Supply of customized software and enabling client personnel to handle the system amounts to “fees for included services” under the India-US tax treaty

Facts

• The Airport Authority of India (“AAI”” or “the applicant”) entered into a contract with Raytheon Company USA (RC) for “Automation Upgrade for third runway at IGI Airport, New Delhi.
• The contract involves RC supplying hardware, software and providing services in connection with installation. The cost of software was the major component of the contract.
• All the activities under the contract were performed outside India by RC and only some support activities relating to installation and site inspection tests were rendered in India.
• The contract specifically provided that the title and risk in the property (hardware and software) shall pass
  on to AAI outside India. AAI was responsible for payment of import duties and customs clearances.
• As regards software and documentation, the contract granted to AAI a non-transferable, non-exclusive, royalty free license for using the software only at Delhi.
• Software supplied by RC under the contract consisted of customer-off-the-shelf (COTS) software required to run the system (e.g. Acrobat Reader, Solaris operating system, Netscape, etc.) and RC’s ATC Automation application software (i.e. Autotrac) along with documentation.
• Facts regarding Autotrac ATC Automation software

–  Copyrights in ATC Automation application software belonged to RC.

– The Autotrac ATC Automation software though was standardized software; it required site specific modifications/adaptations depending on the operational requirements of the concerned airport where it is installed.

– Modification/adaptation related to number of runways in use, number of radar sensors available, total air-space to be controlled, quantum of air traffic, etc.

– Therefore, in the instant contract, the said standardized software was customized to suit the site specific requirements of the IGI Airport, New Delhi.

Contentions of the Applicant

• Hardware and software were imported into India after paying applicable customs duty. This is indicative of the fact that they were treated as goods.
• Essence of the contract was only purchase of certain copyrighted software and hardware on outright basis subject to certain end-use restrictions.
• Payments received by RC cannot be construed as giving rise to income by way of royalty and/ or fees for technical services.
• Amounts received by RC for supply of hardware, software and support services are in the nature of business profits and would not be taxable in India in the absence of Permanent Establishment (PE) in India as per the provisions of Article 7 of tax treaty between the India and USA.

Issues raised by the Applicant

• Whether payment received by RC was liable to tax in India?
• Whether tax was required to be deducted at source on payments to be made to RC? If yes, at what rate?

Ruling of the Authority for Advance Rulings (AAR)

Though the questions raised by the applicant (AAI) were covered by three earlier rulings of the AAR in the case of the same applicant, the AAR agreed to pronounce ruling in the light of subsequent exposition of law in some cases. The AAR observed that –

• The installation of software system is done after suitably modifying and adapting the software on physical verification and the study of various factors on ground.
• A site acceptance test was finally done and the procedure therefore was contained in a document. After trial testing, a Systems Manual was provided.
• Software as such had no value to AAI unless RC in close collaboration with AAI made the system functional at all times without the presence of RC’s technicians.
• By means of various technical services provided by RC’s personnel and the sharing of their technical knowledge and experiences with AAI personnel at the time of integration with the existing system and the site acceptance test and the technical manuals and data furnished for putting the system to effective use, RC made available to AAI its technical knowledge and skills.
• The substance of the transaction was rendering of technical and consultancy services which made available to AAI the technical knowledge, experience and skills possessed by RC in the field and the provision of software system is only part of that exercise.
• Software was a part of the package of setting up upgraded automation system; it had no value unless the supplier shared the technical knowledge, information and experience with the user and suitably  equipped the personnel of AAI to handle the system by them.

In this background, the AAR held that the payment towards software can be legitimately brought within the fold of Article 1 2(4)(b) of the India-US tax treaty.

Accordingly, the AAR held that payment for software is taxable in India at the rate of 10 per cent (plus applicable surcharge and cess). As regards installation services, there was no dispute about its tax ability. Regarding payment made for hardware and COTS software, the AAR held that payment for the same is not taxable in India in the absence of RC having PE in India.

Conclusion:- Under the specific facts of the case, customization of standardized software specific to client specifications was held to be “fees for included services” as the software developer made available technical knowledge, experience or skill to the client to enable client personnel to operate the software system themselves.

Source: Airport Authority of India (AAR) A.A.R. No. 819 of 2009 dated 18 March 2010