IN INCOME TAX APPELLATE TRIBUNAL HYDERABAD BENCH B', HYDERABAD BEFORE SHRI B.RAMAKOTAIAH, ACCOUNTANT MEMBER AND SHRI SAKTIJIT DEY, JUDICIAL MEMBER. ITA No.867 & 868/Hyd/03 (Assessment year 2003-03 & 2004-05) Dy. Commissioner of Income- V/s. Dr.Reddy s Laboratories Limited, tax Circle 1(2), Hyderabad Hyderabad ( PAN - AAACD 7999 Q ) (Appellant) (Respondent) Assessee by : Shri Sampath Raghunathan, AR Revenue by : Shri D.Sudhakara Rao, DR Date of Hearing 21.05.2013 Date of Pronouncement 24.05.2013 ORDER Per B.Ramakotaiah, Accountant Member: These two appeals by Revenue are directed against common order of CIT(A) dated 25.3.2003 for assessment years 2002- 03 and 2003-04. 2. Revenue is contesting issue of payments made by assessee company to Contract Research Organisations (CRO) without making deduction of tax at source. detailed grounds raised by Revenue, which are common for both assessment years, are as under- 1. order of Hon ble Commissioner of Income-tax(Appeals) is erroneous on facts and in law. 2. Hon'ble Commissioner of income tax (Appeals) erred in his findings that CROs do not part with their technical knowledge/skill to assessee. bio-equivalence study is research activity. technical knowledge or know bow in respect of research study is findings or result of study which will be consolidated in report. payments made by assessee to CROs is to obtain study report or to obtain technical knowledge/knowhow from study. 'This attracts provisions of para 4(b) of Article 12 of DTAA with USA. 2 ITA No.867-868/Hyd/2003 Dr.Reddy s Laboratories Limited, Hyderabad 3. Hon'ble Commissioner of Income-tax (Appeals) erred in his findings that Protocol is developed in tune with requirements of their respective regulatory authorities and there is no transfer of technical plan/design in it. This is like arguing that there is no transfer of technical plan/design when architect designs and gives building plan, simply because it is prepared in accordance with norms laid down by municipal authorities. Similarly, Protocol development/design of course is in accordance with norms set apart by regulatory authorities, but for each bio-equivalence study separate plans (Protocols) are to he designed. Further Protocols say clearly that is is developed for Dr. Reddy's Laboratories Ltd by CRO. Protocol is technical plan for bio- equivalence study of assessee's drugs, which is developed by CROs and research is conducted by CROs under Dr.Reddy's Laboratories supervision and this definitely attracts provisions of para 4(b) of Article 12 of DTAA with USA and Canada. 4. process involved in research study is steps or manner in which study is conducted. Protocol clearly states different steps in which study is conducted and how is it conducted with minutest details. Making available technical processes also attracts provisions of para 4(b) of Article 12 of DTAA with USA and Canada. 5. Hon'ble Commissioner of Income-tax (Appeals) erred in his findings that said payment is not fees for included services as envisaged in Article 12 of DTAA with USA and Canada. If anyone of conditions discussed in paras 2, 3 & 4 (i.e 1) transfer of technical knowledge/ knowhow, 2) transfer of processes, 3) development and transfer of technical plan/design) of grounds of appeal is satisfied payment partakes nature of fees for included services as defined in second limb of Clause 4(b) of Article 12. In instant case not one but all three conditions are satisfied and definitely it is fees for included service. 6. Hon'ble Commissioner of Income-tax (Appeals) erred in holding that as DTAA's with USA and Canada are very similar definition of business profit in DTAA of USA can be applied for Canada also. DTAA's are broadly of three models: US Model, UN Model and OECD Model. DTAA with USA follows US Model and is unique in many respects. Canada follows UN Model which is obviously different from US Model. Further DTAA with each country is prepared taking into account taxation laws of that country and comparing it with taxation laws of India. Hence it is not proper to apply provisions of DTAA with one country with that of other. Some countries have kept separate clause in Protocols in DTAA to allow them to apply changes incorporated in DTAA with any other country incorporated in DTAA with any other country in their DTAA also if it is favourable to them. (eg; Clause 3 of Protocol of DTAA between India and Israil, Para 4 of Protocol of DTAA between India and Sweden). In DTAA with Canada or USA such 3 ITA No.867-868/Hyd/2003 Dr.Reddy s Laboratories Limited, Hyderabad Provision is not there. Further Canada and USA follows two different models of DTAA and applying provision of USA DTAA to Canada DTTAA is against law. Federal taxation laws are very stringent that taxation is done transaction wise. Hence any payment from federal countries to India is made after withholding taxes at source. 