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TMI Blog2018 (8) TMI 1056X X X X Extracts X X X X X X X X Extracts X X X X ..... which are liable to be taxed u/s. 28 of the Act are what are understood to be such according to ordinary commercial principle. - Claim of deduction as business expenditure/ loss allowed. - Decided in favor assessee. - I.T.A. No. 677/Kol/2014 And I.T.A. No. 751/Kol/2014 - - - Dated:- 14-8-2018 - Shri P.M. Jagtap, AM And Shri A. T. Varkey, JM For The Assessee : Shri Anubhav Rustogi, AR For The Revenue : Shri Sanjay Mukherjee, Addl. CIT ORDER Per Shri A.T.Varkey, JM These are cross appeals preferred by the assessee and the revenue against the order of the Commissioner of Income Tax (Appeals)-XII, Kolkata dated 10.01.2014 for Assessment Year 2008-09. 2. At the outset itself, the Ld. AR of the assessee has brought to our notice that the sole issue which the assessee assails is in respect of disallowance of ₹ 15,66,910/- made by AO u/s. 40(a)(i) of the Income-tax Act, 1961 (hereinafter referred to as the Act ) for nondeduction of tax u/s. 195 of the Act on Microsoft license fee payable to Organon NV (AE). According to the Ld. AR, the precise issue cropped up in AY 2003-04 wherein also similar action was done by the AO and confirmed by the L ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re as well as installation and commissioning of the two and also after sale services) manufactured by it in Finland to Indian telecom operators from outside India on a principal to principal basis, under independent buyer-seller arrangements-Installation activities were undertaken by Indian subsidiary under its independent contracts with Indian telecom operators-AO and CIT(A) held that LO and Indian subsidiary constituted assessee s PE in India and part of the revenue was attributable to PE and the whole of software revenue was assessed as royalty under s. 9(1)(vii) and Article 13-Tribunal granted partial relief to both assessee and Revenue-Held, LO has not carried out any business activity for the assessee in India, its role has been only to assist assessee in the preliminary and preparatory work-LO has only carried out advertising activity which cannot by any means furnish business connection- Even by law, the LO was prohibited in engaging itself in any business activities in India on behalf of the foreign enterprise, which could be considered to furnish a business connection in India-LO does not constitute assessee s PE in India-Further for taxing the profits for supply of equ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he receipts in respect of license to use software which is part of the hardware alone could be taxed in India as royalty. The Assessee argued before the Tribunal that the payment made by the assessee for the use of software in the equipment does not amount to royalty. The Tribunal in the aforesaid context examined the issue as to whether the payment is for a copyright or for a copyrighted article. If it is for copyright, it should be classified as royalty, both under the Income-tax Act and under the DTAA and it would be taxable in the hands of the assessee on that basis. If the payment is really for a copyrighted article, then it only represents the purchase price of the article and, therefore, cannot be considered as royalty either under the Act or under the DTAA. The Tribunal after referring to definition of Royalty under the Act and the definition copyright under the Copyright Act, 1957 held that what was sold by the non- resident was a copyrighted article and payment to the non-resident was not for copyright. On further appeal by the Revenue, the Hon'ble Delhi High Court held that income did not accrue to the non-resident by virtue of a business connection in India and ther ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it is not open for the income tax authorities to split the same and consider part of the payment for software to be royalty ( v) The bill of entry for importing of goods shows that the price has been separately mentioned for software and that this was only for the purposes of customs. There is no evidence to show that the assessee was a party to the fixation of value for the customs duty purposes ( vi) The software provided under the contract is goods and therefore no royalty can be said to be paid for it. 53. Mr. Prasaran, countered the aforesaid reasoning arguing that Clause 20 of the Supply Contract uses the term licence and the same term is used in the context of software throughout the three Agreements, indicating that it is not an outright sale of goods, or a full transfer of rights from the assessee to the Indian company. He also submitted that the software is a computer programme, which is treated differently from a book, not only in the Copyright Act, 1957 but also the Income Tax Act itself. His submission was that Section 52(1) (aa) of the Copyright Act only deems that certain acts will not to amount to infringement in the light