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TMI Blog2016 (7) TMI 1135X X X X Extracts X X X X X X X X Extracts X X X X ..... 16 - SHRI G S PANNU, ACCOUNTANT MEMBER AND SHRI AMIT SHUKLA, JUDICIAL MEMBER For The Appellant : Shri Sunil M Lala For The Respondent : Shri Rajendra Kumar ORDER PER AMIT SHUKLA, JM: The aforesaid appeals have been filed by the revenue as well as by the assessee, against separate impugned orders. Since the major issue involved in all the appeals relates to taxability of sale of software as Royalty with similar facts permeating through, therefore, all the appeals were heard together and are being disposed off by way of this consolidated order for the sake of convenience. 2. To understand the facts and its implication thereof on the issue of taxability of sum received from sale of computer software by the assessee in India as Royalty or not, we will first take-up revenue s appeal in ITA No.7048/Mum/2010 which has been filed against order dated 30th July, 2010 passed by CIT (Appeals)-10, Mumbai for the quantum of assessment passed under section 143(3) for the assessment year 2006-07. In the grounds of appeal, the revenue has raised following grounds: On the facts and in the circumstances of the case and in law, the ld. CIT(A) has erred in holdin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ated as business profit. Hence, this amount was not shown chargeable to tax in India in absence of any PE in India. In response to the show cause notice by the AO, as to why the said amount received from sale of computer software should not be taxed in India as royalty , the assessee submitted that, the receipts from the sale consideration of computer software cannot be treated as royalty both under the Income-tax Act as well as under the Tax Treaty between India and Netherland. In support, various decisions were relied upon, which for sake of ready reference are reproduced hereunder:- S.No. Case Law Citation 1 Tata Consultancy Services vs State of AP [2004] 271 ITR 401(SC) 2 Samsung Electronics Co Ltd. v ITO [2005] 276 ITR 1(Bang-AT) 3 Hewlett Packard (India) Pvt Ltd v ITO (International Taxation) [2006] 5 SOT 660 (Bang) 4 Sonata Information Technology Ltd v DCIT [2006] 7 SOT 465 (Bom) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sed. Further, he has not examined whether the customers have the right to use the copyright embedded in the software or it was a sale of copyrighted article. These was very crucial facts and key factors which AO should have analyzed before coming to his conclusion rather than taking pain in explaining the theory and the concepts on various aspects of definition of royalty under the Act, commentaries and judgments. He has not examined the scope and definition of royalty under the DTAA and how on facts it is applicable in the case of assessee, when treaty benefit has been invoked. Thus the entire order of the AO is quite general sans any specific finding given on the material facts placed before him. 6. In the First appeal, the assessee has specifically stated that, it is involved purely in sale of Off the Shelf Software to INFOR. It has a distribution agreement with INFOR which carried out all the marketing and sale of the software. Under the agreement, there is no transfer of any copyright or any right to use of any copyright, knowhow has been given to the customers or INFOR. None of the conditions or terms falls within the definition and scope of royalty in Explanatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... held that the payment received by the assessee emanated only from sale of a copy righted article and therefore, it does not amount to royalty within the meaning of Article 12(4) of the India-Netherland DTAA. His relevant observations are reproduced hereunder:- 1.3.8 I have considered the arguments of the AR and I have also examined the facts. The appellant had entered in to distribution agreement with its infor India its Indian subsidiary company for supply of its software to Indian customer on which it has to receive a fixed percentage sum as per agreement. The appellant had entered into an agreement with Infor India for sale and distribution of computer software. The examination of the agreement for the computer software reveals that the software provided to the Indian customer through Infor India is for mere use of the customer in India. The appellant does not have the right to use the copyright embedded in the software. The customer s are not permitted to make copies and sell the software. Except for the limited right to access the copyrighted software for its own business purpose, the customer does not acquire any right to exploit the copyright in the software. Whereas ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y of computer programme. 1.4.9 Examination of the agreement of the appellant with infor India reveals that the agreement forbids the appellant from transferring or modifying the software. The agreement also forbids them from decompiling, reverse engineering or disassembling the software. The agreement also provides that the end user shall use the software only for the operation and shall not sublicense or modify the software. The perusal of the agreement clearly reveals that the appellant has got no right as envisaged in section 14 of the Copyright Act to duplicate the software, to issue copies of software in public or to reverse engineer, de compile or modify the software. Thus, the current transaction under consideration cannot be considered as the transfer of the copyright either in part or in whole. Thus, consideration record by the appellant for sale and distribution of software computer software is not for the use of copyright or transfer of right to use of copyright. As mentioned above, copyright is different from the work in respect of which copyright subsists, the appellant has only got a copy of software without any part of the copyright of the software. Thus, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... an 