7. Hon'ble Commissioner of Income-tax (Appeals) erred in holding that even for Canada payments if payment does not fall under definition of fees for included services it falls under business profits. Clause 3 of Article 12 of DTAA with Canada says that any income that is taxable as per Indian Laws can be taxed in India but @ 15% only. Since payments towards bio-equivalence studies are taxable in India U/s 9(1) (vii) r.w.sec.5(2)(b) of IT. Act, 1961. Even it is not fees for included service it must be taxed in India @ 15% as per Clause 3 of Article 21 of DTAA with Canada. 8. assessee ought to have made application to Assessing Officer for non-deduction of tax at source Vis 195(2), had it felt that payments are not taxable in India. Supreme Court in case of CIT Vs. S.F.Upper Sileru (239 ITR 587) held that assessee is obliged to deduct tax at source U/s 195 even though entire amount may not be income or profit of non-resident. 9 3. Facts of case in brief are that assessee company is engaged in business of manufacturing, trading and exporting of bulk drugs and pharmaceuticals. It is also engaged in research and development of bulk drugs and pharmaceuticals. In order to market its products in Untied States of America (USA) and Canada, assessee company is required to get approval from respective regulatory authorities. In USA, authority is called as US Federal Drug Authority (USFDA) and in Canada, authority is called Therapeutic Product Pogram Authority(TPPA). For this purpose, appellant company is required to get its products tested through certain specialized organisations in USA, which are called as Contract Research Organisations(CRO). testing process is called Bio-equivalence study . 4 ITA No.867-868/Hyd/2003 Dr.Reddy s Laboratories Limited, Hyderabad During bio-equivalence study, CROs do clinical research and analyse impact of drug on human beings. After conducting bio- equivalence studies, CROs submit report to assessee company, which contains findings of study. This report is then submitted to regulatory authorities and if regulatory authorities are satisfied, then patents are registered. 4. For conducting above bio-equivalence studies, assessee company has made following payments to CROs mentioned below- Name of CRO Amount paid during F.Y. Amount paid during F.Y. 2001-02 2002-03 M/s. Anapharm, Canada 2,84,74,878 16,06,42,979 M/s. MDS Pharma Services 10,55,47,693 12,35,86,857 Canada Sub-total 13,40,22,571 18,42,29,836 M/s. Applied Analytical 3,19,32,665 1,54,21,361 Industries Inc. USA M/s. Med Trials Inc., USA 0 42,48,928 Sub total 3,19,32,665 1,96,70,289 TOTAL 16,59,55,236 20,39,00,125 5. assessee company on reason that amounts paid do not require any TDS to be effected, repatriated amounts to above company without making deduction of tax at source under provisions of Act. DCIT Circle 14(3)(TDS) Hyderabad, conducted inspection on assessee company and issued show cause letter as to why payment by company should not be treated as fee for included services in terms of Article 12 of respective Double Taxation Avoidance Agreement (DTAA). 5 ITA No.867-868/Hyd/2003 Dr.Reddy s Laboratories Limited, Hyderabad 6. It was submission of assessee company that payments are not fee for included services , being business profits in hands of recipients in terms of Article 7 of DTAA. It was further submitted that since CROs did not have any Permanent Establishment (PE) in India, amounts are not taxable in India and accordingly, there is no need for making any TDS by assessee. contentions of assessee were not acceptable to DCIT, who held that assessee should have deducted TDS at 15% of amount or at least should have obtained non-deduction certificate at time of remittance of amount and on failure in doing so, he ordered assessee to pay both TDS and interest under S.201(1A) of Act. Accordingly, he demanded sum of Rs.3,44,53,108 for assessment year 2002-03 and Rs.3,81,78,026 for assessment year 2003-04, by passing detailed orders in that behalf. 