Reimbursement towards services attracts tax withholding requirements

 Reimbursement towards services in the nature of assistance, professional and administrative consultation and training @ attracts tax withholding requirements

In a recent AAR ruing in case of Mersen India Private Limited, it was held that--under Article 13 of the India-France DTAC, there is no stipulation that managerial services should 'make available' any, knowledge experience, skills, and know-how before the consideration paid for it can be taxed. In other words, mere rendering of managerial services to the applicant would invite the liability to be taxed in India for the consideration received for that service. Advice on business strategy, on general management, on marketing and commercial matters, on financial control and accounting matters, and on purchase and sales, environment and safety and the giving of training to optimize sales techniques to the employees of the applicant, are all capable of being put to use by the applicant on its own and hence can be said to be 'made available' to applicant and taxable in terms of Article 13.4 of India-France DTAC read with para 4 of Article 12 of India-US DTAC.

In short, reimbursement towards with services in the nature of assistance, professional and administrative consultation and training @ attracts tax withholding requirements.

[2012] 20 taxmann.com 475 (AAR - New Delhi) AUTHORITY FOR ADVANCE RULINGS (INCOME TAX), NEW DELHI

Mersen India (P.) Ltd., In re JUSTICE P.K. BALASUBRAMANYAN, CHAIRMAN

A.A.R. NO.1074 OF 2010

RULING

________________________________________

1. The applicant is a company incorporated under the companies Act 1956. It is a 100% subsidiary of a French company. The French company in turn has another 100% subsidiary incorporated in France. The said subsidiary is now known as Mersen Corporate Services. The applicant originally entered into what is called a "Services agreement" on 1.1.2008, which was to be in force for a period of one year. On the expiry of one year, another agreement was entered into which was also to be for one year. With effect from 1.1.2010, the applicant has entered into a fresh agreement with the French company. Though the agreement stipulates the term of one year, unlike the earlier agreements, it provides for an automatic renewal of its terms for one year at a stretch. The applicant has also produced the agreement dated 30.12.2009 which is to come into effect on 1.1.2010, which is the agreement currently governing the relationship between the parties. The applicant and its parent company in France, are both in the business of manufacturing electrical components. The applicant is doing its business in Bangalore and Chennai for over a decade.

2. Under the services agreement, Mersen has undertaken to provide the applicant with services in the nature of assistance, professional and administrative consultation and training. The applicant has to pay the expenses incurred by Mersen for the services rendered to the applicant plus 5% of that amount. The invoice was to be in Euro and the money had to be remitted to a bank in Paris in France. The payment had to be made free of and without withholding taxes and duties and other charges and if such withholding was necessary, the same had to be borne by the applicant and there could be no deduction of the same from the amount to be paid to Mersen. The applicant had also entered into another agreement with Mersen wherein Mersen had undertaken transactions in the nature of E-Sourcing, Mail messaging, ERP maintenance etc. The applicant was not seeking an advance ruling in respect of that transaction. The applicant was seeking a ruling on the transaction evidenced by the services agreement.

3. After hearing the applicant and the Revenue which raised no objection to the allowing of the application under section 245R(2) of the Income-tax Act, this Authority allowed the application for giving a ruling on the following questions:

(1) Whether, pursuant to the "Services Agreement" entered into by the Applicant with Mersen, France, the payment made by the Applicant to Mersen, France, towards advisory services is 'fees for technical services' as per Article 13 (4) of the India-French DTAA read with the protocol to the said DTAA?

(2) If the answer to query 1 is in the affirmative, what is the rate at which the Applicant is required to deduct tax at source from such payment under Section 195(1) of the Income tax Act, 1961 (hereinafter referred to as the IT Act)?

(3) If the answer to query 1 is in the negative, is the above payment in the nature of business profits dealt with by Article 7 of the Indo-French DTAA?

(4) If the answer to query 3 is in the affirmative, is the above payment not taxable in India as Mersen, France does not have a permanent establishment in India as per Article 5 of the India-French DTAA?

(5) If the answer to query 4 is in the affirmative, is the Applicant required to deduct tax at source under section 195(1) in respect of the aforesaid payment to Mersen, France?

4. Though in the application, as part of its contentions, a contention is raised that what is payable under the services agreement to the French company was not fees for technical services within the meaning of section 9(1)(vii) of the Income-tax Act, at the hearing, learned counsel for the applicant did not dispute the position that the payment would be fees for technical services within the meaning of the Act. It was also agreed that going by the Double Taxation Avoidance Convention between India and France the amount would qualify as fees for technical services under paragraph 4 of Article 13 of the Convention. What was mainly contended for was that in terms of clause 7 of the protocol annexed to the DTAC, the applicant was enabled to claim the benefit of the limiting of the scope for taxation of technical services and if one restricted it to the convention between India and the United States, for satisfying the definition of included services in that Convention, it had also to be shown that the know-how was made available to the applicant before the payment for it could qualify as fees for included services under that Convention. It was also pointed out that managerial services were not included in the concept of "included services" under the India-US Convention and hence, the payments could be understood only as the business income of the French company and the payments to it could not be taxed in India in the absence of that company having a permanent establishment in this country.

5. On behalf of the Revenue it was contended that going by the definition contained in the Income-tax Act and the DTAC between India and France, payments made under the services agreement, would be fees for technical services and taxable as such. The exemption contained in section 9(1)(vii) of the Act did not apply and the transaction was liable to tax in India. In terms of the DTAC, what was inter alia being provided was consultancy services and the same fell within the concept of included services as now put forward. As regards the protocol, it is submitted that it will make no difference to the situation and the payments were taxable in India.

6. As per explanation 2 to section 9(1)(vii) of the Income-tax Act, fees for technical services means any consideration for the rendering of any managerial, technical or consultancy services. Under paragraph 4 of Article 13 of the Convention between India and France also, fees for technical services means payment of any kind as consideration for services of a managerial, technical or consultancy nature. Learned counsel is right in his submission that the position under the Convention and under the Act are the same regarding the nature of the payment. He has, therefore, rightly pitched his arguments on the modification brought about by the protocol to the DTAC wherein it is provided as follows:

"7. In respect of articles 11 (Dividends), 12 (Interest) and 13 (Royalties, fees for technical services and payments for the use of equipment), if under any Convention Agreement or Protocol signed after 1.9.1989, between India and a third State which is a member of the OECD, India limits its taxation at source on dividends, interest, royalties, fees for technical services or payment for the use of equipment to a rate lower or a scope more restricted than the rate of (?) scope provided for in this Convention on the said items of income, the same rate or scope as provided for in that Convention, Agreement or Protocol on the said items of income shall also apply under this Convention, with effect from the date on which the present Convention or the relevant Indian Convention, Agreement or Protocol enters into force, which ever enters into force later."

7. It is curious to see that the convention between India and France was signed on 29.9.1992. The protocol was also signed on the same day with a preamble that the same was to form an integral part of the Convention. But a look at clause 7 of the protocol indicates that if any other Convention, agreement or protocol had been signed by India after 1.9.1989 (a date preceding the signing of the DTAC between India and France) with a third state, which is a member of the OECD, in which India limits its taxation at source on fees for technical services (relevant for our purpose) to a rate lower or scope more restricted than the rate of (?) scope provided for in this Convention, the same rate or scope as provided for in that Convention, was also to apply under the DTAC.

8. Learned counsel for the applicant submitted that the DTAC between India and the United States was entered into on 12.9.1989, a date later than 1.9.1989 referred to in clause 7 of the protocol and that the applicant was relying on the relevant clause of that Convention, which had a more restricted scope for taxation of such fees. He submitted that in Article 12 of the Convention between India and the US, what was taxable was fees for included services. He pointed out that paragraph 4 of Article 12 of that Convention, provides that fees for "included services" means payment of any kind in consideration for the rendering of any technical or consultancy services, if such services are ancillary and subsidiary to the application or enjoyment of the right, property or information for which the payment described as royalty is received or make available technical knowledge, experience, skill, know how or consists of the development and transfer of a technical plant or technical design. His submission was that even though the DTAC between India and the French Republic did not insist on the making available of the technical knowledge etc., by virtue of the protocol, this concept had also to be taken note of while deciding the question whether the payment made is fees for technical services. Similarly, the Convention between India and the US has not taken in managerial services as part of included services the payment in consideration of which would be fees for technical services and consequently, notwithstanding the relevant paragraph in the India-France DTAC, payment made for managerial services, cannot be taxed as fees for technical services.

