2010 (10) TMI 583 - AT - Income Tax

DTAA between US & India - Royalty or sale of copyrighted articles - assessing officer assessed the entire payments in the hands of MRSC as royalty income on the ground that payments have been received towards licensing of Microsoft software products which amounts to grant of right in Intellectual property Rights (IPRs) - whether the sale of off the shelf software product by US based non-resident companies to independent Indian distributors is taxable in the hands of such non-resident companies as royalties within the meaning of Explanation 2 to section 9(1)(vi) of the Act as well as under Article 12 of Double Taxation Avoidance Agreement between India and US - During the course of assessment proceedings the assessing officer noted that on 1/01/1999 Microsoft Corporation granted M/s. Gracemac Corporation the assessee a hundred per cent subsidiary of Microsoft Corporation licence to manufacture and distribute all MS retail software products - It clearly provides that product is protected by copyright and the other intellectual property laws and treaties and that Microsoft (or its suppliers of software code if any) own the title copyright and other intellectual property rights in the product - user is paying for getting a copy of the software and not certain limited rights in software which rests with the copyright owner of the software programme - There is nothing either in the Income tax Act or Indo-US DTAA that once a case falls in one of the clauses of Explanation 2 of section 9(1)(vi) it cannot be considered in any other clause - Held that Microsoft computer programmes are inventions and the payment made for the use or the right to use the same would amount to royalty - In the result the appeals filed by Microsoft Corporation and Gracemac are dismissed and the appeals filed by MRSC are allowed

Issues Involved:
1. Taxability of payments received by non-resident companies from Indian distributors for sale of software products as 'royalty' under Section 9(1)(vi) of the Income Tax Act, 1961 and Indo-US DTAA.
2. Whether the payments received by the non-resident companies from Indian distributors are for the use of or the right to use intellectual property rights (IPRs) in software.
3. Applicability of the concept of 'copyrighted article' versus 'copyright' in the context of software.
4. Taxability of royalty income under different clauses of Section 9(1)(vi) of the Act and the Indo-US DTAA.
5. Double taxation of the same income in the hands of different entities within the Microsoft group.
6. Levy of interest under Sections 234-A, 234-B, and 234-C of the Income Tax Act.

Detailed Analysis:

1. Taxability of Payments as 'Royalty':
The Tribunal examined whether the payments received by non-resident companies from Indian distributors for the sale of software products are taxable as 'royalty' under Section 9(1)(vi) of the Income Tax Act, 1961, and Article 12 of the Indo-US DTAA. It was held that the payments made by end-users for the use of or the right to use software products constitute 'royalty' since the software contains intellectual property rights (IPRs). The Tribunal rejected the argument that these payments were for the sale of 'copyrighted articles' and not for the use of 'copyright'.

2. Use of Intellectual Property Rights in Software:
The Tribunal determined that the payments received by the non-resident companies from Indian distributors were for the use of or the right to use IPRs in software. It was noted that the End User License Agreement (EULA) signed between Microsoft Corporation and the end-users granted the right to use the software, which includes the right to copy and install the software on a computer. This right to use the software was considered a transfer of rights in respect of copyright, making the payments 'royalty'.

3. 'Copyrighted Article' vs. 'Copyright':
The Tribunal rejected the argument that the software products sold were 'copyrighted articles' and not 'copyright'. It was held that the software products contain copyright and other intellectual property rights, and the payments received for their use are for the use of 'copyright'. The Tribunal emphasized that the distinction between 'copyright' and 'copyrighted article' made in the OECD Commentary and US IRS Regulations is not applicable for interpreting the provisions of the Indian Income Tax Act and Indo-US DTAA.

4. Taxability under Different Clauses of Section 9(1)(vi):
The Tribunal addressed the applicability of different clauses of Section 9(1)(vi) of the Act. It was held that the payments received by non-resident companies are taxable under clause (b) of Section 9(1)(vi), as they are payments made by residents for the use of or the right to use IPRs in software. The Tribunal also noted that the Explanation inserted by the Finance Act, 2010, with retrospective effect from 1/06/1976, clarifies that income by way of royalty shall be deemed to accrue or arise in India irrespective of the non-resident's residence or place of business in India.

5. Double Taxation:
The Tribunal addressed the issue of double taxation of the same income in the hands of different entities within the Microsoft group. It was held that since the royalty income has already been taxed in the hands of Gracemac Corporation, it cannot be taxed again in the hands of Microsoft Regional Sales Corporation (MRSC) for the same assessment years. The Tribunal deleted the addition made in the hands of MRSC to avoid double taxation.

6. Levy of Interest:
The Tribunal upheld the levy of interest under Sections 234-A, 234-B, and 234-C of the Income Tax Act, following the decision of the Hon'ble Supreme Court in the case of CIT v. Anjum M.H. Ghaswala, where it was held that charging of interest under these sections is mandatory.

Conclusion:
The Tribunal concluded that the payments received by non-resident companies from Indian distributors for the sale of software products are taxable as 'royalty' under Section 9(1)(vi) of the Income Tax Act, 1961, and the Indo-US DTAA. The Tribunal rejected the argument that these payments were for the sale of 'copyrighted articles' and not for the use of 'copyright'. The Tribunal also addressed the issue of double taxation and upheld the levy of interest under Sections 234-A, 234-B, and 234-C of the Act.

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