7. Aggrieved by said orders of DCIT, assessee preferred appeals before CIT(A) and reiterated submissions that as per DTAA, so as to fall within purview of fee for technical services , said party should make available technicality, experience, skill, know-how or process or consist of development and transfer of technical plan or technical design. It was submitted that CROs are only conducting clinical trials and submitting reports and they are not making available any technical know or expertise to Indian company. They also elaborately submitted work that was being done by CRO and made detailed submissions with reference to Article 7 and Article 12. Considering submissions of assessee, learned CIT(A) held amounts remitted by assessee are only business profits and not fee for included services . Accordingly, he held that there is no need for deducting tax at source. His detailed order on this issue is as under- '2.9. I have carefully considered issue in question. It is not contention of either DCIT or appellant that provisions of DTAA do not apply to this case. In fact, both parties say that payments come under 6 ITA No.867-868/Hyd/2003 Dr.Reddy s Laboratories Limited, Hyderabad DTAAs. On going through DTAAs of both USA and Canada. it is found that payment should come under any one of following heads of income:- 1. Income from immovable property 2. Business profits 3. Shipping and air transport 4. Associate Enterprises 5. Dividends 6. Interest; 7. Royalties and fees for included services 8. Gains; 9. Permanent Establishment tax; 10. Independent personal services; 11. Dependent personal services; 12. Royalties and fees for included services; 13. Directors fees; 14. Income earned by entertainers and athletes 15. Remuneration and pensions in respect of Government services; 16. Private pensions and annuities, alimony and child support; 17. Payments received by students and apprentices 18. Payments received by professors, teachers and research scholars and 19. Other income. These heads are like heads of income in Income Tax Act and any receipt has to be brought under only one head of income and if particular receipt does not fall under any of heads, it has to be brought under last omnibus head, namely, other income. 2.10. It is not contention of DCIT and appellant that payments come under last head viz. Other Income". It is contention of appellant that receipt falls under head "business profit" for recipient. whereas according to DCII, receipts falls under head "royalties and fees tor included services" in general and "tees tor included services" in particular. 2.11. Therefore, only issue to be decided in this case is whether payment made by appellant to four of CROs were "business profits" in hands of CROs or "fees for included services". 2.12. Wile there is no definition of business profits in DTAA with Canada, para 7 of Article 7 of DTAA with USA defines business profits as under:- Business profits means income derived from any trade or business including income from furnishing of services other than included services and including income from rental of tangible personal property other than property described in paragraph 3(b) of article 12. 7 ITA No.867-868/Hyd/2003 Dr.Reddy s Laboratories Limited, Hyderabad Therefore, in order to bring receipt under head business profits , receipt should be proved to have been derived from any trade or business. For this purpose, furnishing of services (other than included services is also treated as business. It is contention of appellant s AR that four CROs in USA and Canada have derived sums paid by appellant from trade/business. 2.13. We have to see whether receipts of CROs were "derived" from any trade or business. It may be stated that Supreme Court, in case of Cambay Electric Supply Industrial Co, Ltd. vs. CIT reported in (1978) 113 ITR 84 (SC), has interpreted word "derived" and according to Supreme Court, phrase derived from" is to be given narrower interpretation than phrase "attributable to". Therefore, in case of appellant also, we have to keep this interpretation of Supreme Court in mind while deciding whether receipts in hands of CROs had been "derived" from any trade or business. As per para 5 of Article 7 of DTAA with Canada and as per para 4 of Article 7 of DTAA with USA "No profits shall be attributed to permanent establishment by reason of mere purchase by that permanent establishment of goods or merchandise for enterprise". Therefore, DTAAs presume existence of business/trade, only if there were purchase and sale of goods/merchandise. In case before me, there is no purchase and sale of any goods/merchandise. Further, as per agreements entered by appellant with these CROs. name given to payment was "the price for work". "study fee". "compensation". "service fee, etc. Therefore, there cannot be any business/trade where one gets "fee". 2.14. Act gives inclusive definition of word "Business" in Section 2(13) of Act and according to this definition. "Business includes any trade commerce or manufacture or any adventure or concern in nature of trade, commerce or manufacture". Even though this is only inclusive definition and not exhaustive definition, I am of view that receipt by CROs cannot be treated as receipt from any trade or commerce or manufacture or any adventure or concern in nature of trade, commerce or manufacture. 