TaxTMI 
TaxTMI 
2010 (1) TMI 47
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....uthorize a VAR to act as the reseller of Products, the applicant enters into a General VAR Agreement ("GVA"). The applicant states that as per the business model, the Product is sold to VAR for a consideration based on the standard list price less discount. The VAR in turn will sell such product to the end-users at a price independently determined by VAR. The end-user will enter into End User License Agreement ("EULA") with the applicant and VAR for the product supplied. The reseller (VAR) gets the order from end-user and places a back-to-back order on the applicant. On acceptance of the order by the applicant, it will provide a license key via e-mail so that the customer will directly download the product through the web link. 2. The modus operandi of the transactions has been set out in brief as follows: - The process starts with the VAR discussing with the end customer details regarding the technical solution i.e. the software and the budget of such end-customer; - The VAR makes a proposal to end-customer. This proposal includes a copy of the standard tripartite End User License Agreement (EULA). In a few cases the VAR forwards a Special Bid Offer (SBO) to applicant, typical....
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....by internal code attached to their processor. 2.2. The applicant submits that the said transaction between (a) the applicant and VAR, (b) VAR and the End-user is on principal to principal basis and that it has no presence in India whether through any employees or in the form of an office or place of business. 3. The following question is framed by the applicant in order to seek advance ruling from this Authority: Whether on the facts and circumstances of the case and in law the payment received by Dassault Systems K.K. (hereinafter referred to as the "the applicant") from sale of software products to independent third party resellers will be taxable as business profits under Article 7 of the India-Japan Double Taxation Avoidance Agreement ("India-Japan DTAA" or "Treaty") and will not constitute 'royalties and fee for technical services' as defined in Article 12 of India-Japan DTAA? 4. Broadly, the applicant's contention is that the payment made by VAR to the applicant is not in the nature of royalty within the meaning of Article 12.3 of the DTAA (Agreement for Avoidance of Double Taxation and Prevention of Fiscal Evasion) (or 'Treaty') between India and Japan notified by the Ce....
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....r technical services arising in a contracting state and paid to a resident of the other contracting state may be taxed in that other contracting state. However, this general rule is qualified by para 2 which enables the contracting State in which they arise to tax the same according to the laws of that State subject to the limitation that the beneficial owner of royalties or f.t.s shall not be subjected to tax at a rate more than 10% of the gross amount. 7. Under the Income-Tax Act, the income arising from royalty is deemed to accrue or arise in India and the non-resident is liable to be taxed under Section 9(1)(vi) of the Act. Explanation 2 thereto defines 'royalty' The relevant part of the definition contained in clause (v) is :"royalty" means consideration for the transfer of all or any rights (including the grant of a licence) in respect of any copy-right, literary, artistic or scientific work, patent, invention, model, design, secret formula or process, trade mark or similar property. 8. The first and foremost question is whether the payments received by the applicant from the VARs represent consideration for the use of, or the right to use, any copyright of literary/scienti....
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....al and so on conferred on him by copyright law. The purchaser does not acquire by his purchase any right, either by way of assignment or licence, to exercise any of those exclusive rights. (p.217)" Referring to the position of a licensee and an exclusive licensee, the legal position was stated as follows at p.310: "A mere licence from the copyright owner confers no proprietary interest on the licensee enabling him, for example, to bring proceedings in his own name, unless coupled with the grant of some other interest, for example, the right to take property away. Statute apart, even an exclusive licence, which is merely the leave to do a thing coupled with a promise not to do, or give anyone else permission to do that thing, gives the licensee no right to sue in his own name for infringement nor any other proprietary interest. In copyright law this general rule is altered by statute in the case of exclusive licences which comply with prescribed formalities. The 1988 Act confers on such a licensee a procedural status which enables him to bring proceedings but otherwise the rule is unchanged: an exclusive licensee has no proprietary interest in the copyright." 9.1. The view ....
