Payment of software cannot be termed as royalty and tax as such

Dear Friends

The Hon’ble Income Tax Appellate Tribunal has allowed a plea filed by E& Y challenging the IT Department demand to pay Rs. 6.60 Crores as Tax.

The company provides centralised services to the member firms of E&Y , the global professional services group.

The CIT International Taxation raised a demand after assessing company’s foreign remittances for a period of four years, which the CIT termed as Royalty paid by the assessee to the parent company.

The IT Department Taxed the E&Y in below-mentioned heads of income;

(i) Software Charges;
(ii) Global Technology Charges; and
(iii) Global Area Network Connectivity Charges.

The E&Y challenged the demand claiming that the payments received by it from Indian Member Firms were reimbursement of cost and not taxable under the Income Tax Act and DTAA between India and UK Authorities.
EY claimed that the tax authorities had erred in not accepting its argument that reimbursement of actual costs relating to software licence and maintenance charges amounting to over ₹5.2 crore "are not in the nature of royalty under the Income Tax Act as well as Double Taxation Avoidance Agreement between India and the UK".

The department also wrongly taxed the company on account of "global technology" and GWAN connectivity charges amounting to over ₹1.1 crore, it claimed.

The company contended that it was established as a non-profit central service provider to enable EY member firms to share the costs of centralised services. It enters into agreements with each member firm and recovers various costs incurred by it from the member firms on an actual usage basis.

The E & Y had filed a "NIL" return of income in March 2012, contending that the payments received by the assessee from Indian member firms were mere reimbursements of costs.

LET’S CONSIDER THE CASE IN BRIEF

The AAA( Authority of Advance Rulings ) upheld the tax assessement, but Delhi High Court ruled in December last year that the payments received for providing computer software to the member firms did not amount to Royalty and were not liable to be taxed.

EY GLOBAL SERVICES LIMITED Vs. ASSISTANT COMMISSIONER OF INCOME TAX & ANR. (DELHI HIGH COURT) 09/12/2021

1. These petition(s) challenge the Rulings/Orders both dated 10.08.2016 of the Authority for Advance Rulings (Income Tax), New Delhi (hereinafter referred to as the „AAR‟) in the Application(s), being AAR No. 1043 of 2011; AAR No. 1408 of 2012; and AAR No. 1409 of 2012.

2. The Application, being AAR No. 1043 of 2011, was filed by EY Global Services Ltd. (formally known as EYGBS Ltd). The Application(s), being AAR No. 1408 of 2012 and 1409 of 2012, were filed by M/s EYME Technologies Private Limited and EYGBS (India) Private Limited, respectively. As recorded in the Impugned Ruling dated 10.08.2016, M/s EYME Technologies Private Limited has been amalgamated with EYGBS (India) Private Limited with effect from 01.04.2016 and therefore, at the request of EYGBS (India) Private Limited, a common order was passed in the two references. The same has been challenged by EYGBS (India) Private Limited before us by way of W.P. (C) 12003 of 2016.

3. EYGSL (UK) and EYGBS (India) filed an application before the learned AAR seeking a ruling on the following questions:

"3. The applicant has raised the following questions:-

1) Whether amounts received /receivable by EYGSL UK in accordance with the agreement entered into with EYGBS India Private Limited inter alia on account of services and / or Deliverables as defined in the Agreement is chargeable to tax in India as "fee for technical services" under Article 13 of the Agreement for avoidance of Double Taxation between India and UK ("the India-UK Tax Treaty")?

2) Whether the amounts received by EYGSL UK from EYGBS India Pvt. Ltd.

('EYGBS India‟), as reimbursement of costs for giving the "Right to benefit from the Deliverables and/or Services" under the terms of the agreement would constitute "income" in the hands of EYGSL UK within the meaning of the term in Section 2(24) of the Income-tax Act, 1961 ("the Act")?

3) Whether the payments received by EYGSL UK for giving "Right to benefit from the Deliverables and/or Services" under the terms of the agreement would be in the nature of "royalty" within the meaning of the term in:

(i) Explanation 2 to clause (vi) of Section 9(1) of the Act?
(ii) Article 13 of the India-UK Tax Treaty?

