Payments for purchase of Software not Royalty – ITAT Mumbai

AAR in the case of Dassault (supra) was a case of sale of shrink wrap software and the AAR has held that reproduction and adaptation envisaged by section 14(a)(i) and (vi) can contextually mean only reproduction and adaptation for the purpose of commercial exploitation. The ruling of the AAR in the case of Dassault (supra) was approved by the Hon’ble Delhi High Court in the case of DIT Vs. Ericsson AB,New Delhi (supra). It can therefore be said that the Hon’ble Delhi High Court has held that consideration paid merely for right to use cannot be held to be royalty. This ratio laid down by the Hon’ble Delhi High Court would also apply when shrink wrap software is sold.

Following the view expressed by the Hon’ble Dellhi High Court in the case of DIT Vs. Ericsson AB, New Delhi (Supra), which is favourable to the Assessee, we hold that the consideration received by the Assessee for software was not royalty. The receipts would constitute business receipts in the hands of the Assessee. Admittedly the Assessee who is a non resident does not have a permanent establishment and therefore business income of the Assessee cannot be taxed in India in the absence of a permanent establishment.

Tuling of the ITAT Mumbai in the case of Solid Works Corporation   though rendered in the context of Non-residents involving definition of Royalty under Double Taxation Avoidance Agreements (DTAA), the ratio laid down therein will equally applicable to definition of Royalty under the Act and both the Hon’ble Karnataka High Court as well as the Hon’ble Delhi High Court have considered the issue in the light of the definition of royalty under the Act also.

INCOME TAX APPELLATE TRIBUNAL, MUMBAI

ITA NO.4446/MUM/201 1(A.Y. 2007-08)

Asstt. Commissioner of Income Tax

V/s.

Sonata Information Tech. Ltd.

Date of pronouncement :30/04/2012

ORDER

PER N.V.VASUDEVAN, J.M

This is an appeal by the revenue against the order dated 9/3/11 of CIT(A)-LTU, Mumbai relating to A.Y 2007-08.

2. Ground No.1 raised by the assessee reads as follows:

“1. On the facts and in the circumstances of the case and in law, the ld. CIT(A) erred in allowing service charges incurred for the service rendered by its holding company “Sonata Software Ltd.”

3. The assessee is a company engaged in the business of purchase and sale of software. The assessee while computing its income from business had claimed expenditure of Rs. 117,611,029/- on account of service charges paid to M/s. Sonata Software Ltd. (SSL). The expenditure was claimed to be in accordance with the agreement dated 28.09.2000 entered into by the assessee with M/s. Sonata Software Ltd., which has been revised on 01.07.2002 and 01.07.2004 and 01.07.2006. As per the said agreement, the assessee was to pay service charges to M/s. Sonata Software Ltd. for rendering the following services:

(a) Advise and assistance to SITL relating to compliance of various laws, Orders, Regulations and legal requirements of the Central, State and other governmental and local authorities concerning the conduct of the business and affairs of SITL.

(b) Training employees of SITL in the above areas;

(c) Assist and liaise with various government departments as and when required by SITL

(d) Overseeing the compliance requirements in regard to Companies Act, including matters related to Board of Directors and shareholders, contractual matters, advice and assistance in maintenance of statutory records, filing required return and form etc.

Further, all out of pocket expenses including travel, conveyance etc. were to be billed separately by Sonata Software Ltd. and was to be reimbursed by the assessee.

The quantum of service charges was determined by adopting the following basis. The expenditure incurred by SSL on account of insurance, salaries, allowances, directors’ remuneration’s electricity & charges, printing & stationery, Professional charges, repairs & maintenance, rent for offices, etc. and also depreciation has been apportioned to the assessee on the basis of turnover as service charges.

4. The AO called upon the Assessee to furnish the necessary documentary evidence to show that services stated at (a) to (d) above were rendered by SSL to the assessee. The assessee was also asked to furnish the supporting evidence for the out of pocket expenses on travel, conveyance, etc. In response, the assessee furnished its explanation on 25.11.2009. The Assessee that SSL was its parent company. SSL was in the business the profits of which were not taxable u/s. 10A of the Income Tax Act, 1961 (the Act) as well as other business. The Assessee company was formed and started operating from 01.07.2000 and took over the business activities of SSL the profits of which were not exempt u/s. 10A of the Act. The assessee entered into an agreement dt.28.9.2000 referred to in the earlier paragraph of this order with SSL for availing common services in the areas of Finance, Accounts, Taxation, Legal Administration, HRD etc. for the consideration on terms and conditions contained in the said agreement. The Assessee pointed out that SSL has raised debit note on the Assessee for rendering services, which are duly authenticated by agreement dated 28.09.2000 which has been duly revised on 01.07.2002 and 01.07.2004 and 0 1.07.2006. The Assessee pointed out that for services rendering during the previous year, the Assessee raised debit notes amounting to Rs. 117,611,029/-.

5. The Assessee submitted before the AO that the agreement was a commercial agreement executed in the best interests of business between two independent corporate entities and there is no room, whatsoever, for doubting the genuineness of the said agreement. As per the terms of the agreement, Sonata Software Ltd. did render services as stated above and in consideration of the services actually rendered, the assessee incurred an amount of Rs. 117,611,029/-. The Assessee pointed out that expenditure incurred for obtaining services/ assistance for the running of the business is an allowable commercial expenditure. The Assessee submitted that the expenditure of Rs. 117,611,029/- was incurred out of commercial expediency. The Assessee relied on the following judicial decisions to highlight that commercial expediency means anything that serves to promote and includes every means suitable to that end and expenditure which a prudent man may incur for the purpose of business. The decisions rendered in the following cases were referred to for the above proposition viz., Indian Steel & Wire Products Ltd. v. CIT (1968) 69 ITR 379 & Calcutta Landing & Shipping Co. Ltd. v. CIT (1967) 65 ITR 1, Calcutta. It was argued that it was the prerogative of the businessman how to run the business and it is not upon the Revenue to prescribe what expenditure an assessee should incur and in what circumstances it should incur. It was reiterated that every businessman knows his interest best – CIT v. Dhanrajgirji Raja Narasinghirji (1973) 91 ITR 544 (SC). The decision of the Hon’ble Supreme Court in the case of CIT vs. Walchand & Co. (1967) 65 ITR 381 (SC) was referred to and it was submitted that in applying the test of commercial expediency whether the expenditure was wholly and exclusively laid out for the purpose of business, reasonableness of the expenditure has to be judged from the point of view of the business man and not of the revenue. The Hon’ble Bombay High Court’s decision in the case of Aruna Mills (31 ITR 153) was also referred to wherein it was held as follows:

“Now, we have had occasion to point out in several decisions that what the Income-tax purports to tax is business profits, and business profits are the true profits of a business as ascertained according to commercial principles. There may be an expenditure or there may be a loss which may not be an admissible loss under any of the provisions of section 10(2) (corresponding to section 29 of the 1961 Act) and yet such an expenditure or loss would have to be allowed in order to determine what were the true profits of a business, and it is the duty of every one who has anything to do with taxing business-people to understand what are the principles of commercial expediency. Unless one understands these principles it is difficult to make a proper assessment on a business or on a businessman.”

