Part – 1 – Impact on domestic trade
The Author, in this article, discusses the impact of recent decision of Supreme Court [SC] in the case of Engineering Analysis on domestic laws and concludes that equalisation levy will be payable on import of computer software provided the conditions are fulfilled and some impact due to notification 21/2012 will be there regarding on TDS u/s 194J.
Part – 2 – Facilitating reading of Judgement
Another reason for reading this judgement is that it is very nice and scholarly written one where SC has not taken a shortcut [which it could have] and has elaborately analysed the situation answering multitude of questions which are there in fine print.
It gives requisite material for a reader to read the judgement in cherry picking manner without missing the point.
This part will equip you to read the judgement in a manner suitable to you.
Citation of the case
Engineering Analysis Centre of Excellence Private Limited Vs CIT (Supreme Court of India), Appeal Number : Civil Appeal Nos. 8733-8734 of 2018, Date of Judgement/Order : 02/03/2021 [Engineering Analysis]
The relevant assessment years are 2001-2002 and 2002-2003. Thus, we are getting a finality on the dispute after 20 off years. It has disposed off some 103 appeals by this common order. The list of appeals occupies 5 pages.
One also has to note that this decision pertains to validity of TDS obligation on import of computer software. The Finance Act, 2012 has made retrospective effect from 1-7-1976 influencing the relevant subject.
This question was answered by Delhi High Court in favour of the Assessee and by Karnataka High Court in favour of the Revenue.
Other judicial forums followed the respective ratio laid down by the jurisdictional High Courts. Non-jurisdictional judicial forums have taken divergent views on this matter.
The decision in the case of Engineering Analysis essentially covers only those cases where one of the parties is a non-resident whereby attracting section 195 and consequently DTAA comes into play.
The article gives authors own analysis. This article is based on a judicial pronouncement and is divided into following parts.
|Part – I – Impact on domestic trade||PART – II – Facilitating reading of Judgement|
|Issue and Answer before SC||Background-:|
|Issues and Answer in the article – 194J||Top 20 observations|
|Other Consequences-:||Interpretation of the term Copyright|
|Inclination to apply the judgement to domestic law||Interpretation of the term Royalty and Tax withholding obligations as per the provisions of ITA read with DTAA and OECD TC.|
|Meaning of Ratio laid down by Supreme Court||Facilitating the reading of the judgement|
|Types of softwares’|
|Relevant provisions of the Copyright Act|
PART – I Impact on domestic trade
Issue and Answer before SC
|Q||whether, on facts and circumstances of the case, the amount(s) paid by the appellant(s) to the foreign software suppliers was not “royalty” and that the same did not give rise to any “income” taxable in India and, therefore, the appellant(s) was not liable to deduct any tax at source?”|
|A||The appeals before us may be grouped into four categories:
i) The first category deals with cases in which computer software is purchased directly by an end-user, resident in India, from a foreign, non-resident supplier or manufacturer.
ii) The second category of cases deals with resident Indian companies that act as distributors or resellers, by purchasing computer software from foreign, non-resident suppliers or manufacturers and then reselling the same to resident Indian end-users.
iii) The third category concerns cases wherein the distributor happens to be a foreign, non-resident vendor, who, after purchasing software from a foreign, non-resident seller, resells the same to resident Indian distributors or end-users.
iv) The fourth category includes cases wherein computer software is affixed onto hardware and is sold as an integrated unit/equipment.
168. Given the definition of royalties contained in Article 12 of the DTAAs mentioned in paragraph 41 of this judgment, it is clear that there is no obligation on the persons mentioned in section 195 of the Income Tax Act to deduct tax at source, as the distribution agreements/EULAs in the facts of these cases do not create any interest or right in such distributors/end-users, which would amount to the use of or right to use any copyright. The provisions contained in the Income Tax Act (section 9(1)(vi), along with explanations 2 and 4 thereof), which deal with royalty, not being more beneficial to the assessees, have no application in the facts of these cases.
