IT/ILT : Payment received by foreign company from Indian franchisee for international marketing activities is not "royalty" under Article 12(4) of DTAA even if its on the basis of % of gross revenue. In order to cover any amount within the purview of "royalties" as per Article 12 (4) of the DTAA, it is imperative that the payment must be a consideration for use or right to use any copyright of the literary artistic work etc. or any patent, trademark etc. (collectively referred to as the 'defined property'). Payment can be made as a consideration for the use or right to use of the defined property only when such property is in existence at the time of use. If a property does not pre-exist or is likely to come into existence because of the given payment, the same cannot qualify as 'royalties' because it would, in such circumstances, lack the condition of 'use or right to use'. Even if we accept that the contribution made by AHL towards the international marketing activities led to the brand building, still it would be a payment for the creation or swelling of the brand and not for the use of such brand, which could qualify to be characterized as 'royalties'
Facts
• Assessee-foreign company(Marriot) entered into a Franchise agreement with Franchisee-hotel in India (AHL) to establish and operate MRHS International Hotel.
• Preamble of the Franchise agreement stated that the Franchisee desires certain sales and marketing publicity and promotion services to be performed outside India in support of the operation of the hotel and Marriott (the assessee) desires to perform such services.
• It further provides that the Franchisee has agreed to enter into an International Sales and Marketing Agreement with Marriott in order to participate in internationally recognized hotel system for the purposes of attracting foreign guests to the hotel.
• Clause 3.2 of the agreement provided that AHL would pay the assessee 1.5% of its gross revenue on quarterly basis to the assessee for 'International Marketing Activities', which are in the nature of purchase of advertising space in magazines, newspapers and similar printed media etc., direct advertising, marketing, promotional, public relations and sales campaigns etc, designated by Marriot.
• AO brought this amount to tax as "royalty" under Article 12(4) India-Netherlands DTAA.
• CIT(A) allowed the appeal holding the amounts to be reimbursements. Aggrieved by CIT(A) order, instant appeal filed by Revenue to ITAT.
Held
• A perfunctory look at the definition of term 'royalties' as per the para 4 of the Article 12 of the DTAA makes it palpable that it represents payment received as a consideration 'for the use of or the right to use' any copyright of literary, artistic or scientific work including cinematograph films, patent, trade mark or design etc.
• The crucial words used in para 4 of the Article 12 of the DTAA are, the 'consideration for the use of or right to use …..'.
• It therefore, becomes vivid that in order to cover any amount within the purview of "royalties" as per Article 12 (4) of the DTAA, it is imperative that the payment must be a consideration for use or right to use any copyright of the literary artistic work etc. or any patent, trademark etc. (collectively referred to as the 'defined property').
• Payment can be made as a consideration for the use or right to use of the defined property only when such property is in existence at the time of use.
• If a property does not pre-exist or is likely to come into existence because of the given payment, the same cannot qualify as 'royalties' because it would, in such circumstances, lack the condition of 'use or right to use'.
• In other words, the term 'royalties' as per article 12(4) contemplates a consideration for the use of or right to use of the defined property which is already in existence and the payment is agreed for its use or right to use.
• If the payment made is of such a nature which helps in the creation of the defined property, that cannot fall within the ambit of Article 12(4) of the DTAA.
• Even if we accept that the contribution made by AHL towards the international marketing activities led to the brand building, still it would be a payment for the creation or swelling of the brand and not for the use of such brand, which could qualify to be characterized as 'royalties'.
• Viewed from any angle, it is abundantly clear that the amount in question cannot be held as 'royalties' falling within the ambit of Article 12(4) of the DTAA. Thus the AO's action in treating this amount as royalties is set aside.
• It is evident that there is an out and out contribution for marketing expenses at a fixed rate on quarterly basis, which was determined in the year 2000.
• Such contribution at 1.5 per cent of the gross revenue for each quarter is not any actual reimbursement of expenses on itemized basis.