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....he following acts in respect of a work or any substantial part thereof, namely:- (a) in the case of a literary, dramatic or musical work, not being a computer programme- (i) to reproduce the work in any material form including the storing of it in any medium by electronic means; (ii) to issue copies of the work to the public not being copies already in circulation; (iii) to perform the work in public, or communicate it to the public; (iv) to make any cinematograph film or sound recording in respect of the work; (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 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; (c) in the case of an artistic work,- xx xx xx xx xx xx xx xx (d) in t....
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....communication of the work to the public where such communication constitutes an infringement of the copyright in the work, unless he was not aware that had no reasonable ground for believing that such communication to the public would be an infringement of copyright; or (b) when any person- (i) makes for sale or hire, or sells or lets for hire, or by way of trade displays or offers for sale or hire, or (ii) distributes either for the purpose of trade or to such an extent as to affect prejudicially the owner of the copyright, or (iii) by way of trade exhibits in public, or (iv) imports into India, any infringing copies of the work: Provided that nothing in sub-clause(iv) shall apply to the import of one copy of any work for the private and domestic use of the importer. Explanation - For the purposes of this Section, the reproduction of a literary, dramatic, musical or artistic work in the form of a cinematograph film shall be deemed to be an "infringing copy"." 10.4. Section 52 specifies the acts which do not constitute infringement of copyright. Insofar as it is relevant, the section is extracted below: " 52(a) xx xx xx xx xx xx xx xx (aa) the making of copies or adaptat....
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.... to the category of intellectual property rights. All intellectual property rights in the licensed programs exclusively belong to the applicant or its licensor and they are retained by the applicant, as per the explicit declaration in the Agreement. The copyright in the software product vests with the applicant who has exclusive rights over the same. In order to see whether the applicant has transferred any rights related to copyright or conferred on the licensee/end-user the rights over the use of copyright, it is necessary to ascertain the true meaning of copyright and the incidents attached to it. 12. In the case of FactSet Research Systems Inc.[(2009) 317 ITR 169 (AAR)], this Authority took the view that it is permissible to take into account the definition in the Copyright Act, while considering a substantially similar question. It was observed thus : "18. The expression "copyright" is not defined in the Income tax Act. It must be understood in accordance with the law governing copyright in India, viz., the Copyright Act, 1957. In State of Madras vs. Gannon Dunkerley and Co., AIR 1958 SC 560 ; 9 STC 353, the Supreme Court held that the expression "sale of goods" in entry 48 ....
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....achines of the end-user, that too for licensee's internal use only, does not amount to the use of copyright or the right to use the same. Apart from copyright, the Revenue cannot bring the income in question within any of the other limbs of the definition of royalty in Art.12.3, it is contended. The consideration received by the applicant from VAR with reference to the transactions entered into with end-users is not a consideration for the use of any of the copy-rights in the software. The applicant finally submits that the income representing the payments received from the VARs can be treated as business profits by the applicant, but in view of the fact that the applicant has no "Permanent Establishment" as defined in Art.5 of the Treaty, that income is beyond the taxable net of the Income Tax Act. In this context, it is contended that VAR cannot be treated as a dependent agent of the applicant. 13.1. The arguments on behalf of the Revenue are summarized below: Whether considered from the angle of domestic law or the Treaty, the license fee paid by the customer in India is for the transfer of rights in respect of copyright in software or for the use of computer programme embedde....
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....ity a dependent agent of the applicant as the applicant controls the operations of the VAR. The discretion given to VAR to independently fix the price payable to it by the end-user is practically a dead letter because the standard price details would be available to the public and the said price will not be exceeded. It is VAR alone, in actual practice, which has authority to conclude the standard form contracts. It is, therefore, submitted that the applicant has an agency PE in India. 14. A reference to the Agreement (GVA) between the applicant and the VAR reveal the following: 14.1. The applicant appoints VAR to act during the term of the agreement as a non-exclusive distributor of products and brands in the 'territory'. "Product" means "the DS Group Computer Software and other products identified by brand" listed in the Brand Exhibit. The applicant or its group companies are at liberty to market and distribute the products directly or indirectly to end-users inside and outside the territory and they may also appoint other distributors of products and brands within or outside the territory.(cl.2.1). The applicant grants to VAR a non-exclusive, non-transferable license to market....