4. By the Impugned Ruling, the learned AAR has answered the questions as follows:
"36. In view of discussions in earlier paragraphs the following rulings are pronounced with respect to questions raised:-

Q.1 Consideration received on account of provision of services/deliverables is not FTS.

Q.2 Consideration received amounts to service fees and it does not amount to reimbursement of expenses.

Q.3 Consideration received from giving right to benefit from the computer software procured from several third party vendors (deliverables) is in the nature of royalty under Article 13 of India -UK DTAA as well as section 9(1)(vi) of the Act whereas consideration received for giving right to benefit from services is not in the nature of royalty under Article 13 of India-UK DTAA.

Q.4 In respect of Q.No.3, we have ruled that consideration for computer software is taxable as royalty. This is irrespective of the fact whether the applicant has a PE in India or not.

Q.5 Consideration received in respect of giving right to benefit from computer software (deliverables) by the applicant would suffer withholding of tax under section 195 of the IT Act."

HON’BLE DELHI HIGH COURT RULED THAT

5. In the present case, the EYGBS (India), in terms of the Service Agreement and the MOU, merely receives the right to use the software procured by the EYGSL (UK) from third-party vendors. The consideration paid for the use of the same therefore, cannot be termed as „royalty‟ as held by the Supreme Court in Engineering Analysis. In determining the same, the rights acquired by the EYGSL (UK) from the third-party software vendors are not relevant. What is relevant is the Agreement between the EYGSL (UK) and the EYGBS (India). As the same does not create any right to transfer the copyright in the software, the same would not fall within the ambit of the term „royalty‟ as held by the Supreme Court in Engineering Analysis Centre (supra).

6. We may also note that the learned AAR in its Impugned Order has relied upon its earlier view in Citrix Systems Asia Pacific Pty Ltd., In Re., (2012) 343 ITR 1 (AAR), which has been expressly stated to be bad law in Engineering Analysis Centre (supra).

7. The submission of the learned counsel for the Revenue that the judgment of the Supreme Court in Engineering Analysis Centre (supra) cannot be applied because it confines itself only to the four categories mentioned in paragraph 4, also cannot be accepted. Though the Supreme Court was on facts considering the four categories of cases that arose in the appeals before it, it has laid down the law for general application. The law, as laid down by the Supreme Court, when applied to facts of the present case, squarely covers the same in favour of the petitioners.

8. The submission made by the learned counsel for the revenue relying upon the amendment to Section 9(1)(vi) of the Income Tax Act, 1961 has also been specifically considered and rejected by the Supreme Court.

9. In view of the above, the Impugned Rulings dated 10.08.2016 passed by the learned AAR are set aside and it is held that the payment received by EYGSL (UK) for providing access to computer software to its member firms of EY Network located in India, that is, EYGBS (India), does not amount to „royalty‟ liable to be taxed in India under the provisions of the Income Tax Act, 1961 and the India-UK DTAA.

10. The petitions are accordingly allowed in the above terms. There shall be no order as to costs.
Source: https://indiankanoon.org/doc/38889185/

2. In the matter of Analysis Centre of Excellence Private Limited v. CIT( Supreme Court of India).

Supreme Court in the case of Engineering Analysis Centre of Excellence Private Limited v. CITholds that payments made to non-resident computer software manufacturers/ suppliers for the resale/use of the software not taxable as Royalty.

The Supreme Court analysed the meaning of the term royalty under the Act and relevant tax treaties along with various decisions of the Courts and derived following conclusions:

i. Copyright is an exclusive right, which is negative in nature, being a right to restrict others from doing certain acts.

ii. Copyright is an intangible, incorporeal right, in the nature of a privilege. Ownership of copyright in a work is different from the ownership of the physical material in which the copyrighted work may happen to be embodied. For example, purchaser of a book or a CD/DVD, who becomes the owner of the physical article, but does not become the owner of the copyright inherent in the work, such copyright remaining exclusively with the owner.

iii. The transfer of the ownership of the physical substance, in which copyright subsists, gives the purchaser the right to do with it whatever he pleases, except the right to reproduce the same and issue it to the public, unless such copies are already in circulation and the other acts mentioned in section 14 of the Copyright Act.

iv. Where the core of a transaction is to authorize the end-user to have access to and make use of the "licensed" computer software product over which the licensee has no exclusive rights, no copyright is parted with and consequently, no infringement takes place, as is recognized by section 52(1)(aa) of the Copyright Act. It makes no difference whether the end-user is enabled to use computer software that is customised to its specifications or otherwise.

