2025 (2) TMI 767 - HC - Income Tax

Payments to non-resident companies don't constitute royalty under DTAA provisions, software sales give usage rights not copyright transfers

The Commissioner Of Income Tax, International Taxation Bengaluru, The Assistant Commissioner Of Income Tax, International Taxation, Circle-2 (2), Bengaluru Versus M/s. Urban Ladder Home Décor Solutions Pvt. Ltd.,

Karnataka HC held that payments made to three non-resident companies do not constitute royalty under DTAA provisions, agreeing with ITAT's conclusion. The ... TDS u/s 195 - liability to deduct TDS on payments made to non-residents - ITAT come to conclusion that the payments made to three non-resident Companies do not fall within the meaning of ‘royalty’ as defined in DTAA - HELD THAT:- We agree with the aforesaid conclusion drawn by the ITAT. The conclusion drawn by the CIT(A) in favour of the Revenue was primarily by relying upon the judgment in the case of Samsung Electronics Co. Ltd. [2011 (10) TMI 195 - KARNATAKA HIGH COURT] and also by holding that the payments received by assessee from two affiliates by granting user right to software is royalty and has been brought to tax in India. The said judgment has been over-ruled. In this regard, we may also refer to the judgment of the Supreme Court in the case of Engineering Analysis [2021 (3) TMI 138 - SUPREME COURT] Similarly, a reference is also made to the judgments of Infrasoft Ltd. [2013 (11) TMI 1382 - DELHI HIGH COURT] and ZTE Corporation [2017 (1) TMI 1338 - DELHI HIGH COURT] to hold High Court is not correct in referring to Section 9 (1) (vi) of the Income Tax Act after considering it in the manner that it has and then applying it to interpret the provisions under the Convention between the Government of the Republic of India and the Government of Ireland for the Avoidance of Double Taxation and for the Prevention of Fiscal Evasion with respect to Taxes on Income And Capital Gains - when a copyrighted article is sold, the end-user gets the right to use the intellectual property rights embodied in the copyright which would therefore amount to transfer of an exclusive right of the copyright owner in the work, is also wholly incorrect. Decided against revenue. 1. ISSUES PRESENTED and CONSIDEREDThe appeals presented to the Karnataka High Court centered on the following substantial questions of law:i) Whether the Tribunal's order is perverse in holding that the assessee is not liable to deduct TDS on payments made to non-residents, relying on the Supreme Court decision in Engineering Analysis Centre of Excellence Pvt. Ltd. vs. CIT, despite differences in facts and lawRs.ii) Whether the Tribunal correctly held that the assessee had no obligation to deduct TDS on payments made to Facebook Ireland, Rocket Science Group, LLC, US, and Amazon Web Services, Inc., by ignoring the nature of usage of technology, model, or process covered by Explanation 2 (iii) to Section 9 (1) (vi) of the Income Tax ActRs.iii) Whether the Tribunal was right in law in allowing the appeal of the assessee by holding that there was no obligation to deduct TDS on payments made to non-resident companies without analyzing the facts and materials with provisions of respective Double Taxation Avoidance Agreements (DTAA)Rs.2. ISSUE-WISE DETAILED ANALYSISThe primary issue revolves around whether the payments made by the assessee to non-resident companies constitute 'royalty' under Indian law and the relevant DTAAs, necessitating the deduction of tax at source.- Relevant legal framework and precedents:The legal framework involves Section 195 of the Income Tax Act, which mandates tax deduction at source on payments to non-residents if such payments are chargeable to tax in India. The definition of 'royalty' under Section 9 (1) (vi) and the corresponding provisions in the DTAAs with the US and Ireland are crucial. The Supreme Court's decision in Engineering Analysis Centre of Excellence Pvt. Ltd. vs. CIT, which clarified the non-taxability of certain software payments as royalties, serves as a significant precedent.- Court's interpretation and reasoning:The Tribunal, relying heavily on the Supreme Court's decision in Engineering Analysis, concluded that the payments made by the assessee to Facebook, Rocket Science Group, and Amazon Web Services do not constitute 'royalty' under the DTAAs. The Court observed that the payments were for the use of platforms and services, not for the transfer of any rights in intellectual property.- Key evidence and findings:The agreements between the assessee and the non-resident companies were scrutinized. The Tribunal noted that the payments were for advertising services on Facebook, email marketing services from Mailchimp, and cloud computing services from Amazon. These services did not involve the transfer of any rights to use intellectual property, which is a prerequisite for classifying payments as 'royalty.'- Application of law to facts:The Tribunal applied the definition of 'royalty' under the DTAAs, which requires the transfer of rights in intellectual property. Since the agreements did not grant the assessee any such rights, the payments were not considered royalties. The Tribunal also noted that the non-resident companies did not have a permanent establishment in India, further negating the requirement for TDS under Section 195.- Treatment of competing arguments:The Revenue argued that the payments should be classified as royalties due to the use of technology and platforms. However, the Tribunal dismissed this argument, emphasizing the lack of transfer of intellectual property rights. The Tribunal also noted that the Supreme Court's decision in Engineering Analysis overruled prior judgments, including the one relied upon by the CIT(A).- Conclusions:The Tribunal concluded that the payments made by the assessee to the non-resident companies were not royalties under the DTAAs, and thus, no TDS was required. The Tribunal set aside the orders of the CIT(A) and directed the deletion of demands raised under Section 201 (1) and interest under Section 201 (1A).3. SIGNIFICANT HOLDINGS- Preserve verbatim quotes of crucial legal reasoning:'In view of the foregoing discussions, we are of the view that the payments made by the assessee to the three non-resident companies referred above cannot be considered as 'royalty payments' and hence they do not give rise to any income chargeable in India under the Indian Income Tax Act in all the three years under consideration.'- Core principles established:The Court reaffirmed the principle that payments for services that do not involve the transfer of intellectual property rights do not qualify as 'royalty' under the DTAAs. The Court also emphasized the precedence of the Supreme Court's decision in Engineering Analysis in determining the taxability of such payments.- Final determinations on each issue:The Court determined that the Tribunal's order was not perverse and correctly applied the law. It held that the payments were not royalties, the assessee was not obligated to deduct TDS, and the Tribunal's reliance on the Supreme Court's decision was appropriate. The appeals were dismissed, with liberty granted to the Revenue to seek review if the Supreme Court's pending review petition in Engineering Analysis is decided in their favor.