9. I find it some what strange that in spite of having entered into a DTAC with United States on 12.9.1989, preceding the signing of the Convention with France, the language or scope of the Convention between India and United States was not adopted for the India-France Convention. If the intention was to adopt the Convention as contained in the India-US DTAC, there would have been no difficulty in adopting the relevant clause in the India-France Convention as well. From the fact that in the India–France Convention, the bargaining countries struck to the definition as it is found in the Convention and parallel to the one found in the Indian Income-tax Act, surely, the intention must be taken to be not to adopt the concept as in the India-US DTAC. When this logical interference follows, in steps the protocol, providing for adopting the scope of taxation from any other treaty entered into after 1.9.1989, a date almost 3 years prior in point of time to the signing of the DTAC between India and France. I find it strange that if the intention was to have an identical regime of taxation, and nothing stood in the way of enacting an Article in the India–France DTAC along the same lines as the one found in the India–US DTAC, why that intention was not given effect to. If one were to draw the interference that the intention was not to adopt the parallel provision found in the India-US Convention, in steps the protocol with its abjuration that the other Convention must be given effect to. It is not clear why this confusing process has been adopted. It has also created considerable difficulty in understanding what exactly was the intention behind wording Article 13 in the Convention between India and France in the manner in which it is done. No doubt, as indicated by the Supreme Court in Azadi Bachao Andolan (263 ITR 706), the approach of a diplomat has to be adopted in interpreting a Convention between nations. Even such an approach does not appear to be capable of removing the confusion created by the circuitous process adopted, while entering into the Convention and signing the protocol with France.

10. Clause 7 of the protocol reads:

"…………………… India limits its taxation at source on dividends, interest, royalties, fees for technical services or payments for use of equipment to a rate lower or a scope more restricted than the rate of scope provided for in this convention on the said items of income the same rate or scope as provided…."(Emphasis supplied)

Can one take what is contained in the emphasized portion, a printer's devil? Or, is it deliberate to show that only provision for lower rate is intended to be applicable? The copy of the protocol provided by the applicant and the publications available in this Authority all show this expression. Counsel for the applicant submits that this is only a printing error, and the expression is really 'rate or scope', and reading it so, will be consistent with the use of the expression in the other parts of the clause. The representative for the revenue submitted that only provision for a lower rate of taxation is roped in and the scope of the provision in the DTAC for taxation cannot be whittled down by using this clause.

11. One supposes that reading the clause as a whole, it would be appropriate to read the expression 'rate of scope' as 'rate or scope' in the context. One also supposes that it is open to this Authority or a court to 'iron out the creases' if warranted, to give a meaning to the provision. On making that approach, I am inclined to accept the submissions of Counsel for the applicant that both rate of taxation and scope of taxation are brought within the purview of clause 7 of the protocol.

12. Going by the submissions of Counsel for the applicant, what has to be considered is whether the payments made by the applicant to the French Company is 'fees for technical services' In Article 12 of the India-US DTAC which provides for taxation of 'Fees for Included Services' paragraph 4 explains that 'fees for included services' means payment of any kind to any person in consideration for the rendering of any technical or consultancy services, if such services make available technical knowledge, experience, skill, know-how, or processes or consist of the development and transfer of a technical plan or technical design. So, notwithstanding the absence of a 'make available' stipulation in the Indo-French Convention, the applicant can rope in the concept of 'make available.' But this can be done only for technical and consultancy services which alone are embraced by the India-US Convention and from the 'Make Available' stipulation, Managerial Services are left out. It is the case of the applicant that consideration for managerial services paid to the French service provider, will only be business income and can be taxed in India only if it has a Permanent Establishment in India.

13. The applicant, receiving services from the French Company, can claim the application of the DTAC between India and France, or the provisions of the Income-tax Act which ever is more beneficial to it. The applicant has claimed the benefit of the DTAC. Now, under the DTAC, managerial services are taxable as 'Fees for Technical Services' under paragraph 4 of Article 13 which says that fees for technical services means payments in consideration for 'services of a managerial, technical or consultancy nature'. So, managerial services are taxable under the DTAC as FTS and under paragraph 2 of Article 13 read with paragraph 7 thereof, the same can be taxed in India as provided therein. By the strength of the protocol it has also claimed the benefit of the India-US Convention. In respect of technical and consultancy services, it is entitled to insist on the 'make available' requirement. This leaves out managerial services to be taxed under the DTAC between India and France. Managerial services are specifically dealt with under Article 13 of that DTAC. So, it is not possible to resort to Article 7 or Article 23 to look for a Permanent Establishment in this country before it being taxed.

14. Under Article 13, there is no stipulation that managerial services should be made available before the consideration paid for it can be taxed. In other words, mere rendering of managerial services to the applicant would invite the liability to be taxed in India for the consideration received for that service.

15. I will now briefly consider the services that are being provided or are to be provided under the services agreement. They include:

(1) Advice and assistance on business strategy and on general management.

(2) Advice and assistance on marketing and commercial matters.

(3) Advice and assistance on international relationship matters.

(4) Advice and assistance on financial matters

(5) Advice and assistance on finance control and accounting matters.

(6) Advice and assistance on tax and legal matters.

(7) Advice and assistance on insurance matters.

(8) Advice and assistance on purchases and sales, environment and safety matters.

(9) Advice and assistance on human resources matters.

16. In addition, the French company is to provide the applicant with services other than those mentioned when requested, if the French company had sufficient expertise and knowledge to render such services. The applicant is also entitled to seek specific services from the French company which it had agreed to provide. Various elements under which all these heads are recited in the services agreement, make it clear that the services to be rendered under any particular head, are not limited to what are enumerated in the agreement but that what are enumerated are to be included. In other words, the services agreement provides to the applicant advice and assistance on management, on marketing, on international relationship, on finance, on financial control and accounting, on taxation and law, on insurance, on purchases and sales, environment and safety and on human resources issues. I have noticed that the applicant is in the business of manufacturing electrical components. A reference to the areas covered by advice and assistance to be made available by the French Company to the applicant, would show that the advice and assistance pervades the entire business of the applicant. One thing to be noticed is that under some of the heads training is also imparted. A reference to the various clauses under each head would also show the pervasiveness of the area of advice and assistance by the French Company. It appears to me that the services rendered take in technical, managerial and consultancy services. The clauses contain provisions for services which relate to over all management and direction, marketing and managing the accounts and financial operations of the applicant. I am, therefore, satisfied that managerial services, within the meaning of paragraph 13 of India-France DTAC, are provided by the French Company to the applicant for a consideration equivalent to the cost incurred by the French Company plus 5% thereof as mark up.

17. It is also clear from a reading of the obligations undertaken by the French Company under the agreement, that it is rendering consultancy services. The services rendered on marketing, on strategy and the training provided to optimize sales techniques all would come within the purview of consultancy services. Though on reading some of the items of advice and assistance, it may even be possible to say that technical services are also rendered, the predominant purpose of the services agreement appears to be to provide managerial and consultancy services.

18. I have already held that for taxing the payment made for managerial services under the India-France DTAC, it is not necessary to make available such services within the meaning of that expression as generally understood with reference to fees for technical services. On the terms of the agreement it is even possible to say that the services are made available so as to satisfy even that test. Suffice it to say, that payments made for managerial services are liable to be taxed in terms of paragraph 4 of Article 13 of the DTAC between India and France.

19. As regards consultancy services, the question is whether such services are made available in the context of the DTAC between India and France read with the DTAC between India and US relied on by the applicant. It is seen that the advice and assistance rendered by the French Company to the applicant are not transient in nature and are capable of being used by the applicant on its own. It is true that some of the consultancy services rendered may not have that quality of permanency and may be a one time assistance, but advice on business strategy, on general management, on marketing and commercial matters, on financial control and accounting matters, and on purchase and sales, environment and safety and the giving of training to optimize sales techniques to the employees of the applicant, are all capable of being put to use by the applicant on its own. The services are enduring and they help in promoting the business of the applicant. The employees of the applicant are in a position to, actually they are expected to use the knowledge gained, in the business of the applicant. Thus, knowledge and know-how are made available to the applicant. Hence, on an understanding of the over all effect of the services agreement, it has to be held that the consultancy services are made available to the applicant.

20. Thus on a true construction of the services agreement between the applicant and the French company, I hold that the French company is rendering managerial and consultancy services to the applicant. The managerial services are taxable under paragraph 4 of Article 13 of the DTAC. They are taxable even if one were to invoke the concept of 'make available' for making the payments for such services taxable. The consultancy services provided are taxable in terms of Article 13.4 of the DTAC between India and France read with paragraph 4 of Article 12 of the India-US DTAC.

21. In the light of what is stated above, I rule on question no. 1 that the payments made by the applicant to Mersen France towards advisory services is fees for technical services in terms of paragraph 4 of Article 13 of the India-French DTAC read with the protocol to the said DTAC.

22. On question number 2, I rule that in terms of paragraph 2 of Article 13, the tax charged is not to exceed 10% of the gross amount of the fees. The deduction under section 195(1) of the I.T. Act has to be on that basis.

23. On question no. 3, I rule that the payments in terms of the services agreement are not in the nature of business profits dealt with in Article 7 of the India-French DTAC.

24. On question no.4, I rule that the question of existence of a permanent establishment does not arise in view of the finding that the payments are liable to be taxed as fees for technical services.