6. Attention of the AO was to drawn to the fact that in the assessment order u/s. 143(3) for A.Y. 200 1-2002, the A.O. disallowed the service charges incurred by the assessee, which was payable to SSL., on the ground that such expenses have been incurred to reduce the tax liability of the assessee and increase the non-taxable profits of Sonata Software Ltd. by relying on Supreme Court Judgment in the case of 154 ITR 148. It was highlighted that the learned CIT(A) however only allowed partial relief to the assessee by allowing expenses to the extent of Rs. 50.00 lacs and upheld the order of A.O. for the balance amount. On second appeal to ITAT, the Hon’ble Tribunal deleted the addition made and allowed total relief to the assessee, Further attention was drawn to the fact that the learned CIT(A) in the preceding years for A. Y. 2002- 03, A.Y. 2003-04 A.Y. 2004-05 & A.Y. 2005- 06, has also allowed relief to the assessee by placing reliance on the Hon’ble Tribunal’s order in assessee’s own case for A.Y. 200 1-02. Further it was also brought to the notice of the AO that the issue of allowability of service charges was also decided in assessee’s favour in its own case by the Hon’ble ITAT in A. Y. 2002-03, A. Y. 2003-04, A. Y. 2004- 05 and A. Y. 2005-06 has also deleted the disallowance in respect of service charges paid by the assessee to SSL In view of the above the Assessee submitted that the entire amount of Rs. 117,611,029/- should be allowed as business expenditure.

7. The AO however was of the view that (i) Payment of service charges by the Assessee to SSL is mere diversion of income without services rendered by SSL. Mens rea for this claim is to reduce taxable profit and claim more 10- A profit in SSL. (ii) The receipts on account of Service Charges in the hands of SSL have not been credited separately as the income of its non-1OA activity. However, these receipts have been reduced from the expenditure claimed of 1 OA activity of SSL. The net implication of this is that the profits of the 1OA activity of SSL have increased and on which no tax has been paid. Whereas in fact, these receipts are clearly pertaining to the non 1OA activity of SSL and therefore such receipts should have been offered to tax. (iii) The assessee has contended that the said agreements have been executed in the best interest of the business between two independent corporate entities. It has also been contended that the same has been incurred out of commercial expediency. It has further been submitted that it is prerogative of the businessman as to how to run its business and the department should be prescribed the quantum of expenditure etc. : These contentions of the assessee would have been acceptable if this agreement was entered into between two independent entities not under the common management and control. In the instant case, the assessee is a 100% subsidiary of SSL. The implication of this agreement is that the taxable profits of the assessee have been reduced and at the same time increasing the non-taxable profits of its holding company – SSL.

8. For the above reasons the AO held that the services agreement between the assessee and its holding company has been entered into with the clear intention of reducing the tax liability of the assessee and increasing the non¬taxable profits of SSL. The AO relied on the decision of the Hon’ble Supreme Court in the case of McDowell (154 ITR 148) wherein it was held that colourable devices cannot be part of tax planning and it is wrong to encourage avoidance of tax by dubious methods and that it is for the Courts to take stock and determine the nature of legal devices to avoid taxes and to expose these devices for what they really are. The AO also held that the Assessee did not prove that services were in fact rendered by SSL with supporting evidence. He also held that the assessee has only submitted debit notes raised by SSL which in no way substantiates as to whether SSL has really provided any services to the assessee company and has incurred any expenses for providing the same. He held that the onus to prove that a particular expenditure has been incurred for the purposes of business is on the assessee and as the assessee has failed to discharge this onus, the expenditure claimed is not allowable. Accordingly, the amount of Rs. 11,76,11,029/- paid to SSL was held to not an expenditure incurred by the assessee for the purposes of its business and thus was not allowable expenditure. The AO also held that the decision of the ITAT in the earlier Assessment years has not been accepted by the department and appeal has been filed before the high court in all the concerned years, the final decision of which is still awaited. Accordingly, the assessee’s claim of payment of services charges of Rs. 117,611,029/- to M/s. Sonata Software Ltd. Was disallowed and added back to the total income of the assessee.

9. On appeal by the assessee the CIT(A) deleted the addition made by the AO following the Tribunal order for the earlier assessment years.

10. At the time of hearing it was agreed by the parties that similar issue had come for consideration in assessee’s own case in A.Y 200 1-02 in ITA No.3702/M/04 and this Tribunal on identical issue held as follows:

“7. The next issue arising from the appeal of assessee relates to the disallowance of Rs.6,55,88,590/- on account of service charges paid to Sonata Software Ltd. (SSL). Brief facts giving rise to this appeal are these: The assessee is 100% subsidiary of SSL. It came into existence in the year under consideration with the object to carry out one of the activities of SSL which was not eligible for exemption u/s. 10A. Prior to the year under consideration, SSL was carrying out two independent activities i.e. (i) activity eligible for exemption u/s. 1OA and (ii) the activity not eligible for exemption u/s. 10A . Separate accounts were maintained by SSL for these activities. Direct expenses relating to these activities were accounted for in the separate accounts respectively. However, service charges were common and later on allocated to these activities on the basis of turnover. The assessee, after its incorporation, took over the activity of SSL, which was not eligible for exemption u/s. 10A on 1.7.2000. However, an agreement was entered into between assessee and SSL to the effect that SSL would continue to incur expenses in the nature of service charges on behalf of assessee as before and the same would be reimbursed by the assessee. The assessee paid the sum of Rs.6,55,80,590/- as service charges for the year under consideration and claimed the same as business expenditure.

8. The Assessing Officer disallowed the entire expenditure by observing as under:

“(i) The following tabulation gives details of the sales, expenditures claimed of the nature “Legal & Professional expenses” and of the nature “Recruitment & Training” in the separate Profit & Loss Accounts prepared for the non-10A activity of SSL in the A. Yrs. 1998-99, 1999-00 and 2000-01 and in the case of the assessee company for the A. Yrs. 200 1-02 and 2002-03.

From the above, it is observed that the expenditure in SSL under the heads “Legal and Professional” and “Recruitment and Training” for the A. Yrs. 1998-99 to 2000-0 1 increased in proportion to the turnover from Rs. 18.25 lakhs to Rs.49.09 lakhs (Rs39.5 lakhs + Rs.9.5 lakhs). However, in comparison to this, the expenditure on account of “Service charges” (which encompasses the expenditures claimed under the said two heads) in the assessee company for A. Yrs. 200 1-02 and 2002- 03 has been claimed at an abnormally high amount of Rs.655.88 lakhs and Rs.9 10.27 lakhs respectively, disproportionate to the turnover of the assessee.

(ii) It has been stated in the said agreement of SSL with the assessee company that all out of pocket expenses including travel, conveyance etc. are to be billed separately by SSL and shall be reimbursed bit the assessee. However, rather than separately billing for these out of pocket expenses, SSL is raising periodic lump sum credit notes by apportioning the expenditure incurred by SSL on account of insurance, salaries and allowances, directors remuneration, electricity and water charges, printing and stationery, professional charges, repairs and maintenance, rent for offices and also depreciation. The assessee was categorically asked to furnish supporting evidences to show that the said services stated at (a) to (d), above were rendered by SSL. However, the assessee has not furnished the same till the finalization of the assessment. The only evidences submitted are the debit/credit notes raised on the assessee by SSL according to which the expenses incurred in SSL have been apportioned to the assessee on the basis of turnover of the assessee and SSL. Payment pf service charges from SITL to SSL is mere diversion of income without services rendered by SSL. Mens rea for this claim is to reduce taxable profit and claim more 10-A profit in SSL.

(iii) The receipts on account of Service Charges in the hands of SSL have not been credited separately as the income of its non-1 0A activity. However, these recetts have been reduced from the expenditure claimed of 10A activity of SSL. The net implication of this is that the profits of the 10A activity of SSL have increased and on which no tax has been paid. Whereas in fact, these receipts are clearly pertaining to the non-10A activity of SSL and therefore such receipts should have been offered for tax.

iv) The assessee has contended that the said agreement has been in the best interest of the business between two independent corporate entities. It has also been contended that the same has been incurred out of commercial expediency. It has further been submitted that it is the prerogative of the businessman as to how to run its business and the Department should not prescribe the quantum of expenditure etc. These contentions of the assessee would have been acceptable if this agreement was entered into between two independent entities not under the common management and control. In the instant case, the assessee is a 100% subsidiary of SSL. The implication of this agreement is that the taxable profits of the assessee have been reduced and at the same time increasing the non-taxable profits of its holding company-SSL.

v) 0n perusal of the Balance Sheet of the assessee company, it is observed that out of the total service charges of Rs. 655 88 lakhs payable to SSL for the relevant year, an amount of Rs.522.57 lakhs is outstanding as on 31.03.2001. MThis further indicates that the basic purpose of this agreement is to reduce the tax liability in the hands of the assessee and increase the non¬taxable profits of SSL”

In Para 4.4 of his order, the Assessing Officer also observed that entire exercise was a colourable device to reduce its tax liability and to increase non-taxable profits of SL.

