Payment for Software--Not Royalty Income

Lucent Technologies International Inc VS DCT--New Delhi

Transfer of right to use of software loaded on the hardware - Fact that the assessee had not transferred the right to the Indian Cellular operator to duplicate or adapt or use the same in public, it was a mere transfer of a copyrighted article and not the copyright - income is not royalty either under the domestic law or the DTAA - CIT(A) order disallowed and the Assessee's argument upheld

Out of these seven appeals, six appeals i.e., three by the assessee and three by the Revenue are cross-appeals which are directed against three separate orders passed by the learned CIT(A)-XXIX, New Delhi on 20-3-2001, 27-8-2003 and 25-1-2006 for assessment years 1997-98, 1998-99 and 2000-01 respectively whereas the remaining appeal of the Revenue being ITA No. 4624/Delhi/2005 is directed against the order of the learned CIT(A) dated 15-9-2005 for assessment year 1999-2000. As the main issues involved in these appeals are common, the same have been heard together and are being disposed of by this single consolidated order.

2. The main common issue relating to the existence of permanent establishment of the assessee-company in India is raised by the Revenue in ground No. 1 of its appeal for assessment year 1997-98 and in the solitary ground raised in appeals for assessment years 1998-99, 1999-2000 and 2000-01.

3. The material facts relevant to this issue are that the assessee Lucent Technologies International Inc. (LTII) is a company incorporated in the USA. It is a tax resident of USA. It is a leading supplier of hardware and software used for GSM cellular radio telephone system. The assessee had supplied telecommunications hardware and software to its customers in India. The Assessing Officer after reading the contract entered into by the assessee with its customers, came to the conclusion that the assessee had sent its employees to India to conduct network survey and undertake negotiations and carried out market activity and on the ground that the company which was to do the installation and the after sale service and which originally was under the name of AT&T India Pvt. Ltd., re-named Lucent Technologies India Ltd. (LTIL), held that the profits on the supply of hardware and software is taxable as per the provisions of the Income-tax Act, profit on the hardware is taxable as per article 7 read with article 5 of the Double Taxation Avoidance Agreement (DTAA) between India and USA and the software and documentation is taxable under the head ‘Royalty’ as per article 12 of DTAA between India and USA. The Assessing Officer had held that the assessee herein i.e., LTII had a fixed office of business in India in the form of office of its Indian subsidiary, being LTIL and the employees of the assessee company were coming to India and were staying here for a long time and the visits were not casual, but were spread over a long time and these employees were utilizing the office furniture and telephone facilities of the Indian company and were provided perquisites like car, use of staff facilities by the Indian company and held that the office of AT&T (India) Pvt. Ltd. subsequently re-named LTIL was the fixed place of business of the assessee herein. The Assessing Officer further held that the contract had been signed by the assessee company in India and the terms were also negotiated in India. The network survey was carried out in India and a complete interface was provided in the form of project coordinators, managers etc. and these activities were not possible unless the assessee did not have a fixed place of business in India. Further, the Assessing Officer had held that the assessee company herein had provided training courses in India to its customers and the perusal of the contract clearly indicated that the hardware is supplied through the Permanent Establishment (PE) in India. Consequently, to his conclusion, the Assessing Officer had held that the Indian company, M/s. LTIL was a dependent agent and consequently, the PE of the assessee company, in regard to software supplied. The Assessing Officer had held that the payment for the same was fees for included services which is described in the treaty between USA and India. Consequently, the Assessing Officer had taken the value as per the contract and brought the same to tax by estimating the profits therefrom at 40 per cent.

4. Aggrieved by the orders of the Assessing Officer, the assessee filed first appeals to the learned CIT(A) and after considering the submissions made on behalf of the assessee in the light of material available on record, the learned CIT(A) held for the reasons given in paragraph Nos. 10.7 to 10.9 of his impugned order that the assessee did not have a PE in India. Aggrieved by the same, the Revenue has raised this issue in the present appeals filed before the Tribunal.

