Payment on shrink-wrapped software is royalty, rules High court of Karnataka

Payment on shrink-wrapped software is royalty, rules High court of Karnataka

‘Firms have an obligation to deduct tax at source from the amount paid'

In a major setback to information technology companies, the Karnataka High Court on Saturday ruled that payments made by these firms in India to their foreign software suppliers would amount to “royalty” and the companies had an obligation to deduct tax at source from the amount that they paid .

This order enables the Income Tax Department to recover tax dues from major IT companies from 2000 onwards, which may run into crores of rupees.

A Division Bench, comprising Justice V.G. Sabhahit and Justice Ravi Malimath, passed the order while allowing an appeal by the I-T Department, challenging the 2005 order of the Income Tax Appellate Tribunal.

The tribunal, on appeals by major IT companies, including Wipro, Infosys, HP, Samsung, Sonata, GE India and others, had said that the payment did not attract tax in India as there was no permanent establishment of non-resident foreign suppliers here.

Purchase

The IT companies, which had purchased software from Microsoft and other foreign companies, claimed that the software imported by them were shrink-wrapped products and the same was not customised.

Hence no tax was deducted on the payment made to the foreign suppliers as it was not taxable in India.

However, the I-T Department contended that the payment amounted to “royalty” and hence IT companies had an obligation to deduct tax at source under Section 195(1) of the Income Tax Act. The IT companies argued that this transaction did not come under the purview of royalty.

The court found that what had been transferred through the shrink-wrapped software to the IT companies was only the licence to use the copyright belonging to the non-resident companies, subject to various terms and conditions , which ultimately authorised the end-users to make use of the copyright software.

Transfer

“This would amount to transfer of part of the copyright and transfer of right to use the copyright for internal use of the IT companies as per the terms and conditions,” the court said while refusing to accept the contention that there was no transfer or copyright or part of copyright.

Right

“We hold that the right to make a copy of the software and use it for internal business by making a copy, storing it in the hard disk of the designated computers and taking back-up would itself amount to copyright under Section 14 (1) of the I-T Act and licence is granted to use the software by making copies, which work, but for licence granted would have constituted infringement of copyright and having obtained licence, the companies are in possession of legal copy of the software.

The price of this software is not the price of the compact disc alone or software alone nor the price of licence granted. This is a combination of all in substance. Unless the licence is granted permitting the end-users to copy and download the software, the dumb CD containing software would not have any help to the end users (IT companies) as software would be operative only if it is downloaded to a designated computer as per terms and conditions,” the court said while pointing out that this aspect make out the difference between the computer software and the copyright.

Ruling

Based on this observation, the court held that payments made by IT companies to non-resident foreign companies for supply of shrink-wrapped software would amount to “royalty” within the meaning of the Article 12 of the Double Taxation Avoidance Agreement with the respective foreign countries and that the payment made by way of royalty attracted income tax under Section 9(1) of the I-T Act.

________________________________________

• Order enables I-T Department to recover tax dues from major IT companies

• The tax dues from 2000 will run into crores of rupees

Source: THE HINDU

Accreditation Fee Paid to UK Co--Not a 'Royalty' Income

Assistant Commissioner of Income-tax, Central Circle 41, Mumbai v. Anchor Health and Beauty Care (P.) Ltd

Facts:

The assessee was engaged in the business of manufacturing and trading of tooth powder, tooth paste, tooth brush and other health care products. During the impugned assessment year it had made payment to a British Dental Foundation 'B' towards accreditation panel fees. The Foundation was a UK based registered charitable institution. The foundation was stated to, inter alia, evaluate consumer oral health care products to ensure that manufacturers' product claim were clinically proven and not exaggerated. As a result of the accreditation granted by the Foundation, the assessee was allowed to use that fact of approval in the marketing of its products. Assessing Officer observed that the payment made by assessee to the Foundation, was in nature of royalty and assessee was obliged to deduct the tax at source from the same, which was not deducted by the assessee.

He further observed that 'the assessee had not submitted any certificate in proof that the amount was not taxable in India', and that 'in view of the above, the expenditure was disallowed under section 40(a)(i), and, was accordingly added to the income of the assessee. On appeal, Commissioner (Appeals) deleted the addition made by Assessing Officer holding that the Foundation, did not had any permanent establishment in India and the amount paid to them could not be treated as royalty.

On revenue's appeal:

CASES REFERRED TO

GE India Technology Centre (P.) Ltd. v. CIT [2010] 327 ITR 456/193 Taxman 234 (SC) (para 5).

Pramod Kumar, Accountant Member. - The short issue that we are required to adjudicate in this appeal is whether or not the CIT(A) was justified in deleting the impugned disallowance of Rs. 11,71,826 under section 40(a)(i) of the Income-tax Act, 1961. The assessment year involved is 2004-05, and the impugned assessment was framed under section 143(3) of the Act.

2. It is a recalled matter. Originally, this appeal was disposed of ex parte, though by an elaborate and reasoned order, by the learned Vice President in SMC bench, but, upon the matter having been recalled at the instance of the assessee respondent, the appeal has been transferred to this division bench. That is how we have come to be in seisin of the matter, and that is how the appeal has once again come up for hearing on merits.