9. The matter was carried in appeal before the CITAO before whom it was submitted that:

“Before me in the appeal proceedings, it was explained on behalf of the assessee that Assessing Officer has misled himself in presuming that the agreement for services covers only the legal and professional charges and recruitment and training expenses. ft was explained that the area of services covered under the agreement is very broad and that the expenditure has been claimed on the basis of actual expenditure incurred on the basis of debit notes received from SSL and that f the expenditure in question was not incurred the assessee would not have been able to carry on its business. ft was further submitted that the debit notes issued by SSL and the details given to the Assessing Officer in support of the expenditure included in the debit notes show that not only legal and other specified services were the subject in the agreement but also other services which are not specifically stated in the agreement were also included.”

10. The CIT(A) examined the details of the expenditure which had been allocated on the basis of respective turnover which was given along with debit notes. It has been made clear that such details were also furnished before Assessing Officer. (See page 23-24 of the order). It was noted by CIT(A) that entire expenditure was incurred commonly for SSL and assessee and was allocated on the basis of turnover. According to him, business activities of SSL was much more expenditure oriented than business activity of assessee. Hence, in his opinion, the expenditure on support services to the assessee in the ratio of turnover was patently wrong. After going through the agreement, it was also held that SSL was required to advise the assessee in the matters of finance, accounts, taxation, legal, administration, HRD etc. and proper maintenance of record, compliance under various laws and training of employees. He also noted that assessee itself had incurred operational expenses of Rs.835.76 lacs which shows that assessee itself maintaining a large force of its employees. Such expenses amounted to 8.31% of total turnover which itself was ver, 1 high. Proceeding further, he examined the nature of expenses of SSL, which had been allocated on the basis of turnover. He found that such expenses were incurred on account of various heads totaling 44. According to him, such services had nothing to do with services mentioned in the agreement. In his view, only a portion of salaries and other allowances of employees working in finance, accounts, taxation, legal, administration, HRD, education and research and training deptt. could be allocated. He then estimated the sum of Rs.50 lacs towards the services of SSL rendered from assessee and held the same to be allowable. Rest of the expenditure was held to be disallowable. Aggrieved by the same, the assessee is in appeal before the Tribunal.

11. We have heard both the parties in the light of the materials placed before us. We find that the issue regarding the allocation of expenses in respect of service charges arose in the case of SSL. In that case, the Assessing Officer was of the view that allocation of expenses for Non-1 OA unit (not eligible for exemption) was excessive as exempted unit was much more expenditure oriented. The matter ultimately reached the Tribunal which accepted the case of assessee that allocation of support services expenses on the basis of turnover was justified. The Tribunal, vide para 34 of its order dated 17.03.2003 in ITA No. 495/496/M/02, held as under:

“We have considered the submissions and we have perused the various records placed in the Paper book. In the Paper book at page 27 to 34, the assessee has placed each and every head of expenditure and this Expenditure has been bifurcated under the three heads- STP unit entitled to deduction under section 10A, non STP not entitled to deduction u/s. 10A and support services. Further, it is found that the basis of allocation amongst the three heads is actual expenses, number of employees and ratio of fixed assets, floor area and turnover ratio. Thus, on the basis of above five criteria, expenditure has been allocated to the three heads.. Further, it is noticed that the total expenditure allocated under third head i.e. support services; has been again allocated under two heads – 1) STP units entitled to deduction u/s. 10A and non-STP which is not entitled for deduction u/s. 10A on the basis of turnover ratio. In our considered opinion the allocation of expenditure contained in the Paper book at page 27 to 31 appears to be appropriate. As per details contained in pages 27 to 31, it can be seen that the appellant company has only allocated expenses of Support Service Division between 1 0A and non-10A activities in the ratio of turnover has been called for by the Assessing Officer by this letter dated 20.01.2000 appearing at page 35 of the Paper book. Further, direct expenses relating to 10A and non- 10A activity has been directly charged against the profits of these activities and do not call for any interference.” .

The above observations of the Tribunal resolve the controversy before us. Admittedly, prior to incorporation of assessee company, SSL was carrying on two units independently i.e. unit exempted u/s. 1OA and the unit not exempted. Direct expenses incurred were separately booked to respective units. Only the support services expenses were allocated on the basis of turnover. Such allocation has been found to be proper and reasonable by the Tribunal. There is no dispute that non exempted unit was taken over by the assessee company and support services were continued to be rendered by SSL. From the inception, the stand of the assessee has been that such expenses were allocated on the basis of turnover as is apparent from para 4.3.3(ii) of the ‘assessment order, wherein it has been mentioned that expenses were allocated in debit notes as the basis of turnover. Even the CIT(A) has also admitted this factual position at page 23 of his order where he mentioned “The details of the expenditure which has been allocated on the basis of respective turnover is given along with debit notes, copies of which were filed before me, as also before the Assessing Officer”. Faced with the same, the id. Departmental Representative had nothing to add except to rely on the order of Assessing Officer. The Id. Departmental Representative submitted that allocation of expenses requires verification and therefore the matter may be referred to Assessing Officer for necessary verification. We are unable to accept this request since there is no dispute to the factual position that allocation of service expenses was made on the basis of turnover. No useful purpose would be served in restoring the issue. Accordingly, following the finding of the Tribunal in the case SSL, we set aside the order of CIT(A) on this issue and delete the disallowance sustained by him.”

11. The above order of the Tribunal has been followed in assessee’s own case for A.Y 2002-03, in ITA No.3027/M/06, A.Y 03-04, 3758/M/06 , A.Y 2004-05 & A.Y 2005-06 ITA No.3158& 3161/M/08. Facts and circumstances under which the disallowance was made in the earlier years and the present Assessment year are identical. Respectfully following the aforesaid decisions we uphold the order of CIT(A) dismiss ground No.1 raised by the revenue.

12. Ground No.2 & 3 raised by the revenue read as follows:

“2. On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in allowing deputation charges in respect of personnel deputed by SSL.

3. On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in allowing reimbursement of various expenses to SSL in respect of for personnel deputed by SSL for an amount of Rs.31,48,285/-.”

13. In the course of assessment proceedings, the AO noticed that the Assessee had claimed expenses under the head “Deputation Expenses” of Rs.5,51,27,246/- and Rs.1,36,63,680/- under the head “Other Expenses”. These expenses were claimed as having been incurred by M/S.Sonata Software Lrtd. (SSL) on behalf of the Assessee, which the Assessee had reimbursed to SSL. The AO called upon the Assessee to establish that SSL had really incurred these expenses on behalf of the Assessee. The Assessee filed debit notes raised by SSL regarding the above expenses. According to the AO no supporting evidence was filed and therefore the Assessee failed to establish that the payment was made to SSL in respect of services performed for and on behalf of the Assessee. The AO also held that the Assessee failed to establish that expenses in question were incurred for the purpose of business of the Assessee. The AO also held that there was already an agreement between the Assessee and SSL whereby SSL was rendering common services in the areas of Finance, Accounts, Taxation, Legal Administration, HRD etc. for which the Assessee was making payment to SSL. The AO held that the Assessee failed to establish that the reimbursement of expenses in question were different from the services for which payment was made by the Assessee to SSL under the agreement for rendering common services. Finally the AO held that the Assessee and SSL were subsidiary and Holding companies and the transaction in question was entered into with a clear intention of reducing the tax liability of the Assessee and increasing the non-taxable profits of SSL as SSL was claiming deduction u/s. 10A of the Act. For all the above reasons the AO disallowed the aforesaid expenditures and added the sums referred to above to the total income of the Assessee.

