AAR : Whether pursuant to the cost contribution agreement proposed to be entered by the applicant with ABB Research Ltd., Zurich (“ABB Zurich”), the payments to be made to ABB Zurich, representing the applicant’s share of the costs incurred towards basic research and development (“R&D”) activities, constitutes “income” in the hands of ABB Zurich within the meaning of the term in s. 2(24)

Authority For Advance Rulings

ABB Ltd., IN RE

Section 9(1)(vi), 195, DTAA between India & Switzerland, art. 7, DTAA between India & Switzerland, art. 12,

P.V. Reddi, J., Chairman; J. Khosla, Member

AAR No. 834 of 2009

15th March, 2010

Counsel appeared :

Percy Pardiwalla with Ms. Vasanti Patel, K.J. Sheth & Anil Lukose, for the Applicant : Prakash H. Adnur, for the CIT concerned

Ruling

P.V. Reddi, J., Chairman :

The applicant—ABB Ltd.—which is a company incorporated in India having its registered office in Bangalore has filed this application seeking advance ruling in respect of the cost contribution agreement which it proposes to enter into with its group company by name, ABB Research Ltd., Zurich. The following questions are formulated by the applicant :

(1) Whether pursuant to the cost contribution agreement proposed to be entered by the applicant with ABB Research Ltd., Zurich (“ABB Zurich”), the payments to be made to ABB Zurich, representing the applicant’s share of the costs incurred towards basic research and development (“R&D”) activities, constitutes “income” in the hands of ABB Zurich within the meaning of the term in s. 2(24) of the IT Act, 1961 ?

(2) Based on the answer to question (1) above, and in view of the facts as stated in attachment III, and also in light of the declaration provided by ABB Zurich that it does not have a PE in India in terms of art. 5 of the agreement between the Government of the Republic of India and the Government of the Swiss Confederation for the avoidance of double taxation with respect to taxes on income (‘India-Swiss tax treaty’), whether the proposed payments by the applicant to ABB Zurich suffer withholding tax under s. 195 of the Act and if so, at what rate ?

(3) Whether tax is required to be withheld on the entire payment in case the cost contribution payment and co-ordination fee are raised under a single invoice by ABB Zurich though identified separately ?

2. The facts stated by the applicant are given hereunder : The applicant has various business divisions such as power products and systems, automation systems, process automation and robotics systems. The applicant’s plants are located at Bangalore and 6 other cities in India. ABB India is a part of the ABB Group, which is a leader in power and automation technologies that enable utility and industry customers to improve performance while lowering environmental impact. The ABB Group of companies operates in over 100 countries and employs about 1,20,000 people. As per ABB Group’s research and development (R&D) policy, all basic R&D for the ABB Group is co-ordinated and directed through ABB Research Ltd., Zurich (‘ABB Zurich’). ABB entities who wish to participate in the basic R&D enter into a cost contribution agreement (for short, CCA or ‘agreement’) with ABB Zurich. As per the agreement, the entire costs of the basic R&D are shared between the ABB entities participating in the agreement, based on an allocation key. The participating ABB entities are allowed a royalty-free unlimited access to the research results including any intellectual property rights (‘IPRs’) generated from the basic R&D.

However, for administrative reasons, the IPR generated as a result of the basic R&D under the agreement is legally owned by ABB Zurich.

2.1 The operative contract research activities under the agreement are performed within the ABB Group through Corporate Research Centres (“CRC”) in various countries and such CRCs are remunerated on a cost plus basis by ABB Zurich. Further, a coordination fee is payable by each participating ABB entity to ABB Zurich for its role as administrator and coordinating agency under the agreement. None of the personnel of ABB Zurich are required to visit India for rendering any work. Any fee received by ABB Zurich from licensing any IPR generated under the agreement to any entity including ABB entities, is used to reduce the overall costs of the basic R&D. Accordingly, the applicant states, the ABB entities participating in the agreement are ‘economic owners’ of the research results including any IPRs generated under the agreement. The CRCs do not have any rights to the research results or the IPR, and act only as contract research units for the ABB Group. The applicant is interested in directly participating in basic R&D activities of the ABB Group and accordingly, the applicant is proposing to enter into a cost contribution agreement with ABB Zurich.

