Royalty and withholding tax: payment for foreign-generated candidate reports was not royalty, and disallowance was deleted.

Depreciation on CISCO IP Phones was remitted for fresh adjudication on the functional-use test: items functionally dependent on computers may qualify at the computer rate, while independently existing equipment may fall under plant and machinery. The Tribunal did not finally decide the rate. Payments for candidate reports to a UK service provider were held not to be royalty because the assessee received only the deliverable and had no right to use, access, modify, duplicate, or exploit the underlying software, source code, equipment, or copyright. As the sum was not chargeable to tax in India, no withholding obligation arose and the disallowance under section 40(a)(i) was deleted.

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Issues: (i) Whether depreciation on CISCO IP Phones was to be allowed at the computer rate of 60% or the plant and machinery rate of 15%. (ii) Whether payments made to Symbiotics Ltd., UK for candidate reports were royalty and, if not, whether disallowance under section 40(a)(i) for non-deduction of tax at source was sustainable.

Issue (i): Whether depreciation on CISCO IP Phones was to be allowed at the computer rate of 60% or the plant and machinery rate of 15%.

Analysis: The issue had already been considered in the assessee's own case for the preceding year, where the matter was remitted to the Assessing Officer to examine the functional dependence of the equipment on the computer system. Following that approach, the Tribunal held that items functionally dependent on computers are to be treated as computers, while items with independent existence may fall under plant and machinery. The Assessing Officer was therefore directed to re-adjudicate the claim in accordance with that functional test.

Conclusion: The issue was remitted to the Assessing Officer for fresh adjudication and was not finally decided in favour of either side.

Issue (ii): Whether payments made to Symbiotics Ltd., UK for candidate reports were royalty and, if not, whether disallowance under section 40(a)(i) for non-deduction of tax at source was sustainable.

Analysis: The agreement showed that the assessee received only candidate reports generated by Symbiotics from its UK infrastructure and software, while the software, source code, and underlying systems remained wholly with Symbiotics. The assessee had no right to access, control, modify, duplicate, or commercially exploit the software or any copyright in it. On that basis, the payment was held to be for a copyrighted article and not for the use of, or right to use, any copyright, equipment, or process within Article 13 of the India-UK DTAA. Since the sum was not chargeable to tax in India in the hands of the non-resident, no withholding obligation arose under section 195.

Conclusion: The payment was not royalty and the disallowance under section 40(a)(i) was deleted, in favour of the assessee.

Final Conclusion: The appeal was allowed on the royalty and withholding-tax issue, while the depreciation issue was sent back for reconsideration on the functional-use test.

Ratio Decidendi: A payment for a deliverable generated abroad through the payee's own software and infrastructure does not become royalty unless the payer is granted a right to use or exploit the underlying copyright, software, or equipment; where the remittance is not chargeable to tax in India, no withholding obligation arises under section 195.

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