TaxTMI 
TaxTMI 
2020 (7) TMI 640
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....l -2, Delhi ('the Ld. DRP'), is a vitiated order, having been passed in violation of principles of natural justice and is otherwise arbitrary and is thus bad in law. 2. That on the facts and circumstances of the case and in law, the Ld. AO has erred in passing the impugned order which is based on surmises and conjectures, and is therefore, bad in law and void-ab-initio. Non-taxability of revenues from sale of hardware equipment 3. That on the facts and circumstances of the case and in law, the Ld. AO has erred in alleging that the revenue earned by the Appellant from sale of hardware equipment is in the nature of 'Royalty' as per provisions of both, section 9(1)( vi) of the Act and Article 12(3) of the India-Switzerland Double Taxation Avoidance Agreement (India-Swiss tax treaty'). 4. That on the facts and circumstances of the case and in law, the Ld. AO has erred in disregarding that the revenue earned by the Appellant from sale of hardware equipment represents business income, which is not taxable in India in the absence of any Permanent Establishment ('PE') of the Appellant in India, in accordance with the provisions of the Act....
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....O has erred in levying interest under sections 234A and 234B of the Act. 11. That the Ld. AO has erred in initiating penalty proceedings under section 271 (1)( c) of the Act. The appellant submits that each of the above grounds are independent and without prejudice to one other. That the Appellant reserves its right to add, alter, amend, substitute or withdraw any ground of appeal either before or at the time of hearing of this appeal. The Appellant prays that appropriate relief be granted on the said grounds of appeal and the facts and circumstances of the Appellant's case." 3. The first issue raised by the assessee vide Ground of appeal Nos. 3 & 4 is against the revenue earned by the assessee from sale of hardware equipment in the nature of 'Royalty' as per provisions of both, section 9(1)(vi) of the Act and Article 12(3) of the India-Switzerland Taxation Avoidance Agreement (India-Swiss Tax Treaty). The case of the assessee is that the revenue earned by the assessee from sale of hardware equipment represents business income, which is not taxable in India in the absence of any Permanent Establishment (in short "PE") of the assessee in India,....
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....upplied by the assessee to its customers were limited, non-exclusive, non-transferable and non sub licensable license for the territory to use the product for the contractual period. Therefore, the Assessing Officer was of the view that these software make available a 'process' to the customers who "use" the process, while carrying out their business. It is, therefore, clear that in addition to software involving a copyright, these specialized software also represent a "process" which can be used in a particular industry specific core activity. After perusing the contract of the assessee with its clients, it was observed by the Assessing Officer that the CAS consists of a set up of hardware and software. The Assessing Officer thus observed that both the hardware and software are integral part of the CAS. A show cause notice dated 13.12.2018 was issued to the assessee citing the reasons why revenue earned from supply of CAS and Middleware Products should not be treated as 'Royalty' income and taxed accordingly. The assessee explained its case in detail and pointed out that it was not a case of 'Royalty', as the purchaser of software does not become the owner of the copyright in t....
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.... been treated to be integral part of CAS and assessed as 'Royalty'. 8. The Ld.DR for the Revenue on the hand pointed out that the Hon'ble Delhi High Court in Infrasoft Ltd. (supra) has decided the issue of copyrighted Article and held the same to be not 'Royalty'. However, in case we come to the definition of Royalty, it talks of process also u/s 9(1)(vi) of the Act. He then placed reliance of the observations of the DRP in para 3.2 and 3.3 at page 4 of the order. The Ld. DR for the Revenue stressed that the Hon'ble Delhi High Court (supra) has not gone into the aspect of the end user, which in the present case is technology driven solution, which changes total use fee structure. He was of the view that dimension has to be seen vis-à-vis customers for whom it is developed; its primary objective is CAS. He placed reliance on the order of the DRP in this regard. 9. The Ld.AR for the assessee pointed out that the Assessing Officer had held it to be in the case of Royalty; even for Satellite and for making signals viewable; for mobile technology, we use technology and process, but we do not use any secret formula. 10. We have heard the rival contentions and perused the ....
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....activities involved in the business of the customer. The process embodied in the software is part of the core activity of the business being run by the respective customers of the assessee. Therefore, these software make available a "process" to the customers who "use" the process while carrying out their business. It is, therefore, clear that in addition to software involving a copyright, these specialized software also represent a "process" which can be used in a particular industry specific core activity. 16. The DRP vide paras 3.4 & 3.5 observed as under:- 3.4. "It is further discussed by the AO that the software programs basically act as a secret process which processes the input commands of the user to desired output by making use of the hardware. The payment made for right to use of such secret process would definitely take form of 'royalty' as the definition of Royalty in DTAA as well as the Income Tax Act encompasses the right to use of a secret process. In view the same, AO considered the receipts of the assessee are taxable as Royalty u/s 9(1)(vi) of the Act. 3.5. From the contract it was observed by the AO that the Conditional Access System consists....
