Wednesday, February 3, 2010

AAR Rules on Taxabiility of Software Payments_As NOT "Royalty"

AAR held that payment received by Dassult Systems from its Indian Reseller for supply of software products to end users should not be classified as "Royalty" and hence NOT taxable in India.

A.A.R. NO. 821/2009
M/s. Dassault Systems K.K.,

Commissioner concerned : Director of Income-tax


1. The applicant is a company incorporated under the laws of Japan engaged in the business of providing ‘Products Lifecycle Management’ software solutions, applications and services. The applicant markets the licensed software products mostly through a distribution channel comprising Value Added Resellers (VAR). It is stated that VARs are independent third party resellers who are in the business of selling software to end-users. To authorize a VAR to act as the reseller of Products, the applicant enters into a General VAR Agreement (“GVA”). The applicant states that as per the business model, the Product is sold to VAR for a consideration based on the standard list price less discount. The VAR in turn will sell such product to the end-users at a price independently determined by VAR. The end-user will enter into End User License Agreement (“EULA”) with the applicant and VAR for the product supplied. The reseller (VAR) gets the order from end-user and places a back-to-back order on the applicant. On acceptance of the order by the applicant, it will provide a license key via e-mail so that the customer will directly download the product through the web link.

2. The modus operandi of the transactions has been set out in brief as follows:

- The process starts with the VAR discussing with the end customer details regarding the technical solution i.e. the software and the budget of such end-customer;

- The VAR makes a proposal to end-customer. This proposal includes a copy of the standard tripartite End User License Agreement (EULA).
In a few cases the VAR forwards a Special Bid Offer (SBO) to applicant, typically to decrease their purchasing price. Applicant does not know the price that VAR intends to propose to the end customer in all cases. If applicant agrees, they then propose to VAR a maximum discount. VAR does not share this information with end-customer.

- VAR obtains a Purchase Order (PO) from the end customer. Applicant does not know of this PO, as this is an arrangement between VAR and end customer. The credit control and risk in relation to the end customer lies solely with the VAR.

- Simultaneously, VAR also obtains a signed and sealed End User Order Form from the customer, which describes the software ordered and whereby end customer accepts
the licensing terms of the EULA. This EUOF does not bear the end customer price. The EULA is standard and does not bear any price.

- The VAR then places a PO with the applicant with the price obtained from either the SBO request or based on list price minus VAR discount. The End customer has no knowledge of this PO, since this is an arrangement between the applicant and VAR. For an order of a new software product, the Brand Order Form must be accompanied with a request for media, a request for license key and the signed EUOF;

- The applicant is not duty bound to accept the PO;

- If and when the PO is accepted, the applicant provides a license key via e-mail and download link directly to end customer. Simultaneously it invoices the VAR.

2.1. As to the manner of supply of product to the customer, the applicant states :
The product will be hosted on a server located outside India. The end-user in India will electronically download the Product by accessing the web link directly on its computer system/storage media. In case the end user is not equipped with the required network infrastructure (bandwidth) to download the product, such download will be made by the end user at VAR’s location. In such a situation the end user will carry its own portable storage device to VAR’s location for downloading the Product. No copy of the Product will be saved, even on a temporary basis, on the computer system/ infrastructure of the VAR. VAR is prohibited from opening or using the product. After the download of the product, the end user will use the license key to activate the software and register the license. Such license key would be generated by the applicant to function only on customer’s designated machine identified by internal code attached to their processor.

2.2. The applicant submits that the said transaction between (a) the applicant and VAR, (b) VAR and the End-user is on principal to principal basis and that it has no presence in India whether through any employees or in the form of an office or place of business.

3. The following question is framed by the applicant in order to seek advance ruling from this Authority:
Whether on the facts and circumstances of the case and in law the payment received by Dassault Systems K.K. (hereinafter referred to as the “the applicant”) from sale of software products to independent third party resellers will be taxable as business profits under Article 7 of the India-Japan Double Taxation Avoidance Agreement (“India-Japan DTAA” or “Treaty”) and will not constitute ‘royalties and fee for technical services’ as defined in Article 12 of India-Japan DTAA?

4. Broadly, the applicant’s contention is that the payment made by VAR to the applicant is not in the nature of royalty within the meaning of Article 12.3 of the DTAA1 (or ‘Treaty’) between India and Japan notified by the Central Govt. under Section 90 of the Income Tax Act on 1.3.1990 and secondly it cannot be subjected to Indian income tax in view of Art.7.1 of the DTAA by reason of absence of Permanent Establishment in India.

5. It is trite that the assessee can invoke the provisions of the Income Tax Act or the India-Japan DTAA, whichever is beneficial to it (vide Section 90(2) of the Income Tax Act, 1961). In other words, the provisions of DTAA will prevail over the provisions of the I.T.Act on the same subject-matter in a case of conflict if they are more beneficial to the tax-payer (vide Union of India vs. Azadi Bachao Andolan2. The Circular of CBDT dt.12th April 1982 approvingly cited by Calcutta High Court in Davy Ashmore’s case (190 ITR 626) further clarifies that “where a specific provision is made in the
1 Agreement for Avoidance of Double Taxation and Prevention of Fiscal Evasion
2 263 ITR 706 at pages 723 & 724 DTAA, that provision will prevail over the general provisions contained in the IT Act”. At this juncture, we may mention that there is no material difference and no conflict between the provisions of the Act and DTAA and therefore the conclusion is reached by referring to both.

6. Article 12 of the DTAA lays down the rules for taxation of “royalties”. The relevant part of Art. 12 is extracted below :
“Article 12. 1. Royalties and fees for technical services arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other Contracting State.

2. However, such royalties and fees for technical services may also be taxed in the Contracting State in which they arise and according to the laws of that Contracting State, but if the recipient is the beneficial owner of the royalties or fees for technical services, the tax so charged shall not exceed 10 per cent of the gross amount of the royalties or fees for technical services.

3. The term ‘royalties’ as used in this article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films and films or tapes for radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for the use of, or the right to use, industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience.”

Art.12.1 of DTAA enjoins that royalties and fees for technical services arising in a contracting state and paid to a resident of the other contracting state may be taxed in that other contracting state. However, this general rule is qualified by para 2 which enables the contracting State in which they arise to tax the same according to the laws of that State subject to the limitation that the beneficial owner of royalties or f.t.s shall not be subjected to tax at a rate more than 10% of the gross amount.

7. Under the Income-Tax Act, the income arising from royalty is deemed to accrue or arise in India and the non-resident is liable to be taxed under Section 9(1)(vi) of the Act. Explanation 2 thereto defines ‘royalty’ The relevant part of the definition contained in clause (v) is :”royalty” means consideration for the transfer of all or any rights (including the grant of a licence) in respect of any copy-right, literary, artistic or scientific work, patent, invention, model, design, secret formula or process, trade mark or similar property.

8. The first and foremost question is whether the payments received by the applicant from the VARs represent consideration for the use of, or the right to use, any copyright of literary/scientific work. Going by the language of the Act, the question is whether there is transfer of all or any rights in respect of the copyright of literary or scientific work.