3. Let us first take a look at the developments leading to this litigation before us. The assessee before us is engaged in the business of manufacturing and trading of tooth powder, tooth paste, tooth brush and other health care products. During the course of scrutiny assessment proceedings, the Assessing Officer noticed that the assessee has paid a sum of Rs. 11,71,826 as accreditation panel fees to British Dental Health Foundation UK, but has not deducted tax at source from the same. On these facts, when the assessee was required to show cause as to why disallowance not be made under section 40(a)(i) in respect of the said payment having been made without deduction of tax at source, it was submitted by the assessee that as the recipient of income was not liable to be taxed, in respect of this income in India, no tax was required to be deducted at source by the assessee. It was in effect contended that disallowance under section 40(a)(i) can only be made when taxes are deductible but not deducted. However, this submission did not find any favour from the Assessing Officer. He was of the view that the aforesaid contention of the assessee "is not correct because, as per section 195 of the Income-tax Act, 1961, tax has to be deducted at source while remitting the monies outside India" . He further observed that "the assessee has not submitted any certificate in proof that the amount is not taxable in India", and that "in view of the above, the expenditure of Rs. 11,71,826 is disallowed under section 40(a)(i), and, is accordingly added to the income of the assessee". Aggrieved by the disallowance so made, assessee carried the matter in appeal before the CIT(A). Learned CIT(A) was of the view that as the British Dental Health Foundation did not have any permanent establishment and as the amounts paid to them could also not be treated as 'royalties' , the payment so made to the BDHF could not indeed be taxed in India. Learned CIT(A) further noted that since the BDHF did not have any tax liability in respect of these payments, and the assessee did not , therefore, have any obligation to deduct tax at source from this payment, disallowance under section 40(a)(i) was not sustainable in law. The impugned disallowance was thus deleted. The Assessing Officer is aggrieved of the relief so granted by the CIT(A) and is in appeal before us.

4. We have heard the rival contentions, perused the material on record and duly considered facts of the case in the light of applicable legal position.

5. We find that, as held by Hon'ble Supreme Court in the case of GE India Technology Centre (P.) Ltd. v. CIT [2010] 327 ITR 456/193 Taxman 234, tax deduction at source obligations under section 195(1) arise only if the payment is chargeable to tax in the hands of non-resident recipient. Therefore, merely because a person has not deducted tax at source from a remittance abroad, it cannot be inferred that the person making the remittance has committed a failure in discharging his tax withholding obligations because such obligations come into existence only when recipient has a tax liability in India. The underlying principle is this. Tax withholding liability of the payee is inherently a vicarious liability, on behalf of the recipient, and, therefore, when recipient does not have the primary liability to be taxable in respect of income embedded in the receipt, the vicarious liability of the payer cannot but be ineffectual. This vicarious tax withholding liability cannot be invoked unless primary tax liability of the recipient is established. Just because the payer has not obtained a specific declaration from the revenue authorities to the effect that the recipient is not liable to be taxed in India in respect of income embedded in particular payment, howsoever desirable be that practice, the Assessing Officer cannot proceed on the basis that the payer had an obligation to deduct tax at source. He still has to demonstrate and establish that the payee has a tax liability in respect of the income embedded in the impugned payment. That exercise was not carried out by the Assessing Officer on the facts of this case. The Assessing Officer was thus clearly in error in proceeding to invoke disallowance under section 40(a)(i) on the short ground that the assessee did not deduct tax at source from the foreign remittance. To that extent, CIT(A) was justified in deleting the impugned disallowance.

6. However, while on this issue, it is also necessary to consider is whether the assessee indeed had an obligation to deduct tax at source from the remittance of Rs. 11,71,826 to British Dental Health Association UK.

7. The assessee had made the payment of Rs. 11,71,826 to British Dental Health Association towards accreditation panel fees. BDHF is a UK based registered charitable institution. This Foundation is stated to, inter alia, "evaluate consumer oral health care products to ensure that manufacturers' product claims are clinically proven and not exaggerated" and "an independent panel of internationally recognised dental experts" is stated to "study all the claims carefully to make sure they are true, and backed up by reliable scientific evidence". As a result of the accreditation granted by the BDHF, the assessee is allowed to use this fact of BDHF approval in the marketing of its products. The question that we actually need to decide is whether the amount so received by BDHF, in consideration of the accreditation, can be brought to tax in India?

8. It is not even in dispute that BDHF does not have any permanent establishment in India, and the assessee has also filed a certificate to that effect as issued by the BDHF. It is also not in dispute that the provisions of the India United Kingdom Double Taxation Avoidance Agreement (206 ITR Stat 235; 'India UK tax treaty', in short) apply to the facts of this case, and that, these provisions being beneficial to the assessee vis-à-vis the provisions of the Income-tax Act, the treaty provisions will apply. Considering the fact that the payee does not have any PE in India, within meanings of that expression under Article 5 of Indo UK tax treaty, and this assertion has not been challenged by the revenue authorities, the income embedded in the accreditation fees cannot be brought to tax in India as business profits under Article 7. Learned Departmental Representative also does not dispute this. His only defence is that even if it is not taxed as business profits, it is at least taxable as 'royalties', since the assessee derives valuable advantage from the accreditation by BDHF and use the same as a marketing tool. However, we find that the scope of expression 'royalty', for the purposes of India UK tax treaty, is quite restricted as scope as evident from the provisions of Article 13(3) as reproduced below:

"(3) For the purposes of this Article, the term 'royalties' means:

(a) payments of any kind received as a consideration for the use of, or the right to use, any copyright of a literary, artistic or scientific work, including cinematograph films or work on films, tape or other means of reproduction for use in connection with radio or television broadcasting, any patent, trademark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience; and

(b) payments of any kind received as consideration for the use of, or the right to use, any industrial, commercial or scientific equipment, other than income derived by an enterprise of a Contracting State from the operation of ships or aircraft in international traffic.

