India: Taxation Of Royalties And Licensing Fees For The Use Of Intellectual Property Rights In India

The taxation of royalties and licensing fees for the use of Intellectual Property Rights in India represents a critical aspect of the country's economic landscape. As the world continues to witness a burgeoning knowledge-based economy, where innovations, inventions, and creative works hold substantial value, the taxation framework surrounding their utilization becomes paramount.

India, as a signatory to various international agreements and conventions, has continually evolved its tax regime concerning the exploitation of intellectual property. The taxation of royalties and licensing fees not only influences the profitability and competitiveness of businesses but also plays a pivotal role in attracting foreign investments and fostering innovation within the domestic market. Understanding the intricacies of this taxation framework is imperative for businesses, investors, policymakers, and tax professionals alike.

What are Intellectual Property Rights

Intellectual property rights ('IPRs') refer to the legal rights that protect the creations of the innovator. These creations can be tangible or intangible and may include inventions, literary and artistic works, designs, symbols, names, and images used in commerce. Intellectual property rights are aimed at encouraging innovation and creativity by providing creators with exclusive rights to their creations.

Types of Intellectual Property Rights

There are several types of intellectual property rights, including:

Patents: Patents grant inventors exclusive rights to their inventions for a limited period, typically 20 years from the filing date.This protection allows inventors to prevent others from making, using, selling, or importing their inventions without permission.

Copyrights: Copyrights protect original works of authorship, such as literary, artistic, musical, and dramatic works, as well as software code and architectural designs. Copyright grants the creator exclusive rights to reproduce, distribute, perform, display,or adapt their work.

Trademarks: Trademarks are symbols, names, words, or devices used to identify and distinguish goods or services from those of others. Trademark protection prevents others from using similar marks that may cause confusion among consumers.

Trade Secrets: Trade secrets are confidential information, such as formulas, processes, or techniques, that provide a business with a competitive advantage. Unlike patents, which require public disclosure, trade secrets must be kept confidential to maintain their protection.

Intellectual property rights are typically enforced through legal mechanisms, such as licensing agreements.

Overview of Licensing Fees and Royalties for the Use of Intellectual Property Rights

Licensing agreements allow individuals or companies to use someone else's intellectual property legally. Royalties/Licensing Fees are the payments made by licensees to licensors for using their intellectual property rights.

Taxation of Royalties and Licensing Fees in India

As per the provisions of Section 90(2) of the Income Tax Act, 1961 ('the Act'), the provisions of the Act or the Double Taxation Avoidance Agreement ('DTAA') shall apply to the taxpayer to the extent they are more beneficial. Considering the same, the taxability of Royalty payments for the use of IPR's has been analysed as under:

Taxability under The Act

As per the provisions of the Act, the term Royalty is covered in Section 9(1)(vi) of the Act. Explanation 2 of the said section provides as under:

"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 ;

(iva) the use or right to use any industrial, commercial or scientific equipment but not including the amounts referred to in section 44BB;

(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; or

(vi) the rendering of any services in connection with the activities referred to in sub-clauses (i) to (iv), (iva) and (v).

From the above definition of Royalty, as provided under the Act, it is evident that any consideration payable for the transfer of any right or the use of any patent, inventions, etc also commonly known as Intellectual property rights shall be treated as consideration in the nature of Royalties and shall be taxed as such.

Further, as per the provisions of Section 9(1)(vi) the payments in the nature of Royalties to a non-resident are taxable in India only if they are deemed to accrue or arise in India i.e., Royalty income of a non-resident shall only taxable in India only if it is payable by:

– Government of India;

– A person resident in India for use of IPRs in business in India;

– Non-resident person in India when such IPRs are used for business or profession carried on in India.

Furthermore, it is pertinent to note that Royalty is taxable in India at the rate of 20% (increased by applicable surcharge and education cess) as per the provisions of Section 115A(1)(b) of the Act.

From the above, it is clear that any payment made to a Non-resident in India for the use of IPRs shall be chargeable to tax as a Royalty at a rate of 20% considering the said income is deemed to accrue or arise in India.