169. Our answer to the question posed before us, is that the amounts paid by resident Indian end-users/distributors to non-resident computer software manufacturers / suppliers, as consideration for the resale/use of the computer software through EULAs /distribution agreements, is not the payment of royalty for the use of copyright in the computer software, and that the same does not give rise to any income taxable in India, as a result of which the persons referred to in section 195 of the Income Tax Act were not liable to deduct any TDS under section 195 of the Income Tax Act. The answer to this question will apply to all four categories of cases enumerated by us in paragraph 4 of this judgment.
Issues and Answer in the article – 194J
The decision of Engineering Analysis essentially requires at least one of the parties to be a foreign / non-resident one.
Section 194J requires only the recipient has to be a resident
|Q||Whether in view of the judgment of Supreme Court in the case of Engineering Analysis, the obligation under clause(b) and (ba) of explanation to section 194J to deduct tax is obliterated?
Clause(b) and (ba) of explanation to section 194J deal with “fees for technical services” and “royalty” as referred to in section 9(1)
|A||No. [the same view has been echoed by ICAI # ]
The author is of an opinion that it is not advisable to apply the above principles to sec 194J at planning stage but one may take this argument if a case is pending at some level of litigation.
# Committee on International Taxation of the Institute of Chartered Accountants of India published a document dated 8th March 2021 on judgment of Supreme Court in the case of Engineering Analysis. The relevant portion is re-produced below.
E – Conclusion.
While the focus of the decision is mainly related to the payments to non-resident, one may hope that the same analogy can also be applied to the payment for domestic software purchase which is not clear at the moment
1) Typically most of the computer softwares’ are imported into India and then they are distributed across the country. Thus, now the transaction of import of computer software will not attract any TDS u/s 195.
2) Notification No. 21/2012 [F.No.142/10/2012-SO(TPL)] S.O. 1323(E), dated June 13, 2012 exempts TDS on subsequent transactions where the transferee obtains a declaration from the transferor that the tax has been deducted either under sub-clause (a) or (b) of clause (ii) [of the notification] along with the Permanent Account Number of the transferor. [Description by author]
3) If such software is purchased through digital platform, equalization levy may be attracted.
4) Thus the first seller / re-seller in India who was not doing TDS on the basis of above notification for past 8 years will now be required to do the TDS as there is no question of getting certificate as mentioned above.
5) A non-resident assessee can very well apply u/s 154, 155(5) r.w.s 240 claiming refund of TDS if the same is borne by him.
Inclination to apply the judgement to domestic law
There are observations in the judgement which may temp anybody to conclude that this decision is applicable for domestic trade are re-produced in the material relied upon.
Exhibit 1 of material relied upon.
But in the opinion of the author, this judgement may not be used / relied upon at planning stage for domestic trade. The sole reason being the question(s) posed before SC essentially included at least one non-resident party. One has to be careful while applying other observations of the Court which do not have direct nexus with the questions posed before the bench.
The reasoning for above observation is as below
Meaning of Ratio laid down by Supreme Court
Article 141 provides that the law declared by the Supreme Court shall be binding on all courts within the territory of India. The law declared has to be construed as a principle of law that emanates from a judgment, or an interpretation of law or judgment by the Supreme Court, upon which, the case is decided.
Supreme Court in the case of Fida Hussain v. Moradabad Development Authority Civil Appeal No. 5448 OF 2006 dated 19-Jul-2011 .
18) In the case of Director of Settlements, A.P. v. M.R. Apparao, (2002) 4 SCC 638, this Court held:
“7. So far as the first question is concerned, Article 141 of the Constitution unequivocally indicates that the law declared by the Supreme Court shall be binding on all courts within the territory of India. The aforesaid Article empowers the Supreme Court to declare the law. It is, therefore, an essential function of the Court to interpret a legislation. The statements of the Court on matters other than law like facts may have no binding force as the facts of two cases may not be similar. But what is binding is the ratio of the decision and not any finding of facts. It is the principle found out upon a reading of a judgment as a whole, in the light of the questions before the Court that forms the ratio and not any particular word or sentence... A judgment of the Court has to be read in the context of questions which arose for consideration in the case in which the judgment was delivered. … The law which will be binding under Article 141 would, therefore, extend to all observations of points raised and decided by the Court in a given case…”
Thus even though there are other observations in the judgement which are not linked to the questions posed before the bench, the same has to be treated as “obiter dicta” i.e. which will not have a “dictum” i.e. enforceability of Law.
