2025 (10) TMI 760 - AT - Income Tax

Cloud software sales to distributor not Fee for Technical Services under Art.12(3)(b) DTAA and s.9(1)(vii) IT Act

ITAT (DELHI - AT) held that receipts from sale of security software to a distributor do not constitute Fee for Technical Services under Art. 12(3)(b) of ... PE in India - Income deemed to accrue or arise in India - receipts arising from the sale of software product to the Distributor, who, in turn resold to different end users - whether taxable in India as Fee for Technical Services (FTS) under Article 12(3)(b) of the India-Ireland DTAA, and additionally taxable u/s 9(1)(vii) of the Income-tax Act, 1961 - amount was taxed 10% as per Article-12 of the India-Ireland DTAA and u/s 9(1)(vii) HELD THAT:- We are of the considered opinion that to fall within the scope of FTS, it is incumbent upon the Revenue to establish an indelible link between the payment received by the assessee and the same constituting consideration for providing technical services which the Revenue has not done. Revenue has not shown that based on the agreement or the invoices, read with details of product portfolio, that software has not been sold and that technical services were rendered in the nature of FTS. Revenue's proposition arose from the fact that the offering by way cyber security protection, the software provided a comprehensive service experience or solution with the help of technology embedded in the security software and therefore there is a rendering of technical service and hence FTS. Such a proposition, we hold are not valid. Assessee supplied a software product which facilitated digital security in a user's technology infrastructure and which was delivered on the cloud. The payment received by assessee from Distributor was for acquiring security software simpliciter for onward selling to end customer. We, therefore, hold that the assessee company is not liable to be taxed on its income earned from sale of software to the Indian Distributor as FTS. We allow the grounds raised by the assessee. ISSUES PRESENTED AND CONSIDERED 1. Whether receipts from sale of software delivered via SaaS/cloud and issued under non-exclusive, non-transferable licenses to Indian distributors and end-users constitute 'Fees for Technical Services' (FTS) under Article 12(3)(b) of the India-Ireland DTAA and Section 9(1)(vii) of the Income-tax Act. 2. Whether human intervention or 'make-available'/interactive provision is a necessary element to characterise a transaction as FTS under Section 9(1)(vii) and the DTAA. 3. Whether the presence of intellectual property, algorithms and technical inputs in a software product transforms a sale of software into FTS (or royalty), and whether the revenue can recharacterise earlier accepted software sales as FTS in light of higher-court decisions. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Whether SaaS/cloud software sales under non-exclusive, non-transferable licenses constitute FTS Legal framework: Article 12(3)(b) of the DTAA and Section 9(1)(vii) of the Income-tax Act tax payments as consideration for technical services. Explanation 2 to Section 9(1) and the concept of 'make available' / service rendering are relevant to distinguish royalty from service income. Precedent treatment: The Tribunal considered and applied rulings of the Delhi High Court and Supreme Court requiring human interface for FTS (as explained in Bharti Cellular and upheld by the Supreme Court), decisions holding that software sales under licence can be sale of goods and not FTS (decisions of ITAT and High Courts cited), and the Supreme Court decision that limited the scope for taxing software as royalty but did not obliterate the human-interface requirement for FTS. Interpretation and reasoning: The Tribunal analysed the distribution agreements and End-User License Agreements showing non-exclusive, non-transferable resale licences with no right to sub-licence, reverse-engineer, modify or transfer copyright. Delivery modes (SaaS login/password or software keys for on-premise installations) and the fact that distributors resell to end users and obtain a margin were found to show a sale of software simpliciter. The Tribunal treated any ancillary installation/maintenance support as incidental technical assistance, not the core consideration. The AO's attempt to characterise receipts as FTS by focusing on embedded algorithms/unique IP was rejected because such characterisation conflicted with the contractual rights transferred and the factual matrix demonstrating a supply of a product via cloud/SaaS rather than a service involving human rendering. Ratio vs. Obiter: Ratio - where a