income-tax Act was pleased to hold that the terms of article III of the agreement will prevail over section 9 of the Act. It was so held considering that sections 4 and 5 of the Act are expressly made subject to the provisions of the Act which means that they are subject to the provisions of section 90 of the Act.

44. Next reference may be made to Circular No. 333, dated April 2, 1982 [1982] 137 ITR (St.) 1, issued by the Central Board of Direct Taxes to the following paragraph as to how the Board has understood the law when there be a conflict between a Double Taxation Avoidance Agreement and the provisions of the Income-tax Act:

“2. The correct legal position is that where a specific provision is made in the Double Taxation Avoidance Agreement, that provision will prevail over the general provisions contained in the Income-tax Act, 1961. In fact the Double Taxation Avoidance Agreements which have been entered into by the Central Government under section 90 of the Income-tax Act, 1961, also provide that the laws in force in either country will continue to govern the assessment, and taxation of income in the respective country except where provisions to the contrary have been made in the agreement.”

45. It would thus be clear that the Central Board of Direct Taxes itself has understood that in the case there is a beneficial provision under the Double Taxation Avoidance Agreement that would prevail over the provisions of the respective statute. The same view was also held by the Division Bench of the Calcutta High Court in CIT v. Davy Ashmore India Ltd., [1991] 190 ITR 626. The learned Division Bench was pleased to hold that the agreement would prevail over the provisions of the Income-tax Act. At the same time, the learned Division Bench was pleased to observe that where there is no specific provision in the agreement, it is the basic law, i.e, the Income-tax Act, that will govern the taxation of income.

46. In our opinion, the issue is no longer res integra considering the judgment of the Supreme Court in Union of India v. Azadi Bachao Andolan, [2003] 263 ITR 706. Dealing with that issue the court observed as under (page 724):

“A survey of the aforesaid cases makes it clear that the judicial consensus in India has been that section 90 is specifically intended to enable and empower the Central Government to issue a notification for implementation of the terms of a double taxation avoidance agreement. When that happens, the provisions of such an agreement, with respect to cases to which where they apply, would operate even if inconsistent with the provisions of the Income-tax Act. We approve of the reasoning in the decisions which we have noticed. If it was not the intention of the Legislature to make a departure from the general principle of chargeability to tax under section 4 and the general principle of ascertainment of total income under section 5 of the Act, then there was no purpose in making those sections ‘subject to the provisions’ of the Act, The very object of grafting the said two sections with the said clause is to enable the Central Government to issue a notification under section 90 towards implementation of the terms of the Double Taxation Avoidance Agreements which would automatically override the provisions of the Income-tax Act in the matter of ascertainment of chargeability to income-tax and ascertainment of total income, to the extent of inconsistency with the terms of the Double Taxation Avoidance Agreement.”

47. Referring to the circular the court held that the circular shall prevail even if inconsistent with the provisions of the Income-tax Act, 1961, in so far as assessees covered by the provisions of the Double Taxation Avoidance Agreement are concerned.

48. It would, thus be clear that though provisions of section 9 would be applicable, however, considering the provisions of the Double Taxation Avoidance Agreement if beneficial, than the provisions of the Income-tax Act, the provisions of the Double Taxation Avoidance Agreement would prevail. In our opinion, therefore, in the absence of a permanent establishment the amounts in respect of which the Tribunal has recorded a finding that the income sought to be assessed is industrial or commercial profit are not assessable to tax in India as admittedly the assessee having no permanent establishment.

49. We may, however, note that Parliament has taken cognizance of the judicial pronouncement in Ishikawajimaharima Heavy Industries Ltd., [2007] 288 ITR 408 (SC) by the Finance Act, 2007, and has inserted Explanation 2 to section 9(1) which we have already reproduced. By this amendment the concept of having residence or place of business connection in India has been done away with. Dealing with this amendment on behalf of the assessee it is sought to be submitted that the amendment would be of no consequence. The submission is that though the object of the Explanation is to get over the judgment of the Supreme Court as is borne out by the memorandum explaining the provisions in the Finance Bill, the said object has not been achieved. The submission is that what the Explanation provides is that it is not necessary for the non-resident to have a business in India or a business connection in India or even to have a residence in India. It is submitted that what the Supreme Court has emphasised is the rendering of services in India. In the present case, if the consideration received by the respondent for grant of the patents and licence is regarded as royalty as the grant admittedly took place outside India, the question of the deeming provisions applying having regard to the interpretation placed upon them by the Supreme Court would not arise. Without going into that issue, considering the ratio in Azadi Bachao Andolan, [2003] 263 ITR 706 (SC) such income would not be taxable in terms of the Double Taxation Avoidance Agreement, as the assessee has no permanent establishment in India and the terms of the Double Taxation Avoidance Agreement are more beneficial to the assessee.