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....ter into written or oral contracts on behalf of the applicant. VAR cannot assign or delegate any of its rights or obligations to any third party without prior consent of the applicant. GVA imposes restrictions on the VAR in relation to the rights to develop any product or derivative work from the software provided to the end-user. Various other restrictions adverted to supra are also imposed on the VAR consistent with his position as non-exclusive distributor. The applicant will invoice VAR and VAR is required to make payment within 30 days irrespective of recoverability of the product price by the VAR from end-user. As noticed earlier, the GAV stipulates that the applicant shall retain all rights, title and interest in products including patent, copyright and trade secret rights. The applicant makes no warranties to VAR regarding products and such warranties are made only to the end-user. The applicant submits that the arrangement is squarely in the nature of purchase of intangible copyrighted products by VAR from the applicant for re-sale to end-user and such sale and purchase is on principal to principal basis. The applicant submits that in the entire transaction, the VAR acts p....
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....contains two or three elements (i) primary license charge (PLC) coupled with annual licence charge (ALC) PLC is a one time non-refundable charge for the grant of perpetual license to use the 'release' of licensed programme made available by company on the effective date of the license. The annual license charge (ALC) is a yearly charge, payable in advance i.e., for the first year of each license or renewed license. Payment of ALC for licensed programme entitles the licensee to support services for the licensed program for one year and a license to use the 'releases' of such program made available by the applicant during the year; (ii) yearly license charge (YLC) which is for renewal of the facility of using the releases of licensed program and support services for one year. Clause 5 refers to Intellectual Property Rights and confidentiality. The stipulations are almost similar to those in the GVA agreement. Transfer, assignment and sub-contract is prohibited. In the event the licensee fails to pay any annual or yearly license fee when due to VAR, the VAR shall have the right to withdraw from the Agreement on giving due notice. The circumstances in which the support services related....
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.... make use of the same for its internal purposes. It is seen from EULA that the Company grants the licensee (end-user) a non-exclusive, non-transferable licence to use the licensed programmes on the computer equipment belonging to the licensee or under its control. Licensed programme is made available to the licensee directly through electronic delivery the details of which have already been set out. The licensee/end-user does not make any payment to the applicant. The license charges (PLC/ALC) are collected by the VAR on its own. The authority to collect such licence fee from the end-user is specifically conferred on the VAR in terms of the agreement. Can it be said that the one time payment based on standard price minus discount paid by VAR to the applicant is in the nature of royalty? It depends on the question whether any rights that the applicant granted to the licensee/end-user include the right of using the copyright. Alternatively, going by the language of I.T.Act, the question is whether any right in respect of copyright has been transferred. It is here the distinction between the use of copyrighted article and the use of copyright has been stressed. The copyright which is ....
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....o the copyrighted product for internal business purpose, it would not be legally correct to state that the copyright itself has been transferred to any extent. It does not make any difference even if the computer programme passed on to the user is a highly specialized one. The parting of intellectual property rights inherent in and attached to the software product in favour of the licencee/customer is what is contemplated by the definition clause in the Act as well as the Treaty. As observed earlier, those rights are incorporated in Section 14. Merely authorizing or enabling a customer to have the benefit of data or instructions contained therein without any further right to deal with them independently does not, in our view, amount to transfer of rights in relation to copyright or conferment of the right of using the copyright. However, where, for example, the owner of copyright over a literary work grants an exclusive license to make out copies and distribute them within a specified territory, the grantee will practically step into the shoes of the owner/grantor and he enjoys the copyright to the extent of its grant to the exclusion of others. As the right attached to copyright i....