14. As far as Deputation charges of Rs.5,51,27,246/- are concerned, the Assessee submitted before CIT(A) additional evidence in support of the expenses regarding deputation charges. The CIT(A) accepted the plea of the additional evidence as it was necessary for disposal of the issue before him. The additional evidence was duly confronted to the AO and his remand report sought on the additional evidence. The additional evidence filed by the Assessee before CIT(A) is available at pages-39 to 62 of Assessee’s paper book filed before the Tribunal. The same gives the details of the employees who were sent on deputation by SSL and the projects of the Assessee in support of which the employees were sent, the amount paid to each of the employees. The AO in his remand report was of the view reiterated the stand as was taken in the order of assessment.

15. The CIT(A) was satisfied that the expenditure on deputation charges were incurred wholly and exclusively for the purpose of business of the Assessee and that the same was genuine. He therefore directed the AO to allow the claim of the Assessee. Aggrieved by the order of the CIT(A), the Revenue has raised Gr.No.2 before the Tribunal.

16. As far as other expenses of Rs.1,36,63,680/- are concerned, the Assessee filed additional evidence before CIT(A) giving details of the other expenses and the debit notes raised by the Assessee regarding those expenses. The same was admitted as additional evidence by the CIT(A). The AO gave remand report giving the same reasons assigned in the order of assessment for rejecting the claim of the Assessee. The additional evidence filed by the Assessee is at pages 63 to 67 of the Assessee’s paper book. The individual items of other expenses under various expenses have been given by the Assessee. The AO in the remand report has not raised any objection pointing out specifically as to how these expenses were not related to the business of the Assessee. The CIT(A) deleted the addition made by the AO as he was satisfied that the expenses in question were incurred wholly and exclusively for the purpose of business of the Assessee and that the same were genuine. He therefore directed the AO to allow the claim of the Assessee. Aggrieved by the order of the CIT(A), the Revenue has raised Gr.No.3 before the Tribunal.

17. We have heard the submissions of the learned DR on Gr.NO.2 and 3 who relied on the order of the AO. The learned counsel for the Assessee reiterated submissions made before CIT(A) and the order of the CIT(A).

18. We have considered the rival submissions. While deciding Gr.No. 1 of the Assessee, we have already seen the terms of the Agreement between the Assessee and SSL by which SSL agreed to render some common services in the areas of Finance, Accounts, Taxation, Legal, Administration, HRD, education, Training , Research etc. Clause-3 of the said agreement which have been referred to in the earlier part of this order clearly shows that the expenses covered by that agreement cannot and do not relate to expenditure incurred on deputing employees to work on specific projects of the Assessee. Therefore the expenses on account of deputation charges as well as other expenses are not covered under the aforesaid agreement. The other reasons given by the AO for making the impugned disallowance cannot also be sustained. The order of the Tribunal referred while deciding Gr.No. 1 will equally apply to Gr.No.2 and 3 also as the other reasons given for making the impugned disallowance are similar to the one given while making the disallowance of expenses which is subject matter of Gr.No. 1. We are therefore of the view that there is no merit in Gr.No.2 and 3 raised by the Revenue. Consequently Gr.No.2 and 3 are dismissed.

19. Ground No.4 raised by the revenue reads as follows:

“4. On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in directing A.O. not to treat the purchase of software from various resident entities as royalty u/s. 91 (1)(vi) of the Act.

20. As far as Gr.No.4 is concerned, the facts are that the Assessee made a payment of Rs. 148,10,25,308 for purchase of software from persons who are resident in India. The Assessee did not deduct tax at source while making payment towards such purchases. According to the AO the Assessee as a purchaser of the software had a right to use the software and the payment was for such right to use software, which was in the nature of a royalty. Under the provisions of Sec.40(a)(ia) of the Act, any payment to a resident which is claimed as deduction while computing income and on which tax is deductible in accordance with the provisions of the Act and where tax is not so deducted, the Assessee will not be entitled to deduction while computing income. The payments have to be in the nature set out in those provisions. The provisions of Sec.40(a)(ia) as amended by the finance Act, 2008 with retrospective effect from 1st April, 2005 read as under:-

“(ia) any interest, commission or brokerage, rent, royalty, fees for professional services or fees for technical services payable to a resident, or amounts payable to a contractor or sub-contractor, being resident, for carrying out any work (including supply of labour for carrying out any work), on which tax is deductible at source under Chapter XVII-B and such tax has not been paid,-

(A) in a case where the tax was deductible and was so deducted during the last month of the previous year, on or before the due date specified in sub-section (1) of section 139 ; or

(B) in any other case, on or before the last day of the previous year.

Provided that where in respect of any such sum, tax has been deducted in any subsequent year, or has been deducted

(A) during the last month of the previous year but paid after the said due date; or

(B) during any other month of the previous year but paid after the end of the said previous year, such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid.”;

According to the AO, the payment in question is in the nature of Royalty because it was for a right to use software and therefore the Assessee ought to have deducted tax at source and since the Assessee had not so deducted tax at source, the sum in question was allowed as deduction in computing income under the head business income and an addition was made accordingly to the business income of the Assessee. The AO also relied on the decision of the Hon’ble Karnataka High Court in the case of CIT(Intl.Taxation) Vs. Samsung Electronics Co. Ltd. ITA No.2808 of 2005 dated 24.9.2009 wherein the issue was decided in favour of the Revenue. The stand of the Assessee was that it was in the business of purchase and sale of software and that it did not have a right to use the software and that it was akin to purchase and sale of goods and therefore the payment in question was not in the nature of royalty and there was no obligation to deduct at source on the part of the Assessee for such payment and therefore no disallowance of expenses can be made u/s.40(a)(ia) of the Act. The AO however made disallowance under the provisions of Sec.40(a)(ia) of the Act.

21. On appeal by the CIT(A), the CIT(A) deleted the addition made by the AO for the following the decision of the ITAT Mumbai in the case of Kansai Nerolac Paints Ltd. Vs. ADIT 134 TTJ 342(Mum) wherein it was held that computer software when put into a media and sold is akin to goods like any other audio cassette or painting on canvass or books and amount paid by the Assessee towards purchase of such computer software cannot be treated as payment of royalty taxable in India.

22. Aggrieved by the order of the CIT(A), the Revenue has raised Gr.No.5 before the Tribunal. We have heard the submissions of the learned DR who relied on the order of the AO and the decision of the Hon’ble Karnataka High Court in the case of CIT Vs. Samsung Electronics co. Ltd. ITA No.2808 of 2005 dated 15.10.2011, a copy of which has been filed before us. The Hon’ble Karnataka High Court was dealing with a case where the question was as to whether the amounts paid to the foreign software suppliers were royalty. The Hon’ble Court after considering the provisions of Sec. 14 of the Copyright Act, 1957, definition of “Royalty” under Double Taxation Avoidance Agreement (DTAA), terms of use of shrink wrap software by the end user, distributor and sub-distributor, held as follows:

“24. It is clear from the above said provisions of the Copyright Act that the right to copyright work would also constitute exclusive right of the copyright holder and any violation of the said right would amount to infringement under Section 51 of the Act. However, if such copying of computer program is done by a lawful possessor of a copy of such computer programme, the same would not constitute infringement of copyright and wherefore, but for the licence granted in these cases to the respondent to make copy of the software contained in shrink-wrapped / off-the-shelf software into the hard disk of the designated computer and to take a copy for backup purposes, the end user has no other right and the said taking backup would have constituted an Infringement, but for the licence. Therefore, licence 1granted for taking copy of the software and to store It in the hard disk and to take a back up copy and right to make a copy Itself is a part of the copyright. Therefore, when licence to make use of the software by making copy of the same and to store it in the hard disk of the designated computer and to take back up copy of the software, it is clear that what is transferred is right to use the software, an exclusive right which the owner of the copyright i.e., the respondent — supplier owns and what is transferred is only right to use copy of the software for the Internal business as per the terms and conditions of the agreement. The decision of the Delhi High Court In COMMISSIONER OF INCOME MTAX DELHI-V Vs. M/s. DYNAMIC VERITCAL SOFTWARE INDIA PVT. LTD in ITA No.1692/2010 DATED 22.02.2011 relied upon by Sri Aravind Dattar, learned senior counsel appearing for the respondent in some of the cases in support of his contention that by no stretch of imagination, payment made by the respondents to the non-resident suppliers can be treated as royalty is not helpful to the respondents in the present cases as in the said case, Delhi High Court was considering the provisions of Sections 40(a)(1) of the Act and the order of the High Court reads as follows: –

“What is found, as a matter of fact, is that the assessee has been purchasing the software from Microsoft and sold it further in Indian market. By no stretch of imagination, it would be termed as royalty.”

Therefore, the contention of the learned senior counsel appearing for the respondents that there is no transfer of any part of copyright or copyright under the impugned agreements or licenses cannot be accepted. Accordingly, we hold that right to make a copy of the software and use it for internal business by making copy of the same and storing the same in the hard disk of the designated computer and taking back up copy would itself amount to copyright work under Section 14 (1) of the Act and licence is granted to use the software by making copies, which work, but for the licence granted would have constituted infringement of copyright and licencee is in possession of the legal copy el the software under the licence. Therefore, the contention of the learned senior counsel appearing for the respondents that there is no transfer of any part of copy right or copyright and transaction only involves sale of copy of the copyright software cannot be accepted. It is also to be noted that what is supplied is the copy of the software of which the respondent – supplier continues to be the owner of the copyright and what is granted under the licence is only right to copy the software as per the terms of the agreement, which, but for the licence would amount to infringement of copyright and in view of the licence granted, the same would not amount to infringement under section 52 of the Copyright Act as referred to above. Therefore, the amount paid to the non-resident supplier towards supply of shrink wrapped software or off-the-shelf software is not the price of the C.D, alone nor software alone nor the price of licence granted. This is a combination of all and in substance, unless licence is granted permitting the end user to copy and download the software, the dumb C D. containing the software would not in any way be helpful to the end user as software would become operative only if it is downloaded to the hardware of the designated computer as per the terms and conditions of the agreement and that makes the difference between the computer software and copyright in respect of books or prerecorded music software as book and prerecorded music CD can be used once they are purchased, but so far as software stored in dumb CD is concerned, the transfer of dumb C.D. by itself would not confer any right upon the end user and the purpose of the CD is only to enable the end user to take a copy of the software and to store it in the hard disk of the designated computer if licence is granted in that. behalf and in the absence of licence the same would amount to infringement of copyright, which is exclusively owned by non-resident suppliers, who would continue to be the proprietor of copyright. Therefore, there is no similarity between the transaction of purchase of the book or prercorded music C.D. or the C.D. containing software and in view of the same the Legislature in its wisdom, has treated the literary work like books and other articles separately from computer software within the meaning of the ‘Copyright’ as referred to above under Section 14 of the Copyright Act.

25. It Is also clear from the above said analysis of the DTAA income Tax Act, Copyright Act that the payment would constitute royalty within the meaning of Article 12(3) of the DTAA and even as per the provisions of 9(l)(vi) of the Act as the definition of royalty under clause 9(1) (vi) of the Act is broader than the definition of royalty under the DTAA as the right that is transferred in the present case is the transfer of copyright including the right to make copy of software for Internal business, and payment made in that regard would constitute royalty for imparting of any information concerning technical, industrial, commercial or scientific knowledge, experience or skill as per clause (iv) of explanation 2 to Section 9(1) (vi) of the Act. In any view of the matter, in view of the provisions of Section 90 of the Act, agreements with foreign countries DTAA would override the provisions of the Act. Once it is held that payment made by the respondents to the non¬resident Companies would amount to royalty within the meaning of Article 12 of the DTAA with the respective country, it is clear that the payment made by the respondents to the non-resident supplier would amount to royalty. In view of the said finding, it is clear that there is obligation on the part of the respondents to deduct tax at source under Section 195 of the Act and consequences would follow as held by the Hon’ble Supreme Court while remanding these appeals to this Court. Accordingly. we answer the substantial, question of law in favour of the revenue and against the assessee by holding that on facts and circumstances of the case, the ITAT was not justified in holding that the amount(s) paid by the respondent(s) to the foreign software Suppliers was not ‘royalty’ and that the same did not give rise to any ‘income’ taxable in India and wherefore, the respondent(s) were not liable to deduct any tax at source and pass the following Order:

“All the appeals are allowed. The order passed by the Income Tax Appellate Tribunal, Bangalore Bench “A” impugned in these appeals is set aside and the order passed by the Commissioner of Income Tax (Appeals) confirming the order passed by the Assessing Officer (TDS)-I is restored.”

23. The learned counsel for the Assessee relied on the decision of the Hon’ble Delhi High Court in the case of Director of Income Tax Vs. Ericsson A.B., New Delhi ITA No.504/2007 dated 23.12.2007. The Hon’ble Delhi High Court was dealing with a question as to whether the Tribunal was justified in holding that the consideration for supply of software was not a payment by way of royalty, and hence was not assessable both u/s.9(1)(vi) of the Act and the relevant clause of DTAA with Sweden. The facts of the aforesaid case were that the assessee company was incorporated in Sweden and was one of the leading suppliers of telecommunication equipment comprising of both, hardware and software. The assessee company had entered into agreements with ten cellular operators in India for supply of hardware and software. The Assessing Officer was of the view that the income of the assessee was taxable in India, both, under the Income-tax Act, 1961 as well as under the treaty between India and Sweden. He held that it was business income and Assessee had a PE in India. The CIT(A) held that the receipts in respect of license to use software which is part of the hardware alone could be taxed in India as royalty. The Assessee argued before Tribunal that the payment made by the assessee for the use of software in the equipment does not amount to royalty. The Tribunal in the aforesaid context examined the issue as to whether the payment is for a copyright or for a copyrighted article. If it is for copyright, it should be classified as royalty both under the Income-tax Act and under the DTAA and it would be taxable in the hands of the assessee on that basis. If the payment is really for a copyrighted article, then it only represents the purchase price of the article and, therefore, cannot be considered as royalty either under the Act or under the DTAA. The Tribunal after referring to definition of Royalty under the Act and the definition copyright under the Copyright Act, 1957 held that what was sold by the non resident was a copyrighted article and payment to the non resident was not for copyright. On further appeal by the Revenue, the Hon’ble Delhi High Court examined the issue which we have set out earlier. The Hon’ble Delhi High Court held that income did not accrue to the non-resident by virtue of a business connection in India and therefore the question of the Non resident having a permanent establishment in India did not arise for consideration at all. On the issue whether the payment to the non resident was of the nature of royalty which could be brought to tax in India, the Hon’ble Delhi High Court held as follows:

“WHETHER THE INCOME FROM THE SUPPLY CONTRACT CAN BE TREATED AS ‘ROYALTY’ UNDER SECTION 9(1)(vi) OF THE ACT:

50. Section 9 (1) (i) of the Act which deals with the taxability of,, royalty income” reads as under:-

“Section 9 .INCOME DEEMED TO ACCRUE OR ARISE IN INDIA. (1) The following incomes shall be deemed to accrue or arise in India :-

(i) All income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India”

51. The submission of Mr. Prasaran, learned ASG was that software part of the equipment supply would attract royalty as copy right of the said software programme still vests with the assessee. Therefore, payments made for the licence to use the software programme give rise to “royalty” for the purposes of both the Income-Tax Act as well as DTAA entered into between Sweden and India. Referring to Explanation-II (v) to Section ((1) (vi) of the Act as well as Article 13, para-3 of DTAA, it was argued that for the purposes of Income-Tax law, royalty is essentially a payment received as consideration for the use or right to use a particular integral property right, whether partially or entirely.