50. The issue can also be considered in the light of the argument advanced on behalf of the assessee that considering the expression royalty as set out in article IX, it has a restrictive meaning. The royalty which is the subject-matter of this appeal can only be taxable under article III provided the predicates therein are satisfied, namely, that there is a permanent establishment. Learned counsel for the assessee had raised the point before the Tribunal and has also reiterated the same before this court, that article III(3) has to be read in consonance with articles V to XII as they are relevant for understanding the Double Taxation Avoidance Agreement.

51. We have earlier reproduced parts of article III of the Double Taxation Avoidance Agreement. Article III(3) sets out that the term “industrial or commercial profits” shall not include income in the form of rents, royalties, interests, dividends, management charges, remuneration for labour or personal services or income from the operation of ships or aircraft but shall include rents or royalties in respect of cinematographic films. A reading of this article may prima facie indicate that only royalties from cinematographic films form a part of industrial or commercial profits and all other incomes by way of royalty would not be taxable except to the extent which may be provided by the Double Taxation Avoidance Agreement. This must also be seen in the context of articles V to XII where the income from the excluded heads under article III are taxable.

52. Article IX provides that any rent received from operation of a mine, quarry or any other extraction of natural resources shall be regarded as income from immovable property and will be taxed in the territory in which the property is situated. Similarly, royalty included under article IX is royalty from the operation of a mine, quarry or any other extraction of natural resources. On the argument advanced by the learned counsel, considering this article, such royalty would not be included in the term “industrial” or “commercial” profits. Similarly, interests, dividends, management charges, remuneration for labour or personal services or income from the operation of ships or aircraft are covered by the various other articles. What this only means is that income from heads under articles V to XII will be taxed as provided in the manner set out in those articles and as such, would not come within the term “industrial” or “commercial” profits. In other words, income from activities covered by articles V to XII by virtue of article III(3) are specifically excluded from the expression “industrial or commercial profits” in article III as they are to be taxed in the manner provided under articles V to XII. An inescapable conclusion, therefore, emerges that income other than those provided by the articles and if it is relatable to industrial or commercial profits would be covered by article III. This income would not be subject to tax in the absence of a permanent establishment of the enterprise in the territory of India. It is not possible to accept that income including from royalties from inventions, trade marks, patents or copyrights or the like are excluded and would not be taxable. In our opinion, the correct interpretation of the Double Taxation Avoidance Agreement would be to include the royalties from patents, copyrights or trade marks and the like within the expression “industrial” or “commercial” profits. The learned Tribunal, therefore, has correctly taken a view that though this income would not be royalties within the meaning of the Double Taxation Avoidance Agreement but would fall under the expression “commercial or industrial profits”. In the absence of a permanent establishment such income would not be taxable in India.

53. This is further fortified by the fact that in the subsequent Double Taxation Avoidance Agreement of July, 1985, article III of the Double Taxation Avoidance Agreement of 1960 has been substituted and article III(3) makes it clear where income is dealt with separately under other articles then those provisions will apply. A new article VIIIA has been inserted which explains the expression “royalties” to include payments of any kind received as consideration for the use of, or the right to use amongst other payments received as consideration for the right to use any copyright, patent, trade mark, etc. Though the word “royalty” was also not defined under the Income-tax Act, as it then stood, the expression would have to be understood in its ordinary grammatical meaning which we have already set out earlier. The conclusion would be that royalty other than royalty for mine, quarry, etc., if relatable to industrial or commercial profits would be taxable under article III (1) provided there was a permanent establishment of the enterprise in India.

