2017 (1) TMI 1338 - HC - Income Tax

Assessee wins in software payment case, not royalty.

The Commissioner Of Income Tax, International Taxation-2 Versus ZTE Corporation

The High Court ruled in favor of the assessee, holding that payments for software were classified as business profits, not royalty, under Article 12(3) of ... Taxability of amount received - PE in India - DTAA - whether payments made by the assessee’s customers to it constituted royalty, in respect of software supplied? - Held that:- The supplies made (of the software) enabled the use of the hardware sold. It was not disputed that without the software, hardware use was not possible. The mere fact that separate invoicing was done for purchase and other transactions did not imply that it was royalty payment. In such cases, the nomenclature (of license or some other fee) is indeterminate of the true nature. Nor is the circumstance that updates of the software are routinely given to the assessee’s customers. These facts do not detract from the nature of the transaction, which was supply of software, in the nature of articles or goods. This court is also not persuaded with the submission that the payments, if not royalty, amounted to payments for the use of machinery or equipment. Such a submission was never advanced before any of the lower tax authorities; moreover, even in Ericson (2011 (12) TMI 91 - Delhi High Court ), a similar provision existed in the DTAA between India and Sweden. Interest payments and Section 234B is concerned, the court is of the opinion that the issue is covered by GE Packaging (2015 (1) TMI 1168 - DELHI HIGH COURT ). This question of law too is answered against the revenue, and in favour of the assessee. Issues Involved:1. Interpretation of Article 12(3) of the Indo-China Double Taxation Avoidance Agreement (DTAA) in light of Explanations 5 & 6 to Section 9(1)(vi) of the Income Tax Act, 1961.2. Correctness of the order regarding the interpretation of Section 234B of the Income Tax Act, 1961.Issue-wise Detailed Analysis:1. Interpretation of Article 12(3) of the Indo-China DTAA:The primary issue was whether the payments for software supplied by the assessee to Indian customers constituted 'royalty' under Article 12(3) of the Indo-China DTAA and Section 9(1)(vi) of the Income Tax Act, 1961. The assessee, a tax resident of China, supplied telecom equipment and mobile handsets to Indian telecom operators and customers. It argued that it had no Permanent Establishment (PE) in India and hence, its revenues were not taxable as business profits. The Assessing Officer (AO) disagreed, concluding that the assessee had various forms of PE in India and attributed profits accordingly.The AO treated payments for embedded software as royalty, citing that the software was essential for the hardware's operation and that the software was licensed, not sold. The assessee contended that the software was an integral part of the hardware, had no independent value, and was not a transfer of copyright but of a copyrighted article.The appellate commissioner (CIT(A)) and the Income Tax Appellate Tribunal (ITAT) sided with the assessee, holding that the software payments were business profits, not royalty. The ITAT emphasized that the software was necessary for the hardware's functionality and could not be used independently, thus following the precedent set by the Delhi High Court in cases like Ericsson and Alcatel Lucent.The High Court upheld the ITAT's decision, stating that the software's supply was akin to the supply of goods, and the payments did not qualify as royalty. The court noted that the software was integral to the hardware, and its supply did not involve transferring copyright rights as defined under Section 14 of the Indian Copyright Act, 1957. The court also rejected the revenue's alternative argument that the payments were for the right to use equipment, as this was not raised before lower authorities.2. Interpretation of Section 234B of the Income Tax Act, 1961:The second issue was whether the interest levied under Section 234B was correct. The CIT(A) had directed the AO to delete the interest, and the ITAT upheld this decision. The High Court referred to its earlier ruling in GE Packaged Power Inc., which held that non-residents are not liable to pay advance tax under Section 234B if the tax is deductible at source. Thus, the court ruled in favor of the assessee, stating that the interest under Section 234B was not applicable.Conclusion:The High Court dismissed the revenue's appeals, affirming that the payments for software were not royalty but business profits and that the interest under Section 234B was not applicable. The court's decision was based on established precedents and a detailed interpretation of relevant legal provisions and agreements.