of various concerns, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt existence. The software supply is an integral part of the GSM mobile telephone system and is used by the cellular operator for providing the cellular services to its customers. There could not be any independent use of such software. The software is embodied in the system and the revenue accepts that it could not be used independently. This software merely facilitates the functioning of the equipment and is an integral part thereof. On these facts, it would be useful to refer to the judgment of the Supreme Court in TATA Consultancy Services v. State of Andhra Pradesh, 271 ITR 401 , wherein the Apex Court held that software which is incorporated on a media would be goods and, therefore, liable to sales tax. Following discussion in this behalf is required to be noted:- In our view, the term goods as used in Article 366(12) of the Constitution of India and as defined under the said Act are very wide and include all types of movable properties, whether those properties be tangible or intangible. We are in complete agreement with the observations made by this Court in Associated Cement Companies Ltd. (supra). A software programme may consist of various commands which enabl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... htable as intellectual property does not alter the fact that once in the form of a floppy disc or other medium, the program is tangible, moveable and available in the marketplace. The fact that some programs may be tailored for specific purposes need not alter their status as goods because the Code definition includes specially manufactured goods. 56. A fortiorari when the assessee supplies the software which is incorporated on a CD, it has supplied tangible property and the payment made by the cellular operator for acquiring such property cannot be regarded as a payment by way of royalty. 57. It is also to be borne in mind that the supply contract cannot be separated into two viz. hardware and software. We would like to refer the judgment of Supreme Court in CIT v. Sundwiger EMFG Co., 266 ITR 110 wherein it was held: A plain and cumulative reading of the terms and conditions of the contract entered into between the principal to principal i.e., foreign company and Midhani i.e., preamble of the contract, Part-I and II of the contract and also the separate agreement, as referred to above, would clearly show that it was one and the same transaction. One cannot ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... icle 20 of the Supply Contract. Distinction has to be made between the acquisition of a copyright right and a copyrighted article . 60. Mr. Dastur is right in this submission which is based on the commentary on the OECD Model Convention. Such a distinction has been accepted in a recent ruling of the Authority for Advance Ruling (AAR) in Dassault Systems KK 229 CTR 125. We also find force in the submission of Mr. Dastur that even assuming the payment made by the cellular operator is regarded as a payment by way of royalty as defined in Explanation 2 below Section 9 (1) (vi), nevertheless, it can never be regarded as royalty within the meaning of the said term in article 13, para 3 of the DTAA. This is so because the definition in the DTAA is narrower than the definition in the Act. Article 13(3) brings within the ambit of the definition of royalty a payment made for the use of or the right to use a copyright of a literary work. Therefore, what is contemplated is a payment that is dependent upon user of the copyright and not a lump sum payment as is the position in the present case. 61. We thus hold that payment received by the assessee was towards the title and GSM sy ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... c or scientific work. In order to treat the consideration paid by the Licensee as royalty, it is to be established that the licensee, by making such payment, obtains all or any of the copyright rights of such literary work. Distinction has to be made between the acquisition of a copyright right and a copyrighted article . Copyright is distinct from the material object, copyrighted. Copyright is an intangible incorporeal right in the nature of a privilege, quite independent of any material substance, such as a manuscript. Just because one has the copyrighted article, it does not follow that one has also the copyright in it. It does not amount to transfer of all or any right including licence in respect of copyright. Copyright or even right to use copyright is distinguishable from sale consideration paid for copyrighted article. This sale consideration is for purchase of goods and is not royalty. 