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....tion thereof. The term 'Royalty' has been defined by clause 3 of Article 12 as payment received for the use of, or the right to use any copyright. Section 9(1)(vi) of the Act defines 'Royalty'. The authorities below were of the view that because of insertion of Explanation 5 to section 9(1)(vi) of the Act with retrospective effect from 01.06.1976, where the meaning of term 'Royalty' has been extended to include use of copyright or copyrighted article is to be applied and on such application, the assessee was held to be taxable. The case of the assessee is that it had not transferred any copyright but had only parted with copyrighted article, in the form of software, then it is not Royalty and was not covered under the provisions of section 9(1)(vi) of the Act. In the alternate, it is submitted by the learned Authorized Representative for the assessee that since the definition of 'Royalty' has not been amended in Tax Treaty and the said provisions being beneficial, then provisions of Article 12(3) of DTAA with Sweden would apply and the assessee's case would fall within non amended provisions of definition of 'Royalty' under Article 12(3) of DTAA. 20. The Hon'ble High Court....
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....lly is the key to the entire controversy and we may now proceed to address this issue. 156. We must look into the meaning of the word "copyright" as given in the Copyright Act, 1957. Section 14 of this Act defines "Copyright" as "the exclusive right subject to the provisions of this Act, to do or authorize the doing of any of the following acts in respect of a work or any substantial part thereof, namely: --------- It is clear from the above definition that a computer programme mentioned in Clause (b) of the section has all the rights mentioned in Clause (a) and in addition also the right to sell or give on commercial rental or offer for sale or for commercial rental any copy of the computer programme. This additional right was substituted w.e.f. 15.1.2000. The difference between the earlier provision and the present one is not of any relevance. What is to be noted is that the right mentioned in Sub -clause (ii) of Clause (b) of Section 14 is available only to the owner of the computer programme. It follows that if any of the cellular operators does not have any of the rights mentioned in Clauses (a) and (b) of Section 14, it would mean that it does not h....
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....that JTM has not been given any of the seven rights mentioned in Clause (a) of Section 14 or the additional right mentioned in Sub-clause (ii) of Clause (b) of the section which relates to a computer programme and, therefore, what JTM or any other cellular operator has acquired under the agreement is not a copyright but is only a copyrighted article. 159. Clause 20.4 of the supply contract with JTM is as under: 20.4 In pursuance of the foregoing JT MOBI LES shall: (a) not provide or make the Software or Documentation or any portions or aspects thereof (including any methods or concepts utilized or expressed therein) available to any person except to its employees on a "need to know" basis; (b) not make any copies of Software or Documentation or parts thereof, except for archival backup purposes; (c) when making permitted copies as aforesaid transfer to the copy/copies any copyright or other marking on the Software or Documentation. (d) Not use the Software or Documentation for any other purpose than permitted in this Article 20, Licence or sell or in any manner alienate or part with its possession. (e) Not use or transf....
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....s has to be read with Clause 20.5 which says that the license can be transferred, but only when the GSM system itself is sold by the cellular operator to a third party. This in a way shows that the software is actually part of the hardware and it has no use or value independent of it. This restriction placed on the cellular operator (not to license or sell the software) runs counter to Section 14(b)(ii) of the Copyright Act which permits a copyright holder to sell or let out on commercial rental the computer programme. For this reason also it cannot be said that JTM or any cellular operator acquired a copyright in the software. 162. A conjoint reading of the terms of the supply contract and the provisions of the Copyright Act, 1957 clearly shows that the cellular operator cannot exploit the computer software commercially which is the very essence of a copyright. In other words a holder of a copyright is permitted to exploit the copyright commercially and if he is not permitted to do so then what he has acquired cannot be considered as a copyright. In that case, it can only be said that he has acquired a copyrighted article. A small example may clarify the position. The pur....
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....are transferred (acquired by JTM) and it would not be a case of merely giving the right to use and consequently Article 13 of the DTAA would not apply. Mr. Dastur, however, was fair enough to concede that if the Department is right in saying that if you have the copyrighted article, you also have the copyrighted rights, then Clause (v) of Explanation 2 below Section 9(1) of the Income-tax Act will apply because his clause ropes in "transfer of all or any rights" and is not restricted to "use" or "right to use", the copyright. However, he added that since the basic proposition of the Department has been demonstrated to be wrong, Clause (v) of Explanation 2 below Section 9(1) is not an impediment to accepting the assessee's contention. 165. We may also usefully refer to the Commentary on the OECD Model Convention (dated 28.1.2003) which is of persuasive value and which throws considerable light on the character of the transaction and the treatment to be given to the payments for tax purposes. Paragraph 14 of the Commentary, a copy of which was filed in Paper book No. V is relevant: COMMENTARY ON ARTICLE 12 - PAPER BOOK V " 14. In other types of transact....
