2017 (2) TMI 916 - AT - Income Tax

Payments to ZES deemed business income, not royalty, due to lack of Permanent Establishment.

DDIT (IT) -3 (1), Mumbai Versus Gujrat Pipavav Port Ltd.

DDIT (IT) -3 (1), Mumbai Versus Gujrat Pipavav Port Ltd. - TMI Issues Involved:1. Determination of whether the license fees payable to ZES constitutes 'royalty' under Explanation 2 to Section 9(1)(vi) of the Income Tax Act and Article 12 of the DTAA between India and the USA.2. Determination of whether the payment to ZES should be classified as business income, given that ZES has no Permanent Establishment (PE) in India.3. Interpretation of the nature of payments for standardized proprietary software as either for the use of copyright or copyrighted article.Issue-Wise Detailed Analysis:1. Determination of whether the license fees payable to ZES constitutes 'royalty' under Explanation 2 to Section 9(1)(vi) of the Income Tax Act and Article 12 of the DTAA between India and the USA:The assessee contended that the license fees payable to ZES, a tax resident of the USA without a PE in India, does not fall within the ambit of royalty as per the provisions of Explanation 2 to Section 9(1)(vi) of the Income Tax Act and Article 12 of the DTAA between India and the USA. The Assessing Officer (AO) held that the license fees payable to ZES could be considered as royalty, relying on the decision of the Karnataka High Court in the case of Samsung Electronics Company Limited. The AO directed the assessee to deduct tax at the rate of 10% plus applicable surcharge.2. Determination of whether the payment to ZES should be classified as business income, given that ZES has no Permanent Establishment (PE) in India:The Commissioner of Income-tax (Appeals) [CIT(A)] held that the payment under consideration is in the nature of business income of ZES. Since ZES has no PE in India, the consideration paid is not taxable in India. The CIT(A) allowed the appeal of the assessee, holding that the AO was not justified in directing the assessee to deduct TDS at 10% on the payment to ZES treating it as royalty.3. Interpretation of the nature of payments for standardized proprietary software as either for the use of copyright or copyrighted article:The assessee argued that ZES provided a license to use its software on a perpetual, non-exclusive, non-assignable, terminable, and non-sublicensable basis. The software is a 'shrink-wrapped' or 'off-the-shelf' copyrighted packaged software readily available and not customized for the assessee. The assessee has no right to use, copy, display, or print the software or documentation in whole or in part. The Tribunal observed that the AO did not bring any material on record to prove otherwise. The Tribunal referred to the decision in M/s Capgemini Business Services India Ltd. vs. ACIT, which held that the sale of a CD ROM or diskette with software constitutes the sale of a product and not a license. The Tribunal concluded that the consideration received on the supply of software without transfer of any copyright is business income and not royalty.The Tribunal further discussed the provisions of the Copyright Act, 1957, and concluded that the fair use of the purchased software for the purpose it was supplied, including making backup copies for protection against loss or damage, does not constitute an infringement of copyright. The Tribunal held that the consideration paid by the assessee for the purchase of the copyrighted work embedded in the CD-ROM cannot be said to be royalty under the DTAA and would be taxable as business income of the recipient.Conclusion:The Tribunal dismissed the appeal filed by the Revenue, holding that the grounds of appeal raised by the Revenue are covered against them by the decisions of the coordinate bench in similar cases. The Tribunal found no merit in the grounds of appeal raised by the Revenue and upheld the order of the CIT(A). The order was pronounced in the open court on February 10, 2017.