2.2 The applicant further submits that ABB Group’s basic R&D activities are coordinated and directed through ABB Zurich. ABB Group entities who wish to participate in the basic R&D activities entered into a CCA with ABB Zurich. As per the CCA, the entire costs of the basic R&D are shared between the ABB entities participating in the CCA based on a pre-agreed allocation key. The ABB entities participating in the CCA are allowed a royalty-free unlimited access to the research results including any IPRs generated. The applicant has referred to para 2 to cl. 6.2 of the CCA which provides as follows : “The total actual costs for corporate R&D shall be borne by the parties in proportion to the value added achieved by the parties and their respective subsidiaries in the parties’ respective countries of domicile. For the purpose of this agreement, value added shall follow the definition in the ABB Accounting and Reporting Guidelines.” Value added is defined as : Personnel expenses + Earnings before interest and tax + Rs. unusual items.

3. The proposed cost contribution agreement between the participating companies and ABB Research Ltd., Zurich states in the Preamble that the parties wish to participate in the funding of corporate research and development in the ABB Group in order to make optimum use of the available resources and to increase efficiency and reduce cost. Moreover, it is stated that the parties wish to appoint a separate company which on behalf of the parties will administer the corporate R&D. ABB Research Ltd., Zurich has been identified as the administrator as seen from cl. (2). The applicant’s counsel has also referred to certain other clauses of the agreement proposed to be entered into, apart from the clauses noted earlier. They are : Article 6.1 of the CCA provides that the R&D Board of the ABB Group would decide the corporate research and development program and the corresponding Budget.

Article 6.2 of the CCA in turn provides that the R&D Board will appoint certain parties (hereinafter referred to as ‘CRCs’) who would carry out the actual R&D within the approved budget. It further provides that the actual costs incurred for carrying out the corporate R&D would be borne by the parties which expression would include the applicant and other parties mentioned in Annex. 1 to the agreement in proportion to the ‘value added’ achieved by the participants and the subsidiaries of the participants in their respective countries of domicile. Article 6.3 of the CCA sets out the manner in which the costs are to be funded. In brief, ABB Zurich would issue quarterly invoices to the participants on the basis of the budgeted costs for corporate R&D for the previous quarter. The costs would be allocated amongst the various participants based on the budgeted value added. At the end of the each year, the actual costs incurred by ABB Zurich would be allocated amongst the participants based on the actual value added and the differential between the actual and the budgeted figures would be adjusted and the necessary recovery/payments made. Article 7.1 of the CCA provides that the information and corresponding intellectual property rights, if any, achieved as a result of the corporate R&D are to become the proprietary rights of ABB Zurich subject to the right of free access which is granted to each of the participants and its subsidiaries in terms of art. 7.4. (Emphasis, italicized in print, supplied) Article 7.5 of the CCA provides that the fruits of the research could be made available for use to persons other than the participants who may or may not be part of the ABB Group. The license income derived is to be deducted from the Corporate R&D costs that are to be shared by the participants as per cls. 6.3. 1 and 6.3. 2 of the CCA.

4. The applicant sets out its case in brief as follows :Under the CCA agreement, ABB Zurich acts as a co- ordinating agency for monitoring the basic R&D undertaken within the ABB Group and ensuring that all the basic R&D costs are pooled and allocated amongst the ABB entities participating in the CCA, based on the allocation key reflecting the benefits. Accordingly, the proposed cost contribution by ABB India as a participant to the CCA represents a reimbursement of the costs incurred by ABB Zurich towards basic R&D, the results of which are freely accessible by ACC India without any further payment. Further, any fee generated by ABB Zurich from licensing any IPR generated under the CCA is used to reduce the overall costs of the basic R&D. Accordingly, such fees go to reduce the basic R&D costs shared amongst the ABB entities participating in CCA. Accordingly, in substance and form, the proposed payment by ABB India to ABB Zurich cannot be described as consideration for any services proposed to be provided by ABB Zurich or a payment towards any royalty. It constitutes only a pooling and co-ordinating arrangement under which the amounts proposed to be contributed by ABB India and other ABB entities participating in the CCA are credited to a joint account from which the basic R&D expenses are met. It is, therefore, submitted that the payments made by the applicant under the CCA, being cost recharged, based on an allocation key, do not constitute income in the hands of ABB Zurich. The applicant has clarified that the ‘co-ordinating fee’ charged by ABB Zurich will be subject to withholding tax under s. 195 of IT Act but not the cost contribution payments made by way of reimbursement. Thus, the applicant invokes a well known principle that a mere reimbursement of expenses cannot be construed as a receipt bearing the characteristics of income.

