TaxTMI 
TaxTMI 
2016 (3) TMI 751
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....t'), is illegal and bad in law. 1.1. That the assessing officer erred on facts and in law in completing the assessment vide order dated 20.01.20 15 under section 143(3) rws 144C of the Act at an income of Rs. 17,39,01,465/- as against returned income of Rs. Nil. 1.2 That the DRP erred on facts and in law in the affirming the draft assessment order by passing a cryptic and non-speaking order, without judiciously considering the entire material and the submissions/ objections filed by the appellant. 2. That the assessing officer erred on facts and in law in holding the payments received by the appellant towards supply of software to the customers in India, as income in the nature of "royalty" within the meaning of Explanation 2(v) of section 9(1)(vi) of the Act and Article 12(3) of the Double Tax Avoidance Treaty between India and Israel (the Treaty') and liable to tax in India @ 10% of gross amount. 3. That the assessing officer erred on facts and in law in not appreciating that software formed integral part of the Galatea machines supplied by the appellant to customers in India without which such machines could not function and thereby th....
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.... arguments in three parts. 6. The first part of the argument of the Ld. Counsel for the assessee is that what has been sold by the assessee is not software as such, but 'Diamonds and Gems Scanning Machine' (hereinafter referred to as 'Machine' or 'Equipment' for the sake of brevity). Software was part of the machine which was required to make that machine operational. The customers who purchased the machine were not concerned with the software but with the functioning of the machine. Our attention has been drawn on various pages of the paper book showing that there was no separate sale of software. All the customers purchased machines along with requisite software to operate that machine. Pages-222, 223 and 224 of the paper book are the lists showing party-wise details and sales made by the assessee. Page-225 of the paper book is the certificate of Galatea Ltd. certifying that software supplied by it to the end user was integrated with various machine supplied by it and the software had no other independent use as such except to enable such machine to function. Our attention was also drawn on the copy of invoice to show that all the customers purchased machine and software both.....
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....ticle-12 of Indo-Israel treaty. It was submitted that it is well settled position of law that in terms of section 90(2) of the Act, provisions of the 'Act' or 'Treaty' whichever is more beneficial, shall apply to the assessee. It was submitted that since no amendment had been made in the definition of the term "Royalty" as envisaged in Article-12 of the treaty, therefore, the case of the assessee was to be examined by interpreting the Articles of the treaty. It was submitted by him that perusal of Article 12(3) of the treaty shows that the term "Royalty" shall encompass payment of any kind received as consideration for use or transfer of copyright, whereas, the admitted facts of the case are that there is no transfer of any copyright. Thus, the provisions of treaty should be read in preference to the provisions of the Act so long as they are more beneficial to the assessee in determining its tax liability. The amendment made in the provisions of the Act cannot be automatically read into the articles of the treaty, unless of course, corresponding amendment is made in the treaty also. For this proposition, he has relied upon the following judgments:- i) DIT v/s Infrasoft Ltd....
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....o various customers and, therefore, the same could not have been treated in the nature of "Royalty" liable to be taxed in India. 10. On the other hand, the Ld. Departmental Representative had also argued this issue at length. It was submitted by him that if software was integral part of the machine then there was no necessity to receive the payment separately and mentioning about the same separately in the invoice. It was further submitted that the software was received separately by e-mail, thus, under these circumstances, it could not be said that software was integral part of the machine. He placed reliance on the following judgment in support of his argument that impugned transaction was in the nature of "Royalty" liable to be taxed in India in the hands of the assessee company: i) DDIT v/s Reliance Infocom Ltd., 37 CCH 69 (Mum.); ii) CIT v/s Synopsis International Old Ltd., 212 Taxman 454 (Kar.) and iii) CIT v/s Samsung Electronics Co. Ltd., 345 ITR 494 (Kar.) 11. It was submitted by him that after the amendment made by way of Explanation-4 in section 9(1)(vi), the consideration received by assessee for sale of software would now be undoubtedly....