25. On question no. 5, I rule that the applicant is required to deduct tax at source under section 195(1) of the Income Tax Act, 1961.

AAR says OTIS’ share buyback deal with Mauritius holding co meant to evade tax

AAR says OTIS’ share buyback deal with Mauritius holding co meant to evade tax

Indian tax authorities have drawn the first blood in the war against sophisticated financial structures used to escape tax. The Authority for Advance Ruling (AAR), a quasi-judicial body that largely decides tax issues relating to foreign companies and cross-border deals, has upheld a tax demand on OTIS Elevators, an Indian firm, and denied capital gains tax benefit provided under the India-Mauritius tax treaty to its holding company OTIS Mauritius.

The transaction between the Indian company and OTIS Mauritius, according to AAR, was designed to avoid tax in India. The tax body gave its ruling on March 22, shortly after the Budget opened up a gamut of complex tax issues with the announcement of the General Anti-Avoidance Rule (GAAR).

The ruling follows the principle of ‘substance over form’, which means concerned parties structuring a transaction purely to avoid tax will come under the tax net. This is central to the spirit of GAAR, which is awaiting Parliament’s approval.

In the case before AAR, OTIS Elevator bought stocks from OTIS Mauritius in a share buyback programme

[2012] 20 taxmann.com 52 (AAR - New Delhi)

AUTHORITY FOR ADVANCE RULINGS (INCOME TAX), New Delhi

A Mauritus, In re

A.A.R. No. P of 2010 March 22, 2012

RULING

--------------------------------------------------------------------------------

Justice P.K. Balasubramanyan, Chairman - The applicant is a company incorporated in India in the year 1953 under the Companies Act of 1913. It is a closely held Public Limited Company. 48.87 % of its share are held by 'A'(USA), 25.06% by 'A'(Mauritius), 27.37% by company 'A' (S), Singapore and 1.76% by the general public. On 15.6.2010, the Board of Directors of the applicant has passed a resolution proposing a scheme of buy-back of its shares from existing shareholders in accordance with Section 77A of the Indian Companies Act.

2. 'A' (Mauritius) which holds 25.06% of shares in the applicant and incorporated on 6.4.2001 in Mauritius, proposes to accept the offer of buy-back. It acquired the shares in the applicant during the period 2001 to 2005 for Rs. 280 per share on the first occasion and Rs. 320 per share on the subsequent occasions. It is in that context that the applicant approached this Authority for Advance Ruling as to whether the capital gains that may arise, is chargeable to tax in India in the context of the Double Taxation Avoidance Convention between India and Mauritius and whether it will have the obligation to withhold tax in terms of Sec 195 of the Indian Income-tax Act.

3. In its comments accompanying the letter dated 31.1.2011, the revenue raised the contention that there was a previous buy-back in the year 2008 and on a return of income filed by 'A' (M) which sold back some of its shares, the question was pending before the assessing officer and hence the entertaining of the application was barred by clause (i) of the proviso to section 245R(2) of the Act. In the letter dated 28.3.2011 it was contended that the whole of the transaction was designed to avoid payment of tax in India. This Authority did not specifically overrule the contention based on clause (i) of the proviso presumably because the transaction of 2008 though similar in nature, was a different transaction and hence that clause was not attracted. As regards the objection based on clause (iii) of the proviso, this Authority overruled the objection then raised based on the ultimate control said to be vesting in the American Company, but with a rider that it can look whether question of avoidance at a later stage, of the circumstances warranted it. Thus this Authority allowed the Application under Sec 245R(2) of the Act to give a ruling on the following questions:-

(1) Whether on the stated facts and in law, the capital gains arising to 'A' (M), a tax resident of Mauritius, pursuant to the tendering of shares of 'A' (the applicant) under the buy-back scheme of the applicant would be Exempt from taxation in India, having regard to the provisions of paragraph 4 of Article 13 of the India-Mauritius Tax Treaty?

(2) If the answer to question No.1 is affirmative then whether, on the stated facts and n law the applicant is required to withhold tax on the remittance of the buy-back proceeds to 'A'(M)?

4. It is argued on behalf of the applicant that a buy-back is a legally recognized transaction and that the buy-back proposed is strictly in terms of section 77 of the Companies Act. In view of section 46A of the Income-tax Act, and the amendment of the definition of Dividend under that Act, there cannot be any doubt that what would be generated would be capital gains. Under paragraph 4 of the DTAC between India and Mauritius such gains are taxable only in Mauritius. It is, therefore, submitted that the questions may be ruled in favour of the applicant.

It is argued on behalf of the Revenue that the hearing of the application is barred by clause (i) of the proviso to Section 245R(2) of the Act. It is submitted that there was an identical buy-back in the year 2008 and on an application being made by the applicant under section 195(2) of the Act it was directed that tax had to be withheld. The applicant had withheld the tax and remitted it. Subsequently, 'A' (M) had filed a return of income claiming Nil liability and the question whether the income was taxable in India was pending before the Assessing Officer when the applicant filed the above application under section 245Q of the Act. The identical question was hence pending adjudication before an income-tax authority when this Authority was approached by the applicant. Senior counsel for the applicant met this by pointing out that the objection had already been overruled either expressly or impliedly when this Authority allowed the application under section 245R(2) of the Act and that in any event the earlier was a different transaction and hence there was no bar as has been held by this Authority on a number of occasions.

5. We find some force in the contention of counsel for the Revenue that the question pending before the Authority was an identical one. We have in this case already overruled the objection either expressly or impliedly when we allowed the application under section 245R(2) of the Act. Moreover, this Authority has been taking the view that if the transaction is different the bar is not attracted. We do not think it necessary in this case to reconsider the question. Hence, we overrule the objection.

6. Learned Counsel for the Revenue then argued that this was a transaction designed to avoid payment of tax in India. He submitted that after the introduction of Section 115-O of the Act with effect from 1.4.2003, the applicant had not declared or paid any dividend to its shareholders. It had allowed the reserves to grow substantially and was now transferring it to 'A' (M) to take over under the DTAC between the two countries and avoid payment of any tax on the sum transferred out of the country. He pointed out that if dividends had been declared and paid as was done prior to 1.4.2003 the applicant would have been forced to pay dividend distribution tax and the ruse adopted was with a view to avoid that tax payment. He submitted that this Authority had not closed the doors on this question while allowing the application under section 245R(2) of the Act and the question may now be considered.

7. Learned counsel sought to meet this contention by submitting that this Authority had already overruled this contention while allowing the application under section 245R(2) of the Act and it is not open to the Revenue to raise this contention all over again. He submitted that buy-back of shares was sanctioned by law and there was no justification in going behind the transaction or to question the motive for the transaction or to question its bona fides. He also submitted that it was for the Board of Directors of the Company to decide on whether dividend was to be paid or not and the decision taken by the Board in that behalf was a bona fide and valid decision. Taking advantage of legal and permissible means to arrange one's affairs cannot be characterized as a scheme for avoidance of tax.

8. We may observe some of the other relevant aspects. Though a buy-back was offered in the year 2008 and now, neither 'A' (USA), nor 'A' (S) accepted the offer. According to the Revenue, this was because the gain on buy-back would have been taxable at the hands of those entities under the India -USA DTAC and conditionally under the India-Singapore DTAC. The India-Mauritius DTAC did not make the gain taxable in India and it was not taxed in Mauritius. The acceptance of the offer by 'A' (M) alone on both occasions, was therefore significant. The public held only 1.76% of the shares and even if some of them had accepted the offer, there was no significant change in the holdings.

9. 'A' (Mauritius) is a wholly owned subsidiary of 'A' (Hong Kong). It was established to undertake offshore business activities as a corporate investment vehicle. 'A' (H) makes adequate funds available to it as and when investment directions for offshore business activities are taken. Until 14-3-2004, the immediate holding company of 'A' (M) was 'A' (UK) Limited, a company incorporated in Hong Kong. From 15-3-2004, the immediate holding company is 'X' International Corporation-Asia Private Limited, a company incorporated in Singapore. The ultimate holding company is 'X' Corporation, a company incorporated in the State of Delaware, USA. It is in this context that the Revenue contended that since the control and management of 'A' (M) was with 'X' Corporation USA, the treaty that should govern the present transaction, is the India-USA DTAC. According to it, the place of management of 'A' (M) lies in USA only.

10. Dividend was being distributed by the applicant to its shareholders until 1.4.2003. With effect from 1.4.2003, Section 115-O of the Act in its present from was introduced. This obliged the applicant to pay a tax on distributed profits. The applicant, if it had paid dividends, would have incurred this liability to pay tax. The applicant did not pay any dividend after 1.4.2003. It allowed its reserves to accumulate. The reserve has grown from Rs.(1) crores as in March, 2003 to Rs.(3) crores in March, 2008 and to Rs.(4) crores in March, 2010. In the year 2008, the applicant offered a buy-back of shares. Neither the shareholder US 'A' nor the shareholder 'A' (S) accepted the offer. In fact, their shareholding remained and remains constant from the year 1998 till the year 2009-2010. The offer of buy-back was accepted only by 'A' (M). It is the case of the Revenue that it is only under the India-Mauritius DTAC that capital gains is totally not taxable in India, and that is the reason why the offer is being accepted only by 'A' (M) among the major shareholders. The general public held only 1.76% of the shares and it is not clear whether anyone among them has chosen to accept the offer. The contention of the Revenue is that what would have been payable as tax on distribution of profits in India, is now evaded and the fund transferred out of the country under the guise of a buy-back of shares. This amounts to clear avoidance of tax in India. A scheme has been devised for such avoidance.

