June 21, 2012

‘Gross Amount’ Royalty under India-US DTAA includes amount paid as WHT: Income Tax Appellate Tribunal Delhi

In a recent ruling in the case involving Pizza Hut International and the Director of International Tax Delhi the Income Tax Appellate Tribunal, Delhi (“ITAT”) has held that the ‘gross amount’ royalty under the India-US DTAA (“DTAA”) includes not only the actual payment by way of royalty but also the tax withheld (“WHT”) by the payer which is borne by him and paid to Central Government on behalf of the payee as agreed between the parties. In short, the ITAT held that the royalty has to be paid on the grossed up amount.  ITAT Delhi also held that royalty is taxable on receipt basis irrespective of the system of accounting adopted by the parties.


Pizza Hut International LLC, (“the taxpayer”) is a tax resident of United States and has entered into a technical license agreement with Yum Restaurant India Ltd. (“Yum Restaurant”). Pursuant to the agreement, the taxpayer was entitled to income by way of royalty from Yum Restaurant. Under the agreement, the license fee payable by Yum Restaurant to the taxpayer was to be free of any taxes including withholding taxes, that is, royalty was payable on a net basis.

In the assessment year 2003-04, the taxpayer claimed that the royalty was taxable at 15% under the India-US DTAA and had also claimed for exemption under Section 10(6A) of the Income-tax Act, 1961 (“the Act”) for the tax borne by Yum Restaurant.1 The Assessing Officer (“AO”) held that assessment had to be made either under the DTAA or the Act and that the benefit of 15% tax on royalty and exemption under Section 10(6A) cannot be availed simultaneously. Consequently, the AO held that the income be taxed at 20% after providing Section 10(6A) benefit as provided under the Act along with an interest payable for nonpayment of advance taxes.2 Against this order, the taxpayer filed an appeal before the Commissioner of Income-tax (Appeals) (“CIT(A)”). On appeal, the CIT(A) held that the taxpayer is qualified for exemption under Section 10(6A) and that the royalty income (excluding the tax borne by Yum Restaurant) is taxable at 15% as provided under the DTAA. Aggrieved by the order of the CIT(A), the revenue filed an appeal before ITAT, Delhi.

Issues before the ITAT were:

  1. Whether the royalty income is taxable at 15% under the DTAA on grossed up basis (including the taxes withheld) or only on net basis

  2. Whether the royalty income is taxable on receipt/ cash basis or accrual/ mercantile basis

  3. Whether interest is chargeable under Section 234B and 234C

Arguments of the Revenue

The revenue put forth the following arguments before the ITAT:

  • The DTAA provides for the rate of tax at 15% on the ‘gross amount’ of royalty. Revenue argued that ‘gross amount’ has not been defined in the DTAA and hence it will have the meaning assigned in the Act. In this context reference to Section 198 of the Act was made which provides that “for the purpose of computing income of the taxpayer, all the sums deducted as WHT (under Chapter XVII of the Act) shall be deemed to be income received”. Therefore, the CIT(A) erred in taxing the net amount at 15% under the DTAA.

  • The Revenue contended that the income accruing for three months, even during the period when the technical license agreement was not in force, was also taxable since Yum Restaurant had made entries to this effect in its books of accounts. The Revenue argued that the taxpayer being a company has to follow mercantile system of accounting, as a result of which the income for those three months even if not received should be taxable. 

  • The Revenue argued that interest would be payable by the taxpayer since tax hadn’t been deducted for the income accruing for those three months and that the determination of ‘gross amount’ was wrong.  

Arguments of the taxpayer

In reply to the Revenue’s arguments, the taxpayer put forth the following arguments:

  • The Act provides for an option to nonresident companies to opt for a beneficial treatment of tax under the Act and that availing such a beneficial treatment under the Act will not imply that the treaty will cease to have effect.

  • The taxpayer further argued that the DTAA only prescribes the rate for taxing royalty, but does not define the terms ‘gross amount’ or ‘amount’. The DTAA states that tax at the rate of 15% shall be deducted on the gross amount paid to the other person.  Therefore, the taxes borne by the payer has not been contemplated in the treaty to be included in the term gross amount but only the amount actually paid by the payer.

