Receipts on sale of software not taxable as royalty

IBM Singapore Pte Ltd. Vs DCIT (ITAT Banglore)

As per the decision rendered by Hon’ble Supreme Court in the case of Engineering Analysis Centre of Excellence Pvt. Ltd., sale proceeds received by the assessee on sale of software licenses cannot be categorized as “Royalty” within the meaning of provisions of DTAA.

FULL TEXT OF THE ORDER OF ITAT BANGALORE

These cross appeals are directed against the order dated 28.9.2018 passed by Ld. CIT(A)-12, Bangalore and they relate to the assessment year 2014-15.

2. At the time of hearing, the Ld A.R did not press grounds 2.1 to 2.10 relating to assessment of amount received as reimbursement of expenses treating the same as “Fee for technical services”. Accordingly, those grounds are dismissed as not pressed. Ground No.1 is general in nature. Ground Nos.3.2 to 3.15 relate to the assessment of sale proceeds received on sale of software licenses as “Royalty income”.

3. The revenue is contesting the decision of Ld CIT(A) in granting relief in respect of interest charged u/s 234B of the Act.

4. The assessee is a Singapore based company engaged in the business of dealing in software & hardware products. Under the provisions of Indian Income tax Act, the assessee is a non-resident. During the year under consideration, the assessee has sold software licenses to its Associated Enterprise (AE) and also to other Indian customers. The assessee did not offer any income on such sale for taxation in India. The Ld A.R submitted that the AE of the assessee, viz., M/s IBM India Pvt Ltd is the authorized distributor of software licenses sold by the assessee. In respect of sales made to Non-Associated enterprises, the Ld A.R submitted that majority of sales were made to “other distributors” and in few cases, it was sold to End users also. The details of sales effected by the assessee during the year under consideration in India are tabulated as under by the A.O.

5. The A.O. took the view that the above said aggregate sale consideration of Rs.441.94 Crores constitute “royalty” in the hands of the assessee both under section 9(1)(vi) of the Income-tax Act,1961 [‘the Act’ for short] and under Double Taxation Avoidance Agreement (DTAA) entered between India and Singapore. Accordingly, he made addition of Rs.441.94 crores to the total income returned by the assessee. The A.O. placed his reliance on the decision rendered by Hon’ble Karnataka High Court in the case of Samsung Electronics Company Ltd. (345 ITR 494) and Synopsis International Old Limited (ITA Nos.11-15/2008). The Ld. CIT(A) also confirmed the addition and hence the assessee has filed this appeal before us.

6. The Ld. A.R. submitted that the assessee has sold only licenses to use the software and it did not part with any of its right over the products within the meaning of Copy right Act. He further submitted that the provisions of DTAA entered between India and Singapore shall govern these transactions and as per the provisions of DTAA, the sale receipts of software licenses cannot be taxed as “royalty”. For all these propositions, the Ld A.R placed his reliance on the decision rendered by Hon’ble Supreme Court in the case of Engineering Analysis Centre of Excellence Pvt. Ltd. (2021) 125 Taxmann.com 42.

7. The Ld A.R submitted that the tax authorities have placed their reliance on the decisions rendered by Hon’ble Karnataka High Court in the case of Samsung Electronics Co Ltd (supra) and Synopsis International Old Ltd (supra). However, both the decisions have been reversed by the Hon’ble Supreme Court in the case of Engineering Analysis Centre of Excellence P Ltd (supra).

8. The Ld A.R further submitted that the Hon’ble Supreme Court has delivered its decision holding that the software licenses cannot be taxed as royalty under the provisions of DTAA unless copy rights are parted with. The Hon’ble Supreme Court has examined some agreements entered by software suppliers with the Distributors/ end users on sample basis in this regard. It included the agreements entered by the assessee with its distributors (referred as “re-marketeers”)/ End users and also the End User’s License Agreement (EULA) entered between the distributors and the end users.

(a) The agreement entered by the assessee with End users has been extracted in paragraph 44(i) of the order of Hon’ble Supreme Court.

(b) The agreement entered by the assessee with IBM India (re-marketeer) has been extracted in paragraph 44(ii)a of its order by Hon’ble Supreme Court and

(c) The agreement entered by IBM India (r-marketeer) with the end users has been extracted in paragraph 44(ii)b of the order.

The Ld A.R submitted that the very same terms and conditions of granting license to use software continue during this year also. The Hon’ble Supreme Court has concluded that the payments made by the distributors and end-users to the non-resident software supplier placed in Singapore, is not “royalty” within the meaning of the provisions of DTAA and hence the distributors/end users are not liable to deduct tax at source u/s 195 of the Act from the payments made to the non-resident software supplier located in Singapore on the reasoning that the distributor’s agreement and end-user’s license agreement in the facts of cases before Hon’ble Supreme Court do not create any interest or right in such distributors/end-users, which would amount to use or right to use any copy right.

