2016 (3) TMI 540 - AT - Income Tax

Tribunal reclassifies software sales, training fees as 'Business receipts' under DTAA Article 7.

The Tribunal allowed the appeal, treating software sales, Annual Maintenance Contracts, and training fees as 'Business receipts' under Article 7 of the ... Characterisation of software receipts as business profits versus royalty under the Indo UK DTAA - Interpretation of 'royalties' in Article 13(3)(a) of the Indo UK DTAA - Applicability of Article 13(6) - permanent establishment/connection rule shifting income to Article 7 (Business profits) - Fees for technical services under Article 13(4) and exclusion in Article 13(5) for services ancillary and inextricably linked to sale of property - Effect of retrospective domestic amendment on Treaty meaning and application of Article 3(3) - Section 90(2) - more beneficial rule where DTAA and domestic law differCharacterisation of software receipts as business profits versus royalty under the Indo UK DTAA - Interpretation of 'royalties' in Article 13(3)(a) of the Indo UK DTAA - Effect of retrospective domestic amendment on Treaty meaning and application of Article 3(3) - Section 90(2) - more beneficial rule - Receipts from sale of shrink wrapped/off the shelf mining software are business profits under Article 7 of the Indo UK DTAA and not royalties under Article 13. - HELD THAT: - The Tribunal examined the Distributor and End user agreements and found that intellectual property rights remained with the head office (Datamine Corporate), the distributor merely resold/licensed copies (shrink wrapped software) and end users received only a perpetual right to use the specific version purchased, without acquisition of copyright. The domestic retrospective insertion (Explanation 4 to section 9(1)(vi)) cannot unilaterally alter the exhaustive definition of 'royalties' in the Treaty; Article 3(3) applies only where the Treaty adopts domestic definitions, and Article 13(3)(a) of the Indo UK DTAA does not expressly include 'computer software'. Further, even if Article 13(3)(a) were construed to cover software, Article 13(6) applies because the beneficial owner (UK resident) carries on business in India through a permanent establishment (the Indian branch), hence amounts are attributable to the PE and fall under Article 7. In view of section 90(2), where the DTAA position is more beneficial, the taxpayer may be governed by the DTAA. The authorities' treatment of the receipts as royalty was therefore set aside and the receipts held to be business profits chargeable under Article 7. [Paras 11, 12, 13, 14, 15]Software sale receipts treated as business profits under Article 7 of the Indo UK DTAA and not as royalties under Article 13.Characterisation of receipts from Annual Maintenance Contracts (AMC) - Ancillary nature of AMC to original software sale and its characterisation under Article 7 - Receipts from Annual Maintenance Contracts, characterised by the AO as having the same character as the original software sale, are business profits under Article 7 of the DTAA. - HELD THAT: - The AO himself treated the AMC receipts as having the same character as the original software sale. Having held that the software sales are business profits under Article 7, the Tribunal consequently held that AMC receipts-being an extension and of the same character-also fall under Article 7. The Tribunal did not independently re examine AMC as royalties or fees for technical services because the AO had equated their character with software sales. [Paras 16]AMC receipts to be treated as business profits under Article 7 of the Indo UK DTAA.Fees for technical services under Article 13(4) and exclusion in Article 13(5) - Ancillary services exclusion for services inextricably linked to sale of property - Training fees paid for imparting training to end users' employees are not 'fees for technical services' under Article 13(4) but are business receipts under Article 7, being ancillary and inextricably linked to the sale of software and thus excluded by Article 13(5). - HELD THAT: - Article 13(4) defines fees for technical services, but paragraph 5 excludes amounts paid for services that are ancillary and subsidiary and inextricably and essentially linked to the sale of property (other than property described in Article 13(3)(a)). The Tribunal held that training provided to end users is ancillary and subsidiary to the sale of the software (which was held to be business profits) and hence falls within the exclusion in Article 13(5). Accordingly, such receipts cannot be taxed as fees for technical services under Article 13(4) and must be treated under Article 7. [Paras 17]Training fees to be treated as business profits under Article 7 and not as fees for technical services under Article 