Software licence payments and offshore supply receipts are not royalty, and PE attribution needs an India-based operational nexus.

Consideration for software supplied as an embedded part of telecom equipment was treated as business income rather than royalty because the licence granted use restrictions but did not transfer independent copyright rights. Offshore supply receipts were not attributed to the Indian permanent establishment because the contracts and payments were offshore, and only income arising from operations carried out in India can be allocated to a PE on a proper financial basis. Interest under section 234B was also held not chargeable to a non-resident where tax was subject to withholding at source.

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Issues: (i) Whether receipts from supply/licensing of software embedded in telecom equipment were taxable as royalty under domestic law and the India-USA DTAA; (ii) whether receipts from supply of telecom equipment and software, though treated as business profits, could be attributed in whole or in part to the Indian permanent establishment; (iii) whether interest under section 234B could be charged from a non-resident where tax was required to be withheld at source.

Issue (i): Whether receipts from supply/licensing of software embedded in telecom equipment were taxable as royalty under domestic law and the India-USA DTAA.

Analysis: The software was supplied as part of an integrated hardware-software package and was embedded in the equipment for operating the telecom network. The licence terms imposed substantial restrictions on use, copying, transfer, modification and disclosure, and did not transfer any independent copyright interest. The governing principle applied was that consideration for use of copyrighted software, as distinct from transfer of copyright rights, is not royalty. The conclusion was reinforced by the Supreme Court ruling on software transactions, especially the category where software is affixed to hardware and sold as an integral unit.

Conclusion: The receipts from software supply/licensing were not taxable as royalty.

Issue (ii): Whether receipts from supply of telecom equipment and software, though treated as business profits, could be attributed in whole or in part to the Indian permanent establishment.

Analysis: The contracts and supplies were between the foreign head office and Indian customers, with direct offshore supply and direct payment to the foreign entity. The Indian branch had only a limited role, mainly marketing support and development of a software patch, and the inter se transactions with the head office were accepted at arm's length. Only income arising from operations carried out in India can be attributed to a permanent establishment, and the entire offshore supply value cannot be shifted to the PE without a financial basis showing the portion linked to Indian operations.

Conclusion: No part of the offshore supply receipts could be attributed to the Indian permanent establishment.

Issue (iii): Whether interest under section 234B could be charged from a non-resident where tax was required to be withheld at source.

Analysis: The assessee was a non-resident, and the payer was under a withholding obligation. In such a situation, advance tax liability does not arise in the same manner as for a resident assessee, and levy of interest under section 234B was not warranted.

Conclusion: Interest under section 234B was not chargeable.

Final Conclusion: The taxability of software receipts as royalty was rejected, attribution of the offshore supply income to the Indian permanent establishment was also rejected, and the levy of interest under section 234B was set aside, resulting in partial relief to the assessee and rejection of the Revenue's challenge.

Ratio Decidendi: Consideration for a software licence does not amount to royalty where no copyright rights are transferred, and offshore supply profits cannot be attributed to an Indian permanent establishment unless the income is shown to arise from operations carried out in India.

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