Software Licensing--Not "Royalty"

Income tax - India-UK DTAA - software licensing - income arising from allowing 'right to use' to Indian software buyers is actually sale of copyrighted article which does not involve transfer of copyright and such receipt is not royalty either under Sec 9(1)(vi) or under DTAA:

M/s INFRASOFT LIMITEDINDIA BRANCH OFFICE,C/o BENTLEY SYSTEMS INDIA PVT LTD203, OKHLA INDUSTRIAL ESTATE, PHASE-III,NEW DELHI - 110020PAN NO : AAACI5073LVsASSISTANT DIRECTOR OF INCOME-TAXCIRCLE-2(2), INTERNATIONAL TAXATION, NEW DELHI

THE use and spread of software application has been phenomenal in India. So is the case with the tax treatment of receipts resulting from either sale of software or licensing of software programmes. What is treated as royalty by the Revenue is actually reckoned as a plain sale of copyrighted article by the assessee. Thus there is nothing new about this dispute as decided by the Special Bench of the Tribunal in the Motorola case. However, there is an element of novelity in the approach of the CIT(A) but the same has been rejected by the Tribunal, relying on the decision of the Special Bench which is binding on it.

And its decision is - the amount received by the assessee under the license agreement for allowing use of the software is not 'royalty' either under Sec 9(1)(vi) of the Income-tax Act or under India-UK DTAA. It has also held that the other receipts on account of maintenance charges and training fees being incidental to the software receipts assume the same character as that of software receipts and the same are liable to be taxed accordingly.

The Tribunal ordered remand of the case to the file of the AO with a direction to reframe the assessment in view of the decision that the payment received by the assessee company against software licensed is not in the nature of royalty but was in the nature of business profits chargeable to tax in its hands under Article 7 of the DTAA.

Facts:

assessee is a marketing and development company of an international group owned by a holding company viz. Infrasoft Corporation, USA. The said group is leader in civil engineering software and has developed a software called Mx which is used for civil engineering work in various countries throughout the world. The said software is used for the design of highways, railways, airports, ports, mines etc. Based on the market position and business potential for the said software and related products in India, a branch office of the group was established in India after obtaining necessary approval mainly for import and supply of software. Branch office also provides support services including system related services such as installation of software, interface to peripherals, uninstallation, imparting of training on the application of software etc. A return of income for the year under consideration was filed by the assessee company on 28.11.2003 declaring a loss of Rs.21,75,246/-.

In the said return, receipts were shown by the assessee company from sale/licensing of the software. According to the AO, the said receipts having regard to the nature of services rendered by the assessee company were in the nature of royalty. He, therefore, required the assessee to show cause as to why the said receipts should not be taxed as royalty as per Article 13 of DTAA and Section 44D read with Section 115A of the Income-tax Act, 1961. In reply, it was submitted on behalf of the assessee company before the AO that the moment copies of software program are made and marketed, the same become goods which are chargeable to sales tax. In support of this submission, reliance was placed on behalf of the assessee company on the decision of Supreme Court in the case of Tata Consultancy Services Vs. State of Andhra Pradesh wherein it was held that software, both canned and uncanned, is intellectual property put on a media and answers the definition of "goods". It was contended that when the software is goods as held by Supreme Court, the assessee company is entitled to deduction of purchase cost of software as well as other expenses incurred and the net profit alone can be taxed and that too, as business profits as per Article 7 of the DTAA between UK and India. It was also contended that even if the receipts of the assessee are to be treated as royalties or fees for technical services, the same having been arisen through a permanent establishment in India, it was chargeable to tax as business profit as per the said Article 7. As regards the applicability of Section 44D, it was submitted on behalf of the assessee company that Section 44D has been inserted by the Finance Act, 2003 making all the expenditure incurred for earning royalty or fees for technical services allowable and although the same has been made effective from 1.4.2004, it can still be applied in the case of the assessee involving AY 2003-04 going by the legislative intention behind inserting the provisions of Section 44D.

AO did not accept the submissions. As regards the decision of Supreme Court in the case of Tata Consultancy Services cited by the assessee company, he held that the same was rendered in the context of Sales Tax Act and the definition of "goods" as given in the relevant Sales Tax Act was interpreted by the SC in order to decide as to whether the software recorded on computer disk was covered within the said definition or not. He held that the said decision rendered in an altogether different context thus was not applicable and the reliance of the assessee on the said decision was clearly misplaced. As regards the provisions of Section 44D relied upon by the assessee, he held that the said provisions inserted in the statute specifically w.e.f. 1.4.2004 are applicable prospectively and the same, therefore, were not applicable in the case of the assessee involving AY 2003-04.