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....the customers, it filed its return of income for the impugned assessment year at nil and claimed refund of the tax withheld / deducted by its customers. The Assessing Officer treated the same as taxable in the hands of the assessee in India. Being aggrieved, assessee filed its objection before the DRP wherein no relief was given and, therefore, still being aggrieved, the assessee approached the Tribunal. 15. On further analyzing the facts, it is noted that admitted facts on record are that the assessee had no business connection in India and it had no P.E. in India. This fact has not been disputed by the Assessing Officer. Rather we can say the Assessing Officer has proceeded on this admitted fact that the assessee has neither any P.E. nor business connection in India. Thus, under these circumstances, the impugned amount of consideration is not liable to be taxed as business income of the assessee. The taxability of the same, however, has to be examined in view of the provisions contained in clause (vi) of sub-section (1) of section 9 of the Act read with relevant provisions of Indo-Israel DTAA. On this issue, we have examined carefully all the arguments made by the Ld. Counsel ....
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.... customer is granted non-exclusive, non-transferable limited license to use the software and related knowhow on the machine for the sole purpose of scanning the internal / external feature of rough diamond and creating a three dimensional image of these features of rough diamond. Clause 2.2 of the agreement puts certain restrictions upon the customers for any other use of the software in any other machine. This clause restrains the customer from duplicating the software or making any copies, modifications, isolating the software and making it available as a standalone data base or product, removing any product identification, copyright or other proprietary notice from the software or decompiling, disassembling, reverse engineering, or making any other attempt to reconstruct or discover the source code, etc. This clause clearly lays down that customer shall not reproduce the software or any of the documentation provided in connection with the software or related knowhow. It is further noted that clause 6.2 of the said agreement lays down that the assessee is and shall remain sole and exclusive owner of the right, title and interest in the software and related know. This software can....
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....cter of the transaction shall not be altered because of these two features only. The break-up of invoice value of hardware and software may be as a result of some other legal requirement or as a matter of convenience or an agreement between buyer and seller. It has been submitted that separate values were given for the purpose of proper assessment of custom duty to be levied at the time of imports of the machines. Further, software has been supplied separately by e-mail for various security reasons and to enable the customer to have the benefits of updated technologies. Similarly, separate payments have been made at the time of sale and subsequently by customer as a matter of terms between both the parties keeping in view various factors such as financial and administrative convenience and commercial expediency. The dominant and essential character of the transaction was sale of machine by the assessee and purchase of the same by the customer, and it shall remain the same with or without these two features. 20. The view taken by us is not res-integra. Our view is supported by many judgments brought to our notice. 21. In case of CIT v/s Alcatel Lucent, Canada, 372 ITR 476 (Del....
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....ns, Article 13(3) of the DTAA was not involved. 5. We have noticed, at the outset, that the ITAT had relied upon the ruling of this Court in Director of Income Tax V. Ericsson A.B. 343 ITR 470 wherein identical argument with respect to whether consideration paid towards supply of software along with hardware - rather software embedded in the hardware amounted to royalty. After noticing several contentions of the revenue, this Court held in Ericsson A.B. (supra) as follows:- "54. It is difficult to accept the aforesaid submissions in the facts of the present case. We have already held above that the assessee did not have any business connection in India. We have also held that the supply of equipment in question was in the nature of supply of goods. Therefore, this issue is to be examined keeping in view these findings. Moreover, another finding of fact is recorded by the Tribunal that the Cellular Operator did not acquire any of the copyrights referred to in Section 14 (b) of the Copyright Act, 1957. 55. Once we proceed on the basis of aforesaid factual findings, it is difficult to hold that payment made to the assessee was in the nature of royalty either....
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....up. What the buyer purchases and pays for is not the disc or the CD. As in the case of paintings or books or music or films the buyer is purchasing the intellectual property and not the media i.e. the paper or cassette or disc or CD. Thus a transaction sale of computer software is clearly a sale of "goods" within the meaning of the term as defined in the said Act. The term "all materials, articles and commodities" includes both tangible and intangible/incorporeal property which is capable of abstraction, consumption and use and which can be transmitted, transferred, delivered, stored, possessed etc. The software programmes have all these attributes... In Advent Systems Ltd. v. Unisys Corpn, (925 F. 2d 670 (3rd Cir. 1991)), relied on by Mr. Sorabjee, the court was concerned with interpretation of uniform civil code which "applied to transactions in goods". The goods therein were defined as "all things (including specially manufactured goods) which are moveable at the time of the identification for sale". It was held: "Computer programs are the product of an intellectual process, but once implanted in a medium are widely distributed to computer owners. An analogy ca....
