2013 (9) TMI 117 - AT - Income Tax

DTAA between US & India - Royalty or sale of copyrighted articles / softwares - assessing officer assessed the entire payments in the hands of MRSC as royalty income on the ground that payments have been received towards licensing of Microsoft software products which amounts to grant of right in Intellectual property Rights (IPRs) - whether the sale of off the shelf software product by US based non-resident companies to independent Indian distributors is taxable in the hands of such non-resident companies as royalties within the meaning of Explanation 2 to section 9(1)(vi) of the Act as well as under Article 12 of Double Taxation Avoidance Agreement between India and US - During the course of assessment proceedings the assessing officer noted that on 1/01/1999 Microsoft Corporation granted M/s. Gracemac Corporation, the assessee, a hundred per cent subsidiary of Microsoft Corporation, licence to manufacture and distribute all MS retail software products - It clearly provides that product is protected by copyright and the other intellectual property laws and treaties, and that Microsoft (or its suppliers of software code, if any) own the title, copyright and other intellectual property rights in the product - user is paying for getting a copy of the software and not certain limited rights in software, which rests with the copyright owner of the software programme - There is nothing either in the Income tax Act or Indo-US DTAA that once a case falls in one of the clauses of Explanation 2 of section 9(1)(vi) it cannot be considered in any other clause. Held that - though the amount constitute royalty, but the same is not assessable in the hands of the present assessee. - such royalty cannot be assessed in the hands of the assessee as it will tantamount to assess the same income which has been assessed in the hands of Gracemac and it has been held by the Tribunal that the aforementioned amount of royalty cannot be assessed in the hands of the assessee as the same is taxable in the hands of the Gracemac - Following decision of Gracemac Corporation Versus Assistant Director of Income-tax, International Tax Division, Circle 2(1), New Delhi 2010 (10) TMI 583 - ITAT, DELHI - Decided partly in favour of assessee.

Summary

Issues Involved:
1. Taxability of revenue from software sales as royalty under the Income-tax Act, 1961.
2. Taxability of revenue from software sales as royalty under the India-US Double Taxation Avoidance Agreement (DTAA).
3. Double taxation of royalty income in the hands of the assessee and Gracemac Corporation.
4. Validity of penalty levied on the assessee for concealment of income.

Issue-wise Detailed Analysis:

1. Taxability of Revenue from Software Sales as Royalty under the Income-tax Act, 1961:
The core issue was whether the revenue earned by the assessee from the sale of Microsoft Retail Products to Indian distributors should be considered as royalty under section 9(1)(vi) of the Income-tax Act, 1961. The Assessing Officer (AO) treated the sales proceeds as royalty income, a view confirmed by the CIT(A) in earlier years. The assessee argued that ITAT had previously held that the royalty should be taxed in the hands of Gracemac Corporation, not the assessee. The ITAT reiterated its stance that though the amount constitutes royalty, it is not assessable in the hands of the present assessee, as taxing the same income in the hands of both the assessee and Gracemac Corporation would result in double taxation.

2. Taxability of Revenue from Software Sales as Royalty under the India-US Double Taxation Avoidance Agreement (DTAA):
The assessee contended that the revenue from software sales should be considered business income, not royalty, under Article 7 of the India-US DTAA, as the assessee did not have a Permanent Establishment (PE) in India. The ITAT had previously held that the sale of software is a sale of a copyrighted article and not a copyright, thus not taxable as royalty under Article 12 of the DTAA. The ITAT confirmed that the revenue earned by the assessee from software sales is not taxable as royalty under the DTAA.

3. Double Taxation of Royalty Income in the Hands of the Assessee and Gracemac Corporation:
The ITAT had earlier ruled that the royalty income should be taxed in the hands of Gracemac Corporation, not the assessee, to avoid double taxation. The AO and CIT(A) had assessed the same income as royalty in the hands of both entities. The ITAT reiterated that taxing the same income in the hands of both the assessee and Gracemac Corporation would result in double taxation, and thus, the addition in the hands of the assessee was deleted.

4. Validity of Penalty Levied on the Assessee for Concealment of Income:
The AO had levied penalties for concealment of income, which were upheld by the CIT(A). The ITAT, however, found that since the income itself was not assessable in the hands of the assessee, there was no justification for the levy of penalties. The ITAT upheld the CIT(A)'s order deleting the penalties on the grounds that the income was not taxable in the hands of the assessee.

Conclusion:
The ITAT concluded that the revenue from software sales, though constituting royalty, is not assessable in the hands of the present assessee. Respecting the earlier ITAT orders, the appeals for assessment years 2007-08 and 2008-09 were allowed, and the additions were deleted. The penalties for concealment of income were also deleted, affirming that the income was not taxable in the hands of the assessee. The decision was pronounced in the open court on 29.02.2012.