2015 (5) TMI 726 - AT - Income Tax

Revenue earned from supply of software taxed as Royalty - DTAA between India and USA - Held that - Respectfully following the decision of Ericsson A.B. (2011 (12) TMI 91 - Delhi High Court) and Infrasoft Ltd. (supra), we hold that the consideration received by the Assessee for supply of product along with license of software to End user is not royalty under Article 12 of the Tax Treaty. Even where the software is separately licensed without supply of hardware to the end users (i.e. eight out of 63 customers), we are of the view that the terms of license agreement is similar to the facts of Infrasoft Ltd (2013 (11) TMI 1382 - DELHI HIGH COURT). Accordingly, we hold that there was no transfer of any right in respect of copyright by the assessee and it was a case of mere transfer of a copyrighted article. The payment is for a copyrighted article and represents the purchase price of an article. Hence, the payment for the same is not in the nature of royalty under Article 12 of the Tax Treaty. The receipts would constitute business receipts in the hands of the Assessee and is to be assessed as business income subject to assessee having business connection/ PE in India Revenue earned from rendering of implementation services and maintenance services to customers in India as Royalty/ FTS/ FIS - Held that -In the present case, the undisputed fact is that the implementation service is inextricably and essentially linked to the supply of software. In view of our decision in Ground No 2 that the supply of software is not taxable as royalty under the Tax Treaty, the provision contained in clause (a) to Article 12 (4) would not apply to both Implementation and maintenance services. Further there is nothing to show that these services provided by the assessee actually made available to the End User/ Channel Partners any technical knowledge, experience, skill, know-how or processes so as to enable them to apply the said technology. Under these circumstances, we uphold the arguments of the learned Counsel of the assessee and allow the ground. Whether ACC constitutes the fixed place, Installation and Dependent Agent PE in India of Aspect US under the Tax Treaty? - Held that - It is submitted that the assessee has not submitted information on sale of equipment and licensing of software that are done directly by Aspect India to customers and those done through channel partners. It is contended that the assessee has not demonstrated that it identifies customers and make sales. The statement recorded from the Director, sales of Aspect India is stated to be contrary to the claim of the assessee that Aspect India only acts as a communication channel between the assessee and the customers. Similarly, the assessee s claim that majority of sales are made to channel partners is stated to be factually incorrect since information on all the channel partners, date of agreement and sales made through them is not submitted. It is argued that copy of I Approve system has not been submitted by the assessee for factual verification. Considering these facts, we are of the view that both the revenue and the assessee have not been able to demonstrate the existence or otherwise of the dependent agent PE . In the absence of proper information in this regard, we are unable to decide whether the assessee has a dependent agent PE in India. We accordingly, set aside the issue of dependent agent PE and restore to the assessing officer for fresh consideration. Revenue earned from supply of software and rendering of maintenance and professional services to customers located in Sri Lanka and Middle East as Royalty/ FTS/ FIS - Held that - to tax the income earned by Aspect US from customers located outside India under Sec. 9(l)(vi)(c)/ 9(1)(vii)(c ) of the Act, the Revenue must prove that the customers located in Sri Lanka / Middle East carry on business in India and that they have used Aspects US rights in the IPs/ services for the purposes of such business in India; or that they have used rights in the IPs/ Services for the purpose of making or earning income from a source in India. In the present case, the Revenue taxed the said income on the sole reason that these services are provided by Indian subsidiary of the asseseee and the asssessee is earning huge income from these customers. The AO has not brought anything on record to show that the customers located in Sri Lanka/ Middle East have used the rights in the IPs/ services for carrying on business in India or for the purpose of making or earning income from any source in India. We find it difficult to accept the arguments of the learned CIT-DR for taxing the said receipts. Thus we hold that the revenues earned from customers located in Sri Lanka/ Middle East are not taxable under the Tax Treaty. Even otherwise, we are of the opinion that the said revenue is not taxable under Sec. 9 of the Act. Attributing the income to the assessee s PE in India - Held that - Where a PE is held to exist, subject to the application of the force of attraction rule, only profits in relation to the assets and activities of the PE may be attributed to it and that an arm s length payment to a subsidiary PE as per FAR analysis would be sufficient for such attribution.In view of the above, we agree with the learned counsel of the assessee that where an associated enterprise (that also constitutes a PE) is remunerated on arm s length basis taking into account all the risk taking functions of the multinational enterprise, nothing further would be left to attribute to PE. For the other A.Ys under appeal, we direct the AO to refer the matter to the TPO wherever there is no existing reference either in the case of Aspect US or Aspect India. The TPO shall determine ALP and attribute the profits accordingly. In this regard, we place reliance in the case of Ranbaxy Laboratories Ltd. Vs. CIT (2011 (11) TMI 196 - DELHI HIGH COURT) wherein the validity of the instruction no.3 dt.25-5-2003 issued by the CBDT u/s 119 of the Income Tax Act was upheld and the reference to TPO for determination of ALP was considered mandatory. Claim for deduction of remuneration paid to the alleged P.E. from the profit attributed to the P.E - Held that - As we have directed the AO to refer the matter to the TPO for determining the ALP and thus decide on attribution of profits, we are of the view that this issue should also go back to the AO for fresh adjudication in accordance with law Applicability of transfer pricing provisions and rejection of Transfer pricing analysis of Aspect India - Held that - the functions identified in transfer pricing study are complete and exhaustive. Aspect India has been remunerated at arm s length for functions provided by it. Accordingly, no further attribution is required to be made for Aspect US. She submitted that this is supported by the fact that tax return of Aspect India was picked up for scrutiny by the Transfer Pricing Officer ( TPO ) for AY 2004-05, 2005-06 and AY 2008-09 and the TPO had accepted the value of international transaction declared by the assessee. In support of her submissions, she relied on the decision of the Hon ble Supreme Court in the case of Morgan Stanley and Co. Inc (2007 (7) TMI 201 - SUPREME Court).Similar issues have been dealt with by us earlier in this order while dealing with attribution of profits to the PE. As the criteria for adjudication of both the issues is similar, consistent with the view taken by us we direct the assessing officer to accept the TPO analysis of Aspect India wherever the same is available. Levy of interest under Sec 234B - Held that - The undisputed fact in the present case is that tax on the entire income received by the assessee was required to be deducted at appropriate rates by the respective payers under section 195(2). Had the payer made the deduction of tax at the appropriate rate, the net tax payable by the assessee would have been Nil.The interest obligation has arisen on account of the AO holding ACC as PE of asseseee in India which resulted in higher assessed income. Further, the Revenue has not brought anything on record to prove that the assessee has led the Indian payers to believe that tax was deductible at lower rates. Under these circumstances, we allow this ground in favor of the assessee.

