Court: Mumbai bench of the Income Tax Appellate Tribunal
Citation: DDIT Vs. TII Team Telecom International Ltd. [2010-TII-62-ITAT-MUM-INTL]
Brief : Mumbai bench of the Income-tax Appellate Tribunal held that the supply of software does not amount to any transfer of copyright but only transfer of copyrighted article. Further, payment received for sale of copyrighted article does not amount to income from royalty within the meaning of the India-Israel tax treaty. Further, the Tribunal held that payment received from sale of software copy does not amount to income from royalty under the tax treaty.
Facts of the case
• The taxpayer, a tax resident of Israel, entered into a contract with Reliance Info comm Ltd. (Reliance) for the supply and license of software for the wireless network of Reliance in India. The taxpayer claimed that the payment received for supply of software was business income and in the absence of Permanent Establishment (PE) in India such business profit was not taxable in India.
• The Assessing Officer held that the payment received for the supply of software was in the nature of royalty and hence liable to taxation in India under Article 12 of the tax treaty and also under section 9(1 )(vi) of the Income-tax Act, 1961.
Issue before the Tribunal
Whether the supply of software was in the nature of royalty and therefore liable to taxation in India under Article 12 of the tax treaty and also under section 9(1 )(vi) of the Act?
• The Tribunal observed the definition of royalty as per Article 12(3) of the tax treaty. The term royalty includes:
> Consideration for the use of, or the right to use, any copyright of a literary, artistic, or scientific work
> Consideration for the use of or right to use of any patent, trademark, design or model, plan, secret formula or process.
• The definition of royalty under the tax treaty includes copyright therefore the Tribunal further observed the definition of copyright. As per Section 14 of the Copyright Act, copyright mainly consists of following rights to:
> reproduce the work in any material form
> issue copies of the work to the public
> sell or give on commercial rental or for sale or for commercial rental any copy of computer programme.
• The Tribunal examined the agreement of the taxpayer with Reliance and observed the following:
> The agreement forbids Reliance from transferring, assigning, sub licensing, using by outsourcing, decompiling, reverse engineering, disassembling or decoding the software
> The agreement also provides that Reliance shall use the software only for the operation of wireless reliance network and shall not sub license or modify the software
> The agreement provides that all copies of the software provided by the taxpayer are its copyright. These copies shall be held secret and software shall not be disclosed to anybody else. All copies of software shall be returned to the taxpayer upon termination or cancellation of the agreement.
• The Tribunal held that Reliance had no right as envisaged in section 14 of the Copyright Act to duplicate the software, to issue copies of software in public or to give copies of software on rent. Reliance has only got a copy of software without any part of the copyright of the software and thus payment by Reliance for acquiring copy of software does not amount to income from royalty within the definition of Article 12(3) of the tax treaty.
• Further, the Tribunal held that the supply of software does not amount to any transfer of copyright but only transfer of copyrighted article. Payment received for sale of copyrighted article does not amount to income from royalty within the meaning of Article 12(3) of the tax treaty.
• The taxpayer being a tax resident of Israel is entitled to the benefit of the tax treaty over the provisions of the Act. As the payment of software is not covered by the definition of royalty in the tax treaty, it would be irrelevant even if covered by section 9( 1)(vi) of the Act.
The Mumbai Tribunal has once again reiterated that the payments on transfer of software cannot be regarded as ‘royalty’ under the tax treaty. Various bench of the Tribunal have held on the similar lines including Special Bench in the case Motorola Inc Vs. DCIT  95 ITD 269 (Del).
In a recent decision in the case of Dassault Systems K.K. [2010-TIOL-02-ARA-IT] the Authority for Advanced Ruling on similar facts held that the payments received by the applicant cannot be construed as ‘royalty’ taxable within the provisions of the Act or the tax treaty. A similar view was also adopted by the Bangalore Tribunal in the recent decision in the case of M/s Velankani Mauritius Ltd & M/s Bye design Solutions Ltd. Vs. DDIT (2010-TII-64- ITAT-BANG-INTL) where it held that income from sale of software cannot be treated as royalty under the Income-tax Act, 1961 or the tax treaty. However, in the present case, the discussion was limited to the implications under the tax treaty.
It is important to note that recently, the Supreme Court in the case of CIT v. M/s Oracle Software India Ltd. [2010-TIOL-04-SC-IT] has held that process of transforming a blank Compact Disks (CDs) into software loaded disks by duplicating the master copy of the software on it, constitutes ‘manufacture or processing of goods’. Based on this decision it may be possible to contend that providing shrink wrap software may result into provision of goods and not service and therefore, to be treated as business income and not royalty income.
It is pertinent to note that how some of the developed economies have treated such payment as not resulting into royalty payments. As per the US regulations when there is a transfer of software program that would effectuate a minimal use of the copyright in the program then such minimal use should be disregarded for characterization purposes as it is merely ‘de minimis’ to the entire transaction. Further, the technical advisory group of Organization for Economic Co-operation and Development also had similar view which held that if the consideration is paid for a right other than a right in the intellectual property, then in that event, the payment made should not be treated as royalty as it is a purchase for the purpose of use of the product. The Singapore Government has subject to satisfaction of certain conditions, also specifically granted exemption from withholding taxes to importers of shrink-wrapped software.