• The actual expenses to be incurred by the assessee may be more or less than the said fixed rate of contribution. In such a situation, there is every possibility of the assessee having some mark up on the costs incurred by it on advertisement. Or alternatively, it may be the other way around also.
• No material has been placed on record to demonstrate that the actual expenses incurred by the assessee were equal to the amount received.
• Ld. CIT(A) was not justified in deleting the addition by holding that it represented 'reimbursement of expenses'.
• Matter remanded to AO to decide whether amounts taxable as Business Profits under Article 7 of DTAA.
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[2013] 35 taxmann.com 400 (Mumbai - Trib.)
IN THE ITAT MUMBAI BENCH 'L'
Deputy Director of Income-tax (IT) - 4(1)
v.
Marriott International Licensing Company BV
R.S. SYAL, ACCOUNTANT MEMBER
AND VIVEK VARMA, JUDICIAL MEMBER
AND VIVEK VARMA, JUDICIAL MEMBER
IT APPEAL NO. 416 (MUM.) OF 2008
[ASSESSMENT YEAR 2004-05]
[ASSESSMENT YEAR 2004-05]
JULY 17, 2013
Ms. Neeraja Pradhan for the Appellant. K.K. Ved for the Respondent.
ORDER
R.S. Syal, Accountant Member - This appeal by the Revenue arises out of the order passed by the CIT(A) on 24.10.2007 in relation to the A.Y. 2004-05.
2. The only effective ground raised in this appeal is as under:-
"On the facts and in the circumstances of the case and in law, the Ld. CIT(A)erred in holding that the payments made under Article 3.1 of the Franchise Agreement and the International sales & Marketing Agreement (ISMA) with M/s Ansal Hotels Limited(AHL) is "Royalty" and the payments made under Article 3.2 of the said agreement is purely reimbursement of expenses on sales promotion and marketing and hence the payments made as per Articles 3.2 and 3.3 is not "Royalty" and not taxable in India."
3. Briefly stated the facts of the case are that the assessee is a company incorporated in and tax resident of Netherlands. Return of income was filed declaring total income of Rs. 43,98,410/- accompanied, inter alia, by exhibit 'A'. Note no.4 of this Exhibit read as under:-
"MILC has entered into International Sales and Marketing Agreement with AHL for providing marketing services outside India. During the year under consideration, AHL has paid marketing fees of Rs. 90,06,525/- on which taxes of Rs. 9,41,264/- have been deducted. MILC has adopted a position that these amounts are not taxable in India and accordingly has claimed a refund of taxes withheld".
4. The assessee was called upon to explain as to why the amount received from Ansal Hotels Ltd. (AHL) for providing marking services outside India should not be taxed in India as per the Double Taxation Avoidance Agreement between India and Netherlands (hereinafter called 'the DTAA') and also under the Income-tax Act 1961 (Act). The assessee submitted that the amount was received for undertaking to perform the advertisement and marketing activities viz., Purchase of advertisement space in magazines, newspaper and other similar media ; advertisement on radio, television and other electronic media; advertising in printing and publication of pamphlets, brochures, directories, etc; advertising, marketing, sales promotional activities; public relations, revenue management and sales campaigns; Development of marketing products, retention of advertising agencies, marketing consultants and other professionals to assist in the aforesaid activities. It was claimed that the amount was received for the performance of marketing activities outside India and hence was not chargeable to tax in India. The Assessing Officer observed that the assessee entered into Franchise agreement with AHL for carrying on hotel business under the name and style of 'Marriott' in India. The receipt of marketing fees of Rs. 90,06,525/- was on account of administering various services viz., providing advertising space in magazines, newspapers and other printing media, slots on radio, television and other electronic media etc. to AHL outside India in order to attract foreign guests. It was also noticed that the marketing and business promotion expenditure was aimed not only for the benefit of the Indian Hotel, but also the Marriot Group as a whole. Since, assessee did not furnish any documentary evidence such as copies of reimbursement of bills of invoices etc. to show the actual nature of services rendered by the assessee, the Assessing Officer held that there was no evidence that the expenditure incurred by the assessee had any link with the money received from AHL. The AO held that the assessee's contention in this regard about the same being "Reimbursement of expenses" was not capable of acceptance. He took note of certain clauses of the Sales and Marketing Agreement dated 26.09.2000 (hereinafter also called 'the Agreement') between assessee and AHL for reaching the conclusion that AHL used the confidential information, know-how of the challenging scenario relating to the market/Industry. He considered Article 12(4) of the DTAA to hold that the entire payment of Rs.90.06 lacs received by the assessee was towards 'Royalty' for the use of brand 'Marriott'/brand preference/brand awareness. As the expenditure incurred by the assessee in international advertising was for building the brand, the AO held the amount to be in the nature of royalty income in terms of Article 12(4) of the DTAA.