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....s are the transfer of copyright rights and the transfer of a copyrighted article. The U.S. regulations distinguished between transfer of copyright rights and transfer of copyrighted articles based on the type of rights transferred to the transferee. Briefly stated, if the transferee acquires a copy of a computer programme but does not acquire any of the rights identified in certain sections (of the U.S. Regulations), the regulation classified the transaction as the Transfer of a copyrighted article. Paragraph 3 of the Explanatory Note says that if a transfer of a computer programme results in the transferee acquiring any one or more of the listed rights, it is a transfer of a copyright right. 167. Paragraph 4 says that if a person acquires a copy of a computer programme but does not acquire any of the four listed copyright rights, he gets only a copyrighted article but no copyright. 168. The actual regulations bring out the distinction very clearly between the copyright right and a copyrighted article. They also specify the four rights which, if acquired by the transferee, constitute him the owner of a copyright right. They are: (a) The right to make copi....
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....) of the Income-tax Act or Article of the DTAA with Sweden. -------- 184. In view of the foregoing discussion, we hold that the software supplied was a copyrighted article and not a copyright right, and the payment received by the Assessee in respect of the software cannot be considered as royalty either under the Income-tax Act or the DTAA." 22. The Hon'ble High Court of Delhi in DIT Vs. Infrasoft Ltd. (supra) then refers to the decision of the Hon'ble High Court of Delhi itself in DIT Vs. Ericsson A.B. (2012) 343 ITR 470 (Del), wherein it was held that once it is held that payment in question is not Royalty which would come within the mischief of clause (vi), the Explanation will have no application and that the question of applicability of the Explanation would arise only when payment is to be treated as "Royalty" within the meaning of clause (vi) or "fee for technical services" as provided in clause (vii) of the Act. After referring to different terms of Licensing Software Agreement, the Hon'ble High Court observed as under:- "85. The Licensing Agreement shows that the license is non-exclusive, nontransferable and the software has to be uses in acc....
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....ght. Copyright or even right to use copyright is distinguishable from sale consideration paid for "copyrighted" article. This sale consideration is for purchase of goods and is not royalty. 88. The license granted by the Assessee is limited to those necessary to enable the licensee to operate the program. The rights transferred are specific to the nature of computer programs. Copying the program onto the computer's hard drive or 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....
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....ourt of Karnataka in CIT Vs. Samsung Electronics Co. Ltd. (supra) and distinguished the same holding as under:- "98. We are not in agreement with the decision of the Andhra Pradesh High Court in the case of Samsung Electronics Co. Ltd (supra) that right to make a copy of the software and storing the same in the hard disk of the designated computer and taking backup copy would amount to copyright work under section 14(1) of the Copyright Act and the payment made for the grant of the licence for the said purpose would constitute royalty. The license granted to the licensee permitting him to download the computer programme and storing it in the computer for his own use was only incidental to the facility extended to the licensee to make use of the copyrighted product for his internal business purpose. The said process was necessary to make the programme functional and to have access to it and is qualitatively different from the right contemplated by the said provision because it 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.....
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....o. Ltd. (supra) and holds that the Bench in DIT Vs. Infrasoft Ltd. (supra) has unequivocally expressed its view that it was not in agreement with that decision. The question was thus, decided holding the consideration paid could not be considered as 'royalty' for use or right to use software. 27. Further, reference may also be made to earlier decision of the Hon'ble High Court of Delhi in DIT Vs. Ericsson A.B. (supra). Relying on the ratio laid down by the Hon'ble Supreme Court in Tata Consultancy Services Vs. State of Andhra Pradesh (2004) 271 ITR 401 (SC), the Hon'ble High Court of Delhi in DIT Vs. Ericsson A.B. (supra) had held as under:- "56. A fortiorari when the assessee supplies the software which is incorporated on a CD, it has supplied tangible property and the payment made by the cellular operator for acquiring such property cannot be regarded as a payment by way of royalty. ........ 59. Be that as it may, in order to qualify as royalty payment, within the meaning of section 9(1)(vi) and particularly clause (v) of Explanation 2 thereto, it is necessary to establish that there is transfer of all or any rights (including the granting of any....
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.... within the mischief of clause (vi), the Explanation will have no application and that the question of applicability of the Explanation would arise only when payment is to be treated as "royalty" within the meaning of clause (vi) or "fee for technical services" as provided in clause (vii) of the Act." 29. The Hon'ble High Court of Delhi in DIT Vs. Nokia Networks OY (2013) 358 ITR 259 (Del) had held that Explanation 4 was added to section 9(1)(vi) of the Act by Finance Act, 2012 with retrospective effect from 01.06.1976 to provide that all consideration for use of software shall be assessable as 'Royalty'. However, the definition in DTAA has been left unchanged. It is an admitted fact that though Explanation 5 has been inserted in section 9(1)(vi) of the Act but no amendment has been made to the definition of 'Royalty' under DTAA and since the provisions of DTAA are beneficial to the assessee, then the said provisions would be applied. 30. In view of the above said propositions, we hold that what has been transferred is limited right to use copyrighted material, then the receipts on sale of licensing of software is not Royalty in view of the beneficial provisions of the DTAA b....