[Opinion] An Insight on Income Payable As Royalty and FTS – Deemed To Accrue or Arise in India

Parnashree Banerjee – [2024] 168 taxmann.com 88 (Article)

1. Introduction

In accordance with the provisions of the Income Tax Act, 1961, every person is liable to pay income tax in respect of his total taxable income. “Person” includes an individual, a Hindu undivided family, a company, a firm, an association of persons or a body of individuals (whether incorporated or not), a local authority and every artificial juridical person not falling within the above categories. For determination of taxability, the Income Tax Act, 1961 in general follows a combination of the “source” and “residence” rules. Accordingly, as a starting point it is essential to examine the residential status of an assessee. The scheme for determination of the same is provided in section 6 of the Income Tax Act. There are different tests laid down for determining the residential status of individuals, companies, etc. The same would largely depend on factors such as duration of stay in India (for individuals), country of incorporation coupled with existence of “control and management” of the affairs in India or place of effective management (for companies), etc.

As per provisions of section 5 of the Income Tax Act, “income” would be liable to tax in India if it is –

• Received or deemed to be received in India; or
• Accrues or arises in India; or
• Is deemed to accrue or arise in India; or
• Accrues or arises outside India (the same would be taxable only in the hands of a “resident” assessee).

Further, the Income Tax Act (hereinafter referred to as the ‘Act’ for the sake of brevity) contains certain deeming provisions which lay down the circumstances under which an income shall be “deemed to accrue or arise” in India, and hence shall be taxable in India. Section 9 of the Income Tax Act is one such provision which was designed as an aggregating provision, and it brought several independent and scattered provisions from the Indian Income Tax Act, 1922 together, collecting them under the head of ‘incomes deemed to accrue or arise in India’. Section 9 covers within its ambit all persons, residents as well as non-residents and is therefore, most inclusive in nature. Due to its extremely wide import and significant impact on the tax liability of non-resident corporations, the section has many a times been challenged as ultra vires the Constitution on the grounds of legislative competence as well as violation of fundamental rights. Nevertheless, the vires of this section has been confirmed each time, with the Supreme Court as well as several High Courts across the country, declaring it to be constitutionally valid. This provision enacts into law a source rule of taxation, deeming a whole range of incomes, from interest and dividend to salary, fees for technical services (FTS) and royalty to ‘accrue or arise’ in India for tax purposes.

Royalty and FTS are two specific streams of income which are liable to tax in India under this deeming fiction, regardless of whether the performance of the income generating activity has been carried out in India or not. The various facets of income in the nature of ‘royalty’ and ‘FTS’, deeming to accrue or arise in India, shall be the scope and ambit of this Article.

Income Payable As Royalty, ‘Deemed To Accrue or Arise in India’

The term ‘Royalty’ normally connotes the payment made by a person who has exclusive right over a thing for allowing another to make use of that thing which may be either physical or intellectual property or thing. The exclusivity of the right in relation to the thing for which royalty is paid should be with the grantor of that right. Mere passing of information concerning the design of a machine which is tailor made to meet the requirement of a buyer does not by itself amount to transfer of any right of exclusive user, so as to render the payment made there for being regarded as “royalty”.

In common legal parlance, “royalty” is a payment to an owner for the use, or right to use of his property, especially patents, copyrighted works, franchises or natural resources. It is somewhat akin to rentals which is broader in scope and concept. The basic ingredients of Royalty are: (i) it is a consideration for use of properties especially intangible rights, (ii) the ownership over such intangible rights is protected by law & (iii) the payment may be periodic or lump sum (iv) The title over such intangible rights remains with the owner during the use of the property by the payee of Royalty (v) the right or title of the owner over the property is exclusive and (vi) consideration payable is determined on the basis of amount of use.

Income payable as ‘Royalty’ to a non resident, ‘deemed to accrue or arise in India’ has been inserted as clause (vi) in section 9 of the Income Tax Act, 1961 by the Finance Act, 1976, as the sum payable for any right, property or information used or services utilized for business. Along with ‘royalty’, ‘interest’ and ‘fees for technical services’ were added to section 9 of the Act by the Finance Act, 1976. These three additions substantially modified the character of section 9 of the Act since liability was attached to non-residents based on an extremely sound territorial nexus previously. Post-1976 however, the section created liability for a non-resident in respect of his income outside India, even if the contract from which the income arose was performed entirely outside India, the only basis for attracting liability being the fact that the payment was made by an Indian.

Click Here To Read The Full Article