2021 (3) TMI 138 - SC - Income Tax

Indian residents' payments to non-resident software suppliers through distribution agreements don't constitute royalty under tax treaties

ENGINEERING ANALYSIS CENTRE OF EXCELLENCE PRIVATE LIMITED Versus THE COMMISSIONER OF INCOME TAX & ANR.

ENGINEERING ANALYSIS CENTRE OF EXCELLENCE PRIVATE LIMITED Versus THE COMMISSIONER OF INCOME TAX & ANR. - [2021] 432 ITR 471 (SC), 2022 (3) SCC 321, 2021 ... Issues Involved:1. Definition and scope of 'royalty' under the Income Tax Act and DTAA.2. Applicability of the doctrine of first sale/principle of exhaustion.3. Interpretation of treaties and OECD Commentary.4. Applicability of retrospective amendments to Section 9(1)(vi) of the Income Tax Act.5. Obligation of TDS under Section 195 of the Income Tax Act.Detailed Analysis:1. Definition and Scope of 'Royalty' under the Income Tax Act and DTAA:The Supreme Court examined whether payments for the use of computer software amounted to 'royalty' under Section 9(1)(vi) of the Income Tax Act and the corresponding provisions in various DTAAs. It was held that the term 'royalties' in the DTAAs refers to payments for the use of or the right to use any copyright. The Court noted that the definition of 'royalty' under the Income Tax Act is broader than that under the DTAAs. However, the Court emphasized that the DTAAs' provisions, being more beneficial to the assessee, would prevail over the Income Tax Act due to Section 90(2) of the Act. The Court concluded that payments for the resale/use of computer software through EULAs/distribution agreements do not constitute 'royalty' as they do not involve the transfer of any rights in the copyright.2. Applicability of the Doctrine of First Sale/Principle of Exhaustion:The Court discussed the principle of exhaustion, which implies that once a copyrighted item is sold, the copyright owner's control over the distribution of that item is exhausted. The Court noted that Section 14(b)(ii) of the Copyright Act, post the 1999 Amendment, does not prevent the resale of legally acquired software. The doctrine of first sale was held applicable, meaning that the resale of software by distributors does not constitute the transfer of copyright and thus does not attract royalty payments.3. Interpretation of Treaties and OECD Commentary:The Court referred to the OECD Commentary on Article 12 of the OECD Model Tax Convention, which defines 'royalties' and provides guidance on interpreting tax treaties. The Court emphasized that treaties should be interpreted liberally to implement the true intentions of the parties. The OECD Commentary was deemed persuasive in interpreting the term 'royalties' in the DTAAs. The Court also noted that India's positions on the OECD Commentary do not alter the DTAA provisions unless bilaterally amended.4. Applicability of Retrospective Amendments to Section 9(1)(vi) of the Income Tax Act:The Court examined the retrospective amendments to Section 9(1)(vi) introduced by the Finance Act 2012, which expanded the definition of 'royalty.' The Court held that these amendments could not apply to assessment years before 2012, as the law does not demand the impossible. The Court applied the maxims 'lex non cogit ad impossibilia' (the law does not compel the doing of impossibilities) and 'impotentia excusat legem' (when there is a disability that makes it impossible to obey the law, the alleged disobedience of the law is excused).5. Obligation of TDS under Section 195 of the Income Tax Act:The Court concluded that there is no obligation on the persons mentioned in Section 195 of the Income Tax Act to deduct tax at source for payments made to non-resident computer software manufacturers/suppliers. The Court held that such payments do not constitute 'royalty' and do not give rise to income taxable in India. Consequently, the persons referred to in Section 195 were not liable to deduct any TDS.Conclusion:The Supreme Court allowed the appeals from the High Court of Karnataka, set aside the AAR ruling in Citrix Systems, and dismissed the appeals from the High Court of Delhi. The Court held that payments for the resale/use of computer software do not constitute 'royalty' and are not subject to TDS under Section 195 of the Income Tax Act.