2011 (10) TMI 195 - HC - Income Tax

Payments to nonresident for shrink-wrapped software held royalty under Article 12(3) DTAA and s.9(1)(vi); TDS required under s.195

Commissioner of Income-tax Versus Samsung Electronics Co. Ltd. & Others

Karnataka HC held that payments to non-resident software suppliers for shrink-wrapped/off-the-shelf software constituted royalty under Article 12(3) of ... TDS - Royalty paid to foreign software Supplier - 'royalty' u/s 9(1)(vi) of the Income Tax Act Or Article 12(3) of the Double Taxation Avoidance Agreement (DTAA) - software which is in legal parlance called computer program is categorized as copyright in India and therefore software-computer program is copyrighted and copyright vests with the foreign supplier - definition of 'copyright' - Held that:- On reading the contents of the respective agreement entered into by the respondents with the non-resident, it is clear that under the agreement, what is transferred is only a licence to use the copyright belonging to the non-resident subject to the terms and conditions of the agreement as referred to above and the non-resident supplier continues to be the owner of the copyright and all other intellectual property rights. It is well settled that copyright is a negative right. It is an umbrella of many rights and licence is granted for making use of the copyright in respect of shrink wrapped software/off-the-shelf software under the respective agreement, which authorizes the end user i.e., the customer to make use of the copyright software contained in the said software, which is purchased off the shelf or imported as shrink wrapped software and the same would amount to transfer of part of the copyright and transfer of right to use the copyright for internal business as per the terms and conditions of the agreement. Therefore, the contention of the learned senior counsel appearing for the respondents that there is no transfer of copyright or any part thereof under the agreements entered into by the respondent with the non-resident supplier of software cannot be accepted. It is well settled that in the absence of any definition of 'copyright' in the Income Tax Act or DTAA with the respective Countries, in view of clause 3 of the DTAA, reference is to be made to the respective law regarding definition of 'Copyright', namely, Copyright Act, 1957, in India, wherein it is clearly stated that 'literary work' includes computer programmes, tables and compilations including computer [databases]. Section 16 of the Copyright Act, 1957 states that no person shall be entitled to copyright or any similar right in any work, whether published or unpublished, otherwise than under and in accordance with the provisions of the said Act or of any other law for the time being in force, but nothing in this section shall be construed as abrogating any right or jurisdiction to restrain a breach of trust or confidence. It is also clear from the above said analysis of the DTAA Income Tax Act, Copyright Act that the payment would constitute 'royalty' within the meaning of Article 12(3) of the DTAA and even as per the provisions of 9(1)(vi) of the Act as the definition of 'royalty' under clause 9(1)(vi) of the Act is broader than the definition of 'royalty' under the DTAA as the right that is transferred in the present case is the transfer of copyright including the right to make copy of software for internal business, and payment made in that regard would constitute 'royalty' for imparting of any information concerning technical, industrial, commercial or scientific knowledge, experience or skill as per clause (iv) of Explanation 2 to Section 9(1)(vi) of the Act. In any view of the matter, in view of the provisions of Section 90 of the Act, agreements with foreign countries DTAA would override the provisions of the Act. Once it is held that payment made by the respondents to the non-resident Companies would amount to 'royalty' within the meaning of Article 12 of the DTAA with the respective country, it is clear that the payment made by the respondents to the non-resident supplier would amount to royalty. In view of the said finding, it is clear that there is obligation on the part of the respondents to deduct tax at source under Section 195 of the Act and consequences would follow as held by the Hon'ble Supreme Court while remanding these appeals to this Court. Accordingly, we answer the substantial question of law in favour of the revenue and against the assessee by holding that on facts and circumstances of the case, the ITAT was not justified in holding that the amount(s) paid by the respondent(s) to the foreign software Suppliers was not 'royalty' and that the same did not give rise to any 'income' taxable in India and wherefore, the respondent(s) were not liable to deduct any tax at source. All the appeals are allowed. Issues Involved:1. Whether the amount paid by the appellant to foreign software suppliers constitutes 'royalty'.2. Whether such payments give rise to any 'income' taxable in India.3. Whether the appellant is liable to deduct any tax at source under Section 195 of the Income Tax Act, 1961.Issue-wise Detailed Analysis:1. Whether the amount paid by the appellant to foreign software suppliers constitutes 'royalty':The primary issue revolves around whether payments made by the appellant to foreign software suppliers qualify as 'royalty' under Section 9(1)(vi) of the Income Tax Act and relevant clauses of the Double Taxation Avoidance Agreement (DTAA). The court examined the definitions of 'royalty' under both the Act and DTAA, noting that the definition under the DTAA is more restrictive and thus more beneficial to the assessee.The court scrutinized the software license agreements, which granted the appellant a non-transferable, non-exclusive license to use the software for internal business purposes. The agreements explicitly stated that the copyright remained with the foreign supplier, and the appellant was only permitted to use the software as per the terms of the agreement. This right to use the software, including copying it for internal purposes, was deemed to be a transfer of part of the copyright, thus constituting 'royalty'.The court rejected the appellant's reliance on the Supreme Court's decision in TATA Consultancy Services v. State of Andhra Pradesh, which dealt with the sale of software under sales tax law, not the definition of 'royalty' under income tax law. The court emphasized that the intent of income tax and sales tax laws are different, and the mere classification of software as 'goods' for sales tax purposes does not preclude it from being considered 'royalty' for income tax purposes.2. Whether such payments give rise to any 'income' taxable in India:The court noted that under Section 195 of the Act, tax must be deducted at source for payments to non-residents if the payments are chargeable to tax under the Act. The Supreme Court had clarified that the obligation to deduct tax arises only if the payment is chargeable to tax in India. The court found that since the payments were for the use of copyrighted software, they constituted 'royalty' and were thus chargeable to tax in India under Section 9(1)(vi) of the Act and the DTAA.The court also referred to the OECD commentary and the views of renowned authors on double taxation conventions, which supported the interpretation that payments for the use of copyrighted software constitute 'royalty'. The court concluded that the payments made by the appellant to the foreign software suppliers gave rise to income taxable in India.3. Whether the appellant is liable to deduct any tax at source under Section 195 of the Income Tax Act, 1961:Given the court's findings that the payments constituted 'royalty' and were chargeable to tax in India, the appellant was obligated to deduct tax at source under Section 195 of the Act. The court emphasized that failure to deduct tax would render the appellant liable for penalties and interest under the Act.The court rejected the appellant's argument that no tax deduction was required because the software was not customized and was merely 'shrink-wrapped'. The court held that the nature of the software (shrink-wrapped or customized) did not alter the fact that the payments were for the use of copyrighted software, thus constituting 'royalty'.Conclusion:The court concluded that the payments made by the appellant to foreign software suppliers constituted 'royalty' and gave rise to income taxable in India. Consequently, the appellant was liable to deduct tax at source under Section 195 of the Income Tax Act. The court allowed the appeals, set aside the order of the Income Tax Appellate Tribunal, and restored the order of the Commissioner of Income Tax (Appeals) confirming the Assessing Officer's decision.