v. A non-exclusive, non-transferable licence, merely enabling the use of a copyrighted product cannot be construed as a licence to enjoy all or any of the enumerated rights mentioned in section 14 of the Copyright Act [State Bank of India (SBI) v. Collector of Customs: 1 SCC 727]

Making a copy or adaptation of a computer program in order to utilize it for the purpose for which it was supplied, making back-up copies as a protection against loss, does not result in infringement of copyright under the Copyright Act. Even storage of computer program, per se, would not result in infringement. Nomenclature of the agreement does not matter and what is relevant is the real nature of the transaction having regard to the overall terms of the agreement and surrounding circumstances.

In the present appeals, the terms of some sample agreements with the distributor and end users of the software were as follows:

• Distributors were granted a nonexclusive, non-transferable license to resell computer software to end users.
• Distributors did not have a right to use the software
• The agreement specifically stated that the copyright in the software was not transferred, either to the distributor or to the ultimate end user
• End users were allowed only to use the software and they were restricted from sub-licensing, transferring, reverse engineering, modifying, or reproducing the software

THE COURT HELD THAT

i) what is "licensed" by the non-resident supplier to the distributor and resold to the resident end user or directly supplied to the resident end user is, in fact, the sale of a physical object which contains an embedded computer program. Such sale of goods does not involve transfer of a copyright in the software. Reliance in this regard was placed on the decision of the Supreme Court in the case of Tata Consultancy Services: 2005 (1) SCC 308.

THE COURT HAS ALSO CONSIDERED

Meaning of royalty under the Act or the tax treaty whichever is more beneficial:

The term 'royalty' is exhaustively defined under the Tax Treaties to 'mean' payment made for the use or right to use any copyright in a literary work. Meaning of the said term under the Act is different and wider than the Tax Treaty inasmuch as transfer of all or any rights includes granting of a license, in respect of any copyright of any literary work.

Since the license granted to distributors and end users does not create any interest or right in the software, grant of such license would not amount to the "use of or right to use" of copyright and, hence, it would not qualify as royalty under the Tax Treaty.
The Court further observed that the phrase "in respect of" used in the Act means "in" or "attributable to". Thus, in order to qualify as royalty even under the Act, it is a sine qua non that there has to be transfer of all or any rights in a copyright by way of license or otherwise. Since the license granted to the distributors and end users did not involve granting of any interest in the rights of an owner of a copyright, payment made for such license does not qualify as royalty both under the Act (upto 2012) as well as the Tax Treaty.

Explanation 4 to section 9(1)(vi) inserted by the Finance Act, 2012, to provide that transfer of all or any rights includes transfer of all or any rights for use of a computer software, expands the definition of royalty and may not be considered as clarificatory in nature. Moreover, since the definition of royalties under the Tax Treaty is narrower and more beneficial, the provisions of the Act would not be applicable and there would be no obligation to withhold taxes under section 195 of the Act.
Revenue had sought to rely on the decision of the Supreme Court in PILCOM v. CIT: 271 Taxman 200 (SC) which dealt with section 194E of Act for the proposition that tax has to be deducted at source irrespective of whether tax is otherwise payable by the non-resident assessee. The Supreme Court observed that acceptance of such contention of the Revenue would lead to absurd results since taxes would have to be withheld even where the income is not chargeable to tax in India which is not the intent of the legislature. Accordingly, the said decision has no application to the case wherein withholding tax obligations are to be determined in terms of section 195 of the Act.

THE COURT HELD THAT

In terms of Article 12 of the relevant Tax Treaties, the payments made 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, does not constitute royalty since the payment is not for the use of or the right to use copyright in the computer software. Accordingly, in terms of section 195 of the Act, the payer is not required to withhold tax at source at the time of making payments to the non-resident supplier.

Agreeing to the high court ruling, the appellate tribunal directed the income tax assessing officer to follow the order effectively, meaning thereby to not charge the taxed amount and issue revised Assessment Order.

CONCLUSION

The decision of Delhi High Court in this matters will benefit many foreign companies dealing in software services as well as Chinese companies against which IT Department has filed cases.

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