Software licence payments are not royalty where only a restricted right to use a copyrighted article is transferred.

Consideration for software licences was held not to be royalty under Article 12(3) of the India-USA DTAA because the licence granted only a restricted, non-exclusive right to use the software for internal business purposes. The Court distinguished a copyright from a copyrighted article and held that mere use of software, including limited installation or backup copying, does not amount to transfer of rights in copyright. As no copyright rights were transferred, the treaty definition of royalty did not apply and the receipts were taxable, if at all, as business income under Article 7 rather than as royalty under the DTAA.

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Issues: Whether consideration received for granting software licences constituted royalty under Article 12(3) of the India-USA Double Taxation Avoidance Agreement, or was only consideration for a copyrighted article taxable as business income under Article 7.

Analysis: The agreement granted the customer a non-exclusive, non-transferable and restricted right to use the software for its own business. The customer was permitted only limited copying for backup and could not exploit, sub-license, transfer, decompile or commercially deal with the software. Applying the treaty definition of royalty, the decisive question was whether any copyright rights were transferred, not whether the software product itself was supplied. The Court held that a distinction must be drawn between a copyright and a copyrighted article. Mere use of software, including copying necessary for installation or backup, did not amount to transfer of rights in copyright. Since the assessee was covered by the DTAA, the treaty definition prevailed over the wider domestic law definition where the treaty was more beneficial.

Conclusion: The receipts were not royalty under Article 12(3) of the DTAA and were not taxable on that basis.

Final Conclusion: The software licence receipts were held to be consideration for use of copyrighted material and not for transfer or use of copyright, so the Revenue's appeal failed.

Ratio Decidendi: For software transactions, royalty arises only where the licensee acquires rights in or over copyright itself; a restricted licence to use a copyrighted article for internal business purposes, without transfer of copyright rights, is business income and not royalty under the treaty.

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