88. The license granted by the Assessee is limited to those necessary to enable the licensee to operate the program. The rights transferred are specific to the nature of computer programs. Copying the program onto the computer's hard drive or random access memory or making an a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... se the software for internal business without having any right for making any alteration or reverse engineering or creating sub-licences while the copyright continues to be with the non-resident as per the agreement-Even as per the agreements entered into with other distributors as also the end-user licence agreement, except as expressly set forth in the agreement, the distributor cannot rent, lease, loan, sell or otherwise distribute the software, documentation or any derivative works based upon the software or documentation in whole or in part-Thus, licence is granted for making use of the copyright in respect of shrink wrapped software/off-the-shelf software under the respective agreements which authorizes the end-user i.e., customer to make use of the copyright in the said software-Hence, the contention of the assessee that there is no transfer of copyright or any part thereof under the agreements entered into by the assessee with the non-resident cannot be accepted-But for the licence granted to the assessee to make copy of the software into the hard disk of the designated computer and to take a copy for back up purposes, the end-user has no other right and the said back up wo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... words chargeable under the provisions of the Act -Payer is bound to deduct tax at source only if the sum paid is assessable to tax in India-A person paying interest or any other sum to a non-resident is not liable to deduct tax if such sum is not chargeable to tax under the IT Act-Sec. 195 also covers composite payments which have an element of income embedded or incorporated in them-Thus, where an amount is payable to a non-resident, the payer is under an obligation to deduct tax in respect of such composite payments-However, obligation to deduct tax is limited to the appropriate proportion of income which is chargeable under the Act- This obligation flows from the said words used in s. 195(1)-Sec. 195(2) pre-supposes that the person responsible for making the payment to the non-resident is in no doubt that tax is payable in respect of some part of the amount to be remitted but is not sure as to what should be the portion so taxable or the amount of tax to be deducted-In such a situation he is required to make an application to ITO(TDS) for determining the amount-It is only when these conditions are satisfied that the question of making an order under s. 195(2) arises-If the cont ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s in that state, of such enterprise which is the payer, this clause comes into operation. Article 9(1), 11(9) or 12(9) does not apply to such intere st, Royalty etc. In such circumstances, interest, royalties and other disbursements shall be deductible in the hands of the payer while determining the taxable profits of the enterprise in that State i.e. India in this case, under the same conditions as if they had been paid to a resident of that state. 15. The Hon ble Delhi High Court was considering an identical Article, wherein, the assessee claimed relief under Article 26(3) of the India-U.S.A DTAA, in the case of Herbalife International (P) Ltd., answered the question in favour of the assessee. This Article reads as follows:- Article 26(3):- Where the provisions of paragraph 1 of Article 9 associated Enterprises), paragraph- 7 of Article 11 (interest) of paragraph- 8 of Article 12 (royalties and fees for included service) apply, interest, royalties and other disbursements paid by a resident to a Contracting State to resident of other Contracting State shall for the purposes of determining taxable profit of the first mentioned resident, be deductible un ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er Sections 30 to 38 of the Act in computing business income would be subject to deductibility condition in Section 40 of the Act. The payment of FTS to HIAI would be allowable in terms of Section 37 (1) of the Act but before such payment can be allowed the condition imposed in Section 40 (a) (i) of the Act regarding deduction of TDS has to be complied with. In other words if no TDS is deducted from the payment of FTS made to HIAI by the Assessee, then in terms of Section 40 (a) (i) of the Act, it will not be allowed as a deduction under Section 37 (1) of the Act for computing the Assessee's income chargeable under the head 'profits and gains of business'. 47. Article 26(3) of the DTAA calls for an enquiry into whether the above condition imposed as far as the payment made to HIAI, i.e., payment made to a non-resident, is any different as far as allowability of such payment as a deduction when it is made to a resident. 48. Section 40 (a) (i) of the Act, as it was during the AY in question i.e. 2001-02, did not provide for deduction in the TDS where the payment was made in India. The requirement of deduction of TDS on payments made in India to residents was i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ction jurisdiction of the taxing country. 