The article provides an in-depth analysis of how royalty income is treated under the India-US Double Taxation Avoidance Agreement (DTAA). It discusses the objective of DTAAs, their benefits, and specifically focuses on the taxability of royalty income under the India-US DTAA. The article also highlights a key case law (Dow Jones) that elucidates the interpretation of royalty income within the DTAA framework.

While the case underscores the importance of accurate definitions in DTAAs, it also raises concerns about potential challenges and uncertainties in determining the tax treatment of specific income streams. Overall, the article underscores the vital role DTAAs play in international taxation and the need for precise interpretation to ensure fair and consistent taxation.  

Introduction
"Taxes are a compulsory imposition, but by virtue of the Constitution of India, taxes can only be imposed by the force of law. The presence of Article 265 of the Constitution gives statutory recognition to taxability." The Indian Constitution, which serves as the fundamental building block for our democratic country, states in Article 265 that "No tax shall be levied or collected except by authority of law".

For a long time, the idea of double taxation has drawn significant attention from both Indian and foreign courts. In the case of Laxmipat Singhania v. CIT , the Hon'ble Supreme Court has demonstrated that "it is a basic rule of the law of taxation that unless otherwise expressly provided, income cannot be taxed twice.

Again, it is not open to the Income Tax Officer, if the income has accrued to the assessee and is liable to be included in the total income of a particular year, to ignore the accrual and thereafter to tax it as the income of another year on the basis of receipt." An explanation through illustration can better comprehend this principle. Let's say an individual earns a salary in the year 2022, but they receive the salary in early 2023 due to administrative delays.

According to the principle of double taxation, the tax should be levied in the same year in which the income is earned, i.e., 2022, and not in the subsequent year when it has been received, i.e., 2023. This principle enunciated by the Supreme Court has also been given statutory recognition in the Income Tax Act through Explanation 2 to Section 5 of the Income Tax Act.

Furthermore, everything relating to taxes is included in the 1961 enacted Income Tax Act, which is the law that governs all tax-related matters, wherein Section 91 declares that an individual can be relieved of being taxed twice by the government, irrespective of whether there is a DTAA between India and the foreign country in question or not.

Objective of DTAAs
The objective of the Double Taxation Avoidance Agreement is clear from the term itself. DTAA's primary goal is to avoid taxing the same revenue twice in the two distinct jurisdictions. This is accomplished by dividing up the taxing jurisdiction among the two nations and establishing procedures for granting exemptions or relief from double taxes.

Apart from the basic benefit of not having to pay double taxes on the same income, there are many additional benefits associated with DTAAs.

Each country establishes its resident status in line with its domestic laws in accordance with the DTAAs, and these DTAAs may serve as a tiebreaker if a person qualifies for tax residency in both countries. Let's take the example of a Person of Indian Origin (PIO). If the PIO exceeds a specific threshold, he/she could qualify as an Indian tax resident.

Eventually, he/she may be identified as a US tax resident by virtue of his/her citizenship. The tiebreak rule outlined in the India-USA DTAA comes into play in the instant case. This rule will determine which country's tax residency takes precedence. Depending on the specific rules outlined in the DTAA, the PIO could end up being classified as a tax resident of one country over another.

Tax relief under DTAAs is available to tax residents of countries with which India has entered into DTAAs. Furthermore, their tax liability in India will be limited to the extent authorized by the DTAAs. In cases where the scope of the income tax laws is broader in India, individuals may still benefit from the DTAA by virtue of Section 90 of the Income Tax Act, 1961. This is subject to certain procedural requirements, such as the submission of Tax Residency Certificates (TRC) from the other country.

India-US DTAA
India and the United States signed, on September 12, 1989, a Double Taxation Avoidance Agreement, which was enforced on December 18, 1990. The DTAA between India and the United States is a bilateral pact signed between the two nations. The objective of this agreement is to avoid double taxation and promote cooperation among the two countries in the field of taxation. The aforementioned DTAA took effect in India according to Section 90 of the Income Tax Act of 1961.

The DTAA defines guidelines and processes for calculating tax obligations for people and companies with residences in either India or the US. Instances where the same income is taxed in both nations are avoided as a result, which eliminates or lessens the double taxation burden.

The DTAA specifies the taxing privileges of each country by allocating several sorts of income, including business commercial earnings, allowance, profit, royalties, and capital gains, between the two nations. It provides mechanisms for determining the residency status of individuals and companies, as well as for resolving disputes related to taxation.

Royalty Income
In a broad sense, royalties are the sums of money given to the owner of a patent, copyright, trademark, or any other kind of intellectual property for the use of such property. It is the portion of a product or profit set aside by the owner in exchange for allowing someone else to exploit his or her intellectual property.

Article 12 of the DTAA between India and the United States covers the treatment of royalty revenue. The later agreement's corresponding clause covers the taxation of royalties and charges for technical services.

In simple terms, it outlines how these types of income should be taxed when they are earned by a person or company in one country but are paid by someone in the other country. The phrase "royalties" used in this article refers to sums of money received for the purpose of any copyright use or authorization, work of literature, creative, or scientific creations, including drawings, methods, plans, movies, procedures, or knowledge pertaining to commercial, scientific, or industrial expertise. Included in this are profit margins from the sale of such rights or assets whose utility, application, or disposal are based on their output.

