The Hindu Business Line : `Fee' engineering put to test

IN COLLABORATION agreements, it is customary for the foreign collaborator to supply designs and drawings for the erection and commissioning of a plant. The Supreme Court, in the well-known Scientific Engineering House (P) Ltd (157 ITR 86 SC) case, had ruled that the rendering of documentation services will result in the acquisition of capital assets and engineering fees paid for designs and drawings prepared and delivered outside India should be treated as paid for plant and machinery. The payment made could be regarded as being mainly for and by way of purchase price of the drawings, designs, charts, and all other documents comprised in the documentation service.

On the basis of the ruling, depreciation is being claimed on designs and drawings treating them as part of plant and machinery. In several other cases, courts have ruled that the supply of designs and drawings will amount to supply of goods. Is there any way by which payments made for designs and drawings can be treated as payments made as technical service fees? Section 9 (I) (vii) of the Income-Tax Act, 1961 brings to tax income of a non-resident arising by way of fees for technical services. Explanation 2 defines `fees for technical services' to mean "any consideration (including any lumpsum) for the rendering of any managerial, technical or consultancy services (including the provision of services of technical or other personnel) but does not include consideration for any construction, assembly, mining or like project undertaken by the recipient or consideration which would be income of the recipient chargeable under the head `salaries'."

This definition does not refer to the specific treatment to be given to designs and drawings. Recently, this question arose in an interesting context before the Karnataka High Court in Aeg Aktiengesllschaft vs CIT (267 ITR 209).

The non-resident German company entered into an agreement with MECON for the supply of electrical portions of the merchant mill. Visakhapatnam Steel plant (VSP) and MECON had an agreement providing for direct payment by VSP to the foreign sub-contractors after certification by MECON. Payments were made by MECON to the German firm which had no permanent establishment in India.

The question was whether the payments can be taxed invoking Section 9 1(vii) of the Income-Tax Act. The company contended that engineering fees were received by it in Germany though services were given in India. Since the payments were made in Germany by the German bank, the taxability on the fees would arise only in Germany and not in India as per Article III read with Article VIIIA (5) of the Indo-German Double Taxation Avoidance Agreement (DTAA). The income-tax officer (ITO), Vizag, had already issued no objection certificate for remittance without tax deduction.

In the assessment of the non-resident German company, the assessing officer (AO) found that the German bank was only an agent of the Indian resident MECON and the payment, though made in Germany, would be considered to have been made by the Indian company and fall squarely within the deeming provisions of Article VIIIA (6) of the agreement.

The AO held that the payment by way of engineering fees was made only towards technical services. The German firm argued that it had prepared documents and drawings which were handed over to the Indian company and for the same purpose it had received consideration and this will constitute plant.

The DTAA provided for two different payments and the payment under consideration was clearly termed in the agreement as `engineering fees'. Article VIII(A) specifically applied for royalty and fees for technical services and this will prevail over Article III dealing with business profits in cases where the payment is clearly of the nature of fees for technical services.

The Karnataka High Court extracted Article VIII(A)(4) which defines fees for technical services on the same lines as Explanation 2 to Section 9(1)(vii) of the Act without the restrictive clause. It also referred to Article III(1) governing taxation of business profits through a permanent establishment (PE). The special provisions of Article VIII(A) will have to prevail over the general provisions of Article III. In the return filed by the non-resident company, the company had shown the receipt as engineering fees. Technical services rendered varied depending upon the nature of work and the nature of services. In the collaboration agreement between the parties, engineering fee was separately set out. The engineering fee was paid only for technical services as contemplated under Section 9(1)(vii) of the Act. Technical services rendered cannot be given a restricted meaning to understand only as oral advice given. It can be in the nature of preparation of designs and drawings.

So long as the parties have treated it as technical advice, they are bound by it and when the question of liability to pay tax arises, the assessee cannot be permitted to turn around and say that the supply of designs, drawings, and so on, are part of plant and machinery and must be added to the cost.

The High Court approved the conclusion reached by the Tribunal that the engineering fees paid to the German firm were for technical services as contemplated under Section 9(1)(vii) of the Act. In many of the double taxation treaties, the definition of technical services fee is similar to the one discussed in the above case.

The German firm did not succeed because it gave one treatment to engineering fee in the collaboration agreement and tried to argue on different lines before the AO. The case emphasises the importance of drafting collaboration agreements keeping in view the definitions in the agreement and in the Act.

(The author is a former Chief Commissioner of Income-tax.)

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