454. The coordinate Bench of Mumbai Tribunal in the case of Dy. Director of Income-tax vs Reliance Info Com Ltd. has also relied upon principle laid down by the Hon ble Karnataka High Court in deciding the issue against the assessee. He further submitted that now in wake of new Explanation 4 in section 9(1)(vi) brought by Finance Act 2012 w.r.e.f. 1.06.1976, the scope and definition of royalty has been enlarged to include any kind of software. This definition is to be read into Treaty also, as the definition given in domestic law is to be read into. 9. On the other hand, Ld. Counsel, Shri Sunil M Lala after explaining the facts emanating from the order of the CIT(A), submitted that it is a case of a payment made by a distributor to a foreign company for supply of software to Indian customers. These are off the shelf sale of software, which are sold to Indian customers as copyrighted software product. No copyright or license in any form is given either to the distributor or to the Indian customer. The facts which have been noted by the CIT(A) have not been controverted either by the AO or by the Department at any stage. The assessee, being a tax resident of Netherland, i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 6 (Del) 6 Director of Income Tax vs Ericsson A B New Delhi (2011) 16 taxmann Com 371(Del) 7 Asst Director of Income Tax (Int. Taxn)-I Hyderabad vs Locuz Enterprise Solutions Ltd [2015] 61 taxmann.com 47 (Hyderabad Trib) 8 Infotech Enterprises Ltd vs Addl CIT Range 2, Hyderabad [2014] 41 taxmann.com 364 (Hyd Trib) 9 Sonic Biochem Extractions (P) Ltd. Vs Income Tax Officer [201] 35 taxmann.com 463 (Mum-Trib) 10 Daimler Chryler AG vs Director of Income Tax (Int Taxn) 1(2), Mumbai [2012] 28 taxmann.com 413 (Mum-Trib) 11 Addl Director of Income Tax (Int. Tax)-Range 2(2) [2011] 12 taxmann.com 502 (Mum Trib) 12 JCIT v Intec Billing American inc ITA No.3196/Mum/2007 Referring and relying upon these decisions, he submitted that, the Hon ble Delhi High Court in the case of M. Tech India P Ltd ( supra ) has dea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s provide under the treaty. Thus, the only issue for consideration is, whether the said payment falls within the terms of royalty under Article 12(4) of India-Netherland DTAA or under 9(1)(vi) of Income Tax Act. Here again, it is an undisputed fact that, assessee being a tax resident of Netherland has sought benefit under Indo- Netherland DTAA, therefore, the payment received by the assessee from its Indian Subsidiary, INFOR India has to be examined under the treaty provisions. Briefly recapitulating the relevant facts for the purpose of our adjudication emanating from the impugned order is that, Assessee Company is engaged in the business of development and sale of computer software and also provides other general services in relation to the software. For both the activities, it has entered into a distribution agreement with its Indian subsidiary INFOR India which mainly functions as a distributor of computer software. So far as payments received from other general services of ₹ 4,79,36,944/-, same has been offered to tax in India as fee for technical services on which there is no dispute. The dispute is with regard to the payment of ₹ 3,75,25,291/- received ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in order to tax the payment in question as royalty , it is sine qua non that the said payment must fall within the ambit and scope of Para 4 of Article 12. The main emphasis on the payment constituting royalty in Para 4 are for a consideration for the use of or the right to use any copyright......... . The key phrases for the use or the right to use any copyright of ; any patent .; or process , or for information , ; or scientific experience , etc ., are important parameter for treating a transaction in the nature of royalty . If the payment doesn t fit within these parameters then it doesn t fall within terms of royalty under Article 12(4). The computer software does not fall under most of the term used in the Article barring use of process or use of or right to use of copyrights Here first of all, the sale of software cannot be held to be covered under the word use of process , because the assessee has not allowed the end user to use the process by using the software, as the customer does not have any access to the source code. What is available for their use is software product as such and not the process embedded in it. Several processes may be i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (v) to make any adaptation of the work; (vi) to do in relation to an adaptation of the work any of the acts specified in relation to the work in sub-clauses (i) to (iv); (d) In the case of cinematograph film, - (i) to make a copy of the film, including a photograph of any image forming part thereof; (ii) to sell or give on hire, or offer for sale or hire, any copy of the film, regardless of whether such copy has been sold or given on hire on earlier occasions; (iii) to communicate the film to the public; (e) In the case of sound recording, - (i) to make any other sound recording embodying it; (ii) to sell or give on hire, or offer for sale or hire, any copy of the sound recording regardless of whether such copy has been sold or given on hire on earlier occasions; (iii) to communicate the sound recording to the public. Explanation: For the purposes of this section, a copy which has been sold once shall be deemed to be a copy already in circulation . Thus, the definition of copyright in section 14 is an exhaustive definition and it refers to bundle of rights. In respect of computer programming, which is relevant for t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not have any bearing on the definition of such term in the context of DTAA. A treaty which has entered between the two sovereign nations, then one country cannot unilaterally alter its provision. Thus, we do not find any merit in the contention of the Ld. DR that the amended and enlarged definition should be read into the Treaty. 