5. It is the contention of the applicant that the payments to be made under CCA to ABB Zurich cannot be treated as income at all as it is merely reimbursement of the cost incurred on account of R&D activity the result of which is shared by all group concerns. Assuming that it is income, it is contended that it partakes the character of business income. That being so, the Indian Government is precluded from subjecting such income to tax having regard to art. 7(1) of the India-Swiss Tax Treaty in the absence of PE in India. The existence of PE in India is a pre-requisite to tax the business profits as per art. 7 In view of the absence of PE, the question arises whether the ‘cost reimbursement’ can be considered to be ‘royalties’ or ‘fees for technical services’ within the meaning of art. 12. The learned counsel submits that art. 12 is not at all attracted in the present case.

6. It is not necessary for us to delve into the question whether the receipts in question can at all be treated as income because even if it amounts to business income, it does not make material difference in the absence of PE. Therefore, the real contentious issue is whether it is income in the nature of royalty. Before going into that question, we may point out that the Revenue has taken a stand, unsupported by reasons, that the payments to ABB Zurich would fall under ‘fees for technical services’ (‘FTS’). ‘FTS’ is defined in art. 12.4 of the treaty as : “payments of any kind to any person in consideration for the rendering of any managerial, technical or consultancy services, including the provision of services by technical or other personnel.” We have no hesitation in rejecting this contention. It cannot be said that ABB Zurich has rendered any service of technical or consultancy nature to the applicant when it makes available to the applicant and other parties to the CCA the results of corporate research. From the statement of facts and the contents of the CCA, it is clear that rendering of any service of the nature of managerial, technical or consultancy is not involved and moreover, ABB Zurich does not deploy any personnel to perform any services in India. Therefore, the only question that deserves consideration is whether the payments made by the applicant to ABB Zurich can be treated as payments in the nature of royalty.

6.1 The expression ‘royalties’ has been defined in para 3 of art. 12 as follows : “3. The term ‘royalties’ as used in this article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of a literary, artistic, or scientific work, including cinematograph films or work on film, tape or other means of reproduction for use in connection with radio or television broadcasting, any patent, trademark, design or model, plan, secret formula or process, or for the use of, or the right to use, any industrial, commercial, or scientific equipment, or for information concerning industrial, commercial or scientific experience.”

6.2 Under the IT Act, income by way of royalty payable by a resident is deemed to be ‘income’ accruing and arising in India. The relevant part of the definition of royalty is as follows : “(i) all income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India. Explanation—For the purposes of this clause— (a) in the case of a business of which all the operations are not carried out in India, the income of the business deemed under this clause to accrue or arise in India shall be only such part of the income as is reasonably attributable to the operations carried out 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 utilized 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 utilized 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 : Provided further that nothing contained in this clause shall apply in relation to so much of the income by way of royalty as consists of lump sum payment made by a person, who is a resident, for the transfer of all or any rights (including the granting of a licence) in respect of computer software supplied by a non-resident manufacturer along with a computer or computer-based equipment under any scheme approved under the Policy on Computer Software Export, Software Development and Training, 1986 of the Government of India. Explanation 2—For the purposes of this clause, ‘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— (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; (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.”

7. We do not think that any payment is being made by the applicant to ABB Zurich in consideration of the conferment of any rights in respect of any of the items enumerated in the said definition clauses. These are broadly intellectual property rights. ‘Information’ is defined in CCA as “the knowledge (data, technical documents, experience)”. The information obtained by the applicant as a result of corporate R&D envisaged by the agreement would normally fall within the definition clause. For instance, it could be “information concerning industrial or scientific experience”. But, the question is whether ABB Zurich or the CRCs would be receiving the consideration for transferring or conferring such rights and benefits. The answer, in our view, is in the negative. As far as the CRCs are concerned, they do not retain any IPR in the fruits of research. They do not commercially exploit them. As per the provisions of the CCA, “Information and corresponding intellectual property rights achieved as a result of corporate R&D shall become proprietary rights of ABB Research Ltd.” (vide cl. 7.1). But it is significant to note that the proprietary right legally vested in ABB Zurich is specifically made “subject to the right of free access” as specified in cl. 7.4 : “7.4 Each party and its subsidiaries in its country of domicile shall have a non- exclusive, nontransferable right of access, free of charge, to all information for its own business during and after the term of this agreement. For special projects, such as research projects supported by third parties, restrictions in the exploitation of information may have to be observed. Such cases shall be dealt with from case to case.”

