Tuesday, February 4, 2014

Payment for Software purchased for bundling with its own software - Not a Royalty - No Tax withholding

Infotech Enterprises Limited v Additional Commissioner of Income Tax, 03 February 2014
 
In favour of: The assessee; Royalty — Software — India–Netherlands DTAA — Article 12 — Assessee purchased software from Dutch company and bundled it with its own software to be sold to its own customers, both in India and abroad — As payment is made to a non-resident company, AO held that payment represented royalty to Dutch company and not purchase price — AO noticed that tax was not deducted at source u/s 195(1), and thus disallowed expenditure u/s 40(a)(i) — DRP upheld order of AO — Held, amount in question is not taxable u/s 9(1)(i) — Even if it is assumed that there is a business connection between assessee and foreign software supplier, there are no operations in India of foreign company to which income may be reasonably attributed — Assessee cannot meddle with copies of software in process of its customisation — Thus, payments made by assessee to Netherlands company will not fall under ambit of Royalty as per Art 12 of India–Netherlands DTAA — Hence, there is no question of tax withholding required by assessee and hence s 40(a)(i) disallowance is erroneous.

ITA No 115/Hyd/2011 and 2184/Hyd/2011,

Assessment Years: 2006–2007 and 2007–2008,

B Ramakotaiah, AM and Asha Vijayaraghavan, JM,

Decided on: 16 January 2014.

Held:
The decision in the case of GE India Technology Centre Pvt Ltd v CIT 327 ITR 456 has clearly stated that the obligation to deduct tax at source is however limited to appropriate proportion of income chargeable under the Act forming part of the gross sum of money payable to the non-resident. In other words, if the tax is not so assessable, there is no question of tax at source being deducted. Hence, the short point is that one has to see whether the amount of ₨ 52,55,881 represents amount chargeable to tax in the hands of the non-resident both in terms of s 9(1)(i) and 9(1)(vi) of the IT Act and also DTAA between India and Netherlands. (Para 24)
 
The amount in question is not taxable u/s 9(1)(i) because even assuming for a moment there is a business connection between the assessee and the foreign software supplier there are no operations in India of the foreign company to which income may be reasonably attributed to as required under Explanation 1(a) to s 9(1)(i). Hence there is no applicability of s 9(1)(i) in the instant case. (Para 25)
 
ITAT was of the opinion that they are simply purchase cost of trading goods especially when the licence in respect of software is not obtained by the assessee and the perpetual licence is given directly to the end customer by the vendor company. Copies of the invoice raised by Net Work Solutions on the assessee support the view of the assessee where the invoice mentioning name of the end customer supports. Hence, when there is no transfer of even the license to the assessee even though it is the purchaser, it cannot be said that there is any royalty payment by the assessee to the vendor company. The amount of ₨ 52,55,81 is simply the cost of imported trading goods and not royalty payment. (Para 26)
 
It is therefore clear that the payments made by assessee to the Netherlands company will not fall under the ambit of Royalty as per Art 12 of the India–Netherlands DTAA. Hence there is no question of tax withholding required by the assessee and hence s 40(a)(i) disallowance is erroneous. (Para 27)
 
Ratio decidendi:
 
When the assessee purchased the software from the foreign company and bundled it with its own software without customising it to sell it to its own customers, the purchase consideration cannot be treated as Royalty u/s 9(1)(vi).
 
In favour of: The assessee; Non-Resident — Business Connection — Fee for technical services — Assessee entered into agreements with foreign AEs for supply and services of computer software — Assessee incurred expenditure towards technical consultancy charges paid in foreign exchange to AEs outside India — AO held that assessee had habitually engaged its subsidiaries to render software services and consultancy services to foreign parties abroad and that foreign subsidiaries were paid periodically by taxpayer for services rendered — AO thus held income of subsidiaries as deemed to have been accrued or arisen in India during year and applied provisions of s 9(1)(i) and accordingly, non-resident companies had business connection with taxpayer — While dealing with communication expenses, AO opined that payments made by taxpayer are in nature of fees for technical services and consequently, provisions of s 195 are applicable and disallowed amount for non-deduction of tax at source — DRP upheld action of AO — Held, assessee has not canvassed/secured any orders for its non-resident subsidiaries, hence, s 9(1)(i) cannot be invoked — Under Act, payments made to subsidiaries may be construed as Fees for Technical Services, however this is only due to fact of retrospective amendment by Finance Act 2010 — At time of payment, case of Ishikawajima-Harima was law of land and twin condition laid down of rendering and utilising technical service in India was not satisfied in assessee’s case as foreign subsidiaries rendered service which was utilised by clients — Thus, assessee could have been of bonafide belief that TDS was not necessary on payments to foreign subsidiaries — Furthermore, assessee could not have been expected to know that TDS should have been deducted in accordance with a law that was to be brought in subsequently — Hence any disallowance u/s 40(a)(i) based on application of a retrospective amendment which assessee could not have foreseen is erroneous — Hence disallowance u/s 40(a)(i) cannot be upheld.

