2022 (6) TMI 510 - AT - Income Tax

Supreme Court: Payments for limited software use not 'royalty' under tax laws

The Supreme Court ruled in favor of the assessee in a tax dispute regarding the classification of payments received on the sale of software to Indian ... Income accrued in India - royalty receipt - payments received by the Appellant on sale of software to Indian resellers/distributors - chargeable to tax under Section 9(1)(vi) of the Income-tax Act, 1961 and under Article 12 of the India- USA DTAA') - whether payments in different cross-border software transactions, i.e. payments made by end users or distributors (resident as well as non-resident) of software and payments made in respect of software embedded in the hardware, qualify as 'royalty' under the Income Tax Act (ITA) as well as various Double Taxation Avoidance Agreements (DTAAs)? - HELD THAT:- The issue is squarely covered in favour of the assessee by the decision of the Hon'ble Supreme Court in the case of Engineering Analysis Centre of Excellence Pvt. Ltd. [2021 (3) TMI 138 - SUPREME COURT] answered in terms of following the Hon'ble Supreme Court referred to the terms of the agreements entered into with various parties for the use of software and noted that distributors were granted a non-exclusive and non-transferable license to resell the software. Furthermore, end users were granted a limited right to use the software without any right to sub-license, transfer, reverse engineer, modify or reproduce the software, in this light, the Hon'ble Supreme Court examined various provisions of the Copyright Act, 1957 in force in India (ICA) and held that a limited right to use the software, make copies of the software for the purpose for which it was granted and without grant of rights of the copyright owner (such as reproduction, issuing copies, commercial exploitation), does not qualify as grant of a copyright under the ICA. As noted that the definition of royalty under the ITA, prior to amendment in 2012, as well as the DTAAs under consideration [which are similar/identical to the OECD Model Convention (MC)], necessarily requires grant of a copyright in software to the licensee for the payment to qualify as royalty. Since the payment made by end users and distributors did not involve payment for grant of any right specified under the ICA, payments made by the distributors and end users do not qualify as royalty under the DTAA, as well as the pre-amended provisions of the ITA. Such payments qualify as business income not taxable in India under the DTAA. The machinery provisions of withholding under the ITA in respect of payment made to non-resident (NR) taxpayers is triggered only in respect of payments chargeable to tax in India after considering the provisions of the ITA as well as the DTAA. In case where a payment is not chargeable to tax in India under the DTAA, then no withholding is required on such payments. In doing so, the Hon'ble Supreme Court distinguished its earlier decision in the case of PILCOM on the grounds that in that ruling, the SC was concerned with payments to NR sportspersons and the withholding provisions in respect of such persons were governed by different provisions of the ITA which were not linked to the chargeability of income. Accordingly, respectfully following the precedent from the Hon'ble Supreme Court as above, we set-aside the orders of the authorities below and decide the issue in favour of the assessee. Issues:1. Taxability of payments received on sale of software to Indian resellers/distributors as 'royalty' under Section 9(1)(vi) of the Income-tax Act and the India-USA Double Taxation Avoidance Agreement (DTAA).2. Classification of consideration received for maintenance and technical support services as fees for technical/included services under the DTAA.3. Discrepancy in the amount brought to tax by the Assessing Officer.4. Initiation of penalty proceedings under section 271(1)(c) of the Act for furnishing inaccurate particulars of income.Analysis:1. The appeal concerned the taxability of payments received by the assessee on the sale of software to Indian resellers/distributors as 'royalty.' The Assessing Officer and the Dispute Resolution Panel held the payments to be 'royalty' chargeable to tax. However, the Hon'ble Supreme Court's decision in the case of Engineering Analysis Centre of Excellence Pvt. Ltd. clarified that payments for the limited right to use software without grant of copyright owner rights do not qualify as 'royalty' under the ITA and DTAAs. The Court emphasized that payments for software transactions are considered business income not taxable in India under the DTAA.2. The classification of consideration received for maintenance and technical support services as fees for technical/included services under the DTAA was also disputed. The authorities classified these services as fees for technical services. However, following the Supreme Court's decision and considering the absence of copyright grant, the Tribunal set aside the orders of the authorities and decided in favor of the assessee, indicating that such payments do not qualify as 'royalty.'3. A discrepancy arose regarding the amount brought to tax by the Assessing Officer, with the assessee contesting the full amount taxed. The Tribunal found the Hon'ble Supreme Court's decision applicable to the case, setting aside the orders of the lower authorities and ruling in favor of the assessee, implying that the entire amount taxed as 'royalty' was not justified.4. Lastly, the initiation of penalty proceedings under section 271(1)(c) of the Act for furnishing inaccurate particulars of income was challenged. However, the Tribunal's decision in favor of the assessee on the taxability issue rendered the penalty proceedings unnecessary, as the payments were determined not to constitute 'royalty.' The appeal of the assessee was allowed based on the above analysis, following the Supreme Court's decision and setting aside the orders of the lower authorities.