2021 (2) TMI 415 - AT - Income Tax

Income accrued in India - Income from cloud hosting services - India - US tax treaty - HELD THAT - As decided in own case 2020 (10) TMI 708 - ITAT MUMBAI as per the distributors agreements, it was the responsibility of the distributors to resolve the end user customers queries. - Decided in favour of assessee.

Issues Involved:
1. Classification of income from cloud hosting services as royalty.
2. Classification of income from cloud hosting services as fees for technical services.
3. Levy of interest under section 234B of the Income Tax Act.

Detailed Analysis:

Issue 1: Classification of Income from Cloud Hosting Services as Royalty
The appellant challenged the Assessing Officer's (AO) decision, which classified income from cloud hosting services as royalty under section 9(1)(vi) of the Income Tax Act, 1961, and Article 12(3)(b) of the India-US tax treaty. The AO, following the directions of the Dispute Resolution Panel (DRP), held that the cloud hosting system, being a combination of hardware, software, and networking elements, constitutes industrial/commercial/scientific equipment. Consequently, the income of INR 6,23,14,703 earned by the appellant was considered royalty for the use or right to use such equipment.

The appellant contended that the AO erroneously applied the definition of royalty under the Act, as retrospectively amended by the Finance Act, 2012, to determine royalty income under the India-US tax treaty, despite no corresponding amendment in the treaty. The appellant also argued that providing clients with a license to use third-party software does not constitute royalty under the Act or the treaty.

Issue 2: Classification of Income from Cloud Hosting Services as Fees for Technical Services
The appellant disputed the AO's classification of income from cloud hosting services as fees for technical services under section 9(1)(vii) of the Act and Article 12(4)(a) of the India-US tax treaty. The AO, guided by the DRP, held that the income from cloud hosting services qualifies as fees for technical services, which include managerial, technical, or consultancy services.

Issue 3: Erroneous Levy of Interest under Section 234B
The appellant contested the AO's levy of interest amounting to INR 24,29,388 under section 234B of the Act. This section pertains to the interest charged for defaults in payment of advance tax.

Judgment Analysis:

Issue 1: Classification of Income from Cloud Hosting Services as Royalty
The Tribunal referred to its previous decision in the appellant's case for the assessment year 2012-13, where similar issues were adjudicated. The Tribunal had held that payments for the sale of specialized software and maintenance and support services (including upgrades) were not in the nature of royalty under Article 12 of the India-Finland tax treaty or the Explanation 2 to section 9(1)(vi) of the Act. The Tribunal emphasized that the appellant had granted only a non-exclusive license to market and distribute software products, retaining all intellectual property rights. The distributors did not have rights to the source code, modify, or reproduce the software, indicating that the payments were sales revenue, not royalty.

The Tribunal also noted that the retrospective amendments to the definition of royalty under the Act could not be unilaterally applied to the tax treaty unless the treaty was correspondingly amended. This view was supported by judicial precedents, including the Delhi High Court's judgment in DIT vs. New Skies Satellite BV.

Issue 2: Classification of Income from Cloud Hosting Services as Fees for Technical Services
Following the rationale in the previous decision, the Tribunal held that the payments for software upgrades, maintenance, and support services did not fall within the definition of fees for technical services under Article 12 of the India-Finland tax treaty. The services provided were ancillary to the distribution of software products and did not involve the transfer of technical knowledge or skills to the distributors.

Issue 3: Erroneous Levy of Interest under Section 234B
The Tribunal found that the issue of interest under section 234B was consequential to the primary issues. Since the primary issues were decided in favor of the appellant, the levy of interest under section 234B was also set aside.

Conclusion:
The Tribunal allowed the appeal, holding that the income from cloud hosting services did not constitute royalty or fees for technical services under the relevant tax treaty and the Income Tax Act. The levy of interest under section 234B was also set aside. The Tribunal's decision was consistent with its previous rulings in the appellant's cases for earlier assessment years.

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