Novel Inc. Vs. DDIT (Intl. taxation) – The proceeds from sale of Software to Distributors, without granting the right to duplicate / alter / modify the software, cannot be construed as ‘Royalty’, regardless of the fact that the taxpayer choose to describe its product as ‘intellectual value’ in its invoices. The Tribunal held that if the creator himself exploits his work by converting it into end products ready for use and transfers the right to use such end products to another but not further the right to copy the same, it would be a case of transfer of a copyrighted product.
Further, the Tribunal held that under Article 12(3)(a) of the India-USA tax treaty (tax treaty), the distinction between ‘use’ or the ‘right to use’ a copyright and the ‘use’ or ‘right to use a’ copyrighted article is required to be kept in mind, for falling within the domain of `Royalty’.Also, the Tribunal held that once a particular stand has been taken by the tax department in one transaction in the hands of the payer, it is impermissible to take diagonally contrary stand on the same transaction in the hands of the payee.
INCOME TAX APPELLATE TRIBUNAL, MUMBAI
ITA No. 4368/Mum/2010 : Asst.Year: 2007-2008
M/s. Novel Inc.
The Deputy Director of Income- Tax (International Taxation)
Date of Pronouncement : 28.11.2011
O R D E R
Per R.S. Syal, AM :
This appeal by the assessee is directed against the order passed by the Commissioner of Income-tax (Appeals) on 23.03.2010 in relation to the assessment year 2007-2008.
2. The only issue raised through various ground is against the treatment to the proceeds from the sale of software as royalty income. Briefly stated the factual matrix of the case is that the assessee, a non-resident, filed its return declaring total income of Rs. 1.76 crore. In a footnote to the return of income, it was stated as under:-
“During the previous year, Novell has sold software to NIPL for resale. The said income is taxable in the hands of Novell as a business income. Since, Novell does not have any permanent establishment as per Article 5 of the India – USA treaty, income arising from such sale of software amounting to Rs. 58,29,858/- is not chargeable to tax in India as per Article 7 of the India-USA Tax treaty.”
3. During the course of assessment proceedings, the Assessing Officer observed that the assessee, a company incorporated in the United States and resident of USA for taxation purposes, is a leading provider of information solutions. The company operates globally through the presence of subsidiaries in other countries. In India it entered into joint venture company called Onward Novell Software (India) Private Limited (hereinafter called “NIPL”) which acts as a distributor for the company and imports certain software from the assessee and duplicates and sells or sometimes resells the same in the Indian sub¬continent. It was noticed by the AO that in the previous year relevant to the assessment year under consideration, the assessee received royalty as per the Distribution agreement amounting to Rs. 1.76 crore towards sales made by NIPL which was offered by the assessee as royalty income. There is no dispute on it inasmuch as the AO accepted the said amount as royalty income and taxed it accordingly. The assessee was also found to have received a sum of Rs. 58,29,858 from NIPL towards the direct sale of software, which were subsequently resold by NIPL to its end customers. The assessee claimed such amount from sale of software as business income and in the absence of it having permanent establishment as per Article 5 of India – USA treaty (hereinafter called the DTAA), not chargeable to tax. During the course of assessment proceedings the assessee, vide its letter dated 06.08.2009, stated that the sale under the Distribution agreement to NIPL was different from the other agreement as per which it authorised NIPL to duplicate its software for the purposes of further sale which resulted in the above offered royalty income. On being called upon to furnish the details in this regard, the assessee filed copies of invoices from which it was observed by the A.O. that the assessee had indicated the sale of “intellectual value” on all such invoices. The A.O. held that a sum of Rs. 58.29 lakh declared by the assessee as business income from the sale proceeds of software also represented royalty income covered under Article 12(3) of the DTAA. In his opinion there was no difference between two situations viz., firstly, in which the NIPL acquired the right to duplicate for which the assessee received income of Rs. 1.76 crore and; secondly in which NIPL acquired software as such from the assessee for a sale consideration of Rs. 58.29 lakh. He, therefore, treated the entire amount of Rs. 2.34 crore as royalty income and charged tax accordingly. The learned CIT(A) echoed the assessment order on this issue except for holding that the amount collected from various Indian parties towards the sale of “intellectual value” was to be assessed as royalty whereas the amount collected for CD case, Compact discs and DVDs etc. as business receipts not taxable to India in view of the assessee not having any permanent establishment in India. The assessee is aggrieved against the finding given by the learned CIT(A) qua the treatment of amount collected from Indian parties towards “intellectual value” to be assessed as royalty.
