2021 (11) TMI 1023 - AT - Income Tax

Tribunal rules on software sales, reimbursements, TDS credit, surcharge rate, interest, and penalty proceedings.

The Tribunal partially allowed the appeals, ruling that receipts from the sale of hardware with embedded software and software receipts were not taxable ... Income accrued in India - Hardware receipts held to be chargeable to tax in India - receipts on sale of hardware with software embedded therein can be taxed as royalty or not? - assessee is a non-resident foreign company incorporated in United Kingdom - hardware is primarily in the form of viewing cards, Set-top-Box (STB) and other connected components,usually used in viewing television through satellite. The embedded software is required to run the hardware components - assessee claimed before the AO that the receipts not offered to tax cannot be regarded as royalty in the hands of the assessee and in particular in the light of the definition of royalty as given in article 12(3)(a) of the Double Taxation Avoidance Agreement (DTAA) between India and UK - HELD THAT:- Since the AY is AY 2010-11 (ie, prior to the Finance Act, 2012 amendment by way of inserting Explanation 4 to Section 9(1)(vi) of the Act, as per the SC in its judgment, the Finance Act, 2012 amendment has to be read as expanding the scope of royalty with prospective effect from the Assessment Year 2013-14 (After FA, 2012 was enacted) and cannot be upheld as clarificatory so as to apply retrospectively for previous assessment years (para 73 - 74, 78 and 79). Therefore, the payments made under the customer contracts are not be treated as “royalty” under section 9(1)(vi) of the Act itself for the subject AY 2010-11, even without reference to the DTAA. Under the DTAA, clearly these are not “royalty” payments under Article 12 of the India – UK DTAA as held by the SC (UK DTAA has also been examined by the SC para 40. Hon’ble Supreme Court in the case of Engineering Analysis Centre of Excellence (P) Ltd. [2021 (3) TMI 138 - SUPREME COURT] ) held that A copyright is an exclusive right that restricts others from doing certain acts. A copyright is an intangible right, in the nature of a privilege, entirely independent of any material substance. Owning copyright in a work is different from owning the physical material in which the copyrighted work may be embodied. Computer programs are categorised as literary work under the Copyright Act. The court held that a licence from a copyright owner, conferring no proprietary interest on the licensee, does not involve parting with any copyright. It said this is different from a licence issued under section 30 of the Copyright Act, which grants the licensee an interest in the rights mentioned in section 14(a) and 14(b) of the Copyright Act. What is ‘licensed’ by the foreign, non-resident supplier to the distributor and resold to the resident end-user, or directly supplied to the resident end-user, is the sale of a physical object which contains an embedded computer program. Therefore, it was a case of sale of goods. Whether the provisions of the Act can override the provisions of the DTAA? - By virtue of Article 12(3) of the DTAA, royalties are payments of any kind received as a consideration for 'the use of, or the right to use, any copyright 'of a literary work includes a computer program or software. It was held that the regarding the expression 'use of or the right to use', the position would be the same under explanation 2(v) of section 9(1)(vi) because there must be, under the licence granted or sales made, a transfer of any rights contained in sections 14(a) or 14(b) of the Copyright Act. Since the end-user only gets the right to use computer software under a non-exclusive licence, ensuring the owner continues to retain ownership under section 14(b) of the Copyright Act read with sub-section 14(a) (i)-(vii), payments for computer software sold/licenced on a CD/other physical media cannot be classed as a royalty. The terms of the licence in the present case does not grant any proprietory interest on the licencee and there is no parting of any copy right in favour of the licencee. It is non-exclusive non-tranferrable licence merely enabling the use of the copy righted product and does not create any interest in copy right and therefore the payment for such licence would not be in the nature of royalty as defined in DTAA. We therefore hold that the sum in question cannot be brought to tax as royalty. On the question whether the sums in question can be taxed as FTS, we agree with the submissions made by the learned counsel for the Assessee set out in paragraph-18 & 19 of this order and hold that the sums in question cannot be brought to tax as FTS. Whether the sum which was offered to tax by the assessee and which by virtue of our conclusions as aforesaid cannot be regarded as royalty or FTS and hence cannot be taxable, the Revenue should be directed to not to tax the aforesaid sum also - Thus taxability of receipts on sale of set-top-box, the amount offered to tax by the assessee which is now found to be not taxable cannot be brought to tax. We hold and direct accordingly and allow the ground of appeal. Reimbursements from Cisco Video for expenses incurred on behalf of Cisco Video - HELD THAT:- We hold that pure reimbursement does not give rise to any income and the decisions cited by the learned AR in this regard lay down the above principle. We find that the revenue authorities have not firstly held that as to whether there was one-to-one tally of sums spent by the Assessee that was reimbursed by NDS Pay Tv. Once this factual finding is rendered then there has been no payment for any services whatsoever. The question is can one infer that the sums reimbursed were for services rendered by Assessee when there is one to one tally. In our view it cannot be said so. As we have already mentioned the AO has proceeded to draw inferences on surmises and conjectures. Firstly there is no evidence to show that