2025 (10) TMI 772 - HC - Income Tax

Payments for sale of copyrighted software to non-residents not 'royalty' taxable in India under Section 195 and DTAA

HC held that payments for sale of copyrighted software to non-resident entities do not constitute 'royalty' taxable in India under Section 195 or the ... TDS u/s 195 - payment made to non-resident entities in respect of purchase of software - income taxable in India OR not? - Tribunal's order is perverse in nature in holding that the payments made to non-resident entities were not in the nature of royalty as defined in Explanation 2 to Section 9(1)(vii) of the Act and the Double Taxation Avoidance Agreement as well? - HELD THAT:- The facts that emerge from the record are that the respondent-assessee has sold copyrighted software and received consideration therefor. The assessee is a foreign company, and the Double Taxation Avoidance Agreement is attracted in the case. The Revenue contends that the income from the sale of software is taxable in India as royalty, being income from the sale of, or licence to use, copyright. The case of the respondent–assessee, on the other hand, is that what has been sold is a copyrighted article and not the copyright itself, and hence, the income is not taxable in India as royalty. Tribunal, upon examining the End User Licence Agreement and after considering the judgment in Engineering Analysis, held that the income is not chargeable to tax in India as royalty. Revenue contends that the case of the assessee requires examination in the context of the law laid down by the Hon’ble Supreme Court in Engineering Analysis[2021 (3) TMI 138 - SUPREME COURT] - The contention of the Revenue is unacceptable for yet another reason. The Hon’ble Supreme Court, in the case of IBM India (payer), in a common judgment along with Engineering Analysis, has held that the payment is not in the nature of royalty. If, in the case of the payer, it has been held that the payment is not royalty, the consequences in the hands of the payee remain unaltered. For this reason also, the income from the sale of software in the case of the respondent–assessee cannot be held to be taxable in India as royalty. Questions raised for consideration before this Court are no longer res integra and stand covered by the judgment of the Hon’ble Supreme Court in Engineering Analysis. ISSUES PRESENTED AND CONSIDERED 1. Whether payments made to non-resident entities for purchase/licence of software constitute 'royalty' taxable in India such that the payers were liable to deduct tax at source under Section 195 of the Income-tax Act? 2. Whether payments for software fall within the definition of 'royalty' as explained in Explanation 2 to Section 9(1)(vii) of the Act and under the applicable Double Taxation Avoidance Agreement? 3. Whether the sale of a software licence includes transfer of a 'right or interest in copyright' so as to constitute royalty under Section 9(1)(vi) of the Act and attract income deemed to accrue or arise in India? 4. Whether development and delivery of advanced cloud-based computer software come within copyright protections envisaged by Section 14(a)/14(b) of the Copyright Act so as to alter the tax characterisation of payments? 5. Whether conditions for applying Explanation 2(v) to Section 9(1)(vi) (treating payments to non-residents as royalty for use of or right to use copyright) were satisfied in the present facts, and whether pending review petitions affecting precedents warranted deferral of adjudication. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Characterisation of payments as 'royalty' and TDS liability under Section 195 Legal framework: Taxability depends on whether the consideration for software is 'royalty' under the Income-tax Act; payer's obligation to withhold tax under Section 195 arises if payments constitute income chargeable to tax in India. Precedent Treatment: The Tribunal applied its earlier orders deleting royalty additions; higher authoritative guidance from the Supreme Court in the referred 'Engineering Analysis' line of decisions bears on the royalty test; a common judgment in respect of payments by the payer held such payments not to be royalty. Interpretation and reasoning: The Tribunal examined the End User Licence Agreement and found that the transaction represented sale of a copyrighted article rather than transfer of copyright. The Assessing Officer had specifically found that the assessee had not parted with its copyright such that an intermediate sale could be characterised as transfer of copyright. Given those factual findings and the Supreme Court's principles on what constitutes royalty, mere sale of a copyrighted article does not automatically render the income royalty taxable in India. Ratio vs. Obiter: Ratio - where factual findings establish no transfer of copyright or grant of right to use copyright, payments for software articles are not royalty for TDS purposes. Obiter - general observations on TDS mechanism beyond the facts. Conclusions: The Court held that the payments were not royalty and therefore no TDS under Section 195 was attracted on the facts of the case; the Revenue's challenge on this ground was dismissed. Issue 2 - Applicability of Explanation 2 to Section 9(1)(vii) and DTAA definitions Legal framework: Explanation 2 to Section 9(1)(vii) and comparable DTAA provisions define 'royalty' to include payments