2025 (9) TMI 304 - HC - Income Tax

Post-sale software services don't transfer rights; software sale income not royalty under Income Tax Act Section 9(1)(vi) and DTAA

Pr. Commissioner Of Income Tax (International Taxation), Bangalore., Deputy Commissioner Of Income Tax Circle-1 (1), Bangalore. Versus M/s. Micro Focus Marigalante Ltd.,

Pr. Commissioner Of Income Tax (International Taxation), Bangalore., Deputy Commissioner Of Income Tax Circle-1 (1), Bangalore. Versus M/s. Micro Focus ... ISSUES PRESENTED AND CONSIDERED 1. Whether the Tribunal erred in applying the Supreme Court's ruling in ENGINEERING ANALYSIS to hold that income from sale of software is not taxable as royalty where the software was customized rather than shrink-wrapped and where ancillary post-sale services were rendered. 2. Whether the Tribunal perversely disregarded the Assessing Officer's finding that the India-UK DTAA's treatment of 'royalty' must be interpreted in harmony with Section 9 of the Income Tax Act. 3. Whether installation, support and maintenance services provided after sale of software constitute Fees for Included Services (FIS)/technical services or otherwise lead to characterization of the receipts as royalty when such services are supplied along with the software and made available to an Indian subsidiary and final customers. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Applicability of ENGINEERING ANALYSIS to software sales (customized vs. shrink-wrapped; post-sale services) Legal framework: Characterization of payments for software under domestic tax law and the India-UK DTAA; concept of 'royalty' as derived from copyright/transfer of rights vs payment for mere use/operation; distinction between sale of a copyrighted article and license/transfer of copyright. Precedent treatment: The Tribunal applied the Supreme Court's decision in ENGINEERING ANALYSIS which held that certain receipts from sale of software did not amount to royalty where there was no transfer of copyright or proprietary right in the copyrighted article. Interpretation and reasoning: The Court examined the assessment record and agreements to determine whether post-sale services effected any transfer of rights in the copyrighted article. The Court found the post-sale services (e.g., periodic upgrades, installation support, maintenance) did not result in transfer of copyright or any proprietary right. The marital factual distinction urged by Revenue - that the software was customized rather than shrink-wrapped - did not, on the material before the authorities, change the legal character of the transaction because no right in the copyright was transferred. Ratio vs. Obiter: The Court treated the ENGINEERING ANALYSIS ruling as directly persuasive and applicable on the material facts; this application as to absence of transfer of copyright is ratio where identical legal question (characterization as royalty) arises. Any discussion of customization vs. shrink-wrapped delineation is treated as factual distinction and thus obiter only to the extent not essential to the holding. Conclusion: The Court held that the Tribunal rightly applied ENGINEERING ANALYSIS; because post-sale services did not transfer copyright, receipts from sale of software are not taxable as royalty. Issue 2 - Interpretation of DTAA in harmony with Section 9 of the Act Legal framework: Principle that treaty provisions and domestic law interact; contention that DTAA interpretation of 'royalty' must accord with domestic charging section (Section 9) when determining taxability of non-resident receipts. Precedent treatment: The Assessing Officer relied on a view that DTAA treatment should be harmonized with Section 9 findings; the Tribunal applied Supreme Court precedent to characterize the receipts independently of such harmonization argument. Interpretation and reasoning: The Court reviewed the Assessing Officer and Dispute Resolution Panel's reliance on Section 9 harmony but concluded that the essential question is whether the transaction amounted to transfer of a right in a copyrighted article under the treaty definition of 'royalty.' Since the factual finding was absence of transfer, the treaty definition did not support treating the receipts as royalty notwithstanding Section 9 considerations urged by the Revenue. Ratio vs. Obiter: The holding that treaty characterization governed by the absence of transfer is ratio as applied to these facts. Any broader pronouncement on the primacy or interaction rules between DTAA and Section 9 was not necessary to dispose of the appeal and thus remains obiter. Conclusion: The Tribunal's approach to characterize receipts under the DTAA without treating Section 9 as determinative was not perverse; no legal error was found in declining to treat the receipts as royalty on the basis of Section 9 harmony alone. Issue 3 - Whether installation, support and maintenance services constitute FIS/technical services making receipts taxable as royalty Legal framework: Distinction between payments for technical services/Fees for Included Services (FIS) and payments constituting royalty; requirement that services must effect transfer of proprietary rights or be of a nature contemplated by the treaty/Act to be taxed as royalty or FIS. Precedent treatment: The Tribunal, following earlier order and Supreme Court authority, examined the scope of post-sale services and whether they changed the character of the transaction to royalty or FIS. Revenue argued that ancillary services, although uncharged, were integral and indispensable, thereby converting the sale into a taxable royalty/technical service. Interpretation and reasoning: The Court analyzed the agreements and scope of work and found the after-sale services did not amount to transfer of copyright or confer proprietary entitlement to use/alter the copyrighted article beyond ordinary support/maintenance. The services were ancillary and did not independently constitute FIS giving rise to royalty characterization. The fact that services were provided to an Indian subsidiary and final customers did not alter this conclusion in the absence of a contractual transfer of rights. Ratio vs. Obiter: The conclusion that installation/support/maintenance, as performed, did not constitute FIS or royalty under the applicable definitions is ratio on the facts. Any general rule that all ancillary services will never amount to FIS is obiter and not decided. Conclusion: Installation, support and maintenance services provided post-sale did not convert the receipts into royalty or FIS; the Tribunal's finding to that effect was upheld. Overall Conclusion on Substantial Questions of Law The Court found no substantial question of law arising from the Tribunal's order and dismissed the appeal, concluding that the Tribunal correctly applied governing precedent and that the facts did not demonstrate transfer of any right in the copyrighted article or that ancillary services rendered converted the receipts into taxable royalty or FIS under the Income Tax Act or the India-UK DTAA.