9. Before entering into a discussion on the applicability of the royalty definition, it is appropriate to recapitulate certain basic principles concerning the copyright as a legal concept. We may, in this connection, refer to some passages from the classic treatise of Copinger and Skone James on Copyright (1999 Edn):
“Copyright gives the owner of the copyright in a work of any description the exclusive right to authorize or prohibit the Copyright, Designs and Patents Act, 1988 of UK
exploitation of the copyright work by third parties. This includes the right to copy the work itself and also to use the work in other ways protected under the law”.(p.26)
Copyright is often described as a negative right. This idea is conveyed by Copinger in the following words:

“Copyright, however, does not essentially mean a right to do something, but rather a right to restrict others from doing certain acts, and, when copyright is referred to as “an exclusive right,” the emphasis is on the word ‘exclusive’. Thus, the 1988 Act, whilst not defining “copyright” otherwise than as a property right, which is transmissible as personal or moveable property, provides that the owner of the copyright in a work has the exclusive right to do the acts restricted by the copyright in a work of that description specified in the 1988 Act.3” (p.27)

The following passage also deserves notice:

“It is important to recognize that ownership of copyright in a work is different from the ownership of the physical material in which the copyright work may happen to be embodied. Just as the owner of the physical material on which a copyright work is first recorded is not necessarily the first owner of the copyright, so the transfer of title to the original physical material does not by itself operate to transfer the title to the copyright…... Thus, to take an obvious example, the purchaser of a book or video recording becomes the owner of the physical article but he does not thereby become the owner of any part of the copyright in the works reproduced in it. The copyright in the literary work remains with the copyright owner, who enjoys and is entitled to enforce all the exclusive rights of copying, publication, adaptation, sale, rental and so on conferred on him by copyright law. The purchaser does not acquire by his purchase any right, either by way of assignment or licence, to exercise any of those exclusive rights. (p.217)”

Referring to the position of a licensee and an exclusive licensee, the legal position was stated as follows at p.310:

“A mere licence from the copyright owner confers no proprietary interest on the licensee enabling him, for example, to bring proceedings in his own name, unless coupled with the grant of some other interest, for example, the right to take property away. Statute apart, even an exclusive licence, which is merely the leave to do a thing coupled with a promise not to do, or give anyone else permission to do that thing, gives the licensee no right to sue in his own name for infringement nor any other proprietary interest. In copyright law this general rule is altered by statute in the case of exclusive licences which comply with prescribed formalities. The 1988 Act confers on such a licensee a procedural status which enables him to bring proceedings but otherwise the rule is unchanged: an exclusive licensee has no proprietary interest in the copyright.”

9.1. The view expressed in the above passage that an exclusive licensee has no property right is based on certain vintage decisions of English courts such as Heap Vs. Hartley (1889) 42 Ch.D 461, London Printing and Publishing Alliance Ltd. Vs. Cox (1891) 3 Ch.D 291, Neilson Vs. Horniman (1909) 26 TLR 188. The learned author states that the 1988 Act confers only procedural rights on the exclusive licensees. However, as pointed out earlier, an exclusive licensee is recognized as an owner of the copyright under Section 54 of the Indian Copyright Act entitling him to all the remedies by way of injunction, damages etc. for the infringement of a right, subject to the requirement of Section 61 that in a suit instituted by an exclusive licensee, the owner of the copyright shall ordinarily be made a defendant.

10. In order to appreciate the legal issue, it would be appropriate to refer to the provisions of The Copyright Act, 1957 (hereinafter referred to as ‘CR Act’). This Act was brought into being by repealing the earlier Act of 1914 with a view to amend and consolidate the law relating to copyright. It broadly follows the model of the British Copyright Act of 1956 which has since been replaced by the Copyright, Designs and Patents Act of 1988. Section 16 of the CR Act lays down that no person shall be entitled to copyright or any similar right in any work, otherwise than under and in accordance with the provisions of this Act or of any other law for the time being in force. The works in which copyright subsists throughout India are specified in section 13 as (a) original literary, dramatic, musical and artistic works (b) cinematograph films and (c) sound recording. “Literary work” includes computer programmes, tables and compilations including computer data bases [vide section 2(o) ]. Section 2(ffc) defines “ computer programme” as a set of instructions expressed in words, codes, schemes or in any other form, including a machine readable medium, capable of causing a computer to perform a particular task or achieve a particular result.

10.1. Then, we get the meaning of ‘copyright’ in section 14 and it is a crucial provision for our purpose. The relevant portion of section 14 is extracted hereunder:

Meaning of copyright-
(1) For the purposes of this Act, “copyright” means the exclusive right, subject to the provisions of this Act, to do or authorize the doing of any of the following acts in respect of a work or any substantial part thereof, namely:-

(a) in the case of a literary, dramatic or musical work, not being a computer programme-
(i) to reproduce the work in any material form including the storing of it in any medium by electronic means;
(ii) to issue copies of the work to the public not being copies already in circulation;
(iii) to perform the work in public, or communicate it to the public;
(iv) to make any cinematograph film or sound recording in respect of the work;
(v) to make any translation of the work;
(vi) to make any adaptation of the work;
(vii) to do, in relation to a translation or an adaptation of the work, any of the acts specified in relation to the work in sub-clauses (i) to (vi);

(b) In the case of computer programme-

(i) to do any of the acts specified in clause(a);
(ii) to sell or give on commercial rental or offer for sale or for commercial rental any copy of the computer programme:

Provided that such commercial rental does not apply in respect of computer programmes where the programme itself is not the essential object of the rental;
(c) in the case of an artistic work,-

xx xx xx xx xx xx xx xx
(d) in the case of a 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 a sound recording,-
xx xx xx xx xx xx xx xx”

10.2. Section 18 of CR Act provides for assignment of copyright by the owner either wholly or partially and either generally or subject to limitations. Sub-section (2) of section 18 provides that in a case where the assignee of the copyright becomes entitled to any right comprised in the copyright, the assignee as respects the rights so assigned and the assignor as respects the rights not assigned, shall be treated for the purpose of this Act as the ‘owner’ of copyright. The mode of assignment is provided for in section 19. Section 30 provides for the owner of the copyright in any existing work or the prospective owner of the copyright in any future work may grant any interest in the right by licence in writing signed by him or by his duly authorized agent. An exclusive licence is defined to mean “a licence……. (vide S.2(j)) Section 54 which occurs in Chapter XII “Civil remedies” specifically states that the expression “owner of copyright” shall include an ‘exclusive licensee’. The owner of the CR Act can maintain an action by way of injunction, damages etc. for the infringement of copyright in any work (vide Section 55). Section 61 enjoins that in any civil suit or other proceeding regarding infringement of copyright instituted by an exclusive licensee, the owner of the copyright shall, unless the Court otherwise directs, be made a defendant.

10.3. Chapter XI contains the provisions relating to the “infringement of copyright”. Section 51 is extracted hereunder:

“51 When copyright infringed- Copyright in a work shall be deemed to be infringed-
(a) when any person, without a licence granted by the owner of the copyright or the Registrar of Copyrights under this Act or in contravention of the conditions of a licence so granted or of any condition imposed by a competent authority under this Act-
(i) does anything, the exclusive right to do which is by this Act conferred upon the owner of the copyright, or
(ii) permits for profit any place to be used for the communication of the work to the public where such communication constitutes an infringement of the copyright in the work, unless he was not aware that had no reasonable ground for believing that such communication to the public would be an infringement of copyright; or

(b) when any person-

(i) makes for sale or hire, or sells or lets for hire, or by way of trade displays or offers for sale or hire, or
(ii) distributes either for the purpose of trade or to such an extent as to affect prejudicially the owner of the copyright, or
(iii) by way of trade exhibits in public, or
(iv) imports into India,

any infringing copies of the work:

Provided that nothing in sub-clause(iv) shall apply to the import of one copy of any work for the private and domestic use of the importer.

Explanation – For the purposes of this Section, the reproduction of a literary, dramatic, musical or artistic work in the form of a cinematograph film shall be deemed to be an “infringing copy”.”