11. It is argued on behalf of the Revenue, that what is devised is a colouable transaction and the authorities under the Act and the courts are free not to accept them. It was submitted that even going by the decision in Azadi Bachao Andolan, the Mc Dowell principle will apply and hence the present proposed transaction may be ignored and it may be held that the payment is taxable as dividend under the Income-tax Act read with the India-Mauritius DTAC. This Authority is reminded of the development of the law from Ramsay to Vodafone in this context.

12. On behalf of the applicant it is reiterated that the application having been allowed under section 245R(2) of the Act, inspite of an objection of similar nature being raised, it was no more open to the Revenue to raise this objection. Even otherwise, the applicant is entitled to arrange its affairs in such a manner that it lightens the burden, by choosing a legal means available to it and that arrangement cannot be characterized as scheme for avoidance of tax. In any event, in view of the amended definition of dividend under the Act, the receipt cannot be taxed as dividend. It is only capital gains attracting Section 46A of the Act and paragraph 4 of Article 12 of the India-Mauritius DTAC.

13. It is true that while allowing the application under section 245R(2) of the Act for giving a ruling, this Authority did not accept the plea of avoidance then put forward. At the same time, this Authority did not shut the door fully on the question. This Authority stated:

"Just because the ultimate holding company of the transferor is 'X' Corporation, USA, it would not ipso facto label the transaction to be prime facie designed for avoidance of tax. At the same time, we may clarify that the hands of this Authority are not tied to take up the issue, if later on, the transaction is proved to be designed for avoidance of tax."

The objection now raised by the Revenue, is not the same as that raised earlier. Moreover, the order makes it clear that if later on adequate material is available to hold that the transaction is designed for avoidance of tax, it could be considered. On the terms of the order, it cannot be said that the consideration of the objection now raised by the Revenue is barred.

14. That apart, a plea that a transaction is colorable or that it is devised as a scheme for avoidance of tax, is a plea that has to be considered while giving a ruling under Section 245R(4) of the Act. According to us, it is a fundamental objection, which if upheld, would disentitle the applicant to a ruling or the ruling he has sought on a set of facts put forward. There is always a duty in this Authority to see whether there has come into existence a devise or scheme for avoidance of tax, before pronouncing on the taxability or otherwise of that transaction. This follows from the long line of judicial precedents which it is unnecessary to reiterate.

15. In this case, there is no dispute that no dividend had been paid to any of the shareholders after 1.4.2003 on which date Section 115-O of the Act was introduced in its present form. The accumulation in the reserves was allowed to be increased considerably. It may be noted that the major shares are held by the 'A' group and only 1.76% of shares are outstanding with the general public. The payment of dividend in the normal course by a company making profits, would have meant that the applicant would have been obliged to pay tax on distribution of profits to its shareholders. Instead of distributing the dividend on the basis of profits that accrued, the applicant allowed the reserves to grow. The proposed buy-back, if followed up, would mean that considerable sums would be repatriated to 'A' (M) in Mauritius without the tax on the distributed profits being paid, by resort to paragraph 4 of Article 13 of the DTAC between India and Mauritius. In this context, it is significant to note that neither 'A' USA nor 'A' (S) accepted the offer of buy-back, obviously because in the case of one it would have been taxable in India as capital gains and in the case of the other, its taxability would have depended on certain conditions being fulfilled, whereas under the India-Mauritius DTAC, capital gains is totally out of the Indian tax net. There was no proper explanation on the part of the applicant as to why no dividends were declared subsequent to the year 2003 when the company was regularly making profits and when dividends were being distributed before the introduction of Section 115-O of the Act in its present form. We are, therefore, satisfied that the proposal projected before us of buy-back is a scheme devised for avoidance of tax. In fact, it is a colorable device for avoiding tax on distributed profits as contemplated in Section 115-O of the Act.

16. It is true that if the receipt in the hands of 'A' (M) is treated as capital gains, it would be Section 46A of the Act that will be attracted and by the force of paragraph 4 of Article 13 of the concerned DTAC, the receipt would not be taxable in India. But in view of our finding that the transaction of buy-back proposed to be resorted to, is a colorable transaction, the question is whether the amount would not be taxable as dividend in terms of Section 2(22) of the Act as amended with effect from 1.4.2003. When the proposed transaction is found to be colorable, it is not a transaction in the eye of law and once it is ignored as such, the arrangement can only be treated as a distribution of profits by a company to its shareholders which does not attract Section115-O of the Act. Dividend in terms of the definition includes any distribution by a company of accumulated profits to its shareholders. The exemption is only in respect of a germin buy-back of shares. On our finding that the proposed buy-back is colourable, the distribution in question will satisfy the definition of dividend under the Act and consequently taxable as such. Under Article 10, paragraph 2 of the DTAC, dividend paid by a company which is a resident of India, to a resident of Mauritius, may also be taxed in India, according to the laws of India but subject to the limitation contained therein,. It may also be noticed that the payment in question, would also satisfy the definition of dividend in paragraph 4 of Article 10 of the DTAC between India and Mauritius. We are of the view that the proposed payment would be taxable in India in terms of paragraph 2 of Article 10 of the DTAC between India and Mauritius.

17. In the light of the reasoning and conclusion as above, we rule on question no. 1 that the amount that would be payable by the applicant to 'A' (M) would be taxable in India in terms of Article 10 of the DTAC between India and Mauritius. On question no. 2, we rule that the applicant is required to withhold tax on the proposed remittance of the proceeds to 'A' (M).

Buy-back of shares by wholly-owned subsidiary taxable as capital gains

In Re RST (AAR)

S. 47(iv) relief not available if holding co and nominees hold 100% of subsidiary

In the case of RST,  it was held that buy-back of shares by a wholly-owned subsidiary (WOS) of a foreign company would be chargeable to tax as capital gains. This is in view of the specific provisions contained in the Income-tax Act, 1961 (the Act). The applicant’s plea seeking exemption from charge to tax was rejected in view of the specific provisions contained in the Act treating a buy-back to be chargeable to tax as capital gains.


The ruling is a first of its kind on buy-back of shares by a WOS and may be of relevance for all WOSs contemplating buy-back of shares.

The applicant, a German company, held 99.99% of the shareholding of an Indian company. The rest of the shares were held by other companies as nominees of the applicant. The Indian company proposed a buy back of shares u/s 77A of the Companies Act which would have resulted in transfer of shares of the Indian company from the applicant to the Indian company at a price to be determined. The applicant claimed that as it and its nominees held 100% of the shares of the Indian company, the exemption conferred by s. 47(iv) on transfers between holding company and 100% subsidiary applied and s. 46A would not apply. HELD by the AAR:

(i) S. 47(iv) exempts a transfer of a capital asset by a company to its subsidiary if “the parent company or its nominees hold the whole of the share capital of the subsidiary company”. The word used is “or” and not “and”. The assessee held only 99.99% of the shareholding. The shares held by the nominees cannot be considered as held by the assessee. If, under Indian law (s. 49 (3) of the Companies Act), a company cannot by itself hold 100% of the shares in a subsidiary, it would only mean that Parliament did not intend to confer the benefit of s. 47(iv) on such a parent company. Though this approach confines the relief to a particular species of parent companies, it does not mean that the provision is unworkable. If the nominees are treated as holding the shares benami for the parent company, it would offend the Benami Transactions (Prohibition) Act, 1988 and also violate s. 49(3) of the Companies Act. The nominees can also not be regarded as a trustee in view of s. 153 of the Companies Act. The result is that the applicant does not hold 100% of the share capital of the subsidiary and so s. 47(iv) is not attracted;

(ii) S. 46A, which provides that in the case of a buyback, the difference between the consideration and the cost of acquisition shall be deemed to be capital gains is a special provision and prevails s. 45. S. 47 overrides s. 45 but not s. 46A. There is no reason to enquire whether s. 46A is a charging section or not. The result is that even if the exemption in s. 47(iv) is held applicable, it does not override s. 46A and the applicant is subject to capital gains.

