Sandeep Dasgupta

Sandeep Dasgupta

Since the inclusion of “royalty” as a form of income attracting deemed taxation, by the Finance Act 1976, the gradually expanding ambit of this definition, have led to seemingly incessant tax controversies on the subject. Divergent views by the Indian tax courts on characterization of remittances to non-residents for usage of software, exploitation of intellectual property rights denied certainty in interpretation of the simultaneously evolving tax provisions. The retrospective amendments to the definition of royalty vide Explanation 2 to section 9(1)(vi) of the Income Tax Act 1961 (“ the Act”) added to woes of taxpayers, by broadening the contours of this income taxation.

The Hon’ble Delhi High Court in the case of Infrasoft Limited [2014] 264 CTR 329 held that fees on account of grant of license in case of use of customized software wherein the licensee was entitled to make a single copy and use the software for its own specific business activity and forbidden from any form of commercial usage of the same viz sub-licensing, selling, copying, decompiling, reverse engineering etc, would not be royalty. The transaction of grant of license to use the said software would bear the character of a permission to use a copyrighted material and not use of a copyright per se. This decision is in contradistinction to an earlier decision by the Hon’ble Karnataka High Court in case of Samsung Electronics Co. Limited [2012] 345 ITR 494 wherein it was held that the right to make a copy of software for own business activity would also be copyright work as per Article 14(1) of the Copyright Act. This earlier decision was subsequently followed by various tribunals across the country.

Recently, the Delhi Tribunal in case of Kinsey Knowledge Center Private Limited (the assessee), had an occasion to examine the tax ability of payments by the assessee to non-residents towards accessing certain databases. Briefly stated, in this case, the assessee a back office of it’s parent company in the USA, sought access to Thomson database for consideration to Thomson Pte, a Singapore company. As per the facts of the case, the assessee typically subscribes to similar other public information databases to render certain back office / support services to it’s parent company. The tax authorities and first appellate authority ruled adversely holding that the impugned payment by the assessee to Thomson, Singapore was taxable as royalty, being consideration for use of copyright and therefore, the assessee is consequentially obligated to withhold tax from such payment. The assessee being aggrieved by the said ruling, appealed before the Hon’ble Delhi ITAT.

Significantly, the Hon’ble Delhi ITAT examined the terms of the Service Contract between the assessee and the vendor to note that impugned consideration paid by the assessee was solely to access the researched and proprietary information captured by Thomson in the database. The contract had covenants to restrict the assessee to make copies of such database and exploit it onward commercially. The Hon’ble ITAT was invited to refer to the jurisdictional High Court decision in case of Infrasoft (supra) essentially on the principle laid down on the criticality to evaluate the purpose of usage of intellectual property for deciding the true character of the payments. In this case before the ITAT, the facts although distinct from the one as in Infrasoft’s case, the key conclusion of the ITAT drawing analogy from Infrasoft’s case, was that this was a case of consideration towards copyrighted material or information and not use of any copyright per se. The Hon’ble ITAT held that since use of copyrighted material or information cannot construed to royalty as defined under the India Singapore tax treaty, the impugned consideration cannot be taxed royalty.

It may be noted that while the Hon’ble ITAT in the Kinsey Knowledge Centre’s case, ruled in favor of the assessee, in the wake of the broadened definition of the term royalty under the Act, it is not unusual to witness interpretations similar to that by the AO in this case holding that these payments are essentially in respect of any right, information. Of course, a tax treaty worded appropriately for the royalty definition carving out such broad ended-ness as in the Act, saves on the tax ability. In the absence of treaty relief, based on similar facts, there may be adverse conclusions pursuant to the provision under Explanation 5 to section 9(1)(vi) of the Act.

While, in many cases which spiral up to the Supreme Court on this issue, the Apex Court will have the last word on this debate, these controversies once again highlight the woes of a taxpayer due unilateral amendments in relation to the domestic law. While one can certainly understand the objective of the Revenue to try and garner tax at source, it is imperative that for allaying uncertainties in taxation of similar intellectual property related payments, a consensus for getting allocation rights of taxing such payments through the OECD or the UN could be a welcome move.

(Sandeep Dasgupta is a Senior Manager with Deloitte Haskins & Sells LLP. The views are personal.)

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One response to “Consideration for use of Intellectual Property – terms critical for “royalty taxation””

  1. vswami says:

    offhand
    Instantly remember a similar type of controversy- rather a spate of controversies- that used to be subject matter of mutually contradicting views, hence litigated, That pertains to common known as ‘KNOW-HOW’ – again categorized as an ‘intellectual property’. The issue was whether any ‘know-how’, if supplied in the ‘FORM’ of a ‘BOOK’ should, for income-taxation, be regarded as a ‘plant’ – that is a capital asset , with all its attendant implications.
    May be, a study of the related case law,will supply another angle in which the subject matter of this write-up need o be explored !

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