2.15. As mentioned earlier. DTAA with USA treats income derived from furnishing of services as business profits . Therefore, can we say that CROs in USA were doing business as they were furnishing services to appellant '? Then, in that case, can we also say that Canadian CROs also do business by applying same yardstick ? Particularly, when Act treats "profits and gains of profession" at par with "profits and gains of business", can't we say that eventhough in hands of recipient CROS, they were professional receipts, they were business profit' in view of these peculiar circumstances ? Before coming to conclusion, let us see para 4(b) of Article 12 of DTAAs. 2.16. CROs conduct sort of study about impact of medicine produced by appellant on human beings in USA and gives its findings at end of study. No doubt, CROs prepare what is known as "Protocol" and appellant and CROs agree with each other that studies are to be conducted according to minute details mentioned in protocol. As per agreement, appellant can check whether CROs make study according to protocol and after satisfying that studies were made according to protocol and after obtaining copy of findings of study, appellant pays fees to CROs. Therefore, payment made by appellant to CROs can be treated only as fees and it cannot be consideration paid for purchase of any commodity or merchandise. 8 ITA No.867-868/Hyd/2003 Dr.Reddy s Laboratories Limited, Hyderabad 2.17. On payment of fees. we have to see what does appellant company gets back in return. Obviously, appellant company gets back finding of study. Therefore, can we say that CROs make available their technical knowledge experience, skill, know-how or processes to appellant ? When I put this question to appellant's AR, he argued that CROs arc experienced in conducting bio-equivalence studies and they do this not only for appellant company, but also for various other companies all over globe. According to AR.CROS have experience in conducting studies and they are not parting with experience and they are parting only with findings of study and, therefore, it cannot be said that CROs are parting with their experience. It is also submitted that CROs do not part with their technical knowledge/skill/know-how/processes to appellant. 2.18. second limb of para 4(b) of Article 12 is services consisting of development and transfer of technical plan or technical design and AR argues that CROs have not provided services of development and transfer of any technical plan/technical design. 2.19. No doubt, CROs prepare protocols - most probably, in tune with requirements of their respective regulatory authorities - and protocol is appended to agreements that they enter with appellant and protocols contain details of study to be conducted. But, can we say CROs develop and transfer protocols even if protocols can be called as technical plan/design? I am afraid it is not. CROs are not in business of development and transfer of protocols. We say such and such thing is transferred only when that thing, parts company of transferor and it comes into possession of transferee. In case under consideration, neither protocol is transferred, nor sending report can be treated as making available technical knowledge, experience, skill, know-how or processes. In these circumstances, I hold that para 4(b) of Article 12 does not apply to case of appellant. 2.20. Now that it is decided that para 4(b) of Article 12 is not applicable and since it is not contention of DCIT that DTAAs do not apply for appellant, only way to reconcile position is that CROs should be treated as having derived profits from furnishing of services, other than included services and hold that receipt should be treated as "business profits" in hands of recipient CROs in USA. Even though similar para (para 7 of Article 7) is not in DTA with Canada, I hold that such interpretation should be given to payment made to Canadian CROs also, as, DTAAs with USA and Canada are very similar and absence of similar definition does not mean that we are prevented from giving such interpretation. In these circumstances I hold that receipt in hands of Canadian CROs should also be treated as "business profits 8. Before us, Learned Departmental Representative reiterated contentions as made out by Assessing Officer vide his detailed order and referred to S.9(1)(vii) and S.5 of Income-tax Act, besides Articles 12 and Article 7 of DTAA, and reiterated that 9 ITA No.867-868/Hyd/2003 Dr.Reddy s Laboratories Limited, Hyderabad payments made by assessee company fall within scope of fee for technical services taxable under Income-tax Act, and accordingly, assessee should have deducted tax at source before making remittances. 