AI OCR 
TaxTMI 
TaxTMI 
TaxTMI 
2016 (12) TMI 1353
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.... of upholding the action of the AO be reversed. Ground 2 - Re-characterization of income received from licensing of software as 'Royalty' and consequent disallowance - Rs. 14,400,044 2.1 The learned CIT(A) erred in upholding the disallowance made by the Assessing Officer (AO) in respect of income received from licensing of software by re-characterizing the same as 'Royalty' under the Double Taxation Avoidance Agreement ('DTAA') between India and Netherlands. 2.2 The learned CIT(A) failed to appreciate that the income was in the nature of business income and in the absence of a Permanent Establishment (PE) in India would not be taxable in India. 2.3 The Appellant submits that the disallowance of Rs. 14,400,044 made by the AO and confirmed by the learned CIT(A) is unwarranted and be deleted. Ground 3 - Treatment of the Appellant as not being the beneficial owner of the income from licensing of software (without prejudice to Ground 1 above) 3.1 The learned CIT(A) erred in upholding the finding of the AO in taxing the income received from licensing of software @ 20% on the grounds that the Appellant is not the beneficial owner of the income. 3.2 Wi....
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....cence of software as royalty income amounting to Rs. 1,44,00,044/-. The claim of the assessee was that the aforesaid income was not liable to be taxed as royalty income but it was in the nature of business income and the same was not taxable in absence of PE of the assessee in India. But, Ld CIT(A) did not accept the submission of the assessee and upheld the order of the AO. 5. During the course of hearing before us, the Ld. Counsel of the assessee made detailed arguments to demonstrate that the transaction of sale of software by the assessee company to Indian customers did not give rise to any kind of transfer of right in the copyright. Our attention was drawn upon various agreements entered into between the assessee and the Indian customers and foreign holding company of the assessee. Our attention was also drawn on various clauses of the master agreement entered into by M/s Quad Inc. with Unilever N.V for sale of licensed products, i.e. ERP software by the said company or through its subsidiaries to Unilever group. It was demonstrated that various clauses of the agreement suggest that there was no transfer of copyright. Our attention was further drawn upon the provisions of DTA....
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....herlands. It is a 100% subsidiary of Qad Inc., USA (in short, Qad Inc.) which is the ultimate parent company of Qad group. Qad Inc. was engaged during these years in the development and sale of Enterprise Resource Planning (ERP) software products. As per the global arrangement, the said company acted as a distributor of aforesaid software products only in USA and Latin American countries, whereas the other Qad group companies worldwide, including the assessee company, undertook marketing responsibilities for countries other than USA and Latin American countries. 9. During the years before us, the assessee company purchased software from Qad Inc. and resold the same to multinational companies outside USA and Latin American countries. These facts were demonstrated with the help of financial statements of the assessee company. Further facts are that Qad Inc. had entered into a multinational software product licence agreement dated 01-06-1977 (called as 'Master Agreement') with M/s Unilever N.V., a multinational company incorporated in Netherlands for sale of licensed product, i.e. ERP software either directly or through its subsidiaries to M/s Unilever N.V. (UNV, in short) and its su....
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....taining software, say for example Microsoft Word, the medium would again be the CD holding the intellectual property, which would be the software technology. This would also be a sale, despite the fact that this same software technology could be put on unlimited number of CDs and sold to multiple users simultaneously. Effective control of that particular software on that one CD is passed to the buyer. The buyer could use it, alienate it, destroy it, and do anything at all that he likes with it. If he made illicit copies of it, this would constitute infringement; and that in itself would not make the transfer of the software on a CD a service. Even if the buyer transferred this non- transferable software, it would amount to a breach of contract provided in the CD package, just as it would under Monsanto India's sub-licensing agreement. However, this does not do anything to disqualify the transaction itself from being a sale. These are all sales. Para 46. In fact, we believe that this sub-licensing of the Bollgard technology may possibly even be an outright sale. For a transaction to qualify for a sale, there must be a transfer of the property in the goods. In legal usage, the ....
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....the levy is not the technology nor the medium. It is the license; and the terms of that license are determinative. Where a license is purchased, it is still a sale, although what the user has 'purchased' is the right to use the software. Every license has a unique key and every sale is therefore uniquely identified. The purchase is therefore a transfer of the right to use that particular, identified software. The proprietory rights to the software do not have to be 'sold' or 'transferred '. Microsoft and Adobe retain all those rights, and all intellectual property continues to vest in them. This is, therefore, a transfer of the right to use that software, and to that extent, the intangible (the software) is sold; but the terms of that license allow the software vendor to retain complete seizin and dominion over all intellectual property rights. The transfer is not of those intellectual property rights, but of the right to use an identified and identifiable version of that software. In the subscription distribution model, where the software usage is dependent on payment of a periodic fee, there is no such transfer, and there is a mere right to use, without an....
