2023 (8) TMI 875 - AT - Income Tax

Taxability of income - Characterization of receipts - taxability of receipts towards software sub-licence fee - income from other sources u/s 56 of the Act and Article 23(3) of India USA Double Taxation Avoidance Agreement (DTAA) OR business income - HELD THAT - The facts of the present appeal, admittedly, the item of income sought to be taxed is the receipts from sublicensing of software licences. Therefore, ordinarily, the income can be characterized as royalty under section 9(1)(vi) of the Act and Article 12 of the DTAA. In case, it is not taxable as royalty income, it can be treated as business income under Article 7 of the tax treaty. Thus, to our understanding, the residuary provision under Article 23 can come into play when an item of income is not expressly dealt with in other articles preceding article 23 of the tax treaty. Characterization of an item of income under a particular Article is different from taxability of that income under the said Article. A particular item of income can fall either under Article 7 or Article 12. However, their taxability under these articles is subject to fulfillment of conditions enumerated therein. The residuary provisions of Article 23 will not apply to items of income, which can be classified under other provisions of the tax treaty, but their taxability is subject to fulfillment of conditions mentioned therein. To our understanding, the receipts in dispute could have been characterized either as royalty income falling under Article 12 or business income under Article 7 of the tax treaty. However, in view of the ratio laid down in judicial precedents, the income is not taxable as royalty. Alternatively, it could have been taxed as business income under Article 7 of the tax treaty. However, in absence of a PE, it cannot be taxed in India. Thus, in our view, the income in dispute, since can be classified under other Articles of the tax treaty, they cannot be brought under the residuary provision contained under Article 23 of the tax treaty. The income cannot be treated as other income under Article 23(3) of the tax treaty. The only provision under which it could have been taxed is as business income under Article 7. Thus in absence of a PE in India, it cannot be taxed under that provision as well. Therefore, we direct the Assessing Officer to delete the addition. Decided in favour of assessee.

Summary

Issues Involved:
1. Taxability of receipts towards software sub-licence fee as income from other sources under section 56 of the Act and Article 23(3) of India - USA Double Taxation Avoidance Agreement (DTAA).

Summary:

Issue 1: Taxability of receipts towards software sub-licence fee as income from other sources under section 56 of the Act and Article 23(3) of India - USA DTAA

The assessee, a non-resident corporate entity and tax resident of the USA, engaged in healthcare business for the GE group, received income from software licence fees cross-charged to its affiliates in India. The Assessing Officer issued a show-cause notice to the assessee, proposing to tax the software licence fee receipts as income from other sources under section 56(1) of the Act and Article 23(3) of the India-USA DTAA. The assessee argued that these receipts should be treated as business income under Article 7 of the tax treaty, not taxable in India due to the absence of a Permanent Establishment (PE).

The Assessing Officer, rejecting the assessee's claim, framed the draft assessment order treating the receipts as income from other sources. The Dispute Resolution Panel (DRP) endorsed this view. The assessee contended that the receipts were for sublicensing standard commercial software licences required by affiliates for business operations and should not be treated as royalty income. The assessee cited judicial precedents, including the Hon'ble Supreme Court decision in Engineering Analysis Centre of Excellence Pvt. Ltd. Vs. CIT (432 ITR 471), to support its claim.

The Tribunal observed that the assessee purchased software licences from third-party licensors and sublicensed them to affiliates in India, recovering only the cost. The software licences were used as business tools by the affiliates, generating service income. The Tribunal noted that the Assessing Officer initially considered the receipts as royalty income but later re-characterized them as other income under section 56(1) of the Act and Article 23(3) of the tax treaty. The Tribunal held that the receipts from sublicensing software licences were part of the assessee's regular business activity and should be treated as business income under Article 7 of the tax treaty. In the absence of a PE in India, the income could not be taxed in India. The Tribunal concluded that the income could not be brought under the residuary provision of Article 23(3) of the tax treaty and directed the Assessing Officer to delete the addition.

Conclusion:

The appeal was allowed, and the Tribunal directed the deletion of the addition made by the Assessing Officer, concluding that the income from sublicensing software licences should be treated as business income under Article 7 of the tax treaty and not taxable in India due to the absence of a PE.