2018 (5) TMI 238 - AT - Income Tax

Income accrued in India - PE In India - supply of equipment - functions of expatriate employees of the group companies seconded to Nortel India - Held that - Income of the assessee wherein from was not chargeable to tax in India and the question relating to the attribution of any part of such income to activities in India does not arise. Income from installation, commissioning and testing activities as well as any function performed by expatriate employees of the group companies seconded to Nortel India would be subject to tax in the hands of Nortel India and the same cannot be considered as income of the assessee therein. In view of our finding, the question of attribution of any income to the alleged PE does not arise Transfer of copyrights - whether will tantamount to sale of a product and not covered within the scope of Royalty - Held that - It is not the case of the revenue that the software involved in this case is independent of the functioning of the hardware. Revenue does not dispute the fact that in this matter the hardware and software are interdependent in the sense that hardware is useless without this particular software and the software cannot be used in any hardware other than the one for which it is permitted to be used. Thus we hold that the payment for the embedded software is not royalty and the receipts on account of sale of embedded software cannot be separately brought to tax Taxing of income from providing training services as fees for technical services under the provisions of article 12 of the DTAA - Held that - What is sold is the telecom equipment embedded with specific software to run that equipment; and for such purpose the assessee claims to have imparted some initial training because without which training the purchaser cannot operate the equipment and this training is only one time job for the use of equipment only. Admittedly, the contract between the assessee and the GAIL is not a service contract and the assessee is not entrusted with the job of any supervision or maintenance of the equipment so that for such continuous supervision or maintenance the requisite skills are made available to the employees of the GAIL. In terms of Article 12(5)(a) of the treaty, payment received by the assessee for the training required for the employees of the Gail at the time of delivery of the product to acquaint them with the operation of the equipment does not amount to FTS and cannot be brought to tax Deduction for R&D expenses - Held that - R&D expenses appear in the same set of accounts of the assessee from which the sales figures of the equipment have been adopted and a GP rate has also been applied on the basis of the same accounts; and there are several cases of foreign, equipment manufacturers and suppliers including Nokia Corporation, being especially in the Department and in all such cases R&D expenses are being allowed and net profit ratio has been adopted from global accounts of the assessee for the purpose of attribution of profits which means R&D expenses have been allowed in that case on the basis of the global accounts. Income from the supply of equipment is not taxable in India. Assessee s income from supply of equipment was not chargeable to tax in India, the receipts on account of sale of embedded software cannot be separately brought to tax and that the income from providing training services cannot be treated as fees for technical services under the provisions of Article 12(5)(a) of the DTAA, the question relating to attribution of any part of such income to activities in India does not arise. Conclusion that the Assessee does not have a PE in India, the question of attribution of any income to the alleged PE also does not arise

Issues Involved:
1. Existence of Permanent Establishment (PE) in India.
2. Taxability of income from the supply of hardware and software.
3. Attribution of income to the alleged PE in India.
4. Classification of income from software as 'Royalty'.
5. Taxability of income from training services as 'Fees for Technical Services' (FTS).
6. Allowability of Research and Development (R&D) expenses.

Issue-wise Detailed Analysis:

1. Existence of Permanent Establishment (PE) in India:
The Assessing Officer (AO) concluded that the assessee had a PE in India through its liaison office and Nortel Networks India Private Limited (Nortel India). This was based on observations that Nortel India and the liaison office were involved in negotiating and concluding contracts, securing orders, and providing technical and financial support. The CIT(A) upheld this view, noting that the assessee undertook all pre-supply and post-supply activities in India, and expatriate employees remained in India for over 30 days. However, the Tribunal referred to a similar case (Nortel Networks India International Inc) where the High Court found no material evidence suggesting that Nortel India or the liaison office acted on behalf of the assessee to constitute a PE.

2. Taxability of Income from the Supply of Hardware and Software:
The AO attributed 55% of the total supply revenues to hardware and 40% to software, taxing the latter as 'Royalty' under Article 12 and section 9(1)(vii) of the Act. The CIT(A) agreed, noting that the supply contract included activities carried out in India. However, the Tribunal, referencing the High Court's decision in a similar case, concluded that the income from the supply of equipment was not chargeable to tax in India as the title to the equipment passed overseas, and the activities in India were performed by Nortel India, not the assessee.

3. Attribution of Income to the Alleged PE in India:
The AO used a gross profit margin of 42.6% from Nortel Networks Ltd's global accounts to estimate the taxable income. The CIT(A) found that 80% of the income from activities in India was a reasonable estimate. However, the Tribunal, following the High Court's decision, ruled that since the assessee did not have a PE in India, the question of attributing any income to the alleged PE did not arise.

4. Classification of Income from Software as 'Royalty':
The AO classified the income from the supply of software as 'Royalty', arguing that it involved the use of a copyright. The CIT(A) agreed, applying the Indian Copyright Act. However, the Tribunal, referencing a decision in a similar case (ZTE Corporation), held that the software was an integral part of the hardware, and the payment for embedded software was not 'Royalty' but business income, not subject to tax as 'Royalty'.

5. Taxability of Income from Training Services as 'Fees for Technical Services' (FTS):
The AO taxed the income from training services as FTS under Article 12 of the DTAA. The CIT(A) upheld this view. However, the Tribunal found that the training services were ancillary and subsidiary to the sale of equipment and thus not taxable as FTS under Article 12(5)(a) of the DTAA.

6. Allowability of Research and Development (R&D) Expenses:
The AO did not allow R&D expenses, arguing they were not verified. The CIT(A) directed the AO to allow these expenses on a proportionate basis, noting that R&D was essential for the business. The Tribunal upheld this view, noting that similar expenses were allowed in other cases involving foreign equipment manufacturers.

Conclusion:
The Tribunal concluded that the assessee's income from the supply of equipment was not chargeable to tax in India, the receipts from the sale of embedded software could not be taxed as 'Royalty', and the income from training services was not FTS under the DTAA. Consequently, the question of attributing any part of such income to activities in India did not arise. The assessee's appeals were allowed, and the revenue's appeals were dismissed.

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