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 constitute "royalty" u/s 9(1)(vi) or under the India-Japan DTAA. The non-exclusive, non-transferable licences merely permit use of the copyrighted software for internal business purposes and do not transfer or assign any copyright rights. Contractual restraints on VARs, including non-compete and reporting obligations, do not create a principal-agent relationship. AAR further held that the applicant has no permanent establishment (PE) in India under Article 5 of the DTAA. Consequently, the payments are not taxable in India as business profits under Article 7.

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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).

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