4. We have heard the rival submissions and perused the relevant material on record. The only question which falls for our consideration in the present appeal is to decide as to whether the sum of Rs. 58.29 lakh is royalty or business profits. If it is held as business profits, then the assessee cannot be charged to tax on this amount because of it having no permanent establishment in India as claimed by the assessee and the categorical finding returned by the learned CIT(A) in his order. If however the said amount is held as royalty income, as has been decided by the learned CIT(A), then the assessee will be chargeable to tax on this amount.
5. Section 9(1)(vi) provides that income by way of royalty shall be deemed to accrue or arise in India where it is payable by ….. (b) a person who is a resident, except where the royalty is payable in respect of any right, property or information used or services utilized for the purposes of a business or profession carried on by such person outside India or for the purposes of making or earning any income from any source outside India. Explanation 2 to this provision defines ‘royalty’ to mean “consideration (including any lump sum consideration but excluding any consideration which would be the income of the recipient chargeable under the head “Capital gains”) for –
(i) to (iva)
“(v) the transfer of all or any rights (including the granting of a licence) in respect of any copyright, literary, artistic or scientific work including films or video tapes for use in connection with television or tapes for use in connection with radio broadcasting, but not including consideration for the sale, distribution or exhibition of cinematographic films;”
(emphasis supplied by us)
6. It is the case of the Revenue that consideration received by the assessee towards the sale of software products to NIPL for resale is royalty income since the consideration of Rs. 58.29 lakh is nothing but payment for transfer of copyright in the computer programme. It is noted that the word “copyright” has not been defined in the Income-tax Act, 1961. In order to find the meaning of this word, which is crucial for our decision, we need to revert to the Copyright Act, 1957. Section 14(1)(a) gives the meaning of copyright as under:-
“14. Meaning of copyright. – (1) For the purposes of this Act, “copyright” means the exclusive right, subject to the provisions of this Act, to do or authorise the doing of any of the following acts in respect of a work or any substantial part thereof, namely:-
(a) in the case of a literary, dramatic or musical work, not being a computer programme, –
(i) to reproduce the work in any material form including the storing of it in any medium by electronic means;
(ii) to issue copies of the work to the public not being copies already in circulation;
(iii) to perform the work in public, or communicate it to the public;
(iv) to make any cinematography film or sound recording in respect of the work
(v) to make any translation of the work;
(vi) to make any adaptation of the work;
(vii) to do, in relation to a translation or an adaptation of the work, any of the acts specified in relation to the work in sub-clauses (i) to (vi);
(b) in the case of a computer programme,—
(i) to do any of the acts specified in clause (a);
(ii) to sell or give on commercial rental or offer for sale or for commercial rental any copy of the computer programme:
Provided that such commercial rental does not apply in respect of computer programmes where the programme itself is not the essential object of the rental.]
(c) to (e) ”
7. Sec. 2(y) of the Copyright Act defines “work” as any of the following namely:- (i) a literary, dramatic, musical or artistic work; (ii) a cinematography film; (iii) a record. Section 2(o), defines a `literary work’ as including computer programmes, tables and compilations including computer databases. Sec. 2(ffc) defines a computer programme as a set of instructions expressed in words, codes, schemes or in any other form including a machine readable medium, capable of causing a computer to perform a particular task or achieve a particular result. Thus `computer programmes’ drop in the meaning of `literary work’, which, in turn, falls in clause (i) of section 2(y) of the Copyright Act defining `work’. A close look at the meaning of copyright of a computer programme as per section 14(b) of the Copyright Act, 1957 indicates that it refers to the exclusive right to do or authorise to do in respect of a work, mainly, to reproduce the work in any material form including the storing of it in any medium by electronic means or to issue copies of the work to the public not being copies already in circulation etc. as per clause (a) or to sell or give on commercial rental or offer for sale or for commercial rental any copy of the computer programme. On reading section 14 of the Copyright Act in juxtaposition to section 9(1)(vi) of the Income-tax Act, 1961, the position which emerges is that any consideration received for transfer of all or any rights in respect of copyright shall be considered as royalty. Thus, only if the consideration received is towards transfer of all or any rights in respect of copyrights, it shall be royalty and in any other case it shall cease to be so.
