Reference to the name Upaid instantly reminds one of January 2009, the Satyam shock and class-action suits. The dispute between the two ended up with a tax issue, which was referred to the Authority for Advance Rulings (AAR). Among withholding tax issues, the AAR recently ruled on “hidden royalties”. Upaid was in the business of designing and developing software technology relating to payment-processing platforms and services. It conceived of an intelligent processing platform for which it outsourced the software development to Satyam. After all the agreements were done and dusted, two products — Call Manager and Net Manager — were developed. Patents were approved.

Two employees of Satyam also produced declarations that they had developed the patents which were assigned to Upaid, who turned out to be bad paymasters, forcing Satyam to acquire 22.06 per cent of its equity and offset its receivables. Disputes resulted in the termination of all agreements, with Upaid getting the intellectual-property (IP) rights and Satyam discontinuing software development.

SETTLEMENT AMOUNT TDS

At the time the Satyam saga was unfolding in India, Upaid was busy fighting in the US with Qualcomm and Verizon regarding infringement of their patents, while developing their software platforms. Qualcomm and Verizon produced two declarations by two employees of Satyam that they hadn't signed any declarations regarding patents, proving that the declarations at the Patent Office were fictitious. Qualcomm and Verizon spotted an opportunity and pounced on Upaid, claiming damages for false patent infringement cases.

After paying up, Upaid pounced on Satyam by filing a class-action suit at Texas alleging forgery, fraud, misrepresentation and breach of covenants. Satyam unsuccessfully tried to get the case heard in London. Wiser counsel prevailed on the parties and they agreed for a settlement according to which Satyam was to compensate Upaid $70 million in two instalments. Satyam deposited the amount into an escrow account. According to the settlement, the IP rights remained with Upaid, and all other agreements between the warring factions were declared null. Having violated accounting conventions, Satyam didn't want to violate TDS provisions and wanted to deduct taxes on this payment. Upaid contended that the payment was a capital receipt and hence not taxable. They approached the AAR for succour.

AAR RULING

The AAR noted that the settlement agreement provided that Upaid will grant a perpetual global, royalty-free licence on all of its patents, pending patents, and any future patents to Satyam and its affiliates, including Tech Mahindra and Mahindra & Mahindra. Such royalty-free licence shall not be assignable. In addition, Upaid covenanted not to sue British Telecommunications and AT&T for patent infringement or any other claim related to its patents.

The AAR ruled that for the settlement of IP rights in favour of Upaid, there was no divestiture of title, and hence there was no taxable income in India. It opined that the term ‘royalty-free licence' was used in the agreement only with an intention to avoid tax. It argued that in the commercial realm it isn't normal to part with such a valuable right for no consideration, except in special circumstances. The immediate next solution that the AAR had to find was to determine what amount constituted royalty, since the $70 million was a composite consideration with no separate breakdown.

The counsel for Upaid offered a solution, which the AAR accepted, since it didn't involve losing too much of grey hair to determine the royalty portion of the consideration. The solution was to shift the onus of determining the royalty component to the Assessing Officer who would also look into the taxability of the component, by applying Section 9(i)(vi) of the Income-Tax Act. The AAR ruled that a 10 per cent tax withholding should be done on the consideration deposited. The legal tangles took enough time for the deposit in the escrow account to earn interest, which belonged to Upaid. The AAR ruled that the interest was taxable in India.

The decision of the AAR gives a hint to the Tax Department to look beyond mere words in an agreement if there are sufficient grounds to believe that those words were framed only with the purpose of hoodwinking the taxman. Hidden royalties would have to be unearthed and brought to tax. In short, tax officers can now pierce the tax-avoidance veil.

(The author is a Bangalore-based chartered accountant.)

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