In Formula One World Championship Limited v. Commissioner of Income Tax (the order is available here), the Delhi High Court on the 30th of August this year, overruled an order of the Authority for Advance Ruling (‘AAR’) on the incidental usage of the trademarks and logos owned by Formula One Licensing B.V. by Jaypee Sports Limited (‘Jaypee’) in the organisation and promotion of the Formula One Grand Prix in India (‘Grand Prix’).
The Grand Prix, that saw three editions in 2011, 2012 and 2013, was cancelled in 2014 due to what news reports called ‘contractual and tax issues’. While the future of the Indian Grand Prix looks bleak, it has been said to be likely to return only if Jaypee’s financial health is remedied. The present order seems to have both good and bad news for Jaypee; while the Court ruled that the consideration paid did not qualify as royalty, it was seen to constitute business income and therefore be taxable. Warning: Long post ahead!
Formula One World Championship Limited (‘FOWC’) holds commercial rights in the FIA Formula One Championship. They entered into a Race Promotion Contract (‘RPC’) with Jaypee, by which it granted to Jaypee Sports the right to host, stage and promote the Grand Prix. The parties additionally entered into an Artworks License Agreement (‘ALA’), which permitted Jaypee the use of their intellectual property which includes licensed trademarks, event program covers, templates for posters, official stationery, media kits etc. The RPC was signed for a consideration of USD $40 million, and the ALA for USD $1.
The main issues for adjudication were as follows:
- Whether the consideration paid as per the RPC and the ALA would qualify as royalty for the use of the trademarks, and therefore be taxable?
- Whether Jaypee was a ‘permitted user’ of the trademarks under the Trademarks Act, 1999 (‘Trademarks Act’)?
- Whether FOWC has a ‘permanent establishment’ in India?
On the first point, the AAR concluded that the consideration paid under the agreements qualified as royalty for the use of the trademarks. The RPC indicated in Clause 23.2 that the parties would enter into such an art work agreement that would permit the incidental use of certain marks and intellectual property. It was held that this clause was not an indication of the main purpose of the contract, and following the Supreme Court’s 1977 decision of Sundaram Finance v. State of Kerala, the dominant intention of the parties needed to be looked into.
The AAR therefore, interpreted the RPC and the ALA to be for the limited purpose of organising the Grand Prix, and no other event. They then read down the Avoidance of Double Taxation Agreement entered into between the Government of UK and the Republic of India (the ‘DTAA’) and Section 9(1)(iv) of the Income Tax Act (‘IT Act’) to mean that payments of any kind, for the use of trademarks would qualify as royalty.
On the second point, the AAR examined the definition of ‘permitted use’ in the Trademarks Act to conclude that it had been expanded in 1999 – to mean the commercial use of a mark not only by the registered user, but also by an unregistered licensee who becomes entitled to use the mark by virtue of a written agreement with the registered proprietor. Since Formula One Licensing B.V. had only entered into an oral agreement with FOWC for the transfer of the trademark, the AAR concluded that Jaypee had not entered into an agreement with the registered proprietor of the trademark, and had therefore not met the conditions specified in Section 2(r)(ii) of the Trademarks Act to qualify as a permitted user. They consequentially held that Section 48(2) – which states that the permitted use of a trade mark shall be deemed to be used by the proprietor – could not be invoked.
On the third point, the AAR held that the determination of a Permanent Establishment (‘PE’) was a question of fact, and had to comply with the tests laid down in the DTAA. I will not be getting into this issue in detail, but in essence, the AAR held that FOWC could not be said to have a PE in India.
Decision of the High Court
The Court’s decision hinged on their interpretation of the conditions in the RPC and the ALA. Clause 23.2 permits the incidental use of IP Rights solely for the purpose of facilitating the event. In the event of a termination, both agreements made Jaypee liable to pay the full contractual amount, as well as cease the use of the trademarks and logo in the event of termination. The Court viewed this as a strong indicator that the consideration under both the RPC and the ALA was not exclusively for the IP rights, and was instead for the privilege of hosting and staging the Grand Prix. Additionally, it was held that the RPC had to be read in conjunction with the ALA, but that the ALA did not confer any additional rights to Jaypee. The Court noted that there was no license of any form between the parties, and that the ALA could not be construed to be in the nature of a license. Hence, it was concluded that there could not have been any payment of royalty under the DTAA.
In Director of Income Tax v. Ericsson A.B, it was held that a lump sum payment which is not based on, or connected with the extent of the use of the IP Rights would not constitute royalties within the meaning of the DTAA. The Court relied on this case, and noted that it was important that the payments made under the RPC were separate lump sum amounts paid for each of the separate editions. It was opined that the AAR order did not contain any discussion or finding on this crucial issue. Holding that the main purpose of the RPC was not for the grant of trademark rights, and hence that the payments made to it under the RPC could not qualify as royalty; the Court concluded that the use of the mark on the tickets sold by Jaypee was only incidental.
The Court clarified that Jaypee’s permitted use, was for a limited duration and of an extremely restricted manner as per the definition of ‘permitted use’ in the ALA. It was reasoned that Jaypee had to publicize the F1 Grand Prix Championship, and was therefore bound to use the F1 marks, logos and devices; however, it was not authorized to use the marks on any merchandise or service offered by it. This condition, in the opinion of the court, confirmed that the use of the trademarks was purely incidental, and the payments made therefore could not be taxed.
Another very significant part of this order is the Court’s ruling on PE. It was held that FOWC did have a PE in India, as it inter alia conducted business and derived income that was taxable in India. The Court reasoned that as long as the taxpayer was in a physically defined geographical area, permanence in such a fixed place could be relative with respect to the nature of business. The decision appears to be fairly reasoned, but it is slightly strange that the AAR, while holding that the consideration paid qualified as royalty, did not spell out the amount of tax to be paid. The High Court too, does not consider the quantitative question of the tax due. They conclude that payments made to FOWC, under the RPC are business income and accordingly chargeable to tax, according to the rates applicable in India at that time. The decision however, brings no real relief to Jaypee, or the Formula One hopefuls in the country as the tax obligations remain.
Image taken from here.