Software Payments Not Royalty: Delhi Court Upholds SC Ruling

CIT Vs Mol Corporation (Delhi High Court)

The Delhi High Court has dismissed a series of Income Tax Appeals filed by the Commissioner of Income Tax (CIT) against MOL Corporation, reinforcing the legal position that payments for the use or resale of computer software do not constitute royalty income taxable in India. The common order, delivered on February 14, 2022, by the Income Tax Appellate Tribunal (ITAT) in ITA No.6194/Del/2018, ITA No.6195/Del/2018, ITA No.6196/Del./2018, and ITA No.6197/Del/2018, had been challenged by the revenue.

During the court proceedings, legal counsel representing the Appellant (Revenue) acknowledged that the legal questions central to these appeals had already been conclusively addressed by a landmark judgment of the Supreme Court of India. This precedent was established in the case of Engineering Analysis Centre of Excellence Pvt. Ltd. Vs. CIT (Civil Appeal No(s). 8733-8734/2018). Despite this admission, the appeals were pursued by the revenue, reportedly to maintain the issue as live, citing a pending review petition against the Supreme Court’s definitive order.

However, the Delhi High Court concluded that the matter of taxability for software receipts was “no longer res integra” – a Latin legal term signifying that the issue has been definitively decided and is not open to further argument. The court firmly based its decision on the Supreme Court’s comprehensive pronouncement in Engineering Analysis Centre of Excellence Private Limited vs. Commissioner of Income Tax and Anr., specifically cited as (2021) SCCOnLine SC 159.

Judicial Precedent: Supreme Court’s Definitive Stance

The Supreme Court’s ruling in Engineering Analysis Centre of Excellence Pvt. Ltd. formed the pivotal judicial precedent, guiding the Delhi High Court’s dismissal. The apex court’s judgment meticulously categorized and analyzed four distinct types of computer software transactions, covering a broad spectrum of commercial arrangements:

1. Direct End-User Purchase: This category involved instances where computer software was purchased directly by an end-user residing in India from a foreign, non-resident supplier or manufacturer.
2. Indian Distributor Model: This addressed cases where resident Indian companies operated as distributors or resellers. They would acquire computer software from foreign, non-resident suppliers or manufacturers and subsequently resell it to resident Indian end-users.
3. Foreign Distributor Model: This third category encompassed scenarios where the distributor itself was a foreign, non-resident vendor. After purchasing software from another foreign, non-resident seller, this vendor would then resell it to resident Indian distributors or directly to end-users in India.
4. Integrated Hardware-Software Units: The fourth category concerned situations where computer software was pre-affixed onto hardware, and the combined unit/equipment was sold by foreign, non-resident suppliers to resident Indian distributors or end-users.

The Supreme Court’s judgment specifically scrutinized the distinction between a “copyright” and a “copyrighted article.” It addressed the reasoning of the Authority for Advance Rulings (AAR) in a previous decision, Citrix Systems (AAR). The AAR had previously held that when a copyrighted article is licensed for a fee, the permission granted encompasses not only the physical or electronic manifestation of the software but also “the use of or the right to use the copyright embedded therein.” The AAR had dismissed the distinction between copyright and copyrighted articles as “illusory,” asserting that the Copyright Act, Income-tax Act, or Double Taxation Avoidance Agreements (DTAAs) do not explicitly use the term “copyrighted article” in a way that would support such a distinction.

The Supreme Court, however, vehemently rejected this interpretation. It clarified that under a non-exclusive license, such as those typically governed by an End-User License Agreement (EULA), an end-user primarily obtains a right to use the software and nothing more. Crucially, the end-user does not acquire any of the inherent copyright rights that the owner explicitly retains under Section 14(b) of the Copyright Act, read in conjunction with its sub-sections (a)(i) to (vii). The Court thus concluded that the AAR’s determination, which suggested that a license for use under an EULA simultaneously licenses the embedded copyright, was “wholly incorrect.” It further reasoned that an EULA, by its nature, imposes restrictive conditions on the end-user and does not transfer any interest related to the rights enumerated in Sections 14(a) and 14(b) of the Copyright Act. Therefore, an EULA cannot be construed as the ‘license’ contemplated by Section 30 of the Copyright Act, which pertains to the granting of an interest in copyright by the owner.

Additionally, the Supreme Court addressed the interpretation of the Income Tax Act in relation to DTAAs. It ruled that any language in the explanations to Section 9(1)(vi) of the Income Tax Act, particularly if it is broader in scope and less beneficial to the assessee than the definition provided in a DTAA, must be disregarded. This principle aligns with Section 90(2) of the Income Tax Act, read with Explanation 4 thereof, and Article 3(2) of the relevant DTAAs, which prioritize the DTAA in cases of conflict or where it offers a more favorable outcome to the taxpayer. The Court also emphasized that the expression “copyright” must be interpreted within the framework of the statute that specifically deals with it, i.e., the Copyright Act. Municipal laws of contracting states are generally applicable, but only to the extent that they are not repugnant to the terms of the DTAA. Based on these cumulative reasons, the Supreme Court unequivocally stated that the AAR’s determination in Citrix Systems (AAR) did not correctly reflect the law and was consequently set aside.

Conclusive Determination and Its Impact

The Supreme Court delivered a comprehensive answer to the central question before it: “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.” This definitive ruling was explicitly made applicable to all four categories of software transactions identified by the Court.

