Court: Mumbai Income Tax Appellate Tribunal

Citation: Reliance Industries Ltd. (Taxpayer) [2010-TII-154-ITAT-MUM-INTL]

Brief : Mumbai Income Tax Appellate Tribunal (Mumbai ITAT) [2010-TII-154-ITAT-MUM-INTL] in a batch of cases, with the lead case being that of Reliance Industries Ltd. (Taxpayer), on the issue of whether consideration paid to a US resident (US entity) for licensing of computer software would be in the nature of ‘royalty’, either under the provisions of the Indian Tax Laws (ITL) or under the India-US Double Taxation Avoidance Agreement (DTAA). The Mumbai ITAT, after considering the various clauses of the license agreement (Agreement), the Indian Copyright Act, 1957 (ICA) and other decisions, including that of the Special Bench of the Delhi ITAT (SB) in the case of Motorola Inc. 95 ITD 91  held that the payment was for the purchase of a copyrighted article and not the copyright itself. Furthermore, the Mumbai ITAT stated that the definition of ‘royalty’ under the DTAA is more restrictive than what is provided in the ITL and that it is incorrect to hold that computer software on a media continues to be an intellectual property right. Therefore, the payment made for the purchase of software cannot be termed as ‘royalty’.

Background and facts of the case

  • · Under the ITL, ‘royalty’ is deemed to accrue or arise in India if payable by a resident. Furthermore, ‘royalty’ is defined, in a wide manner, to mean consideration for the transfer of all or any rights (including the granting of a license) or use of any copyright, literary, artistic or scientific work, patent, invention, model, design, secret formula or process or trade mark or similar property. However, the comparable provision in the DTAA defines ‘royalty’ to mean consideration for the use of, or the right to use, any copyright of a literary, artistic or scientific work.
  • · The software purchased by the Taxpayer was operational software for its internal use. The Taxpayer was granted perpetual, non-exclusive, irrevocable, royalty-free, worldwide license to use the number of copies of the software, as specified in its Agreement with the US entity, solely for its internal operations.
  • · The Agreement contained various restrictions on its usage, such as:

o No right to use the software for services on behalf of third parties.

o No right to use, copy, duplicate or display the software except as specifically provided in the Agreement; the Taxpayer could make copies only to the extent specified in the Agreement.

o Restrictions on the Taxpayer in providing access to the software.

o No right to sell, license, distribute, pledge, lease, rent or commercially share (including timeshare) the software or any rights therein.

o No right to use the software for purposes of providing a service bureau, third party hosting or third party application, integration etc.

o No right to modify, translate, reverse engineer, decrypt, decompile, disassemble or otherwise attempt to discover the above mentioned software source code or underlying ideas or algorithms.

  • · The US entity supplied the software to the Taxpayer outside India on a computer disk on free-on-board basis. Also, the US entity does not have any presence in the form of a permanent establishment (PE) in India.
  • · As provided in the provisions of the ITL, the Taxpayer approached the Tax Authority for a nil withholding tax order to remit the payment for purchase of software, without withholding any taxes, on the basis that the payment was not in the nature of ‘royalty’ but business profits which is taxable in India only if the US entity had a PE in India. Since the US entity did not have a PE in India under the DTAA, the said payment was not taxable in India.
  • · The Tax Authority rejected the Taxpayer’s claim – and held that the Agreement was for the use of software constituting ‘royalty’, both under the provisions of the ITL and the DTAA, requiring taxes to be withheld on such payments.
  • · The Taxpayer paid the taxes under protest and appealed before the first appellate authority. The first appellate authority agreed that the Taxpayer acquired only a copy of the software and not a copyright in the software. Therefore, such payments for purchase of copyrighted articles did not constitute ‘royalty’ under the DTAA and, hence, the Tax Authority was not justified in requiring taxes to be withheld on such payments. The Tax Authority, aggrieved by this order, appealed before the Mumbai ITAT.

 Mumbai ITAT’s ruling

  • · Payment for purchase of software cannot be considered as patent, invention or an intellectual property so as to label it as ‘royalty’. For this purpose, reliance was placed on the Bangalore ITAT’s decision in the case of Samsung 94 ITD 91 which, on comparable facts, had held that what was acquired was only a copy of the copyrighted article whereas the copyright remained with the owner. No right was granted to the purchaser to utilize the copyright of the computer program.
  • · Reliance was also placed on the SB’s ruling which had examined the ICA in detail to infer the meaning of copyright in software. The SB had been of the view that the rights which an author of a work has by virtue of creating the work are defined under the provisions of the ICA. Some of the exclusive and key rights under the ICA include reproduction rights, distribution rights, rental or lending rights etc. The special feature of the rights conferred on the computer program is the ‘right to sell’ or ‘give on commercial rental’ or ‘offer for sale or for commercial rental’ any copy of the computer program and such right can only be exercised by the owner of the computer program.
  • · Furthermore, the SB had also held that the ownership of copyright in a work is independent of the ownership of the physical material in which the work is fixed. Citing an example of a book, the SB had observed that if a person buys a book, he will be the owner of the same but he has no right to reproduce the work or publish an abridgement or translation of the work. Such right belongs to the author or the copyright owner of the book. Furthermore, the ICA brings out the distinction between a copyrighted article and a right in the copyright. The ICA specifies the following four rights which, if acquired by the transferee, will constitute him as the owner of such copyright:

o Right to make copies of the computer program for purposes of distribution to the public by sale, rental, lease, or lending.

o Right to prepare derivative computer programs based upon the copyrighted computer program.

o Right to make a public performance of the computer program.

o Right to publically display the computer program.

  • · In the instant case, considering the binding ruling of the SB, as the Taxpayer was not entitled to any of the rights in the software, the payment was for a copyrighted article and not for a copyright. Hence, it cannot be considered as ‘royalty’, either under the ITL or the DTAA. The payment is business income of the recipient, which, in the absence of a PE in India, is not taxable in India.
  • · Also, the payment does not qualify as ‘royalty’ under the DTAA as the definition in the DTAA is more restrictive than that under the ITL. For this purpose, the propositions of another Bangalore ITAT ruling in the case of Hewlett Packard 5 SOT 660 was applied, which considered only payments for the use of, meaning exploitation of, the copyright of literary or scientific work as ‘royalty’ under the DTAA. This Bangalore ITAT ruling also relied on the OECD Commentary to the Model Tax Convention (OECD Commentary) in arriving at its conclusion.


  • · The characterization of computer software transactions has been a contentious issue with the Indian Tax Authority over the last several years. The dispute has principally focused on whether such transactions should be characterized as ‘royalty’ or as business profits/sales income. While the Tax Authority is of the view that such payments should be classified as ‘royalty’, regardless of the nature and extent of rights granted to the end user or the purpose for which the end user uses the software, the taxpayers had generally taken a view that where an end user does not obtain rights that enable commercial exploitation of the intellectual property in the computer software, the transaction should be classified as generating business profits.
  • · The Taxpayer’s position was largely based on the OECD Commentary and was supported by a number of ITAT decisions, including that of a Special Bench. The OECD Commentary and the ITAT decisions had recognized the distinction between a right in the copyright and a copyrighted article. In a recent decision, though, the Delhi ITAT, in the case of Microsoft Corporation and its affiliates [4] , had ruled in support of the view proposed by the Tax Authority.
  • · This Mumbai ITAT decision should seek to reinforce the taxpayers’ position on the contentious issue.

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Category : Income Tax (25538)
Type : Judiciary (10289)
Tags : DTAA (298)

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