5. In the first appeal, the ld. CIT(A) noticed that the amount of Rs. 90.06 lacs was on account of payment received under clauses 3.1 to 3.3 of the Agreement. The first part of the amount, being the receipt under clause 3.1 of the Agreement was held to be royalty and the second part of the amount under clauses 3.2 and 3.3 was held to be towards 'Reimbursement of expenses' on sales promotions and marketing and hence not chargeable to tax in India. The Revenue is in appeal against the direction of the ld. CIT(A) in relation to the payment made under clauses 3.2 and 3.3 of the Agreement treating it as 'Reimbursement of expenses' and not 'Royalty'. The ld AR fairly conceded that the impugned order in directing to tax the receipt under clause 3.1 of the Agreement as 'Royalty' has been accepted by the assessee. We are, therefore, required to adjudicate upon the nature of receipt under clauses 3.2 and 3.3 of the Agreement.
6. We have heard the rival submissions and perused the relevant material on record. As we have been called upon to determine the correct nature of the receipt under clauses 3.2 and 3.3 of the Agreement, it would be in the fitness of things to go through the relevant clauses of the Agreement dated 26.09.2000, a copy of which has placed on record. Preamble of the Agreement provides that the Franchisee (Ansal Hotels Ltd.) is the owner of the hotel and desires to establish and operate an MHRS International Hotel between Marriott and Franchisee. The Franchisee desires certain sales and marketing publicity and promotion services to be performed outside India in support of the operation of the hotel and Marriott (the assessee) desires to perform such services. It further provides that the Franchisee has agreed to enter into an International Sales and Marketing Agreement with Marriott in order to participate in internationally recognized hotel system for the purposes of attracting foreign guests to the hotel.
7. The bone of contention is the payment received by the assessee in lieu of clauses 3.2 and 3.3 of the Agreement, which read as under:-
"3.2 International Marketing Payment; Payments for Other Marketing Programs
| A. | Franchisee shall reimburse in U.S. Dollars to Marriott, or as otherwise directed by Marriott, with respect to each Quarterly Period an "International Marketing Payment'" which as of the Effective Date shall be one and one-half percent(1.5%) of Gross Revenues for each. Quarterly Period during the term of this Agreement beginning on the Opening Date, as a contribution to the International Marketing Fund. All amounts received by Marriot under this Section 3.2A shall be used to pay for International Marketing Activities outside of India. | |
| B. | In addition to the International Marketing Payment, Franchisee shall reimburse in U.S. Dollars to Marriott, or as otherwise directed by Marriott, the Hotel's share, as determined by Marriott, of the costs of every additional advertising, marketing, promotional or public relations program or activity outside of India in which Franchisee is required to participate pursuant to Sections 4.1 and 4.5 A or in which Franchisee elects to participate pursuant to Section 4.5 B. At the request of Franchisee, Marriott shall provide necessary supporting invoices, bills, debit notes, etc. evidencing such costs. | |
| 3.3 Special Advertising Costs | ||
| To compensate Marriott for the provision of special services related to international advertising and potential liabilities arising therefrom and to participation of the Hotel as part of the group of MHRS International Hotels, Franchisee shall reimburse Marriott for the Hotel's allocable share of all costs and expenses incurred by Marriott and its Affiliates in providing such special services which shall be charged to all participating MHRS International Hotels on a fair and reasonable basis, with payments to be made for each calendar year as provided in Section 3.4. The basis on which the costs and expenses of such special services are charged may change from time to time as reasonably determined by Marriott." |
8. Total receipt of Rs. 90.06 lacs comprises of two components, viz., Marketing Fee of Rs. 51.46 lacs (towards clause 3.1 of the Agreement) and International Marketing Fee of Rs. 38.59 lacs (towards clauses 3.2 and 3.3 of the Agreement). The ld. AR submitted that the assessee has accepted the decision of the ld. CIT(A) qua the Marketing Fee of Rs. 51.46 lacs as having been held as 'Royalty'. The Revenue is in appeal against the other amount of Rs. 38.59 lacs towards clause 3.2 and 3.3 of the Agreement as having been held as 'Reimbursement of expenses' and thus thwarting taxation on it.