52. We find that the Tribunal has held that there was no payment towards any royalty and this conclusion is based on the following reasoning:-

(i) Payment made by the cellular operator cannot be characterized as royalty either under the Income Tax Act or under the DTAA.

(ii) The operator has not been given any of the seven rights under S.14 (a) (i) to (vii) of the Copyright Act, 1957 and, therefore what is transferred is not a copyright but actually a copyrighted article

(iii) The cellular operator cannot commercially exploit the software and therefore a copyright is not transferred.

(iv) Further, the parties to the agreement have not agreed upon a separate price for the software and therefore it is not open for the income tax authorities to split the same and consider part of the payment for software to be royalty

(v) The bill of entry for importing of goods shows that the price has been separately mentioned for software and that this was only for the purposes of customs. There is no evidence to show that the assessee was a party to the fixation of value for the customs duty purposes

(vi) The software provided under the contract is goods and therefore no royalty can be said to be paid for it.

53. Mr. Prasaran, countered the aforesaid reasoning arguing that Clause 20 of the Supply Contract uses the term “licence” and the same term is used in the context of software throughout the three Agreements, indicating that it is not an outright sale of goods, or a full transfer of rights from the assessee to the Indian company. He also submitted that the software is a computer programme, which is treated differently from a book, not only in the Copyright Act, 1957 but also the Income Tax Act itself. His submission was that Section 52(1) (aa) of the Copyright Act only deems that certain acts will not to amount to infringement in the light of various concerns, where otherwise such acts would amount to infringement under Section 51 of the Copyright Act. The provision cannot by itself be used to hold that no right exists in the first place, since the scope of the right has to be understood only from the provisions of Section 14 of the Copyright Act, 1957. He also argued that the ITAT has misinterpreted the provisions of the DTAA, specifically Article 13, para 3 of the DTAA (Article 12, para 3 of the Model Convention) which defines royalties 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??. The ITAT, it was submitted, has not appreciated that the royalty is for the use or right to use any copyright. According to him, since title of the software continued to vest with the assessee as provided in clause 20.2 of the Supply Agreement and the assessee was free to grant non¬exclusive licenses to other parties, it follow that there was no full time transfer of copyright but it was only a case of right to use the software, and thus payment for use of software is to be treated as royalty. He further argued that reference to OECD Commentary was not apposite as it could not be used to interpret the scope of the relevant provisions of DTAA.

54. It is difficult to accept the aforesaid submissions in the facts of the present case. We have already held above that the assessee did not have any business connection in India. We have also held that the supply of equipment in question was in the nature of supply of goods. Therefore, this issue is to be examined keeping in view these findings. Moreover, another finding of fact is recorded by the Tribunal that the Cellular Operator did not acquire any of the copyrights referred to in Section 14 (b) of the Copyright Act, 1957.

55. Once we proceed on the basis of aforesaid factual findings, it is difficult to hold that payment made to the assessee was in the nature of royalty either under the Income-Tax Act or under the DTAA. We have to keep in mind what was sold by the assessee to the Indian customers was a GSM which consisted both of the hardware as well as the software, therefore, the Tribunal is right in holding that it was not permissible for the Revenue to assess the same under two different articles. The software that was loaded on the hardware did not have any independent existence. The software supply is an integral part of the GSM mobile telephone system and is used by the cellular operator for providing the cellular services to its customers. There could not be any independent use of such software. The software is embodied in the system and the revenue accepts that it could not be used independently. This software merely facilitates the functioning of the equipment and is an integral part thereof. On these facts, it would be useful to refer to the judgment of the Supreme Court in TATA Consultancy Services Vs. State of Andhra Pradesh, 271 ITR 401, wherein the Apex Court held that software which is incorporated on a media would be goods and, therefore, liable to sales tax. Following discussion in this behalf is required to be noted:-

“In our view, the term “goods” as used in Article 366(12) of the Constitution of India and as defined under the said Act are very wide and include all types of movable properties, whether those properties be tangible or intangible. We are in complete agreement with the observations made by this Court in Associated Cement Companies Ltd. (supra). A software programme may consist of various commands which enable the computer to perform a designated task. The copyright 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. Even intellectual property, once it is put on to a media, whether it be in the form of books or canvas (In case of painting) or computer discs or cassettes, and marketed would become “goods”. We see no difference between a sale of a software programme on a CD/floppy disc from a sale of music on a cassette/CD or a sale of a film on a video cassette/CD. In all such cases, the intellectual property has been incorporated on a media for purposes of transfer. Sale is not just of the media which by itself has very little value. The software and the media cannot be split up. What the buyer purchases and pays for is not the disc or the CD. As in the case of paintings or books or music or films the buyer is purchasing the intellectual property and not the media i.e. the paper or cassette or disc or CD. Thus a transaction sale of computer software is clearly a sale of “goods” within the meaning of the term as defined in the said Act. The term “all materials, articles and commodities” includes both tangible and intangible/incorporeal property which is capable of abstraction, consumption and use and which can be transmitted, transferred, delivered, stored, possessed etc. The software programmes have all these attributes.”

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“In Advent Systems Ltd. v. Unisys Corpn, 925 F. 2d 670 (3rd Cir. 1991), relied on by Mr. Sorabjee, the court was concerned with interpretation of uniform civil code which “applied to transactions in goods”. The goods therein were defined as “all things (including specially manufactured goods) which are moveable at the time of the identification for sale”. It was held: “Computer programs are the product of an intellectual process, but once implanted in a medium are widely distributed to computer owners. An analogy can be drawn to a compact disc recording of an orchestral rendition. The music is produced by the artistry of musicians and in itself is not a “good,” but when transferred to a laser-readable disc becomes a readily merchantable commodity. Similarly, when a professor delivers a lecture, it is not a good, but, when transcribed as a book, it becomes a good. That a computer program may be copyrightable as intellectual property does not alter the fact that once in the form of a floppy disc or other medium, the program is tangible, moveable and available in the marketplace. The fact that some programs may be tailored for specific purposes need not alter their status as “goods” because the Code definition includes “specially manufactured goods.”

56. A fortiori 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.

57. It is also to be borne in mind that the supply contract cannot be separated into two viz. hardware and software. We would like to refer the judgment of Supreme Court in CIT Vs. Sundwiger EMFG Co., 266 ITR 110 wherein it was held:

“A plain and cumulative reading of the terms and conditions of the contract entered into between the principal to principal i.e., foreign company and Midhani i.e., preamble of the contract, Part-I and II of the contract and also the separate agreement, as referred to above, would clearly show that it was one and the same transaction. One cannot be read in isolation of the other. The services rendered by the experts and the payments made towards the same was part and parcel of the sale consideration and the same cannot be severed and treated as a business income of the non-resident company for the services rendered by them in erection of the machinery in Midhani unit at Hyderabad. Therefore, the contention of the Revenue that as the amounts reimbursed by Midhani under a separate contract for the technical services rendered by a non-resident company, it must be deemed that there was a “business connection”, and it attracts the provisions of Section 9(1) (vii) of the Income Tax Act cannot be accepted and the judgments relied upon by the Revenue are the cases where there was a separate agreement for the purpose of technical services to be rendered by a foreign company, which is not connected for the fulfillment of the main contract entered into principal to principal. This is not one such case and thus the contention of the Revenue cannot be accepted in the circumstances and nature of the terms of the contract of this case.”