10.4. Section 52 specifies the acts which do not constitute infringement of copyright. Insofar as it is relevant, the section is extracted below:
“ 52(a) xx xx xx xx xx xx xx xx
(aa) the making of copies or adaptation of a computer programme by the lawful possessor of a copy of such computer programme from such copy-
(i) in order to utilize the computer programme for the purpose for which it was supplied; or
(ii) to make back-up copies purely as a temporary protection against loss, destruction or damage in order only to utilize the computer programme for the purpose for which it was supplied;

(ab) the doing of any act necessary to obtain information essential for operating interoperability of an independently created computer programme with other programmes by a lawful possessor of a computer programme provided that such information is not otherwise readily available;
(ac) the observation, study or test of functioning of the computer programme in order to determine the ideas and principles which underline any elements of the programme while performing such acts necessary for the functions for which the computer programme was supplied;
(ad) the making of copies or adaptation of the computer programme from a personally legally obtained copy for non-commercial personal use.”

10.5. Adaptation is defined to mean “in relation to any work, any use of such work involving its rearrangement or alteration”.

11. Computer software is embraced within the definition of literary work in the Indian Copyright Act. Even otherwise, the computer programme embedded in the software is a scientific work. In the I.T.Act, Computer software is defined in Explanation 3 to Section 9(1)(vi) to mean any computer programme recorded on any disk, tape, perforated media or other information storage devices and includes any such programme or any customized literary data. Though this definition holds good for the purposes of 2nd proviso to Section 9(1)(vi), the ordinary meaning and understanding of computer software is no different. Computer programme is defined in the Copyright Act as follows :
“Computer programme means a set of instructions expressed in words, codes, schemes or in any other form, including a machine 4 (2009) 317 ITR 169 (AAR)
readable medium, capable of causing a computer to perform a particular task or achieve a particular result.”

11.1. There is no doubt that the computer programme forming part of the software falls within the description of literary or scientific work. A copyright in or over the computer software produced by the applicant is in the nature of an intangible, incorporeal right belonging to the category of intellectual property rights. All intellectual property rights in the licensed programs exclusively belong to the applicant or its licensor and they are retained by the applicant, as per the explicit declaration in the Agreement. The copyright in the software product vests with the applicant who has exclusive rights over the same. In order to see whether the applicant has transferred any rights related to copyright or conferred on the licensee/end-user the rights over the use of copyright, it is necessary to ascertain the true meaning of copyright and the incidents attached to it.

12. In the case of FactSet Research Systems Inc.4, this Authority took the view that it is permissible to take into account the definition in the Copyright Act, while considering a substantially similar question. It was observed thus :

“18. The expression “copyright” is not defined in the Income tax Act. It must be understood in accordance with the law governing copyright in India, viz., the Copyright Act, 1957. In State of Madras vs. Gannon Dunkerley and Co., AIR 1958 SC 560 ; 9 STC 353, the Supreme Court held that the expression “sale of goods” in entry 48 of List II (VII Schedule) to the Government of India Act is a nomen juris and shall be construed in its legal sense. The legal sense can only be what it has in the law relating to sale of goods and, therefore, the said expression shall bear the same meaning as it has in the Indian Sale of Goods Act. Looking at the Treaty, we have Article 2(2) which clarifies how the undefined terms shall be understood. In substance, it says that an undefined term shall have the meaning which it has under the taxation law of the State concerned. When the term is not defined in the taxation law (Income-tax Act), the definition in the law governing the subject-matter ought to be adopted, more so when there is no basic difference between the statutory definition and the ordinary legal concept. Section 16 of the Copyright Act lays down that no person shall be entitled to copyright or any similar right in any work otherwise than under and in accordance with the provisions of this Act or any other law in force.”

There is no good reason to think that under the I.T. Act, the concept of copyright has to be understood differently from that evolved under the law of the land. The reference of the Revenue’s representative to the provisions in Section 115A(1A) and the 3rd Expln to cl.(vi) of sub-section (1) of Section 9 is in a different context and cannot control the meaning to be given to ‘copyright’. From the said provisions, it cannot be concluded that the supply of computer software necessarily carries with it the copyright owned by
the producer of software.

13. It is the contention of the applicant that what is transferred to the end-user is copyrighted software containing computer programme but not the copyright therein. The copyright continues to be vested in its entirety with the applicant and none of the rights therein including the right to use are made available to the VAR or end-user. It is contended that no consideration is paid for the use of copyrights in the computer programme. All that is transferred is a limited right to use a copyrighted product. The rights associated with the copyright are those which enables the recipient to commercially exploit the product and that is absent here. The permitted use, it is pointed out, is only for licensee’s internal use. It is argued that a non-exclusive licence to the end-user to have access to the licensed programmes though the machines of the end-user, that too for licensee’s internal use only, does not amount to the use of copyright or the right to use the same. Apart from copyright, the Revenue cannot bring the income in question within any of the other limbs of the definition of royalty in Art.12.3, it is contended. The consideration received by the applicant from VAR with reference to the transactions entered into with end-users is not a consideration for the use of any of the copy-rights in the software. The applicant finally submits that the income representing the payments received from the VARs can be treated as business profits by the applicant, but in view of the fact that the applicant has no “Permanent Establishment” as defined in Art.5 of the Treaty, that income is beyond the taxable net of the Income Tax Act. In this context, it is contended that VAR cannot be treated as a dependent agent of the applicant.

13.1. The arguments on behalf of the Revenue are summarized below:
Whether considered from the angle of domestic law or the Treaty, the license fee paid by the customer in India is for the transfer of rights in respect of copyright in software or for the use of computer programme embedded in it. The question whether there is transfer of any rights in the copyright has to be judged with reference to the provisions of Income-tax Act and DTAA and not the Indian Copyright Act, except to find out the meaning of ‘Copyright’. Moreover, a distinction has been maintained in the Copyright Act between copyright in a literary work like a book and the computer software and a separate sub-section is enacted for ‘computer programme’. The right of sale is also recognized as part of the copyright in relation to computer programme and the VAR, according to the applicant is granted such a right under the license. If so, Section 14

(b) is attracted. The Income-tax Act maintains a distinction between ‘royalty’ arising in respect of “copyright in a book’ and “computer software” as seen from Section 115A(1

A) as well as the 3rd Expln to cl.(vi) of sub-section (1) of Section 9. The term ‘copyrighted article’ may be aptly used for a book or music CD, but it is a misnomer in the case of a computer programme (software) where one or more rights in copyright have to be necessarily transferred to make it workable. The payment is clearly for obtaining a right to copy the program on to the hard disc and to use it and therefore falls within the scope of Section 14(a)(i) of Copyright Act. The use of any right in Intellectual Property for captive use is nonetheless a business/commercial use. It is clear from EULA that the product is licensed and not sold and the consideration received is license fee. The claim of the applicant that as per the terms of GVA and EULA, the transaction is in the nature of purchase of intangible products by VAR and resale to the end-user is unsustainable and goes contrary to the stipulation in EULA that the product is licensed and not sold. Reliance on the OECD commentary on Article 12 cannot be placed for the reason that the Indian Government has not agreed to the viewpoint expressed in the commentary. Alternatively, it is contended the applicant has granted the rights for the use of process/equipment and, therefore, the payment falls within the definition of ‘royalty’. Then, it is submitted that in reality, the VAR is acting on behalf of the applicant for securing the customers to whom the products and services of the applicant are to be licensed. The consideration flows from the end-user to the applicant through the channel of VAR. VAR is in reality a dependent agent of the applicant as the applicant controls the operations of the VAR. The discretion given to VAR to independently fix the price payable to it by the end-user is practically a dead letter because the standard price details would be available to the public and the said price will not be exceeded. It is VAR alone, in actual practice, which has authority to conclude the standard form contracts. It is, therefore, submitted that the applicant has an agency PE in India.

