Offshore supply and embedded software taxation turns on place of sale, copyright rights, and non-resident advance-tax exposure.

Offshore supply of hardware and embedded software by a non-resident was treated as a principal-to-principal sale completed outside India, with title and risk passing abroad; on those facts, no business connection or India-based operations generated taxable income under section 9(1)(i). The software component was held to be a copyrighted article forming part of the supplied GSM system, not a transfer of copyright rights, so it did not constitute royalty under section 9(1)(vi) or the treaty provision. Interest under section 234B was held not leviable because the non-resident had no advance-tax obligation where tax was deductible at source. The notice under section 142(1) was upheld after the validating amendment.

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Issues: (i) whether the assessee had business connection in India and whether the income from offshore supply of hardware and software accrued or was deemed to accrue in India; (ii) whether the software component of the supply contract constituted royalty; (iii) whether interest under section 234B of the Income-tax Act, 1961 was leviable; (iv) whether the notice under section 142(1) of the Income-tax Act, 1961 was invalid.

Issue (i): whether the assessee had business connection in India and whether the income from offshore supply of hardware and software accrued or was deemed to accrue in India.

Analysis: The supply contract was treated as a contract for sale of goods executed on principal-to-principal terms, with property and risk passing outside India. The acceptance test in India was held not to be the material event for transfer of title or risk. The overall agreement and the associated installation arrangement did not alter the character of the offshore supply, and the existence of coordinated commercial arrangements did not by itself create a business connection in India. Since no operations generating the supply income were carried out in India, no part of that income was held taxable under section 9(1)(i) of the Income-tax Act, 1961.

Conclusion: The issue was decided in favour of the assessee.

Issue (ii): whether the software component of the supply contract constituted royalty.

Analysis: The software was found to be an inseparable part of the GSM system supplied as goods and not a transfer of copyright rights. The cellular operators obtained a copyrighted article and not any of the rights comprised in copyright. The contract did not show a separate transfer of copyright or a use of copyright within the meaning of section 9(1)(vi) of the Income-tax Act, 1961 or the relevant treaty provision. The attempted bifurcation of hardware and software consideration was not accepted for royalty taxation on these facts.

Conclusion: The issue was decided in favour of the assessee.

Issue (iii): whether interest under section 234B of the Income-tax Act, 1961 was leviable.

Analysis: The assessee was a non-resident whose Indian tax exposure, if any, was subject to deduction at source. In the circumstances, it was held that there was no obligation to pay advance tax and therefore no liability to interest under section 234B.

Conclusion: The issue was decided in favour of the assessee.

Issue (iv): whether the notice under section 142(1) of the Income-tax Act, 1961 was invalid.

Analysis: The objection to the notice was rejected in view of the subsequent statutory amendment validating notices issued after the end of the assessment year.

Conclusion: The issue was decided in favour of the Revenue.

Final Conclusion: The Revenue's appeals failed on the substantive taxability questions, while the procedural objection to the notice did not survive, resulting in the dismissal of the Revenue's appeals and the assessee obtaining relief on the principal issues.

Ratio Decidendi: Offshore supply of goods by a non-resident is taxable in India only when the income arises from operations carried out in India or from a real business connection in India, and payment for software embedded in supplied goods is not royalty unless copyright rights are transferred or licensed.

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