The Assessing Officer then considered the definition of 'royalty' given in Section 9(1)(vi) of the Income tax Act as well as in Article 13 of the DTAA and came to the conclusion that the amount received by the assessee company from licensing of software was qualified to be royalty as per the said definitions.The issue went to the CIT(A) who gave a detailed findings which are,

++ As per provisions of 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. In this case the payment under software license agreement has fulfilled both the conditions and the income from software license was taxable in India as royalty.

++ As per provision of section 9 the payment made for import of software are royalty payment and the only exception provided is in the form of second proviso to section 9(1)(vi) of the Act which excludes such royalty income from purview of section 9(1)(vi) only when the computer software is supplied by a non-resident manufacturer along with computer or computer based equipment under any scheme approved under the policy of computer software export, software development and training 1986 of the Government of India. However, this exception is not applicable to the facts of this case where appellant had granted software licence to various Indian customers.

++ The characterization taxability of income from import of software has been made amply clear in the Income-tax Act through section 115A of the Act which specifically refers to cases where royalties are paid to non-resident for the transfer of all or any right (including the granting of the license) in respect of any computer software to a person resident in India.++ A copy of software supplied by the appellant did not amount to a sale but it is a licence to use the software. This is because software is an intellectual property right (IPR) which can be licensed to one user and can be given further to any number of user. In other words the IPR in software still remain intact with the supplier. Thus effectively the consideration paid is only for license use. It is pertinent to mention here that the Finance Act, 2004 has inserted Category No.55B to include "intellectual property services" to mean"(a) transferring whether permanent or otherwise or(b) permitting use or enjoyment of any intellectual property right" for levy of service tax. This amendment has been noticed by the CESTAT in Araco Corporation v. CCE

++ By the expedient of "deeming fiction" or "inclusive definition" Parliament and State Legislatures are competent to give a specific definition to a particular transaction. Such definition is confined to the specific statute only. Such definition cannot be imported into a different statute which defines the same transaction differently. The necessary corollary is that "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.

++ OECD recommendations remain mere recommendations unless they are incorporated into domestic law and/or DTAAs. The distinction between "copyright right" and "program copy" recommended by the OECD has been dissented from even by several member States (discussed supra) not to speak of India which is no Tribunal even a member of the OECD. Indian laws and India's DTAA recognize only two types of transactions in respect of computer software: sale and licence (letting). No further dissection of licensing (on the lines of the OECD commentary) is permitted under the Indian Copyright Act, Income-tax Act and Indian DTAAs. Therefore, notwithstanding attractive phraseology and nomenclature, any computer software licence fees, where the vendor retains ownership and grants user rights only to the licensee are, without an iota of doubt, taxable as royalties having an Indian source.''Having heard the parties the Tribunal observed that,

++ the material facts involved in the present case relevant to the issue under consideration are similar to the facts involved in the case of Motorola Inc. inasmuch as the relevant clauses of the concerned agreements as referred to by the Special Bench and analyzed to come to the conclusion in the case of Motorola Inc. are almost identical. For example, the license granted to the licensee by the assessee company to use the software was a non-exclusive and non-transferable license as stipulated in clause 2(a) of the license agreement. The licensee was also allowed to make only one copy of the software and associated support information for back up purposes with a condition that such copy shall include Infrasoft copyright and all copies of the software shall be the exclusive property of Infrasoft as per clause 2(d) of the license agreement.

++ As per clause 2(f) of the license agreement, the licensee was allowed to use the software only for his own business as specifically identified and was not allowed to loan, rent, sale, sub-licenses or transfer the copy of software to any third party without the consent of Infrasoft. The licensee was also prohibited from copying, de-compiling, de-assembling or reverse engineering the software without the written consent of Infrasoft as per clause 2(h) of the license agreement.

++ It was also stipulated in clause 5(a) of the license agreement that all copyrights and intellectual property rights in and to the software and copies made by the licensee are owned by Infrasoft and only Infrasoft has the power to grant the license rights for the use of the software. Clause 7(b) of the license agreement also provided that upon termination of the said agreement for any reason, licensee shall return the software including supporting information and license authorization devices to Infrasoft.

++ The sum and substance of the relevant clauses material in this context of the agreement entered into by the assessee with the licensee in the present case thus were similar to that of the agreement analyzed and relied upon by the Special Bench in the case of Motorola Inc. (supra) to come to the conclusion that the payment made for transfer of right to use the software was not for any copyright in the software but only for the software as such as a copyrighted article and the same, therefore, could not be considered as royalty within the meaning of explanation (2) below Section 9(1) of the Income-tax Act or Article 13.3 of the relevant DTAA.