Furthermore, the Supreme Court specifically allowed appeals that challenged judgments of the High Court of Karnataka, leading to those judgments being set aside. Conversely, the appeals against the impugned judgments of the High Court of Delhi were dismissed, indicating that the Delhi High Court’s prior rulings on this matter were consistent with the Supreme Court’s ultimate determination. The AAR ruling in Citrix Systems (AAR) was also formally set aside, affirming the incorrectness of its prior interpretation.

In light of this binding precedent from the Supreme Court, the Delhi High Court, in the present CIT Vs Mol Corporation appeals, found that no substantial question of law remained. Consequently, the appeals were dismissed, thus reaffirming the established legal position that payments for software use or resale, as defined by EULAs and distribution agreements, are not to be treated as royalty income for taxation purposes in India. This outcome clarifies the tax obligations for both domestic and foreign entities involved in software transactions with Indian end-users and distributors.

FULL TEXT OF THE JUDGMENT/ORDER OF DELHI HIGH COURT

Present Income Tax Appeals have been filed challenging the common Order dated 14^th February, 2022 passed by the Income Tax Appellate Tribunal (‘ITAT’) in ITA No.6194/Del/2018, ITA No.6195/Del/2018, ITA No.6196/Del./2018 and ITA No.6197/Del/2018.

Learned Counsel for the Appellant admits that the questions of law urged in the present appeal are covered by the decision of the Supreme Court in Engineering Analysis Centre of Excellence Pvt. Ltd. Vs. CIT in Civil Appeal No(s). 8733-8734/2018. He, however, states that the revenue has preferred a review petition against the said order of the Supreme Court and hence the present appeals have been filed to keep the matter alive.

In the opinion of this Court, the issue of taxability of software receipts in the present cases is no longer res integra as the Supreme Court in Engineering Analysis Centre of Excellence Private Limited vs. Commissioner of Income Tax and Anr., (2021) SCCOnLine SC 159 has held 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) The third category concerns cases wherein the distributor happens to be a foreign, non-resident vendor, who, after purchasing software from a foreign, non-resident seller, resells 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.

5. These cases have a chequered history. The facts of C.A. Nos.8733-8734/2018 shall be taken as a sample, indicative of the points of law that arise from the various appeals before us. In this case, the appellant, Engineering Analysis Centre of Excellance Pvt. Ltd. [‘EAC”], is a resident Indian end-user of shrink- wrapped computer software, directly imported from the United States of America [“USA”]. The assessment years that we are concerned with are 2001-2002 and 2002-2003.

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97. The AAR then reasoned that the fact that a licence had been granted would be sufficient to conclude that there was a transfer of copyright, and that there was no justification for the use of the doctrine of noscitur a sociis to confine the transfer by way of a licence to only include a licence which transferred rights in respect of copyright, by referring to explanation 2 to section 9(1)(vi) of the Income Tax Act. It then held:

“Considerable arguments are raised on the so-called distinction between a copyright and copyrighted articles. What is a copyrighted article? It is nothing but an article which incorporates the copyright of the owner, the assignee, the exclusive licensee or the licencee. So, when a copyrighted article is permitted or licensed to be used for a fee, the permission involves not only the physical or electronic manifestation of a programme, but also the use of or the right to use the copyright embedded therein. That apart, the Copyright Act or the Income-tax Act or the DTAC does not use the expression ‘copyrighted article’, which could have been used if the intention was as claimed by the applicant. In the circumstances, the distinction sought to be made appears to be illusory.”

98. This ruling of the AAR flies in the face of certain principles. When, under a non-exclusive licence, an end-user gets the right to use computer software in the form of a CD, the end-user only receives a right to use the software and nothing more. The end-user does not get any of the rights that the owner continues to retain under section 14(b) of the Copyright Act read with sub­section (a)(i)-(vii) thereof. Thus, the conclusion that when computer software is licensed for use under an EULA, what is also licensed is the right to use the copyright embedded therein, is wholly incorrect. The licence for the use of a product under an EULA cannot be construed as the licence spoken of in section 30 of the Copyright Act, as such EULA only imposes restrictive conditions upon the end-user and does not part with any interest relatable to any rights mentioned in sections 14(a) and 14(b) of the Copyright Act.

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101. Also, any ruling on the more expansive language contained in the explanations to section 9(1)(vi) of the Income Tax Act would have to be ignored if it is wider and less beneficial to the assessee than the definition contained in the DTAA, as per section 90(2) of the Income Tax Act read with explanation 4 thereof, and Article 3(2) of the DTAA. Further, the expression “copyright” has to be understood in the context of the statute which deals with it, it being accepted that municipal laws which apply in the Contracting States must be applied unless there is any repugnancy to the terms of the DTAA. For all these reasons, the determination of the AAR in Citrix Systems (AAR) (supra) does not state the law correctly and is thus set aside.

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173. Our answer to the question posed before us, is that the amounts paid by resident Indian end-users/distributors to non­resident 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.

174. The appeals from the impugned judgments of the High Court of Karnataka are allowed, and the aforesaid judgments are set aside. The ruling of the AAR in Citrix Systems (AAR) (supra) is set aside. The appeals from the impugned judgments of the High Court of Delhi are dismissed.”

Accordingly, no substantial question of law arises in the present appeals and the present appeals are dismissed in terms of the judgment of the Supreme Court in Engineering Analysis Centre of Excellence Private Limited (supra).