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Reimbursement of R&D Expenses Under Cost Contribution Agreement not Liable to Tax in India
The Authority for Advance Rulings ("AAR") in India has delivered an important ruling holding that the reimbursement of research and development ("R&D") expenses to a non-resident under Cost Contribution Agreement ("CCA") is not liable to tax in India. ABB Limited ("ABB India") was a company incorporated in India. As per ABB Group's Research & Development ("R&D") policy, all basic R&D activities were coordinated and directed through ABB Research Limited, Zurich ("ABB Zurich"). The group entities could avail the benefit of the R&D activities by entering into a CCA with ABB Zurich, whereby the participating entities ("ABB entities") agreed to contribute towards the R&D expenses incurred by ABB Zurich based on an agreed allocation key. ABB entities were allowed royalty-free unlimited access to the results of the research undertaken including any Intellectual Property Rights ('IPRs') generated from the R&D. The IPRs generated were legally owned by ABB Zurich. A fee was paid by ABB entities to ABB Zurich for acting as a coordinating agency under the CCA. Taxand India summarises the key points of the ruling.
The main issue before the AAR was whether the ABB India's contribution to the R&D expenses incurred by ABB Zurich would constitute income of ABB Zurich liable to tax in India under the provisions of the Income-tax Act, 1961 ("Act").
ABB India contended that the payment under the CCA was a reimbursement of R&D cost and could not be treated as income of ABB Zurich and even if the payment was regarded as income of ABB Zurich, it was not liable to tax in India in the absence of PE for ABB Zurich in India. On the contrary, the Revenue asserted that the payment should be regarded as 'fees for technical service' in the hands of ABB Zurich and should be liable to tax in India.
The ruling of the AAR is summarised below:
- The payment cannot be regarded as fees for technical services. Sharing the results of the R&D activities with ABB entities cannot be regarded as managerial, technical or consultancy services
- ABB Zurich did not have any right to withhold the research information or results from the ABB entities. The CCA did not even contemplate granting of license by ABB Zurich to the ABB entities, which were entitled to avail the fruits of research without any restriction
- While legal ownership of IPRs generated through the R&D activities rests with ABB Zurich, the ABB entities were the beneficial owners thereof. The contribution under the CCA cannot be regarded as consideration for transferring or conferring any rights or benefits of R&D activities
- The R&D Board of ABB group and ABB Zurich devised cost allocation keys. Further, the CCA provided that the income derived from the commercial exploitation of IPRs would be reduced from the R&D expenses. These clauses in the CCA indicated that it was a joint group initiative to derive the benefits of R&D activities
- Thus, ABB Zurich did not transfer any rights in the nature of intellectual property to the ABB entities which could be covered within the definition of royalty either under the India-Switzerland Tax Treaty or the Act
- Further, the cost reimbursement, even if regarded as business income, will not be liable to tax in India in the absence of PE for ABB Zurich in India and ABB India was not obliged to withhold tax on the reimbursement of R&D expenses
This is an important ruling upholding that contributions under the CCA are not liable to tax in India. Several multinational companies implement the CCA as a part of their IP development strategy. While such arrangements are more prevalent in R&D activities, it is also common in developing other intangible assets. This ruling clarifies the withholding tax aspects of such contributions. The ruling also reiterates the principle that tax is to be withheld at source only if the underlying payment is liable to tax in India.
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