Payment of ‘off-the shelf software’ held not to be royalty

Mumbai Tribunal Ruling: Once the payment of ‘off-the shelf software’ held not to be chargeable to tax as a royalty on the basis of the certificate obtained from a chartered accountant, no penalty and interest can be levied on the grounds that the assessee did not take prior approval of the assessing officer under section 195(2) of the Act

[ADIT v. Tata Communications Ltd. (2010-TII-157-ITAT-MUM-INTL)]

Facts:

Tata Communications Ltd. (‘the assessee’) had made payment for ‘off-the shelf software’ to a company resident in USA without deducting tax at source on the basis of a certificate obtained from a Chartered Accountant under an alternate procedure laid down by the Central Board of Direct Taxes (CBDT). The assessee had not applied to the assessing officer (‘the AO’) under section 195(2) of the Income-Tax Act (‘the Act’) for determining whether or not, the tax was liable to be deducted at source. The AO issued a show-cause notice for raising the demand under section 201 read with section 195 of the Act.

In response to the show-cause notice, the assessee contented that it had purchased ‘off-the shelf software’ and it did not have any tax implications in India as the assessee had not purchased any copyrights in the software; but had purchased only a copyright software. The assessee further submitted that since the USA based company from whom, software was purchased, did not have a Permanent Establishment (PE) in India, the question of income could have arisen only in the event of the payment for purchase of software being treated as royalty, but given the facts of the case and given the fact that purchase was made only of the copyright software and not copyright per se, the amount had not therefore been treated as royalty in the hands of the USA based company.

However, the AO held that it is not open to the assessee to take any unilateral decisions on whether the amounts paid by the assessee are chargeable to income tax or not, and, therefore, the assessee could not have made the payments without deduction of tax at source, without the concurrence of the AO under section 195(2) of the Act. The AO further noted that “provisions of section 195(2) are not provisions of convenience, which the assessee may use or may not use”.

The AO held that since the assessee had not made any payment for purchase of software but only for licence to use the software, the amount was paid by the assessee is clearly in the nature of ‘Royalty’. Accordingly, the AO held that the amount paid to USA based company for the purchase of software was taxable under section 9(1)(vi) r.w. Explanation 2(iva) of the Act as also under the India – USA Double Taxation Avoidance Agreement (tax treaty). Since, the assessee failed to discharge the obligation of deducting the tax at source under section .195(1), the assessee was liable to pay the amount of tax along with interest under section 201(1A) of the Act.

On appeal, the Commissioner of Income Tax (Appeals) [‘CIT(A)’], held that the purchase of

‘off-the shelf software’ was only a copyright software and that the amount paid for the purchaseof software is not liable to be taxed in India in terms of the provisions of the Act as also applicable tax treaty. Accordingly, the CIT(A) relying on various decisions reversed the order of the AO.

Aggrieved by the order of the CIT(A), the Revenue filed an appeal before the Income Tax Appellate Tribunal (‘the Tribunal’).

Observation and decision of the Tribunal:

• In the landmark case of Motorola Inc v. DCIT (95 ITD 269), the Special Bench of theTribunal took a note of the fact that copyright article is distinct from copyright per se and payment for copyright article, therefore, cannot be treated as payment of copyright, which could be brought to tax. While payment for use of copyright in indeed covered by the definition of ‘royalty’, the payment for use of copyright article would not be covered by the definition of ‘royalty’. It is, thus, clear that so far as the merit of the issue is concerned, there is unanimous view of various benches of the Tribunal that payment for use of copyright article cannot be brought to tax as royalty.

• As regards the question that it is not open to the assessee to decide whether or not tax is required to be deducted at source from payment, it is only an elementary that tax deduction liability at source is a vicarious liability and it can be invoked only when primary liability survives. As the Tribunal has held that the USA company itself did not have any tax liability in respect of the payments, the vicarious tax liability does not survive either.

• In accordance with the procedure stipulated by the CBDT, the assessee had duly obtained the Chartered Accountant’s certification regarding applicability tax withholding right and based on the certification, made the remittance for deduction at source. The Tribunal found no infirmity in this approach of the assessee and in such a situation, and particularly when no tax is indeed payable by the recipients of the income, a demand under section 201(1A) cannot be raised on the assessee merely because he had not obtained prior approval of the AO under section 195(2) of the Act.

• Section 195(2) is based on the “principle of proportionality”. The said sub-section gets attracted only in cases where the payment made is a composite payment in which a certain proportion of payment has an element of “income” chargeable to tax in India. It is in this context, the Supreme Court in case of India GE Technology Centre Pvt Ltd v. CIT, 327 ITR 456 (SC) stated that, “If no such application is filed, income-tax on such sum is to be deducted and it is the statutory obligation of the person responsible for paying such ‘sum’ to deduct tax thereon before making payment. He has to discharge the obligation to TDS”. If one reads the observation of the Supreme Court, the words “such sum” clearly indicate that the observation refers to a case of composite payment where the payer has a doubt regarding the inclusion of an amount in such payment which is exigible to tax in India. The above observations of Supreme Court in Transmission Corporation case [239 ITR 587 (SC)] with respect, has been misunderstood by the Karnataka High Court in the case of Samsung Electronics Company Limited (320 ITR 209) to mean that it is not open for the payer to contend that if the amount paid by him to the non-resident is not at all “chargeable to tax in India”, then no TDS is required to be deducted from such payment.

This interpretation of the High Court completely loses sight of the plain words of section 195(1) which in clear terms lays down that tax at source is deductible only from “sums chargeable” under the provisions of the Act, i.e., chargeable under Sections 4, 5 and 9 of the Act.

• Thus, unless the amount remitted by the assessee constitutes tax liability in India in the hands of recipients, the withholding tax liability under section 195 cannot arise.