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Technology Transfer and Tax Laws

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Tax Laws in Technology Transfer

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Technology Transfer and Tax Laws

  1. 1. Law of Technology Transfer denotes: “intellectual equipment coupled with the necessary physical equipment which is required for being applied in the field of trade, business, manufacture or other profitable activity, being intellectual equipment in which a legal right is recognized.” Technology: Confidential information and trade secret, patents for inventions, copyrights, designs, semi-conductor chip protection, trademarks etc. Transfer: as defined in the Oxford dictionary means conveyance from one place or person to another. In the tax regime transfer is clearly defined under Section 2(47) of the Income Tax Act, 1961 and Section 2(xxiv) of the Gift Tax Act, 1958.
  2. 2. Tax implications arising on transfer of technology: Transfer of technology gives rise to a consideration (ie income). Depending upon the mode of the transfer, this can take diverse hues such as royalty, fees for technical services or even business profits. The tax implications in each case are bound to vary. Domestic tax laws may offer added benefits in case of outbound transfer of technology (such as tax benefits under Section 80-O, Section 80-HHE of the Income Tax Act, 1961). Certain imports of technology may be exempted by custom duties or the foreign entity which is supplying the requisite technology may escape withholding taxes.
  3. 3. Income deemed to accrue or arise in India. Section 9. (1) The following incomes shall be deemed to accrue or arise in India: (vi) income by way of royalty* payable by— (a) the Government ; or (b) a person who is a resident, except where the royalty is payable in respect of any right, property or information used or services utilised for the purposes of a business or profession carried on by such person outside India or for the purposes of making or earning any income from any source outside India ; or (c) a person who is a non-resident, where the royalty is payable in respect of any right, property or information used or services utilised for the purposes of a business or profession carried on by such person in India or for the purposes of making or earning any income from any source in India.
  4. 4. Income deemed to accrue or arise in India. Section 9. (1) The following incomes shall be deemed to accrue or arise in India: (vii) income by way of fees for technical services payable by— (a) the Government ; or (b) a person who is a resident, except where the fees are payable in respect of services utilised in a business or profession carried on by such person14 outside India or for the purposes of making or earning any income from any source outside India ; or (c) a person who is a non-resident, where the fees are payable in respect of services utilised in a business or profession carried on by such person in India or for the purposes of making or earning any income from any source in India :
  5. 5. “Royalty" means consideration (including any lump sum consideration but excluding any consideration which would be the income of the recipient chargeable under the head "Capital gains") for— (i) the transfer of all or any rights (including the granting of a licence) in respect of a patent, invention, model, design, secret formula or process or trade mark or similar property ; (ii) the imparting of any information concerning the working of, or the use of, a patent, invention, model, design, secret formula or process or trade mark or similar property ; (iii) the use of any patent, invention, model, design, secret formula or process or trade mark or similar property ; (iv) the imparting of any information concerning technical, industrial, commercial or scientific knowledge, experience or skill ; (v) the transfer of all or any rights (including the granting of a licence) in respect of any copyright, literary, artistic or scientific work including films or video tapes for use in connection with television or tapes for use in connection with radio broadcasting, but not including consideration for the sale, distribution or exhibition of cinematographic films.
  6. 6. Any payment made by an Indian company towards royalty or fees for technical services are taxable in India in the hands of the foreign collaborator. The tax rate is 20% on such payments under Section 44D of the Indian Income-tax Act (“ITA”). This can be reduced to a lower rate based on India’s tax treaties. The payment of these taxes either by the Licenser or the licensee is frequently a negotiating point. The following considerations are important in the negotiation: 1) Taxes paid in India by a foreign collaborator is normally available as a tax credit in the collaborator’s home country. If a tax credit is available, it may be preferable that the foreign collaborator bear the tax in India as it reduces the tax cost of the total transaction.
  7. 7. 2) In certain cases, the foreign collaborator may not be able to use the tax credits as the overseas company may have carried forward losses or is located in a low-tax country. In such a case, if the taxes are paid by the licensee, no tax credit would be available to the foreign collaborator. No gross-up is required to compute the tax payment made by the licensee under section 10(6A) of the ITA as long as the agreement relates to a matter included in the industrial policy in force or is an agreement that is approved by the Central Government. Research and development Cess of 5% is payable by the licensee on all payments made in connection with the payment of royalty or fees for technical services.