PART – II – Facilitating reading of Judgement
As been opined by the author, another reason for reading this judgement is that it is very nice and scholarly written one where SC has not taken a shortcut [which it could have] and has elaborately analysed the situation answering multitude of questions which are there in fine print.
The author has resisted the temptation to write another detailed analysis of the Judgement.
This part will equip you to read the judgement in a manner suitable to you.
Before we proceed, a few things to know.
Consider an example.
Suppose you have a book. Consider whether in following cases, there is any infringement of any copyright ? – The answer is No.
When the author was about to close the article, Committee on International Taxation of the Institute of Chartered Accountants of India published a document dated 8th March 2021 which included Top 20 observations.
Top 20 observations
Interpretation of the term Copyright
1. Under section 2(o) of the Copyright Act, a literary work includes a computer programme and a computer programme has been defined under section 2(ffc) of the Copyright Act to mean a set of instructions expressed in words, codes, schemes or in any other form capable of causing a computer to perform a particular task or achieve a particular result.
2. In the case of a computer programme, section 14(b) specifically speaks of two sets of acts – the seven acts enumerated in sub-clause (a) and the eighth act of selling or giving on commercial rental or offering for sale or for commercial rental any copy of the computer programme.
3. No copyright exists in India outside the provisions of the Copyright Act or any other special law for the time being in force, vide section 16 of the Copyright Act. When the owner of copyright in a literary work assigns wholly or in part, all or any of the rights contained in section 14(a) and (b) of the Copyright Act, in the said work for a consideration, the assignee of such right becomes entitled to all such rights comprised in the copyright that is assigned and shall be treated as the owner of the copyright of what is assigned to him.
4. As per section 30 of the Copyright Act, the owner of the copyright in any literary work may grant any interest in any right mentioned in section 14(a) of the Copyright Act by licence in writing by him to the licensee, under which, for parting with such interest, royalty may become payable.
5. The making of copies or adaptation of a computer programme in order to utilise the said computer programme for the purpose for which it was supplied, or to make up back-up copies as a temporary protection against loss, destruction or damage so as to be able to utilise the computer programme for the purpose for which it was supplied, does not constitute an act of infringement of copyright under section 52(1)(aa) of the Copyright Act.
6. A licence from a copyright owner, conferring no proprietary interest on the licensee, does not entail parting with any copyright, and is different from a licence issued under section 30 of the Copyright Act, which is a licence which grants the licensee an interest in the rights mentioned in section 14(a) and 14(b) of the Copyright Act. Where the core of a transaction is to authorize the end-user to have access to and make use of the “licensed” computer software product over which the licensee has no exclusive rights, no copyright is parted with and consequently, no infringement takes place, as is recognized by section 52(1)(aa) of the Copyright Act. It makes no difference whether the end-user is enabled to use computer software that is customised to its specifications or otherwise.
7. A non-exclusive, non-transferable licence, merely enabling the use of a copyrighted product, is in the nature of restrictive conditions which are ancillary to such use, and cannot be construed as a licence to enjoy all or any of the enumerated rights mentioned in section 14 of the Copyright Act, or create any interest in any such rights so as to attract section 30 of the Copyright Act.
8. Section 16 of the Copyright Act, which states that “no person shall be entitled to copyright otherwise than under and in accordance with the provisions of this Act or of any other law for the time being in force” makes it clear that the expression “copyright” has to be understood only as is stated in section 14 of the Copyright Act and not otherwise.
9. The right to reproduce and the right to use computer software are distinct and separate rights, as has been recognized in SBI v. Collector of Customs, 2000 (1) SCC 727 (see paragraph 21), the former amounting to parting with copyright and the latter, in the context of non-exclusive EULAs, not being so.