13. Now, we come to the various decisions relied upon by the parties. Before us, the Ld DR has heavily relied upon the two decisions of Karnataka High Court, one in the case of Synopsis International Old Ltd. (supra) and other in the case of Samsung Electronics Co Ltd. (supra). Both these decisions, admittedly, are against the assessee. However, we find that Hon ble Delhi High Court in series of decisions have specifically disagreed with the ratio and the conclusion of Hon ble Karnataka High Court. In the case of DIT vs Infrosoft Ltd. ( supra ), the Hon ble Delhi High Court precisely on similar nature of agreement and the issue before it has dealt and decided the mater in the following manner:- 87. In order to qualify as royalty payment, it is necessary to establish that there is transfer of all or any rights (including the granting of any licence) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uct for internal business purpose, it would not be legally correct to state that the copyright itself or right to use copyright has been transferred to any extent. The parting of intellectual property rights inherent in and attached to the software product in favour of the licensee/customer is what is contemplated by the Treaty. Merely authorizing or enabling a customer to have the benefit of data or instructions contained therein without any further right to deal with them independently does not, amount to transfer of rights in relation to copyright or conferment of the right of using the copyright. The transfer of rights in or over copyright or the conferment of the right of use of copyright implies that the transferee/licensee should acquire rights either in entirety or partially co-extensive with the owner/ transferor who divests himself of the rights he possesses pro tanto. 90. The license granted to the licensee permitting him to download the computer programme and storing it in the computer for his own use is only incidental to the facility extended to the licensee to make use of the copyrighted product for his internal business purpose. The said process is necessary t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent from the right to use a programme embedded in a cassette or a CD which may be a software and the payment made for the same cannot be said to be received as consideration for the use of or right to use of any copyright to bring it within the definition of royalty as given in the DTAA. What the licensee has acquired is only a copy of the copyright article whereas the copyright remains with the owner and the Licensees have acquired a computer programme for being used in their business and no right is granted to them to utilize the copyright of a computer programme and thus the payment for the same is not in the nature of royalty. 95. We have not examined the effect of the 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 the DTAA, the provisions of which are more beneficial. 96. The amount received by the Assessee under the licence agreement for allowing the use of the software is not royalty under the DTAA. 97. What is transferred is neither the copyright in the software nor the use of the copyright in the software, but wha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... T had relied upon the ruling of this Court in Director of Income Tax V. Ericsson A.B. (2012) 343 ITR 470 wherein identical argument with respect to whether consideration paid towards supply of software along with hardware rather software embedded in the hardware amounted to royalty. After noticing several contentions of the revenue, this Court held in Ericsson A.B. (supra) as follows: 54. It is difficult to accept the aforesaid submissions in the facts of the present case We have already held above that the assessee did not have any business connection in India. We have also held that the supply of equipment in question was in the nature of supply of goods. Therefore, this issue is to be examined keeping in view these findings. Moreover, another finding of fact is recorded by the Tribunal that the Cellular Operator did not acquire any of the copyrights referred to in Section 14 (b) of the Copyright Act, 1957. 55. Once we proceed on the basis of aforesaid factual findings, it is difficult to hold that payment made to the assessee was in the nature of royalty either under the Income-Tax Act or under the DTAA. We have to keep in mind what was sold by the assessee to the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tings or books or music or films the buyer is purchasing the intellectual property and not the media i.e. the paper or cassette or disc or CD. Thus a transaction sale of computer software is clearly a sale of goods within the meaning of the term as defined in the said Act. The term all materials, articles and commodities includes both tangible and intangible/incorporeal property which is capable of abstraction, consumption and use and which can be transmitted, transferred, delivered, stored, possessed etc. The software programmes have all these attributes In Advent Systems Ltd. v. Unisys Corpn, (925 F. 2d 670 (3rd Cir. 1991)), relied on by Mr. Sorabjee, the court was concerned with interpretation of uniform civil code which applied to transactions in goods . The goods therein were defined as all things (including specially manufactured goods) which are moveable at the time of the identification for sale . It was held: Computer programs are the product of an intellectual process, but once implanted in a medium are widely distributed to computer owners. An analogy can be drawn to a compact disc recording of an orchestral rendition. The music is produced by the art ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e 12(4) of DTAA between India and Netherlands ignoring the facts of the case and detailed reasoning given by AO . 