9. While clause (b) of the definition of clearly inapplicable on the facts of this case as this clause deals with the equipment leasing only, clause (a) also does not deal with a situation in which the accreditation or approval granted by a resident is used, in another country, for promoting the sales. This accreditation does not allow the accredited product to use, or have a right to use, a trademark, nor any information concerning industrial, commercial or scientific experience - or, for that purpose, use or right to use of anything falling in any other category of clause (a). An accreditation or approval by a reputed body may give certain comfort level to the end users of the product, and thus may constitute a USP (i.e. unique selling proposition) to that extent, but it may also be, therefore, used for the purposes of marketing of the products, but, legally speaking, the payment made for such an accreditation is not covered the definition of 'royalty' as set out in Article 13(3) of India UK tax treaty. Learned Departmental Representative's argument is that in substance the payment for BDHS accreditation is nothing but a royalty to use their name for marketing, and, therefore, this payment should be treated as a payment of royalty. We see no substance in this simplistic plea. When an expression has been defined in law, and the impugned payment is not covered by such a specific definition, it cannot be open to us to look at normal connotations of this expression in business parlance. Simply because assessee is benefited by this accreditation, and the assessee uses the same for its marketing purposes, the character of payment cannot be classified as 'royalty'. The expression 'royalty' is neatly defined under Article 13(3) of Indo UK tax treaty, and unless the payment fits into the description set out in Article 13(3), it cannot be termed as 'royalty' for the purposes of examining its taxability under the tax treaty. In our considered view, on the facts of the case, the impugned remittance is in the nature of business profits in the hands of the UK based recipient, and since the recipient admittedly did not have any permanent establishment in India, the same is not taxable in India. In our considered view, therefore, the recipient did not have any primary tax liability in India, as a corollary thereto, the assessee did not have tax withholding obligations from this remittance.

10. For the foregoing reasons, we approve the conclusions arrived at by the learned CIT(A) and decline to interfere in the matter.

11. In the result, the appeal is dismissed.

Taxability of Cost Contribution Agreements

Dresser-Rand India Pvt Ltd vs. ACIT (ITAT Mumbai)

The assessee entered into a ‘cost contribution agreement’ with its parent company pursuant to which it paid a sum of Rs. 10.55 crores as its share of the costs. The TPO, AO & DRP disallowed the expenditure on the ground that (i) the ALP was ‘Nil’ as no real services had been availed by the assessee and the arrangement was not genuine, (ii) the cost sharing could not be on the basis of head count but on the basis of actual services availed by the assessee, (iii) the expenditure was “excessive & unreasonable” u/s 40A(2) and (iv) as there was no TDS, the disallowance u/s 40(a)(i) had to be made. The assessee also rendered field services to its associated enterprises where it granted a discount of 10% over the price charged to third parties on the basis that such discount was a part of reciprocal global policy. It was held that the ALP had to be computed by ignoring the discount. On appeal by the assessee, HELD:

(i) The TPO was not entitled to determine the ALP under the cost contribution agreement at “Nil” on the basis that the assessee did not need the services at all. How an assessee conducts his business is entirely his prerogative and it is not for the revenue authorities to decide what is necessary for an assessee and what is not. The TPO went beyond his powers in questioning the commercial wisdom of the assessee’s decision to take benefit of its parent company’s expertise. Further, the TPO’s argument that the assessee did not benefit from the services is irrelevant because whether there is benefit or not has no bearing on the ALP of the services. The fact that similar services may have been granted in the past on gratuitous basis is also irrelevant in determining the ALP. The argument that no evidence of services having been rendered was produced is not acceptable because the assessee did produce voluminous evidence before the DRP which was not dealt with. The DRP ought to have dealt with the material and given reasons. Matter remanded to the AO to determine actual rendering of services (Vodafone Essar Ltd vs. DRP 240 CTR 263 (Del) followed);

(ii) A cost contribution arrangement has to be consistent with the arm’s length principle. The assessee’s share of overall contribution to costs must be consistent with the benefits expected to be received, as an independent enterprise would have assigned to the contribution in hypothetically similar situation. The TPO’s objection that the cost should be shared in the ratio of actual use of services and should be charged as per Indian employee costs is not acceptable. There is no objective way in which the use of services can be measured and as is the commercial practice even in market factors driven situation, the costs are shared in accordance with some objective criterion, including sales revenues and number of employees. The question of charging as per domestic employee costs cannot be a basis of allocating the costs because such an allocation will deal with some hypothetical pricing whereas the allocations are to be done for the actual costs incurred;

