Over the last few years, it has increasingly been noticed that Indian companies are acquiring software licences/products from international companies for business requirements. The software licences could typically be off the shelf (commonly known as shrink-wrap software), or a licence to use a particular software (often with a condition not to commercially exploit the copyright in the software).
Taxability of software payments would generally depend on the nature of rights the transferee acquires under a particular agreement regarding the use and exploitation of the software/programme. However, in the Indian context, the taxability of the revenue streams earned by the international companies has been a subject of much debate and litigation.
The Delhi bench of the tax tribunal passed an interesting decision dated 19 December in the case of Infrasoft Technologies Ltd on the tax liability of revenue streams received on the grant of software licences to Indian companies.
The facts before the tribunal were that Infrasoft, a US company and leader in civil engineering software, had developed a software called Mx, which is used for civil engineering work, particularly in the designing of highways, railways, airports, ports and mines.
Infrasoft had established a branch office in India after getting the necessary approvals, mainly for the import and supply of the software. Incidentally, the branch office also provided support services, including system-related services such as installation of software, interface to peripherals and imparting training. The licence granted to Indian companies was a non-exclusive and non-transferable one and the companies were allowed to use the software only for their own business, without any liberty to loan, rent, sell, sub-license or transfer the software or any rights therein without the prior written consent of Infrasoft.
Illustration: Jayachandran / Mint
The assessing officer (AO) had considered the receipt from the licensing of the software “royalty”. The position adopted by the AO was also confirmed by the commissioner (appeals) on various counts, including that as per the provisions of Section 9 of the Income-tax (I-T) Act, 1961, payments for import of software qualify as royalties; the decision of the special bench in the case of Motorola Inc. was distinguishable on the fact that the high-powered committee constituted by the ministry of finance considered such transactions royalty income; and many international countries consider such transactions in the nature of royalty.
The tribunal considered the issues and narrowed down the dispute, within the royalty definition, to whether the payment received is for a copyright or a copyrighted article. If the payment is for a copyrighted article, it represents the purchase price of the article and cannot be considered royalty either under the I-T Act or under the India-US double tax avoidance agreement (DTAA). However, if it is a copyright, then it should be classified as royalty.
The matter of software taxability was extensively considered by the special bench of the Delhi tribunal in a 2005 decision in the case of foreign telecom companies [Ericsson/Motorola/Nokia decision (95 ITD 269)].
In the case of Motorola, the special bench had held, based on the facts in the given case, that the licensees were not allowed to exploit the computer software commercially, which was the essence of the copyright. Hence, what the licensee had acquired under the licence agreement was only the copyrighted software, which was an article by itself and not the copyright.
Accordingly, the special bench had ruled that the payment could not be construed to be in the nature of royalty. The context was that telecom software was required to run the hardware supplied by the telecom companies to cellphone operators.
The tribunal also relied on Section 14 of the Indian Copyright Act, 1957, and especially on the fact that if the licensee did not have any right mentioned in Section 14 a and b (such as to reproduce the work or to sell or give the computer programme on commercial rent), then the payment would not be for a copyright and, therefore, could not be characterized as royalty.
The tribunal came to the conclusion that the licensee had been denied the right of making copies of the software, except for archival backup purposes, and therefore, it could not be said that the licensee had acquired a copyright in the software.
The tribunal also referred to the Organisation of Economic Cooperation and Development (OECD) model commentary on tax treaties and observations therein, which are similar to those in the Motorola case, and remarked that while the OECD model commentary was of persuasive value, it threw considerable light on the tax treatment for such payments.
In the present context, the Delhi tribunal also relied on the decision of the Bangalore tribunal in the case of Samsung Electronics Co. Ltd (276 ITR [AT] 1), in which the tribunal had held that what the assessee had acquired was a copyrighted article, i.e., software, whereas the copyright remained with the owner.
Accordingly, what was acquired was a computer programme for use in business and no right was granted to utilize the copyright of the programme. Hence, the Bangalore tribunal had ruled that the payment for a copyrighted article could not be construed as royalty.
The Delhi tribunal also held that the appeals commissioner’s disregard of the decision of the special bench of the tribunal in the case of Motorola, on the basis that it was distinguishable, was inappropriate and without any basis.
The appeals commissioner was seeking to distinguish the Motorola case on the basis that the issue was of an integrated electronic switching system consisting of both hardware and software, whereas, in the present case, there was no hardware involved.
The tribunal held that the appeal order passed by the commissioner did not indicate how the factual difference was so material as to justify not following a well-considered, well-discussed and binding precedent.
The tribunal in its order also mentioned that the commissioner had relied on the decisions rendered by courts of other countries in which software payments have been characterized as royalty. This, according to the tribunal, was inappropriate since in doing so, the commissioner had overlooked the fact that in the decisions rendered by the courts as well as by the tribunal in India, including the special bench and division bench, similar payments had been held to be not in the nature of royalty and these were binding on the commissioner. Hence, there was no justification to prefer international decisions in preference to binding Indian judicial precedents.
The tribunal also relied on the Supreme Court judgement in the case of Tata Consultancy Services Ltd [TCS(271 ITR 401)], in which the court had, among other things, held computer software to be “goods” under Article 366(12) of the Constitution.
The Supreme Court in the case of TCS had stated that the term “goods”, as used in Article 366(12) of the Constitution, was very wide and included all types of movable properties, whether those properties be tangible or intangible.
The Delhi tribunal observed that the commissioner, while holding that the payments for the software licence were in the nature of royalty, had relied heavily on the conclusions reached by the high-powered committee set up by the finance ministry in 1999.
The tribunal in the order stated that there was nothing either in the order of the commissioner or even brought on record by the revenue authorities that the committee’s report had been accepted by the government.
Further, the tribunal noted that the said report or, more particularly, the recommendation or suggestion of the committee, had not been incorporated anywhere in the relevant provisions of the I-T Act. Hence, the tribunal found no merit or basis on which the said report could justifiably be preferred to the decision of the special bench of the tribunal in the case of Motorola.
Based on the above, the Delhi tribunal concluded that the payments received by Infrasoft were for a copyrighted article and not for a copyright. Hence, the payments did not qualify as “royalty” either under the provisions of the I-T Act or DTAA.
The decision of the Delhi tribunal provides some interesting and important points:
• Binding decisions of the special bench cannot summarily be distinguished on facts; appropriate justification needs to be provided as to why the principles laid down by the special bench are not applicable in a particular case.
• The recommendations made by a committee (such as the high-powered committee set up by the finance ministry in 1999 to examine the tax aspects of e-commerce transactions) are not binding if these are not accepted by the government or incorporated in the taxing statute.
• Reliance on international judgements should be avoided in situations where there are binding Indian judicial precedents.
The economy is going through turmoil and, particularly at this time, one would hope that revenue authorities would not take needlessly aggressive positions and create financial demands on companies which are already creaking under the weight of a global meltdown. Taxing software licences of this nature as royalty can be particularly counterproductive to Indian software companies and one hopes that wiser counsel will prevail.
Ketan Dalal is executive director and Manish Desai is associate director, PricewaterhouseCoopers. Your comments and feedback are welcome at firstname.lastname@example.org