While the developed countries are moving towards protectionism policies to encourage domestic production, India seems rather confident to face the competition from the outside forces when it comes to technology. This is evident from the move to abolish the Research & Development Cess Act, 1986 ("Act") that was announced by the Finance Minister in Budget 2017.

With the elimination of Research & Development Cess ('R&D Cess'), the 5% cost to companies importing technologies stands reduced thus making the import of technology cheaper.

Why was R&D Cess introduced?

R&D Cess was introduced in 1986 on all payments made for import of technology into India. The preamble of the Act suggested that the object of levying the cess was twofold namely to encourage commercial application of indigenously developed technology and for adapting imported technology for wider application.

The terms ‘technology’ and ‘industrial concern’ as defined under the Act have a wide definition and consequently, R&D Cess was payable with respect to virtually all payments made by an industrial concern including technical fees/consultancy/royalty or knowhow fee, by whatever nomenclature called, as long as it involved ‘import of technology’ into India. The judicial pronouncements held that ‘mere one-time import of technology’ to not be liable to R&D Cess and made the same due on import of technology under a collaboration between an Indian entity and a foreign entity.

A strict penalty extendable up to 10 times the amount in default was provided for non-payment of the cess.

Current regime and issues

A 'cess' is a tax that is levied by the government to raise funds for a specific purpose. A cess is different from the usual taxes such as income tax, excise duty and customs duty.

R&D Cess has to be paid to the government where it is used for providing capital or any other form of financial assistance to industrial concerns attempting commercial applications of indigenous technology or adapting imported technology to wider domestic applications.

This cess payable on the import of technology is a cost to businesses. In the existing service tax regime, the service tax payable on payment towards royalties / technical knowhow is reduced to the extent of R&D Cess paid. This R&D Cess waiver on service tax is pursuant to service tax notification No. 14/2012 - ST dated 17-03-2012, introduced to overcome double taxation in the form of service tax and the R&D Cess by providing for exemption from service tax to the extent of payment of R&D Cess made under the Act, subject to fulfilment of certain conditions.

The effect of introducing R&D Cess was that credit was available on the residual service tax paid after deducting the R&D Cess which became an expense.

In addition, the definition of 'foreign collaboration' was subject matter of litigation as the contest between 'one-time import of technology' and 'collaboration' distinct from such import to qualify as foreign import continued. This issue was settled by Calcutta High Court in Indian Oxygen & Anr. v UOI & Ors. [1992(40)ECC1], wherein referring to the definition of technology under the Act, the Court observed:

"The foreign collaboration itself must be distinct from the knowledge imported or the special service imported. The definition clarifies that…foreign collaboration itself would be distinct from, and wider than, the isolated instances of importation of knowledge or service."

The Apex Court also considered the possibility of importations of technical knowledge or special services made from time to time, or from place to place upon a sufficiently wide span to cover the meaning of the phrase 'foreign collaboration'. However, the Court held an agreement for sale as outside the definition of ‘foreign collaboration’ within the meaning of prescribed in the Act.

Budget 2017

The R&D cess has now been abolished and this measure would benefit the companies which were earlier unable to offset the same against their service tax liability. So, as opposed to R&D Cess deduction from the service tax which added to the costs of importers arising from restriction on availing credit on the reduced service tax amount deposited, the importer of technology would now be able to claim credit on the entire input tax paid.

Introduced at the time of 'demonetisation' and 'digital India' initiatives, this measure is aimed at reducing the tax burden on the manufacturers across sectors importing technology from overseas and utilising the same for domestic manufacturing, but also putting an end to the compliances associated with R&D Cess. Pharmaceutical companies, tech companies that had to bear the brunt of R&D Cess will heave a sigh of relief.

Further, repeal of R&D Cess indicates the progress towards the GST regime which will merge all major existing taxes and cesses, with few exceptions. This will simplify the overall tax regime and compliances, resulting in reduced consequential costs to be borne by the concerned industry sectors.