(iii) The disallowance of payment under the ‘cost contribution agreement’ u/s 37(1) & 40A(2) is not justified because the payment did not involve mark-up and was at arms length price. The services were for furtherance of the assessee’s business interests;

(iv) The disallowance of payment u/s 40(a)(i) for want of TDS is not justified because the payment was not taxable in the AE’s hands under Article 5 & 12 of the India-USA DTAA as the AE did not have a PE and the services did not constitute “fees for included services”. (GE India Technology Centre 327 ITR 456 (SC) followed);

(v) The TPO’s argument that in charging for the services rendered to the AE, a 10% discount could not be given is not acceptable because (i) the assessee had followed the TNMM for determination of ALP which had not been disputed as the appropriate method, (ii) Even under CUP, all sales need not be at the same price and there can be variations of prices for the same product or services on grounds such as quantum of business, risk factors, etc. Discount is a normal occurrence even in independent business situations. The material factor is whether the 10% discount is an arm’s length discount and there is nothing on record to suggest that it is not so.

Profits attributable to “Dependent Agent Permanent Establishment” Taxable in India

Rolls Royce Singapore Pvt Ltd vs. ADIT (Delhi High Court)

The assessee, a Singapore company, rendered repair and maintenance services and supplied spares to customers in India. While the income from repairs was offered to tax as “fees for technical services“, the income from supply of spares was claimed to be not taxable on the ground that it had accrued outside India. The AO, CIT (A) and Tribunal took the view that the assessee had a “permanent establishment” on the basis that it had a “dependent agent” in India under Article 5(9) of the India-Singapore DTAA and that the income earned from supplying spare parts was taxable in India. The AO held that 25% of the profits on sales of spare parts were chargeable to tax which was reduced to 10% by the CIT (A) & the Tribunal. On appeal to the High Court, HELD:

(i) To constitute a “Dependent Agent Permanent Establishment” under Article 5(9) of the DTAA it has to be seen whether the activities of the agent are “devoted wholly or almost wholly on behalf of the assessee“. While the issues as to (a) whether the agent is was prohibited from taking competitive products and (b) whether the assessee exercised extensive control over the agent were relevant, they are not conclusive. It is not correct to say that merely because the agent is prohibited from taking a competitive product means that it is not an agent of independent status. What has to be seen is whether the “activities” of the agent are devoted wholly or almost wholly on behalf of the assessee. If the assessee can show that it was not the sole client of the agent and that activities of the agent were not devoted wholly or almost wholly on behalf of the assessee, there may be no DAPE. The income earned by the agent from other clients and the extent of such income is very relevant to decide whether the criteria stipulated in Article 5(9) is satisfied or not. (Matter remanded for fresh consideration);

(ii) While in principle it is correct that if a fair price is paid by the assessee to the agent for the activities of the assessee in India through the DAPE and the said price is taxed in India at the hands of the agent, then no question of taxing the assessee again would arise, this is subject to a Transfer Pricing Analysis being undertaken u/s 92. The facts showed that the manner in which the commission/ remuneration had been fixed was usually not done between independent parties in an uncontrolled transaction. The assessee was in a position to dictate terms to the agent and so it could not be said that the commission was at “arms length” within the meaning of Article 7 (2) of the DTAA. The Transfer Pricing analysis to determine the “arms length” price has to be done by taking the “Functions, Assets used and Risk involved” (FAR). As this has not been done, the assessee’s argument on “arms length” price is not acceptable (Morgan Stanley 292 ITR 416 (SC) & Set Satellite (Singapore) 307 ITR 205 (Bom) distinguished);

(c) As the commission paid by the agent to the DAPE is not at “arms length“, the estimation that 10% of the profits on sales of spare parts were attributable to the activities carried out by the agent in India and taxable is reasonable. The test is “profits expected to make” and has to be determined bearing in mind the fact that the agent was merely rendering support services and had no authority to negotiate and accept contracts and also assumed limited risk.

Payment made by the resident company to KPMG, Brazil for assisting in the acquisition of sugar mills in Brazil is not “Fees for Technical Services

The payment made by the resident company to KPMG, Brazil for assisting in the acquisition of sugar mills in Brazil is not “Fees for Technical Services”. Hence, the assessee is not liable to deduct TDS, as held by MumTrib in ITO(IT)-TDS-3 v Bajaj Hindustan Ltd — In favour of: The assessee.

12 August 2011.

ITO(IT)-TDS-3 v Bajaj Hindustan Ltd.



ITAT BENCH “L”, MUMBAI

ITA No. 63/MUM/09(2007-08)

1. This is an appeal by the assessee against the order dated 17/9/2008 of CIT(A) 33 Mumbai relating to assessment year 2007-08.

2. The assessee is a company. It is engaged in the business of manufacturing of sugar. According to the assesse, it engaged the services of M/s. KPMG Corporate Finance Ltd.,
Brazil (KPMG)(Non-Resident), to advice and assist the assessee in acquisition of Sugar Mills/Distilleries in Brazil. In connection with the services rendered by KPMG for the said
purpose, the assessee had made payment to KPMG. The question before the ITO (International Taxation),TDS-3, Mumbai (AO), was as to whether the Assessee was bound to deduct tax at source on the payment made to KPMG in terms of Sec.195 of the Income Tax Act, 1961 (the Act). That would again depend on the question whether the payment by the Assessee to KPMG would be taxable in the hands of KPMG in India.