14. A reference to the Agreement (GVA) between the applicant and the VAR reveal the following:

14.1. The applicant appoints VAR to act during the term of the agreement as a non-exclusive distributor of products and brands in the ‘territory’. “Product” means “the DS Group Computer Software and other products identified by brand” listed in the Brand Exhibit. The applicant or its group companies are at liberty to market and distribute the products directly or indirectly to end-users inside and outside the territory and they may also appoint other distributors of products and brands within or outside the territory.(cl.2.1). The applicant grants to VAR a non-exclusive, non-transferable license to market and distribute the products for the internal use of any end-user within the territory. Such license shall also include a non-exclusive, non-transferable right to set, invoice and collect license fee due by the end-user pursuant to the EULA as long as VAR remains a party to such EULA. (cl.3.1.1). VAR acknowledges that except for demonstration purposes, it has no right to develop any product or derivative work from products and it has no right to engage in reverse engineering of any products for which demonstration license has been granted (cl. 3.4.1 & 3.4.2). VAR further acknowledges that the agreement does not grant VAR any right or license to the products or the proprietary rights therein or to the source code for the products.(cl.3.4.3). Clause 8.1 which bears the heading “Ownership of Products” declares that the applicant and its licensor shall retain all right, title and interest in products throughout the world including patent, copyright and trade secret rights. Clause 4.6 enjoins that subject to clause 6, VAR shall be entitled to invoice and collect any license fee due pursuant to EULA to which it is a party and such license fee shall be paid directly by the end-user to VAR. Under clause 6, VAR shall have the sole right to set the license fee for products in accordance with clause 3.1.1. Clause 6.2 refers to ‘distributor price’. It says: “VAR shall order licenses for products at the prices indicated in the brand price list effective as of the date the Company accepts the Order minus the discount rate set forth in the Discounts Exhibit”. The applicant shall have the right to change the prices on 60 days’ notice (clause 6.2).

14.2. Thus, the terms of the agreement explicitly provide for the appointment of reseller/distributor of product on a non-exclusive basis for making the product available to the end-user within the territory for his internal use. The reseller gets the order from end-user and places back to back order. Reseller does not hold any inventory of software in India. VAR is free to negotiate the price with the customer but VAR pays to the applicant the standard price in force less the agreed discount. Of course, the price is not the same as the reseller gets from the customer. VAR is the primary point of contact for any end-user. The applicant may accept or reject any order at its discretion and VAR is not granted any authority to enter into written or oral contracts on behalf of the applicant. VAR cannot assign or delegate any of its rights or obligations to any third party without prior consent of the applicant. GVA imposes restrictions on the VAR in relation to the rights to develop any product or derivative work from the software provided to the end-user. Various other restrictions adverted to supra are also imposed on the VAR consistent with his position as non-exclusive distributor. The applicant will invoice VAR and VAR is required to make payment within 30 days irrespective of recoverability of the product price by the VAR from end-user. As noticed earlier, the GAV stipulates that the applicant shall retain all rights, title and interest in products including patent, copyright and trade secret rights. The applicant makes no warranties to VAR regarding products and such warranties are made only to the end-user. The applicant submits that the arrangement is squarely in the nature of purchase of intangible copyrighted products by VAR from the applicant for re-sale to end-user and such sale and purchase is on principal to principal basis. The applicant submits that in the entire transaction, the VAR acts purely as a trader who purchases the products from the manufacturer for re-sale to the end customers and the applicant has not transferred nor permitted the use of copyright by VAR.

15. It is relevant to refer to the provisions in the End-user License Agreement. EULA is a tripartite agreement which defines rights and obligations in relation to end-user. VAR joins the Agreement in every case in which the order is placed by end-user pursuant to a Quote issued by VAR. Clause 2.1 declares that the Company grants to the licensee (end-user) subject to the terms and conditions of the Agreement, a non-exclusive, non-transferable license to use the licensed programme on the computer equipment of the licensee. ‘Licensed Program’ means “(i) any data processing program for which a license is ordered by and provided to licensee pursuant to a Quote (commercial proposal), consisting of a series of instructions or databases in machine readable form (ii) associated documentation (iii) maintenance delivery (correction of errors for a given Release) (Release means a periodic update of the same version of a licensed program) and (iv) Releases”. The licensee has no right to sub-license and moreover the licensed programmes can only be operated by licensee for internal use. It is specifically stated that license keys or license tokens do not themselves grant the legal right to use the licensed program. Clause 2.2 lays down the ‘restrictions’. The licensee is not authorized to use the licensed programme to develop software applications for use by or distribution to any third party or to perform or offer any type of services relating to licensed programs including consulting, training, out-sourcing, customization or development for any third party. Should the licensee wish to use the licensed programme for any such purposes, the licensee has to enter into a separate agreement with a DS Group Company. Licensee may make the necessary number copies of the licensed program for installation and one copy for back-up per machine in support of licensee’s authorized use. The mode of delivery through electronic means is detailed in the Agreement. Subject to the payment of applicable charges, the applicant or VAR or any other designated third party will provide ‘support services’ for licensed programmes. The Price and licensee’s payment obligations are specified in cl.4. The pricing structure contains two or three elements (i) primary license charge (PLC) coupled with annual licence charge (ALC) PLC is a one time non-refundable charge for the grant of perpetual license to use the ‘release’ of licensed programme made available by company on the effective date of the license. The annual license charge (ALC) is a yearly charge, payable in advance i.e., for the first year of each license or renewed license. Payment of ALC for licensed programme entitles the licensee to support services for the licensed program for one year and a license to use the ‘releases’ of such program made available by the applicant during the year; (ii) yearly license charge (YLC) which is for renewal of the facility of using the releases of licensed program and support services for one year. Clause 5 refers to Intellectual Property Rights and confidentiality. The stipulations are almost similar to those in the GVA agreement. Transfer, assignment and sub-contract is prohibited. In the event the licensee fails to pay any annual or yearly license fee when due to VAR, the VAR shall have the right to withdraw from the Agreement on giving due notice. The circumstances in which the support services related to licensed programs can be terminated by the licensee, by VAR or applicant are set out in clause 10 of EULA. Payments shall be made to VAR in the event the Quote is made by VAR or to the applicant in case the Quote is made by the applicant.

16. In the present case, the software product dealt with by the applicant is standardized but special purpose software. It is not customized software. It will not be available off the shelf nor is it produced pursuant to an order placed by the end-user according to the specifications given by him. Broadly, the software products supplied by the applicant go by the description of Product Lifecycle Management (PLM) Software Solutions. PLM is “the process of managing the entire lifecycle of the product from its conception, through design and manufacture, to service and disposal”. We get the description of the PLM solutions which the applicant deals with from the website, an extract from which has been placed before us by the Departmental Representative. It says that “CATIA provides solution for product design and innovation”. In the brand order form pertaining to one of the VARs (TATA Technologies), the product description is given as CATIA Team PLM, CATIA – Mechanical Product Creation and CATIA – Mechanical Shape Design. Some other programs specified in ‘General Brand Appendix are : Enovia VPLM, Simulia V5, KEM, 3 D Live etc. In the web site, it is stated that Enovia is for “collaborative lifecycle management, Simulia for virtual testing, 3d VIA is for online 3D lifelike experience”. The learned counsel for the applicant has informed us in the course of hearing that the products of the applicant are mostly ordered by the automobile industry. It has been clarified more than once that they are not customized or tailor-made.

