2017 (2) TMI 916 - AT - Income Tax

TDS on the payment to ZES treating it in the nature of royalty - liability for the payment to ZES for the use of copy right or for copyrighted article - Permanent Establishment (PE) in India - taxability in India - payments made to ZES are its business income or Royalty - Held that - Assessee throughout his submission urged that, ZES provided the assessee a license to use its software on perpetual, non- exclusive, known as assignable, terminable and known sub licensable basis. ZES software is a Shrink wrapped or off the shelf copyrighted packaged software readily available and which has not been customized to meet specific requirement of the assessee. The assessee will have no right to use, copy, and display or print the software or documentation in whole or in part. Similarly the assessee is prohibited from using the software on a service bureau basis or otherwise providing data catching and /or management functionality to third party except or otherwise permitted in the agreement. The AO has not brought any quantity material on record to prove it otherwise. As decided in M/s Capgemini Business Services India Ltd. vs. ACIT 2016 (3) TMI 280 - ITAT MUMBAI the assessee can not be said to have paid the consideration for use of or the right to use copyright but has simply purchased the copyrighted work embedded in the CD- ROM which can be said to be sale of good by the owner. The consideration paid by the assessee thus as per the clauses of DTAA can not be said to be royalty and the same will be outside the scope of the definition of royalty as provided in DTAA and would be taxable as business income of the recipient. The assessee is entitled to the fair use of the work/product including making copies for temporary purpose for protection against damage or loss even without a license provided by the owner in this respect and the same would not constitute infringement of any copyright of the owner of the work even as per the provisions of section 52 of the Copyright Act,1957. - Decided in favour of assessee

Summary

Issues Involved:
1. Determination of whether the license fees payable to ZES constitutes "royalty" under Explanation 2 to Section 9(1)(vi) of the Income Tax Act and Article 12 of the DTAA between India and the USA.
2. Determination of whether the payment to ZES should be classified as business income, given that ZES has no Permanent Establishment (PE) in India.
3. Interpretation of the nature of payments for standardized proprietary software as either for the use of copyright or copyrighted article.

Issue-Wise Detailed Analysis:

1. Determination of whether the license fees payable to ZES constitutes "royalty" under Explanation 2 to Section 9(1)(vi) of the Income Tax Act and Article 12 of the DTAA between India and the USA:

The assessee contended that the license fees payable to ZES, a tax resident of the USA without a PE in India, does not fall within the ambit of royalty as per the provisions of Explanation 2 to Section 9(1)(vi) of the Income Tax Act and Article 12 of the DTAA between India and the USA. The Assessing Officer (AO) held that the license fees payable to ZES could be considered as royalty, relying on the decision of the Karnataka High Court in the case of Samsung Electronics Company Limited. The AO directed the assessee to deduct tax at the rate of 10% plus applicable surcharge.

2. Determination of whether the payment to ZES should be classified as business income, given that ZES has no Permanent Establishment (PE) in India:

The Commissioner of Income-tax (Appeals) [CIT(A)] held that the payment under consideration is in the nature of business income of ZES. Since ZES has no PE in India, the consideration paid is not taxable in India. The CIT(A) allowed the appeal of the assessee, holding that the AO was not justified in directing the assessee to deduct TDS at 10% on the payment to ZES treating it as royalty.

3. Interpretation of the nature of payments for standardized proprietary software as either for the use of copyright or copyrighted article:

The assessee argued that ZES provided a license to use its software on a perpetual, non-exclusive, non-assignable, terminable, and non-sublicensable basis. The software is a 'shrink-wrapped' or 'off-the-shelf' copyrighted packaged software readily available and not customized for the assessee. The assessee has no right to use, copy, display, or print the software or documentation in whole or in part. The Tribunal observed that the AO did not bring any material on record to prove otherwise. The Tribunal referred to the decision in M/s Capgemini Business Services India Ltd. vs. ACIT, which held that the sale of a CD ROM or diskette with software constitutes the sale of a product and not a license. The Tribunal concluded that the consideration received on the supply of software without transfer of any copyright is business income and not royalty.

The Tribunal further discussed the provisions of the Copyright Act, 1957, and concluded that the fair use of the purchased software for the purpose it was supplied, including making backup copies for protection against loss or damage, does not constitute an infringement of copyright. The Tribunal held that the consideration paid by the assessee for the purchase of the copyrighted work embedded in the CD-ROM cannot be said to be royalty under the DTAA and would be taxable as business income of the recipient.

Conclusion:

The Tribunal dismissed the appeal filed by the Revenue, holding that the grounds of appeal raised by the Revenue are covered against them by the decisions of the coordinate bench in similar cases. The Tribunal found no merit in the grounds of appeal raised by the Revenue and upheld the order of the CIT(A). The order was pronounced in the open court on February 10, 2017.