  • In this context, the taxpayer relied on a Board Circular No. 333 of 1982, which states that the mode of computation provided under the DTAA has to be followed. However, if the DTAA does not provide for the computation, then the Act will govern the mode of taxation. Since the India-USA DTAA does provide for the mode of computation, the computation under the Act i.e. exemption available under Section 10(6A) and the rate of tax at 15% as provided in the DTAA has to be followed.

  • Again, for the tax on the royalty accrued for three months when the agreement was not in force, the taxpayer relied on Article 12(1) of the DTAA which uses the words “Royalties and fees for included services arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State”. Based on this, it was argued that the taxation of royalty under the DTAA is based on cash system and not mercantile system of accounting.

  • Finally on the interest part, the taxpayer argued that since the income of the taxpayer was subject to WHT, there was no liability to pay advance tax by it and consequently, the liability to pay interest would not arise.

Ruling of the ITAT

As regards the first issue, the ITAT stated that even though ‘gross amount’ has not been defined in the DTAA the intention was to tax the amount received as royalty including the taxes withheld. If the intention was not to include the WHT, then the word ‘amount’ and not the words ‘gross amount’ would have been used in the relevant article. Further, the ITAT took guidance from Section 198 of the Act which embodies the principle that WHT is nothing but payment of income utilized for payment of tax on behalf of the taxpayer. As a result, there is no computation required for determining the gross amount and hence, there would be no requirement for reliance on computation provisions such as Section 10(6A) of the Act. Therefore, relying on Section 198 which is in the nature of a definition, the order of CIT(A) was reversed.

With respect to the second issue, the ITAT relied on its earlier decision in the case of CSC Technology Singapore Pte Ltd.3 which stated that “the amount which has accrued as income to a foreign company cannot be taxed in the source country, being India, unless the amount has been received by the foreign company”. Accordingly, royalties are taxable on receipt (cash) basis. In the instant case, even though Yum Restaurant has provided for payment of royalty in its books of accounts on accrual basis, the royalty has not actually been paid to the taxpayer. Therefore, the royalty for the three months when the agreement was not in force and not paid to the taxpayer is not taxable.

On the question of payment of interest, the ITAT held that the Finance Bill, 2012 has proposed an amendment on this issue. Hence, it has to be reverted to the AO, who shall decide it based on the facts and in accordance with the law.


The ITAT has extended the meaning of the words ‘gross amount’ as applicable in the Act.  In the Act, a specific provision has been introduced (Section 198) to include the taxes withheld to the income of the recipient.  Such clarity is not available in the DTAA.  However, the words ‘gross amount’ in its common parlance would mean an amount before excluding the operational expenses incurred in relation to it.  Such expenses do not include the taxes payable on such amount.  Interestingly, the definition of the term ‘royalties’ as found in the DTAA refers only to various kinds of payments and does not intend to include grossing up of taxes. 

However, had the taxpayer preferred the Act to the DTAA then taxes have to be withheld on the grossed up amount.  Consequently, the benefit under Section 10(6A) would have also been available.  The ITAT relying on the Act only for purpose of grossing up and not on the exemption requires deliberation.

Further with respect to chargeability of interest, even though ITAT has reverted it to the AO to decide, it is prudent to examine Section 209 as amended by the Finance Act. Under Section 209 as it stood earlier, the amount of advance tax payable was computed by reducing the amount of income-tax which would be deductible or collectible during the financial year from income-tax on estimated income. Therefore, in cases where the assessee received or paid any amount (on which the tax was deductible or collectible) without deduction or collection of tax, it was held by Courts that he is not liable to pay advance tax to the extent the tax is deductible or collectible from such amount. An amendment was made to remedy this and as per the amended Section 209 an assessee is liable for payment of advance tax in respect of income which has been received or paid without deduction or collection of tax. Consequently, a person who has received any income without deduction or collection of tax, shall be liable to pay advance tax in respect of such income.



1 As per Section 10(6A) of the Act, any agreement for royalty or fees for technical services entered between March 31, 1976 and June 1, 2002 by an Indian company with a nonresident company, the taxes withheld by the Indian company on such payments would not be included in the income of the nonresident company

2 Section 234B and 234C of the Act.

3 ITA No. 5604/Del/2010 dated February 17, 2012.


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