17. Looking at the broad pattern of transactions between the applicant, the VAR and the end-user, it is clear that on the acceptance of the order by the applicant, the VAR makes one time payment to the applicant which is known as ‘distributor price’ which is arrived at by deducting the discount from the brand price list. It may be clarified that the PLC/ALC fixed by the applicant forms the basis for working out the ‘distributor price’. Obviously, this payment is made in consideration of the applicant “providing the licensed programmes” of the brand ordered by the end-user and authorizing the end-user to make use of the same for its internal purposes. It is seen from EULA that the Company grants the licensee (end-user) a non-exclusive, non-transferable licence to use the licensed programmes on the computer equipment belonging to the licensee or under its control. Licensed programme is made available to the licensee directly through electronic delivery the details of which have already been set out. The licensee/end-user does not make any payment to the applicant. The license charges (PLC/ALC) are collected by the VAR on its own. The authority to collect such licence fee from the end-user is specifically conferred on the VAR in terms of the agreement. Can it be said that the one time payment based on standard price minus discount paid by VAR to the applicant is in the nature of royalty? It depends on the question whether any rights that the applicant granted to the licensee/end-user include the right of using the copyright. Alternatively, going by the language of I.T.Act, the question is whether any right in respect of copyright has been transferred. It is here the distinction between the use of copyrighted article and the use of copyright has been stressed. The copyright which is a species of intellectual property rights belongs to the owner or its assignee if any. The ownership thereof carries with it a bundle of rights which are by and large directed towards commercial exploitation of this intangible property right. Those rights attached to copyright are enumerated in Section 14 of the Copyright Act, 1957. If any of these rights are parted with in favour of another so that the other person can enjoy that right in the same manner in which the owner can, it can then be said that those specific rights concerning the use of copyright have been conferred on him. In the instant case, the end-user is not given the authority to do any of the acts contemplated in sub-clauses (i) to (vii) of clause (a) of Section 14, not to speak of the exclusive right to do the said acts. In fact, the restrictions placed on the end-user and the VAR which have been referred to earlier coupled with a declaration that the intellectual property rights in the licensed programmes will remain exclusively with the applicant (or its licensors) and the non-exclusive and non-transferable character of licence are all meant to ensure that none of the rights vesting in the applicant as copyright-holder can be claimed or enjoyed by the licensee and that they will remain intact and are preserved. The entire tenor of the Agreement and the various stipulations contained therein make it clear that no rights in derogation of the applicant’s exclusive rights in relation to the copyright have been conferred on the licensee i.e., the end-user or VAR. The core of the transaction is to authorize the end-user to have access to and make use of the licensed software products over which the applicant has exclusive copyright, without giving any scope for dealing with them any further.

17.1. Passing on a right to use and facilitating the use of a product for which the owner has a copyright is not the same thing as transferring or assigning rights in relation to the copyright. The enjoyment of some or all the rights which the copyright owner has, is necessary to trigger the royalty definition. Viewed from this angle, 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 a copyright. Where the purpose of the licence or the transaction is only to establish access to the copyrighted product for internal business purpose, it would not be legally correct to state that the copyright itself has been transferred to any extent. It does not make any difference even if the computer programme passed on to the user is a highly specialized one. The parting of intellectual property rights inherent in and attached to the software product in favour of the licencee/customer is what is contemplated by the definition clause in the Act as well as the Treaty. As observed earlier, those rights are incorporated in Section 14. 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, in our view, amount to transfer of rights in relation to copyright or conferment of the right of using the copyright. However, where, for example, the owner of copyright over a literary work grants an exclusive license to make out copies and distribute them within a specified territory, the grantee will practically step into the shoes of the owner/grantor and he enjoys the copyright to the extent of its grant to the exclusion of others. As the right attached to copyright is conveyed to such licencee, he has the authority to commercially deal with it. In case of infringement of copyright, he can maintain a suit to prevent it. Different considerations will arise if the grant is non-exclusive that too confined to the user purely for in-house or internal purpose. The transfer of rights in or over copyright or the conferment of the right of use of copyright implies that the transferee/licencee should acquire rights – either in entirety or partially co-extensive with the owner/transferor who divests himself of the rights he possesses pro tanto. That is what, in our view, follows from the language employed in the definition of ‘royalty’ read with the provisions of Copyright Act, viz., Section 14 and other complementary provisions.

17.2. We may refer to one more aspect here. In the definition of royalty under the Act, the phrase “including the granting of a licence” is found. That does not mean that even a non-exclusive licence permitting user for in-house purpose would be covered by that expression. Any and every licence is not what is contemplated. It should take colour from the preceding expression “transfer of rights in respect of copyright”. Apparently, grant of ‘licence’ has been referred to in the definition to dispel the possible controversy a licence – whatever be its nature, can be characterized as transfer.

17.3. We may in this context usefully refer to the well-reasoned opinion expressed by OECD in its Commentary* on Article 12.

“Transfers of rights in relation to software occur in many different ways ranging from the alienation of the entire rights in the copyright in a programme to the sale of a product which is subject to restrictions on the use to which it is put. The consideration paid can also take numerous forms. These factors may make it difficult to determine where the boundary lies between software payments that are properly to be regarded as royalties and other types of payment. The difficulty of determination is compounded by the ease of reproduction of computer software, and by the fact that acquisition of software frequently entails the making of a copy by the acquirer in order to make possible the operation of the software.
Payments made for the acquisition of partial rights in the copyright (without the transferor fully alienating the copyright rights) will represent a royalty where the consideration is for granting of rights to use the programme in a manner that would, without such license, constitute an infringement of copyright. Examples of such arrangements include licenses to reproduce and distribute to the public software incorporating the copyrighted programme, or to modify and publicly display the programme. In these circumstances, the payments are for the right to use the copyright in the programme (i.e. to exploit the rights that would otherwise be the sole prerogative of the copyright holder).

In other types of transactions, the rights acquired in relation to the copyright are limited to those necessary to enable the user to operate the programme, for example, where the transferee is limited rights to reproduce the programme. This would be the common situation in transactions for the acquisition of a programme copy. The rights transferred in these cases are specific to the nature of computer programmes. They allow the user to copy the programme, for example onto the user’s computer hard drive or for archival purposes. In this context, it is important to note that the protection afforded in relation to

# (of copying the programme on to the user’s computer hard drive)
computer programmes under copyright law may differ from country to country. In some countries the act of copying the programme onto the hard drive or random access memory of a computer would, without a license, constitute a breach of copyright. However, the copy right laws of many countries automatically grant this right to the owner of software which incorporates a computer programme. Regardless of whether this right# is granted under law or under a license agreement with the copyright holder, copying the programme onto the computer’s hard drive or random access memory or making an archival copy is an essential step in utilizing the programme. Therefore, rights in relation to these acts of copying, where they do no more than enable the effective operation of the programme by the user, should be disregarded in analyzing the character of the transaction for tax purposes. Payments in these types of transactions would be dealt with as commercial income in accordance with Article 7.
The method of transferring the computer programme to the transferee is not relevant. For example, it does not matter whether the transferee acquires a computer disk containing a copy of the programme or directly receives a copy on the hard disc of her computer via a modem connection. It is also of no relevance that there may be restrictions on the use to which the transferee can put the software.”

17.4. The analysis and reasoning appeals to us and it appears to project a sound approach to the issue under consideration.