3. According to Sec.9 of the Act, the following incomes shall be deemed to accrue or arise in India.


(vii) income by way of fees for technical services payable by……..


(b) a person who is a resident, except where the fees are payable in respect of services utilized in a business or profession carried on by such person outside India or for the
purposes of making or earning any income from any source outside India; or The aforesaid clause (b) provides two exceptions. In the first case, the payment if made by a
resident for services which are utilized in a business or profession carried out by such person outside India, then the said payment would not be deemed to be income accruing or arising to the payee in India. The second exception envisaged by clause(b) of Sec.9(1)(vii) of the Act, is if the payment is made by a resident for the purpose of making or earning any income from any source outside India, then the said payment would not be deemed to be income accruing or arising to the payee in India.


4. The AO was of the view that the assessee ought to have deducted tax at source on the payment made to KPMG. According to the AO the amount received from the assessee by
KPMG was in the nature of fees for technical services rendered. The AO was also of the view that in terms of section 9(1)(vii) of the Income Tax Act, 1961(the Act) income by way of Fees for Technical Services (FTS) payable to a person who is a resident shall be income deemed to accrue or arise in India. According to the AO the payment by the assessee to KPMG did not fall within the exceptions and, therefore, the payment would be income which accrues or arises in India in the hands of KPMG chargeable to tax. The AO therefore held that since the amount was chargeable to tax in India in the hands of KPMG, the assessee in the terms of section 195 of the Act ought to have deducted tax at source on the payment made to KPMG.


Since the assessee had not done so the AO treated the assessee as an assessee in default and passed an order for recovery of the taxes that ought to have been deducted and interest thereon in terms of section 201(1) and 201(1A) of the Act.

5. Before CIT(A), the assessee submitted that the assessee was the largest sugar producer in India and in order to expand their operations they appointed KPMG to explore the possibility of acquiring sugar mill/distillery plant in Brazil. In this regard the assessee submitted that KPMG was to provide the assessee the following services:


(i) Assistance in the identification of targets fitting assessee’s needs and contact of those companies;


(ii) Present the assessee selected information on those targets.


(iii) Perform pricing analysis of selected targets;


(iv) Assist the assessee in the acquisition process of target(s), with the internal team of the Assessee and other external advisors named by the company, for a closing of the transactions9s) in the best possible conditions.


6. It was further submitted that the assessee incorporated a company called Bajaj International Paatici Pacoes Ltd. in Brazil in order to acquire sugar mills/distillery plants in Brazil. A copy of the Memorandum of Association of the subsidiary company so incorporated in Brazil was also filed. It was pointed out that the objective of appointing KPMG was to identify and acquire sugar mills/distillery plants in Brazil. Thus the assessee made the payment in question to carry on business outside India and for the purpose of earning any income from any source outside India. It was submitted that the payment made by the Assessee was towards services which would be utilized in the business which will be carried out outside India i.e. Brazil through the Assessee’s subsidiary company and therefore the aforesaid payment would be squarely covered by the first exception provided in section 9(1)(vii)(b) of the Act and will therefore not be taxable in India. It was submitted that the very fact that the sugar mills/distillery plants to be acquired are located outside India would only mean that the income derived from the said mills/plants will be earned from a source outside India therefore payment made to KPMG would be covered even by the second exception provided in clause (b) of section 9(1)(vii) of the Act viz., “for the purposes of making or earning any income from any source outside India”. It was therefore submitted that the payment of USD 100,000 to KPMG does not constitute income deemed to accrue or arise in India under section 9(1)(vii) of the Act and is not taxable in India in the hands of KPMG and therefore the Assessee was not liable to liable to deduct tax at source thereon.

7. Since the aforesaid submission was made by the assessee for the first time before the CIT(A), the CIT(A) called for a remand report from the AO. In his remand report dated
18/1/08, the AO accepted that the contention put forth by the assessee was legal contention and requested the CIT(A) to consider the said contention on merits. However, the CIT(A) informed the CIT(A) that the facts regarding incorporation of a subsidiary by the Assessee in Brazil needed to be verified.

8. On a consideration of the above submissions the CIT(A) noticed that the agreement between the assessee and KPMG was in the form of proposal dated 11/5/2006. The proposal refers to the Assessee being the largest sugar producer in India and its desire to study the possibility of expanding its operations, through transactions involving the acquisition of a sugar mills/ distillery plants in Brazil. For the said purpose the Assessee was considering appointment of a financial advisor to assist during the acquisition process. KPMG being one of the leaders in Brazil in Mergers and Acquisitions (M&A) in the sugar and alcohol section and have already advised in transactions related to disposals of sugar mills and sugar refinery were being engaged for the aforesaid purpose. The proposal also mentions that the acquisition is to be done by the Assessee or any of its subsidiaries or its nearest company or any company controlled by the Assessee.