15. As admitted by both the parties, issue involved in this appeal is exactly the same. Accordingly, our finding given in the aforesaid appeal will apply mutatis mutandis in this appeal also and accordingly, the ground raised by the revenue is treated as dismissed. 16. Now, we shall take up assessee s appeal in ITA No.776/Mum/2013 for the AY 2006-07 arising out of Final Assessment order dated, 11.10.2012 passed under section 144C(5) r.w.s. 148 in pursuance of the direction given by the DRP-I, Mumbai under section 144C(5). 17. At the outset, it is noted that appeal filed by the assessee is barred by limitation by 33 days. In the application for condonation of delay, the assessee has stated following reasons:- The Company is a foreign Company based out of the Netherlands with no operations and presence in India; On receipt of the final assessment order, the Company took time to understand the order and to discuss internally the same, which led to the delay in preparation of the appeal documents; Since the Company is a foreign company and n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ant doesn t have the right to access or copy the unique license key that is required to make the software functional / operative. 6. The Ld. AO and the Hon ble DRP erred in law in treating the software as a secret process and a property similar to patent, invention, design, secret formula, thereby treating the sale of software products as transfer of rights in the software. 7. The Ld. AO and the Hon ble DRP has erred in treating the sale of the software products which is a copyrighted article as use or right to use of a copyright . 8. The Ld. AO and the DRP further erred in law in passing the order based on the above contention without considering the various judicial precedents cited by the Appellant in its written submissions and during the course of the hearing, including the binding precedent of the Hon ble ITAT, Mumbai. 9. The Ld. AO and the Hon ble DRP has erred in passing the order without considering the order passed by the Commissioner of Income Tax (Appeals) [ CIT(A) ] in Appellant s own case for the FY 2005-06 wherein the CIT(A) held that the consideration received by the Appellant on account of sale of software products is not in the nature of r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... remain pari-materia. 20. However in this year Ld. DRP has raised certain additional points, in this appeal which reads as under:- The assessee s submission has been considered. As regards the royalty under the domestic law the provisions of section 9(1)(vi) have been amended by the Finance Act, 2012 and explanation 4 has been Inserted therein. The said explanation specifically provides that use of computer software would amount to royalty. As regards application of the DTAA it is relevant to refer to pare 2 of article 3 Indian Netherland DTAA, The said article provides that for interpreting any provision of the convention, when any term is not defined therein, the term shall have same meaning that it carries under the domestic law of the stale applying the convention, concerning the taxes to which the convention applies. Thus, unless the context otherwise requires, for interpreting the DTAA, reference to domestic law is mandated by article 3(2) of the said treaty. Though the term royally has been defined in article 12 para 4 as the consideration for the use of or the right to use any copyright of literary artistic or scientific work, the terms use of or right to use an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ame as has been decided in ITA No.7048/Mum/2010, except that the Ld. DRP has decided the issue against the assessee, by taking additional reasoning that now in wake of new Explanation 4 to section 9(1)(vi) that has the enlarged the definition of royalty should be read into DTAA by virtue of Article 3(2). On this aspect we have already dealt with and have given our reasons that, the amendment carried out in the domestic law with retrospective effect will not automatically alter the provisions of DTAA. Article 3(2) of DTAA provides that, as regards the application of the Convention by one of the States any term not defined herein shall, unless the context otherwise requires, have the meaning which it has under the law of that State concerning the taxes to which the Convention applies . This envisages that, if a particular term has not been defined in the treaty but the same has been defined in the domestic law, then the definition given in the domestic law will be considered for analyzing the transaction under the treaty. However, if a particular term has been specifically defined in the treaty, then any reference to the domestic law or any amendment carried out in the definitio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... de form temporarily on the Equipment, for disaster recovery of Licensee s computer operations (i.e., loaded on a separate, non-production, off-powered server) . Source Code . Unless otherwise explicitly provided in an Order Form, Licensee has no license to access or use, or any other rights in or to, the Source Code for a particular Component System. If the Order Form grants Licensee a license to use Source Code for a particular Component System, then Licensee has the limited right to use such Source Code to modify such Component System for its own, internal computing operations. Subject to the foregoing, Licensee will not disclose all or any part of the Source Code for a Component System to any person except Licensee Employees who, before obtaining access to the Source Code, have been informed by Licensee in writing of the non-disclosure obligations imposed on both Licensee and such Licensee Employees under this Agreement. Infor will own all right, title and interest to all derivative works of the Component System ( Derivative Works ), even if solely created by Licensee pursuant to a license to use Source Code hereunder. Licensee hereby assigns to Infor absolutely all ..... X X X X Extracts X X X X X X X X Extracts X X X X
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