5. At the time of hearing, it was submitted by the Ld. DR that the Indian subsidiary LTIL was the PE of LTII, the assessee herein. He drew our attention to the contracts entered into between the assessee and M/s. Escotel Mobile Communications Ltd. which was at pages 69-137 of the paper book as also the contract entered into between Escotel Mobile Communications Ltd. and M/s. AT&T (India) Pvt. Ltd. which was at pages 139-186 of the paper book. It was also placed before us the copy of the technical explanation of the convention and protocol between the USA and the Republic of India signed on 12-9-1989 issued by the Treasury Department of USA. He further placed before us the Notification No. GSR 990(E), dated 20-12-1990 in regard to the DTAA between USA and India. He also drew attention to the article 3 of the said notification wherein as per sub-clause (2), it had been clarified that the terms not defined in the convention were to have meanings which it has under the laws of the State concerning the taxes to which the convention applies. It was also his submission that though on a similar issue the Special Bench of this Tribunal in the case of Motorola Inc. v. Dy. CIT [2005] 95 ITD 269 (Delhi) had held that there was no PE therein, in a subsequent Mutual Agreement Procedure (MAP) after the decision of the Special Bench of the Tribunal, Motorola Inc. had conceded that it had a PE in India and Motorola Inc. had agreed to be subjected to tax law in regard to transactions in India. He further drew our attention to article 5(2) which was an inclusive definition of the PE. He relied upon clauses (k) & (l) of the said sub-clause (2) of article 5 of the DTAA . It was the submission that as per sub-clause (1) of article 5(2), if any service is rendered by the non-resident assessee company to an associated enterprise for even one day there will be a PE. It was also his submission that no formal permission to use the subsidiaries’ premises was required and even a casual use would lead to the existence of a PE. He further drew our attention to page 71 of the assessee’s paper book which is the copy of the agreement between the assessee and M/s. Escotel wherein the assessee has been categorized as the contractor and as per the said agreement the assessee was to supply the GSM network in accordance with the functional specifications and the product and design specification set out. The assessee was to complete the GSM network project on a turnkey basis. He further drew attention to page 77 of the paper book wherein clause (1) under the head “Definitions and interpretations” it has been specifically mentioned that AT&T India Pvt. Ltd., a wholly owned subsidiary of the contractor (assessee) was to supply all hardware and software services under the terms of the separate contract entered into between the Escotel and AT&T (India) Pvt. Ltd. dated on or about the date of the contract entered into between the assessee and M/s. Escotel. He further drew attention to page 82 of the paper book under the heading “Contractor’s general responsibilities” in article 3 wherein the assessee herein had agreed to prepare designs as also manufacture, supply and deliver all hardware, software and related services in accordance with the contract to enable installation, testing, commissioning and achievement of provisional acceptance and final acceptance of the system or sub-system (as the case may be) by AT&T (India) Pvt. Ltd. with the exception of installation, testing and commissioning of receiver station, control equipment, GSM antennas and feeder cables etc. The contractor being the assessee herein shall inspect the installation and supervise the testing andcommissioning of the various equipments by Escotel. In para 3.4 of the said contract the 8.1 software version release for mobile switch centre etc. was to support certain features required for GSM standard. As per clause 3.5, assessee was to install the said software along with the call monitoring system for Escotel. As per clause 5, the assessee was to appoint the project manager responsible for ensuring that the assessee complies with the project management processes and the identity of the project manager was subject to Escotel’s prior written approval. As per clause 6, within one calendar month of the date of the contract the assessee and M/s. AT&T India was to submit the schedule of works to Escotel for its approval. As per clause 12, the assessee was to perform certain structural testing programmes, sufficient to the satisfaction of Escotel that the hardware, software, sub-system, system to meet the requirement of the contract and achieve provisional acceptance and final acceptance. He drew our attention to clause 17 of the said contract which required the assessee to keep available of necessary spare parts for the system, repair any defective hardware modify, enhance or otherwise update the software during the operational life of the hardware and software as per the support contract. As per clause 19 during the operational life of the hardware and software, the assessee was to provide training to Escotel personnel in accordance with the provisions of support contract. He further drew our attention to clause 37 of the said contract which was the address for correspondence and the said address given was that of the “Contracts Manager, AT&T (India) Pvt. Ltd.” in India. He further drew our attention to page 123 of the paper book under clause 46 wherein Escotel reserved itself the right to have any of the assessee’s support personnel replaced for various reasons specified therein. He further showed us the chart in regard to division of responsibilities between the assessee and its Indian subsidiaries in the contract with M/s. Escotel. It was also his submission that as per article 5(2)(1)(i) of the DTAA between USA and India, if any of the employees or other personnel of LTII, the assessee was involved in furnishing of any services for a period of or periods aggregating more than 90 days within 12-month period for the Indian subsidiary LTIL, even then there was a service PE. It was his submission that the personnel of LTII did function under the control and did provide services to LTIL being a subsidiary and consequently there was a PE.