9. On a consideration of the above features of the Agreement, the CIT(A) was of the view that the Assessee wanted to acquire sugar mills/distillery plants in Brazil. For that purpose, the Assessee had availed the services of KPMG. He found that the services were to be rendered in Brazil and that services are connected with the acquisition of sugar mills/distilleries in Brazil. The CIT(A) was of the view that the words used in Sec.9(1)(vii) clause (b) second exception was “ for the purposes of earning any income from any source outside India.”. He was of the view that the services rendered by KPMG were to be used for the purpose of acquisition of sugar mill / distillery in Brazil for the purpose of earning income from sugar mill / distillery from Brazil. He was of the view that the words used in sec. 9(1)(vii) were vide enough to cover even future source of income. The CIT(A) therefore held that that the services rendered by M/s. KPMG was utilized by the Assessee for the purpose of earning income from a source outside India and therefore the payment by the Assessee of fees for technical services rendered by M/s. KPMG was outside the scope of Sec. 9(1)(vii) of the Income Tax Act. Hence it cannot be considered as income deemed to have accrued in India and not chargeable to tax in India and hence the Assessee is not liable to deduct tax u/s. 195 of Income Tax Act. The demand raised for tax and interest u/s.201(1) and 201(1A) of the Act was deleted.


10. Aggrieved by the order of the CIT(A) the revenue has preferred the present appeal before us.

11. The ld. D.R submitted that the assessee initially accepted before the AO that there was an obligation on its part to deduct tax at source while making payment to KPMG. Only on 17/8/2007 the assessee in a letter to the AO took a stand that the services rendered by KPMG were in the nature of market research and, therefore, not in the nature of FTS. The ld. D.R also drew our attention to the proposal dated 11/5/06 and submitted that the proposal( contained in page 1 to 17 of the assessee’s paper book) is not in the form of an agreement and the genuineness of the claim of the assessee that this was the agreement for rendering services is doubtful. We have examined this contention and find that in the letter dated 17/8/2007 the assessee has made a claim that the proposal ( contained in page 1 to 17 of the assessee’s paper book) was the agreement between assessee and KPMG. The Assessee also made it clear that KPMG was engaged to study the possibility of expansion of assessee’s business for acquisition of sugar mills/distillery plants in Brazil. The AO has proceeded to examine the proposal dated 11/5/2006 accepting the same as an agreement between the parties. At this stage it is not open to the ld. D.R to raise issues concerning the genuineness of the agreement. We, therefore, proceed to examine the case on the basis that the proposal dated 11/5/2006 as contained in page 1 to 17 of the assessee’s paper book constitutes the agreement between the assessee and KPMG in connection with which the assessee made payment to KPMG.

12. The next submission of the ld. D.R was that the assessee was utilizing the services of KPMG in respect of a business or profession carried on by the assessee in India and, therefore, the payment was FTS. Further it was submitted that the claim of the assessee that the payment made to KPMG was “for the purpose of earning any income from any source outside India” ought not to have been accepted by the CIT(A) because the exception contemplated in section 9(1)(vii)(b) of the Act is only in respect of an existing source of income. It was submitted by him that in a case where the source of income is to come into existence at future date the exception cannot apply. It was pointed out by the ld. D.R that the payment in question was for the purpose of earning income from a source outside India which source had not come into the existence and the assessee only proposed to create the source of earning income outside India in future. The ld. D.R brought to our notice Circular No.202, para 16.2 which explains the provisions of Finance Bill 1976, wherein it has been observed as follows:

“16.2 Under the new provision, income by way of “fees for technical services” of the following types will be deemed to accrue or arise in India:


(a) fees for technical services payable by the Central Government or any State Government;


(b) fees for technical services payable by a resident, except where the payment is relatable to a business or profession carried on by him outside India or to any other source of his income outside India, and


(c) fees or technical services payable by a non-resident if the payment is relatable to a business or profession carried on by him in India or to any other source of his income in India.”

13. It was argued that even the Circular talks about source of income outside India which means that it should be an existing source. It was submitted that the exception in clause (b) cannot apply to a future source to be set up. Reliance was also placed on the decision of the ITAT Mumbai in the case of Hindalco Industries Ltd. vs. ITO 91 ITD 64(Mum), wherein it was held that utilization of services is essential by the resident only in business or profession carried on by the resident outside India. If a resident pays FTS outside India for the services to be utilized in India then that income per-se will be treated as income accruing or arising to the person in India.