Held:
 
With respect to IEAI USA, factually the assessee has secured the orders from PRATT (PWC) for its own benefit and it only parceled out a portion of the work entrusted to it by PRATT & WHITNEY to IEAI USA. The said Explanation to s 9(1)(i) can be invoked only when the Indian company secures orders for the benefit of non-resident. In the present case, the assessee has not canvassed/secured any orders for its non-resident subsidiaries. Hence, s 9(1)(i) cannot be invoked. (Para 36)
 
Assessee obtained orders on its own behalf and it has only parcelled out a portion of its work to its foreign subsidiaries. As per the terms of the agreement, the assessee “shall release the work order” before the commencement of the work by IEAI USA and each work order shall be supported by end customers order copy. (Para 37)
 
Operation transactions were effected at arms length price. Foreign subsidiaries do not work exclusively for the assessee and they obtain orders on their own from other foreign parties and also sub contract the work to the assessee depending on exigencies. (Para 38)
 
No operations have been undertaken by foreign subsidiaries in India and no engineers have been deputed by them to India and even they do not have permanent establishment in India. In terms of the respective DTAA, no income of the foreign subsidiary is taxable in India in terms of either s 9(1)(i) or the concerned Articles relating to business profits (Art 7 rw Art 5) in the respective DTAAs. As submitted by the assessee, the Board Circular No 29 dated 27 March 1969 is inapplicable to the present case as the example given by the Board, the non-resident is the parent company whereas, in the present case, the Indian Company is the parent company and the assessee has not sold the products of its US subsidiaries or any other foreign subsidiaries. The contention of the assessee that the rate of tax in India is lesser than the rates in USA is also well taken. Hence there is no income taxable in India u/s 9(1)(i) and hence no requirement for TDS and there can be no application of s 40(a)(i). (Para 39)
 
DRP in its order seem to have held that the entire amount paid by assessee to its foreign companies may be regarded as Fees for Technical Services u/s 9(1)(vii). Firstly, under the Act, the payments made to the subsidiaries may indeed be construed as Fees for Technical Services. However this is only due to the fact of the retrospective amendment by Finance Act 2010. (Para 41)
 
At the time of the payment in the instant case Ishikawajima-Harima was the law of the land and the twin condition laid down of rendering and utilising the technical service in India was clearly not satisfied in the assessee’s case as the foreign subsidiaries rendered the service which was utilised by the clients (such as PWC). Thus the assessee could have been of the bonafide belief that TDS was not necessary on payments to the foreign subsidiaries. Furthermore, the assessee could not have been expected to know that TDS should have been deducted in accordance with a law that was to be brought in subsequently. Hence any disallowance u/s 40(a)(i) based on the application of a retrospective amendment which the assessee could not have foreseen is wholly erroneous. Hence under the Act the disallowance u/s 40(a)(i) for FTS payments cannot be upheld. (Para 42)
 
Even under the India–USA and India–UK treaties (not the India–Germany treaty though) due to the presence of the “make available” clause in these two Treaties the payments made by the assessee will not fall under FTS. This is because no technical knowledge has been made available by the non-resident to the assessee. Further, no technical plan or technical design placement has been transferred by US subsidiary to the assessee. What IEAI did was only in fulfilment of contractual requirement with PRATT & WHITNEY and not for the benefit of the assessee. The non-resident has simply executed the portion of work parcelled out to it by the assessee. (Para 43)
 
In the instant case, the UK and USA subsidiaries did only contractual work parcelled out to it whose results were given to clients directly and no technical knowledge was made available to assessee. Hence, even under the respective DTAA, the payments made to UK and US subsidiaries/companies would not fall under the ambit of FTS. (Para 44)
 
In any case, as we have shown above, under the IT Act, none of the payments made by the assessee can be disallowed u/s 40(a)(i) based on effect of retrospective amendment of Explanation to s 9(1). (Para 47)
 
Ratio decidendi:
 
Disallowance u/s 40(a)(i) cannot be made based on the application of a retrospective amendment which the assessee could not have foreseen.

 

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