7.1 According to the working arrangement contemplated under the agreement, ABB Zurich is entrusted with the responsibility of administering the corporate R&D. Corporate R&D is carried out by the CRCs or “as otherwise determined by the corporate R&D Board”. Corporate R&D Board consists of the member of the KL responsible for R&D as chairman and 4 representatives appointed by the parties i.e. those who are parties to the agreement. As ABB Zurich administers the R&D programmes, the signatories to the agreement have identified it as the legal owner of IPRs connected with the research results. ABB Zurich has no right to withhold the research information/results from the participating group entities who are signatories to CCA. Even the grant of licence by ABB Zurich is not contemplated. Every party to the CCA has a right flowing under the terms of the agreement itself to avail of the fruits of research in its own right. Though the legal ownership of IPR rests with ABB Zurich as a matter of convenience and by mutual agreement, the beneficial ownership of the products of research belongs to all those ABB group companies which have signed the CCA. It is exactly for this purpose that the applicant and other parties to the agreement contribute to the cost of research establishment set up for the benefit of all of them. The resources are pooled by all the entities which are parties to CCA to promote corporate R&D for common benefit. The cost contribution formula is evolved so as to ensure the distribution of the burden of actual cost amongst the participating entities. The fact that R&D information can only be accessed by the parties to CCA and the further fact that the licensed income derived by the limited commercial exploitation of IPR as per cl. 7.5 would go to reduce the amount which the participants would have to contribute are clear pointers that an internal arrangement has been evolved by the participating group entities through a joint endeavour to reap the benefits of research conducted by an organized set up of R&D Board consisting inter alia of the representatives of those entities. It is clear, as stated by the applicant, that ABB Zurich merely acts as a co-ordinating agency for the purpose of recouping the costs that are contributed by the various participants and acts as a medium for organizing and providing the CRCs with the funds for the research that is carried out. For the services rendered by ABB Zurich as a co-ordinating agency, it gets ‘co-ordination fee’ the taxability of which is not under dispute in this application. The manner in which the corporate funding will be arranged by the R&D Board and ABB Zurich based on budgeted cost and revised cost would indicate that the parties to CCA have devised a methodology to reimburse the actual cost. We are therefore of the view that the payments made by the applicant to ABB Zurich cannot be treated as payments in the nature of royalties liable to be taxed in India.

8. In the case of CIT vs. Dunlop Rubber Co. Ltd. (1982) 29 CTR (Cal) 25 : (1983) 142 ITR 493 (Cal), a Division Bench of Calcutta High Court, on substantially similar facts, observed thus : “It appears to us that the Tribunal was right in arriving at the view that it was the recoupment of the expenses incurred for the technical data for which a Research Department was maintained in London. The result of the research was for the benefit of all concerned including the head office and the subsidiary concerns. It was for sharing of the expenses of the research which was utilized by the subsidiaries as well as the head office organization that the payments were made by the Indian company and received by the London company. The fact that after the termination what was to happen to these informations gathered was not mentioned indicates that it could not be anything but sharing of the expenses because if it had provided that the information would belong either to the parent company or to the subsidiary, then perhaps it might have been contended that payments were either royalty or hiring charges of the information as such could be treated as income. But the very fact that the technical data was jointly obtained and the expenses were shared together indicates that it could not be treated as income.”

8.1 The ruling of this Authority in Decta, In re (1999) 153 CTR (AAR) 54 : (1999) 237 ITR 190 (AAR) also supports the contention of the applicant. The question there was whether the amount of contribution received to recover part of the cost of technical assistance provided by the applicant within the framework of its aid programme to the companies identified by it in India is the income of the applicant under the provisions of IT Act. The contention that the amount received was in the nature of fees for technical services was negatived. Adverting to the argument of the Department, it was observed in para 12 as follows : “The case of the Department may appear, at first sight, to be covered by the definitions given above. There is no doubt that the DECTA provides various kinds of services to the companies with which it enters into MoU and, if the contributions or amounts paid by the companies into the account of the DECTA with the Standard Chartered Bank really represent the consideration for the services so rendered, then the amount thereof will be clearly taxable as income in India, both by virtue of s. 9(1)(vii) as well as by virtue of art. 13(4) of the DTAA. But the real and crucial question is whether the payments made are capable of being described as the consideration for the services rendered by DECTA. One way of looking at the transaction is that, on the one hand, DECTA provides some services to the companies and towards those services the companies make a cash payment. The cash payment may not be equivalent to the cost of the services rendered but it can be said that it is nonetheless a consideration for the services rendered. It was open to DECTA to have offered these services for nothing as it used to do once. It is equally open to DECTA to charge full consideration for these services or even a consideration that generates profit for itself. The fact that DECTA has chosen to receive from the companies only 25 per cent of its cost of the project does not render the amount received anytheless a consideration for the services rendered. It may be said to be a case of inadequate consideration perhaps, but nonetheless it is a consideration for the services rendered and, hence, will attract the statutory provision referred to earlier. 13. Attractive as the above arguments, it fails to take into account the real nature of the projects, the spirit in which they have been conceived and the specific terms of the contract.”

