2021 (3) TMI 138 - SC - Income Tax

Payments by residents to nonresident software suppliers under distribution agreements not royalties under s.9(1)(vi); no TDS under s.195

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

SC held that payments by Indian residents to non-resident software suppliers under distribution agreements/EULAs are not royalties for use of copyright ... TDS u/s 195 - Payments for the use of computer software amounts to 'royalty' - payment by the concerned persons resident in India to non-resident, foreign software suppliers - Applicability of the doctrine of first sale/principle of exhaustion - Applicability of retrospective amendments to Section 9(1)(vi) - Interpretation of Treaties and OECD Commentary - Whether constitutes as taxable income deemed to accrue in India u/s 9(1)(vi) - income deemed to accrue or arise in India - expression “royalty”. Whether assessee had purchased only a right to use the copyright i.e. the software and not the entire copyright itself, the payment cannot be treated as Royalty as per the DTAA? HELD THAT:- The subject matter of each of the DTAAs with which we are concerned is income tax payable in India and a foreign country. Importantly, as is now reflected by explanation 4 to section 90 of the Income Tax Act and under Article 3(2) of the DTAA, the definition of the term “royalties” shall have the meaning assigned to it by the DTAA, meaning thereby that the expression “royalty”, when occurring in section 9 of the Income Tax Act, has to be construed with reference to Article 12 of the DTAA. This position is also clarified by CBDT Circular No. 333 dated 02.04.1982. By virtue of Article 12(3) of the DTAA, royalties are payments of any kind received as consideration for “the use of, or the right to use, any copyright” of a literary work, which includes a computer programme or software. There can be no doubt as to the real nature of the transactions in the appeals before us. What is “licensed” by the foreign, non-resident supplier to the distributor and resold to the resident end-user, or directly supplied to the resident end-user, is in fact the sale of a physical object which contains an embedded computer programme, and is therefore, a sale of goods, which, as has been correctly pointed out by the learned counsel for the assessee. The logic behind Article 30 of the India-USA DTAA is for reasons connected with USA’s municipal taxation laws, and has nothing to do with Indian municipal law governing the liability of persons to deduct tax at source under section 195 of the Income Tax Act. This is reinforced by the fact that the OECD Commentary on Articles 30 and 31 acknowledges the fact that the “entry into force” provisions, unlike the rest of the provisions in the OECD Model Tax Convention on Income and on Capital, depend on the domestic laws of Contracting States. The “person” mentioned in section 195 of the Income Tax Act cannot be expected to do the impossible, namely, to apply the expanded definition of “royalty” inserted by explanation 4 to section 9(1)(vi) of the Income Tax Act, for the assessment years in question, at a time when such explanation was not actually and factually in the statute. We cannot accede to the argument made by the learned Additional Solicitor General that the distribution of copyrighted computer software, on the facts of the appeals before us, would constitute the grant of an interest in copyright under section 14(b)(ii) of the Copyright Act, thus necessitating the deduction of tax at source under section 195. Given the definition of royalties contained in Article 12 of the DTAAs it is clear that there is no obligation on the persons mentioned in section 195 of the Income Tax Act to deduct tax at source, as the distribution agreements/EULAs in the facts of these cases do not create any interest or right in such distributors/end-users, which would amount to the use of or right to use any copyright. The provisions contained in the Income Tax Act (section 9(1)(vi), along with explanations 2 and 4 thereof), which deal with royalty, not being more beneficial to the assessees, have no application in the facts of these cases. Doctrine of first sale/principle of exhaustion - the doctrine of first sale/principle of exhaustion is dependent, in the first place, upon legislation which either recognises or refuses to recognise the doctrine (thereby continuing to vest distribution rights in the copyright owner, even beyond the first sale of the copyrighted work). Thus, for example, prior to the amendment of section 14(d)(ii) in 2012, dealing with a cinematograph film, the distribution right to sell or give on hire or offer for sale or hire, any copy of the film, would continue to vest in the copyright owner, “regardless of whether such copy ha[d] been sold or given on hire on earlier occasion”, which manifested the legislative intent against the application of the doctrine of first sale/principle of exhaustion. Post 2012, however, the balance between the copyright owner’s distribution right and the right of the purchaser to further resale, was tilted in favour of the latter, the words “regardless of whether such copy has been sold or given on hire on earlier occasion” being deleted by the amendment. Likewise, when it comes to section 14(a)(ii) of the Copyright Act, the distribution right subsists with the owner of copyright to issue copies of the work to the public, to the extent such copies are not copies already in circulation, thereby manifesting a legislative intent to apply the doctrine of first sale/principle of exhaustion. The language of section 14(b)(ii) of the Copyright Act makes it clear that it is the exclusive right of the owner to sell or to give on commercial rental or offer for sale or for commercial rental “any copy of the computer programme”. Thus, a distributor who purchases computer software in material form and resells it to an end-user cannot be said to be within the scope of the aforesaid provision. The sale or commercial rental spoken of in section 14(b)(ii) of the Copyright Act is of “any copy of a computer programme”, making it clear that the section would only apply to the making of copies of the computer programme and then selling them, i.e., reproduction of the same for sale or commercial rental. The object of section 14(b)(ii) of the Copyright Act, in the context of a computer program, is to interdict reproduction of the said computer programme and consequent transfer of the reproduced computer programme to subsequent acquirers/end-users. By way of contrast, once a book is sold, on further resale of the same book, the purchaser loses the material book altogether, as such purchaser has, for consideration, parted with the book once and for all. It is significant to note that after India took such positions qua the OECD Commentary, no bilateral amendment was made by India and the other Contracting States to change the definition of royalties contained in any of the DTAAs that we are concerned with in these appeals, in accordance with its position. As a matter of fact, DTAAs that were amended subsequently, such as the Convention between the Republic of India and the Kingdom of Morocco for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes On Income, Notification : No. GSR 245(E), dated 15-3-2000 [“India-Morocco DTAA”], which was amended on 22.10.2019, Amended by Notification No. S.O. 3789(E) [No.84/2019/F.No.503/09/2009-FTD-II], Dated 22-10-2019 incorporated a definition of royalties, not very different from the definition contained in the OECD Model Tax Convention. We cannot accede to the argument made by the learned Additional Solicitor General that the distribution of copyrighted computer software, on the facts of the appeals before us, would constitute the grant of an interest in copyright under section 14(b)(ii) of the Copyright Act, thus necessitating the deduction of tax at source under section 195 of the Income Tax Act. Our answer to the question posed before us, is that the amounts paid by resident Indian end-users/distributors to non-resident computer software manufacturers/suppliers, as consideration for the resale/use of the computer software through EULAs/distribution agreements, is not the payment of royalty for the use of copyright in the computer software, and that the same does not give rise to any income taxable in India, as a result of which the persons referred to in section 195 of the Income Tax Act were not liable to deduct any TDS under section 195 of the Income Tax Act. The answer to this question will apply to all four categories of cases enumerated by us in paragraph 4 of this judgment. The appeals from the impugned judgments of the High Court of Karnataka are allowed, and the aforesaid judgments are set aside. The ruling of the AAR in Citrix Systems (AAR) [2012 (2) TMI 258 - AUTHORITY FOR ADVANCE RULINGS] is set aside. The appeals from the impugned judgments of the High Court of Delhi are dismissed. 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.