9. The Ld A.R submitted that the assessee herein is a Singapore resident governed by the DTAA entered between India and Singapore. On the examination of very same DTAA provisions, the Hon’ble Supreme Court has held that the payments given by the distributors/end users to the assessee are not “royalty” within the meaning of provisions of DTAA and hence there was no liability to deduct tax at source from those payments u/s 195 of the Act, since no income is chargeable to tax in India. In the instant case, the AO has assessed the sale proceeds received on sale of licenses as “royalty”. In view of the above cited decision of Hon’ble Supreme Court, the sale proceeds received on sale of software licenses cannot be assessed as “royalty”. Accordingly, the Ld. A.R. submitted that the impugned addition made by the A.O. and confirmed by Ld CIT(A) is liable to be deleted.

10. The Ld. D.R. on the contrary, placed his reliance on the decision rendered by Ld. CIT(A).

11. We heard the parties on this issue and perused the record. As submitted by Ld. A.R., the Hon’ble Supreme Court has examined the issue whether the payments received by non-resident suppliers for selling software licenses are royalty or not in the case of Engineering Analysis Centre of Excellence (P) Ltd (supra). The Hon’ble Supreme Court examined this question considering four types of situations, which has been narrated as under:-

“4. 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) third category concerns cases wherein the distributor happens to be a foreign, dent vendor, who, after purchasing software from a foreign, non-resident esells 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 by foreign, non-resident suppliers to resident Indian distributors or end-users.

12. The Hon’ble Supreme Court analysed sample agreements in respect of all the four categories and gave the following finding:-

“45. A reading of the aforesaid distribution agreement would show that what is granted to the distributor is only a non-exclusive, non-transferable license to resell computer software, it being expressly stipulated that no copyright in the computer programme is transferred either to the distributor or to the ultimate end-user. This is further amplified by stating that apart from a right to use the computer programme by the end-user himself, there is no further right to sub-license or transfer, nor is there any right to reverse-engineer, modify, reproduce in any manner otherwise than permitted by the license to the end-user. What is paid by way of consideration, therefore, by the distributor in India to the foreign, non-resident manufacturer or supplier, is the price of the computer programme as goods, either in a medium which stores the software or in a medium by which software is embedded in hardware, which may be then further resold by the distributor to the end-user in India, the distributor making a profit on such resale. Importantly, the distributor does not get the right to use the product at all.

46. When it comes to an end-user who is directly sold the computer programme, such end-user can only use it by installing it in the computer hardware owned by the end-user and cannot in any manner reproduce the same for sale or transfer, contrary to the terms imposed by the EULA.

47. In all these cases, the “license” that is granted vide the EULA, is not a license in terms of section 30 of the Copyright Act, which transfers an interest in all or any of the rights contained in sections 14(a) and 14(b) of the Copyright Act, but is a “license” which imposes restrictions or conditions for the use of computer software. Thus, it cannot be said that any of the EULAs that we are concerned with are referable to section 30 of the Copyright Act, inasmuch as section 30 of the Copyright Act speaks of granting an interest in any of the rights mentioned in sections 14(a) and 14(b) of the Copyright Act. The EULAs in all the appeals before us do not grant any such right or interest, least of all, a right or interest to reproduce the computer software. In point of fact, such reproduction is expressly interdicted, and it is also expressly stated that no vestige of copyright is at all transferred, either to the distributor or to the end-user. A simple illustration to explain the aforesaid position will suffice. If an English publisher sells 2000 copies of a particular book to an Indian distributor, who then resells the same at a profit, no copyright in the aforesaid book is transferred to the Indian distributor, either by way of license or otherwise, inasmuch as the Indian distributor only makes a profit on the sale of each book. Importantly, there is no right in the Indian distributor to reproduce the aforesaid book and then sell copies of the same. On the other hand, if an English publisher were to sell the same book to an Indian publisher, this time with the right to reproduce and make copies of the aforesaid book with the permission of the author, it can be said that copyright in the book has been transferred by way of license or otherwise, and what the Indian publisher will pay for, is the right to reproduce the book, which can then be characterised as royalty for the exclusive right to reproduce the book in the territory mentioned by the license.

13. After analysing the provisions of Income tax Act, provisions of DTAA, the relevant agreements entered by the assessees with non-resident software suppliers, provisions of Copy right Acts, the circulars issued by CBDT, various case laws relied upon by the parties, the Hon’ble Supreme Court concluded as under:-

“CONCLUSION

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.”

14. We also notice that the decision rendered by Hon’ble Karnataka High Court in the case of Samsung Electronics Co Ltd (supra) has been reversed by Hon’ble Supreme Court in paragraph 101-102 of its order. Similarly, the decision rendered in the case of Synopsis International Old Ltd (supra) by Hon’ble Karnataka High Court has been reversed in paragraph 103 – 109 of its order. Before us, the Ld. A.R. submitted that the terms of agreements remain the same during the year under consideration also. Accordingly, as per the decision rendered by Hon’ble Supreme Court in the case of Engineering Analysis Centre of Excellence Pvt. Ltd. (supra), sale proceeds received by the assessee on sale of software licenses cannot be categorized as “Royalty” within the meaning of provisions of DTAA. Accordingly, we set aside the order passed by Ld. CIT(A) on this issue and direct the A.O. to delete the addition made as “royalty” income.

