2016 (8) TMI 729 - AT - Income Tax

Nature of Royalty - payments received towards sale of software as part of machinery - India-Israel DTAA - Held that - Following the decision of the Coordinate Bench of the Tribunal in the assessee s own case for A.Y. 2011-12 we hold that the amounts received by the assessee on sale of operational/application software and spare parts is not exigible to tax as Royalty and therefore the addition made by the AO and sustained by the DRP is to be deleted. We hold and direct the AO accordingly.

Issues Involved:
1. Legality of the assessment order.
2. Taxability of payments received for software as "Royalty."
3. Integral nature of software with the supplied machine.
4. Definition of "Royalty" under DTAA vs. Income Tax Act.
5. Credit of TDS.
6. Levy of interest under Sections 234A and 234B.
7. Initiation of penalty proceedings under Section 271(1)(c).

Issue-wise Detailed Analysis:

1. Legality of the Assessment Order:
The assessee contended that the assessment order dated 09.10.2015 under section 143(3) read with section 144C of the Income-tax Act, 1961, was illegal and bad in law. The Dispute Resolution Panel (DRP) affirmed the draft assessment order without judiciously considering the material and submissions/objections filed by the appellant.

2. Taxability of Payments Received for Software as "Royalty":
The primary issue was whether the payments received by the assessee for the supply of software to customers in India constituted "Royalty" under Explanation 2(v) of section 9(1)(vi) of the Act and Article 12(3) of the India-Israel DTAA. The assessee argued that the software was integral to the machines sold and thus should not be taxed as "Royalty." The Tribunal referenced its decision in the assessee's case for A.Y. 2011-12, where it was held that such payments did not constitute "Royalty."

3. Integral Nature of Software with the Supplied Machine:
The assessee contended that the software was an integral part of the machines, without which the machines could not function. The Tribunal agreed, noting that customers purchased the machines and software together, and the software had no independent existence. The Tribunal referenced multiple judicial decisions supporting the view that payments for software integral to hardware should not be treated as "Royalty."

4. Definition of "Royalty" under DTAA vs. Income Tax Act:
The assessee argued that the definition of "Royalty" in the DTAA should prevail over the Income Tax Act due to section 90(2) of the Act, which states that treaty provisions beneficial to the assessee should apply. The Tribunal agreed, citing judicial precedents that amendments to the Act cannot automatically alter treaty provisions unless the treaty itself is amended.

5. Credit of TDS:
The assessee claimed that the assessing officer erred in not allowing credit of TDS amounting to ?32,85,560 while computing the income tax liability. The Tribunal did not provide specific details on this issue in the summarized judgment.

6. Levy of Interest under Sections 234A and 234B:
The assessee challenged the levy of interest amounting to ?4,22,447 and ?1,81,65,221 under sections 234A and 234B of the Act. The Tribunal did not provide specific details on this issue in the summarized judgment.

7. Initiation of Penalty Proceedings under Section 271(1)(c):
The assessee contended that the initiation of penalty proceedings under section 271(1)(c) was erroneous. The Tribunal held that the ground was premature and not maintainable since no penalty had been levied in the impugned order.

Conclusion:
The Tribunal partly allowed the assessee's appeal, holding that the payments received for software integral to the machines did not constitute "Royalty" and should not be taxed as such. The grounds related to the credit of TDS, levy of interest, and initiation of penalty proceedings were either not pressed or dismissed as premature.

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