SKP Tax Alert
24 June 2015 | Volume 8 Issue 11
Licence fees and management charges cannot be treated as head office expenses under section 44C

Background
Recently, the Mumbai Income Tax Appellate Tribunal (Mumbai ITAT) in the case of M/s Lloyd's Register Asia (ITA No. 387/Mum/2013) (India Branch Office or the Assessee) held that the licence fees and management charges are not in the nature of head office expenses as contemplated under section 44C of the Income Tax Act (the Act).

Facts of the Case
  • Lloyd's Register UK (Lloyd UK) has a subsidiary named Lloyd's Register Asia UK (Lloyd's Asia) which in turn has an Indian branch (Assessee). Lloyd UK is in the business of survey and inspection of ships, industrial inspection activity and drawing appraisal.
  • Lloyd UK entered into a licence agreement with all its subsidiaries whereby it has granted licence to use the trademark and trade name owned by it. Besides this, Lloyd UK also provides general, technical and marketing support services to all its products referred in the licence agreement as 'Intellectual Property Rights'. As per the worldwide policy, Lloyd UK would send the invoices to Lloyd's Asia which in turn allocates it to its Indian branch. During the year under consideration, the total licence fees paid to Lloyd's Asia amounted to INR 138,920,438.
  • Lloyd UK and Lloyd's Asia had also entered into a 'Management Services Agreement' for providing various services such as corporate communications, human resources, taxation, treasury services, etc. During the year under consideration, the total management charges amounted to INR 44,292,396.
  • The case of the assessee was selected for scrutiny and the Assessing Officer (AO) held that both the above mentioned payments are covered within the definition of head office expenditure. Accordingly, the AO restricted the allowance of such payments to 5% of the adjusted total income.
  • The first appellate authority i.e. the Commissioner of Income Tax (Appeals) (CIT(A)) held that the licence fees is not hit by the definition of head office expenditure and thus, the amount of INR 138,920,438 should not be disallowed. As regards, management charges, CIT(A), relying on the case of Lloyd UK for assessing year (AY) 2005-06, held that only 50% of such expenditure is covered within the definition of head office expenses.
  • The matter is before the Mumbai ITAT.
The limited issue before Mumbai ITAT is whether the payments made are in line with the provisions of section 44 C of the Act.

In the ensuing paragraph all the above issues, contentions and the ruling of the Mumbai ITAT has been discussed.
 
Assessee's Contention
  • There is no transaction between the head office and the branch. The transaction is between Lloyd UK and the assessee. Lloyd UK has rendered services to the subsidiaries including the Indian Branch. Lloyd's Asia has not incurred the expenses but is only collecting the amount and passing it on to Lloyd UK. The payment is routed through the head office i.e. Lloyd's Asia.
  • Lloyd UK is filing a separate return of income and offers the income earned by it in India to tax.
  • Further, licence fees paid by Lloyd's Asia to Lloyd UK have been apportioned on a proportionate basis through an internal debit note and this is reimbursed by the assessee to Lloyd's Asia.
  • Licence fees and management charges do not fall within the definition of head office expenses in Clause (iv) of section 44C of the Act.
  • As regards, management charges, they are in the nature of specialised services and hence do not fall in the category of general and executive expenses.
  • Alternatively, it was contented that the business profit of an assessee should be determined under Article 7 (Business Profits) of India - UK Double Taxation Avoidance Agreement (DTAA). According to paragraph 5 of this Article, executive and general administrative expenses shall be allowed as deduction subject to limitation of local laws. However, paragraph 7 provides that it will not apply in the case of reimbursement of actual expenses. Further, basis the case of Lloyd UK for AY 2005-06, it is not disputed that the payments are in the nature of reimbursement.
  • Lastly, provisions of section 44 C of the Act will not apply in view of Article 26 of DTAA, which is a non-discrimination clause. Hence, wherever such a clause is provided in the DTAA, section 44C shall not apply. The assessee relied on the decision of Metchem Canada Inc[1].
 
Revenue's Contention
  • The purpose of this section was to overcome the difficulty in scrutinising and verifying the claim of head office expenses in the absence of accounting books of the head office which are kept outside India.
  • With respect to the licence fees, the services provided are in nature of general, technical and marketing support services which can be attributable as head office expenditure.
  • Further, the management services are a wide range of activities which are akin to administration, legal, accounting, human resources, etc., which are in fact concerned with head office expenses.

Mumbai ITAT's Ruling
  • Section 44C of the Act indicates that the head office expenditure is defined to include general administration and executive expenditure incurred outside India.
  • In the present case, payment towards licence fees are purely for using the brand/trademark and other business intangibles, which are in the nature of intellectual property. If the nature of expenditure as covered under section 44C is compared with the nature and kind of services provided to the assessee branch under the licence fee agreement, then it shows that none of the expenditures under the head licence fees even remotely fall within this category.
  • Regarding the management charges, the general, technical and marketing support services provided to the assessee are not in nature of rent, repairs, insurance, salary or wages but are in nature of specialised services. Hence, these specialised services which are not in the nature of head office expenditure as illustrated in sub-clause (a) to sub-clause (d) cannot be brought within the ambit of section 44C.
  • Technical fees are not covered under the head office expenditure as specified under section 44C of the Act. Clarified vide circular number 649 dated 31 March 1993.
  • Thus, the licence fees and management charges do not fall within the ambit and purview of section 44C.
 
[1] 100 ITD 251 (2006)
SKP's Comments
  • This decision clarifies that the payments in the nature of technical fees do not fall within the ambit of head office expenditure as specified in section 44C.
  • Further, it would be pertinent to note that the Mumbai ITAT has made a passing remark that they agree with the view that in case of reimbursement of expenses, no disallowance of head office expenditure shall be made in view of Article 7 read with paragraphs 5 and 7 of the DTAA.
  • One of the contentions of the assessee was that there is no transaction between the head office and the branch office as the final payment is made to Lloyd UK. However, the Mumbai ITAT has not yet adjudicated on this matter.

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