8. Adverting to the facts of the instant case it is observed that the assessee had two types of transactions in India with NIPL. First, being the giving of right to NIPL to copy its certain specified software for sale by them in Indian market. For this purpose the assessee entered into Software license and distribution agreement (hereinafter called Agreement A) with NIPL, a copy of which is available on pages 47 to 75 of the paper book. Clause 3(3) of this agreement stipulates that the assessee grants a non-exclusive and non-transferable license to NIPL to duplicate, distribute and market the Duplicated Products solely in the defined areas without modifying or creating any derivative works of the Duplicated Products. Clause 3(4) of this agreement provides that the royalty shall become due to the assessee from NIPL for each copy of the Duplicated Products distributed by it. Clause 6.1 of the agreement provides that the software acquired under the agreement is to enable NIPL to market the Duplicated Products only under the provisions of the agreement and further all the end customers receiving the Duplicated Products agree to be bound by the software license agreement. From different clauses of this Agreement A, it divulges that the assessee holds intellectual property rights in the software. It simply granted license to NIPL to duplicate, distribute and market the Duplicated Products without any modification to the intellectual property of the assessee in the form of software. Further NIPL is liable to pay royalty to the assessee at the rate of 35% of its net revenues from offering Duplicated Products to the end users in the specified territories. This sum amounted to Rs. 1.76 crore, which was duly offered by the assessee as royalty income in its return.
9. Now let us examine the second agreement, the proceeds flowing from which have become the bone of contention. A copy of this agreement called Novell Distributor Agreement (hereinafter called “Agreement B”) is available at pages 76 to 92 of the paper book. The preamble of this agreement is as under:-
“Novell develops, manufactures and sells computer software products. Distributor is in the business of distributing computer software products. This Agreement authorises Distributor to acquire from Novell the computer software products identified as eligible in Exhibit A and to market them through an identified marketing channel.”
10. Distributor in this agreement has been referred to as NIPL and the “computer software products” have been defined to mean the intellectual property of the assessee in the form of computer software, which NIPL shall sell in the defined market to the end customers. As per this agreement NIPL has been appointed as Distributor of the assessee “to market the Novell products acquired under the Agreement within the Defined area”. Clause 3 of the agreement provides that NIPL may acquire Novell products at the price listed in the appropriate Novell product price list less the discount set forth. As per this agreement, NIPL is to secure orders for the Novell products and after purchasing the same from the assessee it has to sell the same products as such to the end users. It has further been set out in the agreement that each Novell product distributed by NIPL will be provided to end users subject to software license agreement which accompanies the Novell products. Still further clause 6(e) of this agreement provides that no title to or ownership of Novell Products acquired under the Agreement is transferred to NIPL. From the perusal of the above terms of the agreement, it is discernible that the assessee sold its computer software products to NIPL, who in turn sold it to end users after marking up towards its costs and profit.
11. When we view agreement A in conjunction with agreement B, the distinction between the two becomes quite apparent and glaring. Whereas under agreement A, the assessee has granted a license to NIPL to duplicate, distribute and market the duplicated products in the definite area, under agreement B, the product as such has been acquired by NIPL from the assessee which is further sold without any modification or alteration. Thus under agreement A, the assessee does not supply its computer software products to NIPL but grants license to duplicate from its intellectual property in the software for making sales in the market. On the other hand, under agreement B no license is granted to NIPL for duplicating computer software products of the assessee but the products as such are sold to NIPL who then sells them to the end users on profit.