10. Honourable Supreme court has reaffirmed that the doctrine of first sale/principle of exhaustion is applicable for the provisions of Copyright Act.
Interpretation of the term Royalty and Tax withholding obligations as per the provisions of ITA read with DTAA and OECD TC.
11. Honourable Supreme Court made it clear by referring to the judgment in GE Technology that the fact that the “person” spoken of in section 195(1) of the Income Tax Act is liable to make the necessary deductions only if the non-resident is liable to pay tax as an assessee under the Income Tax Act, and not otherwise. This judgment also clarifies, after referring to CBDT Circular No. 728 dated 30.10.1995, that the tax deductor must take into consideration the effect of the DTAA provisions. The crucial link, therefore, is that a deduction is to be made only if tax is payable by the non-resident assessee, which is underscored by this judgment, stating that the charging and machinery provisions contained in sections 9 and 195 of the Income Tax Act are interlinked.
12. The definition of Royalty as per the DTAA is exhaustive definition which uses the expression “means” and secondly, the term “royalties” refers to payments of any kind that are received as a consideration for the use of or the right to use any copyright in a literary work.
13. The Definition of Royalty as per the ITA has three elements. Firstly, it speaks of “consideration”, but also includes a lump-sum consideration which would not amount to income of the recipient chargeable under the head “capital gains”. Secondly, it speaks of the transfer of “all or any rights”, it expressly includes the granting of a licence in respect thereof and thirdly, it states that such transfer must be “in respect of” any copyright of any literary work.
14. In paragraph 64 of the order, Honourable Supreme Court observed that even where such transfer is “in respect of” copyright, the transfer of all or any rights in relation to copyright is a sine qua non under explanation 2 to section 9(1)(vi) of the Income Tax Act. In short, there must be transfer by way of licence or otherwise, of all or any of the rights mentioned in section 14(b) read with section 14(a) of the Copyright Act.
15. In paragraph 71 of the order, Honourable Supreme Court observed that the transfer of “all or any rights (including the granting of a licence) in respect of any copyright”, in the context of computer software, is referred to sections 14(a), 14(b) and 30 of the Copyright Act. Also, the expression “in respect of” is equivalent to in or “attributable to”. Thus, explanation 2(v) to section 9(1)(vi) of the Income Tax Act, when it speaks of “all of any rights in respect of copyright” is certainly more expansive than the DTAA provision, which speaks of the “use of, or the right to use” any copyright.
16. Honourable Supreme court reemphasised the importance of two latin maxims, lex non cogit ad impossibilia, i.e., the law does not demand the impossible and impotentia excusat legem, i.e., when there is a disability that makes it impossible to obey the law, the alleged is obedience of the law is excused.
17. In paragraph 89 of the order, Honourable Supreme Court emphasized that in the definition of royalty under the Act, the phrase “including the granting of a licence” is found. The court explained that it does not mean that even a nonexclusive licence permitting user for in-house purpose would be covered by that expression. Any and every licence is not what is contemplated. It should take colour from the preceding expression “transfer of rights in respect of copyright”.
18. Honourable Supreme Court observed that any ruling on the more expansive language contained in the explanations to section 9(1)(vi) of the Income Tax Act would have to be ignored if it is wider and less beneficial to the assessee than the definition contained in the DTAA, as per section 90(2) of the Income Tax Act read with explanation 4 thereof, and Article 3(2) of the DTAA. Further, the expression “copyright” has to be understood in the context of the statute which deals with it, it being accepted that municipal laws which apply in the Contracting States must be applied unless there is any repugnancy to the terms of the DTAA.