9. Per contra, learned counsel reiterated submissions made before CIT(A), with reference to activity undertaken by CROs, as well as for paying amounts without effecting TDS and also interpretation of Articles 12 and 7 of DTAA. He relied on decision of Authority for Advance Ruling in case of Anapharm INC., INC In RE (305 ITR 394), wherein similar issue was considered by AAR. It was pointed out that Anapharm INC is also one of CRO-recipients in case of assessee also which paid amounts in question. Therefore, it is submitted that principles laid down in that case will equally apply to present case. 10. On query by Bench, whether any action has been taken separately in case of said recipient companies apart from proceedings under S.201 and 201(1A), both parties agreed that no action was taken on said CROs independently for taxing said amounts in their hands. 11. We have considered issue. Keeping in mind detailed order of CIT(A), which is extracted above and provisions of Income-tax Act read with DTAA with USA and Canada, which are almost similar, we have no reason to differ from order of CIT(A). Even though Assessing Officer considered that payments were made by way of fee for technical services as per Article 12 of DTAA, same is taxable in source country only if such services make available any technical knowledge, expertise, etc. or there is transfer of technical plan or design. In this case, as rightly considered by learned CIT(A), assessee was conducting clinical trials through CROs in USA to 10 ITA No.867-868/Hyd/2003 Dr.Reddy s Laboratories Limited, Hyderabad comply with regulations therein and CROs who are experts in this field were only conducting studies and submitting reports in relation thereto. They are neither transfer of technical plan or technical design nor making available of technical knowledge, experience or know-how by CROs to assessee company. In fact, assessee company did not get any benefit out of said services in USA and assessee was only getting report in respect of field study on its behalf, which would help it in getting registered with Regulatory Authority. Since there is no making available of technical skill, knowledge or expertise or plans or designs in present case, amounts paid by assessee do not fall under Article 12, but come within purview of Article 7 of DTAA. Therefore, amounts paid are to be considered as business receipts of said CROs and since they do not have any PE in India on which aspect there is no dispute, there is no need to deduct tax at source. Similar issue was analysed and considered by AAR in case of Anapharm INC (supra), which is one of recipients in assessee s case also. AAR in that case held as under- Mere provision of technical services is not enough to attract art. 12(4)(b). It additionally requires that service provider should also make his technical knowledge, experience, skill, know-how etc., known to recipient of service so as to equip him to, independently perform technical function himself in future, without help of service provider. In other words, payment of consideration would be regarded as 'fee for technical/included services' only if twin test of rendering services and making technical knowledge available at same time is satisfied. In present case, applicant renders bioanalytical services which, no doubt, are very sophisticated in nature, but applicant does not reveal to its clients as to how it conducts those tests or inputs that have gone into it, so as to enable them to carry out those tests themselves in future. broad description or indication of type of test carried out to reach this conclusion does not enable applicant's client to derive requisite knowledge to conduct tests or to develop technique by itself. mere fact that tests in question are highly technical in nature will not make difference. In its affidavit applicant affirms that only final results, conclusion of data of bioequivalence tests are provided to recipient. Clinical procedure, analytical methods, etc., which are proprietary items of applicant, have neither been nor will they ever be transferred, assigned or handed over to 5 or any other Indian client. From perusal of relevant agreements, no provision is found which 11 ITA No.867-868/Hyd/2003 Dr.Reddy s Laboratories Limited, Hyderabad would entitle clients to know details of analytical methods and procedures employed by applicant in carrying out bioequivalence tests. only doubt cast by c1. 