Authority must consider chargeability aspects under Rule 28AA(2) when denying tax withholding certificate applications

Delhi HC held that denial of tax withholding certificate u/s 197 was improper where competent authority failed to consider chargeability aspects as statutorily mandated under Rule 28AA(2). Court ruled that supply/licensing of computer software to associated entities did not constitute royalty under Income Tax Act or India-US DTAA, as no copyright transfer occurred - only usage rights were granted. Authority erred in relying on draft assessment order which is inchoate and non-conclusive. Following Engineering Analysis Centre SC precedent, payments for software usage rights without proprietary interest transfer cannot be termed royalty. Writ petitions allowed, impugned orders quashed, nil withholding certificate application to be re-examined.

---

---

Issues Involved:
1. Failure to grant Nil Withholding Tax Certificate under Section 197 of the Income Tax Act, 1961.
2. Determination of whether reimbursements for software licenses constitute "royalty" under the Income Tax Act and the India-US Double Tax Avoidance Agreement (DTAA).
3. Examination of the procedural and substantive requirements under Section 197 and Rule 28AA of the Income Tax Rules, 1962.

Detailed Analysis:

1. Failure to Grant Nil Withholding Tax Certificate under Section 197 of the Income Tax Act, 1961:
The petitioner, a US-based company providing localization and translation solutions, sought Nil Withholding Tax Certificates for FY 2022-23 and FY 2023-24. The respondents issued certificates at a 9.99% withholding rate, based on a Draft Assessment Order dated 21 September 2022, which treated the petitioner's receipts as "royalty" under the Income Tax Act and the India-US DTAA. The petitioner challenged these orders and certificates, arguing that the reimbursements were not taxable.

2. Determination of Whether Reimbursements for Software Licenses Constitute "Royalty":
The petitioner contended that reimbursements for software licenses used internally by its group entities, including its Indian entity, did not constitute "royalty." The respondents relied on the Draft Assessment Order, which treated these receipts as "royalty" due to the centralized procurement and distribution of software licenses. The ITAT, in its order dated 20 September 2023, set aside the final Assessment Order, concluding that cost-to-cost reimbursements for software licenses cannot be treated as "royalty." The ITAT emphasized that the reimbursements did not include a markup and were purely for internal use.

3. Examination of Procedural and Substantive Requirements under Section 197 and Rule 28AA:
The court highlighted that Section 197 allows for a certificate for lower or no tax deduction if the income is not chargeable to tax. The authority must undertake a prima facie evaluation of taxability. Rule 28AA requires consideration of various factors, including tax payable on estimated income, assessed or returned income, existing liabilities, and advance tax payments. The respondents failed to properly consider these aspects and relied solely on the Draft Assessment Order, which was inchoate and not a final determination.

The court cited the Supreme Court's decision in Engineering Analysis Centre of Excellence Pvt. Ltd. v. CIT, which clarified that tax deductions under Section 195 are only required if the non-resident is liable to pay tax. The court also referred to its own decisions in Milestone Systems A/S vs. Deputy Commissioner of Income Tax and EY Global Services Ltd. vs. Assistant Commissioner of Income Tax, emphasizing the need for a thorough examination of taxability before denying a Nil Withholding Tax Certificate.

Conclusion:
The court quashed the impugned orders and certificates, directing the respondents to re-examine the petitioner's application for Nil Withholding Tax Certificates in accordance with the law and the observations made. The court stressed that the authority must consider all relevant aspects, including the Supreme Court's decision in Engineering Analysis and the procedural requirements under Section 197 and Rule 28AA.

---