2010 (1) TMI 47 - AAR - Income Tax

Sale of software Business profit -royalties and fee for technical services u/s 9(1)(vi) permanent establishment held that - Passing on a right to use and facilitating the use of a product for which the owner has a copyright is not the same thing as transferring or assigning rights in relation to the copyright. The enjoyment of some or all the rights which the copyright owner has, is necessary to trigger the royalty definition. Viewed from this angle, a non-exclusive and non-transferable licence enabling the use of a copyrighted product cannot be construed as an authority to enjoy any or all of the enumerated rights ingrained in a copyright. Where the purpose of the licence or the transaction is only to establish access to the copyrighted product for internal business purpose, it would not be legally correct to state that the copyright itself has been transferred to any extent - The customer information is necessitated in order to ensure that the product is not misused and that the service needs of the customers are attended to diligently in case of neglect on the part of VAR. As regards the perusal of the financial statements, the applicant clarifies that it is meant to ensure that the VAR is not selling competing products in violation of the restrictions imposed. The restraints placed on VAR not to market or license competing products subject to certain exceptions is again not a factor that points to the existence of principal and agent relationship. applicant has no PE in India - It is ruled that the payment received by the applicant from VARs ( third party re-sellers ) on account of supplies of software products to the end-customers (from whom the licence fee is collected and appropriated by VAR) does not result in income in the nature of royalty to the applicant and moreover payments received by the applicant cannot be taxed as business profits in India in the absence of permanent establishment as envisaged by Article 7 of the India-Japan Tax Treaty.

Summary

Issues Involved:
1. Taxability of payments received by the applicant from the sale of software products to independent third-party resellers under the India-Japan Double Taxation Avoidance Agreement (DTAA).
2. Classification of such payments as business profits or royalties under Article 7 and Article 12 of the India-Japan DTAA.
3. Determination of the existence of a Permanent Establishment (PE) in India.

Issue-wise Detailed Analysis:

1. Taxability of Payments Under the India-Japan DTAA:
The applicant, a Japanese company, contended that payments received from Value Added Resellers (VARs) for software products should be classified as business profits under Article 7 of the India-Japan DTAA and not as royalties under Article 12. The applicant argued that the payments were not in the nature of royalties as defined in Article 12.3 of the DTAA and that they should not be subjected to Indian income tax due to the absence of a Permanent Establishment (PE) in India.

2. Classification as Business Profits or Royalties:
The ruling examined whether the payments received from VARs represented consideration for the use of, or the right to use, any copyright of literary or scientific work. The analysis referenced the Indian Copyright Act and noted that the applicant retained all intellectual property rights in the software. The end-user was granted a non-exclusive, non-transferable license to use the software for internal purposes only, without any rights to commercially exploit the software or its copyright. The ruling emphasized that merely authorizing the use of a copyrighted product does not equate to transferring or assigning rights in relation to the copyright. The ruling concluded that the payments were not royalties as they did not involve the transfer of rights in respect of the copyright.

3. Determination of Permanent Establishment (PE):
The ruling considered whether the applicant had a PE in India through VARs acting as dependent agents. The analysis focused on the nature of the relationship between the applicant and VARs, the control exercised by the applicant, and the activities of the VARs. The ruling found that VARs operated as independent distributors, transacting on a principal-to-principal basis, and did not have the authority to conclude contracts on behalf of the applicant. The VARs were free to determine their own prices and bore the economic risk of the products. The ruling concluded that the VARs were not dependent agents and, therefore, the applicant did not have a PE in India.

Conclusion:
The ruling determined that the payments received by the applicant from VARs for software products did not constitute royalties under Article 12 of the India-Japan DTAA. Additionally, the applicant did not have a PE in India, and therefore, the payments could not be taxed as business profits under Article 7 of the DTAA. The ruling was pronounced on January 29, 2010, and was signed by both members of the Authority for Advance Rulings.