12. Coming back to the definition of copyright u/s 14 of the Copyright Act, 1957, it is seen that copyright is a concept giving the creator of original work an exclusive right to do certain specified acts in respect of its work such as `to reproduce the work in any material form’ including the storing of it in any medium by electronic means or `to issue copies of the work’ to the public etc. It is thus seen that in essence “copyright” means “the right to copy” the work which may be in the nature of intellectual property like patent, trademark, trade secret etc. Reproduction of the work or to issue copies of the work in the context of computer programmes is akin to making copies of it. Thus copyright of a computer programme means the exclusive right to reproduce it in any material form or copy it. When we read section 9(1)(vi) in the setting of royalty from copyright of computer programmes, it becomes manifest that the consideration paid assumes the character of royalty if it is for reproducing the same in any material form or issuing copies of it etc. As per agreement A, the assessee authorised NIPL to duplicate its computer software programme, which is the same thing as reproducing it in any material form or issuing copies of it. The duplicated products so made by NIPL were as a result of grant of exclusive right by the assessee to reproduce a work in any material form, thereby coming within the ambit of transfer of copyright in the computer programme. The consideration so paid apparently fell within section 9(1)(vi), as rightly declared by the assessee. However coming to the agreement B, by which the assessee did not allow NIPL to reproduce the computer software programme or to issue its copies, but only to re-sell the software made and sold by the assessee to it from the intellectual property of computer software programme. The assessee simply transferred its computer software products to NIPL for consideration for the purposes of resale without giving any right to duplicate the same in any manner. It is a clear cut case of consideration received for the transfer of copyrighted products and not for the transfer of copyrights in the computer software programme. The distinction between the transfer of a copyright and the transfer of a copyrighted product is prominent. Where the creator of an intellectual property allows another to exploit it commercially by taking copies and selling it, but retaining the dominion over such property with himself, the same is a case of transfer of copyright. If however, the creator himself exploits his work by converting it into end products ready for use and transfers the right to use such end products to another but not the further right to copy the same, it would be a case of transfer of a copyrighted product. The consideration in the former case would be royalty, but that in the latter would be business profit.
13. Coming back to the facts of the instant case it is noticed that the assessee received Rs. 58.29 lakh from NIPL towards the sale of its software products. Neither NIPL nor its end users were permitted to copy the same and exploit such products for commercial purposes. The customers were bound to use such software only for their own business purpose. They did not have any right to make any further copies of the product. It can further be seen that the end users were bound by the software license agreement. These clauses fairly indicate that NIPL simply acquired the possession of the software and the end users acquired the right to install such software on their computers for personal use. The end users were not entitled to copy or sell or otherwise transfer the software acquired from NIPL. From here it clearly follows that by acquiring the Novell products from the assessee, neither the end users nor NIPL acquired any copyright over the computer software of the assessee. Since the consideration of Rs. 58.29 lakh in question is sale price of the copyrighted product and not a consideration for transfer of copyright in the software of the assessee, in our considered opinion, the authorities below were not justified in treating it as royalty income.
14. The learned Departmental Representative has placed strong reliance on the ruling given by the Authority for Advance Rulings in Millennium IT Software Ltd., In re [(2011) 338 ITR 391 (AAR)]. It was argued that in this case it has been held in para 41 that : “When that right of user is given, the right to use the copyright is also given. On the terms of the Income-tax Act, read in the light of the Copyright Act, the right granted for use of a copyrighted article for consideration, would also be royalty since going by the relevant definition, the grant of right to use the copyrighted article would also be a licence by the owner of the copyright, though limited in nature, limited to the use of the other contracting party alone, without entitling the grantee to further exploit the copyright”. It is in this light of the aforesaid observations of the Authority that the learned Departmental Representative forcefully argued that even the consideration for transfer of a copyrighted article shall be considered as royalty. Let us examine the facts of that case. The applicant therein entered into a software licence and maintenance agreement with Indian Commodity and Exchange Limited (ICEL). Under the agreement, the applicant allowed ICEL to use the software product (the licensed programme) owned by it. The licensed programme was to be installed into the computer machines designated by ICEL. The applicant was to deploy its personnel to the designated site to train the employees of ICEL. The applicant was required to provide at its own cost, maintenance and support services. For installation and implementation of the licensed programme, the applicant was to be paid Rs. 4 crore. The licence to use the licensed programme was for four years and thereafter its renewal was left to the discretion of ICEL. It was under these facts that that question before the Honourable Authority for Advance Rulings was whether the fees paid by ICEL to the applicant would be taxable as royalty or business profits. The Honourable Authority held such payment as royalty and not as business profit by noting that the ICEL has also been granted the right to take copies of the licensed programme. It has further been accentuated in para 40 that :`When a software developed over which a copyright is acquired, is permitted to be used by another for a consideration or another is given a right to use it including the taking of copies for the purpose of its business, for consideration, it appears to me to be a case of receiving royalty for enabling that person to exercise the right to use the programme or literary work.’ Thus it is abundantly manifest from the facts of that case that not only right of user was given but also the right to use the copyright also. This fact is further corroborated from para 45 that :`In the present case, not merely the use is licensed but the licensee is given the right to copy it and use it wherever it is needed by it for its business. The right given for a consideration to copy the copyrighted software and use it for its own purposes by ICEL whenever and wherever needed by it, clearly attracts the definition of royalty to the consideration paid by ICEL to the applicant….’. It is thus amply borne out that the facts of the instant case are materially different from those considered by the Authority for Advance Ruling in the case of Millennium IT Software (supra). Neither it is the case of the AO/CIT(A) nor any material has been brought to our notice by the ld. DR to disclose that the end users of the Novell Products were entitled to copy it and use it wherever needed. When the right to copy a product is assigned, the payment obviously assumes the character of royalty. But if it is consideration only for the use of a copyrighted product divorced from the right to copy the same, it, by no stretch of Imagination, can be construed as royalty for the obvious reason that the right to copy, which is sine qua non of copyright, is lacking.