9. Before embarking upon the taxability or otherwise of the amount of Rs. 38.59 lacs, it is sine qua non to understand the correct nature of this amount. Both the sides are in agreement that this sum was received towards clauses 3.2 and 3.3, reproduced above, of the Agreement. A cursory look at the clause 3.2 divulges that AHL made contribution at the rate of 1.5% of the Gross revenues for each quarter towards "International Marketing Fund". The term "International Marketing Fund" has been defined as per clause 1 of the Agreement as under : -
"International Marketing Fund" means the fund administered by Marriot and the other Marriott Companies for 'International Marketing Activities' which is used to pay all costs associated with developing, preparing, producing, directing administering, researching, conducting, and disseminating International Marketing Activities."
10. The expression "International Marketing Activities" as employed in the definition of the expression "International Marketing Fund" has been defined in clause 1 of the Agreement, as under:
"International Marketing Activities" means advertising, marketing, promotional, public relations and sales campaigns, materials, programs, seminars and other activities for MHRS International Hotels and other hotels designated by Marriott. Not all International Marketing Activities will include all MHRS International Hotels. Programs described in section 4.5 are not include in International Marketing Activities. International Marketing Activities shall include the following: purchase of advertising space in magazines, newspapers, and similar printed media; purchase of advertising on radio, television and other electronic media: printing and publication of pamphlets, brochures, the Directory, other directories, and other materials; advertising marketing, promotional, public relations, revenue management and sales campaigns designed to increase sales or public awareness of the System of MHRS International Hotels; market research, customer surveys and guest satisfaction audits; the development of marketing products; the retention of advertising agencies, marketing consultants, and other professionals to assist in the development and implementation of any of the foregoing; the advertising, marketing, promotional and sales activities of the Marriott Companies' marketing and sales offices throughout the world; and any other advertising, marketing, promotional, public relations, sales or related activities and materials deemed appropriated by Marriott."
11. A conjoint reading of the definitions of the expressions 'International Marketing Activities' and 'International Marketing Fund' along with clause 3.2 of the Agreement makes it manifest that AHL agreed to contribute at the rate of 1.5% of its gross revenue on quarterly basis to the assessee for 'International Marketing Activities', which are in the nature of purchase of advertising space in magazines, newspapers and similar printed media etc., direct advertising, marketing, promotional, public relations and sales campaigns etc, designated by Marriot.
12. In the backdrop of such circumstances the primary question which arises for our consideration is as to whether the contribution of 1.5% made by AHL can be characterized as 'Royalties' under Article 12 of the DTAA. Para 4 of the Article 12 defines 'royalties' as under: -
"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 literary, artistic or scientific work including cinematography films, any patent, trade mark, design or model, plan, secret formula or process or for information concerning industrial, commercial or scientific experience."