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....e purpose of software is to make the machine operational and functional. Para-14.2 of the judgment is reproduced for the sake of ready reference:- "14.2 On a close analysis of the decisions relied upon by both sides, in matters relating to classification/valuation, the following important guidelines/principles emerge apart from the meanings of various relevant technical terms: (a) In classification of products, the commercial understanding is more relevant than technical specifications except in respect of commodities for which such specifications are prescribed requiring the assistance of experts in the respective fields. In other words, the method to be adopted for classification is to be based on easily understandable parameters. (b) The decisions in respect of software and hardware in relation to computer are to the effect that if any software is embedded/etched/burnt then it has to be included as part of the hardware and cannot be treated as stand-alone software and that the value of such embedded software should be part of the value of computer. However, it cannot be concluded that only the value of software which is embedded/etched/burnt is to be i....
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.... followed by the assessee as per well accepted position of law. It has been further submitted that if the amendment has been made in the provisions of the Act, the same shall not be automatically and by implication imported into the articles of the treaty unless of course a corresponding amendment is made in the tax treaty as well. It was thus submitted that amendment made in section 9(1)(vi) by way of insertion of an Explanation by Finance Act, 2012, for extending the scope of the term "Royalty", shall not be read into the provisions of Article 12.3 of the Indo-Israel tax treaty incorporated in the treaty for explaining meaning of the term 'Royalty'. 26. We have carefully considered this argument of the assessee also. We find that position of law on this aspect is clear. Recently, Hon'ble Bombay High Court in DIT v/s A.P. Mollar Maersk, ITA no.1306/2013, vide order dated 29th April 2015 reiterated the same position by observing as under:- "12. Our attention is also drawn to the decision of this Court in the case of Commissioner of Income-tax V/s. Siemens Aktiongeselleschaft reported in [2009] 310 ITR 320 (Bom), wherein this Court has held that once there is a treat....
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....e then the provisions of the Act would not apply and the assessee would be governed by the provisions of DTAA. Hon'ble Delhi High Court followed the judgment of Hon'ble Supreme Court in Azadi Bachao Andolan, 263 ITR 706 (SC), wherein it was laid down that in case of conflict, the provisions of DTAA would override the statutory provisions of the Act so long as these are more beneficial to the assessee. It was further held by the Hon'ble High Court that in the absence of any corresponding amendment in DTAA, there was no need to examine effect of subsequent amendment to section 9(1)(vi) and also fact as to whether amount received for use of software would be "Royalty" in terms thereof. 32. Recently, Hon'ble Delhi High Court in the case of DIT v. NEW SKIES SATELLITE BV in its order dated 8th February 2016 in ITA NO.473/M/12 got an occasion to analyse in detail entire law on the issue that amendment made in the domestic law i.e. Income Tax Act shall not be automatically read in to provision of DTAA, unless specific amendment is made by both the countries in the DTAA, as the DTAA is an agreement of two sovereign countries and one of them cannot unilaterally amendment the t....
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....eld that "tax treaties are...... considered to be mini legislation containing in themselves all the relevant aspects or features which are at variance with the general taxation laws of the respective countries". Thus, an interpretive exercise by the Parliament cannot be taken so far as to control the meaning of a word expressly defined in a treaty. Parliament, supreme as it may be, is not equipped, with the power to amend a treaty. It is certainly true that law laid down by the Parliament in our domestic context, even if it were in violation of treaty principles, is to be given effect to; but where the State unilaterally seeks to amend a treaty through its legislature, the situation becomes one quite different from when it breaches the treaty. In the latter case, while internationally condemnable, the State's power to breach very much exists; Courts in India have no jurisdiction in the matter, because in the absence of enactment through appropriate legislation in accordance with Article 253 of the Constitution, courts do not possess any power to pronounce on the power of the State to enact a law contrary to its treaty obligations. The domestic courts, in other words, are not empowe....
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..... Therefore, mere amendment to Section 9(1)(vi) cannot result in a change. It is imperative that such amendment is brought about in the agreement as well. Any attempt short of this, even if it is evidence of the State's discomfort at letting data broadcast revenues slip by, will be insufficient to persuade this Court to hold that such amendments are applicable to the DTAAs." 33. Thus, from the above judgments, the position of law is very clear that provisions of Indo-Israel treaty would be preferred over the provisions of the Act, since there is no amendment in the treaty and the Department is seeking to put more tax liability upon the assessee taking help of amendment made in section 9(1)(vi). 34. We have gone through the provisions of Article-12 of India Israel tax treaty which defines the term "Royalty". Article 12(3) has revised this term "Royalty" as under:- "(3). The term "Royalty" as used in this Article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph film, any patent, trade mark, design or model, plan, secret formula or process, or for in....
