2010 (1) TMI 47 - AAR - Income Tax

Software payments to non-resident VAR supplier not royalty u/s 9(1)(vi), no PE, untaxable under India-Japan DTAA

AAR held that payments received by the non-resident applicant from Indian value-added resellers (VARs) for supply of software to end-customers do not ... Royalties as consideration for the use of, or the right to use, copyright - distinction between use of a copyrighted article and transfer of rights in copyright - non-exclusive, non-transferable licence - business profits under Article 7 (DTAA) - dependent agent permanent establishment - agency versus distributorship (independent agent)Royalties as consideration for the use of, or the right to use, copyright - distinction between use of a copyrighted article and transfer of rights in copyright - non-exclusive, non-transferable licence - Whether payments received by the applicant from third party resellers (VARs) for licensed software constitute 'royalty' under Article 12 of the India Japan DTAA and the domestic definition of royalty - HELD THAT: - The Authority held that the payments are not royalties. The revenue characterization would require that rights in relation to the copyright or the right to use the copyright (as set out in Section 14 of the Copyright Act) be transferred or conferred so as to permit commercial exploitation akin to the owner's exclusive rights. The contracts (GVA and EULA) granted only non exclusive, non transferable licences permitting internal use and access (including incidental copying to enable operation), while expressly reserving all intellectual property rights with the applicant. Incidental acts necessary to operate software (copying to hard disk, backups) are qualitatively different from transfer of copyright rights and are excluded by Section 52(aa) from constituting infringement; consequently such incidental rights do not amount to transfer or licence of the copyright itself. The OECD Commentary approach (distinguishing rights enabling mere operation from rights that permit exploitation such as reproduction/distribution/modification for commercial use) was adopted as persuasive. Past rulings and tribunal decisions (FactSet, Motorola, Samsung) were followed to conclude that a limited licence to use software for internal purposes results in commercial income (Article 7) rather than royalty under Article 12 or Section 9(1)(vi). The Revenue's alternative contentions that the VAR had been conferred rights to sell or that the end user was using any 'process' in the sense of transferable know how were rejected as unsupported by the agreements and the nature of the transaction. [Paras 17, 18, 21, 22]Payments received by the applicant from VARs for supply of the licensed software do not constitute 'royalty' under Article 12 of the India Japan DTAA or the corresponding domestic provision.Business profits under Article 7 (DTAA) - dependent agent permanent establishment - agency versus distributorship (independent agent) - Whether the applicant has a permanent establishment in India through VARs (dependent agents) such that its business profits from software supplies are taxable in India under Article 7 of the India Japan DTAA - HELD THAT: - The Authority found no agency permanent establishment. Article 5(7) requires that a person acting in the State be a dependent agent who habitually concludes contracts, maintains stock for delivery, or secures orders wholly or almost wholly for the enterprise. The factual and contractual matrix (GVA and EULA) established non exclusive distributorships: VARs could deal with other products, did not have authority to conclude or bind the applicant (applicant retained acceptance discretion), bore commercial risk (payment to applicant irrespective of end user recovery), and were free to fix end user prices. Reporting and restraint clauses were held to be consistent with distributorship oversight and product protection, not indicia of dependency converting the relationship into an agent of the applicant for PE purposes. Consequently, the conditions in Article 5(7)(a)-(c) were not satisfied and no PE arose. [Paras 24, 25]The applicant does not have a permanent establishment in India through the VARs; accordingly its business profits are not taxable in India under Article 7 of the India Japan DTAA.Final Conclusion: The Authority ruled that amounts received by the non resident software supplier from independent third party resellers for supplying licensed software are not royalties under Article 12 (nor under the corresponding domestic provision) and, since the applicant has no permanent establishment in India through the VARs, such receipts are not taxable in India as business profits under Article 7 of the India Japan DTAA. Issues: (i) Whether payments received by the non-resident licensor from independent third-party resellers for supply of software constitute 'royalties' under Article 12 of the India-Japan DTAA and Section 9(1)(vi) of the Income-tax Act; (ii) Whether such payments can be taxed as business profits in India under Article 7 of the India-Japan DTAA by reason of a permanent establishment through the resellers (i.e., whether resellers are dependent agents creating an agency PE under Article 5(7)).Issue (i): Whether the payments are royalties for use of or right to use copyright.Analysis: The court analysed the definition of 'royalties' in Article 12 of the Treaty and the statutory meaning of copyright under Section 14 of the Copyright Act, applying Section 52(aa) which excludes copying incidental to lawful use. It examined the contractual terms (non-exclusive, non-transferable licences; retention of all IP rights by the licensor; restrictions on resale, development, sublicensing), the delivery method (electronic download), and authorities including FactSet, Motorola, and OECD Commentary. The court distinguished transfer of rights in copyright from mere provision of access/use of software for internal purposes, holding that rights necessary only to operate the software (incidental copying/storage) do not amount to transfer of copyright or confer the right to use copyright within the royalty definition.Conclusion: The payments are not royalties; they are not consideration for transfer of rights in or for the use of copyright and therefore do not fall within Article 12 or Section 9(1)(vi).Issue (ii): Whether the resellers (VARs) are dependent agents creating a permanent establishment under Article 5(7), making the licensor taxable in India on business profits.Analysis: The court examined Article 5(7)/(8) and the distributor agreements' terms relied on by Revenue (reporting obligations, discounts, restrictions). It found that VARs acted as non-exclusive distributors dealing with other products, did not have authority to conclude contracts on behalf of the licensor, did not habitually secure orders wholly or almost wholly for the licensor, and bore commercial risk. The restrictions and reporting obligations were held consistent with distributorship and not sufficient to establish legal/economic dependency or authority to conclude contracts that would create an agency PE.Conclusion: The resellers are independent distributors and do not create an agency permanent establishment under Article 5(7); therefore the licensor has no PE in India and its business profits are not taxable in India under Article 7.Final Conclusion: On the facts and contracts before the Authority, payments received by the non-resident licensor from independent resellers for supplying non-customized PLM software by way of non-exclusive, non-transferable licences are not royalties under Article 12 and, in the absence of an agency PE through the resellers, are not taxable as business profits in India under Article 7 of the India-Japan DTAA.Ratio Decidendi: A non-exclusive, non-transferable licence that merely enables an end-user to operate and access software for internal use, while the copyright owner retains all proprietary rights and restrictions on exploitation, does not amount to transfer of rights in copyright or confer 'use of or right to use' copyright for the purposes of Article 12 and analogous domestic provisions; incidental acts necessary to operate software are disregarded in characterising the payment, and independent distributors who do not habitually conclude contracts or act under the licensor's control do not create an agency PE under Article 5(7).