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.... where the consideration is for granting of rights to use the programme in a manner that would, without such license, constitute an infringement of copyright. Examples of such arrangements include licenses to reproduce and distribute to the public software incorporating the copyrighted programme, or to modify and publicly display the programme. In these circumstances, the payments are for the right to use the copyright in the programme (i.e. to exploit the rights that would otherwise be the sole prerogative of the copyright holder). In other types of transactions, the rights acquired in relation to the copyright are limited to those necessary to enable the user to operate the programme, for example, where the transferee is limited rights to reproduce the programme. This would be the common situation in transactions for the acquisition of a programme copy. The rights transferred in these cases are specific to the nature of computer programmes. They allow the user to copy the programme, for example onto the user's computer hard drive or for archival purposes. In this context, it is important to note that the protection afforded in relation to computer programmes under copyright law ....
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....d the computer programme and storing it in the computer for his own use. The copying/reproduction or storage is only incidental to the facility extended to the customer to make use of the copyrighted product for his internal business purpose. As admitted by the Revenue's representative, that process is 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. Apart from such incidental facility, the customer has no right to deal with the product just as the owner would be in a position to do. In so far as the licensed material reproduced or stored is confined to the four corners of its business establishment, that too on a non-exclusive basis, the right referred to in sub-clause (i) of Section 14(a) would be wholly out of place. Otherwise, in respect of even off the shelf software available in the market, it can be very well said that the right of reproduction which is a facet of copyright vested with the owner is passed on to the customer. Such an inference leads to unintended and irrational results. We may in this context refer ....
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....pyright in that programme may remain with the originator of the programme. But the moment copies are made and marketed, it becomes goods, which are susceptible to sales tax." Viewed from any angle, we have no hesitation in rejecting the contention of the Revenue referred to in para 18 supra. 19. Next, it has been argued on behalf of the Revenue that the right to sell or offer for sale the applicant's software product has been conferred on the VAR and therefore such authority given to VAR amounts to conferment of rights in or over the copyright in view of cl.(b)(ii) of Section 14. We are unable to sustain this contention. First of all, this contention of Revenue goes contrary to its stand that the product was licensed but not sold. Be that as it may, even for other reasons, the contention has to be rejected. VAR has not been given an independent right to sell or offer for sale the software products of the applicant to the end-users. What the VAR does in the course of carrying out its marketing function is to canvass for orders, collect the purchase order from the interested customer and forward that offer to the applicant. It is the applicant that accepts or rejects that offer. Fo....
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....ose, the applicant is called upon to do collation, analysis, indexing and noting wherever necessary. These value additions are the product of the applicant's efforts and skills and they are outside the public domain. In that sense, the database is the intellectual property of the applicant and copyright attaches to it; but, the question is whether in making this centralized data available to the customer-licensee for a 36 consideration, can it be said that any rights which the applicant has as a holder of copyright in database are being parted in favour of the customer? The answer, in our view, must be in the negative. No proprietary right and no exclusive right which the applicant has, has been made over to the customer." The ruling in FactSet may not apply in all fours to the case on hand in view of the qualitative difference in the nature of software. However, some of the passages therein have a bearing on the issue confronting us in the present case as well. It was observed at para 25 (of ITR): "25. Even examining from the standpoint of Treaty, we do not think that "the use of or right to use any copyright of a literary or scientific work" is involved in the subscriber getti....
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....ion 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 have any right in a copyright. In that case, the payment made by the cellular operator cannot be characterized as royalty either under the Income-tax Act or under the DTAA. The question, therefore, to be answered is whether any of the operators can exercise any of the rights mentioned in the above provisions with reference to the software supplied by the assessee." It was then pointed out in para 158 that in the definition of copyright, the emphasis is on the exclusive right granted to the holder thereof. This condition, it was observed, was not satisfied in the case of JTM because the license granted to it by the assessee was a "non-exclusive, restricted license". It was then observed: "This means that the supplier of the software, namely, the assessee, can supply similar software to any number of cellular operators to which JTM will have no objection and further all the cellular operators can use the software only for the purpose of their own operation and....