14. We have considered the arguments of ld. D.R. There is not dispute that the payment in question made by Assessee to KPMG is in respect of services which otherwise fell within the definition of FTS as given in the Act. The dispute is whether the exceptions mentioned in clause (b) to Sec. 9(1)(vii) of the Act would apply so that it can be said that the fees in thenature of FTS has not accrued or arisen to KPMG in India. As far as the first exception in Sec.9(1)(vii) clause (b) of the Act, is concerned viz., “where the fees are payable in respect of services utilized in a business or profession carried on by such person outside India”, we find that the Assessee carries on business in India and has utilized the services of KPMG in connection with such business. Therefore the case of the Assessee would not fall within the first exception, notwithstanding the fact that services were rendered only in Brazil. As far as the second exception mentioned in Sec.9(1)(vii) clause (b) is concerned viz., “ for the purposes of earning any income from any source outside India.”, the undisputed facts are that the Assessee wanted to acquire sugar mills/distillery plants in Brazil and for that purpose also wanted to set up a subsidiary company. In fact, the Assessee had set up a subsidiary company on 8.8.2006 in Brazil. Thus the Assessee was contemplating to create a source for earning income outside India. It is no doubt true that the source of income had not come into existence. But there is nothing in Sec. 9(1)(vii) clause (b) of the Act, to show that the source of income should have come into existence so as to except the payment of fees for technical services. The expression used is “for the purpose of earning any income from any source outside India”. There is nothing in the language of Sec.9(1)(vii) clause (b) of the Act, which would go to show that the same is restricted to only to an existing source of income. We therefore agree with the conclusions of the CIT(A) on this aspect. We therefore uphold the order of the CIT(A) holding that the payment by the Assessee of fees for technical services rendered by M/s. KPMG was outside the scope of Sec. 9(1)(vii) of the Income Tax Act. Hence it cannot be considered as income deemed to have accrued in India and not chargeable to tax in India and hence the Assessee was not liable to deduct tax u/s. 195 of Income Tax Act. The demand raised for tax and interest u/s.201(1) and 201(1A) of the Act was therefore rightly
directed to be deleted. We find no grounds to interfere with the order of the CIT(A) and uphold the order of CIT(A) and dismiss the appeal by the Revenue.


15. In the result, the appeal by the Revenue is dismissed.

Income from license of software not assessable as “royalty”-- Gracemac not followed/Motorola still good law

ADIT vs. TII Team Telecom International Pvt Ltd (ITAT Mumbai)

Income from license of software not assessable as “royalty”. Gracemac not followed; Motorola still good law

The assessee, an Israeli company, entered into an agreement with Reliance Infocomm for supply and licence of software for RIL’s wireless network in India. The assessee received Rs. 3 crores which it claimed to be “business profits” and not taxable for want of a permanent establishment (PE) in India. The AO took the view that the said sum was assessable as “royalty”. This was reversed by the CIT (A) following Motorola Inc 96 TTJ 1 (Del) (SB). In appeal before the Tribunal, the department argued that in view of Gracemac Corp 42 SOT 550 (Del), the use of software was assessable as “royalty”. HELD dismissing the appeal:

(i) Under Article 12 (3) of the India-Israel DTAA, royalty is defined inter alia to mean payments for the “use of” a “copyright” or a “process”. There is a distinction between “use of copyright” and “use of a copyrighted article”. In order to constitute “use of a copyright”, the transferee must enjoy four rights viz: (i) the right to make copies of the software for distribution to the public, (ii) The right to prepare derivative computer programmes based upon the copyrighted programme, (iii) the right to make a public performance of the computer programme and (iv) The right to publicly display the computer programme. If these rights are not enjoyed, there is no “use of a copyright”. The consideration is also not for “use of a process” because what the customer is paying for is not for the “process” but for the “results” achieved by use of the software. It will be a “hyper technical approach totally divorced from ground business realities” to hold that the use of software is use of a “process”. (Motorola Inc 96 TTJ 1 (Del) (SB) and Asia Sat 332 ITR 340 (Del) followed. Gracemac Corp 42 SOT 550 (Del) not followed);

(ii) It is well settled that a DTAA prevails over the Act where it is more favourable to the assessee. The view taken in Gracemac, relying on Gramophone Co AIR 1984 SC 667, that the Act overrides the treaty provisions where there is irreconcilable conflict is not acceptable because (a) it is obiter dicta, (b) contrary to Azadi Bachao Andolan 263 ITR 706 (SC) and (c) Gramophone Co not applicable to I. T. Act as it dealt with law in which specific enabling clause for treaty override did not exist. (Ram Jethmalani vs UOI also considered).

Source: ITATonline

Fees paid to a foreign company for rendering testing and certification services--Not Income accrued in India

Fees paid to a foreign company for rendering testing and certification services could not be treated as income deemed to accrue or arise in India under Section 9(1)(vii) of the Income-tax Act

Recently, the Delhi Bench of Income-tax Appellate Tribunal (the Tribunal) in case of Havells India Ltd1 (the taxpayer) held that testing fees paid to non-resident company could not be treated as income deemed to accrue or arise in India under Section 9(1)(vii) of the Income-tax Act 1961 (the Act).

Further since the income did not accrue or arise in India, the question of deducting tax at source does not arise and consequently payment made to the non-resident was not to be disallowed under Section 40(a)(i) of the Act.

Havells India Ltd v. ACIT [ITA No.1300/Del/2010, dated 27 May 2011]

Facts of the case

• The taxpayer paid INR 1.48 million to CSA International (CSA), a US Company for getting witness testing of AC Contactor as part of CB report and KEMA certification. CSA was assigned this job since it had a specialized knowledge and facility for the requisite testing and certification.

• The Assessing Officer (AO) held that fees paid for testing and certification services rendered by CSA were in the nature of making available of technical knowledge, expertise and skill of CSA, rendering such services to be ‘Fees for Included Services” as per Article 12(4)(b) of the India-USA tax treaty (tax treaty).

