2024 (8) TMI 1434 - HC - Income Tax

Denial of Tax Withholding Certificate u/s 197 - supply of computer software to associated entities - whether constitute royalty under the Income Tax Act and the India-US Double Tax Avoidance Agreement (DTAA)? - as argued reimbursement payments made by it did not constitute income liable to tax under the Act - HELD THAT - As is apparent from a reading of Rule 28AA(2), the competent authority stands placed under a statutory duty to determine the estimated liability taking into consideration aspects such as tax payable on estimated income, tax payable on the assessed or returned income in the previous years, existing liabilities, advance tax payments as well as tax deducted at source or tax collected at source in the previous years. Rule 28AA of the 1962 Rules thus clearly required the authority to confer and accord due consideration on aspects pertaining to chargeability when raised by the assessee. What needs to be emphasised is that merely because the grant of a certificate under Section 197 of the Act is not accorded finality or may not amount to a definitive determination on the question of taxability, the same would not absolve the authority from considering all aspects in light of the statutory mandate referred to above. We are constrained to observe that while passing the impugned order, the respondent has clearly failed to bear the aforesaid aspects in consideration. Not only was the decision in Engineering Analysis cited for its consideration, it also appears to have been vehemently urged that the supply or licensing of software cannot possibly be viewed as being royalty either under the Act or the DTAA. The aforesaid submissions could not have possibly been negated merely on the basis of a Draft Assessment Order. In the scheme of Section 144C of the Act, a draft order of assessment is clearly inchoate and does not represent a final or conclusive verdict on the question of chargeability to tax. This, since on receipt of the draft order, the assessee is entitled in law to file objections before the DRP, and if the said objections are not accepted, the same can always be assailed before the ITAT. In any case, the final Assessment Order would have to await the completion of determination by the DRP. Till such time, the Draft Assessment Order clearly does not constitute a determination under the Act of which cognizance could have possibly been taken. As decided in EY Global Services Ltd. 2021 (12) TMI 571 - DELHI HIGH COURT for the payment received by EYGSL (UK) from EYGBS (India) to be taxed as royalty , it is essential to show a transfer of copyright in the software to do any of the acts mentioned in section 14 of the Copyright Act, 1957. A licence conferring no proprietary interest on the licensee, does not entail parting with the copyright. Where the core of a transaction is to authorise the end- user to have access to and make use of the licenced software over which the licensee has no exclusive rights, no copyright is parted with and therefore, the payment received cannot be termed as royalty . EYGBS (India), in terms of the service agreement and the memorandum of understanding, merely receives the right to use the software procured by the EYGSL (UK) from third-party vendors. The consideration paid for the use of the same therefore, cannot be termed as royalty as held by the Supreme Court in Engineering Analysis Centre 2021 (3) TMI 138 - SUPREME COURT . In determining the same, the rights acquired by the EYGSL (UK) from the third-party software vendors are not relevant. What is relevant is the agreement between the EYGSL (UK) and the EYGBS (India). As the same does not create any right to transfer the copyright in the software, the same would not fall within the ambit of the term royalty . We, accordingly, allow the instant writ petitions and quash the impugned orders - The application of the petitioner for grant of Nil Withholding Tax Certificates shall consequently be examined afresh.

Summary

Issues Involved:
1. Failure to grant Nil Withholding Tax Certificate under Section 197 of the Income Tax Act, 1961.
2. Determination of whether reimbursements for software licenses constitute "royalty" under the Income Tax Act and the India-US Double Tax Avoidance Agreement (DTAA).
3. Examination of the procedural and substantive requirements under Section 197 and Rule 28AA of the Income Tax Rules, 1962.

Detailed Analysis:

1. Failure to Grant Nil Withholding Tax Certificate under Section 197 of the Income Tax Act, 1961:
The petitioner, a US-based company providing localization and translation solutions, sought Nil Withholding Tax Certificates for FY 2022-23 and FY 2023-24. The respondents issued certificates at a 9.99% withholding rate, based on a Draft Assessment Order dated 21 September 2022, which treated the petitioner's receipts as "royalty" under the Income Tax Act and the India-US DTAA. The petitioner challenged these orders and certificates, arguing that the reimbursements were not taxable.

2. Determination of Whether Reimbursements for Software Licenses Constitute "Royalty":
The petitioner contended that reimbursements for software licenses used internally by its group entities, including its Indian entity, did not constitute "royalty." The respondents relied on the Draft Assessment Order, which treated these receipts as "royalty" due to the centralized procurement and distribution of software licenses. The ITAT, in its order dated 20 September 2023, set aside the final Assessment Order, concluding that cost-to-cost reimbursements for software licenses cannot be treated as "royalty." The ITAT emphasized that the reimbursements did not include a markup and were purely for internal use.

3. Examination of Procedural and Substantive Requirements under Section 197 and Rule 28AA:
The court highlighted that Section 197 allows for a certificate for lower or no tax deduction if the income is not chargeable to tax. The authority must undertake a prima facie evaluation of taxability. Rule 28AA requires consideration of various factors, including tax payable on estimated income, assessed or returned income, existing liabilities, and advance tax payments. The respondents failed to properly consider these aspects and relied solely on the Draft Assessment Order, which was inchoate and not a final determination.

The court cited the Supreme Court's decision in Engineering Analysis Centre of Excellence Pvt. Ltd. v. CIT, which clarified that tax deductions under Section 195 are only required if the non-resident is liable to pay tax. The court also referred to its own decisions in Milestone Systems A/S vs. Deputy Commissioner of Income Tax and EY Global Services Ltd. vs. Assistant Commissioner of Income Tax, emphasizing the need for a thorough examination of taxability before denying a Nil Withholding Tax Certificate.

Conclusion:
The court quashed the impugned orders and certificates, directing the respondents to re-examine the petitioner's application for Nil Withholding Tax Certificates in accordance with the law and the observations made. The court stressed that the authority must consider all relevant aspects, including the Supreme Court's decision in Engineering Analysis and the procedural requirements under Section 197 and Rule 28AA.