Software distributor receipts not taxable as royalty under section 9(1)(vi) and India-Singapore DTAA Article 12(3)

The ITAT Delhi held that software sale receipts by a distributor were not taxable as royalty under section 9(1)(vi) or Article 12(3) of the India-Singapore DTAA. The AO incorrectly interpreted the distribution agreement, failing to recognize that the assessee was merely a distributor without copyright ownership, which remained with the original software owner. The tribunal found the case squarely covered by the SC decision in Engineering Analysis Centre of Excellence Pvt. Ltd., distinguishing it from royalty payments. The assessee's appeal was allowed.

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Issues Involved:
1. Legality of the order passed by the Assessing Officer (AO).
2. Classification of receipts from software sales as 'royalty' under Section 9(1)(vi) of the Income Tax Act and Article 12(3) of the India-Singapore DTAA.
3. Applicability of the Supreme Court judgment in Engineering Analysis Centre of Excellence Pvt. Ltd. v. CIT.
4. Interpretation of clauses in agreements between the assessee and its Indian Associated Enterprises (AEs).
5. Misinterpretation of the nature of software as shrink-wrapped software.
6. Authority to reproduce and modify software and access to source code.
7. Penalty proceedings under Section 270A of the Act.

Summary:

1. Legality of AO's Order:
The assessee challenged the AO's order dated 30.01.2023, asserting it was contrary to the law, facts, and the India-Singapore DTAA, and should be set aside.

2. Classification of Receipts as 'Royalty':
The AO assessed the income of the assessee at Rs. 23,21,52,964, treating it as 'royalty' under Section 9(1)(vi) of the Act and Article 12(3) of the DTAA. The assessee contended that the AO erred by not adhering to the Supreme Court's principles in Engineering Analysis Centre of Excellence Pvt. Ltd. v. CIT.

3. Applicability of Supreme Court Judgment:
The assessee argued that it was a mere distributor of software and did not transfer any copyright, thus the SC judgment in Engineering Analysis Centre of Excellence Pvt. Ltd. was applicable. The AO, however, differentiated the case based on the contractual terms and nature of the software.

4. Interpretation of Agreement Clauses:
The AO interpreted various clauses of the agreement to conclude that the Indian AE had rights to reproduce and modify the software, which the assessee disputed. The assessee clarified that the clauses were misinterpreted and that it retained ownership and control over the software.

5. Nature of Software:
The AO concluded that the software was not shrink-wrapped based on its features and clauses in the agreement. The assessee rebutted this, stating that the software's features do not determine its classification as shrink-wrapped.

6. Authority to Reproduce and Modify Software:
The AO claimed that the Indian AE had rights to reproduce and modify the software, including access to the source code. The assessee countered that the right to reproduce was limited to making backup copies and did not include access to the source code.

7. Penalty Proceedings:
The AO initiated penalty proceedings under Section 270A of the Act, which the assessee contested.

DRP's Role:
The Dispute Resolution Panel (DRP) remanded the matter to the AO for verification, which the assessee argued was contrary to Section 144C of the Act. The AO, after verification, reiterated the draft assessment order in the final assessment.

ITAT's Findings:
The ITAT found that the AO misinterpreted the agreement clauses and that the assessee's case was indeed covered by the Supreme Court's judgment in Engineering Analysis Centre of Excellence Pvt. Ltd. Consequently, the ITAT allowed the appeal of the assessee.

Conclusion:
The appeal of the assessee was allowed, and the AO's order was set aside based on the Supreme Court's precedent and proper interpretation of the agreements.

Order Pronounced:
The order was pronounced in the Open Court on 02/01/2024.

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