6. In reply, the learned counsel for the assessee submitted that as per article 5(2)(1) of the DTAA between USA and India, it was required that employees of the assessee company should have provided the services to the subsidiary in India. He drew our attention to page 260 of the paper book which is a copy of the list of expatriates during the year 1996-97 which run into 17 names. He drew our attention to pages 270-283 of the paper book which is a copy of the return of one Shri Topolski Francis, one of the expatriates as also pages 284-295 which is a copy of the return of Mr. Lowri Charles. It was his submission that the expatriates who had worked with LTIL were not the employees of LTII. It was his submissionthat these expatriates were employees of various other companies in which the assessee, LTII, had certain interest. It was thus his submission that it was the employees of the affiliates of the assessee who had provided the services to LTIL and consequently it could not be said that LTIL was a service PE of the assessee here. He further drew our attention to the various clauses of the agreement between the assessee and Escotel as also the agreement between LTIL, AT&T (India) Pvt. Ltd. and Escotel. It was his submission that as per the contract between the assessee and Escotel, the assessee was to prepare the designs, solutions, manufacture, supply and deliver all hardware, software and related services in accordance with the provisions of the contract and the contract between Escotel & LTIL was for the installation, testing, commission and achieving provisional acceptance and final acceptance. He drew our attention to clause 3 of both the agreements which provided for the said different responsibilities. It was his submission that all other clauses in the contracts were basically mirror images. It was his submission that it was only to protect the interest of Escotel that Escotel had required that both the assessee and LTIL, enter into identical contracts with Escotel except for the specific acts required by each of the persons. It was his submission that the contract had not been signed in India and for this he drew our attention to affidavit of Shri Kenneth G. Jackson on pages 187-190. Shri Kenneth G. Jackson has categorically admitted that he was the corporate counsel employed by Lucent Technologies Asia/Pacific Ltd. and he acted as a legal counsel for the various subsidiaries and affiliates of the assessee in the Asia/Pacific region including India. He has categorically declared that the agreements between the assessee and Escotel were signed on two dates, the one on behalf of Escotel in India on 18-5-1996 and on behalf of assessee subsequently at Singapore. It was his submission that the negotiations before the contract did not establish a PE in India in regard to the contract. He further drew our attention to page 201 of the paper book which is the certificate issued by LTIL specifying that they did not hold any spares on behalf for the equipments supplied by the assessee under the contract with Escotel. He also drew our attention to pages 202-234 of the paper book which is a copy of the support service agreement between Escotel and AT&T (India) Pvt. Ltd. (LTIL). It was his submission that as per the support service agreement, the Indian subsidiary was to provide all the support service and repairs and replacements of the turnkey project. It was thus his submission that the assessee has not undertaken in other obligations with Escotel other than supply of hardware and software. It was also his submission that the decision of the Special Bench of the Tribunal in the case of Motorola Inc. (supra) would squarely cover the facts of the assessee’s case and just because Motorola has entered into a mutual agreement procedure it did not make the decision of the Special Bench of the Tribunal, otiose. It was also his submission that the equipments supplied by the assessee was through sale and the sale had taken place outside India and all other services were rendered by the Indiansubsidiary as per the terms of the contract between Escotel and the Indian subsidiary LTIL. It was his further submission that the interpretations provided by the US Treasury though specified the requirement of a lesser nexus for the creation of a PE, in the assessee’s case there was no nexus at all and therefore, it could not be said that there was a PE of the assessee in the form of LTIL in India.

7. We have considered the rival submissions. At the outset, what is noticed from the two agreements, being the one between the Escotel and the assessee and the other between Escotel & AT&T (India) Pvt. Ltd., now knows as LTIL shows that the contract is for two different purposes. The agreement between Escotel and the assessee herein is for the supply of the hardware and software. The agreement between Escotel and LTIL is for commissioning, installation and operations. However, both the agreements provided for the turnkey functioning of the project of the GSM network. In short, what is noticed is that by entering into the contract by Escotel with both the assessee and its LTIL, Escotel has made both the assessee and LTIL responsible for the turnkey completion of the GSM project, individually and severally. Thus, if either one breaks its terms of conditions of contract with Escotel, the other would be responsible for its completion. In short, a consortium or partnership has been created between the assessee and its Indian subsidiary LTIL. With this situation, the next question that comes up is, can either the assessee or its subsidiary LTIL complete the contract with Escotel on a turnkey basis without the assistance of the other. Obviously, the assessee is to supply the hardware and the software and LTIL is to do the installation, testing, commissioning and bringing up to operation of the turnkey project. If the assessee herein does not provide the hardware and the software, it would be the duty of the LTIL to provide the requisite hardware and the software in the completion of the turnkey project. Similarly, if LTIL does not comply with its duties of commissioning, installation, testing, and bringing up to operation, the turnkey project, such responsibility would rest on the shoulder of the assessee. Here, what is noticed is that there is no dispute that the assessee herein has completed its part of its contract i.e., the supply of the hardware and the software. It is also specifically noted here that the installation, commissioning, testing and bringing up to operational status of the hardware and the software supplied by the assessee herein has been undertaken by the Indian subsidiary, LTIL. For this purpose, LTIL has also undisputedly taken the assistance of the expatriates, here the employees of the affiliates of the assessee herein. Thus, what is noticed here is that the parent company being the assessee herein has made personnel in form of the employees of the affiliates of the assessee available to the LTIL, the subsidiary, for remuneration. Further, a perusal of the agreement between Escotel and the assessee clearly shows that the warrantees provided by the assessee company is in relation to the defects in the hardware. This is noticed in clause 16 of the agreement. As per this clause, in the hardware, if any defect is noticed, the same has to be replaced or repaired within the time scale detailed in the support contract. This warrantee clause in identically form is also found in clause 16 of the agreement contract between Escotel and LTIL. Thus, what is noticed is that normally the warrantee for a particular product which is to be supplied by one person, is the responsibility of that person alone, but in the present case it is noticed that this burden is also shifted to the subsidiary being LTIL. Though, LTIL has certified that does not keep any spares on behalf of the assessee for the equipments supplied by the assessee under the contract with Escotel still the fact that LTIL has also assumed the responsibilities of the warrantee in regard to the hardware supplied by the assessee as also the responsibility to replace the same within the period specified in the support contract between Escotel and LTIL clearly shows that the subsidiary LTIL is also acting on behalf of the assessee. A perusal of article 5(2)(1) clearly shows that it is not only the employees through whom if services are provided the PE is to set to come into existence. It also includes other personnel. Obviously, the term other personnel has to be read with reference to the earlier words as provided in the said article 5(2)(1). The other personnel specified here would be persons over whom the enterprise would be having a control. In the present case undisputedly employees of the affiliates of the assessee had been employed through LTIL the services of installation, commissioning, testing and bringing up to operation of the hardware and the software sold by the assessee to Escotel through its contract in regard to GSM project to be completed on a turnkey basis. These employees of the affiliates over whom the assessee has a control would fall within the term other personnel and consequently, it would have to be held that a PE did exist as per the inclusive term as provided in article 5(2)(1) of the DTAA between USA and India. A copy of the returns of the expatriates which have been placed in the paper book also clearly show that they have been in India for more than 90 days within the 12 month period from April, 1996 to March, 1997. Consequently, the terms of article 5(2)(1)(i) of the DTAA between USA and India are fulfilled. Consequently, it would have to be held that LTIL in fact was a service PE of the assessee. Consequently, the findings of the CIT(A) on this issue stand reversed.