18. It has been contended on behalf of the Revenue that the right to reproduce the work in any material form including the storing of it in any medium by electronic means (vide Section 14(a)(i) of the C.R Act) must be deemed to have been conveyed to the end-user. It is pointed out that a CD without right of reproduction on the hard disc is of no value to the end-user and such a right should necessarily be transferred to make it workable. It appears to us that the contention is based on a mis-understanding of the scope of right in sub-clause (i) of Section 14(a). As stated in Copinger’s treatise on Copyright, “the exclusive right to prevent copying or reproduction of a work is the most fundamental and historically oldest right of a copyright owner”. We do not think that such a right has been passed on to the end-user by permitting him to download the computer programme and storing it in the computer for his own use. The copying/reproduction or storage is only incidental to the facility extended to the customer to make use of the copyrighted product for his internal business purpose. As admitted by the Revenue’s representative, that process is necessary to make the programme functional and to have access to it and is qualitatively different from the right contemplated by the said provision because it is only integral to the use of copyrighted product. Apart from such incidental facility, the customer has no right to deal with the product just as the owner would be in a position to do. In so far as the licensed material reproduced or stored is confined to the four corners of its business establishment, that too on a non-exclusive basis, the right referred to in sub-clause (i) of Section 14(a) would be wholly out of place. Otherwise, in respect of even off the shelf software available in the market, it can be very well said that the right of reproduction which is a facet of copyright vested with the owner is passed on to the customer. Such an inference leads to unintended and irrational results. We may in this context refer to Section 52(aa) of C.R.Act (extracted supra) which makes it clear that “the making of copies or adaptation” of a computer program by the lawful possessor of a copy of such program, from such copy (i) in order to utilize the computer program, for the purpose for which it was supplied or (ii) to make back up copies purely as a temporary protection against loss, destruction, or damage in order to utilize the computer program for the purpose of which it was supplied” will not constitute infringement of copyright. Consequently, customization or adaptation, irrespective of the degree, will not constitute ‘infringement’ as long as it is to ensure the utilization of the computer program for the purpose for which it was supplied. Once there is no infringement, it is not possible to hold that there is transfer or licensing of ‘copyright’ as defined in CR Act and as understood in common law. This is because, as pointed out earlier, copyright is a negative right in the sense that it is a right prohibiting someone else to do an act, without authorization of the same, by the owner.

18.1 It seems to us that reproduction and adaptation envisaged by Section 14(a)(i) and (vi) can contextually mean only reproduction and adaptation for the purpose of commercial exploitation. Copyright being a negative right (in the sense explained in para 9 supra), it would only be appropriate and proper to test it in terms of infringement. What has been excluded under S.52(aa) is not 5 271 ITR 401 commercial exploitation, but only utilizing the copyrighted product for one’s own use. The exclusion should be given due meaning and effect; otherwise, Section 52(aa) will be practically redundant. In fact, as the law now stands, the owner need not necessarily grant licence for mere reproduction or adaptation of work for one’s own use. Even without such licence, the buyer of product cannot be said to have infringed the owner’s copyright. When the infringement is ruled out, it would be difficult to reach the conclusion that the buyer/licensee of product has acquired a copyright therein.
The following observations of the Constitution Bench of the Supreme Court in Tata Consultancy Services vs. the State of Andhra Pradesh5 case are quite apposite, though made in a different context :

“a software programme may consist of various commands which enable the computer to perform a designated task. The copyright in that programme may remain with the originator of the programme. But the moment copies are made and marketed, it becomes goods, which are susceptible to sales tax.”

Viewed from any angle, we have no hesitation in rejecting the contention of the Revenue referred to in para 18 supra.

19. Next, it has been argued on behalf of the Revenue that the right to sell or offer for sale the applicant’s software product has been conferred on the VAR and therefore such authority given to VAR amounts to conferment of rights in or over the copyright in
view of cl.(b)(ii) of Section 14. We are unable to sustain this contention. First of all, this contention of Revenue goes contrary to its stand that the product was licensed but not sold. Be that as it may, even for other reasons, the contention has to be rejected. VAR has not been given an independent right to sell or offer for sale the software products of the applicant to the end-users. What the VAR does in the course of carrying out its marketing function is to canvass for orders, collect the purchase order from the interested customer and forward that offer to the applicant. It is the applicant that accepts or rejects that offer. For this purpose, a non-exclusive and non-transferable license to distribute the product has been given to VAR. The transaction emanating from the order of the end-user followed up by back to back order of VAR is finalized by the applicant and unless the purchase order is accepted by the applicant, the transaction does not materialize. The VAR’s role is only to forward the order to the applicant with the necessary documents. It is upto the applicant to accept it or not to accept it. Once the product is delivered to the end-user, the sale if any by VAR takes place simultaneously and that transaction is a different one. In the absence of an independent right to conclude the sale or offer for sale, sub-clause (ii) of clause (b) of Section 14 cannot be invoked to bring the case within the fold of Art.12.3 of the Treaty or Section 9(1)(vi) of the Act. It is also noteworthy that VAR is not an
exclusive distributor for a territory and he does not pay any consideration to the applicant distinctly for acquiring the distribution rights. He gets the discount for each individual transaction at the agreed rate.

20. Before winding up the discussion on the copyright issue, we may usefully refer to the observations made by this Authority in FactSet Research (supra) and the decisions of the Income Tax Appellate Tribunal on the subject.

20.1. In the FactSet case, the payment made for accessing computer data base pursuant to an agreement under which the Indian customers were granted limited, non- exclusive, non-transferable right to use information in the data base for personal use was held to be not royalty in terms of Explanation 2 to Section 9(1)(vi) as well as Art.12(3) of the Indo-US Tax Treaty. The features of the transaction in the above case were brought out in the following sentences:

“21. The applicant’s database is a source of information on various commercial and financial matters of companies and similar entities. What the appellant does is to collect and collate the said information/data which is available in public domain and put them all in one place in a proper format so that the customer (licensee) can have easy and quick access to this publicly available information. The applicant has to bestow its effort, experience and expertise to present the information/data in a focused manner so as to facilitate easy and convenient reference to the user. For this purpose, the applicant is called upon to do collation, analysis, indexing and noting wherever necessary. These value additions are the product of the applicant’s efforts and skills and they are outside the public domain. In that sense, the database is the intellectual property of the applicant and copyright attaches to it; but, the question is whether in making this centralized data available to the customer-licensee for a 6 (2005) 95 ITD 269
consideration, can it be said that any rights which the applicant has as a holder of copyright in database are being parted in favour of the customer? The answer, in our view, must be in the negative. No proprietary right and no exclusive right which the applicant has, has been made over to the customer.”

The ruling in FactSet may not apply in all fours to the case on hand in view of the qualitative difference in the nature of software. However, some of the passages therein have a bearing on the issue confronting us in the present case as well. It was observed at para 25 (of ITR) :

“25. Even examining from the standpoint of Treaty, we do not think that “the use of or right to use any copyright of a literary or scientific work” is involved in the subscriber getting access to the database for his own internal purpose. It is like offering a facility of viewing and taking copies for its own use without conferring any other rights available to a copyright holder. The expression “use” (of copyright) is not used in a generic and general sense of having access to a copyrighted work. The emphasis is on the “use of copyright or the right to use it”. In other words, if any of the exclusive rights which the owner of copyright (the applicant) has in the database are made over to the customer/subscriber so that he could enjoy such rights either permanently or for a fixed duration of time and make a business out of it, then, it would fall within the ambit of the phrase “use or right to use the copyright”. What rights of exclusive nature attached to the ownership of copyright have been passed on to the subscriber at least partially? Is the licensee conferred with the right of reproduction and distribution of the reproduced work to its own clientele? Can it be publicly exhibited or its contents be communicated to the public? Is the applicant given the right to adapt or alter the “work” for the purpose of marketing it? The answer is obviously – no. The underlying copyright behind the database cannot be said to have been conveyed to the licensee who makes use of the copyrighted product.”

