The word ‘Royalty’ has French origins. Recently, in earlier of March, this word had caught attention across the Globe due to television interview of ex-royal couple of the UK! However, here in India same has caught attention due to landmark ruling of the Honourable Supreme Court in case of Engineering Analysis Centre of Excellence Pvt. Ltd and others. By delivering this landmark ruling, Apex Court has given rest to long running controversy of taxability of Royalty, once and for all.
Readers must be aware that; taxability of royalty and withholding tax obligations on it, is matter of litigation since ages. Due to its pervasive definition in the Income Tax Act , each and every payment made by residents to non-resident software service providers has raised eye brow of the Revenue to trap it into tax net in India in hands of Non-Resident. Not any more though! Thanks due to sense and sensibility of our judiciary system, who has denied claim of the Revenue in such a subtle way in this historical ruling!
The common appeals were filed by the assessese arises from common judgment of Karnataka HC in case of Samsung Electronics Co-Ltd. (2012)345 ITR 494, which was subsequently followed in various other cases and held in favour of Revenue.
The common question poised before the court-
Amounts paid by the concerned persons who are resident in India to non-resident, foreign software suppliers, amounted to royalty and as this was so, the same constituted taxable income deemed to accrue in India under section 9(1)(vi) of the Income Tax Act, 1961 , thereby making it incumbent upon all such persons to deduct tax at source and pay such tax deductible at source under section 195 of the Income Tax Act.
The SC’s Take on:
In this landmark ruling, the Apex Court has not only discussed the relevant provisions of the Income Tax Act, 1961 and DTAA but also ancillary laws impacting the transactions under the appeal, at length.
1. Section 4
2. Section 5
3. Section 9
4. Sec .90
5. Various DTAA
6. The Copyright Act, 1957
7. OCED Model Convection
8. Vienna Convection
Substance over Form:
The ‘substance over form’ has universal applicability. It is one of the basic principles of accounting and taxation laws also. In case of The Income Tax Act, 1961, Sec.4, Sec 5 and Sec9 are charging sections which means they have “ substance” while remaining sections under various heads of income are machinery provisions to calculate the income and tax liability , which is mere “form” to implement the “substance” .
In nutshell, any income which does not fall under purview of chagrining sections, no tax can be levied on such income.
Nevertheless, while reading the Act, one is needed to keep holistic approach. Sec 90 empowers Central Govt to enter into an agreement with Foreign Governments for granting relief in respect of incomes on which is taxable in more than one countries. Sec. 90 (2) lays down one extremely important proposition that; assesse to whom such agreement applies, the provisions of the Act shall apply to the extent they are more beneficial to the assesse. Thus, any such DTAA has always overriding effects over the Income Tax Act.
It is discussed at great length in another landmark ruling the Apex Court in case of Azadi Bachao Andolan.
Thus following steps are essential to determine chargeability of doubly taxed income:
1. See whether income is chargeable u/s 4 rws 5 and 9
2. See the machinery provision of Act to calculate tax liability
3. Check whether assesse is eligible to get Treaty benefit
4. Check whether any benefit is available either in terms of exemption or credit in corresponding treaty.
5. Apply the provision (either under Sr. 2 or Sr. 4), which is more beneficial in nature.
The Apex Court has exactly followed above steps in this ruling and delivered this pronouncing.
Sale of “copyright’’ v/s Sale of “copyrighted goods”:
Before this judgement, in majority of the cases, whenever resident assessee entered into agreement with non-resident to purchase software for its end-use , revenue opined that; such income in hands of non-resident would taxable in India in terms of Royalty . And hence resident assesse is required to deduct tax u/s 195 of the Act. Failing on which, assesse held as in default.
Without going into substance of the transaction, Plethora of notices had been issued by the Revenue to consider the resident assesse as “Assessee in Default” for not meeting with withholding obligations.
This judgment has cleared our clouds over sale of copyright and sale of copyrighted goods. When resident assessee enters into contract with non-resident for software purchase, what they actually buy “goods” and not any “rights”. They don’t get any rights either to re-produce or to re-sale except to use them for their own.
Since sale of software for end-use is business income of non-resident, in absence of PE, such income is not taxable in India and hence no withholding tax obligations arises for buyer.
From time to time, by delivering such brave and bold judgements, Apex Court always restores faith of honest taxpayers of this nation.