15. It is observed that the assessee is a resident of USA. In that view of the matter, it would be apposite to consider the DTAA. The Assessing Officer has also considered Article 12 of the treaty which deals with Royalties and fees for included services. Clause 3 of Article 12 defines royalties as under:-
“3. The term “royalties” as used in this article means:
(a) payments of any kind received as consideration for the use of, or the right to use, any copyright of a literary, artistic, or scientific work, including cinematograph films or work on film, tape or other means of reproduction for use in connection with radio or television broadcasting, any patent, trademark, design or model, plan secret formula or process, or for information concerning industrial commercial or scientific experience, including gains derived from the alienation of any such right or property which are contingent on the productivity, use or disposition thereof; and
(b) payments of any kind received as consideration for the use of, or the right to use, any industrial, commercial or scientific equipment, other than payments derived by an enterprise described in paragraph 1 of article 8 (Shipping and Air Transport) from activities described in paragraph 2(c) or 3 or article 8.”
16. It can be seen from the above Article 12(3) that clause (b) is not attracted in the present case. Clause (a) is relevant for our purpose as per which payments of any kind received as consideration for the use of or the right to use any copyright of a literary work etc. is royalty. Incorporation of the words “any copyright of a .” after the expression “for the use, or the right to use” fairly brings out that when the payment is for the use of any copyright, it is a royalty and not otherwise. From here it follows that unless payment is for using or acquiring the right to use the copyright of a work, it cannot be characterized as royalty. Here it is pertinent to note that the requirement is the use of `copyright’ of work and not that of the product derived from such copyright. So in order to be covered under this clause, it is imperative that the payment must be made `to use’ the `copyright’ or the `right to copy’ the work. The distinction between `use’ or the `right to use’ a copyright and the `use’ or the `right to use a’ copyrighted article is required to be kept in mind. Once the language of Article 12(3) unequivocally co-relates the payment for `use of’ the `right to copy’ the `work’ as a pre-condition for falling within the domain of `Royalty’, it is difficult to hold that the payment for the `use of’ copyrighted article finally drawn from the `work’ also qualifyies for royalty. As in the instant case the said sum of Rs. 58.29 lakh has been received by the assessee not as a consideration “for the use of, or the right to use any copyright” of a computer software but is a consideration for acquisition of the computer software meant for the exclusive use of the end users, it cannot be brought within the ambit of Article 12(3).
17. It would be relevant to note at this juncture that the authorities below appear to have been swayed by the nomenclature of `Intellectual value’ given in the invoices raised by the assessee on NIPL. It is an elementary principle, which is fairly settled that in order to construe an agreement, one has to look at the essence of it rather than its form. No party can get rid of the consequences merely for describing a particular item in a particular form though in essence and in substance it may be a different transaction. Going by the same logic, if an item of expenditure is given the name of an asset, it shall remain expenditure and will not find its place in the balance sheet. Similarly if an item of income is given the name of liability, it shall not shed its character of income merely for the reason that the assessee described it as liability. There is no dearth of judgements laying down this proposition. The Hon’ble Supreme Court in CBDT VS. Oberoi Hotels (1998) 231 ITR 148 (SC) has held that :`It is the substance of the case which matters and not the name.’ Similar view has been reiterated by the Mumbai bench of the tribunal in a third member case in Nicholas Apple-gate South East Asia Fund Ltd. VS. ADI (International Taxation) (2009) 117 ITD 299 (Mum) (TM).
