Software licence payments not royalty where no copyright rights pass and no permanent establishment exists under the distribution model.

A non-exclusive, non-transferable licence to use software for internal purposes, without transfer of any exclusive copyright rights, was treated as a supply of a copyrighted product rather than consideration for use of copyright, process, or equipment. The amount received was therefore not royalty under the Income-tax Act or the India-Japan DTAA. The distributor arrangement also did not create a permanent establishment because the resellers acted on a principal-to-principal basis, lacked authority to conclude contracts, did not maintain stock on the applicant's behalf, and were not shown to habitually secure orders for the applicant. In the absence of a permanent establishment, the receipts were not taxable in India as business profits.

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Issues: (i) Whether consideration received from Indian resellers for supply of software products was taxable as royalty under the Income-tax Act and the India-Japan DTAA. (ii) Whether the reseller arrangement created a permanent establishment in India so that the receipts could be taxed as business profits.

Issue (i): Whether consideration received from Indian resellers for supply of software products was taxable as royalty under the Income-tax Act and the India-Japan DTAA.

Analysis: The relevant enquiry was whether any rights in copyright were transferred, or whether the arrangement merely enabled end-users to use a copyrighted article for internal purposes. The licence granted to the resellers and end-users was non-exclusive and non-transferable, the copyright in the software remained with the applicant, and the users were not permitted to commercially exploit the software or exercise any of the exclusive rights attached to copyright. Temporary copying or downloading necessary to make the software functional for internal use did not amount to use of copyright. The payment was therefore for the supply of a copyrighted product and not for the use of, or right to use, copyright, process, or equipment.

Conclusion: The amount received was not royalty and was not taxable on that basis.

Issue (ii): Whether the reseller arrangement created a permanent establishment in India so that the receipts could be taxed as business profits.

Analysis: The distributors operated on a non-exclusive basis and acted on a principal-to-principal footing. They had no authority to conclude contracts on behalf of the applicant, did not maintain stock from which deliveries were made on its behalf, and were not shown to habitually secure orders wholly or almost wholly for the applicant. The contractual controls and reporting obligations were consistent with a distributorship arrangement and did not establish legal or economic dependence sufficient to constitute an agency permanent establishment.

Conclusion: No permanent establishment was created in India.

Final Conclusion: The receipts from software supplies were held outside the royalty net and, in the absence of a permanent establishment, were not taxable in India as business profits.

Ratio Decidendi: A non-exclusive, non-transferable licence to use software for internal purposes, without transfer of any exclusive rights in copyright or authority for the distributor to conclude contracts or act as a dependent agent, does not give rise to royalty income or a permanent establishment.

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