Payments received by owner of copyright in software from distributor--Is Royalty

Payments received by owner of copyright in software from distributor for sale of software product to end-users is 'royalty' within meaning of section 9(1)(vi):

The definition of royalty; in the Income-tax Act in Explanation 2(i) to section 9(1)(vi) covers consideration for the transfer of all or any rights (including the granting of a license) in respect of a patent, innovation, model, design, secret formula or process or trade-mark or similar property; consideration for grant of the use of any of the above is also royalty; it also takes in the consideration for the transfer of all or any rights (including the granting of a license) in respect of any copyright, literary, artistic or scientific work; the 'license' is not confined to an exclusive license

The words within brackets 'including the granting of a license' in Explanation 2(i) to section 9(1)(vi) indicates an expansive definition; it is a devise to bring in something which might not otherwise be included in the words used

Payment received by the applicant for grant of the right to down-load/receive version updates for software products of the applicant(owner of copyright in software) would also be payment received for grant of a right to use the copyright embedded in the Subscription Advantage Programme and it will be royalty

[2012] 18 taxmann.com 172 (AAR - New Delhi); AUTHORITY FOR ADVANCE RULINGS (INCOME TAX), NEW DELHI

Citrix Systems Asia Pacific Pty. Ltd., In re

A.A.R. NO. 822 OF 2009†

FEBRUARY 6, 2012

RULING:

Justice P.K. Balasubramanyan, Chairman - The applicant is a company incorporated in Australia. It claims to be one of the leading providers of software services which help in virtualization, networking and application delivery. It also offers a range of application collaboration, firewall, networking and streaming solutions. The applicant has entered into an agreement with independent Indian distributors for the distribution and sale of its software and hardware products in India. In the year 2006, the applicant entered into a distribution agreement with Ingram Micro India Limited (hereinafter referred to as "Ingram"), an independent Indian company engaged in the business of distribution of computer software and hardware. Under the agreement, Ingram was appointed as a non-exclusive distributor of the products of the applicant in India. Some of the key products distributed under the agreement are Citrix XenApp, Citrix Access Gatway and Citrix Netscaler. According to the applicant, under the agreement, the software products are purchased by the distributor from the applicant and sold by the distributor. With respect to the hardware products, the applicant shifted the products directly to the distributor which in turn supplied these products to re-sellers and end-user customers. But, for the software product, Citrix XenApp, while sale and collection is made through the distributor, no physical delivery of the product is made to the distributor. On the basis of the demand of the customers for Citrix XenApp, the distributor places orders of purchase with the applicant and makes payments for the same to the applicant. The applicant then directly transmits a "key" to the end-user customer who is required to download the XenApp software. On receipt of the key, the end-user customer downloads the software from the server of the applicant. The distributor Ingram owns the responsibility for collection of the price for the product from its customers. In addition to the distribution of hardware products and Citrix XenApp under the distribution agreement, Ingram also facilitates the execution of the Citrix Subscription Advantage Programme between the applicant and its existing customers. The programme is offered by the applicant in the form of a package of support services during the period of the programme. The support activities include product version updates, the subscription advantage news and updates and secure portal access. Ingram facilitates execution of the subscription programme in the same manner as in the case of software products. All transactions between Ingram and the applicant are on a principal to principal basis. Ingram effects direct sales to the customers at its discretion and earns a profit on every sale based on a percentage of the sale price.

2. The applicant is seeking an advance ruling on the taxability in India of the payments made by Ingram to it for the software product, Citrix XenApp and the Subscription Advantage Programme. The application under section 245Q of the Income-tax Act is made in that context.

3. While admitting the application for a ruling under section 245R(2) of the Act, this Authority accepted the following questions for the ruling.

1. Whether the payments received by the applicant from the Distributor for sale of the software product is in the nature of 'royalty' within the meaning of the term in Explanation 2 to clause (vi) of Section 9(1) of the Income-tax Act, 1961 ("the Act") ?

2. Whether the payments received by the applicant from the Distributor for sale of the software product is in the nature of 'royalty' within the meaning of the term in Article 12 of the Agreement between the Government of Australia and the Government of Republic of India for the avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on income' ("the India-Australia Tax Treaty") ?

3. Whether the payments received by the applicant from the Distributor for the right to downloand/receive version updates for the software products of the applicant (i.e. the Citrix Subscription Advantage Program) is in the nature of 'royalty' within the meaning of the term in Explanation 2 to clause (vi) of Section 9(1) of the Act?

4. Whether the payments received by the applicant from the Distributor for the Citrix Subscription Advantage Program is in the nature of "fees for technical services" within the meaning of the term in Explanation 2 to clause (vii) of Section 9(1) of the Act?

5. Whether the payment received by the applicant from the Distributor for the Citrix Subscription Advantage Program, is in the nature of 'royalty' within the meaning of the term in Article 12 of the India-Australia Tax Treaty?

6. Based on answers to questions (1) to (5) above, and in view of the facts as stated in Annexure 1, and also in the light of the declaration provided by the applicant that it does not have a permanent establishment in India in terms of Article 5 of the India-Australia Tax Treaty, whether the payment received by the applicant will be chargeable to tax in India.

7. Based on the answers to question (6) above, would the receipts by the applicant from the Distributor suffer withholding tax under section 195 of the Income-tax Act, 1961 and if yes, at what rate?"

4. Hearing under section 245R(4) was elaborate and more than once. Various statements in opposition were filed on behalf of the Revenue and replied to by the applicant. Detailed arguments were addressed.

5. The main question that has to be ruled on is the question whether the payment received by the applicant from Ingram for the software dealt with in the distribution agreement between the parties, is the price for sale of software products or is royalty as defined in Section 9(1)(vi) of the Income-tax Act and/or under Article 12 of the Double Taxation Avoidance Agreement between India and Australia. According to the applicant, section 9(1)(vi) of the Act when it defines 'royalty,' inter alia, envisages payment for transfer of all or any right in Intellectual Property, by the owner of such intellectual property, to any other person. Intellectual Property is not defined in the Act to show what are included within the scope of 'royalty'. A patent, copyright, etc. would be Intellectual Property. The applicant further submits that a computer programme (software) is protected under the Indian Copyright Act, 1957. In the context of that Act, a computer programme cannot be characterized as a patent, invention, model, design, secret formula or process. Taxability of a computer programme has to examined under clause (v) of Explanation 2 to Section 9(1)(vi) of the Act which specifically deals with taxability of transfer of rights in respect of a copyright.

6. Under the Distribution Agreement, the applicant as the owner of the copyright in the software, is offering it for distribution through the Distributor. The distributor is granted license to use the software for its internal purposes. The Distributor is to locate the end-users. No order procured by the Distributor is binding on the applicant. On accepting a subscriber, the software is distributed electronically, direct to the end-user. The right to translate the software vests with the applicant. The software is for operation only with the computer systems specified on software packaging and/or documentation. The applicant retains the right to alter the specified type of computer systems with which the software will operate or function.

7. The warrantees to the end-user are set out in the documentation. The distributor will ensure that the end-users are notified that they will receive the benefits of such warrantees as set forth in the documentation. Documentation means the user documentation with the applicant, or its affiliates, distributors for the applicable product.

8. The Distributor is to pay the purchase price to the applicant as per the price list, less their applicable discount set forth in the letter of Authorisation. The Distributor is obviously to collect what is payable by the end-users. The applicant retained the sole and exclusive right to bring an action for infringement of copyright against third parties. The Distributor is to cooperate in that action.

9. Thus, on the terms of the agreement, the end-user is given the right to use the software over which the applicant has a copyright, for a subscription. That right is conferred directly on the end-user by supplying him with a key to down load the software on to his computer and to use the programme and to use the programme over which the applicant has a copyright. The end-user gets the right to use the software. What is involved in that grant of right, is the question.

10. The term 'copyright' has not been defined in the Income-tax Act. The dictionary meaning is that it is the exclusive right given by law for a certain term of years to an author, composer, etc. or his assignee to print, publish and sell copies of his original work. According to the applicant, this dictionary meaning links the term 'copyright' to the rights provided by law and in India the rights are governed by the Copyright Act. Therefore, one has to necessarily rely on the terms of the Copyright Act. Section 14 of the Copyright Act defines the term 'copyright'. According to the applicant, the definition indicates that the term copyright in the case of a literary, dramatic or musical work not being a computer programme, means the exclusive right to do or authorize another to do, the work of reproducing the work in any material form including the storing of it in any medium by electronic means, to issue copies of the work to the public, not being copies already in circulation, to perform the work in public or communicate it to the public, to make any cinematograph film or sound recording in respect of the work, to make any translation of the work, to make any adaptation of the work, to do in relation to translation or adaptation of the work any of the acts specified above. In the case of a computer programme it is to do any of the acts specified above, to sell or give on commercial rental or offer for sale or for commercial rental any copy of the computer programme. According to the applicant, copyright clearly vests in the person who has an exclusive right to do all or any of the acts mentioned above to the exclusion of others. He may exercise those exclusive rights by himself or he may authorize others to exercise a particular right or a combination of the rights. Therefore, what has to be seen is whether there is a transfer of the right, the right of commercial exploitation of the intellectual property contained in the product.