15. In the appeal filed by the revenue, following grounds have been urged:

1. The Hon’ble CIT(A) has erred in holding that the assessee is entitled to adopt provision of Section 115A(1)(b)( ) of the Income Tax for computing the tax payable on royalty income received in pursuance of agreements entered into after 1.6.2005 and provisions of Article 12 of the Indo-US DTAA for computing the tax payable on royalty income received in pursuance of agreements entered into after 1.6.2005.

2. The Hon’ble CIT(A) has erred in holding that the assessee can avail the benefits of Sec. 90(2), when it is not legally permissible for the assessee to have a mix of both DTAA and a portion of the Income Tax Act in order to minimize that tax

3. The Hon’ble CIT(A) has erred in holding that the assessee being non-resident is not liable for payment of advance tax as its total chargeable income is liable for TDS u/s 195, and hence not liable for levy of interest u/s 234B of the IT Act.

4. The Hon’ble CIT(A) has failed to appreciate that the deduction of tax at source u/s 195, and payment of advance tax u/s 210 are not mutually exclusive.

5. The Hon’ble CIT(A) has failed to appreciate that Sec. 209 is a computation section of advance tax on assessment of future tax liability and these words would not have been construed to mean that neither the advance tax provisions are applicable to the cases covered u/s 195 nor the assessee are at liberty to evade their tax liability even though TDS is effected.

6. The Hon’ble CIT(A) has erred in holding that the assessee is not liable for levy of interest u/s 234 even though charging of interest is mandatory and consequential as per the Status.

7. The CIT(A) failed to consider the fact that the decision of the ITAT has not been accepted and appeals u/s 260A has already been filed and the same is pending before the Hon’ble High Court of Karnataka.

8. For these and such other grounds that may be urged at the time of hearing it is prayed that the order of the CIT(A) may be annulled and that of the AO be restored.

16. Ground Nos.1 & 2 relate to taxability of receipts on sale of software licenses as royalty income. We have already held, following the decision rendered by Hon’ble Supreme Court in the case of Engineering Analysis Centre of Excellence Pvt. Ltd. (supra) that the receipts on sale of software is not taxable as royalty. Hence, above said grounds urged by revenue are liable to be dismissed.

17. Ground Nos.3 to 6 relate to chargeability of interest u/s 234B of the Act. The Ld. CIT(A) has given relief to the assessee on this issue with the following observations:

35. INTEREST U/S 234B (Ground 4.3 to 4.5 )

The appellant is aggrieved that the AO has levied interest u/s 234B. This issue is covered in favour of assessee by the decision of Hon’ble ITAT in the case of IBM Corporation (ITA No. 01/Bang/2014). The relevant extract is reproduced hereafter:

With regard to the Revenue grounds of appeal, it is clear from the above that the CIT (A) on due application of the ratios of various High Courts held that ” interest u/s 234B cannot be levied on an assessee who is not liable to pay advance tax at all and the amount received by the nonresident is subject to 100 percent tax deduction at source. The assessee filed its return and tax liability of Rs 10.94 crores was determined u/s 115A of the Act. The liability was fully discharged by way of TDS credit of Rs 10.94 crores. Hence in absence of any rulings in favour of the revenue on the point, the view expressed by various High Courts necessarily has to be followed in the instant case. The issue being similar, the levy of interest u/s. 234 B by the AO is struck down.

Respectfully following the decision of Hon’ble ITAT Bangalore, this ground is allowed.”

18. We heard the parties on this issue. The Ld. A.R. submitted that the Ld. CIT(A) has followed the decision rendered by the coordinate bench on the issue of chargeability of interest u/s 234B of the Act. In any case, if the Tribunal deletes the addition made by A.O. treating sale proceeds as royalty income, then the quantum of interest chargeable u/s 234B of the Act will come down drastically. He further submitted that the TDS credit available with the assessee will be more than the tax, if any, payable by the assessee and hence there was no liability for the assessee to pay advance tax. In that event, no interest u/s 234B of the Act shall be payable by the assessee.

19. We heard Ld. D.R. on this issue and perused the record. We find merit in the submissions of the Ld. A.R. First of all, the Ld. CIT(A) has followed the decision rendered by coordinate bench on an identical issue. Secondly, the addition relating to sale of software has been deleted by us in the earlier paragraph. Thirdly, according to the Ld. A.R., it is not liable to pay advance tax at all, since the TDS credit available with it is more than tax payable by it. In view of the above, we are of the view that no interference in the order passed by Ld. CIT(A) on this issue is called for.

20. Ground Nos. 7 & 8 are general in nature.

21. In the result, the appeal filed by the assessee is partly allowed and the appeal of the revenue is dismissed.

Order pronounced in the open court on 23^rd Aug, 2021