54. That leaves us with the second question in respect of the payments that have been held by the Tribunal to be by way of technical services. Reference by the Tribunal is whether the payments under the agreement dated July 27, 1975, and October 28, 1975, were in the nature of fees for technical services within the meaning of section 9(1)(vii) or royalty within the meaning of Explanation 2 to section 9(1)(vi) of the Act. There are two aspects of the matter. Findings have been recorded that in so far as agreement dated March 15, 1967, is concerned, that work had been done in Germany and there was no question of any transfer or licence of any existing technical know-how to BHEL. It was pure and simple consultancy for manufacture of contract products. Secondly, the issue whether they were taxable had come up before the Tribunal at Delhi in the matter of deduction of tax at source. The Tribunal recorded a finding that these are not taxable in India. The argument advanced on behalf of the Revenue is that these are prima facie findings and, therefore, not binding on the court. It is further submitted that merely because an appeal was not preferred would be of no consequence. Reliance for that purpose is placed on the judgment in CCE v. Hira Cement, [2006] 194 ELT 257 (SC). In that case, the, Supreme Court held that non-filing of an appeal by itself against the order would not be a ground for refusing to consider the matter on its own merits and when public interest is involved in interpretation of law the court is entitled to go into the question. In that case, the precedent relied upon by the Tribunal was expressly overruled by the Supreme Court.

55. In the instant case, we are concerned with the same assessee on the same question. Recourse had been had to the provisions of the Income-tax Act as to whether the income was assessable to tax in India and the Tribunal recorded a finding that it was not taxable in India. Gainful reliance can be placed in the judgment of the Supreme Court in Berger Paints India Ltd. v. Commissioner Of Income Tax, Calcutta, [2004] 266 ITR 99. In respect of the same assessee and in respect of the very same agreement if a Tribunal of co-ordinate jurisdiction has decided that issue and if the Revenue has not challenged the same it will not be open to the Revenue in collateral proceedings to contend that the said issue is still open for reconsideration. In our opinion, there must be a finality to orders. Once in respect of the same assessee the issue was in issue before the Tribunal of competent jurisdiction and the Tribunal having answered the issue and that having not been challenged it will not be open to the Revenue to raise the said issue again in respect of the same assessee. The only exception would be if the statute expressly provides that such findings are not conclusive. This is not the case here.

56. That leaves us with the last contention as to whether the amounts by way of reimbursement are liable to tax. To answer that issue, we may gainfully refer to the judgment of a Division Bench of the Delhi High Court in Commissioner Of Income-Tax v. Industrial Engineering Projects Pvt. Ltd., [1993] 202 ITR 1014. The learned Division Bench of the Delhi High Court was pleased to hold that reimbursement of expenses can, under no circumstances, be regarded as a revenue receipt and in the present case the Tribunal had found that the assessee received no sums in excess of expenses incurred. A similar issue had also come up for consideration before the Division Bench of the Calcutta High Court in CIT v. Dunlop Rubber Co. Ltd., [1983] 142 ITR 493 (Cal). The learned Division Bench was answering the following question:

“Whether, on the facts and in the circumstances of the case, the amounts received by the assessee (English company) from M/s. Dunlop Rubber Co. (India) Ltd. (Indian company) as per agreement dated July 29, 1957, constituted income assessable to tax?”

57. On considering the issue the learned Bench noted that the Tribunal was of the view that what was recouped by the English company was part of the expenses incurred by it. The learned court upheld the said finding. The learned Bench was pleased to hold that sharing of expenses of the research utilised by the subsidiaries as well as the head office organisation would not be income which would be assessable to tax. A similar view was taken in CIT v. Stewards and Lloyds of India Ltd., [1987] 165 ITR 416. We are in respectful agreement with the view expressed by the Delhi and Calcutta High Courts.

58. Considering the above, the reference is answered as under:

(1) Question No. 1 — In the affirmative and against the Revenue.

(2) Question No. 2 — The income would be royalty but falls within the expression ‘industrial or commercial profits’ within the meaning of article III of the Double Taxation Avoidance Agreement.

(3) Question No. 3 — In the affirmative and against the Revenue.

(4) Question No. 4 — In the affirmative and against the Revenue.

(5) Question No. 5 — In the affirmative and against the Revenue.