11. According to the applicant, in the case on hand, the payment by Ingram is towards purchase of a software product. Ingram gets only the right to re-sell/distribute the software product and does not get any right to reproduce or make copies of the software product. The Copyright Act distinguishes the copyright from the material object, which is the subject of the copyright. Therefore, a transfer of the material object does not necessarily involve the transfer of the copyright. The distribution agreement entered into by the applicant with Ingram concerns the transfer of material object and not the transfer of copyright. There was also a distinction between a copyright and a copyrighted article and where the payment is for obtaining rights limited to enabling effective operation of the software and not for the end-user to commercially exploit the underlying rights in the software, it would be inappropriate to classify the payment as royalty. It is submitted by the applicant that payment received by the applicant from Ingram is for sale of a copyrighted article and the price paid is not royalty under the provisions of the Act.

12. On the question whether the payment received is royalty within the meaning of Article 12 of the DTAC between India and Australia, in addition to reiterating the submissions made relating to the definition in the Income-tax Act, it is contended that the sum received by the applicant is in the nature of sale revenue, the right acquired by the purchaser from the sale is only to use the copyrighted article and not the right to use the copyright embedded in the software. It is pointed out that the OECD commentary also makes a distinction between the transfer of rights in the underlying copyright in the computer programme and the transfer of rights in a copy of computer programme, based on the nature and extent of rights which have been granted.

13. On behalf of the Revenue, it is contended that the Agreement between the applicant and Ingram makes it clear that the applicant owns all right, title and interest in the products and services subject to the agreement. Therefore, what the applicant parts with to the end-user is only a right to reproduce/copy the software to the server of the customer, from the server of the applicant and to use the software for its applications. So, one of the rights embedded in the intellectual property, that is the software product, being a right to copy and use, is transferred by the applicant to the distributor and later on to the end-user for which the applicant is receiving payment. Therefore, what is involved is not the sale of a copyrighted article as contended by the applicant, since no physical product was being delivered, but what was being transferred was a right to use the software which is facilitated by another right to copy the software. The payment is, therefore, in the nature of royalty. The Revenue seeks to take inspiration from Section 115A(IA) of the Income-tax Act and also the Board's Circular No. 621 dated 19.12.1991. In the case on hand, the applicant was supplying software separately and not along with the hardware. The payment was royalty within the meaning of the Income-tax Act. As regards the concept of royalty under Article 12 of the DTAC, the arguments as above are reiterated.

14. In its additional written submissions, the Revenue has reiterated its position in a more elaborate manner. The interpretation of the term 'royalty' is dealt with. The reliance on the Copyright Act, 1957 for adjudicating on the liability to tax under the Income-tax Act is questioned and it is pointed out that the Act contains the definition of 'royalty' and the DTAC also contains the definition of 'royalty' and we have to test the claim of the applicant in the light of those definitions, uninhibited by what may be contained in the Copyright Act. It is pointed out that Ingram has been given the right to make an offer for sale and the payment, it makes for it, is in the nature of royalty under the provisions of the Copyright Act read with the definition of royalty. It is emphasized that the payment made for the use or the right to use the copyright with reference to the distribution agreement, would amount to royalty. It is pointed out that the right parted with to the end-user and the exercise of the right so granted, also take in within it, the grant of a right to use the intellectual property. If it were not so, the use of the software would be in violation of the copyright, the Intellectual Property embedded in the software.

15. We shall notice some of the provisions of the Copyright Act before we consider the question whether the Revenue is right in its contention that the provisions of the Copyright Act cannot make a dent in the taxability of the particular income in terms of the Income-tax Act. As noticed, the Income-tax Act or DTAC does not define copyright. But Section 14 of the Copyright Act, gives the meaning of the expression 'copyright'. It says that for the purpose of that Act, copyright means the exclusive right subject to the provisions of that Act to do or authorize doing of any of the acts referred to therein in respect of a work or any substantial part thereof. In the case of a literary, dramatic or musical work other than a computer programme, the right takes in; the right

(i) to produce the work in any material form including the storing of it in any medium by electronic means;

(ii) to issue copies of the work in 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);

16. Clause (b) deals with copyright in the case of a computer programme. It means the exclusive right to do any of the acts specified in clause (a) of sub-section (1); 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. Some of the definitions are also relevant.

Section 2(y) defines 'work' as meaning:

(i) literary, dramatic or musical work;

(ii) A cinematograph film;

(iii) A sound recording.

Section 2(ffb) defines 'computer' as including any electronic or similar device having information processing capabilities. Section 2(ffc) defines 'computer programme' as meaning, a set of instructions expressed in words, codes, schemes or in any other form, including a machine readable medium, capable of causing a computer to perform a particular task or achieve a particular result. Section 2(o) defines 'literary work' as including computer programmes, tables and compilations including computer databases. Section 2 does not define a license but it defines an 'exclusive license' as meaning a license which confers on the licensee to the exclusion of all others, including the owner of the copyright , any right comprised in a copyright in a work. Section 17 specifies who is the first owner of the copyright. Section 18 recognises the assignment of a copyright. Section 19 prescribes the mode of assignment of a copyright. Section 30 then speaks of licenses by owners of copyright. It is to be noticed that section 30 does not speak of an exclusive license, which is a defined expression in the Act. It confers a right in the owner of the copyright to grant any interest in the right by license in writing signed by him.

Regarding the mode of transfer, the provisions of Section 19 are made applicable by Section 30A of the Act. Section 51 lays down that a copyright in a work shall be deemed to be infringed, if some one does anything, the exclusive right to do which is by the Act conferred upon the owner of the copyright without a license from the owner. When a person makes for sale or hire or sells or lets for hire or distributes any work without license, it will be an infringement. Section 52 indicates what would not be an infringement of a copy right. The making of copies or adaptation of a computer programme by a lawful prossessor of a copy of such computer programme from such copy, in order to utilize the computer programme for the purpose for which it was supplied or make backup copies purely as an temporary protection against loss destruction or damage in order only to utilize the computer programme for the purpose for which it was supplied, is not an infringement. Making of copies or adaptation of the computer programme from a personally legally obtained copy for non-commercial personal use will not be an infringement. Chapter XII of the Act deals with civil remedies of the owner of a copyright. Section 54 provides that for the purpose of that Chapter, unless the context otherwise required, owner of a copyright included an exclusive licensee. An exclusive licensee as per definition, can even exclude the owner. A licensee, who is not an exclusive licensee, will not be an owner.

17. The definition of Copyright says that for the purposes of that Act, copyright means the exclusive right to do or authorize the doing of the acts referred to in that section. This has nothing to do with the consequence of the Copyright holder passing on his rights otherwise than absolutely, either by assignment under section 18 of the Act or otherwise. The owner can also grant an exclusive license to another to exploit the Copyright. In terms of Section 30 of the Act, he can also grant a mere licence limited in point of right, limited in point of user, limited in point of duration. The farming out of that right under Section 30 of the Act is neither an assignment nor need it be exclusive license. It can be a mere license.

18. Thus, a reference to the Copyright Act indicates that use of a copyright either by an owner or a licensee, would not be an infringement of a copyright. The transfer of ownership can be by an assignment to another of the copyright either wholly or partially, either generally or with special limitations and either for the whole term of the copyright or any part thereof. Similarly, a license can be granted by the owner of the copyright of any interest in the right. An exclusive right also can be granted excluding even oneself from the right to use the copyright owned. So, a transgression of the limitations of an assignment or of a license would prime facie be an infringement of the copyright and invite the consequences provided for under the Act. Similarly, the act of taking copies or act of adaptation will not be an infringement only if it is done by a lawful possessor of a copy of the computer programme. A lawful possessor can only be an assignee, an exclusive licensee or a licensee of the programme. When he acquires a computer programme, he also gets the right to use that programme to a limited extent. This in our view, is on the basis that in so acquiring the computer programme, he has also got a right, absolute or limited to use the copyright.

19. When a software is created by a person who acquires a copyright for it, he becomes the owner of that copyright. He can transfer or license that right either by himself or through an agent. When he sells or licenses the software for use, he is also selling or licensing the right to use the copyright embedded therein. If a software is used without being lawfully acquired either by purchase or by license, that would amount to an infringement of the copyright obviously because of the copyright embedded in the software. The software is a literary work and clearly the copyright of the creator over the software is an important and commercially valuable right. So, whenever a software is assigned or licensed for use, there is involved an assignment of the right to use the embedded copyright in the software or a license to use the embedded copyright, the Intellectual Property Right in the software. Therefore, it appears to us that it is not possible to divorce the software from the Intellectual Property Right of the creator of the software embedded therein. The amendment to Section 14(1)(b) of the Copyright Act, by Act 49 of 1999, clarifying that in the case of a computer programme, copyright means the right to sell or give on commercial rental or offer for sale or commercial rental any copy of the computer programme, seems to be significant. This addition would suggest that even the right to sell or give on rental, would amount to a copyright and would be a right to be dealt with as a copyright.

