2006 (11) TMI 639 - AAR - Income Tax

Whether periodical payments made to the non-resident person having no office/establishment in India in connection with the use of software developed by him on internet are subject to tax deduction at source under the Double Taxation Avoidance Agreement with the USA ?

Issues Involved:
1. Tax liability of non-resident arising from a transaction with a resident.
2. Classification of payments as business profits or royalties under the Double Taxation Avoidance Agreement (DTAA) with the USA.
3. Applicability of Section 195 of the Income-tax Act, 1961 regarding tax deduction at source.

Issue-wise Detailed Analysis:

1. Tax Liability of Non-Resident Arising from a Transaction with a Resident:
The applicant, IMT Lab (India) Pvt. Ltd., entered into an agreement with a non-resident company, Conversagent Inc., to secure a software license. The applicant contended that the payments made to Conversagent, which does not have any establishment in India, should be classified under Article 7 of the DTAA with the USA as business profits, which are not chargeable to tax in India.

2. Classification of Payments as Business Profits or Royalties under the Double Taxation Avoidance Agreement (DTAA) with the USA:
The jurisdictional Commissioner argued that the payments should be classified as royalties under Article 12 of the DTAA. The Commissioner referred to the agreement between IMT India and Conversagent, which stated that the payments were for the use of software, thus falling under the definition of royalties as per Article 12.3 of the DTAA and Section 9(1)(vi) of the Income-tax Act, 1961. The software is considered a copyrightable work under both Indian and US Copyright Acts.

The applicant countered that the payments should be considered business profits under Article 7 of the DTAA, as the software information is available to anyone on the internet for a fee, and the non-resident does not have an establishment in India.

During the oral hearing, the applicant's counsel emphasized that the payments should be classified under Article 7 of the DTAA. However, the Authority noted that the license agreement specified that the payments were for the use of software on the Conversagent Server platform, with royalties paid monthly based on usage.

The Authority examined Article 7.6 of the DTAA, which states that if the profits include items of income dealt with separately in other articles, those provisions shall not be affected by Article 7. Therefore, if the payments fall under Article 12, they must be dealt with accordingly.

The Authority concluded that the payments were indeed royalties under Article 12, as they were for the use of scientific equipment (the software on the Conversagent Server platform) for commercial purposes. Additionally, the technical and consultancy services provided by Conversagent were ancillary and subsidiary to the use of the software, thus falling under "Fees for included services" as per Article 12.4(a) of the DTAA.

3. Applicability of Section 195 of the Income-tax Act, 1961 Regarding Tax Deduction at Source:
The Authority examined Section 195 of the Income-tax Act, which requires any person responsible for paying a non-resident any sum chargeable under the Act to deduct income tax at the time of payment. The Supreme Court's decision in Transmission Corporation of A.P. Ltd. v. CIT was cited, emphasizing that the payer must deduct tax on sums chargeable under the Act, whether or not the entire amount is income.

Given that the payments to Conversagent were classified as royalties and fees for included services under Article 12 of the DTAA and Section 9 of the Act, the Authority ruled that the applicant was required to deduct tax at source under Section 195.

Conclusion:
The Authority ruled that the periodical payments made to the non-resident Conversagent Inc., for the use of software, are classified as "Royalties and fees for included services" under Article 12 of the DTAA with the USA. Consequently, these payments are subject to tax deduction at source under Section 195 of the Income-tax Act, 1961. The reliance on the decision in Dun and Bradstreet Espana S.A. was deemed misplaced due to differing facts.

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