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....ppellant therein imported off-the-shelf software from different suppliers abroad. It was pointed out that what the appellant had acquired was only a copy of the copyrighted article i.e., software and the incorporeal right to software remained with the owner. The right to the use of copyright is different from the right to use the programme embedded in cassette or CD. 21. In view of the above discussion, we are of the view that no rights in relation to copyright have been transferred nor any right of using the copyright as such has been conferred on the licensee. 22. The Revenue has contended alternatively that the payments received by the applicant must be regarded as consideration for the use of or right to use the 'process' or the transfer of rights in respect of a process developed by the applicant. The Revenue's representative has drawn our attention to the recent order of the Special Bench of ITAT Principal Bench in the case of New Skies Satellite Telecommunications Ltd. (ITA no.5385/DEL/2004). After referring to the dictionary meaning which defines 'process' as a series of actions or steps towards achieving a particular end, the learned members of the Tribunal held "that a ....
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....enue's contention on this score therefore fails. We refrain to go into the other controversial question whether the adjective 'secret' governs both formula and process. However, we would like to observe that much can be said against the view taken by the Tribunal in the case of New Skies Satellite case that the 'process' need not be secret and it can be any kind of process, whereas the 'formula' should be in the domain of secrecy. 23. We may mention that the learned DR at one stage made a feeble attempt to bring the transaction under equipment royalty. However, it was not pursued further and moreover we find no legal basis for holding that there is any usage of equipment here. 24. The last point to be considered is whether the applicant can be said to have a permanent establishment or whether VARs are dependent agents of the applicant so as to give rise to an agency PE in India by virtue of article 5(7) of the DTAA. If the applicant is held to have a permanent establishment (PE) in India, it will have to pay tax on the business income even if the income is not royalty (vide article 5(1) of the DTAA). Article 5(7) reads thus: "Notwithstanding the provisions of paragraphs 1 and ....
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....d upon is clause 6.11 which says that in the event of the failure of VAR to invoice and collect license fees when due by end-users, the applicant shall have the right after consulting with VAR, to request VAR to assign to the applicant its obligations to invoice license fees and the right to collect the same. Yet another clause in the agreement referred to by Revenue's representative is clause 7 which deals with "VAR reports, records and plans". Under this clause, VAR is required to report to the business manager of the applicant, certain informations, namely, forecast reports, sales reports, capacity reports and such other information relating to the marketing and distribution of the products as the applicant may require. Under the head 'capacity reports' VAR is required to submit monthly details of number of sales representatives and application engineers working in each brand. Then, under clause 7.2, VAR is required to maintain accurate records relating to the marketing and sales of products to end-users in the territory which shall include details regarding the identity of each end-user, address, end-user contact, operating environments of each end-user, the date of receipt of ....
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....ave not been satisfied. On the point of legal dependency, it is submitted that VAR is a distinct legal entity which is unrelated to applicant. The management of VAR and the applicant is not common. As regards economic dependency, it is stated that the prohibition on sale of competing products is not total and further, the economic risk of the products has to be borne by VAR only and the applicant is not bound to take the product back or reimburse the VAR. Above all, VAR is not concluding contracts on behalf of applicant nor securing orders wholly or almost wholly for the applicant and, therefore, dependent agency does not arise. 25. We do not think that the contentions of the Revenue on the existence of an agency PE can be sustained. The business of VARs such as Tata Technologies Ltd. is not confined to the dealings only with the applicant and its products. They are appointed and known as distributors. It is not uncommon that a distributor carries out some functions and obligations similar to those of an agent. Improvement of the business of the applicant, assisting the applicant in formulating its marketing strategies and preventing the misuse of the product supplied to the end-u....