20. The Copyright Act, more or less equates an exclusive licensee to an owner of a copyright. It also recognizes a non-exclusive license. Nobody has a case that a copyright cannot be granted on license otherwise than by way of an exclusive license. In fact, Section 30 provides for grant of any interest on license. A licensee has the right to use the license subject to the limitations in the grant in his favour, to the extent it is granted to him.

21. Moreover, under section 14, copyright in respect of a computer programme also means the right to sell or give on commercial rental any copy of the computer programme. A computer programme as defined only means a set of instructions expressed in words, codes, schemes or in any other form including a machine readable medium capable of causing a computer to perform a particular task or achieve a particular result. A software is nothing but a programme and other operating information used by a computer. Is not a software a set of instructions in machine readable medium capable of causing a computer to perform a particular task or achieve a particular result? So, sale or licensing of a software for use passes to the grantee a copyright as defined in section 14 of the Copyright Act.

22. The definition of 'royalty; in the Income-tax Act is, consideration for the transfer of all or any rights (including the granting of a license) in respect of a patent, innovation, model, design, secret formula or process or trade-mark or similar property. Consideration for grant of the use of any of the above is also royalty. It also takes in the consideration for the transfer of all or any rights (including the granting of a license) in respect of any copyright, literary, artistic or scientific work. It is to be noted that license is not confined to an exclusive license. According to the applicant, this definition, among other things, envisages payment for transfer of all or any rights in intellectual property by the owner of such intellectual property to any other person. When a software, over which a copyright is acquired and thus owned, is licensed for use to another or sold to another for his own use, what are the rights that pass on to the licensee or the buyer? When software is acquired either on license or on purchase, the licensee or the purchaser gets the right to use the software without being held guilty of infringement of the copyright. But a user of the software without a license or a purchase would obviously make the user of the software liable for infringement of the copyright embedded in the software. More often than not, software for such special applications like Citrix XenApp, is also patented. When the use of software, without anything more, would render the user liable for infringement of the copyright embedded in the software, can it not be said that the sale or the licensing of the software involves the grant of a right to use the copyright in the software? Will it not be the grant of a right to use the intellectual property embedded in the software? We think that it does. It is, therefore, difficult to accept the argument that the licensing of a software for use by the end-use customer, is the mere sale of a copyrighted article and does not involve the grant of a right to use the copyright in the software.

23. It is pointed out that consideration paid for such a licensing or sale of software is not royalty, has been held by this Authority and there is no reason to go behind the ratio of those rulings. The ruling of this Authority in Factset Systems (AAR No. 787 of 2008) is referred to. In that case, it was held that subscription fee collected for access to data base located outside, was not royalty and in the absence of a permanent establishment, the payee of such a fee was not liable to be taxed on the income as royalty. After elaborating the terms of the agreement involved in that case, it was held that the subscription fee received by the applicant therein from the licensee, the user of the data base, did not fall within the scope of clause (v) of Explanation 2 to Section 9(1)(vi) of the Act. It was reasoned that the computer data base fell within the definition of literary work in the Copyright Act. It was also held that the data base was the intellectual property of the applicant in that case and a copyright was attached to it and the question was posed whether in making the centralized data available to a licensee for a consideration, any of the rights which the applicant had as the owner of copyright in the data base, was being passed on in favour of the customer. It was stated that no proprietary right and no exclusive right which the applicant had, was made over to the customer. The copyright or the proprietary right remained, in tact, with the applicant notwithstanding the fact that the right to view and make use of the data for internal purposes of the customer was conferred on the licensee.

24. It was emphasized that the licensee had not been given the exclusive right to reproduce or adapt the work or to distribute the contents of the data base to others. The grant of license was only to authorize the licensee to have access to the copyrighted data base rather than granting any right in or over the copyright as such. We may notice with respect, that the definition of royalty in the Income-tax Act speaks only of transfer of all or any rights, including the granting of a license, in respect of the copyright. It does not speak of the grant of any exclusive right. In fact, if one were to go by Section 18 of the Copyright Act, the transfer of a copyright itself may be, whole or partial, general or subject to limitations or for the whole term of the copyright or any part thereof. Therefore, even a partial right or confined right granted to the assignee would attract the definition of royalty as found in the Income-tax Act. Similarly, license recognized by Section 30 of the Copyright Act, contemplates the grant of any interest in the copyright by license. That interest can also be a limited interest or a comprehensive interest. The concept of conveying of exclusive right either by way of assignment or by way of license does not appear to be the sine qua non for coming within the definition of royalty in respect of the consideration paid for the transfer or licensing of a copyright. The fact that in Section 14 of the Copyright Act, copyright is said to mean the exclusive right to do or authorize the doing of any of the acts referred to therein, or that an exclusive licensee is equated to the owner, does not mean that the copyright holder has to convey exclusive rights either by assignment or by way of a license for attracting the definition of royalty in respect of the consideration he receives for the grant or licensing of that right.

25. In M/s. Dassault (AAR 821 of 2009), it was noticed that the core of the transaction in that case was to authorise the end-user to have access to and make use of the licensed software products over which the applicant had exclusive copyright without giving any scope for dealing with them any further. The reasoning or the line of reasoning in Factset on applicability of the Copyright Act, in this context, was followed. It was also noticed that in Tata Consultancy Services (271 ITR 401), the Supreme Court had held that "a software programme may consist of various commands which enable the computer to perform a designated the task. The copyright in that programme may remain with the originator of the programme. But, the moment copies are made and marketed it becomes goods which are susceptible to sales-tax." The Supreme Court was speaking in the context of the Sales-tax Act. The Court had no occasion to consider what was involved in the sale of a software programme. The Court had no occasion to consider what all are the rights that pass on to the grantee when a software programme is transferred or licensed to him. It was concluded in Dassault, that in the absence of an independent right to conclude a sale or offer for sale, section 14 could not be invoked to bring the case within Section 9(1) (vi) of the Act by invoking sub-clause (ii) of Clause (b) of that section. It was concluded that no right to use the copyright as such has been conferred on the licensee. In our view whenever software is transferred or licensed for use, it takes within it the copyright embedded in the software and the one cannot be divorced from the other.

26. In the Income-tax Act, royalty is defined as consideration for the transfer of all or any rights (including the grant of license) in respect of any Copyright. Computer software is also defined as meaning of any computer programme recorded on any disc, tape, perforated media or other information storage device and includes any such programme or any customized electronic data. The expression computer software is not used in the body of the section or in Explanation 2 to clause (vi) of Section 9(1) of the Act. It is pointed out that this Authority in the Ruling in Geo Quest Systems BV and Dassault Systems KK has understood the explanation thus:-

"In the definition of royalty under the Act, the phrase 'including the granting of a licence' is found. That does not mean that even a non exclusive license permitting user for in-house purpose would be covered by that expression. Any and every license is not what is contemplated. It should take colour from the preceding expression 'transfer of rights in respect of a Copyright'."

27. With respect, the words within brackets, 'including the granting of a license' indicates an expansive definition. It is a devise to bring in something which might not otherwise be included in the words used. Clearly, the legislature must be taken to be aware of the possibilities ushered in by Section 30 of the Copyright Act. When words of expansion are used, is it justified to fall back upon the rule of ejusdem generis or Noscitur a sociis? Will not the application of that principle nullify the legislative intention of expanding the definition of transfer to include the grant of a license as well? With respect, we think that such a reading of the relevant provision would tend to defeat the legislative intent. In Craies on Statute Law, Seventh Edition, at page 213, it is stated "where the word defined is declared to include so and so, the definition is extensive".

28. A license is a mere permission or authority to do a particular thing. It is not transfer. One mode of enjoyment of a Copyright by its owner or an exclusive licensee (who is equated to an owner by section 54 of the Copyright Act) is by licensing it for use. Section 30 of the Copyright Act recognizes that any interest may be granted on license. 'Interest' means advantage or participation. So, grant of any advantage by the owner is roped in. Obviously, the Income-tax Act wanted to bring within the scope of royalty what is payable as consideration for obtaining such a license. Hence, in addition to the words, transfer of any rights, it brought in by way of inclusion, the words "including the granting of a license." How can we then read with justification that a license must also be akin to a transfer?

29. An inclusive definition is a definition of expansion. The Supreme Court has held that the words used in an inclusive definition denote extension and they cannot be treated as restricted in any sense. When inclusive definition is dealt with, it would be inappropriate to put a restrictive interpretation upon terms of wider denomination. The word 'includes' is an inclusive definition and expands the meaning. [See for instance, Corporation of the City of Nagpur v. Its employees (AIR 1960 SC 675), Vasudev Ramachandra Shelat v. Pranlal Jayanand Thaker (AIR 1974 SC 1728) and Doypack Systems (P) Ltd. v. Union of India (AIR 1988 SC 782)]. With great respect, we therefore feel, that a license cannot be restricted to transfer of a right dealt with earlier by the provision and should be understood as taking in, the grant of a license simpliciter. We cannot also forget that the Copyright Act has separately dealt with a computer programme different from copyrights covered by Section 14(1) of that Act. We are therefore unable to agree with this line of argument.