20.2. A Special Bench of Income Tax Appellate Tribunal in Motorola Inc. vs. DC(IT), Delhi6, has exhaustively dealt with the question and that decision has been followed in several decisions of ITAT till date. In that case, the assessee-Companies were suppliers of telecommunication equipments comprising both hardware and software. The software was for the specific use of the customer and was not available off-the-shelf. The assessing officer held that the assessee had licensed the software and the customers had the right to use the software and therefore the payment received by the assessee was in the nature of royalty under the DTAA between India and Sweden. This finding was challenged in appeal. The crux of the issue before it, as stated by the Tribunal, was whether the payment was for a copyright or for a copyrighted article. After referring to the definition of ‘copyright’ under Section 14 of the Copyright Act, the Tribunal observed thus:

“What is to be noted is that the right mentioned in sub-clause (ii) of clause (b) of section 14 is available only to the owner of the computer programme. It follows that if any of the cellular operators does not have any of the rights mentioned in clauses (a) and (b) of section 14, it would mean that it does not have any right in a copyright. In that case, the payment made by the cellular operator cannot be characterized as royalty either under the Income-tax Act or under the DTAA. The question, therefore, to be answered is whether any of the operators can exercise any of the rights mentioned in the above provisions with reference to the software supplied by the assessee.”
It was then pointed out in para 158 that in the definition of copyright, the emphasis is on the exclusive right granted to the holder thereof. This condition, it was observed, was not satisfied in the case of JTM because the license granted to it by the assessee was a “non-exclusive, restricted license”. It was then observed: “This means that the supplier of the software, namely, the assessee, can supply similar software to any number of cellular operators to which JTM will have no objection and further all the cellular operators can use the software only for the purpose of their own operation and maintenance of the system and not for any other purpose. The user of the software by the cellular operators in the public domain is totally prohibited. ……Thus, JTM has a very limited right so far as the use of software is concerned, …., JTM has not been given any of the seven rights mentioned in clause (a) of section 14 or the additional right mentioned in sub-clause (ii) of clause (b) which relates to a computer programme and, therefore, what JTM or any other cellular operator has acquired under the agreement is not a copyright but is only a copyrighted article.”
Then, it was held :

“162. A conjoint reading of the terms of the supply contract and the provisions of the Copyright Act, 1957 clearly shows that the cellular operator cannot exploit the computer software commercially which is the very essence of a copyright. In other words a holder of a copyright is permitted to exploit the copyright commercially and if he is not permitted to do so then what he has acquired cannot be considered as a copyright. In that case, it can only be said that he has acquired a copyrighted article. A small example may clarify the position. The purchaser of a book on income-tax acquires only a copyrighted article. On the other hand, a recording company which has recorded a vocalist has acquired the copyright in the music rendered and is, therefore, permitted to exploit the recording commercially. In this case the music recording company has not merely acquired a copyrighted article in the form of a recording, but has actually acquired a copyright to reproduce the music and exploit the same commercially. In the present case what JTM or any other cellular operator has acquired under the supply contract is only the copyrighted software, which is an article by itself and not any copyright therein.”

The contention of the Revenue’s counsel that if a person acquires a copyrighted article, he automatically gets a right over the copyright also has been negatived. Then, after referring to OECD Commentary etc. the conclusion was reached that the payment made by the cellular operator was not for any copyright in the 7 (2005) 94 ITD 91
software but was only for the software as such, as a copyrighted article. Hence, it was held to be not royalty either under the Act or the DTAA.

20.3. In the case of Samsung Electronics Ltd.7, a case decided by Bangalore Bench of the Tribunal, the appellant therein imported off-the-shelf software from different suppliers abroad. It was pointed out that what the appellant had acquired was only a copy of the copyrighted article i.e., software and the incorporeal right to software remained with the owner. The right to the use of copyright is different from the right to use the programme embedded in cassette or CD.

21. In view of the above discussion, we are of the view that no rights in relation to copyright have been transferred nor any right of using the copyright as such has been conferred on the licensee.

22. The Revenue has contended alternatively that the payments received by the applicant must be regarded as consideration for the use of or right to use the ‘process’ or the transfer of rights in respect of a process developed by the applicant. The Revenue’s representative has drawn our attention to the recent order of the Special Bench of ITAT Principal Bench in the case of New Skies Satellite Telecommunications Ltd. (ITA no.5385/DEL/2004). After referring to the dictionary meaning which defines ‘process’ as a
40 series of actions or steps towards achieving a particular end, the learned members of the Tribunal held “that a process is involved in the transponder through which the telecasting companies are able to uplink the desired images/data and downlink the same in the desired area which inter alia covers Indian territory” and that the consideration paid by the telecasting companies is a consideration for user of the process. It was further pointed out that it is not necessary that the process in respect of which the consideration is paid should be a secret process. “The simple process, even if unprotected intellectual property, will fall within the ambit of royalty.” It was observed that as per the Agreement, the use of process was provided by the Satellite Companies to the telecasting Companies whereby the telecasting companies were enabled to telecast their programmes by uplinking and downlinking the same with the help of that process. The assessee in that case is a non-resident company engaged in the business of providing satellite transponders to the telecasting and telecom companies in the Asian region. The payments received by the assessee were held to be royalty within the meaning of the Act as well as DTAA. We do not think that on the same analogy and reasoning, the payment received by the applicant from VAR can be treated as royalty income. We are unable to hold that the analogy of use of process in a transponder can be invoked in the present case. The nature of operations involved therein is different and not comparable to the software product with which we are concerned. We do not think that the right of using the process involved in the software has been conveyed to the end-user in the instant case. Usage of process contained in the software or acquisition of rights in that process is not the real nature and substance of the transaction. The ‘process’ contemplated by the definition clause is broadly referable to know-how. The scope of preceding expression ‘formula’ too belongs to the same genus. By making use of or having access to the computer programs embedded in the software, it cannot be said that the customer is using the process that has gone into the end-product or that he acquired any rights in relation to the process as such. Nor can it be said that following the series of instructions so as to be able to effectively make use of the programs contained in the software amounts to the use of process or acquisition of any rights in relation thereto. The Revenue’s contention on this score therefore fails.

We refrain to go into the other controversial question whether the adjective ‘secret’ governs both formula and process. However, we would like to observe that much can be said against the view taken by the Tribunal in the case of New Skies Satellite case that the ‘process’ need not be secret and it can be any kind of process, whereas the ‘formula’ should be in the domain of secrecy.

23. We may mention that the learned DR at one stage made a feeble attempt to bring the transaction under equipment royalty. However, it was not pursued further and moreover we find no legal basis for holding that there is any usage of equipment here.

24. The last point to be considered is whether the applicant can be said to have a permanent establishment or whether VARs are dependent agents of the applicant so as to give rise to an agency PE in India by virtue of article 5(7) of the DTAA. If the applicant is held to have a permanent establishment (PE) in India, it will have to pay tax on the business income even if the income is not royalty (vide article 5(1) of the DTAA). Article 5(7) reads thus:

“Notwithstanding the provisions of paragraphs 1 and 2, where a person other than an agent of an independent status to whom paragraph 8 applies – is acting in a Contracting State on behalf of an enterprise of the other Contracting State, that enterprise shall be deemed to have a permanent establishment in the first-mentioned Contracting State, if

(a) he has and habitually exercises in that Contracting State an authority to conclude contracts on behalf of the enterprise, unless his activities are limited to those mentioned in paragraph 6 which, if exercised through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph;

(b) he has no such authority, but habitually maintains in the first-mentioned Contracting State a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the enterprise; or

(c) he habitually secures orders in the first-mentioned Contracting State, wholly or
almost wholly for the enterprise itself or for the enterprise and other enterprises controlling, controlled by, or subject to the same common control as that enterprise.”
Para (8) refers to independent agent. It reads:

“5.8. An enterprise shall not be deemed to have a permanent establishment in a Contracting State merely because it carries on business in that Contracting State through a broker, general commission agent or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business”.

