2008 (12) TMI 245 - AT - Income Tax

Tribunal Rules Software Payments Are Business Profits, Not Royalties, Under DTAA; Aligns with Motorola, Samsung Cases.

The Tribunal set aside the CIT(A)'s order, determining that the payments received by the assessee for the sale of software, annual maintenance charges, ... Royalty - business profits - transfer of a copyrighted article versus transfer of copyright - Explanation 2 to s. 9(1)(vi) - Article 13 of the DTAA (royalties) - Article 7 of the DTAA (business profits) - permanent establishment - binding precedents of the Tribunal (Motorola Inc. and Samsung Electronics)Royalty - business profits - transfer of a copyrighted article versus transfer of copyright - Explanation 2 to s. 9(1)(vi) - Article 13 of the DTAA (royalties) - Article 7 of the DTAA (business profits) - Nature of receipts for software licence, maintenance and training - whether taxable as royalty or as business profits - HELD THAT: - The Tribunal held that the payments received under the licence agreements were not 'royalty' under Expln. 2 to s. 9(1)(vi) or art. 13 of the DTAA but constituted business profits chargeable under art. 7. The decision rests on the terms of the licence: non-exclusive, non-transferable, restricted rights; prohibition on commercial exploitation, sublicensing and unrestricted copying; retention of copyrights and IPR by the vendor; limited backup copies remaining property of the vendor; and obligation to return software on termination. These factual features show the transferees acquired a copyrighted article (a copy) and not the copyright or any of the exclusive rights that define a copyright. The Tribunal applied and followed binding coordinate decisions of the Tribunal (Special Bench in Motorola Inc. and the Samsung Electronics bench) which analysed identical licence clauses and concluded such transactions are transfers of copyrighted articles and not transfers of copyright giving rise to royalties. The Revised OECD Commentary and reports of international committees were treated as persuasive but not determinative; where domestic law, treaty text and binding domestic tribunal precedent govern characterization, OECD commentary cannot override those sources. The Supreme Court's sales-tax characterization of software as 'goods' was inapposite to income-tax/treaty characterisation and could not be imported to alter the meaning of 'royalty' under the Income-tax Act or DTAA. Consequently, the software licence receipts and incidental maintenance and training receipts follow the same character as business income. [Paras 30, 40, 41, 46, 47]Payments for software licence, annual maintenance and training were not 'royalty' but business profits; matter remitted to AO to reframe assessment accordingly.Final Conclusion: Appeal allowed: Tribunal held software licence, maintenance and training receipts to be business profits (not royalty) and set aside CIT(A)'s order; assessment restored to AO for recomputation in accordance with this conclusion. Issues Involved:1. Classification of receipts from the sale of software, annual maintenance charges, and training fees as royalty.2. Applicability of the Supreme Court decision in Tata Consultancy Services vs. State of Andhra Pradesh.3. Interpretation of the term 'royalty' under Section 9(1)(vi) of the IT Act and Article 13 of the DTAA.4. Applicability of Section 44D and Section 115A of the IT Act.5. Distinction between transfer of copyright and transfer of copyrighted article.6. Relevance of OECD Commentary and High Powered Committee Report.7. Binding nature of Tribunal decisions in similar cases.Issue-wise Detailed Analysis:1. Classification of Receipts as Royalty:The assessee challenged the classification of receipts from the sale of software, annual maintenance charges, and training fees as royalty. The AO treated these receipts as royalty under Article 13 of the DTAA and Section 44D read with Section 115A of the IT Act. The AO's reasoning was based on the definition of royalty in Section 9(1)(vi) and the nature of the software and services provided. The CIT(A) upheld this classification, noting that the software was customized and licensed to Indian customers, and the payments were for the use of intellectual property.2. Applicability of Tata Consultancy Services vs. State of Andhra Pradesh:The assessee relied on the Supreme Court decision in Tata Consultancy Services vs. State of Andhra Pradesh, where software was considered 'goods' for sales tax purposes. The AO and CIT(A) distinguished this case, stating that the decision was in the context of the Sales-tax Act and not applicable to income tax. The CIT(A) emphasized that the treatment of software under different statutes could vary, and the sales tax definition could not be imported into the IT Act.3. Interpretation of 'Royalty' under Section 9(1)(vi) and Article 13 of the DTAA:The AO and CIT(A) interpreted the term 'royalty' to include payments for the use of or the right to use software. The CIT(A) referred to the Indian Copyright Act and concluded that the payments were for the use of copyrighted software, thus qualifying as royalty. The CIT(A) also relied on the High Powered Committee's report, which characterized software payments as royalty, contrary to the OECD Commentary.4. Applicability of Section 44D and Section 115A:The AO applied Section 44D, which prohibits the allowance of expenses for earning royalty income, and taxed the receipts at 20% under Section 115A. The CIT(A) upheld this application, stating that the provisions were clear and applicable to the assessment year in question.5. Distinction between Transfer of Copyright and Transfer of Copyrighted Article:The assessee argued that the payments were for a copyrighted article, not a copyright, and thus not royalty. The CIT(A) rejected this argument, stating that the license agreements granted rights to use the software, which constituted a transfer of rights in respect of copyright. The CIT(A) distinguished the case from the Tribunal's decision in Motorola Inc., noting that the software in the present case was customized and not an off-the-shelf product.6. Relevance of OECD Commentary and High Powered Committee Report:The CIT(A) did not accept the OECD Commentary's conservative interpretation of 'use' and relied on the High Powered Committee's report, which supported the classification of software payments as royalty. The CIT(A) noted that India's position on software payments differed from the OECD's and that the report provided a basis for treating the payments as royalty.7. Binding Nature of Tribunal Decisions:The Tribunal analyzed the decisions in Motorola Inc. and Samsung Electronics Co. Ltd., where payments for software were not considered royalty. The Tribunal found that the facts of the present case were similar and that the CIT(A) incorrectly distinguished these decisions. The Tribunal held that the payments were for copyrighted articles, not copyrights, and thus not royalty.Conclusion:The Tribunal set aside the CIT(A)'s order, holding that the payments received by the assessee were not royalty but business profits under Article 7 of the DTAA. The Tribunal directed the AO to reframe the assessment accordingly and did not adjudicate the remaining grounds as they were consequential. The appeal was treated as allowed.