19. Honourable Supreme court observed that When the definition of “royalties” is seen in all the DTAAs that are concerned with, it is found that “royalties” is defined in a manner either identical with or similar to the definition contained in Article 12 of the OECD Model Tax Convention. This being the case, the OECD Commentary on the provisions of the OECD Model Tax Convention then becomes relevant. The OECD Commentary has been referred to and relied upon in several earlier judgments. Additionally, it is also important to refer to the judgment of Supreme Court, in Ram Jethmalani v. Union of India, (2011) 8 SCC 1, noted that though India is not a party to the Vienna Convention on the Law of Treaties, the principles of international law and the principle of interpretation contained in Article 31 thereof provide broad guidelines to interpret treaties in the Indian context also.
20. OECD TC on Article 12 of the OECD Model Tax Convention, incorporated in the DTAAs will continue to have persuasive value as to the interpretation of the term “royalties” contained therein.
Facilitating the reading of the judgement
|Page||Nos.||Contents in Brief.|
|009||022||History of issue under consideration and arguments made before K’taka HC, Delhi HC.|
|022||027||Arguments by Government|
|027||036||Relevant sections of Income Tax Act|
|036||042||Brief discussion on scheme of income tax law as referred above. PILCOM decision distinguished.|
|042||050||Relevant sections of the Copyright Act|
|050||054||Brief discussion on scheme of Copyright law as referred above.|
|054||060||DTAA relevant articles re-produced|
|060||072||EULA relevant articles re-produced|
|072||082||Interpretation of EULA|
|082||100||Applicability of DTAA and interpretation thereof by taking some sample DTAAs’|
|100||113||Definition of Royalty under Income Tax Act vis-à-vis DTAA|
|114||124||Doctrine of Impossibility|
|125||170||Rulings of AAR and other high courts perused and conclusions about Copyright established [Para 117]|
|171||197||Doctrine of First sale / principle of exhaustion|
|197||225||Interpretation of treaties, DTAA vis-à-vis actions of Govt. vis-à-vis stand taken by Govt.|
|0||Relevant Legislative Enactment|
|1||Relevant observations of judgement which temt to apply the ratio to domestic trade|
|2||Relevant provisions of the Copyright Act|
Types of softwares’
A Shrink-Wrap Software means any generally commercially available software in executable code form (other than development tools, development environments and software that is incorporated into any Company Product)
But now days, sometimes even the code is given to enable the end user to adapt the software to his environment.
The types of licensing of a software and methodology of distribution as codified by Microsoft for its software are given for overall understanding.
|OEM||Original Equipment Manufacturer. Most major computer or computer vendor will bundle operating system license together with their products. This ‘bundled’ license is called OEM. Clone PCs will require users to purchase the ‘OEM’ license at the same time when purchasing a new ‘do-it-yourself’ PC (clone PC).
Technically, customers are not allowed to purchase OEM licenses without purchasing a new PC or notebook together. However, customers may purchase OEM Microsoft Office license within 60 days of purchase of a new PC or notebook.
|Cheapest among the licenses||The license dies with the hardware|
|FPP||Full Pack (FPP) is usually available in a ‘shrink-wrapped’ box that is available ‘over the counter’ for individual purchase. Customers can buy these licenses individually. Typically, this license is required to legalize an ‘unlicensed’ PC or notebook that is more than 60 days old. This is the most expensive form of licensing and only recommended for users who require less than 5 units of licenses.||– Legalize and authorize unlicensed (pirated) software;
– Available in single units;
– Licensed to use in an existing PC that does not have any prior license;
– Licenses can be transferred in 90 days.
|Costs about double the price of an OEM license.|
|Volume license||Available only with a minimum of 5 units Open License on first purchase. This can be a mix of different products. The license is perpetual (no expiry) and belongs to the company, not the computer or notebook. Therefore it is transferable between PCs and even between companies.||– License can be transferred from old PCs to new PCs (with no version upgrade). Therefore, newly purchased PCs does not require the purchase of new OEM licenses;
– Makes licensing management easier paper license instead of physically handling large volume of CDs and booklets.
|– Costs almost double than OEM;
– Licenses are perpetual but users are stuck with the same version ‘forever’ even after new versions and updates are released. This can be avoided by purchasing ‘Software Assurance’ which is renewed annually.