50. While the above explanation provides the rationale for insisting on deduction of TDS from payments made to non-resident, the point here is not so much about the requirement of deduction of TDS per se but the consequence of the failure to make such deduction. As far as payment to a non-resident is concerned, Section 40 (a) (i) of the Act as it stood at the relevant time mandated that if no TDS is deducted at the time of making such payment, it will not be allowed as deduction while computing the taxable profits of the payer. No such consequence was envisaged in terms of Section 40 (a) (i) of the Act as it stood as far as payment to a resident was concerned. This, therefore, attracts the non-discrimination rule under Article 26 (3) of the DTAA. 51. The arguments of counsel on both sides focussed on the expression same conditions in Article 26(3) of the DTAA. To recapitulate, a comparison was drawn by learned counsel for the Revenue with Article 26(1) which speaks of preventing discrimination on the basis of nationality and which provision employs the phrase same circumstances . Article 26 (2) which talks of prevention of d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... countries are keen to provide to them. It was further noted that the corresponding loss of tax revenues could be insignificant compared to the other non-tax benefits to the economies of developing countries which need foreign investment. The Court felt that this was a matter best left to the discretion of the executive as it is dependent upon several economic and political considerations. 55. Consequently, while deploying the nexus test to examine the justification of a classification under a treaty like the DTAA, the line of enquiry cannot possibly be whether the classification has nexus to the object of the statute for the purposes of Article 14 of the Constitution of India, but whether the classification brought about by Section 40 (a) (i) of the Act defeats the object of the DTAA. A perusal of the wordings of Article 24(4) of the Indo-Netherlands DTAA and the wordings of Article 26(3) of the India-U.S. DTAA brings us to a conclusion that the propositions of law laid down by the Hon ble Delhi Court in the case of Herbalife India Pvt. Ltd. (supra) applies to the facts of this case. Thus respectfully following the same, we decide the addition of ground raised by t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... this issue does not fall within the exception to Article 24(4) of the Indo- Netherlands DTAA. 17. The Delhi Bench of the Tribunal in the case of Honda Cars India Ltd. vs. DCIT (supra), where one of us was an author, had considered a similar issue and held that the there is no transfer pricing adjustment made by the TPO in an international transaction, then that transaction is not covered by Article 9 (1) of the DTAA. This view is fortified by the judgement of the Hon ble Delhi High Court in the case of Herbalife India Pvt. Ltd. (supra). 17.1. Respectfully following the same reject the argument of the ld. DR, as devoid of merit. 18. As no deduction of tax need be made by the assessee for the similar payment made to a resident for the purchase of software during the impugned Assessment Years, the non discrimination clause under Article 24(4) of the Indo-Netherlands DTAA, applies to the facts of this case. 18.1. The reliance of the ld. DR in the case of M/s. Andaman Sea Foods is not correct as in that case, it was held that the DTAA between India and Singapore, does not apply and the decision has to be made under the Domestic law. Consequently, it was held that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f income. During the course of assessment proceedings the AO required the assessee to provide explanation in respect of allowability of such expenses as business deduction. Though the assessee filed detailed response vide its letter dated 22.12.2011, the AO did not accept the explanation offered by the assessee by observing as under: 1) The expenses pertain to some previous year not relating to relevant Assessment Year, i.e., AY 2008-09. These expenses were not claimed as revenue expense in the said previous year and hence the assessee itself has claimed it as capital expense under the head capital work in progress. Once the expenses have been treated as capital expense the same cannot be treated as revenue expense just because no benefit could be derived from it. 2) The same view was taken by Hon'ble Kolkata High Court in case of Hasimara Industries Ltd. -Vs.- CIT 231 ITR 842. 3) The case laws relied upon by assessee is distinguishable on facts. 4) The payments are in the nature of consulting fees for land and engineering fees for formulation plant. The payment was attracting TDS, which was not made by the assessee. 6. Aggrieved, the assessee pre ..... X X X X Extracts X X X X X X X X Extracts X X X X
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