2018 (4) TMI 172 - AT - Income Tax

Supply of software embedded in the hardware - whether it result in to royalty income? - allowable business income - attribution to the income of PE in India - Held that - The transfer of all or any rights in respect of any right, property or information includes and has always included transfer of all or any right for use or right to use a computer software (including granting of a licence) irrespective of the medium through which such right is transferred. This insertion of the Explanation has the effect of including supply of computer software within the ambit of Royalty . However, when a software is embedded in hardware and there is one composite price, the entire amount remains as Business income and a part of the same cannot be considered as royalty within the Explanation 4. Payment received for software, which is embedded in the hardware, has to be treated as business profits, which is of the same nature as from the supply of hardware. The impugned order is set aside to this extent and the AO is directed to compute the income of the assessee afresh by considering income from supply of software embedded in hardware as Business profits.

Summary

Issues:
Taxation of software income and attribution of income between hardware and software sales and services.

Analysis:
The judgment pertains to five appeals relating to the assessment years 2002-03 to 2006-07. The appeals were disposed of by the Tribunal in a combined order, following a lead order in a similar case. The Tribunal held that the initiation of re-assessment was valid, established the fixed place and agency PE of the entities in India, and determined the income attribution at 2.6% of sales made in India. The High Court remitted the matter back to the Tribunal for adjudication on the issues of software income taxation and income attribution between hardware and software. The AR conceded that these issues were not argued in the original proceedings. The Tribunal then focused on the taxability of software income and income attribution based on the facts recorded in the assessment order for the A.Y. 2002-03.

The AO held that 80% of the revenues were from hardware supply and 20% from software and related services. The AR disputed the taxability of software income, arguing it should be treated as business income and not royalty. The Tribunal found that income from software embedded in hardware cannot be treated as royalty income, citing precedents like CIT VS. ZTE Corporation and CIT vs. Alcatel Lucent Canada. It noted that supply of software embedded in hardware does not result in royalty income, supported by various judgments. The Tribunal also considered the insertion of Explanation 4 to section 9(1)(vi) by the Finance Act, 2012, clarifying the treatment of computer software as royalty.

Based on the above analysis and legal precedents, the Tribunal held that income received for software embedded in hardware should be treated as business profits, similar to income from hardware supply. The impugned order was set aside, directing the AO to compute the income afresh considering income from software embedded in hardware as business profits. The Tribunal noted that the decision for subsequent years under appeal would remain the same, and all appeals were allowed for statistical purposes.

In conclusion, the Tribunal's detailed analysis and application of legal principles led to the decision that income from software embedded in hardware should be treated as business profits, not royalty income. The judgment provided clarity on the tax treatment of such income, aligning with established legal precedents and statutory provisions.