8. The next common issue raised in ground No. 2 of the assessee’s appeal for assessment years 1997-98 and 1998-99 and ground No. 1 of its appeal for assessment year 2000-01 relates to the treatment given by the Assessing Officer as well as by the learned CIT(A) to the payments received by the assessee company under license agreement of allowing use of computer software as ‘royalty’ as against the claim of the assessee company that the same constituted its business profits.

9. The amounts received by the assessee company under the license agreements in allowing use of computer software was claimed to be its business profit. In this regard, the stand of the assessee as taken before the Assessing Officer was that there was no transfer of copyright in the software to the Indian operator and what was transferred or sold was merely a copyrighted article. It was pointed out in this context that the Indian operator had no right to sub-lease or sub-license the software and the copyright thus remained with the assessee. The Assessing Officer did not accept this stand of the assessee. According to him, the software constituted intellectual property right and not goods or equipment. He held that the amount received by the assessee for transfer of such rights thus was in the nature of royalty income and the same was chargeable to tax in the hands of the assessee company as such. When the matter was carried before the learned CIT(A), he discussed the facts and submissions of the assessee in relation to this issue in paragraph 11.1 of his impugned order before recording his conclusions in paragraph 11.2. The relevant portion of the learned CIT(A)’s order in this context is reproduced below:—

“11.1 This brings us to the issue whether the licensing of software led to the receipt of royalties or receipt of commercial income. In general terms, the case of the ld. Assessing Officer was that software constituted intellectual property right (IPR) or not goods or equipment. The appellant did not pass the title in the software but the Indian operator was given a limited right to use the software. On the other hand, the case of the appellant was that it did not transfer copyright in the software to the Indian operator. What it sold was a copyrighted article. The Indian operator had no right to sub-lease or sub-license the software. All the arguments of the rival parties are not reproduced here for the sake of brevity. However, it is pointed out that the provisions of the DTAA are more favourable to the appellant and, therefore, the discussion is restricted to these provisions only. These provisions have been discussed in OECD commentary and IRS of USA has also issued guidelines on what constitutes copyright and what constitutes copyrighted article. These guidelines are most beneficial to the appellant. Insofar as Indian cases are concerned, there is only one decision of Andhra Pradesh High Court in which levy of sales tax on branded software was upheld. The Hon’ble High Court went only to the extent of saying that branded software, sold off the shelf, is liable to sales tax and the relevant provisions in the UPGST were not ultra vires the constitution. However, it also held that that will not apply to customized software or the software not sold off the shelf.