non-exclusive, non-transferable licence is granted to resell software delivered via SaaS and no rights to modify/sub-licence/copyright transfer are conferred, and where consideration is the price of the software passed by distributor to end user, such receipts are sale of software and not FTS. Obiter - observations on factual contrasts with other authorities where facts differed (e.g., bespoke services) beyond the present factual matrix. Conclusion: Receipts from the distributor for SaaS/on-premise software subscriptions were not taxable as FTS; they constituted sale/supply of software products and are outside the scope of Article 12(3)(b) and Section 9(1)(vii) in the present facts. Issue 2 - Necessity of human intervention / 'make-available' for characterising FTS Legal framework: The Tribunal relied on the interpretation of Section 9(1)(vii) and Explanation 2 which, as interpreted by higher courts, requires services to be rendered by human agency (human interface) to qualify as FTS; the 'make-available' test under certain DTAA contexts was considered relevant to distinguish royalty from service. Precedent treatment: The Tribunal followed the Delhi High Court decision (affirmed by the Supreme Court) that emphasises human intervention as essential to FTS, and noted that later Supreme Court observations acknowledging technological developments do not displace the human-interface requirement established in earlier rulings. Interpretation and reasoning: The Tribunal found no human interface in the automated delivery and use of software (SaaS or software keys). The software operated without human intermediation at the time of delivery or use; installation/maintenance assistance was ancillary. Consequently, the absence of human rendering meant that the payments could not be characterised as FTS under Section 9(1)(vii) or the DTAA. Ratio vs. Obiter: Ratio - human intervention is a necessary ingredient for FTS under the statutory and treaty provisions as applied to these facts. Obiter - remarks that certain modern technological contexts flagged by higher courts do not automatically negate the human-interface criterion absent contrary factual findings. Conclusion: The Tribunal held that, on the facts, the absence of human intervention precludes treatment of the receipts as FTS. Issue 3 - Role of intellectual property/algorithms and prior departmental treatment in characterisation; (re)characterisation in light of higher-court rulings Legal framework: Distinction between royalty (consideration for use of IP/process) and FTS (consideration for services rendered) under domestic law and the DTAA; principles governing recharacterisation and estoppel/consistency in tax assessments. Precedent treatment: The Tribunal examined the Supreme Court decision that restricted treating software receipts as royalty but did not abrogate the human-interface requirement for FTS. It considered ITAT and High Court authorities holding that the presence of technical inputs or unique IP does not automatically convert a product sale into a service chargeable as FTS. Interpretation and reasoning: The Tribunal observed that the AO's own note that customers paid for unique IP would, if anything, point to royalty rather than FTS; the AO's recharacterisation to FTS after earlier acceptance of sales as product sales lacked persuasive basis. The Tribunal rejected the AO's reliance on higher-court rulings to re-cast the nature of the receipts absent contractual or factual features showing rendering of human-delivered technical services or a 'make-available' transfer of know-how. Ratio vs. Obiter: Ratio - the existence of IP/algorithms or technology embedded in a product does not, by itself, transform a sale into FTS; correct characterisation depends on contractual rights transferred and factual mode of delivery. Obiter - comments on the revenue's commercial recharacterisation attempts where prior years were treated as product sales. Conclusion: The revenue failed to establish an indelible link between payments and provision of technical services; pre-existing departmental acceptance of software sales as product sales and the contract terms supported the assessee's characterisation; recharacterisation to FTS was not justified. Overall Conclusion of the Tribunal The Tribunal held that, on the particular facts (non-exclusive, non-transferable resale licences, SaaS/on-premise delivery, absence of rights to sub-licence/modify/copyright transfer, and lack of human interface), receipts from distributors for software subscriptions are sale of software and not Fees for Technical Services under Article 12(3)(b) of the DTAA or Section 9(1)(vii) of the Act; the appeal was allowed.