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

Karnataka HC held that payments to non-resident software suppliers for shrink-wrapped/off-the-shelf software constituted royalty under Article 12(3) of ... Royalty - tax deduction at source under Section 195(1) - sum chargeable under the provisions of the Act - agreement for the use of or the right to use copyright - DTAA prevails under Section 90 - shrink wrapped/off the shelf software - licence to use copyrighted softwareRoyalty - agreement for the use of or the right to use copyright - shrink wrapped/off the shelf software - licence to use copyrighted software - DTAA prevails under Section 90 - Whether payments made for import/purchase of shrink wrapped/off the shelf software constituted 'royalty' taxable in India under the DTAA and Section 9(1)(vi) of the Act. - HELD THAT: - The Court examined the contractual licences and the statutory/DTAA definitions of 'royalty' and copyright. It held that computer programs are literary works under the Copyright Act and that the agreements granted a licence to copy (install) and use the software for internal business subject to conditions while the supplier retained copyright. The licence to make copies and to use the software (including storing on hard disk and making backup copies) is a transfer of a right to use the copyright; without that licence the acts would infringe copyright. The DTAA definition of 'royalty' requires payment as consideration for the use of, or the right to use, a copyright; the agreements in these appeals transferred precisely such a right. Because the DTAA definition is narrower and more beneficial to the assessee, the Court applied it and concluded that the payments fall within 'royalty' under Article 12 and therefore also within the broader Explanation (2) to Section 9(1)(vi). The Court rejected reliance on sales tax precedents (TCS) as addressing a different statutory purpose and not determinative of the income tax question; the distinct nature of software (operable only when copied to hardware) and the licence to copy/use were decisive. Consequently the amounts were held to be royalty chargeable to tax in India. [Paras 21, 22, 23, 24, 25]Payments for the imported shrink wrapped software constituted 'royalty' under the DTAA and Section 9(1)(vi), because the agreements conferred a licence/right to use copyrighted software.Tax deduction at source under Section 195(1) - sum chargeable under the provisions of the Act - DTAA prevails under Section 90 - Whether the payers were obliged to deduct tax at source on those payments under Section 195(1) and the legal consequences of non deduction. - HELD THAT: - Reading Section 195 in conjunction with the charging provisions (Sections 4, 5 and 9) and the Supreme Court's directions on remand, the Court held that TDS obligation arises only where the sum is 'chargeable under the provisions of the Act.' Having found that the payments were 'royalty' chargeable to tax under the DTAA/Section 9, the payers were obliged to deduct tax at source under Section 195(1). The Court restored the Assessing Officer/CIT(A) findings to this effect and noted the statutory consequences for failure to deduct (assessees in default, penalties and interest) as set out in the Act and the Supreme Court's analysis on Section 195. [Paras 18, 25]Because the payments were 'royalty' chargeable to tax in India, the respondents were under a statutory obligation to deduct tax at source under Section 195(1); consequential liability for non deduction follows.Final Conclusion: All appeals are allowed in favour of the revenue. The ITAT orders are set aside; the Commissioner (Appeals) and Assessing Officer (TDS) orders are restored. The payments for import of shrink wrapped software were held to be 'royalty' chargeable to tax in India and the payers were therefore obliged to deduct tax at source under Section 195(1). 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.