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 ... Sale of software – Business profit -royalties and fee for technical services u/s 9(1)(vi) – permanent establishment – held that - Passing on a right to use and facilitating the use of a product for which the owner has a copyright is not the same thing as transferring or assigning rights in relation to the copyright. The enjoyment of some or all the rights which the copyright owner has, is necessary to trigger the royalty definition. Viewed from this angle, a non-exclusive and non-transferable licence enabling the use of a copyrighted product cannot be construed as an authority to enjoy any or all of the enumerated rights ingrained in a copyright. Where the purpose of the licence or the transaction is only to establish access to the copyrighted product for internal business purpose, it would not be legally correct to state that the copyright itself has been transferred to any extent - The customer information is necessitated in order to ensure that the product is not misused and that the service needs of the customers are attended to diligently in case of neglect on the part of VAR. As regards the perusal of the financial statements, the applicant clarifies that it is meant to ensure that the VAR is not selling competing products in violation of the restrictions imposed. The restraints placed on VAR not to market or license competing products subject to certain exceptions is again not a factor that points to the existence of principal and agent relationship. – applicant has no PE in India - It is ruled that the payment received by the applicant from VARs (“third party re-sellers”) on account of supplies of software products to the end-customers (from whom the licence fee is collected and appropriated by VAR) does not result in income in the nature of royalty to the applicant and moreover payments received by the applicant cannot be taxed as business profits in India in the absence of permanent establishment as envisaged by Article 7 of the India-Japan Tax Treaty. 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).