2017 (3) TMI 1888 - AT - Income Tax

TDS u/s 195 - Disallowing software purchased by way of imports 40(a)(i) on account of non deduction of TDS - Whether payments made for software purchased by the assessee amounted to royalty as envisaged in Explanation 3 to section 9(1)(vi)? - CIT-A deleted the addition - HELD THAT - Perusal of the agreement suggests that neither there was any transfer of copyright nor the vendor has given any permission for commercial exploitation of the copyright of the software. No source codes etc have been supplied by the vendor to the assessee. There is no permission given to the assessee to make any modification or re-engineering of the software, which was supplied for the limited purpose of internal use of the assessee. Ownership with regard to title and interest in the licensed software is retained by the supplier. It is noted that in the case of Shinhan Bank vs DDIT 2016 (7) TMI 1432 - ITAT MUMBAI similar situations arose before the Mumbai bench of the Tribunal wherein the AO had disallowed the deductions claimed by the assessee on account of payment made for purchase of software u/s 40(a)(i) for non deduction of tax at source u/s 195 by the said assessee. Hon ble Bench examined latest legal position in this regard and held that impugned payments were not liable to the taxed as royalty in the hands of payees (i.e. suppliers) and therefore, no tax was required to be deducted at source and thus no disallowance could have been made u/s 40(a)(i). Identical situation came up in the case of CIT vs Vinzas Solutions India (P) ltd 2017 (1) TMI 1102 - MADRAS HIGH COURT wherein the department invoked provisions of section 40(a)(i) by treating the amount of purchase of software as royalty under Explanations 4 and 5 of section 9(1)(vi) of the Act and the assessee in the said case was a dealer engaged in buying and selling of software products in the open market. It was contended on behalf of the assessee before the Hon ble High Court that the transaction in question was one of purchase and sale of product and nothing more. Thus we find that it was rightly held by Ld. CIT(A) that TDS was not required to be deducted in this case. Therefore, disallowance made by AO by invoking provisions of section 40(a)(i) has been rightly deleted by Ld. CIT(A). No interference is called for in his order and therefore, the same is upheld. - Decided against revenue.

Summary

Issues Involved:
1. Disallowance under Section 40(a)(i) for non-deduction of TDS on software expenses.
2. Classification of software payments as 'royalty' under Section 9(1)(vi) of the Income Tax Act.
3. Applicability of retrospective amendments by Finance Act, 2012.
4. Distinction between 'copyrighted article' and 'copyright' in software transactions.
5. Applicability of Double Taxation Avoidance Agreements (DTAAs).

Detailed Analysis:

1. Disallowance under Section 40(a)(i) for non-deduction of TDS on software expenses:
The Tribunal had to reconsider Ground No. 3, which was previously unadjudicated, regarding the disallowance of software expenses under Section 40(a)(i) due to non-deduction of TDS amounting to ?25,11,88,831. The Revenue argued that the payments for software amounted to 'royalty' under Explanation 3 to Section 9(1)(vi) and thus required TDS deduction. The assessee contended that the payments were for acquiring a 'copyrighted article' and not 'royalty,' thus not necessitating TDS under Section 195 and consequently, no disallowance under Section 40(a)(i).

2. Classification of software payments as 'royalty' under Section 9(1)(vi) of the Income Tax Act:
The Revenue supported the AO's stance that the software payments constituted 'royalty,' citing the Karnataka High Court's judgment in CIT vs Samsung Electronics Company Limited. The assessee, however, argued that the software purchases were for copyrighted articles, not the transfer of copyright, and thus not 'royalty.' The Tribunal examined various judgments, including Shinhan Bank, Vinzas Solutions India (P.) Ltd., and M Tech India (P.) Limited, which supported the assessee's position that such payments do not constitute 'royalty.'

3. Applicability of retrospective amendments by Finance Act, 2012:
The Tribunal considered the retrospective amendment by Finance Act, 2012, which included software payments under 'royalty.' The assessee argued that it was impossible to retrospectively comply with TDS requirements for past transactions. The Tribunal agreed, referencing the principle of 'impossibility of performance' and judgments like Shinhan Bank and Channel Guide India Ltd., which held that retrospective amendments cannot impose TDS obligations for past transactions.

4. Distinction between 'copyrighted article' and 'copyright' in software transactions:
The Tribunal analyzed the nature of the software transactions, distinguishing between acquiring a copyrighted article and acquiring copyright. The agreements reviewed indicated that the assessee only obtained a license for internal use, without rights to modify or commercially exploit the software. The Tribunal, referencing the Copyright Act and various judgments, concluded that payments for such software are for copyrighted articles, not 'royalty.'

5. Applicability of Double Taxation Avoidance Agreements (DTAAs):
The Tribunal noted that under DTAAs, the definition of 'royalty' is narrower than under the Income Tax Act. Judgments like Qad Europe B.V. and First Advantage (P.) Ltd. supported the view that software payments do not constitute 'royalty' under DTAAs. The Tribunal upheld that the payments were business income and not taxable as 'royalty' in the absence of a Permanent Establishment (PE) in India.

Conclusion:
The Tribunal upheld the CIT(A)'s decision, finding that the software payments were not 'royalty' and thus not subject to TDS under Section 195. Consequently, the disallowance under Section 40(a)(i) was rightly deleted. The Tribunal dismissed Ground No. 3 raised by the Revenue, affirming that no interference was required in the CIT(A)'s order.