Taxability of Royalty Income under India-US DTAA
According to Article 12, the nation where the beneficiary resides (in this case, India) has the right to tax that revenue if a resident of one country (let's say, India) gets royalties or charges for technical services from a resident of another country (let's say, the US). However, there are some conditions that need to be met. However, the country where the income arises can also tax these royalties and fees according to its own laws. However, the tax levied must not be greater than a specific amount if a member of another country resides as the wholesome possessor of the income:

• The tax on royalty and charge for inclusive amenity (apart from particular services) should not be more than:
  
  • 15% of the gross amount of royalties or fees if the payer is the government, a political subdivision, or a public sector company of the country where the income arises, during the first five taxable years of the DTAA's effect.
  • 20% of the gross amount of royalties or fees in all other cases during the first five taxable years of the DTAA's effect.
  • 15% of the gross amount of royalties or fees for all subsequent years.
     
• For royalties and fees for included services that are ancillary and subsidiary to the enjoyment of a property, the tax should not exceed 10% of the gross amount of royalties or fees.

ITAT's View
A major decision on the calculation of royalty income under the India-US DTAA was made by the Delhi Bench of the Income Tax Appellate Tribunal (ITAT) in December 2021. The ITAT determined that the compensation for database access cannot be regarded as "Royalty" under the India-US Double Taxation Avoidance Agreement (DTAA) in the matter of M/s Dow Jones & Company Inc. vs. A.C.I.T.

In this case, there is an American company that provides global business and financial news through various platforms such as newspapers, websites, and conferences. They appointed an Indian company, "Dow Jones Consulting India Pvt Ltd (DJCIPL)", to distribute their products in India and receive payment for it at a fair price.

However, during the assessment process, the tax officer believed that the money received from DJCIPL should be considered as "Royalty Income" and taxed in India according to both the Indian tax laws and the India-USA Double Taxation Avoidance Agreement (DTAA).

This assumption was made by the tax official on the basis of the meaning of "Royalty" found in Section 9(1)(vi) of the Indian tax regulations. They also looked at the pertinent section of the said DTAA and concluded that the money received in India should be taxed under both the Indian tax laws and the DTAA.

The counsel representing the company strongly argued that the money received by the company is for granting DJCIPL the right to use its database, rather than transferring the actual copyright itself. Therefore, they claimed that the received amount should not be considered as "Royalty" income and should not be subject to taxation in the company's hands.

They also looked at the essential portion of the DTAA between the USA and India. obtain copyrights of work of literature, art, or scientific works within the definition of "Royalty." The tribunal reached the conclusion that only payments that give the payer the capacity to make use of or obtain the right to make use of a copyright fall within the concept of "Royalty."

In the instant case, payments made to acquire the right to use the product itself, without any granting of copyright usage rights, are not covered by the definition of "Royalty.

Given that the copyrighted piece still belongs to the American company, the facts of the current case demonstrate that there has been no transfer of legal title. Only DJCIPL is being given access to the appellant's database.

The panel further noted that when a book is bought, the buyer just gets to enjoy the contents�he does not get the right to use the underlying copyright. Similar to this, the database user only uses the product in the regular course of his company and is not granted the right to exploit the database's copyright.

In light of this, the tribunal determined that under Article 12 of the India-US DTAA, the payment received by the American firm from DJCIPL for the distribution of their products in India cannot be considered to be "Royalty" in nature. As a result, neither DJCIPL nor the American corporation are responsible for paying any taxes on this payment.

Conclusion
The above mentioned case law is an illustrative example of how the interpretation of royalty income under the DTAA can impact taxation outcomes. The said judgment aligns with the purpose of DTAAs in preventing double taxation and providing clarity on the tax treatment of various income streams across international jurisdictions. By examining whether compensation for database access qualifies as "Royalty" under the India-US DTAA, the court demonstrates the need for precise definitions and interpretations within DTAAs to achieve fair and consistent taxation.

However, a critical examination reveals potential challenges. While the judgment rightly emphasizes the importance of not overly taxing income that doesn't qualify as "Royalty," it could also lead to disputes over the classification of income, potentially creating uncertainties and room for tax avoidance. The subjective determination of whether an income stream fits the exact definition of "Royalty" might vary across cases, making consistent application challenging.

Additionally, the judgment might inadvertently open avenues for tax planning strategies aiming to classify income as non-royalty, even if it involves the utilization of intellectual property rights. This could be seen as a departure from the original intent of DTAAs, which is to avoid double taxation while ensuring a fair share of tax revenue between countries.

Overall, DTAAs play a pivotal role in preventing double taxation, providing guidelines for tax treatment, and resolving disputes in the realm of international taxation. The case law underpins the significance of accurately interpreting the terms of DTAAs and domestic tax laws to determine the taxability of specific income streams, such as royalty income, in a cross-border context.

Written By:

1. Prakhar Tiwari, B.Com.LL.B., Guru Ghasidas Vishwavidyalay, Bilaspur, C.G.
2. Jhalak Sachdev, B.Com.LL.B., Guru Ghasidas Vishwavidyalay, Bilaspur, C.G.