11.2 I have carefully considered the facts of the case and rival submissions. The words Copyrighted article are oxymoron words, being copyright and article at the same time. Such words should be viewed with great circumspection. The appellant has also adopted dual standards in interpreting the agreements, sometime saying that the legal liabilities should flow strictly from the agreement terms, and not arguing that the words in the agreements should be read down. I am of the view that on the facts and in the circumstances the license of software amounted to transfer of copyright and not merely transfer of copyrighted article. The case of the appellant is caught within the mischief of Article 12 of the DTAA and is not saved under OECD commentary or IRS guidelines. For this purpose, let us first describe the facts briefly. The appellant entered into agreement of sale of hardware and software to the operator in terms of the supply contract with a view to set up GSM. Three types of software, namely, prepaid software, BTS software and MSC software, of the value of US$ 71,24,680, were licensed. In view of these distinction and also due to difference in nature of the two properties, it is quite clear that the supply agreement was, in fact, two agreements for transfer of the respective properties. It is not necessary that there should be two separate agreements for arriving at this conclusion. Consequently hardware was sold and the software was licensed as per two separate agreements in the light of aforesaid discussion. The purpose of the GSM was to enable the operator to provide mobile telephony services to its customers. This fact was very well known to the appellant. On obtaining the license, the contractor loaded the software on the equipment and trained its contractor’s personnel to use the hardware and the software. But the story does not end here and setting up the GSM for the sake of setting it up would mean nothing to the operator. At this stage the customer, who wants to use mobile telephone services, enters the scene with a handset. A part of the software, depending upon his requirements, is loaded on to his handset for giving him connectivity. And with this loading of the software, the GSM comes alive. It is this software which permits the customer to get connectivity with GSM and consequently with any other telephone users, mobile or stationary. No such connectivity is feasible without loading a part of the software on the handset of the customer. Once the connectivity is allowed, the customer can enter the GSM, and use its software for doing his business, namely get connected to another person outside the GSM. The process involves the use of software of the GSM by the customers. Therefore, the ld. Assessing Officer was right when he mentioned that with every call, the customer of Indian operator used the GSM and its software. It cannot be pleaded that the appellant was not aware of the importance of this connectivity. Even if such a plea would have been taken, then that plea would have been wrong for the simple reason that the preamble to the Supply Contract states that the appellant wishes to provide supply of GSM Mobile Telephone System and Application Software. It was in this context that the software was licensed and not sold as goods. All these were not unintended errors in the contract or choice of wrong words. It is also not a case where the connectivity is provided by the operator by breach of contract or by stealth. The connectivity to customers and their use of GSM was of essence of the contract. In this scenario, we may now examine the example given in IRS guidelines and the facts of the case.

Example 10

‘A’ transfers a disk containing software to ‘B’ and grants right to it to load the software into its 50 workstations for use of A and its employees on the basis of one-time per-user fee. If additional workstations are introduced subsequently, the software may be loaded into those machines for additional one-time per-user fees. B is prohibited from selling the disc or any copy or reverse engineering the software. The term of license is stated to be perpetual.

Analysis

The right to copy software on 50 workstations without the right to distribute it to the public is not the transfer of copyright but it is transfer of copyrighted article.
Paraphrasing the appellant’s case
‘A’ licenses software, contained in a medium, to ‘IO’ and permits ‘IO’ to get the software loaded into its equipment by ‘IO’. Equipment is also installed by ‘IO’. ‘A’ trains the personnel of ‘IO’ in case of equipment and software. ‘IO’ is permitted to transfer a part of the software on the handsets of IO’s customers so that he uses the IO’s GSM for telephone.

Analysis

The terms of license permit public display or use of license to and by IO’s customers. In fact, they use the software of ‘A’ while using the GSM. It is not a sale of copyrighted article, but transfer of the copyright.
There is sea of a difference in the fact of Example 10 and the facts of appellant. The facts are not at all in pari materia. The whole complexion changes when we examine the intent and purpose of the setting up of the GSM, which both parties knew and which has been set forth in the preamble. The software was not to be used exclusively by the operator. It was to be loaded not merely on the workstation of the operator for internal use. It was to be publicly used by the customers of the operator. They could use it through the connectivity supplied to them without intervention of appellant or its employees. I am also of the view that, designed specifically to undertake complex operation on the basis of logic sequence of commands, there is no difficulty in holding software to be a scientific work. In any case, the discussion in the OECD commentary and the IRS guidelines has taken place because software is otherwise is copyright. If it was not so, all this discussion would have been unnecessary. The OECD and IRS guidelines are the most liberal interpretation in favour of the appellant. Here, I am not accepting it to be the final word, but as the appellant’s case fails even under these interpretations, it is not necessary to go into other arguments advanced by ld. Assessing Officer and the ld. counsels. Thus, the case of the appellant is covered under article 12 of the DTAA and, therefore, he is liable to pay tax on the royalties received from the operators.”

10. The learned CIT(A) thus held that there was a transfer of copyright by the assessee company in relation to the software and the amount received on account of such transfer was royalty as per the relevant Article of DTAA which was chargeable to tax in India.

11. At the time of hearing before us, the learned counsel for the assessee at the outset has submitted that this issue involved in the case of the assessee is squarely covered by the decision of Special Bench of ITAT in the case of Motorola Inc. (supra). He has taken us through the relevant portion of the order passed by the Special Bench in this case and has pointed out that the issue has been examined by the Tribunal from all the relevant angles. He has contended that on such examination, the Tribunal has held that there was merely a transfer of the copyrighted article and no transfer of copyright and the amount received for such transfer was not royalty either under the domestic law or even under the relevant DTAA. He has also filed a chart giving a comparison in the relevant facts as involved in the case of the assessee with that of the case of Motorola Inc. (supra).

