Cloud service subscription payments ruled not royalty under India-Ireland tax treaty by Delhi High Court

Delhi HC held that subscription payments received for cloud services do not constitute royalty under India-Ireland DTAA. The court distinguished the SC decision in Engineering Analysis Centre, noting it was not restricted to embedded software. Following precedents in SFDC Ireland Ltd. and Salesforce.com, the court ruled that DTAA provisions do not include rights "for use" or "to use" computer software, unlike domestic tax law's Explanation 4. The ITAT's finding that CRM software licensing consideration was not royalty income under India-Singapore DTAA was upheld, favoring the assessee.

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The core legal questions considered by the Court are as follows:

A. Whether subscription payments received by the assessee towards Cloud Services constitute taxable Royalty income under Article 12(3) of the India-Ireland Double Taxation Avoidance Agreement (DTAA) and Section 9(1)(vi) of the Income-tax Act, 1961.

B. Whether the payments received from customers by the assessee, who grants access to online services rather than providing services as an end user, amount to royalty under clause (iv) of Explanation 2 to Section 9(1)(vi) of the Income-tax Act.

C. Whether the ITAT erred in relying on precedents such as the decisions in Commissioner of Income Tax (International Taxation)-2 v. MOL Corporation and Amazon Web Services, Inc. v. Assistant Commissioner of Income Tax, given the factual differences in the present case.

Issue-wise Detailed Analysis:

Issue A & B: Characterization of Subscription Payments as Royalty

Relevant Legal Framework and Precedents: The Court primarily examined the definition of "royalty" under Article 12(3) of the India-Ireland DTAA and Section 9(1)(vi) of the Income-tax Act, 1961, including Explanation 2 thereto. The Supreme Court's decision in Engineering Analysis Centre of Excellence (P) Ltd. v. CIT [(2022) 3 SCC 321] was pivotal, where it was held that payments for computer software supplied under End User License Agreements (EULAs) do not constitute royalty, but rather business income, unless there is a Permanent Establishment (PE) in India.

Other significant precedents considered include:

• SFDC Ireland Ltd. v. CIT and Commissioner Of Income Tax - International Taxation -3 v. Salesforce.com Singapore PTE LTD, where subscription fees for software were held not to constitute royalty.
• The Commissioner of Income Tax-International Taxation-3 vs. Relx Inc., which clarified that subscription fees do not transfer copyright rights but merely grant access to copyrighted material.
• Director of Income Tax Vs. Infrasoft, which distinguished between transfer of copyright rights and mere license to use copyrighted software, holding that the latter does not amount to royalty.

Court's Interpretation and Reasoning: The Court emphasized the distinction between transfer of copyright and mere grant of a license or right to use copyrighted material. It reiterated that subscription payments granting access to cloud-based software do not amount to transfer of copyright or confer rights that would constitute royalty under the DTAA or the Income-tax Act.

The Court extracted key observations from Engineering Analysis, noting 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." It further noted that the copyright remains with the owner at all times, and the licensee's rights are limited and non-transferable.

In Salesforce.com Singapore, the Court held that granting access to a database or cloud-based software does not amount to transfer of copyright. It underscored that the subscription agreement does not create any interest or right in the subscriber that would amount to "use of or right to use any copyright."

The Court also rejected the contention that subscription to cloud-based software services could be equated with "use" or "right to use" industrial, commercial, or scientific equipment under Article 12(4)(b), noting that this provision is specifically excluded from the scope of sub-article (3)(b) which deals with royalty.

Further, the argument based on Article 12(4)(a), which pertains to managerial, technical, or consultancy services ancillary to the enjoyment of rights, was also rejected, as it presupposes that the payment falls within the ambit of royalty as defined in Article 12(3).

Key Evidence and Findings: The Court relied on the nature of the subscription agreements, the absence of transfer of copyright, and the limited rights granted to the subscribers. The license agreements stipulated that copyright and intellectual property rights remained with the owner, and subscribers were restricted from exploiting the software commercially or transferring rights to third parties.

Application of Law to Facts: Applying the legal principles to the facts, the Court found that the subscription payments for cloud services do not amount to royalty income. The assessee's business model, which involves granting access to online services without transferring copyright or conferring any proprietary rights, does not fall within the scope of royalty under the DTAA or the Income-tax Act.

Treatment of Competing Arguments: The Court considered the Revenue's argument that the payments should be treated as royalty under Explanation 2(iv) to Section 9(1)(vi). However, it found this argument to be misconceived, given the established jurisprudence distinguishing between transfer of copyright and mere licensing or access. The reliance by the ITAT on precedents such as MOL Corporation and Amazon Web Services was upheld, with the Court rejecting the Revenue's contention that these cases were distinguishable on facts.

Issue C: Reliance on Precedents MOL Corporation and Amazon Web Services

Relevant Legal Framework and Precedents: The ITAT had relied on the decisions in MOL Corporation and Amazon Web Services to hold that subscription payments for cloud services are not royalty. The Revenue contended that these precedents were factually distinguishable.

Court's Interpretation and Reasoning: The Court examined the factual matrix of these cases and found no material distinction that would justify departing from the principles established therein. It affirmed the ITAT's reliance on these precedents, emphasizing consistency in the interpretation of royalty provisions in the context of software and cloud services.

Key Evidence and Findings: The Court noted that the factual circumstances in the present case were analogous to those in the cited precedents, particularly regarding the nature of rights granted under subscription agreements and the retention of copyright by the licensor.

Application of Law to Facts: The Court applied the legal principles from the precedents to the facts of the present case, concluding that the payments do not constitute royalty.

Treatment of Competing Arguments: The Revenue's contention on factual differentiation was found unpersuasive, and the Court upheld the ITAT's approach.

Significant Holdings:

"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."

"There is a clear distinction between royalty paid on transfer of copyright rights and consideration for transfer of copyrighted articles. Right to use a copyrighted article or product with the owner retaining his copyright, is not the same thing as transferring or assigning rights in relation to the copyright."

"Merely authorising or enabling a customer to have the benefit of data or instructions contained therein without any further right to deal with them independently does not, amount to transfer of rights in relation to copyright or conferment of the right of using the copyright."

"The right of subscription to a cloud-based software cannot possibly be said to be equivalent to the 'use' or 'right to use' any industrial, commercial or scientific equipment."

"The licence granted to the licencee permitting him to download the computer programme and storing it in the computer for his own use is only incidental to the facility extended to the licencee to make use of the copyrighted product for his internal business purpose."

"The licencees are not allowed to exploit the computer software commercially, they have acquired under licence agreement... The incorporeal right to the software i.e. copyright remains with the owner and the same was not transferred by the Assessee."

Final determinations:

• The subscription payments received by the assessee for cloud services do not constitute royalty income under Article 12(3) of the India-Ireland DTAA or Section 9(1)(vi) of the Income-tax Act.
• The payments do not amount to transfer or conferment of copyright or rights to use copyright as contemplated under the relevant statutory and treaty provisions.
• The ITAT's reliance on precedents including MOL Corporation and Amazon Web Services was appropriate and not erroneous.
• The appeal filed by the Revenue was dismissed.

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