Royalty: No Disallowance u/s 40(1)(ia) on Basis of Explanation 4 to Sec.9(1)(vi)

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Section 9 of the Income tax Act deals with income deemed to arise or accrue in India . Subsection vi of Section 9 explicitly includes payments in nature of royalty which is defined in Explanation 2.  Finance Act 2012 further enlarged the definition of royalty by inserting another Explanation below section 9(1)(vi) as under

Explanation 4.—For the removal of doubts, it is hereby clarified that the transfer of all or any rights in respect of any right, property or information includes and has always included transfer of all or any right for use or right to use a computer software (including granting of a licence) irrespective of the medium through which such right is transferred.

The aforesaid clarification that transfer of all or right to use computer software including granting of a license shall be considered with the definition of payment in nature of royalty was introduced with retrospective effect from 01-06-1976.

Tribunal on Explanation 4 to Royalty Definition

Now section 40(a)(ia) of the Income Tax Act provides for disallowance of royalty on which tax was deductible , but was not deducted . In one of the case  Sonata Information Technology Limited vs Dy.CIT before ITAT , Mumbai , held that since Explanation 2 is mentioned in section 40(a)(ia) and not the Explanation 4 , the meaning enlarged by Explanation 4 cannot be brought in to decide whether the amount is disallowable under section 40(a)(ia) of the Income tax Act.

Excerpt of the relevant portion

As can be seen from the above for the purpose of section 40(a)(ia), royalty shall have the same meaning as in Explanation-2 of clause vi of sub- section 1 of section 9. Explanation-4 which was introduced w.e.f. 1.6.1976 by the Finance Act, 2012 has no effect as that explanation was not referred to in section 40(a)(ia). Since the definition of royalty was specifically mentioned in section 40(a)(ia), the examination of the issue can only be made with reference to Explanation2 alone. This is by the concept of legislation by incorporation.

Argument of the learned DR that Explanation-4 increases the scope of royalty in section 9(1)(vi) may have validity for examining the issue of royalty under section 9(1)(vi) in its entirety, but not for the purpose of disallowance under section 40(a)(ia) wherein the scope of royalty was limited to Explanation -2 to clause vi of section 9(1). The explanation-4 cannot be considered as the same was not incorporated in definition of Royalty in sec 40(a)(ia). Argument of the DR to consider the Explanation-4 also has no validity and accordingly the same was to be rejected.

32. AO is directed to consider whether the amounts paid to Indian suppliers can be considered as royalty keeping in mind the latest pronouncements of various higher judicial authorities on the issue and the nature of purchase and the rights involved therein, in order to examine whether the payments can be considered as royalty as per Explanation 2 of clause vi of sub- section 1 of section 9. Assessee should be given due opportunity and issue should be considered in the light of the facts and the law on the issue. Ground is accordingly considered allowed for statistical purposes.

Thus , if by virtue of Explanation 4 to section 9(1)(vi) , disallowance u/s 40(a)(ia) has been resorted to be an A.o, assessee can fight back with aforesaid decision by Mumbai ITAT.

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