12. The learned DR, on the other hand, has invited our attention to section 14 of the Copyright Act, 1957 giving definition of Copyright Act with regard to the software. He has contended that a perusal of this definition clearly indicates that in case of computer programmes, selling or giving on hire of software for sale or hire any copying of computer programme regardless of whether such copy has been sold or given on hire on earlier occasions constitutes a grant of or right to use copyright. He hascontended that the said definition also makes it clear that copy of legally obtained software on an electronic medium which may either be a computer or a network constitutes grants or exercise of a copyright. According to him, if a person obtains a copy of the software and he uses thus for his personal or commercial use for copying it on an electronic medium, it constitutes exercise of a copyright. He has submitted that paragraph 3(2) of the Indo-US DTAA makes it mandatory to adopt the definition of the word “copyright” as given in the law of the state applying the provisions of the treaty and therefore, the definition as given in domestic Copyright Act, 1957 shall be applicable in the present case. He has contended that even though the Special Bench of the Tribunal in the case of Motorola Inc. (supra) has placed reliance on the OECD Commentary and internal revenue regulations of USA dealing with classification of transactions involving computer programmes, the same cannot be applied at all in view of the provisions of paragraph 3(2) of the DTAA. He has contended that the license granted for use of a software on network by the assessee company thus has to be analyzed in the light of the relevant DTAA as well as Indian Copyright Act, 1957. He has submitted that neither the Indian Copyright Act, 1957 nor any circular issued by the CBDT makes any distinction between copyright right and copyrighted article and such distinction made in US regulations cannot be extended to the Indian territory as within the territory of sovereign, the loss promulgated by the Indian sovereign was applied. He has contended that similarly, the OECD Commentary making a distinction between a Copyright Act and copyrighted article cannot be used to interpret Indian Copyright Act in a different fashion than what the words used therein suggest. He has contended that the distinction between the copyright and copyrighted article created artificially and not recognized by the Indian Copyright Act or Indian Income-tax Act is liable to be ignored and cannot be applied to decide the issue involved in the present case.

13. The learned DR has also submitted that even the facts involved in the present case are different from that in the case of Motorola Inc. (supra) decided by the Special Bench of the Tribunal inasmuch as in the case of Motorola Inc., the software was to be used in respect of various handsets whereas in the present case, the software is to be installed on the network system supplied by the assessee-company. The learned DR has also contended that in the case of Tata Consultancy Services v. State of AP [2004] 271 ITR 401 (SC) decided by the Hon’ble Supreme Court and referred to by the Special Bench of the Tribunal in the case of Motorola Inc., the decision was rendered by the Hon’ble Supreme Court on the basis of Andhra Pradesh Sales-tax Act and not on the basis of provisions of the Income-tax Act. Relying on the decision of Hon’ble Karnataka High Court in the case of AEG Aktiengesllschaft v. CIT [2004] 267 ITR 209, he has contended that the definition given in other Act such as Sales-tax Actcannot be extended to Income-tax Act especially when express definition is already given in the Income-tax Act.

14. We have considered the rival submissions and also perused the relevant material on record. We have also carefully gone through the various judicial pronouncements cited by the learned representatives of both the sides as well as relied upon by the learned CIT(A) in his impugned order. The main issue which is required to be considered and decided by us in the present context is whether the payment received by the assessee under the license agreement for allowing use of the software is in the nature of royalty income or it constitutes the business profit of the assessee. The issue as to whether the same is in the nature of royalty is required to be decided in the light of Article 12 of the relevant Double Taxation Avoidance Agreement (DTAA in short).

15. There is no dispute that the amount in question has been sought to be treated as royalty income by the Revenue authorities on the basis that there was a transfer of some rights in respect of the copyright. It is, therefore, relevant to ascertain as to whether there was transfer of any rights including the granting of a license in respect of copyright by the assessee in the present case under the license agreements. In this regard, the stand taken by the assessee before the authorities below as well as before us is that there was no transfer of any rights in respect of copyright by the assessee and it was a case where there was merely a transfer of the copyrighted article. The crux of the issue thus is whether the payment received by the assessee under the license agreement is for a copyright or copyrighted article and as held by the Special Bench of ITAT in the case of Motorola Inc. (supra), if it is for a copyright, it should be classified as royalty both under the Income-tax Act and under the DTAA. On the other hand, if the payment is actually for a copyrighted article, then it only represents the purchase price of the article and the same, therefore, cannot be considered as royalty either under the Income-tax Act or under the DTAA.

