DIT v. Infrasoft Ltd.

INCOME TAX ACT, 1961

--Income deemed to accrue or arise in India --Under section 9(1)(vi)Granting of licence to use sotware whether royalty--The assessee was primarily into the business of devel oping and manufacturing civil engineering software. One such software, which is subject matter of the present controversy, is called MX. The said MX software is used for civil engineering work and for design of highways, railways, airports, ports, mines, etc. The said software is used by private consultants. In view of the market position, the Board of the assessee opened a branch office in India. The branch in India imports the package in the ; form of floppy disks or CDs depending on the requirements of their customeRs. The system is delivered to a client/customer. The delivery of the system entails installation of the system on the computers of the customers and training of the customers for operation of the system. The branch office further undertakes the responsibility of updation and operational training apart from providing support for solving any software issues. The assessee develops customized software to be used by the customers for designing highways, railways, airports, ports, mines, etc. The software so customized is then licensed to an Indian customer and the branch office of the Assessee in India perform services involving interface to peripheral installation and training, etc. The assessment order was framed by the AO (hereinafter referred to as the “AO”) whereby the AO taxed the receipts on sale of licensing the software as “royalty” as per article 13 (Sic Article 12) of Indo-US Double Taxation Avoidance Agreement. Under section 44D read with section 115A of the Income Tax Act, the AO brought the aggregate amount of Rs. 2,85,76,278, received by the assessee during the year under consideration to tax at 20%. The AO issued a show cause notice to the assessee-company requiring them to show cause as to why the receipts shown by the assessee-company sale/licensing of software, having referred to the nature of service rendered by the assessee company, should not be taxed as royalty as per article 13 (Sic article 12) of DTAA and section 44D read with section 115A of the Act. In reply to the said show cause notice, the assessee company relying on the judgment of the Supreme Court in the case of Tata Consultancy Services v. State of Andhra Pradesh (2004) 271 ITR 401 (SC) (BCAJ) (2005) 1 SCC 308 stated that the moment copies of software programmes were made and marketed, the same become goods which were chargeable to sales tax. The assessee company further contended that when the software were goods as held by the Supreme Court in the said case, the assessee company would be entitle to deduction of purchase cost of software as well as other expenses incurred and the net profit al one could be taxed as business profit as per article 7 of DTAA between USA and India. The assessee company further objected to the show cause notice contending alternatively that even if the receipts were to be treated as royalties or even for technical services, the same having arisen through a permanent establishment in India, it was chargeable to tax as business profit as per the said Article 7 of DTAA. The assessee further contended before the AO that section 44D inserted by Finance Act, 2003 w.e.f 1-4-2004, m a king all the expenditure incurred for earning royalty or fee for technical services allowable, was liable to be given retrospective application to the case of the assessee for the assessment year 2003-04 as that was the legislative intent behind insertion of the said provision. The AO rejected the contention of the Assessee company. With respect to the decision of the Supreme Court in TATA Consultancy Services (supra), the AO distinguished the said judgment holding that the same had been rendered in the context of the Sales Tax Act and was applicable in terms of the definition of 'goods' as given in the Sales Tax Act and was in the context of deciding whether the software recorded on the computer disk was covered within the said definition of goods or not. In the context of the facts of the case as per the AO, the said judgment was not applicable. With regard to the definition of royalty as given in section 9(1)(vi) of the Act as well as article 12 of the DTAA, the AO came to the conclusion that the amount received by the assessee company sales/licensing of the software was royalty in terms of the said definition. The AO treated the entire amount received by the assessee company for transfer of software as well as other incidental services towards installation of software, imparting of training, etc. in the nature of royalty. He further held that since the royalty income had accrued/arisen to the assessee company through its PE in the form of branch office in India, the same was chargeable to tax in India as per article 13 (vi) (Sic article 12 (vi)) of the DTAA. He held that though the royalty income was liable to be taxed as business profit under article 7 of DTAA, the expenses incurred for earning the said income were to be allowed as per domestic law and as per him, since section 44D was applicable to the assessment year 2003-04 specifically prohibited any allowance for such expenditure, the entire amount received by the Assessee as royalty was thus chargeable to tax @ 20% of the gross receipts as per the provisions of section 44D read with section 115A of the Act. The AO thus brought the aggregate amount of Rs. 2,85,76,278 received by the assessee during the year under consideration to tax @ 20%. The AO thus framed the assessment under section 143(3). The CIT(A) rejected the contention of the assessee company and held the receipts to be royalty income. The CIT(A) held the income earned by the assessee company from software licence is in the nature of royalty both under the domestic law and the DTAA and thus upheld the order of the AO holding the Income from software licence chargeable to tax in India as royalty under section 9(1)(vi) of the IT Act, 1961 read with article 13 (Sic article 12) of the DTAA. The ITAT held that the amount received by the Assessee under the licence agreement for allowing the use of the software was not royalty either under the Income Tax Act or under the DTAA. The ITAT set aside the order of the Commissioner (Appeals) and restored the matter to the file of the AO with a direction to reframe the assess emitters of the said decision. Held: The Tribunal has held and rightly so that the question whether there was a transfer of a copyright right or only of a copyrighted article must be determined taking into account all the facts and circumstances of the case and the benefits and burden of ownership which have been transferred. All copy rights and intellectual property rights in and to the Software, and copies made by licensee, are ownedby or duly licensed to assessee. 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. A non-exlusive and non-ransferable licence enabling the use of a copyrighted product cannot be construed as an authority to enjoy any or all of th3e enumerated rights ingrained in aricle 12 of DTAA. Where the purpose of the licence or the ransaction is only to restrict use of the copyrighted product for internal business purpose, it would not be legally correct to state that the copyright itself or right to use copyrifht has been ransferred 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 contemplatede by the treaty. 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. The Tribunal was right in holdin that the consideration received by the assessee on grant of licences for use of softwre is not royalty within the meaning of article 12(3) of the Double taxation Avoidance Agreement between India and the United States of America. Where there is no transfer of any right in respect of copyright by the assessee and it is a case of mere transfer of a copyrihted article the payment is for copyrighted article and represents the purchase price of an article and cannot be cosdiered as royalty either under the IT Act or under the DTAA, but business income.