30. Article 12 of the India-Australia DTAC defines royalties to mean payment made as consideration for the use of or the right to use any copyright, patent, design or model, plan, secret formula or process, trademark or other like property or right. In Azai Bachao Andolan (263 ITR 706) the Supreme Court has spoken as to how a treaty is to be interpreted. It is a contract between sovereign States and varying considerations go into making it. It is a matter of bargain between the two countries involving adjustments and compromises. According to Bennion on Staturoy Interpretation 'the words in a treaty has to be given meaning not strictly according to rules of interpretation of Statutes, but the meaning of the diplomat rather than a lawyer'. (See page 751 of 263 ITR 706). So, when the convention speaks of royalty, and defines it, it must be understood as it is commonly understood. There is much to be said for the argument on behalf of the Revenue, that we should not feel ourselves constrained by the definition of Copyright in Section 14 of the Copyright Act, a definition that explicitly states that it is for the purposes of that Act, especially when construing the tax convention.

31. The article speaks of the use of or the right to use of any copyright. Use of a copyright takes place, when the copyright is used. This is distinct from the right to use a copyright. The two expressions are used disjunctively and the expression used is 'or'. The context does not warrant the reading of 'or' as 'and'. If so, the consideration received for permitting another to use a copyright is also royalty.

32. Considerable arguments are raised on the so-called distinction between a copyright and copyrighted articles. What is a copyrighted article? It is nothing but an article which incorporates the copyright of the owner, the assignee, the exclusive licensee or the licencee. So, when a copyrighted article is permitted or licensed to be used for a fee, the permission involves not only the physical or electronic manifestation of a programme, but also the use of or the right to use the copyright embedded therein. That apart, the Copyright Act or the Income-tax Act or the DTAC does not use the expression 'copyrighted article', which could have been used if the intention was as claimed by the applicant. In the circumstances, the distinction sought to be made appears to be illusory.

33. We also find that in P.No.30 of 1999 In re (238 ITR 296) on a finding that the Indian Company is allowed to use the software developed and protected by the foreign company, the applicant before the Authority, it was held that the consideration payable by the Indian Company for this privilege was royalty. Various aspects were considered in detail. This Authority noticed that the practice in Canada, the USA and other developed countries, allowing the use of protected software for a consideration by way of a contract was to treat the income as royalty. Commentary by Klaus Vogel was also quoted in support. The reasoning appeals to us. We see no compelling reason why we should depart from this position adopted by other countries while interpreting Article 12.3 of the DTAC and even Section 9(1)(vi) of the Act.

34. In IMT Labs (India) Pvt. Ltd., In re (287 ITR 450), this Authority held that payments made by a resident to use the software developed by the non-resident on its server platform, was royalty.

35. In Airport Authority of India, In re (304 ITR 216), this Authority holding that the ratio of the decision in Tata Consultancy (AIR 2003, SC 371) cannot conclude the question, proceeded to observe that the OECD views are not binding, India being not a signatory to the convention and that there is no unanimity even among the member countries of OECD. This Authority held that income relatable to supply of documents and software under the contract there in question, was royalty as the documents and software were copyrights which had been given to the applicant therein for use. This Authority even went to the extent of stating that the provisions of the Income-tax Act and the DTAA were clear on the point and no reference to the Copyright Act appears to be necessary.

36. In Millenium IT Software Ltd. (AAR No.835 of 2009), we have held that the payment made under the contract involved therein was royalty, based on the reasons contained therein supplementing the reasons we have given here.

37. Thus, it could be stated that there is no clear unanimity of view on the question even in this Authority.

38. A ruling by this Authority is based on the facts involved in the application leading to that ruling. It appears to be difficult to postulate the application of the doctrine of precedent to a Ruling under section 245R(4) of the Act. The Act has itself made it clear that the ruling is binding on the applicant in the application and the Revenue, in respect of that application and the transaction involved therein.

39. Even then, there is the aspect of judicial discipline and consistency involved. We have already noticed what we consider to be the divergence in views in this Authority. We are inclined to take the view that the sale or licensing for use of a copyrighted software amounts to or amounts also to the grant of a right to use a copyright. Differing views by this Authority can be got resolved and the matter set at rest only by a decision of the Supreme Court, laying down the law finally, to be followed by all the Courts and Tribunals including this Authority. Only an authoritative pronouncement by the Supreme Court can settle this controversy.

40. We find from the decision of the Karnataka High Court in CIT v. M/s. Samsung Electronics Co. Ltd (ITA No. 2808 of 2005) and connected cases that that High Court has held that in that case, the argument that it would be only a sale of copy of the copyright software could not be accepted. It was a payment towards the price of CD, the software and the license to use granted. The payment was royalty as defined in the Income-tax Act and the DTAC involved therein.

41. Some decisions of Income-tax Appellate Tribunals and the decision of the High Court of Delhi in DIT v. Ericssion AB are also brought to our notice where the view has been taken that the payment would not be royalty. The decision of a Delhi Tribunal, taking a contrary view has also been brought to our notice. We are not persuaded to adopt the reasoning of the Bombay Tribunal and that of the High Court of Delhi in the light of our discussion above and that in the Ruling in Millennium.

42. In the light of our discussion above, on question no.1, it has to be ruled that the payments received by the applicant from the distributor for sale of the software product is in the nature of royalty within the meaning of Section 9(1)(vi) of the Income-tax Act.

43. Question no. 2 is whether the payments concerned would be royalty as defined in Article 12 of the DTAA between India and Australia. On the basis of the reasoning leading to our ruling on question no. 1, the payment would be royalty. That apart, Article 12.3 of the DTAA defines royalties as payments, whether periodical or not and however described or computed, as consideration for "the use of, or the right to use any copyright, patent, design or model, plan, secret formula or process, trade mark or other like property or right." The definition is seen to be wider than the one contained in the Income-tax Act. It also ropes in payment of consideration for the use of a copyright in addition to the consideration paid for the right to use a copyright, covered by the definition in the Income-tax Act. Consideration paid for use of a copyrighted software, as we have reasoned earlier, is also payment for use of the copyright embedded in the software. The observations in the ruling in P.No. 30 of 1999 (AAR) that countries like the USA consider the payment as royalty and the passages from Klaus Vogel quoted therein support this position. There cannot be a use of software, over which exists a copyright, without a use of the copyright therein. The payment for such use can only be royalty. We may notice here with respect, that in our view, in M/s. Dassault ruling, the scope of the expression 'use of a copyright' used in Article 12 has not been specifically considered. For these reasons and the reasons given, leading to the ruling on question no.1, we rule on this question, that the payment received by the applicant is royalty within the meaning of Article 12 of the DTAC between India and Australia.

44. Question no. 3 concerns the character of the payment received by the applicant for grant of the right to down-load/receive version updates for software products of the applicant. We have ruled above that the payment received from the distributor for making available the software product of the applicant to the end-user is royalty within the meaning of the Income-tax Act and the DTAC between India and Australia. Citrix Subscription Advantage Programme is the updating of the software product already granted or licensed for use by the end-user. Consistent with our view expressed above, the payment received by way of Subscription for the updates would also be payment received for grant of a right to use the copyright embedded in the Subscription Advantage Programme and it will be royalty.

45. In the light of our answer to question no. 3 holding that the payment is royalty, it is not necessary for us to rule on the question whether the payment for Subscription Advantage Programme would be in the nature of fees for technical services within the meaning of the Income-tax Act. We decline to rule on question no.4.

46. The ruling on question no.5 has again to be that the payment received is royalty within the meaning of Article 12 of the DTAA between India and Australia. We have already reasoned that the subscription for the programme update would be a payment for the use of and the right to use the copyright embedded in the programme. In this view, we rule that the payment would be royalty. In view of the fact that the payment would be royalty in terms of clause (a) of Article 12.3 of the DTAC, it is not necessary to consider the question whether it will fall under clause (g) of Article 12.3 of the DTAC. We decline to rule on that aspect of the question.

47. While raising question no. 6, the applicant has taken up the position that it does not have a permanent establishment in India. Even if we accept that position adopted, in our view that the payment received is royalty, the amount is liable to be taxed in India under Article 12.2 of the DTAC. Therefore, the ruling on this question is that the consideration received by the applicant in respect of the original software and the Subscription Advantage Programme are both taxable as royalty in India.

48. In view of our answers above, ruling on question no. 7 is that the distributor Ingram is required to withhold taxes in India at the time of making payments to the applicant in terms of Section 195 of the Income-tax Act at the rate of 10% of the gross amount of royalty, as provided under Article 12.2 of the DTAC.

49. Accordingly, the ruling is pronounced on this, the 6th day of February, 2012.

Link: http://aarrulings.in/it-rulings/uploads/pdf/1329205160_ruling.citrix.pdf