Summary

Issues Involved:
1. Taxability of revenue from software supply as "Royalty".
2. Taxability of revenue from implementation and maintenance services as "Royalty"/"FTS".
3. Existence of a Permanent Establishment (PE) in India.
4. Taxability of revenue from software and services to customers in Sri Lanka and Middle East.
5. Double taxation and incorrect tax rate application.
6. Attribution of profits to the alleged PE.
7. Deduction of remuneration paid to the alleged PE.
8. Applicability of Transfer Pricing provisions.
9. Levy of interest under section 234B of the Act.
10. Initiation of penalty proceedings.

Detailed Analysis:

1. Taxability of Revenue from Software Supply as "Royalty":
The Assessing Officer (AO) and the Dispute Resolution Panel (DRP) classified the revenue from software supply as "Royalty" under Section 9(1)(vi) of the Income Tax Act and Article 12 of the India-USA DTAA. The Tribunal, however, disagreed, citing the Delhi High Court's rulings in Ericsson A.B. and Infrasoft Ltd., which held that payments for software licensed for internal use do not constitute "Royalty". The Tribunal concluded that the revenue from software supply is not taxable as "Royalty" under the Tax Treaty, considering it a payment for a copyrighted article rather than for the use of copyright.

2. Taxability of Revenue from Implementation and Maintenance Services as "Royalty"/"FTS":
The AO taxed the revenue from implementation and maintenance services as "Fees for Technical Services" (FTS) under Section 9(1)(vii) and as Fees for Included Services (FIS) under the Tax Treaty. The Tribunal found that these services do not make available technical knowledge or skills to the customers, and thus, do not qualify as FIS under Article 12(4)(b) of the Tax Treaty. Consequently, the Tribunal held that the revenue from these services is not taxable as FTS or FIS.

3. Existence of a Permanent Establishment (PE) in India:
The AO held that the assessee had a fixed place, installation, and dependent agent PE in India. The Tribunal remitted the issue back to the AO for proper verification, as neither party conclusively demonstrated the presence or absence of a fixed place of business in India. The Tribunal also concluded that there is no installation PE, as the installation services were not connected to a building site or construction project. The issue of dependent agent PE was also remitted to the AO for fresh consideration due to insufficient information.

4. Taxability of Revenue from Software and Services to Customers in Sri Lanka and Middle East:
The AO taxed the revenue from customers in Sri Lanka and the Middle East under Section 9(1)(vi) and (vii) and Article 12 of the Tax Treaty. The Tribunal held that the revenue from these customers is not taxable under the Tax Treaty or the Act, as the AO did not demonstrate that the customers used the rights in the IPs/services for business in India or for earning income from any source in India.

5. Double Taxation and Incorrect Tax Rate Application:
The Tribunal noted that the AO taxed the revenue on a gross basis at 15% and also attributed a portion of the revenue to the alleged PE, resulting in double taxation. The Tribunal did not need to adjudicate this issue further due to its findings on other grounds.

6. Attribution of Profits to the Alleged PE:
The AO attributed 15% of the revenue from software licensing and hardware sales and 57.5% of the revenue from services to the alleged PE. The Tribunal remitted the issue to the AO for fresh adjudication, directing the AO to refer the matter to the Transfer Pricing Officer (TPO) to determine the Arm's Length Price (ALP) and attribute profits accordingly.

7. Deduction of Remuneration Paid to the Alleged PE:
The Tribunal directed the AO to consider the deduction of remuneration paid to the alleged PE while determining the profits attributable to the PE, in accordance with Article 7 of the Tax Treaty.

8. Applicability of Transfer Pricing Provisions:
The AO held that the transfer pricing provisions apply to the assessee and rejected the Transfer Pricing analysis of Aspect India. The Tribunal directed the AO to accept the TPO analysis of Aspect India wherever available.

9. Levy of Interest Under Section 234B of the Act:
The Tribunal allowed the assessee's ground against the levy of interest under Section 234B, citing the Delhi High Court's ruling in Jacobs Civil Incorporated, which held that non-residents cannot be held liable for interest under Section 234B if the payer defaults in deducting tax at source.

10. Initiation of Penalty Proceedings:
The Tribunal found it premature to question the initiation of penalty proceedings under Sections 271BA, 271AA, and 271(1)(c) at this stage, as they are independent proceedings whose outcomes can be challenged if the assessee feels aggrieved.

Conclusion:
The Tribunal partly allowed the appeals filed by the assessee for the relevant assessment years and dismissed the Cross Objections filed by the Revenue as withdrawn. The Tribunal's detailed analysis and decisions on each issue provide a comprehensive resolution to the complex tax matters involved.