Director of Income Tax vs. Infrasoft Ltd.
Delhi High Court
Key Words: taxability, use of software, royalty, double taxation, Double Taxation Avoidance Agreement, license, transfer of copyright, transfer of copyrighted article, copyright, computer programme
Relevant Statutory Provisions:
- Income Tax Act, 1961: Ss. 260A, 9(1)(vi),
- Double Taxation Avoidance Agreement (DTAA): Article 7, 12(3)
The Respondent/Assessee (A) in this case is an international software marketing and development company of an international group. The holding company is based in US being Infrasoft Corporation. R is primarily into the business of developing and manufacturing civil engineering software. The branch in India imports the software package in the form of floppy disks or CDs. 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.
Assessing Officer (AO): The Assessing Officer (AO) taxed 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 on the following grounds-
- The amount received by the Assessee company from sales/licensing of the software was royalty in terms of definition of royalty as given in Section 9(1)(vi) of the Act as well as Article 12 of the DTAA;
- 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.
- Even though the copyright of the software remains with the Assessee, it allows the use of copyright to the person making payment to it. In case of computer programmes, the Indian Copyright Act recognizes ‘copyright’ as doing or authorizing the act of selling or giving on commercial rental or offer for sale or for commercial rental any copy of the computer program.
- The software owned by the Assessee is patented software. Consideration for allowing the use of the patented article falls within the definition or royalty payment.
- The software are purchased by private consultant or end users and they further exploits for commercial purposes. This clearly falls under definition of ‘royalty’.
- Although the royalty income was liable to be taxed as business profit under Article 7 of DTAA and the expenses incurred for earning the said income were to be allowed as per domestic law, Section 44D was applicable to the Assessment Year 2003-04 which specifically prohibited any allowance for such expenditure;
Aggrieved by the same, A filed an appeal before the Commissioner of Income Tax (Appeals) [‘CIT (A)’].
Contentions (Respondent/Assessee (A))-
- The moment copies of software programmes were made and marketed, the same become goods which were chargeable to sales tax. When the software were goods, A would be entitle to deduction of purchase cost of software as well as other expenses incurred and the net profit alone could be taxed as business profit as per Article 7 of DTAA between USA and India;
- Even if the receipts were to be treated as royalties or even for technical services, the same having arisen through a permanent establishment (PE) in India, it was chargeable to tax as business profit as per the Article 7 of DTAA;
- The provision of DTAA override the provision of Income Tax;
- The right to use a copyright was totally different from the right to use a programme embedded in a software. There was no transfer of right in a copyrighted article. Therefore, the payment received by A was payment for copyrighted article and NOT copyrighted right and thus the same could not be assessed as royalty under Article 13 (Sic Article 12) of DTAA;
- Section 115A could not be applied as the receipts were not royalty and since the receipts were not taxable as royalty and fee for technical services, the same could not be subjected to tax under Section 44D read with Section 115A;
- As per Revised OECD Commentry, only transfer that enabled a transferee to commercially exploit a software copyright gave rise to royalty income and as only limited right to use the software had been transferred, the amount received for such limited use was not royalty income.
CIT(A): The CIT(A) rejected the submissions of A and held-
- What was taxed as royalty was the amount received as consideration for the use or right to use and not outright purchase of the right to use an asset. A copy of software supplied by A did not amount to a sale but a licence to use the software. This is because software is an intellectual property right (IPR) which can be licensed to one use and can be given further to any number of user. Therefore, the consideration paid is effectively only for license use.
- The revised OECD commentary on software payment is
not applicable in India because
India is not even a member of OECD and OECD recommendations are mere recommendations unless they are incorporated into domestic law and/or DTAAs.
- With regard to the reliance of A on the judgment of the Supreme Court in the case of Tata Consultancy Services, CIT(A) held that different statutes or different phrases to treat the same transaction differently and thus it was not permissible to import the meaning assigned in one statute into the different statues. The “sales treatment of computer software under sales tax law, does not, per se, influence income tax treatment of software transactions, as income-tax law defines this transaction differently.
- As per Section 9(1)(vi) the royalty income should satisfy twin conditions that there has to be consideration, and this consideration should be for transfer of all or any right (including the granting of the licence) in respect of the copyright, patent, invention, design, secret formula or process, scientific work. Since, the payment under software license agreement has fulfilled both the conditions, the income from software license was taxable in India as royalty.
