2022 (4) TMI 966 - AT - Income Tax

Income accrued in India - Taxability of revenue from sale of software - Royalty receipt - software is protected by patent, copyright and trade mark protections, therefore the AO held the payments made by the users as the consideration for the use or the right to use of such patents, Software and Cloud Infrastructure covering them in the definition of royalty both by clause 9 (1)(vi) Explanation 2 sub-clause (iii) and (v) of the Income Tax Act, 1961 and also Article 12 (3) of the India US, DTAA - HELD THAT - Revenue has been following a persistent approach in regard to assessee and its sister assessee subsidiaries of MS Corp holding sale of MS Retail Software Products to Indian Distributors as royalty under the Act as well as under DTAA between India and US. The assessment in the hands of present assessee was made on substantive basis while the protective assessment was in the hands of M/s Microsoft Regional Sales Corporation(MRSC). The assessments in the hands of Gracemac which stands amalgamated with the assessee stands set aside in regard to assessment years 2005-06, 2006-07 and 2007-08 by the co-ordinate Bench s judgment 2020 (11) TMI 1049 - ITAT DELHI which have been further upheld by Hon ble Delhi High Court by judgment 2022 (3) TMI 482 - DELHI HIGH COURT . The same were based on the principles of law that sale of software products does not give rise to royalty income as laid down by the Hon ble Delhi High Court in Infrasoft Ltd. case 2013 (11) TMI 1382 - DELHI HIGH COURT which have now further been affirmed by the Hon ble Supreme Court of India in the case of Engineering Analysis Centre of Excellence P. Ltd. 2021 (3) TMI 138 - SUPREME COURT In the light of aforesaid as there are no distinguishing facts with regard to present assessment years and as this Bench has also allowed the similar grounds for the assessment year AY for 2010-11, 2011-12 and 2012-13 the grounds in hand are sustained. The assessment order for AY for 2012-13 is liable to be set aside. Income from cloud hosting services - Subscription received towards Cloud Services to be royalty income - HELD THAT - The cloud base services do not involve any transfer of rights to the customers in any process. The grant of right to install and use the software included with the subscription does not include providing any copy of the said software to the customer. The assessee s cloud base services are though based on patents / copyright but the subscriber does not get any right of reproduction. The services are provided online via data centre located outside India. The Cloud services merely facilitate the flow of user data from the front end users through internet to the provider s system and back. The ld. AO has fallen in error in interpreting it as licensing of the right to use the above Cloud Computing Infrastructure and Software (para 10.5 of the Ld. AO order). Thus the subscription fee is not royalty but merely a consideration for online access of the cloud computing services for process and storage of data or run the applications. Thus the Bench is of considered view that the ld. Tax Authorities below had fallen in error in considering the subscription received towards Cloud Services to be royalty income.

Summary

Issues Involved:
1. Taxability of revenue from the sale of software.
2. Taxability of revenue from cloud services.
3. Transfer of TDS credit.
4. Penalty proceedings under section 271(1)(c) of the Income Tax Act, 1961.

Issue-wise Detailed Analysis:

1. Taxability of Revenue from Sale of Software:
The primary issue was whether the revenue earned from the licensing of Microsoft software products to end users in India should be classified as "royalty" and thus taxable in India. The assessee argued that the revenue from the sale of software should not be considered royalty based on the precedent set by the Hon’ble Delhi High Court in the case of DIT vs. Infrasoft Ltd. [2014] 220 Taxman 273, which was further upheld by the Hon’ble Supreme Court in Engineering Analysis Centre of Excellence (P) Ltd. vs. Commissioner of Income Tax (2021) 125 taxmann.com 42 (SC). The Tribunal noted that the revenue had consistently treated the sale of MS Retail Software Products to Indian distributors as royalty. However, the Tribunal found no distinguishing facts for the assessment year in question compared to previous years where similar grounds were allowed, and thus, the assessment order for AY 2012-13 was set aside.

2. Taxability of Revenue from Cloud Services:
The second issue was whether the revenue from cloud services should be treated as royalty. The assessee contended that the subscription to cloud-based services does not involve any transfer of rights to the customers in any process, and thus should not be classified as royalty. The Tribunal referred to the judgment in M/s. Salesforce.com Singapore Pte. Vs. Dy. D.I.T. Circle-2(2) ITA No. 4915/DEL/2016, where it was held that subscription to cloud computing services does not give rise to royalty income. The Tribunal also cited similar judgments from the Mumbai and Chennai Benches, concluding that the cloud-based services do not involve any transfer of rights to the customers and thus the subscription fee is not royalty but merely a consideration for online access to cloud computing services. Consequently, the Tribunal held that the tax authorities had erred in treating the subscription received towards cloud services as royalty income.

3. Transfer of TDS Credit:
The assessee argued that the AO erred in not transferring the TDS credit claimed by MRSC to MOLC, despite the mandatory directions of the Hon’ble DRP and the law laid down by the Supreme Court in ITO vs. Bachu Lal Kapoor (60 ITR 74) (1966) (SC). However, this issue was not elaborated upon in the detailed analysis as the arguments were restricted to grounds 1 to 3.

4. Penalty Proceedings:
The assessee contended that the AO erred in initiating penalty proceedings under section 271(1)(c) of the Income Tax Act, 1961. Similar to the TDS credit issue, this was not elaborated upon in the detailed analysis as the arguments were restricted to grounds 1 to 3.

Conclusion:
The Tribunal allowed the appeal on grounds 1 to 3, setting aside the assessment order for AY 2012-13. The revenue from the sale of software and cloud services was not considered royalty and thus not taxable in India under the India-US DTAA. The Tribunal's decision was consistent with previous judgments and upheld the principles of law regarding the classification of software sales and cloud services revenue.