15 of agreement with 5 is cleared by S's statement that said clause which was part of standard format was never given effect to. It seems to be inapplicable also having regard to actual modalities of transaction as set out in application. Then agreement with R says that R shall be owner of tested samples and test compounds. Further, applicant will store tested samples and test compounds for three months and make these available to client at expiry of that period. Handing over tested samples and test compounds cannot be equated with making technology, know-how, etc., available to R. agreement also states that R shall be owner of all intellectual property rights resulting from services. This would mean that, if on basis of these results, client is able to acquire patent or other intellectual property rights in respect of new generic drugs developed by it, then applicant shall not claim any interest whatsoever in such right. It is altogether different aspect. By agreeing to this provision, applicant has not made its technical expertise, know-how, etc., available to R. It is only natural that R which has developed generic drug should enjoy intellectual property rights in relation thereto. analytical test has not contributed to development of new generic drug. test has only shown whether that drug is as efficacious as reference drug. Development of new drug and testing its efficacy are not one and same thing. By merely acquiring knowledge of testing methods one does not get any insight as to how new drug could be developed. In light of above discussion interpreting expression 'make available', it follows that c1. (b) of art. 12(4) relied upon by Revenue does not come into play and services in question cannot be considered to be "fees for included service" within meaning of this provision. second limb of cl. (b) refers to "development and transfer of technical plan or technical design". Obviously, that has no application here. applicant uses its experience and skill itself in conducting bioequivalence tests, and provides only final report containing conclusions, to client. information concerning scientific or commercial experience of applicant or relating to method, procedure or protocol used in conducting bioequivalence tests is not being imparted to pharmaceutical companies and consideration is not paid for that purpose. On basis of final report, pharmaceutical companies will not be able to find out what method, procedure or protocol was used in conducting tests. Moreover, test reports are drug specific. Hence material furnished by applicant will not in any way help customers to facilitate further research and development of new drugs as contended by Revenue. As such, fees received by applicant are to be treated as business income and not royalty income. Since applicant is in business of providing bio- analytical services to various pharmaceutical companies, consideration received by it from them would be its business income. In view of art. 7 r/w art. 5, such income can be taxed in India only if applicant has PE in this country. applicant has denied existence of any PE here and there is nothing on record to indicate 12 ITA No.867-868/Hyd/2003 Dr.Reddy s Laboratories Limited, Hyderabad anything to contrary. On facts stated, existence of PE in India cannot be inferred also. It is, therefore, ruled that fee paid by S and R to applicant in respect of bioequivalence tests conducted by it is in nature of 'business profits' under art. 7 and same is not taxable in India as applicant does not have PE situated in this country.-Raymond Ltd. vs. Dy. CIT (2003) 80 IT] (Mumbai) 120 : (2003) 86 ITD 791 (Mumbai), McKinsey & Co. Inc. (Phillippines) & Ors. vs. Asstt. Director of IT (2006) 99 IT] (Mumbai) 857 concurred with; Diamond Services International (P) Ltd. vs. Union of India (2008) 216 CTR (Bom) 120 : (2008) 169 Taxman 201 (Bom) relied on. Conclusion: Applicant, tax resident of Canada, only providing final results to its Indian clients by using highly sophisticated bio-analytical know-how, without providing any access whatsoever to clients to such know-how, fee received by it is business income and not fee for technical/included services or royalty and applicant having no PE in India, such income would not be taxable in India by virtue of relevant provisions of DTAA between India and Canada. 12. We agree with above opinion expressed by AAR and accordingly, we uphold that amounts paid by assessee company to CROs are not taxable in India. That being so, there is no need for assessee to deduct tax at source. Consequently, impugned order of CIT(A) is confirmed and grounds raised by Revenue in these appeals are rejected. 13. In result, both appeals of Revenue are dismissed. Order pronounced in court on 24.05.2013 Sd/- Sd/- (Saktijit Dey) (B.Ramakotaiah) Judicial Member Accountant Member Dt/- 24th May, 2013 Copy forwarded to: 1. Corp. Taxation, Dr.Reddy s Laboratories Limited, 7-1-27, Ameerpet, Hyderabad 2000 016 2. Dy. Commissioner of Income-tax Circle 1(2), Hyderabad 13 ITA No.867-868/Hyd/2003 Dr.Reddy s Laboratories Limited, Hyderabad 3. Commissioner of Income-tax(Appeals) III, Hyderabad 4. Commissioner of Income-tax II, Hyderabad. 5. Departmental Representative, ITAT, Hyderabad. BVS ACIT v. M/s Dr.Reddy's Laboratories Ltd