  8. 8. Customs Duty: Drawings and designs are subject to customs duty. However, it is important to note that if capital goods and technology are being imported in a composite transaction, the cost of the technology may be added to the value of capital goods for purposes of custom duty. Rule 9 (1)(b)(4) of Customs Valuation (Determination of Price of Imported Goods) Rules, 1988 – royalties and licence fees related to the imported goods that the buyer is required to pay, directly or indirectly, as a condition of the sale of the goods being valued, to the extent that such royalties and fees are not included in the price actually paid or payable. Central Excise Duty: Exemptions are rare, the royalties are included in cost of transaction and duty is imposed on the same.
  9. 9. Depreciation of assets are allowed under section 32 (1) (ii) of the IT Act in the cases of Know-how, patents, copyrights, trade-marks, licences, franchises ar any other business or commercial rights of a similar nature. Expenditure on acquisition of patents are dealt under Section 35A of the IT Act. If they are purchased for a lump-sum consideration with an enduring benefit, the purchaser is entitled to claim depreciation over a period of time. Section 35AB allows the same for Know-how. Sales Tax: No mechanism in India to monitor the movement of IPRs inter-state for the purposes of taxing. Tata Consultancy Services v. State of Andra Pradesh: SC: “In a case of customized Intellectual Property, namely software, is incorporate in media for use, hence that software in a media is goods.”
  10. 10. DOUBLE TAX AVOIDANCE AGREEMENTS (DTAA) India has entered into DTAAs with almost all its major trading partners. DTAAs provide some degree of stability in interpretation of tax laws and determining the tax incidence or the incidence of withholding tax vis a vis the foreign entity, which is supplying the technology in case of an inbound transfer or to whom the technology is provided in case of outbound transfers. Section 90 of the Income Tax Act, 1961 empowers the Central Government to enter into agreements with the government of another country to grant relief to avoid double taxation.
  11. 11. Section 90(2): Where the central government has entered into an agreement with the government of any other country outside India under sub-section (1) for granting relief of tax or as the case may be, for avoidance of double taxation, then in relation to the assessee to whom such agreement applies the provisions of this Act shall apply to the extent they are more beneficial to the assessee (resident of the foreign country). This section bestow the right upon the resident of the foreign country to choose between the provisions of the applicable DTAA and those of the Income Tax Act, 1961. While switching between the provisions of the Indian Income Tax Act and the DTAAs is permissible, it would be an anomaly to choose those provisions of the Act and ignore those which are not in relation to the same transaction.
  12. 12. INBOUND TRANSFER OF TECHNOLOGY Nature of income and tax incidence of the foreign entity As mentioned earlier, transfer of technology results in income which can be in the nature of royalty, fees for technical services, business profits, independent personal services or even other income. Section 9 of the Income Tax Act, 1961 specifies incidence of income which would be deemed to accrue or arise in India. Most DTAAs which India has entered into prescribe for taxation of gross royalties and fees for technical services at rates varying between ten to twenty per cent. On the other hand, if such royalty or fees which are paid to a foreign entity can be attributed to a place of business in India (ie a permanent establishment), then such income can be taxed in the hands of the foreign entity, under the Articles pertaining to business profits.
  13. 13. On the other hand, DTAAs call for taxation of royalties and fees for technical services on a gross basis. Moreover, Section 44D of the Income Tax Act, 1961 overrides the provisions of Sections 28 to 44C and prohibits the deduction of any expenditure which may have been incurred by the foreign entity, while computing the royalties and fees for technical services which may be deemed to accrue or arise in India. At present under the Indian Income Tax Act, a foreign entity is taxed at the rate of 48 per cent on its business profits. Section 115 A prescribes a lower rate of taxation of 20 per cent (gross basis) in respect of income from royalties or fees for technical services in the hands of foreign companies, if the relevant agreement has been made after May 31, 1997. If such fees or royalties are received by the foreign entity pursuant to an agreement entered before this date, then the rate of taxation is 30 per cent.
  14. 14. OUTBOUND TRANSFER OF TECHNOLOGY The aim in outbound transfer of technology is to reduce the overall tax incidence to the barest minimum and at the same time, full advantage should be taken of the tax-breaks available under domestic laws relating to exports. The Finance Act, 1997 has restricted the deduction available under section 80-O only to any income received from the foreign government or foreign enterprise in consideration for the use outside India of any patent, invention, design or registered trademark. Section 80-O: Deduction in respect of royalty, commission, fees or any similar payment received by an assessee from a foreign government or foreign enterprise in consideration of technical and professional service rendered outside India, up to 50% of such income, received in India in convertible foreign exchange.
  15. 15. Section 80-O of the Income Tax Act, 1961 provides for a deduction of 50% from the income of an Indian resident by way of royalty, commission, fees or any similar payment from a foreign government or enterprise – (a) in consideration for the use outside India of any patent, invention, model, design, secret formula or process etc or (b) in consideration of technical or professional services rendered or agreed to be rendered outside India to such foreign government or enterprise. (include services rendered from India but shall not include services rendered in India.)

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