58. No doubt, in an annexure to the Supply Contract the lump sum price is bifurcated in two components, viz., the consideration for the supply of the equipment and for the supply of the software. However, it was argued by the learned counsel for the assessee that this separate specification of the hardware/software supply was necessary because of the differential customs duty payable.

59. Be as it may, in order to qualify as royalty payment, within the meaning of Section 9(1) (vi) and particularly clause (v) of Explanation-II thereto, it is necessary to establish that there is transfer of all or any rights (including the granting of any license) in respect of copy right of a literary, artistic or scientific work. Section 2 (o) of the Copyright Act makes it clear that a computer programme is to be regarded as a,,literary work”. Thus, in order to treat the consideration paid by the cellular operator as royalty, it is to be established that the cellular operator, by making such payment, obtains all or any of the copyright rights of such literary work. In the presence case, this has not been established. It is not even the case of the Revenue that any right contemplated under Section 14 of the Copyright Act, 1957 stood vested in this cellular operator as a consequence of Article 20 of the Supply Contract. Distinction has to be made between the acquisition of a “copyright right” and a “copyrighted article”.

60. Mr. Dastur is right in this submission which is based on the commentary on the OECD Model Convention. Such a distinction has been accepted in a recent ruling of the Authority for Advance Ruling (AAR) in Dassault Systems KK 229 CTR 125. We also find force in the submission of Mr. Dastur that even assuming the payment made by the cellular operator is regarded as a payment by way of royalty as defined in Explanation 2 below Section 9 (1) (vi), nevertheless, it can never be regarded as royalty within the meaning of the said term in article 13, para 3 of the DTAA. This is so because the definition in the DTAA is narrower than the definition in the Act. Article 13(3) brings within the ambit of the definition of royalty a payment made for the use of or the right to use a copyright of a literary work. Therefore, what is contemplated is a payment that is dependent upon user of the copyright and not a lump sum payment as is the position in the present case.

61. We thus hold that payment received by the assessee was towards the title and GSM system of which software was an inseparable parts incapable of independent use and it was a contract for supply of goods. Therefore, no part of the payment therefore can be classified as payment towards royalty.”

24. It was the submission of the learned counsel for the Assessee that where two views are available on an issue one favourable to the Assessee and the one against the Assessee, the view which is favourable to the Assessee and does not support levy of tax on the Assessee should be preferred. The learned counsel for the Assessee also relied on the decision of the ITAT Mumbai in the case of The DDIT (IT)2(1) Vs. M/s .Solid Works Corporation ITA No.32 19/Mum/20 10 dated 8.2.2012 wherein following the decision of the Hon’ble Delhi High Court the tribunal held that the view favourable to the Assessee should be followed and deleted addition made u/s.40(a)(ia) of the Act in respect of payments made for purchase of software.

25. The learned D.R. on the other hand submitted that the decision of the Hon’ble Delhi High Court in the case of ericsson (Supra)was rendered in the context of sale of equipment in which software was embedded and therefore not applicable to the facts of the present case.

26. Before us the learned D.R. as well as the learned counsel for the Assessee referred to several decisions of the Tribunal/AAR rendered on identical issue. These decisions are not being considered as the two decisions of the Hon’ble High court of Karnataka and Hon’ble High Court of Delhi are the decisions of High Court available as of now on the issue.

27. The next submission of the ld. Counsel for the assessee before us, by way of alternate submission was that as on the last date of the previous year the payments to the suppliers of software in a majority of cases had already been paid. In this regard the learned counsel sought to file before us additional evidence to show the payments made on or before the last day of the previous year. The ld. Counsel for the assessee drew our attention to the decision of the Special Bench of the ITAT, Visakhapatnam Bench in the case of Merilyn Shipping & Transports vs. ADCIT in ITA No.477/VIZ/2008 A.Y 2005-06 , order dated 29/3/20 12. The Special Bench of the Tribunal in the aforesaid decision by a majority expressed the view that the provisions of section 40(a)(ia) of the Act are applicable only to the amounts of expenditure which are payable as on the date 31st March of every year and it cannot be invoked to disallow expenditure which had been actually paid during the previous year, without deductions of TDS. The ld. Counsel for the assessee submitted that the factum of actual payment can be verified by the AO and subject to that disallowance under section 40(a) (ia) of the Income Tax Act,1961(the Act) can be deleted, if the AO find that the payment have already been made on or before the last date of the previous year.

28. The next submission of the learned counsel for the Assessee was that u/s.40(a)(ia) of the Act, any payment on account of royalty on which tax is deductible u/s. 194-J of the Act alone can be subject matter of disallowance. In this regard it was submitted that Sec. 194-J of the Act cast an obligation to deduct tax at source on payment on account of royalty by the Taxation Laws (Amend.) Act, 2006, wef. 13-7-2006. Therefore any payments made prior to 13-7-2006 cannot be subject matter of disallowance u/s.40(a)(ia) of the Act only on or after 13.7.2006 and not prior to that date.

29. The next submission of the learned counsel for the Assessee was that in the past the Assessee has not been deducting tax at source based on the decision of the Hon’ble Bombay High Court in the case of CIT Vs. Kotak Securities Ltd. 340 ITR 333 (Bom) wherein the Hon’ble Bombay High Court took the view that if due to bonafide belief a person does not deduct tax at source while making payment, then there can be no disallowance u/s.40(a)(ia) of the Act. In this regard it was also submitted that the recipient of payment from the Assessee had duly paid taxes on the income embedded in such receipts and therefore there is no loss to the revenue. In this regard it was submitted that the provisions of Sec.40(a)(ia) of the Act are meant to ensure that taxes are duly paid and the revenue is not put to loss and this purpose is fulfilled in the present case.

30. We have considered the rival submissions. On the question whether the payment in question would constitute Royalty, we find that the ITAT Mumbai in the case of Solid Works Corporation (supra) after considering the decision of the Hon’ble Karnataka High Court in the case of Samsung (supra) and the Hon’ble Delhi High Court in the case of Ericsson (supra) held as follows:

“9. On the other submission of the learned D.R. that the decision rendered by the Hon’ble Delhi High Court was in respect of use of software embedded in an equipment supplied and therefore the same should not be applied to the case of shrink wrap software, we are of the view that the Hon’ble Delhi High Court after referring to the decision of the Hon’ble Supreme Court in the case of Tata Consultancy Services (supra) went on to observe at para-56 of its judgment that when software is incorporated in a CD it becomes a tangible property and the payment made for acquiring the same is not a payment by way of royalty. In para-60 of its judgment, the Hon’ble Delhi High Court has approved the ruling of the Authority for Advance Ruling (AAR) in the case of Dassault Systems KK 322 ITR 125 (AAR). The facts giving rise to the ruling of the AAR were that the applicant, a Japanese company, engaged in the business of providing “Products lifecycle management” software solutions, applications and services, marketed licensed software products mostly through a distribution channel comprising value added resellers (VAR) who were independent third party resellers. To authorize a VAR to act as a reseller the applicant entered into a general VAR agreement. The terms of the agreement explicitly provided for the appointment of reseller/distributor of product on a non-exclusive basis for making the product available to the end-user within the territory for his internal use. The product was sold to the VAR for a consideration based on the standard list price less discount ; and the VAR in turn would sell the product to the end-users at a price independently determined by the VAR. The end-user would enter into the end-user licence agreement with the applicant and the VAR for the product supplied. The reseller did not hold any inventory of the software in India. The VAR was free to negotiate the price with the customer but the VAR paid to the applicant the standard price in force less agreed discount. The reseller (VAR) would get the order from the end-user and place a back-to-back order on the applicant. On acceptance of the order by the applicant, the applicant would provide a licence key via e-mail so that the customer would directly download the product through the web link. On these facts, the applicant sought the advance ruling of the Authority on the question “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 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 ?” On the facts stated, the Authority ruled on the question whether the payment would amount to royalty as follows:

(i) That the computer programme forming part of the software fell within the description of literary or scientific work. A copyright in or over the computer software produced by the applicant was in the nature of an intangible, incorporeal right belonging to the category of intellectual property rights. All intellectual property rights in the licensed programs exclusively belonged to the applicant or its licensor and they were retained by the applicant.