for use of, or right to use, copyright and similar rights; interpretation requires analysis of contractual rights actually transferred. Precedent Treatment: The Tribunal's approach followed earlier internally consistent decisions; the Supreme Court's pronouncements in the Engineering Analysis line clarified the scope of 'royalty' by focusing on substance of rights transferred rather than mere form. Interpretation and reasoning: The Court emphasised examination of the End User Licence Agreement to determine whether the payer obtained a right to use the copyright or whether a copyrighted article was merely sold. On the facts, contractual and factual findings did not indicate transfer of the copyright or grant of rights that fall within Explanation 2; therefore the DTAA/Explanation 2 test for royalty was not satisfied. Ratio vs. Obiter: Ratio - Explanation 2/DTAA apply only if the substance of the transaction effects a right to use copyright; absent such substance, payments do not fall within those provisions. Obiter - suggestions on further scrutiny of licence terms in other factual matrices. Conclusions: Payments did not satisfy Explanation 2/DTAA definitions of royalty on the recorded facts; the Tribunal's deletion was sustained. Issue 3 - Whether sale of software licence transfers right/interest in copyright (Section 9(1)(vi)) Legal framework: Section 9(1)(vi) deems income accruing or arising in India where a right or interest in copyright is transferred; the test is whether copyright (or rights therein) is actually transferred or only a copy/article is sold. Precedent Treatment: The Court applied the Supreme Court's guidance in Engineering Analysis and the judgment concerning the payer which concluded absence of royalty when the payer's payment did not carry requisite copyright rights. Interpretation and reasoning: The factual finding by the Assessing Officer that the assessee had not parted with its copyright was decisive. The Court held that the mere sale of a copyrighted article (copy) does not equate to transfer of the copyright itself. The substance-over-form inquiry leads to exclusion from Section 9(1)(vi) where rights in copyright are not alienated. Ratio vs. Obiter: Ratio - transfer of a copy does not ipso facto amount to transfer of copyright; Section 9(1)(vi) applies only when a right or interest in the copyright is actually transferred. Obiter - comments on factual importance of licence terms. Conclusions: The sale/licence in the present facts did not constitute transfer of a copyright right/interest, hence payments were not chargeable under Section 9(1)(vi). Issue 4 - Whether cloud-based/advanced software development alters copyright characterisation (Sections 14(a)/14(b) of Copyright Act) Legal framework: Copyright Act provisions identify literary works and rights; whether cloud-based delivery changes the nature of the right depends on contractual allocation of proprietary rights and the type of interest conveyed. Precedent Treatment: The Tribunal and Court relied on statutory interpretation and Supreme Court guidance rather than a presumption that cloud delivery automatically confers or withholds copyright rights. Interpretation and reasoning: The Court observed that development/delivery of advanced cloud-based software does not per se bring the transaction within copyright provisions that would convert consideration into royalty; the decisive factor remains whether copyright or rights in copyright are transferred under the agreement. Ratio vs. Obiter: Ratio - nature of software (cloud-based or otherwise) does not by itself determine tax character; contractual substance controls. Obiter - technological mode of delivery is relevant only insofar as it evidences the rights granted. Conclusions: Cloud-based software development/delivery does not automatically attract royalty treatment; here it did not change the non-royalty character of receipts. Issue 5 - Applicability of Explanation 2(v) to Section 9(1)(vi) and effect of pending review petitions on adjudication Legal framework: Explanation 2(v) applies to payments to non-residents by way of royalty for use of or right to use copyright; pending higher court review may influence legal stability but does not suspend binding Supreme Court pronouncements already rendered. Precedent Treatment: The Revenue relied on existence of review petitions in related jurisprudence; the Court noted that key review petitions had been rejected and that the Supreme Court had, in the payer's case, held payments not to be royalty. Interpretation and reasoning: The Court held that the present questions were no longer res integra in light of the Supreme Court's ruling; the pendency or maintenance of review petitions did not warrant deferment because the relevant review had been rejected or the Supreme Court had already decided the payer's issue adversely to the Revenue. Ratio vs. Obiter: Ratio - adjudication need not be deferred where controlling Supreme Court authority exists and related review petitions have been resolved unfavourably to the party seeking deferment. Obiter - procedural advisories on interplay of payer-side and payee-side adjudications. Conclusions: Conditions for applying Explanation 2(v) were not met on the facts; pending or disposed review petitions did not justify deferring or upsetting the Tribunal's order; appeals by Revenue were dismissed as devoid of merit.