18. Thus it follows that the relevant thing to be examined is the true nature of transaction devoid of the name given. If the true nature of a payment is royalty, it will remain the same notwithstanding the fact that the parties preferred to refer it as sale and vice versa. When we slip back to the facts of the instant case, we find that the true nature of payment is sale of copyrighted articles and not the transfer of copyright. As such, it would partake of the character of business profits and not royalties regardless of the fact that the assessee chose to describe its product as `Intellectual value’ in its invoices.
19. It is interesting to examine the issue under consideration from another angle also. NIPL filed its return declaring payments to the assessee as royalty on the sale of duplicate software at Rs. 1.76 crore and purchase of software at Rs. 58.29 lakh. These transactions were duly reflected in Form No. 3CEB. Appendix B to the report contains particulars in respect of transactions in tangible property from assessee. Description of transactions has been given as “Purchase of software” and the amount is declared at Rs. 58.29 lakh. In Annexure-C description has been given as “Royalty on sale of duplicated software” to the assessee with a consideration of Rs. 1.76 crore. When the case of NIPL came up for scrutiny assessment before the A.O., he referred the matter to the TPO, who vide his order dated 27.04.2010 accepted the ALP declared by the assessee in respect of royalty and purchases made by the NIPL from the assessee. The AO, in turn, not only accepted the exercise done by the TPO and gave effect to the same in the assessment order, but also accepted the purchase transactions done by NIPL from the assessee as such. He did not hold the purchase transactions as the payment of royalty. It is axiomatic that profit from off-shore sale made by a non¬resident does not result into accrual of any income to the non-resident u/s 9(1)(i) of the Income-tax Act. But if the non-resident earns royalty income from India, it is chargeable to tax u/s 9(1)(vi) in his hands despite his status of non-resident. Once a payment made by an Indian to a non-resident is chargeable to tax in his hands, it becomes the duty of the Indian payer to deduct tax at source in terms of section 195. If the payer fails to deduct tax at source, the mandate of section 40(a)(i) is attracted and as such the payer suffers dis-allowance of the amount paid in its assessment. Clause (i) of section 40(a) specifically provides that any royalty etc. chargeable under this Act, which is payable outside India or in India to a non-resident, not being a company or a foreign company, on which tax is deductible at source under Chapter XVII-B and such tax has not been deducted or, after deduction has not been paid during the previous year, or in the subsequent year before the expiry of the time prescribed u/s 200(1), shall be disallowed. Thus it follows that if royalty is paid by an assessee to a non-resident which is chargeable to tax in the hands of such non-resident, it is the duty of the payer to deduct tax at source. In case of his failure to deduct tax at source, the amount paid, suffers dis-allowance u/s 40(a)(i). Coming back to the facts of the instant case it is noted that from the assessment order of the NIPL that no dis-allowance u/s 40(a)(i) has been made, which implies, that the AO accepted such payment to the assessee by NIPL as having been made on transaction of purchase and not as royalty. Once a particular stand has been taken by the Revenue in one transaction in the hands of the payer, it is impermissible to take diagonally contrary stand on the same transaction in the hands of the payee. Since the Department accepted such payment of Rs. 58. lacs as having been made by NIPL on account of transaction of purchase from the assessee, it cannot now turn around to hold that the very same payment is royalty in the hands of payee. We jettison the viewpoint of the Revenue on this score as well.
20. In view of the foregoing reasons we are satisfied that the learned CIT(A) was not justified in holding that the amount collected by the assessee towards the “intellectual property” be assessed as royalty. The impugned order on this issue is, therefore, overturned and it is held that the entire amount of Rs. 58.29 lakh be considered as business profits. The learned CIT(A) has recorded a categorical finding that the assessee does not have a permanent establishment in India and thus its business profit cannot be taxed in India. No appeal has been preferred by the Revenue to challenge this finding given by the learned CIT(A). Ex consequenti the business profits amounting to Rs. 58.29 lakh cannot be charged to tax in India in view of the assessee not having any PE in India.
21. In the result, the appeal is allowed.
Order pronounced on this 28th day of November, 2011.