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....ed, rented, sold, sublicensed or transferred to any third party or used by any parent, subsidiary or affiliated entity of Licensee or used for the operation of a service bureau or for data processing. The Licensee is further restricted from making copies, decompile, disassemble or reverseengineer the Software without Infrasoft‟s written consent. The Software contains a mechanism which Infrasoft may activate to deny the Licensee use of the Software in the event that the Licensee is in breach of payment terms or any other provisions of this Agreement. All copyrights and intellectual property rights in and to the Software, and copies made by Licensee, are owned by or duly licensed to Infrasoft. 86. The Licensing Agreement shows that the license is non-exclusive, non-transferable and the software has to be uses in accordance with the agreement. Only one copy of the software is being supplied for each site. The licensee is permitted to make only one copy of the software and associated support information and that also for backup purposes. It is also stipulated that the copy so made shall include Infrasoft‟s copyright and other proprietary notices. All copies of the ....
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....random access memory or making an archival copy is an essential step in utilizing the program. Therefore, rights in relation to these acts of copying, where they do no more than enable the effective operation of the program by the user, should be disregarded in analyzing the character of the transaction for tax purposes. Payments in these types of transactions would be dealt with as business income in accordance with Article 7. 89. There is a clear distinction between royalty paid on transfer of copyright rights and consideration for transfer of copyrighted articles. Right to use a copyrighted article or product with the owner retaining his copyright, is not the same thing as transferring or assigning rights in relation to the copyright. The enjoyment of some or all the rights which the copyright owner has, is necessary to invoke the royalty definition. Viewed from this angle, a non-exclusive and nontransferable licence enabling the use of a copyrighted product cannot be construed as an authority to enjoy any or all of the enumerated rights ingrained in Article 12 of DTAA. Where the purpose of the licence or the transaction is only to restrict use of the copyrighted produc....
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.... and all copies of the software shall be exclusive properties of Infrasoft. Licensee was allowed to use the software only for its own business as specifically identified and was not permitted to loan/rent/sale/sub-licence or transfer the copy of software to any third party without the consent of Infrasoft. 93. The licensee has been prohibited from copying, decompiling, de-assembling, or reverse engineering the software without the written consent of Infrasoft. The licence agreement between the Assessee company and its customers stipulates that all copyrights and intellectual property rights in the software and copies made by the licensee were owned by Infrasoft and only Infrasoft has the power to grant licence rights for use of the software. The licence agreement stipulates that upon termination of the agreement for any reason, the licensee shall return the software including supporting information and licence authorization device to Infrasoft. 94. The incorporeal right to the software i.e. copyright remains with the owner and the same was not transferred by the Assessee. The right to use a copyright in a programme is totally different from the right to use a prog....
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.... is only integral to the use of copyrighted product. The right to make a backup copy purely as a temporary protection against loss, destruction or damage has been held by the Delhi High Court in DIT v. M/s Nokia Networks OY (Supra) as not amounting to acquiring a copyright in the software. 99. In view of the above we accordingly hold that what has been transferred is not copyright or the right to use copyright but a limited right to use the copyrighted material and does not give rise to any royalty income. 100. The question of law is thus answered in favour of the Assessee and against the Revenue that the Income Tax Appellate Tribunal was right in holding that the consideration received by the respondent Assessee on grant of licenses for use of software is not royalty within the meaning of Article 12(3) of the Double Taxation Avoidance Agreement between India and the United States of America. 101. The appeal is accordingly dismissed leaving the parties to bear their own costs." ii) In the case of Ericsson A.B. v/s DIT (supra), Delhi High Court held that consideration for use of computer software in the absence of transfer of copyright therein would not co....