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....ight in work. Our above also finds support from certain other provisions of the Copyright Act." 12. Thus, from the above judgments, it may be noted that in the above said cases it has been held that in absence of transfer of rights to authorise doing of certain acts as mentioned in sections 2, 13 & 14 of the Copyright Act it cannot be said that there was transfer of copyright. Therefore, in view of these judgments it was vehemently argued that the payment on sale of software shall not fall within the definition of 'Royalty', as per DTAA. 13. Turning back to the facts of this case, it is noted that the rights and obligations of the parties, i.e. the assessee and its customer, viz. HLL flow from the Master Agreement. Therefore, the relevant clauses of this agreement were examined by us, and are reproduced below:- "Article 2-Licenses: 2.1 Grant: Upon issuance of a Purchase Order by any Participant to QAD, QAD shall, in consideration of the license fee to be paid, grant to such Participant a non-exclusive, non-transferable license, for perpetual use, to use the Products on one (1) Hardware System at the Site designated in the Purchase Order in accordance with the terms and condit....
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....uthorized and unlicensed distributions of the Products. Participant may not subvert or change any of this information. 9.2 Ownership of Modifications: The parties hereby agree that the ownership of all intellectual property rights embodied in, or by, any modification to the Programs created by, or for, Participant under this Agreement, shall vest solely in QAD. Participant hereby assigns all rights title and interest in all such modifications to the Products to QAD." (emphasis supplied in bold and underline) 14. On the basis of analysis of the relevant clauses of the Master Agreement and other facts brought before us, salient features of the agreement defining rights and obligations of the parties can be summarised as under:- i) The assessee Company has granted to HLL a non-exclusive, non- transferable, license for perpetual use. ii) The license was for use of Product on one Hardware System. A Hardware System may include up to four servers. iii) HLL did not acquire any copyrights in the product. iv) The license could be used by HLL alone and HLL was not permitted to assign, transfer or sublicense. v) HLL was permitted to use the license for the purpose of its own ope....
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....reement does not permit HLL to carry out any alteration or conversion of any nature, so as to fall within the definition of 'adaptation' as defined in Copyright Act, 1957. The right given to the customer for reproduction was only for the limited purpose so as to make it usable for all the offices of HLL in India and no right was given to HLL for commercial exploitation of the same. It is also noted that the terms of the agreement do not allow or authorise HLL to do any of the acts covered by the definition of 'copyright'. Under these circumstances, the payment made by HLL cannot be construed as payment made towards 'use' of copyright particularly when the provisions of Indian Income-tax Act and DTAA are read together with the provisions of the Copyright Act, 1957. 17. Further, it is also noted by us that DTAAs of few countries make a specific mention that payment made for software would be included within the definition of 'Royalty'. Reference can be made to the DTAA with Malayasia, Romania, Kazakhistan and Morocco. However India Netherlands DTAA does not include software while defining 'Royalty'. Under these circumstances, we find that it would be difficult to characterise the pa....
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....thout the prior written consent of DCL or its authorized channels which, if given, is subject to the third party's consent to the terms and conditions of this agreement." 6. This clause fairly indicates that the end user can install the software on any number of computers, make copies for back up purposes for his own use only but with the qualification that he cannot operate/execute simultaneous copies of the software product more than the purchased seats. For example, if three copies of a product are purchased, these three software can be installed in any number of computers, but, at a time the usage cannot by of more than three seats. If only one copy is purchased, that can be installed by the end customer on any number of computers, but, at a time only one can be used. Then, there is a warranty clause in this Agreement which provides that the warranty duration varies from product to product and during such warranty period, the Datamine group will repair any programme error that may have been found. A perusal of the above clauses of the End user Agreement divulges that the end user acquires perpetual right to use the software and the number of permissible seats to the user is e....
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....ntext is that if a particular term has not been defined in the Treaty but the same has been defined in the Act and further there is a retrospective amendment to that term under the Act, then it is this amended definition of the term as per the Act, which shall apply in the Treaty as well. If however a particular term has been specifically defined in the Treaty, the amendment to the definition of such term under the Act would have no bearing on the definition of such term in the context of the Convention, unless the DTAA is also correspondingly amended. A country which is party to a Treaty cannot unilaterally alter its provisions. An amendment to a Treaty can be made bilaterally after entertaining deliberations from both the countries who signed it. If there is no amendment to the provision of the Treaty but there is some amendment adverse to the assessee in the Act, which provision has been specifically defined in the Treaty or there is no reference in the Treaty to the adoption of such provision from the Act, then such amendment will have no effect on the DTAA. 8.3. Reverting to the facts of the extant case, we observe that the term "Royalties" has been defined in the DTAA as ....