24.1. On a reading of the said provisions, it is clear that the existence of an agent of independent status covered by paragraph 8 does not give rise to a PE. However, if the person employed by the applicant for the purpose of business operations in India is not of an independent status, the PE is triggered if such an agent engages himself in the activities specified in clauses (a), (b) & (c) of Article 5.7.

24.2. It is the contention of the Revenue that VAR is in reality a dependent agent of the applicant as the applicant controls the operations of VAR and VAR acts exclusively for the applicant or its group. In this regard, the Revenue relies on clause 4.17 of the Agreement (GVA) under which VAR undertakes not to develop, license, market, distribute or maintain competing products or become the agent of any competitor within or outside of the territory. Another provision relied upon is clause 6.11 which says that in the event of the failure of VAR to invoice and collect license fees when due by end-users, the applicant shall have the right after consulting with VAR, to request VAR to assign to the applicant its obligations to invoice license fees and the right to collect the same. Yet another clause in the agreement referred to by Revenue’s representative is clause 7 which deals with “VAR reports, records and plans”. Under this clause, VAR is required to report to the business manager of the applicant, certain informations, namely, forecast reports, sales reports, capacity reports and such other information relating to the marketing and distribution of the products as the applicant may require. Under the head ‘capacity reports’ VAR is required to submit monthly details of number of sales representatives and application engineers working in each brand. Then, under clause 7.2, VAR is required to maintain accurate records relating to the marketing and sales of products to end-users in the territory which shall include details regarding the identity of each end-user, address, end-user contact, operating environments of each end-user, the date of receipt of end-user order for each product, the dates of products delivery etc. The applicant shall have a right upon reasonable notice to audit and copy these records and in the event of any breach being revealed, pay to the applicant the full cost of such audit and copying. VAR is also required to furnish sales plan, financial information and other material information which may affect directly or indirectly the performance of VAR’s obligations under the agreement.

24.3. According to the Revenue’s representative, these provisions in the agreement would reveal that the business of VAR is substantially controlled and directed by the applicant and VAR is economically dependent on the applicant as “almost entire business of VAR under the terms and conditions of GVA would be for the applicant and its group”. The nature of records, reports and informations to be submitted by VAR would, according to the Revenue, throw light on the fact that it is the applicant which is operating vis-à-vis the end-user and the role of VAR is only that of an agent performing the functions on behalf of the applicant. These stipulations, the Revenue points out, are inconsistent with the alleged independent status of VAR. Further, it is submitted that VAR is a person who would habitually secure the orders wholly for the applicant and other companies of DS group. The fact that theoretically, VAR is free to determine the final price to be charged from the end-user does not alter the dependent status of the agent because it would be difficult for VAR to collect anything over and above the standard price for the given product as notified by the applicant from time to time. In regard to the authority to conclude contracts, it is pointed out that “in case of mass contracts (EULA) made out on standard form, it cannot be said that authority lies with the applicant”.

24.4. The applicant repudiates these contentions by contending that each VAR is a non-exclusive distributor of the applicant transacting with the applicant on principal-to-principal basis. It is disputed that the VAR is an agent of the applicant and it is submitted that placing of restrictions upon and requiring the VAR to furnish certain reports does not alter the status of distributorship to that of agency. In any case, it is submitted that VAR cannot be considered to be dependent agent at all as the criteria laid down in article 5(7) have not been satisfied. On the point of legal dependency, it is submitted that VAR is a distinct legal entity which is unrelated to applicant. The management of VAR and the applicant is not common. As regards economic dependency, it is stated that the prohibition on sale of competing products is not total and further, the economic risk of the products has to be borne by VAR only and the applicant is not bound to take the product back or reimburse the VAR. Above all, VAR is not concluding contracts on behalf of applicant nor securing orders wholly or almost wholly for the applicant and, therefore, dependent agency does not arise.

25. We do not think that the contentions of the Revenue on the existence of an agency PE can be sustained. The business of VARs such as Tata Technologies Ltd. is not confined to the dealings only with the applicant and its products. They are appointed and known as distributors. It is not uncommon that a distributor carries out some functions and obligations similar to those of an agent. Improvement of the business of the applicant, assisting the applicant in formulating its marketing strategies and preventing the misuse of the product supplied to the end-users are all functions which are not extraneous to the distributorship. The business of the VAR is not controlled by the applicant except to the extent necessary to promote its own business. It is beyond dispute that the VAR does not negotiate or conclude contracts with the end-users on behalf of the applicant. As noticed earlier, the acceptance of the order placed by the end-user and procured by VAR is left to the discretion of the applicant. That authority is not delegated to VAR. Moreover, VAR is free to determine its own price while entering into the deal with the end-user on the acceptance of the order by the applicant. It is not possible to accept the contention that arriving at the price is an empty formality and always follows a set pattern. The VAR does not notify or render account to the applicant for the amount collected from the end-user. The VAR cannot claim reimbursement from the applicant for the loss caused to him by reason of VAR’s failure to pay the amount. It is difficult to perceive any predominant features which point to the relationship of principal and agent. As regards the obligations cast on the VAR to furnish reports and informations, it is clarified by the applicant that they are meant to help the applicant estimate the demand for the product and to ensure that adequate effort is put in by the VAR to increase sales. The customer information is necessitated in order to ensure that the product is not misused and that the service needs of the customers are attended to diligently in case of neglect on the part of VAR. As regards the perusal of the financial statements, the applicant clarifies that it is meant to ensure that the VAR is not selling competing products in violation of the restrictions imposed. The restraints placed on VAR not to market or license competing products subject to certain exceptions is again not a factor that points to the existence of principal and agent relationship.

25.1. On the point whether the criteria laid down in Art.5.7 is satisfied (even assuming that the distributor is an agent), clause (c) of Art..5.7, if at all, is relevant. But, having regard to the fact that indisputably, the VARs deal with other software products of different types and their business activities are not confined to the enterprises of the applicant or its group concerns, there is hardly any scope to apply cl.(c ) of Art.
5.7. Viewed from any angle, it is not possible to reach the conclusion that the VARs/distributors are the agents much less dependent agents of the applicant and therefore the applicant must be deemed to have a permanent establishment in India.

26. In the light of the foregoing discussion, the Question is answered as follows:
The answer to the question framed by the applicant is broadly in the negative. It is ruled that the payment received by the applicant from VARs (“third party re-sellers”) on account of supplies of software products to the end-customers (from whom the licence fee is collected and appropriated by VAR) does not result in income in the nature of royalty to the applicant and moreover payments received by the applicant cannot be taxed as business profits in India in the absence of permanent establishment as envisaged by Article 7 of the India-Japan Tax Treaty.

26.1. It is nobody’s case that the payments are in the nature of fees for technical service; therefore, that aspect has not been discussed.
Accordingly, the ruling is given and pronounced on the 29th day of January, 2010.


Find enclosed Compilation of FAQ’s on GST for your ready reference. This is only for educational and guidance purposes and do not hold an...