Purchase of software as a product being a transaction of sale, payment cannot be considered as royalty

Brief of the Case

Delhi High Court held In the case of Principal CIT vs. M. Tech India Pvt. Ltd that in cases where the payments are made for purchase of software as a product, the consideration paid cannot be considered to be for use or the right to use the software. It is well settled that where software is sold as a product it would amount to sale of goods. In the case of Tata Consultancy Services v. State of Andhra Pradesh: (2004) 271 ITR 401 (SC), the Supreme Court examined the transactions relating to the purchase and sale of software recorded on a CD in the context of the Andhra Pradesh General Sales Tax Act. The court held the same to be goods within the meaning of Section 2(b) of the said Act and consequently exigible to sales tax under the said Act. Clearly, the consideration paid for purchase of goods cannot be considered as ‘royalty’

Facts of the Case

The Assessee entered into an agreement with M/s Track Health Pty. Limited, Australia (THPL) captioned “VAR Agreement”. The Assessee had also entered into an agreement with M/s Speed Miners, Malaysia which is stated to be similar to the VAR Agreement entered into by the Assessee with THPL. In terms of the agreements, the Assessee had paid a sum of Rs. 66,87,509 and Rs. 9,35,987/- to THPL and M/s Speed Miner respectively. According to the AO, the said payments of Rs 66,87,509/- and Rs.9,35,987/- were in the nature of ‘royalty’ and since the Assessee had not withheld any tax, the AO disallowed the same under Section 40(a)(i).The Assessee had also entered into a similar agreement with M/s Intersystems India Pvt. Ltd., Gurgaon in terms of which the Assessee had paid a sum of Rs. 13,78,496/- without deducting any tax at source. This expenditure was disallowed by the AO under Section 40(a)(ia).

Contention of the Assessee

The ld counsel of the assessee supported the decision of the CIT (A) and the Tribunal. He also referred to the decisions of this Court in Dynamic Vertical Software India P. Ltd. (2011) 332 ITR 222 (Del) wherein the payments made by a reseller for purchase of software for sale in the Indian market were held not to be royalty. He also referred to the decision of this Court in Director of Income Tax v. Infrasoft Ltd.: (2014)

220 Taxman 273 (Del) and drew the attention of this Court to paragraph 98 of the said judgment wherein this Court had unequivocally expressed that it was not in agreement with the decision of the Karnataka High Court in the case of Samsung Electronics Co. (2012) 345 ITR 494 (Kar.). He also referred to paragraph 3 of Article 12 of the Double Taxation Avoidance Treaty between India and Australia and contended that the payments made to THPL did not fall within the definition of royalty under the said Treaty.

Contention of the Revenue

The ld counsel of the revenue submitted a copy of the “VAR Agreement” and submitted that the payments made under the said Agreement were not for the purchase of software but were in the nature of royalty. He drew the attention of the Court to clause 4.2 (d) of the Terms and Conditions of the said Agreement which entitled the Assessee “to customize the Software for the purposes of End Users”. On the strength of the aforesaid Clause, he contended that the Agreement entitled the Assessee to use the software and, therefore, the payments were royalty within the meaning of Explanation 2 to Section 9(1) (vi).

He further referred to the decision of the Karnataka High Court in CIT v. Samsung Electronics Co. Ltd.: (2012) 345 ITR 494 (Kar.) in support of his contention that computer software is recognised as a copyright work and the payments made by an Assessee for import of the software would be payments for transfer of copyright and the same would fall within the definition of the term ‘royalty’. He then referred to the decisions of Authority for Advance Ruling (AAR) in Citrix Systems Asia Pacific Pty Ltd., In Re: (2012) 343 ITR 1 (AAR) and Skillsoft Ireland Ltd., In Re: (2015) 376 ITR 371 (AAR) in support of his contentions.

Held by CIT (A)

The CIT (A) took note of the Assessee’s submission that while the AO had treated similar payments to M/s Data Innovation Asia Limited as made for the purchase of software, it had treated the payments made to THPL and M/s Speed Miners as royalty and, thus, the decision of the AO was self contradictory. The CIT (A) accordingly accepted the Assessee’s contention that the payments made by it for the purchase of software from THPL and M/s Speed Miners were not royalty. With regard to the disallowance of Rs. 13,78,496/- made under Section 40(a)(ia), the CIT(A) found that the transactions were identical to the ones entered into by the Assessee with THPL and M/s Speed Miners and, therefore, the payments made to Inter systems India Pvt. Ltd., Gurgaon were also held to be on account of purchases. The CIT (A) accepted the Assessee’s contention that it was not obliged to deduct any tax at source on such payments.

Held by ITAT

ITAT upheld the order of CIT (A). It was further held that the decision of this Court in Dynamic Vertical Software India P. Ltd. (2011) 332 ITR 222 (Del) squarely covered the issue raised and following the aforesaid decision, rejected the Revenue’s contention. For similar reasons, the Tribunal also rejected the Revenue’s contention that the payments made by the Assessee to Intersystem India Pvt. Ltd., Gurgaon were to be disallowed as deductions under Section 40(a)(ia).

Held by High Court

High Court held that the Assessee had entered into a “VAR Agreement” with THPL, Paragraph 1.1 of the said agreement expressly indicates that THPL had appointed the Assessee (described as VAR) to “market and sell the products” in the Territory. Article 2 of the said Agreement provides for “VAR’s Obligations”. Paragraph 4.2 entitles the Assessee to, inter alia, use the software and source codes for a limited purposes to sell and promote the software for use by third parties; demonstrate the software to third parties; and to customize the software for the purposes of End Users. The said agreement further contains a number of covenants to ensure that the Intellectual Property Rights in respect of the software, related material and source codes remains with THPL. Further the CIT (A) found that the Assessee was engaged in the resale of software and the payments made by it to THPL and others were on account of purchases made by the Assessee. The ITAT concurred with the aforesaid finding. It is also not disputed that in the preceding years, the AO had accepted the transactions in question to be that of purchase of software.

In the cases where an Assessee acquires the right to use software, the payment so made would amount to royalty. However in cases where the payments are made for purchase of software as a product, the consideration paid cannot be considered to be for use or the right to use the software. It is well settled that where software is sold as a product it would amount to sale of goods. In the case of Tata Consultancy Services v. State of Andhra Pradesh: (2004) 271 ITR 401 (SC), the Supreme Court examined the transactions relating to the purchase and sale of software recorded on a CD in the context of the Andhra Pradesh General Sales Tax Act. The court held the same to be goods within the meaning of Section 2(b) of the said Act and consequently exigible to sales tax under the said Act. Clearly, the consideration paid for purchase of goods cannot be considered as ‘royalty’. Thus, it is necessary to make a distinction between the cases where consideration is paid to acquire the right to use a patent or a copyright and cases where payment is made to acquire patented or a copyrighted product/material.

A Coordinate Bench of this Court has also expressed a similar view in the case of Infrasoft (2014) 220 Taxman 273 (Del)). In that case, the Revenue sought to tax the receipts on sale of licensing of certain software as royalty. The Tribunal held that there was no transfer of rights in respect of the copyright held by the Assessee in the software and it was a case of mere transfer of copyrighted article. This Court concurred with the Tribunal and held that what was transferred was not copyright or the right to use a copyright but a limited right to use the copyrighted material and that did not give rise to any royalty income. In another case, Dynamic Vertical Software India P. Ltd. (2011) 332 ITR 222 (Del), this Court had reiterated the view that payment made by a reseller for the purchase of software for sale in the Indian market could by no stretch be considered as royalty.

Accordingly appeals of the revenue dismissed.