2008 (12) TMI 245 - AT - Income Tax

DTAA between UK and India - Sale of software - payment received by the assessee under the license agreement for allowing use of the software - chargeable to tax under Article 7 of DTAA as business income of the assessee OR not under Article 12 as Royalty - PE in the form of branch office in India. HELD THAT - We are of the view that the issue involved in the present case relating to nature of software receipts is squarely covered by the decisions of Tribunal in the cases of Motorola Inc. 2005 (6) TMI 226 - ITAT DELHI-A and Samsung Electronics Co. Ltd. 2005 (2) TMI 438 - ITAT BANGALORE-A and respectfully following the same, we hold that the amount received by the assessee under the license agreement for allowing use of the software was not 'royalty' either under the IT Act or under DTAA. We also hold that the other receipts on account of maintenance charges and training fees being incidental to the software receipts assume the same character as that of software receipts and the same are liable to be taxed accordingly. We therefore, set aside the order of the CIT(A) on this issue and restore the matter to the file of the AO with a direction to reframe the assessment in view of our decision on the preliminary issue that the payment received by the assessee company against software licensed was not in the nature of royalty but was in the nature of business profits chargeable to tax in its hands under art. 7 of the DTAA. As we have restored the matter to the file of the AO for framing the assessment afresh keeping in view our decision on the preliminary issue relating to the taxability of the software payments, we do not deem it necessary or expedient to adjudicate upon the remaining grounds raised by the assessee in this appeal which are mainly consequential in nature. In the result, the appeal of the assessee is treated as allowed.

Issues Involved:
1. Classification of receipts from the sale of software, annual maintenance charges, and training fees as royalty.
2. Applicability of the Supreme Court decision in Tata Consultancy Services vs. State of Andhra Pradesh.
3. Interpretation of the term "royalty" under Section 9(1)(vi) of the IT Act and Article 13 of the DTAA.
4. Applicability of Section 44D and Section 115A of the IT Act.
5. Distinction between transfer of copyright and transfer of copyrighted article.
6. Relevance of OECD Commentary and High Powered Committee Report.
7. Binding nature of Tribunal decisions in similar cases.

Issue-wise Detailed Analysis:

1. Classification of Receipts as Royalty:
The assessee challenged the classification of receipts from the sale of software, annual maintenance charges, and training fees as royalty. The AO treated these receipts as royalty under Article 13 of the DTAA and Section 44D read with Section 115A of the IT Act. The AO's reasoning was based on the definition of royalty in Section 9(1)(vi) and the nature of the software and services provided. The CIT(A) upheld this classification, noting that the software was customized and licensed to Indian customers, and the payments were for the use of intellectual property.

2. Applicability of Tata Consultancy Services vs. State of Andhra Pradesh:
The assessee relied on the Supreme Court decision in Tata Consultancy Services vs. State of Andhra Pradesh, where software was considered "goods" for sales tax purposes. The AO and CIT(A) distinguished this case, stating that the decision was in the context of the Sales-tax Act and not applicable to income tax. The CIT(A) emphasized that the treatment of software under different statutes could vary, and the sales tax definition could not be imported into the IT Act.

3. Interpretation of "Royalty" under Section 9(1)(vi) and Article 13 of the DTAA:
The AO and CIT(A) interpreted the term "royalty" to include payments for the use of or the right to use software. The CIT(A) referred to the Indian Copyright Act and concluded that the payments were for the use of copyrighted software, thus qualifying as royalty. The CIT(A) also relied on the High Powered Committee's report, which characterized software payments as royalty, contrary to the OECD Commentary.

4. Applicability of Section 44D and Section 115A:
The AO applied Section 44D, which prohibits the allowance of expenses for earning royalty income, and taxed the receipts at 20% under Section 115A. The CIT(A) upheld this application, stating that the provisions were clear and applicable to the assessment year in question.

5. Distinction between Transfer of Copyright and Transfer of Copyrighted Article:
The assessee argued that the payments were for a copyrighted article, not a copyright, and thus not royalty. The CIT(A) rejected this argument, stating that the license agreements granted rights to use the software, which constituted a transfer of rights in respect of copyright. The CIT(A) distinguished the case from the Tribunal's decision in Motorola Inc., noting that the software in the present case was customized and not an off-the-shelf product.

6. Relevance of OECD Commentary and High Powered Committee Report:
The CIT(A) did not accept the OECD Commentary's conservative interpretation of "use" and relied on the High Powered Committee's report, which supported the classification of software payments as royalty. The CIT(A) noted that India's position on software payments differed from the OECD's and that the report provided a basis for treating the payments as royalty.

7. Binding Nature of Tribunal Decisions:
The Tribunal analyzed the decisions in Motorola Inc. and Samsung Electronics Co. Ltd., where payments for software were not considered royalty. The Tribunal found that the facts of the present case were similar and that the CIT(A) incorrectly distinguished these decisions. The Tribunal held that the payments were for copyrighted articles, not copyrights, and thus not royalty.

Conclusion:
The Tribunal set aside the CIT(A)'s order, holding that the payments received by the assessee were not royalty but business profits under Article 7 of the DTAA. The Tribunal directed the AO to reframe the assessment accordingly and did not adjudicate the remaining grounds as they were consequential. The appeal was treated as allowed.

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