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....oyalties may also be taxed in India. As the assessee is a resident of UK,income from royalties arising in India, is otherwise chargeable to tax in India at the stipulated rate of tax. But in order to tax any amount under this Article, it is sine qua non that the receipt must fall within the scope of `Royalties' as defined in para 3 of the Article 13. The AO has enclosed the case of the assessee within sub-para (a) of para 3. It is apparent that sub-para (b) of para 3 of Article 13, dealing with consideration for the use of any industrial, commercial or scientific equipment etc., has absolutely no relevance in the present context as no equipment has been transferred by the assessee to the end users, which is simply a software. Now coming to sub-para (a) of para 3 of the Article, we find that the term `royalties' has been defined to mean a consideration for the use of, or the right to use, any copyright of a literary, artistic or scientific work, including cinematograph films or work on films, tape or other means of reproduction for use in connection with radio or television broadcasting, any patent, trademark, design or model, plan, secret formula or process, or for information conc....
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....ow, computer software programme, secret formula or process.....' Similarly, the DTAA between India and Kazakhstan defines the term 'royalties' in Article 12(3)(a) to mean : '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 software, cinematograph films...'. Similarly, the DTAA with Turkmenistan also defines `Royalties' in Article 12 to mean : 'payments of any kind received as consideration for the use of or the right to use any copyright of literary, artistic or scientific work, ..... computer software, any patent, trade mark...'. It is thus clear that wherever the Government of India intended to include consideration for the use of software as 'Royalties', it explicitly provided so in the DTAA with the concerned country. Since Article 13(3)(a) of the DTAA with UK does not contain any consideration for the use of or the right to use any `computer software', the same cannot be imported in to it. 12.2. The second segment, which is quite pertinent, is that Article 13(3)(a) encompasses consideration for the use of or the right to use any copyright of literary, artistic or scientific ....
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....rk, v. to make any translation of the work vi. to make 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 sub clauses (I) to (vi) b. in the case of a computer programme- (i). to do any of the acts specified in clause (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. .......... Explanation - For the purposes of this section, a copy which has been sold once shall be deemed to be a copy already in circulation." 12.5. When we consider the relevant parts of the End user Agreement, it clearly emerges that the customers have not been assigned any of the things which have been mentioned in section 14 of the Copyright Act, so as to constitute an assignment of a copyright of the computer software to the end user. Insofar as the view point of the ld. DR about the taking of copies of the Software by the end customer is concerned, we find that the....
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....y the assessee for sale of shrink wrapped software cannot be considered as `Royalties' within the meaning of Article 13 of the DTAA as the same is a consideration for sale of a copyrighted product and not use of any copyright. 13.1. Now we take up the contention of the ld. DR that provisions of section 9(1)(vi) should be applied to determine the taxability of the amount. It was contended that as the ld. AR has admitted the amount of sale of software covered under Explanation 4 to section 9(1)(vi), the same should be taxed as such. 13.2. In this regard, we find that sub-section (1) of section 90 of the Act provides that the Central Government may enter into an agreement with the Government of any other country for the granting of relief of tax in respect of income on which tax has been paid in two different tax jurisdictions. Sub-section (2) of section 90 unequivocally provides that where the Central Government has entered into an agreement with the Government of any country outside India under sub-section (1) for granting relief of tax or for avoidance of double taxation, then, in relation to the assessee to whom such agreement applies, ' the provisions of this Act shall ap....
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....ting State, carries on business in the other Contracting State in which the royalties or fees for technical services arise through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the right, property or contract in respect of which the royalties or fees for technical services are paid is effectively connected with such permanent establishment or fixed base. In such case, the provision of Article 7 (Business profits) or Article 15 (Independent personal services) of this Convention, as the case may be,shall apply." 14.2. Para 6 of Article 13, to the extent applicable, states that the provisions of paragraphs 1 and 2 of this Article shall not apply if the beneficial owner of the royalties or fees for technical services, being a resident of a Contracting State, carries on business in the other Contracting State in which the royalties or fees for technical services arise through a permanent establishment situated therein. In simple terms, this means that the amount falling under para 3 of Article 13 cannot be taxed as Royalties under paras 1 and 2, if the beneficial owner of the royalties,....
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.... commercial or scientific experience." 20. It may be noted from the above said definition that it is identical to the definition given in the Indo UK DTAA. Further, this definition does not include the word 'computer programme' or 'software'. It has been held by the bench after making analysis in detail that the payment is made for the customer for using the software as such and not the 'process' involved in it. It is further noted that since the definition given in Article 12(4) of the DTAA does not contain any consideration for the use or right to use in 'computer programme' or 'software', the same cannot be imported into it. Further, as discussed above also, the perusal of clauses of the Master Agreement demonstrate that the customer, viz. HLL has paid the consideration for 'use of computer software' and not 'copyright of the computer software'. But, the DTAA treats consideration for the use of copyright of a laboratory or artistic work, etc. as 'Royalty', there can be no question of including consideration for the use of a laboratory or artistic work, etc within the ambit of 'Royalty' defined in Article 12(4) of the DTAA. 21. It was also argued by the Revenue that provisions ....