++ A perusal of the impugned order of the learned CIT(A), however, shows that the decision of Special Bench of ITAT in the case of Motorola Inc. (supra) cited on behalf of the assessee was distinguished by him on the basis that the assessee in that case had purchased an integrated electronic switching system consisting of both hardware as well as software whereas the assessee in the present case has licensed only the software to Indian customers without there being any sale of integrated hardware. The decision of the Special Bench in the case of Motorola Inc. on this issue as discussed by us in the foregoing portion of this order, however, shows that this aspect of the matter was not at all taken as basis by the Tribunal to come to the conclusion as it ultimately did. There is nothing whatsoever in the order of the Special Bench to indicate or even suggest that this was in any way the material aspect on the basis of which the Tribunal had proceeded or had rendered its decision.

++ We also fail to understand how this aspect of the matter is so material to distinguish the well-considered and well-discussed decision of the Special Bench rendered after taking into consideration all the relevant aspects. Even the impugned order of the learned CIT(A) does not throw any light on the issue as to how this difference in factual position was so material to justify his action in not following the decision of the Special Bench of the Tribunal which was binding on him. In our opinion, the material facts of the present case relevant to the issue on the other hand were exactly similar to that of the case of Motorola Lac. (supra) as already pointed out by us and the ratio decidendi of the decision of the Tribunal thus was directly applicable in the present case. The difference in facts sought to be pointed out by the learned CIT(A) was actually immaterial or insignificant in this context and the learned CIT(A), in our opinion, ought to have followed and applied the decision of the Special Bench of ITAT in the present case being a binding precedent.

++ heavy reliance has been placed by the CIT(A) in support of his conclusion on the report of the high powered committee stated to be set up by Ministry of Finance, Government of India in the year 1999. This report has been relied upon by the learned CIT(A) for categorization of the software payment as royalty which is different from the revised OECD Commentary. As submitted by the learned counsel for the assessee in this regard, there is, however, nothing either in the order of the learned CIT(A) or even brought on record by the learned DR during the course of appellate proceedings before the Tribunal that the said report of the high powered committee has been accepted by the Government. In any case, the said report or more particularly the recommendation or suggestion of the high powered committee as contained in the said report have not been incorporated anywhere in the relevant provisions of the Income-tax Act. We also see no basis on which the said report can justifiably be preferred to the decision of Special Bench of the Tribunal in the case of Motorola Inc. (supra) which is directly on the point in issue and which is binding on us.

++ The CIT(A) has also relied on the decisions rendered by the courts of other countries wherein software payments have been characterized as royalty in contradistinction to the revised OECD Commentary. He, however, has overlooked the fact that in the decisions rendered by the Courts as well as by the Tribunal in India including especially the Special Bench and Division Bench of the ITAT, the similar payments have been held to be not in the nature of royalty and the same being binding on him, there was no justification to prefer the decisions of the Courts from other countries in preference to the said binding precedent.

++ Even the decision of Supreme Court in the case of Tata Consultancy Services (supra) cited on behalf of the assessee before him was distinguished by him on the ground that the same was rendered in the context of Sales-tax Act and the software was held to be goods liable to sales tax relying on the extended definition of "goods" as given in the Sales Tax Act. According to the learned CIT(A), when different statutes by different phraseology treat the same transaction differently, the attempt at importing the meaning assigned in one statute into a different statute is prohibited.

++ He, however, overlooked that in the case of Tata Consultancy Services (supra), Supreme Court had not only considered the issue from the angle of whether the software was goods for the purpose of Andhra Pradesh Sales Tax Act but the computer software was held to be goods by the Apex Court even under Article 366(12) of the Constitution of India. As held by the Supreme Court in this context, the term "goods" as used in Article 366(12) of the Constitution of India is very wide and includes all types of movable properties, whether those properties be tangible or intangible.

++ It was also held by the Supreme Court that a software program may consist of various commands which enable the computer to perform the designated task and the copyright in that program may retain with the originator of the program. However, the moment copies are made and marketed, they become goods which are susceptible to sales tax. It was further held that even intellectual property once it is put on the media whether it is in the form of books or canvas or computer discs or cassette and marketed would become goods. It was held that in all such cases the intellectual property is incorporated on a media for purposes of transfer and when the sale is made it is not just that of media which by itself has very little value. What the buyer purchases and pays for is not the disc or CD. A perusal of the other case laws relied upon by the CIT(A) in his impugned order as well as those cited by the DR at the time of hearing before us also shows that the decisions rendered therein are not directly applicable to the point in issue.

Thus the Tribunal finally held that the amount received by the assessee under the license agreement for allowing use of the software was not 'royalty' either under the Income-tax Act or under DTAA. It also held that the other receipts on account of maintenance charges and training fees being incidental to the software receipts assume the same character as that of software receipts and the same are liable to be taxed accordingly.