• The AO observed that irrespective of whether the non-resident is having a business connection in India or not, the payment made by the taxpayer as Fees for Technical Services (FTS) being utilised in business in India would lead to income being deemed to accrue or arise in India. Further the AO held that since tax was not deducted at source under Section 195 of the Act in respect of testing fees paid by the taxpayer, the amount of INR 1.48 million would be disallowed under Section 40(a)(i) of the Act.

• The Commissioner of Income Tax Appeal [CIT (A)] relying on the decision of Cochin Refineries Ltd.2 confirmed the disallowance made by the AO.

2 Cochin Refineries Ltd. v. CIT [1996] 222 ITR 354 (Ker)


3 GE India Technology Centre P Ltd v. CIT [2010] 327 ITR 456 (SC)


4 Titan Industries Ltd v. ITO [2007] 11 SOT 206 (Bang)


5 Ishikawajima–Harima Heavy Industries Ltd v. DIT [2007] 158 Taxman 259 (SC)

Taxpayer’s contentions

• The taxpayer contended that it had made exports to the USA and the fees in question had been paid to earn income from the USA, i.e. from a source outside India. Therefore, the fees paid to CSA could not be deemed to accrue or arise in India under Section 9(1)(vii) of the Act and tax was not required to be deducted at source on such payments under Section 195 of the Act.

• The taxpayer relied on the decision of GE India Technology Centre P Ltd3 where it was held that duty to withhold tax did not arise on a mere remittance to a non-resident, unless the remittance consisted of wholly or partly taxable income. Since the fees were payable in respect of services utilised outside India, the said income was not taxable and tax was not required to be deducted at source.

• The taxpayer relying on the decision of Titan Industries Ltd4 contended that provisions of Section 40(a)(i) of the Act had no applicability since services has been utilised outside India for earning an income from a source outside India. Accordingly, the payment was covered in the exception provided in Section 9(1)(vii)(b) of the Act, due to which, there was no need to deduct tax at source under Section 195 of the Act.

• The taxpayer further contended that the CIT(A) had failed to consider the decision of the Supreme Court in Ishikawajimi–Harima Heavy Industries Ltd5 where it had been held that income can be deemed to accrue or arise in India, only if the services were utilised in India as well as rendered in India; that in the taxpayer’s case, neither were the services rendered by CSA in India, nor were they utilised in India.

• The taxpayer further contended that services of CSA did not make available technical know-how to the taxpayer, therefore, it did not amount to FIS under the tax treaty and there was no obligation on the part of the taxpayer to deduct tax under Section 195 of the Act.

Tax department’s contentions

• The tax department contended that testing reports and certifications were obtained from CSA in respect of the manufacturing activity of the taxpayer in India and that the taxpayer did not deduct tax at source while making the payment to CSA.

• The tax department relying on the decision of Cochin Refineries Ltd contended that fees paid to CSA US was in the nature of FTS and it would fall under the definition of FTS within the provisions of Section 9(1)(vii) of the Act and the income was thus taxable in India.

• The tax department contended that the payment was covered as “Fees for Included Services” as referred to in Article 12(4)(b) of the tax treaty as the testing report and certification made available to the taxpayer were in the nature of technical knowledge, expertise and skill made available to the taxpayer. Further the same was utilised in the manufacture and sale of products in the business of the taxpayer in India.

• The tax department contended that if the assessment order was found to be deficient with regards to whether services was utilised in India or not, the matter should be referred to the AO for a fresh decision concerning this aspect of the matter.

Tribunals ruling

• The Tribunal observed that the testing and certification was necessary for the export of the product and was utilised for such export. The said services were rendered and utilised outside India. Therefore, the income fell outside the purview of Section 9(1)(vii) of the Act and did not deem to accrue or arise in India.

• The Tribunal observed that the tax department had failed to prove its contention that the testing and certification were utilised in the taxpayer’s production activity in India. The burden in this regard was entirely on the tax department, which the tax department had failed to discharge.


6 Raymond Ltd v. DCIT [2003] 86 ITD 791 (Mum)


Joint Accreditation System of Australia and New Zealand [2010] 326 ITR 487 (AAR)


Diamond Services P Ltd v. Union of India & Others [2008] 304 ITR 201 (Mum)


NQA Quality System Registrar Ltd v. DCIT [2005] 92 TTJ 946 (Del)


ICICI Bank Ltd v. DCIT [2008] 20 SOT 453(Mum)

• The tax department’s argument on remitting the matter to the AO was neither required, nor appropriate to be adopted. The Tribunal observed that it was not possible to remit the matter to the AO since the appellate authority examines whether the assessment had been framed in accordance with law and if the assessment was not framed in accordance with law it was not the responsibility of the authority to start investigation suo moto and in order to fill up the gap which was missing.

• The Tribunal further observed that the tax department did not bring anything on record to substantiate its observation of the testing and certification services provided to the taxpayer by CSA having been utilised for the taxpayer’s business activity in India. Accordingly, it was held that fees paid by the taxpayer did not deemed to accrue or arise in India and withholding of tax under Section 195 of the Act was not required and thus disallowance under Section 40(a)(i) of the Act was also not required.