Deputy Director of Income-tax (IT) – 4(1) VS. Marriott International Licensing Company BV [2013] (Mumbai ITAT) dated 17th July, 2013.

Facts of the case:

• Assessee-foreign company (Marriott) entered into a Franchise agreement and International sales & Marketing Agreement (ISMA) with Franchisee-hotel M/s Ansal Hotels Limited (AHL) in India.

• Preamble of the Agreement provides that the Franchisee is the owner of the hotel and desires to establish and operate an MHRS International Hotel between Marriott and Franchisee. The Franchisee required certain sales and marketing publicity and promotion services to be performed outside India in support of the operation of the hotel and Marriott (the assessee) chose to perform such services.

• The Franchisee also had entered into an International Sales and Marketing Agreement with Marriott in order to participate in internationally recognized hotel system for the purposes of attracting foreign guests to the hotel.

• Assessee made certain payments as per Article 3.1 of the Franchise Agreement. Clause 3.2 of the agreement provided that AHL shall reimburse the assessee 1.5% of its gross revenue on quarterly basis for International Marketing Activities. In addition to this, it shall reimburse every additional cost and special advertising costs as mentioned in Clause 3.2B and 3.3. of the agreement.

• AO brought total amount to tax as "royalty" under Article 12(4) India-Netherlands DTAA.

• CIT(A) allowed the receipt under clause 3.1 of the Agreement to be royalty and the second part of the amount under clauses 3.2 and 3.3 was held to be towards 'Reimbursement of expenses' on sales promotions and marketing and hence not chargeable to tax in India.

• Aggrieved by CIT(A) order, appeal was filed by Revenue to ITAT.

Issue before the Tribunal:

• Whether payment received by a foreign company from Indian franchisee for international marketing activities is "royalty" under Article 12(4) of DTAA even if its on the basis of % of gross revenue?

Held:

• A perfunctory look at the definition of term 'royalties' as per the para 4 of the Article 12 of the DTAA makes it clear that it represents payment received as a consideration 'for the use of or the right to use' any copyright of literary, artistic or scientific work including cinematograph films, patent, trade mark or design etc.

• In order to cover any amount within the purview of "royalties" as per Article 12 (4) of the DTAA it is imperative that the payment must be a consideration for “use or right to use” any copyright of the literary artistic work etc. or any patent, trademark etc. (collectively referred to as the 'defined property').

• In the present case, even if the contribution made by AHL towards the international marketing activities led to the brand building, still it is a payment for the creation or swelling of the brand and not for the” use “of such brand, which could qualify to be characterized as 'royalties'.

• The term 'royalties' as per article 12(4) contemplates a consideration for the use of or right to use of the defined property which is already in existence and the payment is agreed for its use or right to use. If the payment made is of such a nature which helps in the creation of the defined property that cannot fall within the ambit of Article 12(4) of the DTAA.

• Thus the AO's action in treating this amount as royalties was set aside.

• However, said contribution at 1.5 per cent of the gross revenue for each quarter is not any actual reimbursement of expenses on itemized basis. The actual expenses to be incurred by the assessee may be more or less than the said fixed rate of contribution. In such a situation, there is every possibility of the assessee having some mark up on the costs incurred by it on advertisement. Or alternatively, it may be the other way around also. No material has been placed on record to demonstrate that the actual expenses incurred by the assessee were equal to the amount received.

• Hence, Ld. CIT(A) was not justified in deleting the addition by holding that it represented 'reimbursement of expenses'.

• Thus, in the interest of justice, the case was remanded to AO to consider the facts on the touchstone of Article 7 of DTAA.