8.2 Then after referring to various clauses in the agreement, it was observed thus : “In substance and reality, therefore, the payments made by the companies cannot be described as consideration for the technical services provided by DECTA. It is, at best, only a pooling arrangement under which the amounts contributed by the ODA and the Indian companies are credited to a joint account (in the name of the DECTA) out of which the project expenses are met. It is really a joint arrangement for the management of the projects and the contribution by the Indian companies is the modus operandi by which they are made to meet a part of the expenses incurred on the projects. It would be totally absurd and incorrect to describe these contributions as being in the nature of a payment to DECTA or as fees for technical services within the meaning of s. 9 or art. 13.”

8.3 The ruling of this Authority in Danfoss Industries (P) Ltd., In re (2004) 189 CTR (AAR) 489 : (2004) 268 ITR

1 (AAR) does not in any way support the plea of royalty. The crux of the ratio of that ruling is to be found in the following passages : “In that case, an agreement was entered into with a foreign company which provided for rendering services to its group of companies including the Indian company (applicant). The services consisted of advice and assistance in market research and strategies, financial matters and customer relations. The consideration for availing of those services was a service fee based on the portion of the services the applicant’s company received in relation to the total cost of the foreign company in providing such services. The question that was addressed by this Authority was whether the payment was in the nature of reimbursement of a portion of the actual expenditure incurred by the Singapore company and whether any income was embedded in it. The question was answered against the applicant. The following observations are crucial : ‘It is thus clear that there is no direct nexus between the actual costs incurred by the Danfoss Singapore in providing the said services to a Danfoss group company and the fees payable by each individual company which avails of the services. In the absence of the break-up of the cost incurred by Danfoss Singapore in providing such services and fees payable by each individual company, the afore-mentioned conclusion, in our view, is unassailable. It is, therefore, not possible to conclude that the service fee payable by the applicant is nothing but reimbursement of costs incurred by Danfoss in providing services to the applicant.’ ” It was mainly on that finding that the applicant’s contention was rejected. Referring to Dunlop Rubber case (supra) the distinguishing feature was pointed out as follows : “That was not the case of the assessee-company providing services to an Indian company on payment of consideration in the form of service fees as in the present case. In that case both the assessee-company and the Indian company were beneficiaries of the research conducted as a joint venture. In the instant case the applicant availed the services provided by Danfoss Singapore on payment of service fees.”

8.4 We may also refer to Chapter VIII of “OECD Guidelines on Transfer Pricing for Multi-National Enterprises and Tax Administrations”, cited by the applicant. Para 8.3 defines a CCA as “a framework agreed among business enterprises to share the costs and risks of developing, producing or obtaining assets, services, or rights, and to determine the nature and extent of the interest of each participating in those assets, services, or rights”. The legal position has been stated thus : “each participant in a CCA would be entitled to exploit his interest in the CCA separately as an effective owner thereof and not as a licensee, and so without paying a royalty or other consideration to any party for that interest. Conversely, any other party would be required to provide a participant proper consideration (e.g., a royalty), for exploiting some or all of that participant’s interest.”

9. In the light of above discussions, questions (1) and (2) are answered as follows : (a) The payments made to ABB Research Ltd., Zurich towards the applicant’s share of the cost incurred in respect of R&D activities are not liable to be taxed under the IT Act, 1961 as business income in the absence of PE in India, having regard to art. 7 of the tax treaty. Nor can it be subjected to tax as royalty or fees for technical services under art. 12 of the treaty. (b) The applicant is not under an obligation to withhold the tax under s. 195 of the Act as the ‘income’ is not chargeable to tax. (c) It is made clear that this ruling does not preclude inquiry in an appropriate proceeding as to whether the cost contribution is on arm’s length basis. Question No. 3 :

10. The applicant is under an obligation to withhold the tax in respect of ‘co-ordination fee’ (covered by single invoice).

[Citation : 322 ITR 564]

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