16. A perusal of the decision rendered by the Special Bench of ITAT in the case of Motorola Inc. (supra) cited by the learned counsel for the assessee shows that an identical issue was involved before the Special Bench in that case and while addressing the same, it was considered by the Tribunal from all the relevant angles. First of all, a reference was to the definition of “copyright” as given in section 14 of the Copyright Act, 1957 wherein it was defined as the exclusive right to do or authorize the doing of any of the following acts in respect of a work or any substantial part thereof viz. :—
“(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 a 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,—
(i) to reproduce the work in any material form including depiction in three-dimensions of a two-dimensional work or in two-dimensions of a three-dimensional work;
(ii) to communicate the work to the public;
(iii) to issue copies of the work to the public not being copies already in circulation;
(iv) to include the work in any cinematograph film;
(v) to make any adaptation of the work;
(vi) to do in relation to an adaptation of the work any of the acts specified in relation to the work in sub-clauses
(i) to (iv);
(d) in the case of 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,—
(i) to make any other sound recording embodying it;
(ii) to sell or give on hire, or offer for sale or hire, any copy of the sound recording, regardless of whether such copy has been sold or given on hire on earlier occasions;
(iii) to communicate the sound recording to the public.
Explanation - For the purposes of this section, a copy which has been sold once shall be deemed to be a copy already in circulation.”

17. It was noted by the Tribunal from the aforesaid definition that the right mentioned in sub-clause (2) of clause (b) of section 14 is available only to the owner of the computer programme. According to the Tribunal, it, therefore, followed that if the licensees do not have any of such rights as mentioned in clauses (a) & (b) of section 14, it would mean that they do not have any right in the copyright and in such a case, the payment made to them could not be characterized as royalty either under the Income-tax Act or under the DTAA.

18. The Special Bench of the Tribunal then proceeded to examine from the relevant license agreement as to whether any of the licensees was allowed to exercise any such rights mentioned in the relevant provisions with reference to the software provided by the assessee. On such examination, it was noted by the Tribunal from the relevant clause of the agreement that the licensee was granted a non-exclusive restricted license to use the software but only for its own operation and not otherwise. The licensee thus was permitted to use the software for the purpose of its own operation and there was a clear bar on the software being used by the licensee in the public domain or for the purpose of commercial exploitations. The grant of a non-exclusive restricted license to use the software again meant that the supplier of the software could supply similar software to any number of persons to which the licensee could have no objection. As held by the Tribunal, the words “restricted” and “not otherwise” used in the relevant license agreement thus were sufficient to show that the licensee had a very limited right so far as the use of software was concerned and the licensee thus had not been given any of the seven rights mentioned in clause (a) of section 14 or the additional rights mentioned in sub-clause (2) of clause (b) of that section which related to a computer program. The Special Bench of the Tribunal thus held that what the licensee/user of the software had acquired under the license agreement was not a copyright but was a copyrighted article.

19. The Tribunal then took note of the stringent restrictions imposed on the licensee under the license agreement so far as use of the software was concerned and found that the licensee had been denied the right of making the copies of the software or parts thereof except for archival back-up purposes. This meant that the licensee could not make copies of the software for commercial purposes which condition was contrary to section 14(a)(i) of the Copyright Act which permits the copyright holder to reproduce the work in any material form including the storing of it in any medium by electronic means. Referring to section 52(1)(aa) of the Copyright Act, it was also held by the Tribunal that merely because the licensee had been permitted to take copies just for back up purposes, it could not be said that he had acquired a copyright in the software. The Tribunal also took note of the restrictions placed on the licensee not to license or sell the software which was running counter to section 14(b)(ii) of the Copyright Act which permits a copyright holder to sell or let out on commercial rental the computer program. It was held by the Tribunal that even from this angle, it could not be said that the licensee had acquired a copyright in the software.

20. The Special Bench of the Tribunal in the case of Motorola Inc. (supra) thus held on a conjoint reading of the terms of the license and the provisions of Copyright Act, 1957 that the licensees were not allowed to exploit the computer software commercially which was the essence of the copyright. What the licensee had acquired under the license agreement was only the copyrighted software which was an article by itself and not any copyright therein. The Tribunal also referred to the third edition of Aiyengar’s Copyright Act wherein it was observed that the transfer of the ownership of a physical thing in which copyright exists gives the purchaser the right to do with it in physical form whatever he pleases except the right to make copies and issue them to the public. Relying on the said observation, the contention raised on behalf of the revenue that if a person owns a copyright article, then he automatically has a right over the copyright also was found to be not acceptable by the Tribunal. It was observed by the Tribunal in this context that even though one cannot have the copyright right without a copyrighted article, it does not follow that one having the copyrighted article has also the copyright in it.

21. The Tribunal then referred to paragraph 14 of the Commentary on OECD Model Convention (dated 28-1-2003) which reads as under:—
“14. Commentary on Article 12.—Paper Book V - 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 granted 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 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 copyright 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.”
According to the Tribunal, the Commentary on OECD Model Convention although was of persuasive value only, the same threw considerable light on the character of the transactions and the treatment to be given to the payments for tax purposes.