13. A perfunctory look at the definition of term 'royalties' as per the para 4 of the Article 12 of the DTAA makes it palpable that it represents payment received as a consideration 'for the use of or the right to use' any copyright of literary, artistic or scientific work including cinematograph films, patent, trade mark or design etc. The crucial words used in para 4 of the Article 12 of the DTAA are, the 'consideration for the use of or right to use …..'. It therefore, becomes vivid that in order to cover any amount within the purview of "royalties" as per Article 12 (4) of the DTAA, it is imperative that the payment must be a consideration for use or right to use any copyright of the literary artistic work etc. or any patent, trademark etc. (collectively referred to as the 'defined property'). Payment can be made as a consideration for the use or right to use of the defined property only when such property is in existence at the time of use. If a property does not pre-exist or is likely to come into existence because of the given payment, the same cannot qualify as 'royalties' because it would, in such circumstances, lack the condition of 'use or right to use'. In other words, the term 'royalties' as per article 12(4) contemplates a consideration for the use of or right to use of the defined property which is already in existence and the payment is agreed for its use or right to use. If the payment made is of such a nature which helps in the creation of the defined property, that cannot fall within the ambit of Article 12(4) of the DTAA.
14. Reverting to the contents of clauses 3.2 and 3.3 of the Agreement, it is manifest that AHL made contribution at the rate of 1.5% towards 'International Marketing Activities', which, in turn, means purchase of advertisement space in magazines, newspaper and other similar media ; advertisement on radio, television and etc. and other activities of the advertising and marketing nature. The Revenue authorities have accepted the Agreement as bona fide without doubting its correctness in any manner. When admittedly contribution at the rate of 1.5% by AHL to the assessee, amounting to Rs. 38.59 lacs, is towards marketing activities, we fail to see as to how it can be characterized as 'royalties' falling within the ambit of Article 12 of the DTAA. The ld. DR referred to para 5 of the Agreement to bolster her submission of the amount being in the nature of royalty. It is beyond our comprehension as to how this para advances her case. It talks of 'Confidential information' and provides that the Franchisee shall not during the term of this Agreement or thereafter copy, duplicate, record or reproduce etc. the confidential information to any person without the assessee's consent. There is no consideration for maintaining such confidential information. The amount with which we are presently concerned is undisputedly contribution for international marketing activities, which is in the nature of advertisement and marketing etc. This amount cannot be tagged with any other clause of the Agreement when it has been stated to be for international marketing activities. It is further noticed that the AO also tried to link this amount with "brand Marriott/brand preference/brand awareness". In other words, he canvassed a view that with such payment AHL facilitated in building and strengthening the brand 'Marriott'. We have noticed above that the term 'royalties' as per Article 12 of the DTAA can always be a consideration for the use or right to use of any defined existing property. It cannot be for the creation of the defined property. Even if we accept that the contribution made by AHL towards the international marketing activities led to the brand building, still it would be a payment for the creation or swelling of the brand and not for the use of such brand, which could qualify to be characterized as 'royalties'. Viewed from any angle, it is abundantly clear that the amount in question relatable to clauses 3.2 and 3.3 of the Agreement cannot be held as 'royalties' falling within the ambit of Article 12(4) of the DTAA. Thus the AO's action in treating this amount as royalties is set aside.
15. Now we espouse the view taken by the ld. CIT(A) in holding that the amount is a pure reimbursement of expenses and hence not chargeable to taxable. There can be no quarrel over the proposition that if some amount is incurred as an expense which is reimbursed by someone, such a receipt will not be chargeable to tax. The logic is simple that if Rs. X have been incurred as business expense and the same amount of Rs. X is recovered, then the net outflow is zero, neither warranting any deduction for expense nor leading to the generation of any income. In such a case, the occasion of receipt of reimbursement of expenses cannot attract any taxability. But if against the actually incurring of expense amounting to Rs. X, the reimbursement is Rs. X+Y, then it would mean that the reimbursement is with mark up. Such reimbursement cannot be equated with the actual reimbursement of expenses not attracting any taxation. In order to claim any reimbursement of expense as immune from taxation, the burden of proof is always on the assessee to establish beyond a shadow of doubt that there is no profit element in such reimbursement.
