2010 (5) TMI 666 - AT - Income Tax

Income taxable in India - Income from sale of software as income from royalty chargeable under the IT Act/DTAA - assessees had supplied off-the-shelf shrink-wrapped software to Infosys Technologies Ltd., (ITL) in India - assessee did not find any reason to declare any income in India in the hands of the assessees for the reason that the software sold by the company to Indian entities were shrink-wrapped off-the-shelf software which is only the sale of copies of copyrighted articles HELD THAT - A very similar issue in similar circumstances was considered by Larger Bench of the ITAT, Delhi Bench A (Special Bench) in the case of Motorola Inc. 2005 (6) TMI 226 - ITAT DELHI-A the cellular operator did not transfer or load any part of the software as to the SIM card or the handset of the subscriber. That established that the software supplied by the assessee to the cellular operator was installed on the hardware and no part of it was loaded on the SIM card or the handset of the subscriber. The Tribunal held that the crux of the issue was whether the payment was for a copyright or for a copyrighted article. If it was for a copyright, it should be classified as Royalty both under the Income-tax Act and under the DTAA and it would be taxable in the hands of the assessee on that basis. If the payment was for a copyrighted article, then it only represented the purchase price of the article and, therefore, could not be considered as Royalty , either under the, IT Act or under the DTAA. The very same principle has been upheld by the Authority for Advance Rulings in the case of Airports Authority of India 2010 (3) TMI 110 - AUTHORITY FOR ADVANCE RULINGS where they have held that the earnings of contract is only purchase of certain copyrighted software on outright basis and when there is no PE in India, royalty income does not arise either within the framework of the Income-tax Act or under the realm of DTAA. In the present case, there is no doubt that both the assesses do not have any PE in India. Also in the case of Sonata Software Ltd. 2005 (4) TMI 530 - ITAT BANGALORE software packages were brought in India for the purpose of distributing to ultimate users and imports were made from non-residents. The Tribunal held that the payments partook the character of purchase and sale of goods; and as there is no PE in India, it could be concluded that no income accrued or deemed to accrue or arise in India. Therefore, in the facts and circumstances of the case, and in the light of the above binding decisions, we find that the sale of software cannot be treated as income from royalty either under the IT Act or under the terms of DTAA. Assessee appeal allowed.

Summary

Issues:
1. Reopening of assessment under section 147 read with section 143(3) of the IT Act, 1961.
2. Treatment of software sale as income from royalty chargeable under the IT Act/DTAA.

Analysis:

1. Reopening of Assessment:
The assessees contended that the Commissioner of Income-tax(A) erred in confirming the action of the Assessing Officer in reopening the assessment under section 147. The assessees argued that the reopening of assessments under section 147 was legally flawed. The Tribunal noted the assessees' objection and considered the issue of reopening the assessments. However, since the appeals were decided on the merits of the main issue, the Tribunal did not delve into the legal ground of reopening the assessments, deeming it as an academic exercise.

2. Treatment of Software Sale as Royalty Income:
The main issue revolved around whether the sale of software by the assessees constituted income from royalty chargeable under the IT Act or the Double Taxation Avoidance Agreement (DTAA). The Assessing Officer had treated the software sale as generating royalties, leading to tax liability for the assessees. The assessees argued that the remittances did not fall under the definition of 'Royalty' as per section 9(1)(vi) of the IT Act or relevant DTAA provisions. The Tribunal analyzed various precedents and legal principles to determine the nature of the transactions. The Tribunal referred to the case of Motorola Inc. where it was established that payments for copyrighted articles did not constitute royalty income. Additionally, the Tribunal cited the Authority for Advance Rulings' decision in the case of Airports Authority of India, which emphasized that without a Permanent Establishment in India, royalty income did not arise. The Tribunal also highlighted the decision in the case of Sonata Software Ltd., where it was held that software sales without a PE in India did not result in income accruing in India. Relying on these precedents and the Supreme Court's ruling in Tata Consultancy Services v. State of Andhra Pradesh, the Tribunal concluded that the sale of software by the assessees did not amount to income from royalty under the IT Act or DTAA. Consequently, the additions made by the Assessing Officer were deleted, and the appeals filed by the assessees were allowed.

In conclusion, the Appellate Tribunal, ITAT Bangalore, after thorough analysis of the issues raised in the appeals, ruled in favor of the assessees, holding that the sale of software by the companies did not constitute income from royalty under the IT Act or DTAA. The Tribunal emphasized the absence of Permanent Establishment in India as a crucial factor in determining the tax liability. The decision provided clarity on the taxation treatment of software sales and set a precedent based on established legal principles and precedents.