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.... in Motorola Inc., 95 ITD 269 (Del.) had after analyzing the provisions of Copyright Act and considering the OECD commentary on characterization of income arising from sale of software license held that payment for software license where no right for use of copyright was granted to the licensee such as right to make copies thereof for commercial exploitation does not constitute use of copyright of literary work and is consequently not "Royalty" under the tax treaty entered into by India. 38. Similarly, Mumbai Bench of the Tribunal in ADIT v/s TII Team Telecom International Pvt. Ltd., 12 Taxman.com 502, followed the judgment of the Special Bench in Motorola Inc. (supra) after distinguishing the judgment of the co-ordinate bench in the Grace Mac Corporation v/s ADIT, 42 SOT 550 (Del.) and held that in view of Article-12(3) of India-Israel DTAA, the consideration for payment of standard software would not constitute "Royalty" under the India Israel DTAA. 39. Similar view has been taken by Co-ordinate bench of Tribunal in Financial Software and Systems Pvt. Ltd. v/s DCIT, 47 Taxman.com, 410 (Chennai), wherein it was held that payment made to non-resident companies for procuring s....
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....ibunal. We observe that all the arguments put forth by the Revenue and the assessee are considered and answered in these decisions. Further, the Delhi High Court in Infrasoft has expressed its disagreement with the view taken by the Karnataka High Court in the case of Samsung Electronics Co Ltd. Hence, the decisions relied by the Ld. CIT-DR in the case of Samsung Electronics and Gracemac Corporation (supra) does not help the case of the Revenue, as we are under the Jurisdiction of the Hon'ble Delhi High Court. 42. In view of the above, respectfully following the decision of Hon'ble Jurisdictional High Court in the case of Ericsson A.B. (supra) and Infrasoft Ltd. (supra), we hold that the consideration received by the Assessee for supply of product along with license of software to End user is not royalty under Article 12 of the Tax Treaty. Even where the software is separately licensed without supply of hardware to the end users (i.e. eight out of 63 customers), we are of the view that the terms of license agreement is similar to the facts of Infrasoft Ltd (Supra). Accordingly, we hold that there was no transfer of any right in respect of copyright by the assessee ....
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....treaty. However, we shall also like to deal with the judgments relied upon by the Ld. Departmental Representative in support of the actions of the lower authorities. 44. Ld. CIT-DR (Departmental Representative) relied upon the two judgment of Hon'ble Karnataka High Court in CIT v/s Synopsis International Old Ltd. (supra) and CIT v/s Samsung Electronics Co. Ltd. (supra). 45. We have gone through both the judgments carefully and find that none of these judgments would be applicable on the facts of the present case for the reason that we have decided this case primarily on the first issue in favour of the assessee on the ground that in the case before us, it was the case of predominantly a transaction of sale of machine by the assessee to its customers and for the customers also it was in effect a transaction of purchase of machine only, and thus it was not a case of sale of software, as such. This issue was not there before the High Court in these judgments. Therefore, this issue has not been addressed by the High Court. 46. Similarly, other case relied upon by the Ld. CIT-DR of DDIT v/s Reliance Infocom (supra), it is noted that this judgment has based its decision mainly r....
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.... any adaptation of the work; (vii) to do, in relation to a translation or an adaptation of the work, any of the acts specified in relation to the work in subcls. (I) to (vi); (b) in the case of a computer programme,- (i) to do any of the acts specified in cl. (a); (ii) to sell or give on commercial rental or offer for sale or for commercial rental any copy of the computer programme. Provided that such commercial rental does not apply in respect of computer programmes where the programme itself is not the essential object of the rental. 48. From the perusal of the above definition what we are able to gather is that none of the clauses is attracted when assessee has sold the machine along with its requisite software to operate and use the machine. The assessee has not given any right, whatsoever, to its customers to resell any copy of the software supplied along with machine, as has been discussed by us in detail in earlier part of this order. The other arguments made on behalf of the Revenue is that the Customers were supplied the software through email and other electronic medium and they has also made copies of the software programme....
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....n of the judgment is reproduced below:- "..........At the same time, it is also mandated that there cannot be imposition of any tax without the authority of law. Such a law has to be unambiguous and should prescribe the liability to pay taxes in clear terms. If the concerned provision of the taxing statute is ambiguous and vague and is susceptible to two interpretations, the interpretation which favours the subjects, as against the revenue, has to be preferred. This is a well established principle of statutory interpretation, to help finding out as to whether particular category of assessee are to pay a particular tax or not. No doubt, with the application of this principle, Courts make endeavor to find out the intention of the legislature. At the same time, this very principle is based on "fairness" doctrine as it lays down that if it is not very clear from the provisions of the Act as to whether the particular tax is to be levied to a particular class of persons or not, the subject should not be fastened with any liability to pay tax. This principle also acts as a balancing factor between the two jurisprudential theories of justice - Libertarian theory on the one hand an....