services were rendered which can be termed as FTS. Under the DTAA FTS can be taxed only when it makes available technical knowledge to the person making payment. On the application of “make available” clause of the DTAA, there is no finding whatsoever as to what was the technical service made available to NDS Pay TV. We, therefore, deem it fit to set aside this issue and remand the same for consideration by the AO in the light of the observations made above (in particular with regard to actual tally of expenses incurred and reimbursed by NDS Pay Tv to Assessee), in accordance with law, after affording assessee opportunity of being heard. Non-grant of credit for TDS - HELD THAT:- It would be just and appropriate to direct the AO to consider the calim of the assessee and allow credit in accordance with law. The issue raised by the assessee in ground No.6 is with regard to levy of interest under section 234B of the Act. In this regard, we find that the issue with regard to levy of interest under section 234B in the case of a non-resident has been settled by the Hon’ble Supreme Court in the case of DIT Vs. Mitsubishi Corporation [2021 (9) TMI 875 - SUPREME COURT] and took when the assessee is a nonresident foreign company incorporated in Japan and when the entire income that arises to them and the payment them is subject to deduction of tax at source there was no question of advance tax payment by assessee, accordingly, no interest under section 234B could be levied upon assessee. Issues Involved:1. Taxability of receipts from the sale of hardware with embedded software as royalty.2. Taxability of software receipts as royalty.3. Reimbursement of expenses and whether they constitute Fees for Technical Services (FTS).4. Non-grant of credit for Tax Deducted at Source (TDS).5. Levy of interest under section 234B of the Income Tax Act.6. Initiation of penalty proceedings under section 271(1)(c) of the Income Tax Act.7. Rates of tax to be applied on royalty and FTS.8. Wrong rate of surcharge applied by the Assessing Officer (AO).9. Short grant of credit for TDS.Detailed Analysis:1. Taxability of Receipts from Sale of Hardware with Embedded Software as Royalty:The primary issue was whether the receipts from the sale of hardware with embedded software could be taxed as royalty. The AO and the DRP treated these receipts as royalty under the Income Tax Act and the India-UK DTAA. The Tribunal referred to the Supreme Court's decision in the case of Engineering Analysis Centre of Excellence Pvt. Ltd. The Supreme Court held that payments for software embedded in hardware do not constitute royalty but are akin to the sale of goods. The Tribunal applied this principle, concluding that the receipts in question could not be taxed as royalty, as the software was part of an integrated system and not independently licensable.2. Taxability of Software Receipts as Royalty:The AO and DRP treated the software receipts as royalty under section 9(1)(vi) of the Act and the India-UK DTAA. The Tribunal, following the Supreme Court's judgment in Engineering Analysis, held that the software receipts were not in the nature of royalty. The Tribunal emphasized that the software was integral to the hardware and did not have an independent existence. Therefore, the receipts could not be taxed as royalty.3. Reimbursement of Expenses and Whether They Constitute FTS:The assessee argued that the reimbursements from Cisco Video for expenses incurred on its behalf were purely on a cost-to-cost basis and did not contain any profit element. The AO and DRP treated these reimbursements as FTS. The Tribunal found that the AO's conclusions were based on assumptions and lacked concrete evidence. The Tribunal remanded the issue to the AO for fresh consideration, directing that the AO should examine if there was a one-to-one tally between the expenses incurred and the reimbursements received. If the reimbursements were purely cost-based, they could not be treated as FTS.4. Non-Grant of Credit for TDS:The assessee raised an issue regarding the non-grant of credit for TDS. The Tribunal directed the AO to consider the claim and allow credit for TDS in accordance with the law.5. Levy of Interest Under Section 234B:The Tribunal referred to the Supreme Court's decision in DIT Vs. Mitsubishi Corporation, which held that interest under section 234B could not be levied on non-resident foreign companies when the entire income was subject to TDS. Following this precedent, the Tribunal directed that no interest under section 234B should be levied on the assessee.6. Initiation of Penalty Proceedings Under Section 271(1)(c):The Tribunal noted that the issue of initiation of penalty proceedings under section 271(1)(c) is not appealable and dismissed this ground as devoid of merit.7. Rates of Tax to be Applied on Royalty and FTS:The Tribunal found that the issue of the rates of tax to be applied on royalty and FTS became academic in light of its conclusion that the receipts in question were not in the nature of royalty or FTS.8. Wrong Rate of Surcharge Applied by the AO:In the appeal for the Assessment Year 2012-13, the assessee raised an issue regarding the wrong rate of surcharge applied by the AO. The Tribunal remanded this issue to the AO for fresh consideration, directing that the surcharge should be levied as per the provisions of law.9. Short Grant of Credit for TDS:The Tribunal directed the AO to allow appropriate credit for TDS in accordance with the law for the Assessment Year 2013-14.Conclusion:The Tribunal allowed the appeals partly, concluding that the receipts from the sale of hardware with embedded software and software receipts could not be taxed as royalty. It remanded the issue of reimbursements to the AO for fresh consideration and directed the AO to grant credit for TDS and apply the correct rate of surcharge. The Tribunal also held that no interest under section 234B should be levied and dismissed the ground regarding the initiation of penalty proceedings.