22. The Tribunal also referred to the proposed amendments to regulations of the International Regulation Service (IRS) in the US and found that a difference between a copyright right and the copyrighted article was clearly made out therein. It was also mentioned therein that if the transferee acquires a copy of the computer programme but does not acquire any of the rights specified in certain sections of the US Regulations, the regulation classified the transaction as the transfer of the copyrighted article and not the transfer of a copyright right. The rights identified in the US Regulations in this context as taken note of by the Tribunal in paragraph 168 of its order were as under:—
“(i) The right to make copies of the computer programme for purposes of distribution to the public by sale or other transfer of ownership, or by rental, lease or lending.
(ii) The right to prepare derivative computer programmes based upon the copyrighted computer programme.
(iii) The right to make a public performance of the computer programme.
(iv) The right to publicly display the computer programme.”

23. The Tribunal also referred to the Commentary of ‘Charl P.du TOIT’ on this issue wherein it was opined that articles such as books and records are copyrighted articles and if they are sold, the user does not obtain the right to use any significant rights in the underlying copyrights itself which is what should determine the characterization of the revenue as sale proceeds rather than royalties. The Tribunal thus held that the payment by the transferee was not for any copyright in the software but the same was only for the software as such as the copyrighted article and the payment for such transfer, therefore, could not be considered as royalty within the meaning of Explanation (2) below section 9(1)(vi) of the Income-tax Act or the relevant article of the DTAA.
24. At the time of hearing before us, the learned DR has made an attempt to submit that the facts involved in the present case are different from the facts involved in the case of Motorola Inc. (supra) decided by the Special Bench. The learned counsel for the assessee, however, has pointed out that the material facts relevant to this issue as involved in the present case are similar to that of the case of Motorola Inc. (supra). In this regard, he has prepared and furnished a comparative chart, a perusal of which shows that not only the material facts but even the contentions raised on behalf of both the sides in the case of Ericsson (supra) are similar to that of the present case.

25. Even a perusal of the license agreement entered into by the assessee-company with the Indian operators in the present case reveals that the sum and substance of the material clauses relevant in this context of the said agreement are 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 either under the domestic law or under the relevant article of the DTAA.

26. The learned DR has raised various contentions at the time of hearing before us seeking us to interpret the provisions of section 14 of the Copyright Act, 1957 dealing with copyright with regard to software differently than what was done by the Special Bench of the Tribunal in the case of Motorola Inc. (supra). However, keeping in view that the decision rendered in the case of Motorola Inc. (supra) by the Larger Bench is binding on us, we cannot entertain such contentions raised by the learned DR. Moreover, as pointed out by the learned counsel for the assessee, all such contentions as attempted to be raised by the learned DR before us were also raised on behalf of the revenue before the Special Bench in the case of Motorola Inc. (supra) and only after dealing with the same extensively, a decision has been rendered by the Special Bench by passing a well-discussed and well-reasoned order. In our opinion, the decision rendered by the Special Bench of ITAT in the case of Motorola Inc. (supra) on the similar issue thus is directly applicable in the present case and respectfully following the said decision which is binding on us, we hold that the amount received by the assessee under the licence agreement for allowing use of the software was not royalty either under the Income-tax Act or under the relevant DTAA and the same constituted the business profit of the assessee-company as claimed by it. We, therefore, set aside the impugned orders of the learned CIT(A) on this issue and allow ground No. 1 of the assessee’s appeal for assessment years 1998-99 and 2000-01 and ground No. 2 of its appeal for assessment year 1997-98.

27. As regards ground No. 2 raised by the revenue in its appeal for assessment year 1997-98, it is observed that the issue raised therein is squarely covered by the decision of Hon’ble Supreme Court in the case of Sedco Forex International Drill Inc. v. CIT [2005] 279 ITR 310 wherein it was held that the entire amount received by the non-resident assessee in India being liable for deduction of tax at source, there was no liability to pay any advance tax and therefore, there was no question of levy of interest under section 234B. Respectfully following the said decision of the Hon’ble Apex Court, we uphold the impugned order of the learned CIT(A) cancelling the interest levied by the Assessing Officer under section 234B and dismiss ground No. 2 of the revenue’s appeal.

28. Ground No. 1 raised by the assessee-company in its appeal for assessment year 1997-98 as well as for assessment year 1998-99 challenging the validity of the assessment on the basis that the notice issued under section 142(1) was barred by limitation has not been pressed by the learned counsel for the assessee at the time of hearing before us. The same is accordingly dismissed as not pressed.

29. Ground No. 3 raised by the assessee-company in its appeals for assessment years 1997-98 and 1998-99 raising an alternative plea about the mistake in quantification of royalty income has become infructuous as a result of our decision rendered on merits of the issue holding that the software receipts were chargeable to tax as business profits and not royalty.

30. As regards ground No. 4 of the assessee’s appeal for assessment years 1997-98 and 1998-99 and ground No. 2 of the assessee’s appeal for assessment year 2000-01, the learned counsel for the assessee has submitted that the assessee is seeking only a consequential relief in respect of the issue raised therein relating to levy of interest under section 234A. Accordingly, the Assessing Officer is directed to allow consequential relief to the assessee on this issue.

31. In the result, all the appeals of the assessee as well as that of the revenue are partly allowed as indicated above.


Regards,
Praveen Boda