Case Law Details
Court: Mumbai bench of the Income Tax Appellate Tribunal
Citation: Kansai Nerolac Paints Ltd Vs. ADIT [2010-TII-155-ITAT-MUM-INTL]
Brief: It was held by ITAT, Mumbai that computer software when put into a media and sold becomes goods like any other audio cassette or painting on canvass or book. Accordingly, the amount paid by taxpayer towards purchase of such computer software from a Singapore company cannot be treated as royalty as per the India-Singapore tax treaty (tax treaty).
Further, the Tribunal held that since the payment for software cannot be treated as royalty, the taxpayer is not liable to deduct tax at source from such payment as per Section 195 of the Income-tax Act, 1961 (the Act).
Facts of the case
• Taxpayer has offices in several locations, which are connected to each other by an online real time accounting system.
• The taxpayer acquired software from IXOS Software Asia Pte Ltd, Singapore (IXOS) to enable it to transfer data from the main server to an auxiliary server in a compressed form as well as retrieves the data in uncompressed form.
• The taxpayer obtained a non-exclusive non-transferable licence to make copies of the programme to enable operation of the programme within its own business. No source code or programming language or technique would be provided with the programme.
• The taxpayer relied on the OECD commentary on Article 12 which states that when rights in relation to act of copying is transferred to enable the effective operation of program by user, the payment will be considered as commercial income in accordance with Article 7. It was argued that the payment in the hands of IXOS was not taxable in India under the tax treaty since it did not have a PE in India under the tax treaty.
• Accordingly, the taxpayer requested the Assessing Officer (AO) to issue a certificate of deduction of tax at source in terms of section 195(2) of the Act.
• The AO however, held that IXOS remained the absolute owner of the computer software and the taxpayer had been allowed to use the licensed software for a fee. Accordingly, the payment made by the taxpayer to IXOS would be in the nature of royalty as per the tax treaty.
CIT(A)’s order
• The agreement states that the taxpayer is only given license to use the software for a specified number of users and it would not own any software. The license permitted the taxpayer to store the software in computers for 50 users & therefore 50 users had the right to copy the software.
• The intellectual property of the author of software is protected through a copyright. When the intellectual property owner permits the customers to use the software through a license, it amounts to granting a right to copy the software programme in the computer.
• As per section 14(a)(i) of the Copyright Act, 1957, copyright includes reproduction of the work in any material form including the storing of it in any medium by electronic means. In the instant case, IXOS has allowed the copying of the work to the taxpayer for the purpose of its business and therefore the consideration received was royalty.
• Software was a literary or scientific work in which copyright exists. If the owner of the copyright allowed somebody to use the software by granting a license, the consideration received would be royalty. The sub-clauses (b) and (f) of section 14 of the Copyright Act, includes the “right to sell” copies of the software or film as copyright.
• Sale of a copyrighted article is different from issue of a license to use the software. If the transaction was a sale of a copyrighted programame, the owner can sell, lease or otherwise transfer the computer programme. Since the taxpayer has no such right, the transaction is not a sale of a copyrighted article.
• Software is a secrete process or formula and works in a series of instruments/operations to achieve the defined result. IXOS granted to the taxpayer the right to use the secret process and obtain the results. CIT(A) relied on the decision of the AAR {P-30 of 1999, In re [1999] 238 ITR 296 (AAR)} and held that the payment made by the taxpayer is for the use of the secret process owned by IXOS and, therefore amounts to royalty.
Tax department’s contentions
• In case of normal sale anybody can pay and buy anything whereas in the case of copyright sale an agreement is necessary. Since an agreement was executed it is a copyright sale.
• Further, the taxpayer is only having a right to use the software and no ownership is vested. Hence the transaction is not a case of sale but only a royalty agreement.
Taxpayer’s contentions
• The software gives the taxpayer a license to use like any other software. The taxpayer does not get any right in copyright but gets a right only to use.
• Reliance was placed on the decision of the Supreme Court in Tata Consultancy Services vs. State of AP [2004] 271 ITR 401(SC) and Motorola Inx Vs. DCIT [2005] 95 ITD 269 (Del) (SB) & Dassault Systems K.K., In re [2010] 322 ITR 125 (AAR) to contend that the transaction is a sale of a copyrighted article.
• The CIT(A) has wrongly held that the payment is for copyright, secret process and scientific equipment and therefore amounts to payment of royalty.
Tribunal’s ruling
• The Tribunal relied on the Supreme Court decision in the case of Tata Consultancy Services in which it was held that:
> The copyright in the 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.
> Intellectual property, once it is put on to a media, whether in the form of books or canvas or computer discs or cassettes, and marketed would become “goods”. Accordingly, a transaction of sale of computer software package off the shelf is clearly a sale of “goods” as per sales tax law in Andhra Pradesh.
• Further, reliance was placed on the Bangalore Tribunal’s decision in the case of Samsung Electronics Co. Ltd. Vs. ITO (TDS) [2005] 94 ITD 91(Bang) wherein it was held that:
> The taxpayer had acquired a ready made off the shelf computer programme for use in its business and no right was granted to utilize the copyright of the computer programme. The taxpayer had merely purchased a copy of the copyrighted article, namely, a computer programme.
> Accordingly the remittance made by the appellant for purchase of software is not an income in India; hence no tax is to be deducted in India under section 195 of the Act.
• The decision { P-30 of 1999, In re [1999] 238 ITR 296 (AAR)} relied on by the CIT(A) was considered by the AAR in the case of Dassault Systems K.K. wherein it was held that:
> Passing on a right to use of a product for which the owner has a copyright is different from transferring or assigning rights in relation to the copyright. The enjoyment of some or all the rights held by copyright owner, is necessary to trigger the royalty definition.
> A non-exclusive and non-transferable license enabling the use of a copyrighted product cannot be constructed as an authority to enjoy any or all the enumerated rights ingrained in a copyright.
> Where the purpose of the license is only to establish access to 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.
> 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 amount to transfer of rights in relation to copyright or conferment of the right of using the copyright.
• The Tribunal relying on the principles laid down by the above decisions held that computer software when put into a media and sold becomes goods like any other audio cassette or painting on canvass or book.
• Accordingly, the amount paid by the taxpayer to IXOS for purchase of software cannot be treated as payment of royalty taxable in India under Article 12 of the tax treaty and the taxpayer is not liable to deduct tax at source under Section 195 of the Act.
Our Comments
This is an important ruling by the Mumbai Tribunal where it has been held that the amount paid by the taxpayer towards purchase of software cannot be treated as payment of royalty taxable in India under Article 12 of the tax treaty and accordingly the taxpayer is not liable to deduct tax at source.
This judgement follows a long series of judgements of the tribunal holding that payment made towards licensing of standardized software cannot be considered as ‘royalties’ under the Act or treaties.
However, in view of the contrary view taken by the Delhi Tribunal in the case of Microsoft corporation8, this issue is likely to remain contentious in the days ahead.
The proposition laid down by this decision is also supported by OECD model commentary. As per clause 14 of OECD model commentary on Article 12, 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. Payments in relation to rights to acts of copying, where they do no more than enable the effective operation of the program by the user should be dealt with as commercial income in accordance with Article 7.
Further, the technical advisory group of OECD also had similar view which held that if the consideration is paid for a right other than a right in the intellectual property, then in that event, the payment made should not be treated as royalty as it is a purchase for the purpose of use of the product.
