2016 (3) TMI 751 - AT - Income Tax

Sale of software as part of machinery - alleging the same to be income in the nature of Royalty within the meaning of section 9(1)(vi) - Held that - It is clear that if customer makes requisite copies to enable it to use the software for exclusively its own purposes or makes back-up copies purely as a temporary protection against loss, in order only to utilize the computer programme for the purpose for which it was supplied, then section 52 of the Act clearly states that it shall not amount to infringement of the copyright. Thus, in the facts of this case which we have discussed in detail above, neither there was any transfer of copyright or any rights therein nor there was any situation giving rise to any type of infringement of copyright by the customers of the assessee. Thus, in our considered view account of sales consideration received by the assessee on account of sale of machine along with it operating software would not constitute Royalty within the meaning of article 12(3) of the Indo-Israel DTAA. We shall like to clarify and reiterate at the cost of repetition that we have not examined the effect of subsequent amendment to section 9(1)(vi) of the Act and also whether the amount received for use of software would be Royalty in terms thereof for the reason that the assessee is covered by tax treaty the provisions of which are more beneficial and also for the reason that in this case transaction under consideration was predominantly and essentially of the character of sale and purchase of machine and not that of software. Thus, in view of the discussion above, it is held that the amount received by the assessee was not liable to tax as Royalty and therefore addition made by the Assessing Officer is directed to be deleted. - Decided in favour of assessee

Summary

Issues Involved:
1. Legality of the assessment order.
2. Taxability of payments for software as "royalty."
3. Software as an integral part of the machine.
4. Definition of royalty under the Indo-Israel DTAA.
5. Credit for TDS.
6. Levy of interest under section 234B.
7. Initiation of penalty proceedings under section 271(1)(c).

Detailed Analysis:

1. Legality of the Assessment Order:
The appellant contested the legality of the assessment order dated 20.01.2015, asserting it was "illegal and bad in law." However, the Tribunal found Grounds no.1 to 1.2 to be general in nature and did not require specific adjudication.

2. Taxability of Payments for Software as "Royalty":
The appellant argued that payments received for software should not be taxed as "royalty" under section 9(1)(vi) of the Act and Article 12(3) of the Indo-Israel DTAA. The Tribunal examined whether the payments for software, integrated with machinery, constituted "royalty." The Tribunal found that the software was integral to the machine and not sold separately. The software had no independent use except to enable the machine's functionality. Citing various judgments, the Tribunal concluded that the transaction was predominantly the sale of a machine, not software, and thus, the income should not be taxed as "royalty."

3. Software as an Integral Part of the Machine:
The Tribunal noted that the software was integral to the machine's operation. The software was not independently sold or used and was necessary for the machine's functionality. The Tribunal referenced several judgments, including DIT v/s Ericsson A.B. and DIT v/s Nokia Networks O.Y., which supported the view that embedded software integral to hardware does not constitute "royalty."

4. Definition of Royalty under the Indo-Israel DTAA:
The Tribunal emphasized that according to Article 12(3) of the Indo-Israel DTAA, "royalty" encompasses payments for the use of or the right to use any copyright. The Tribunal found that the software provided did not transfer any copyright to the customers. The Tribunal cited judgments like DIT v/s Infrasoft Ltd. and CIT v/s Siemens Aklcongesllschaft, which clarified that payments for copyrighted articles, not the copyright itself, do not constitute "royalty."

5. Credit for TDS:
The appellant claimed that the AO did not allow credit for TDS amounting to Rs. 8,52,664. The Tribunal directed the AO to verify and grant the TDS credit as per law and facts.

6. Levy of Interest under Section 234B:
The appellant argued against the levy of interest under section 234B, citing the judgment in DIT v/s NGC Network Asia LLC, which held that no advance tax was required if tax was deductible at source. The Tribunal, having decided the main issue in favor of the appellant, found this ground infructuous and dismissed it.

7. Initiation of Penalty Proceedings under Section 271(1)(c):
The Tribunal found the initiation of penalty proceedings under section 271(1)(c) to be premature and dismissed this ground.

Conclusion:
The Tribunal concluded that the payments received for software integrated with the machinery did not constitute "royalty" and thus were not taxable in India. The appeal was partly allowed for statistical purposes, with directions to grant TDS credit and dismissing other grounds as either infructuous or premature.