16. Reverting to clause 3.2 of the Agreement, it is noticed that AHL agreed to contribute @ 1.5% of its gross revenue for each quarter towards the international marketing activities. Thus, it is evident that there is an out and out contribution for marketing expenses at a fixed rate on quarterly basis, which was determined in the year 2000. Such contribution at 1.5% of the gross revenue for each quarter is not any actual reimbursement of expenses on itemized basis. The actual expenses to be incurred by the assessee may be more or less than the said fixed rate of contribution. In such a situation, there is every possibility of the assessee having some mark up on the costs incurred by it on advertisement. Or alternatively, it may be the other way around also. No material has been placed on record to demonstrate that the actual expenses incurred by the assessee were equal to the amount received. In our considered opinion, the ld. CIT(A) was not justified in deleting the addition by holding that it represented 'reimbursement of expenses', which does not appear to be correct in the light of our above discussion.
17. When the CIT(A) reverses assessment order on a point and the Revenue prefers appeals, it becomes the duty of the tribunal to vet the view point of the first appellate authority. The rule is that the allowing or dismissing of the Revenue's appeal by the tribunal has the direct effect of judging the correctness or otherwise of the CIT(A)'s opinion, which indirectly and automatically results in evaluating and examining the AO's opinion. If the conclusion of the CIT(A) is echoed, it means that the AO was incorrect on that point. Per contra, where the view of the first appellate authority is overturned, it means that the AO was correct on that issue. But this rule is not without exception. In a given case, where the view of the CIT(A) is overturned, there may not be automatic approval of the AO's opinion. If the view of the CIT(A) is held to be not sustainable but at the same time, the view of the AO is also found to be incorrect, then the tribunal cannot act as a mute spectator leaving the parties remedyless. It has to step in to lay down the correct position. The position presently prevailing before us is somewhat akin to that.
18. We have noticed that the view taken by the ld. CIT(A) in the present case about the deletion of addition on account of 'reimbursement of expenses' is not sustainable and further the view point of the AO about the amount being in the nature of 'royalties' as also equally not acceptable. If we leave the position as it is, there will be quandary about the taxability or otherwise of the amount in question. In such a situation, it becomes paramount to decide the correct nature of the amount and its taxability or otherwise.
19. It is pertinent to note that the amount of Rs. 38.59 lacs has been received by the assessee from its business franchisee which is in the nature of a revenue receipt. It has no semblance of capital receipt. Obviously such amount, in the absence of any concrete evidence to show as equal to the amount spent, needs to be treated as a receipt in the nature of 'Business profits' covered under Article 7 of the DTAA. Para 1 of this Article clearly provides that the profits of an enterprise of one of the States shall be taxable only in that State unless the enterprise carries on business in the other State through a permanent establishment situated therein. If the enterprise of one State carries on business in other State through a permanent establishment situated therein, then the profits of the enterprises may be taxed in the other State but only so much of them as are attributable to that permanent establishment. The assessee before us is a tax resident of Netherlands. Its business profits are otherwise chargeable to tax in Netherlands. However, the taxability will be attracted in India if assessee carries on business in India through a permanent establishment situated in India. Such taxability will be restricted to the profits of the permanent establishment subject to the other provisions of the DTAA.
20. The Assessing Officer, in the absence of any further details of actual expenses coming up from the side of the assessee, treated the entire amount as 'royalties' covered under Article 12 of the DTAA and straightway included it in the assessee's total income. So, he had no occasion to consider the taxability of the amount in terms of Article 7 read with Article 5 of the DTAA. As we have set aside the view taken by the Assessing Officer about the treatment of this amount as 'royalties' under article 12 and also that of the ld. CIT(A) in treating the amount as 'Reimbursement of expenses', the natural corollary which follows in the present circumstances is that the taxability of this amount is required to be determined in terms of Article 7. We, therefore, set-aside the impugned order and remit the matter to the file of the AO for considering the facts on the touchstone of Article 7 of the DTAA.
21. In the result the appeal is allowed for statistical purposes.
Regards
Prarthana Jalan
__._,_.___
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