(ii) That passing of a right to use and facilitating the use of a product for which the owner had a copyright was not the same thing as transferring or assigning rights in relation to the copyright. Where the purpose of the licence or the transaction was only to establish access to the copyrighted product for internal business purpose, it was not legally correct to say that the copyright itself had 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 did not amount to transfer of rights in relation to copyright or conferment of the right of using the copyright.

(iii) That the VAR had 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 did, in the course of carrying out its marketing function, was to canvass for orders, collect the purchase order from the interested customer and forward that offer to the applicant; and it was the applicant that accepted or rejected that offer. In the absence of an independent right to conclude the sale or offer for sale, section 14(b)(ii) of the Copyright Act, 1957, could not be invoked to bring the case within the fold of article 12(3) of the DTAA or section 9(1)(vi) of the Income-tax Act, 1961.

10. In Para 60 of its judgment the Hon’ble Delhi High Court has accepted the commentary on OECD Model Convention referred to in Dassault Systems KK (Supra), which is as follows:

“Transfers of rights in relation to software occur in many different ways ranging from the alienation of the entire rights in the copyright in a programme to the sale of a product which is subject to restrictions on the use to which it is put. The consideration paid can also take numerous forms. These factors may make it difficult to determine where the boundary lies between software payments that are properly to be regarded as royalties and other types of payment. The difficulty of determination is compounded by the ease of reproduction of computer software, and by the fact that acquisition of software frequently entails the making of a copy by the acquirer in order to make possible the operation of the software.

Payments made for the acquisition of partial rights in the copyright (without the transferor fully alienating the copyright rights) will represent a royalty where the consideration is for granting of rights to use the programme in a manner that would, without such licence, 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 has 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 may differ from country to country.

In some countries the act of copying the programme onto the hard drive or random access memory of a computer would, without a licence, constitute a breach of copyright. However, the copy right laws of many countries automatically grant this right to the owner of software which incorporates a computer programme. Regardless of whether this right is granted under law or under a licence agreement with the copyright holder, copying the programme onto the computer’s hard drive or random access memory or making an archival copy is an essential step in utilizing the programme. Therefore, rights in relation to these acts of copying, where they do no more than enable the effective operation of the programme 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 commercial income in accordance with article 7.

The method of transferring the computer programme to the transferee is not relevant. For example, it does not matter whether the transferee acquires a computer disk containing a copy of the programme or directly receives a copy on the hard disc of her computer via a modem connection. It is also of no relevance that there may be restrictions on the use to which the transferee can put the software.”

(Underlining by us for emphasis)

11. After referring to the aforesaid OECD Commentary, the AAR in its decision rendered in the case of Dassault Systems KK (supra) observed as follows:

“It has been contended on behalf of the Revenue that the right to reproduce the work in any material form including the storing of it in any medium by electronic means (vide section 14(a)(i) of the Copyright Act) must be deemed to have been conveyed to the end-user. It is pointed out that a CD without right of reproduction on the hard disc is of no value to the end-user and such a right should necessarily be transferred to make it workable. It appears to us that the contention is based on a misunderstanding of the scope of right in sub-clause (i) of section 14(a). As stated in Copinger’s treatise on Copyright, “the exclusive right to prevent copying or reproduction of a work is the most fundamental and historically oldest right of a copyright owner”. We do not think that such a right has been passed on to the end-user by permitting him to download 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 to section 52(aa) of the Copyright Act (extracted supra) which makes it clear that “the making of copies or adaptation” of a computer programme by the lawful possessor of a copy of such programme, from such copy (i) in order to utilize the computer program, for the purpose for which it was supplied or (ii) to make back up copies purely as a temporary protection against loss, destruction, or damage in order to utilize the computer programme for the purpose of which it was supplied” will not constitute infringement of copyright. Consequently, customization or adaptation, irrespective of the degree, will not constitute “infringement” as long as it is to ensure the utilization of the computer programme for the purpose for which it was supplied. Once there is no infringement, it is not possible to hold that there is transfer or licensing of “copyright” as defined in the Copyright Act and as understood in common law. This is because, as pointed out earlier, copyright is a negative right in the sense that it is a right prohibiting someone else to do an act, without authorization of the same, by the owner.

It seems to us that reproduction and adaptation envisaged by section 14(a)(i) and (vi) can contextually mean only reproduction and adaptation for the purpose of commercial exploitation. Copyright being a negative right (in the sense explained in paragraph 9 supra), it would only be appropriate and proper to test it in terms of infringement. What has been excluded under section 52(aa) is not commercial exploitation, but only utilizing the copyrighted product for one’s own use. The exclusion should be given due meaning and effect; otherwise, section 52(aa) will be practically redundant. In fact, as the law now stands, the owner need not necessarily grant licence for mere reproduction or adaptation of work for one’s own use. Even without such licence, the buyer of product cannot be said to have infringed the owner’s copyright. When the infringement is ruled out, it would be difficult to reach the conclusion that the buyer/licensee of product has acquired a copyright therein.”

(underlining by us for emphasis)

12. The above decision of the AAR in the case of Dassault (supra) was a case of sale of shrink wrap software and the AAR has held that reproduction and adaptation envisaged by section 14(a)(i) and (vi) can contextually mean only reproduction and adaptation for the purpose of commercial exploitation.

13. The ruling of the AAR in the case of Dassault (supra) was approved by the Hon’ble Delhi High Court in the case of DIT Vs. Ericsson AB,New Delhi (supra). It can therefore be said that the Hon’ble Delhi High Court has held that consideration paid merely for right to use cannot be held to be royalty. This ratio laid down by the Hon’ble Delhi High Court would also apply when shrink wrap software is sold.

14. Following the view expressed by the Hon’ble Dellhi High Court in the case of DIT Vs. Ericsson AB, New Delhi (Supra), which is favourable to the Assessee, we hold that the consideration received by the Assessee for software was not royalty. The receipts would constitute business receipts in the hands of the Assessee. Admittedly the Assessee who is a non resident does not have a permanent establishment and therefore business income of the Assessee cannot be taxed in India in the absence of a permanent establishment.

15. For the reasons given above, we confirm the order of CIT(A) and dismiss the appeal of the Revenue.”

31. The above ruling of the Tribunal though rendered in the context of Non-residents involving definition of Royalty under Double Taxation Avoidance Agreements (DTAA), the ratio laid down therein will equally applicable to definition of Royalty under the Act and both the Hon’ble Karnataka High Court as well as the Hon’ble Delhi High Court have considered the issue in the light of the definition of royalty under the Act also. We are therefore of the view that the order of the CIT(A) deleting the addition made by the AO is justified and calls for no interference.

32. Since we have confirmed the order of the CIT(A) on the ground that the payment in question is not royalty, the other arguments of the learned counsel for the Assessee on applicability of Sec.40(a)(ia) based on decision of Special Bench ITAT, Vishakapatnam in the case of Merilyn Shipping (supra) and Hon’ble Bombay High Court in the case of Kotak Securities (supra) are not taken up for consideration.

33. For the reasons given above, we dismiss ground No.4 raised by the Revenue.

34. In the result, the appeal by the revenue is dismissed.

Order pronounced in the open court on the 30th day of April 2012