Taxability under the DTAA

Different organizations have come up with their model laws in regard to forming a framework for taxation especially of multinational entities and cross-border transactions and money flows which can be used by countries to base their tax treaties with each other. The two most popular ones are the OECD and the UN model tax conventions which have been used by many countries to design treaties amongst themselves.

The UN Model Convention defines "royalty" as follows–

"Royalty 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 cinematograph films, or films or tapes used for 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, industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience"

Further, the OECD Model Convention defines "royalty" as under –

"Royalty 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 cinematograph films, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience".

From the above, it can be inferred that the definition of Royalty is narrower in the OECD model convention as compared to the UN model convention. However as far as consideration for the use of IPRs is concerned, both the model conventions treat such consideration as Royalty.

The tax rate at which the Royalty incomes are taxable under the DTAA differs in each DTAA India has with different countries. E.g. Royalty is taxable at a rate of 10% under the India- Japan DTAA whereas the same is taxable at a rate of 20% under the India – Spain DTAA

The exact tax rate needs to be checked on a case-to-case basis considering the country of residence of the person receiving the Royalty income.

Taxation of Royalty in the presence of a Permanent Establishment ('PE')

The tax treatment of Royalty in India differs when such Royalty income is being earned by a non-resident carrying its business through a PE situated in India and such Royalty income is effectively connected with such establishment. In such a case, the taxability of such income shall be governed by the provisions of Section 44DA of the Act.

Section 44DA of the Act provides that any income by way of Royalties earned by a non-resident in pursuance to an agreement with an Indian Concern which is effectively connected with a PE in India shall be treated as the income of the non-resident under the head of Profits and Gains from Business and Profession ('PGBP') and shall be taxed after giving deductions for expenditure wholly and exclusive incurred for such PE and deduction for reimbursement of actual expenses made to the head office.

The income so calculated (after allowing for expenses from the Royalty income) shall be taxed at a rate of 40% (increased by applicable surcharge and cess.)

Withholding Tax Implication Royalties

As per the provisions of Section 195 of the Act, a person making any payment to a non-resident shall be responsible for withholding taxes from such payment at the applicable rates. Therefore, considering the same, the person making payments for the use of IPRs shall be required to withhold taxes at a rate of 20% under the Act or rate applicable under DTAA (whichever is more beneficial).

Further, in case such Royalty is connected with a PE in India. Then tax at a rate of 40% shall be withheld from the payments.

In order to claim the benefit of a lower rate under the respective DTAA, the recipient person must provide the following documents to the other person:

• Form 10F (filed online);
• Tax Residency Certificate;
• No PE Declaration

In the absence of any of the above documents, tax shall be withheld under the provisions of the Act.

Transfer Pricing Regulations Applicable on Royalties

Transfer Pricing ('TP') regulation shall apply when the transaction for sharing of IPR is entered into by associated enterprises wherein 1 enterprise is a non-resident in India. Under the said regulation, the Royalty paid for the use of IPRs shall be on an arm's length price basis determined based on a benchmarking study undertaken.

Both the enterprises shall be required to undertake TP compliances in India namely filing of Form 3CEB.

Compliances and Regulations Applicable on Royalties

• The person receiving the Royalty income shall be responsible for filing the income tax return in India on or before 31st October of the assessment year (30th November if TP is applicable). However, filing of the income tax return is not mandatory when the tax is being deducted as per the provisions of the Act.

• In case the transaction is entered into by two associated enterprises. Then the entities shall be responsible for undertaking TP compliances in India (i.e., filing of Form 3CEB). The said form shall be on or before 31st October of the assessment year.

• In case the provisions of 44DA are applicable to the non-resident person, then the said person shall be responsible for filing Form 3CE before filing the income tax return.

• The PE shall be required to undertake other secretarial compliances in India

Other important considerations

• The entities shall ensure that a proper agreement has been entered into by the parties for the use of the IPRs.

• The agreement shall entail the terms for the use of the IPRs and the consideration.

• Proper documentation shall be maintained by both the parties.

• Both the parties shall adhere to the terms and conditions of the agreement.

• Both parties shall ensure that the laws and regulations in place shall be complied with.