ITAT: The ITAT set aside the order of the CIT(A) and held that the amount received by A under the licence agreement for allowing the use of the software was not royalty either under the Income Tax Act or under the DTAA on the following grounds-
- There was no transfer of any right in respect of copyright by A and it was a case of mere transfer of a copyrighted article. Since, the payment was for a copyrighted article then it would represent the purchase price of an article and could not be considered as royalty either under the Act or under the DTAA.
- The right mentioned in sub-clause (ii) of clause (b) of Section 14 was available only to a computer programme and if the licensees did not have any of such rights, as mentioned in clauses (a) and (b) of Section 14, it would mean that they did not have any right in the copyright and in such cases, the payments made to them could not be characterized as royalty under the Act for DTAA.
Aggrieved by the decision of the ITAT, the Revenue filed the appeal before the High Court.
Issue: Whether consideration received by Respondent-Assessee on grant of licences for use of software is ‘royalty’?
Held (Delhi High Court):
What has been transferred is not copyright or the right to use copyright but a limited right to use the copyrighted material and does not give rise to any royalty income.
Section 90 of the Act gives relief to the taxpayer who have paid the tax to a country with which India has signed the double taxation avoidance agreement. Section 90(2) lays down that where the Central Government has entered into an agreement with the government of any other country for granting relief of tax or for avoidance of double taxation, then the provisions of this Act shall apply to the Assessee only to the extent that they are more beneficial to the said Assessee.
What has been transferred is not copyright or the right to use copyright but a limited right to use the copyrighted material and does not give rise to any royalty income. To be taxable as royalty income covered by Article 12 of the DTAA the income of the Assessee should have been generated by the “use of or the right to use of” any copyright.
Section 90 of the Act gives relief to the taxpayer who have paid the tax to a country with which India has signed the double taxation avoidance agreement. Section 90(2) lays down that where the Central Government has entered into such an agreement with the government of any other country for granting relief of tax or for avoidance of double taxation, then the provisions of this Act shall apply to the Assessee only to the extent that they are more beneficial to the said Assessee. In case of conflict the provisions of the Double Taxation Avoidance Agreement would prevail over the statutory provisions of the Act in case the same are more beneficial to the Assessee. Therefore, A has the right to be governed by the provisions of the DTAA as the same is more beneficial.
The Court noted the following aspects of the License Agreement to conclude that it was mere transfer of copyrighted material and NOT of copyright as such-
- The License was a non-exclusive, non-transferable licence to use the software in accordance with this Agreement;
- Licensee can make only one copy of the software and associated support information for backup purposes, provided that the copy shall include Infrasoft’s copyright and other proprietary notices.
- All copies of the Software shall be the exclusive property of Infrasoft.
- The Software can be used exclusively for Licensee’s own business as defined in the Licence.
- The Software cannot be loaned, rented, sold, sub-licensed or transferred to any third party, used by any parent, subsidiary or affiliated entity of Licensee or used for the operation of a service bureau or for data processing without prior written consent from Infrasoft.
- Licensee cannot copy, decompile, disassemble or reverse-engineer the Software without Infrasoft’s written consent.
- All copyrights and intellectual property rights in and to the Software, and copies made by Licensee, are owned by or duly licensed to Infrasoft. Infrasoft has the power to grant the licence rights contained in this Agreement.
- Upon termination of the agreement for any reason, the licencee shall return the software including supporting information and licence authorization device to Infrasoft.
Therefore, the High Court concluded that merely authorizing or enabling a customer to have the benefit of data or instructions contained in a software 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. A non-exclusive and non-transferable licence enabling the use of a copyrighted product cannot be construed as an authority to enjoy any or all of the enumerated rights ingrained in Article 12 of DTAA. Here, the incorporeal right to the software i.e. copyright remains with the owner and the same was not transferred by the Assessee. Hence, payments in these types of transactions would be dealt with as business income in accordance with Article 7.
Outcome: ITAT was right in holding that the consideration received by A on grant of licences for use of software is not royalty within the meaning of Article 12(3) of the Double Taxation Avoidance Agreement between India and the United States of America.