13(4).Rejection of books of account and estimation of income - Requirement of pointing out deficiencies before disturbing declared profits - Addition estimated at 18% on consultancy and miscellaneous receipts is unsustainable; in absence of rejection of books with reasons, declared income must be accepted. - HELD THAT: - The AO applied a net profit rate of 18% to consultancy and miscellaneous receipts without demonstrating any defect in or rejecting the assessee's books of account. The Tribunal reiterated the well settled principle that declared profits cannot be disturbed unless books are rejected after pointing out deficiencies; lacking any evidence to justify rejection, the addition was deleted and amounts accepted as declared. [Paras 18]Estimation disallowed; consultancy and miscellaneous receipts included in income as declared.Final Conclusion: The appeal is allowed: receipts from sale of software, annual maintenance contracts and training fees held to be business profits chargeable under Article 7 of the Indo UK DTAA (not royalties or fees for technical services under Article 13); the estimation addition on consultancy and miscellaneous receipts is deleted and the declared amounts are accepted. Issues Involved:1. Treatment of 'Business receipts' from the sale of software as 'Royalty'.2. Treatment of receipts from Annual Maintenance Contracts as 'Royalty'.3. Treatment of receipts from training fees as 'Fees for technical services'.4. Estimation of income from business at 18% on Consultancy receipts and Miscellaneous income.Detailed Analysis:1. Treatment of 'Business receipts' from the sale of software as 'Royalty':The primary issue was whether the receipts from the sale of software amounting to Rs. 1,04,18,783/- should be treated as 'Business receipts' or 'Royalty'. The assessee, a UK-based company with a branch in India, declared these receipts as business income. The AO, however, treated them as 'Royalty' under section 9(1)(vi) of the Income-tax Act and Article 13(3)(a) of the Indo-UK DTAA. The AO's conclusion was based on the nature of the software, which was specialized for mining activities and considered to be making available a 'process' to the customers. However, the Tribunal held that the software sold was a copyrighted product and not the copyright itself. The intellectual property rights remained with Datamine Corporate, and the end-users only had the right to use the software. The Tribunal concluded that the receipts from the sale of software should be treated as 'Business receipts' under Article 7 (Business profits) of the DTAA, not 'Royalty'.2. Treatment of receipts from Annual Maintenance Contracts as 'Royalty':The AO treated the receipts of Rs. 36,69,021/- from Annual Maintenance Contracts as 'Royalty', considering them an extension of the original software process. However, the Tribunal, referencing its earlier decision on software sales, held that these receipts should also be treated as 'Business receipts' under Article 7 of the DTAA. The AO's own version that these receipts had the same character as software sales supported this conclusion.3. Treatment of receipts from training fees as 'Fees for technical services':The AO treated the receipts of Rs. 9,62,372/- from training fees as 'Fees for technical services' under Article 13(4) of the DTAA. The Tribunal examined whether these receipts fell under Article 13(4) or were excluded by Article 13(5). It concluded that the training provided was ancillary and subsidiary to the sale of software, which did not fall under Article 13(3)(a). Therefore, the receipts from training fees were not 'Fees for technical services' but 'Business receipts' under Article 7 of the DTAA.4. Estimation of income from business at 18% on Consultancy receipts and Miscellaneous income:The AO estimated the income from Consultancy receipts of Rs. 25,000/- and Miscellaneous income of Rs. 61,584/- at an 18% profit rate, without rejecting the assessee's books of account. The Tribunal held that unless the books of account were rejected after pointing out deficiencies, the declared profit could not be disturbed. Consequently, the Tribunal overturned the AO's estimation and ordered the inclusion of these amounts in the income as originally declared by the assessee.Conclusion:The Tribunal allowed the appeal, treating the software sales, Annual Maintenance Contracts, and training fees as 'Business receipts' under Article 7 of the DTAA. The estimation of income from Consultancy receipts and Miscellaneous income was also overturned, and the declared amounts were accepted. The judgment emphasized the distinction between the sale of copyrighted products and the use of copyrights, aligning the tax treatment with the provisions of the DTAA over the domestic law where beneficial to the assessee.