Authority for advance ruling recently held that payments received by the Applicant from its Indian reseller for supply of software products to end users should not be classified as royalty. The AAR further held that the relationship between the Applicant and the re seller does not create a permanent establishment (PE) for the Applicant under the agency rule. Hence, the payment should not be taxed in India under the provisions of the India-Japan Tax Treaty (Treaty).
Background and facts of the case
- The Applicant, a company incorporated in Japan, is engaged in the business of providing software solutions, applications and services. The software product dealt with by the Applicant is a standardised but special purpose software. It is neither customised nor is it available off the shelf.
- The Applicant markets its software products in India through a distribution channel comprising value added re sellers (VAR). The VAR are unrelated third parties who are in the business of selling software to end users on a non-exclusive basis.
- The software product is sold to the VAR for a consideration, based on the standard list price, less discount agreed with the VAR. The VAR in turn sells this software product to the end user at a price independently determined by the VAR. The credit control and risk in relation to the end user lies solely with the VAR.
- The VAR gets a purchase order ( from the end user and places a back-to-back order with the Applicant. The end user enters into a tripartite End User License Agreement (EULA) with the Applicant and the VAR for the software product ordered. The Applicant is not duty bound to accept the purchase order placed by the VAR. If and when the purchase order is accepted, the Applicant provides a licence key via e-mail and a download link directly to the end user. Thereafter, the Applicant invoices the VAR for the software product supplied.
Issue for consideration:- Whether payments received by the Applicant from the sale of software products to the VAR would be treated as business profits under Article 7 of the Treaty or classified as royalty under Article 12 of the Treaty. The Treaty provides for a 10% withholding tax on royalty while business profits may be taxed only if the Applicant has a PE to which the profits are attributable.
Contentions of the Applicant
