Income from Transfer of licensed software is not royalty

Transfer of licensed software was a transfer of copyrighted article and not the right in the copyright and, consequently, income from the transfer thereof was not royalty.

The Delhi Bench of the Income-tax Appellate Tribunal (the Tribunal) in the case of Infrasoft Limited v. ADIT [2009-TIOL-21-ITAT-DEL] has held that the amount received by the taxpayer company for transfer of the right to use the licenced software was not for the use of copyright in the software but only the software as such (which was a copyrighted article) and, therefore, could not be taxed as royalty but as business income under Article 7 of the India-UK Tax Treaty (the tax treaty). The Tribunal further held that other receipts on account of maintenance charges and training fees being incidental to the software receipts assume the same character as that of software receipts and, are also therefore, taxable as business income.

Facts of the case

The taxpayer was marketing and Development Company of an international group owned by a USA based holding company, which was the leader in civil engineering software and had developed software for civil engineering work in various countries. The taxpayer had set up a branch office in India, after obtaining the necessary approval, mainly for import and supply of software. The branch office also provided support services including system related services such as installation of software, interface to peripherals, uninstallation, imparting of training on the application of the software, etc. In the return of income of its India branch, the taxpayer company had shown the receipts from sale/licensing of the software as business income. The Assessing Officer (AO) held that the entire amount received by the taxpayer for transfer of software and the other incidental services was taxable as royalty and such royalty having been accrued or arisen to the taxpayer through its permanent establishment (PE) in India (the branch), the same was taxable under Article 13(6) of the tax treaty and under section 44D read with section 115A of the Income-tax Act, 1961 (the Act).

The Commissioner of Income-tax (Appeals) [CIT(A)] observed that the taxpayer had transferred certain rights to Indian customers to use the software for fixed license fees. It was observed that the software supplied by the taxpayer was customised to include Indian standard on project specific requirements of the Indian customers.

The CIT(A) strongly relied on the report of the High powered committee set up by Ministry of Finance, Government of India in the year 1999 for categorisation of the software payment as royalty which was different from the revised OECD Commentary relied on by the taxpayer and held that the amount received by the taxpayer from its Indian customers under software license agreement was in the nature of royalty and the same was chargeable to tax in India as per Explanation (2) to Section 9(1)(vi) of the Act as well as the tax treaty.

The CIT(A) also held that the decision of the Supreme Court in the case of Tata Consultancy Services v. State of Andhra Pradesh [2004] 271 ITR 401(SC) relied upon by the taxpayer was not of much help because the transfer of right to use software has been held as ‘sale of goods’ under the Sales Tax Laws, however, such transfer would be taxable as royalty under the Act. The CIT (A) also distinguished various decisions cited by the taxpayer on facts.

Issue for consideration:- Whether the amount received by the taxpayer in respect of sale of the licenced software was royalty or business income?

Taxpayer’s Contentions

• The activities of the taxpayer were to import the software exclusively from its parent company and to standardise it to make the same India specific whenever the customers so demanded.

• A non-exclusive and non-transferable license was granted by the taxpayer to the Indian clients and as the licensee permitted an Indian licencee to use the software only for its own business without any liberty to loan, rent, sale, sub-license or transfer the said software or any rights therein without the prior written consent of the taxpayer, it could not be said that there was any transfer of all or any rights in the software.

• Payment for the right to use a software program could not be equated with a right to use process or formula.

• Payments in connection with software as per the OECD model convention represent royalty only when there was a right given to commercially develop the software in reproduction or adaptation of the software for onward adaptation.

• Where the software was acquired for personal or business use of the purchaser, it would, not give any rise to royalty income even under Article 13 of the tax treaty.

• The HPC report has gone into characterisation of specific category of transactions. Income from transactions not covered by the report ought still to be treated as business income.

• The HPC report has not been accepted by the Government of India and its recommendations have also not been incorporated in the Act.

• If there was no international consensus on the issue of characterisation of transaction relating to allowing use of computer software, the view which was in favour of the taxpayer must be adopted.

• The OECD and US models characterised the computer software payments as business profits rather than royalties and the same treatment was required to be adopted in the present case.

• The software could be licensed to one user only and could not be given further to any number of users. The Intellectual Property Rights (IPR) in the software, thus, still remains with the taxpayer and the consideration it received was only for allowing the licensed use of the software.

• The computer software was held to be ‘goods’ by the Supreme Court relying on Article 366(12) of the Constitution of India in the case of Tata Consultancy Services.

• The decision of the Supreme Court has been correctly analysed and explained by the Bangalore Bench of the Tribunal in the case of Samsung Electronics Co. Ltd. v. ITO [2005] 276 ITR (AT) 1 (Bangalore) by observing that by sale of software program, the incorporeal right to the software is not transferred. It was also held that the incorporeal right to the software is the copyright which remains with the originator and what is sold is a copy of the software which is akin to the instance of one buying a copy of novel from a book store or a recorded song in a cassette or video tape.

• Strong reliance was placed on the decision in the case of Motorola Inc. v. DCIT [2005] 95 ITD 269 (Delhi-SB) to contend that the payment for the software could not be taxed under Article 13 of the tax treaty as the payment was for a copyrighted article and not for the copyright right and the same, was therefore in the nature of business income and not royalty income.

• Provisions of the tax treaty override the provisions of the Act and if the payment for software cannot be in the nature of royalty as per Article 13 of the tax treaty, section 9(1)(i) of the Act could not be applied.

• Reliance was also placed on the decision in the case of Wipro Ltd. v. ITO (2005) 278 ITR (AT) 57 (Bangalore).

Tax Department’s Contentions

• The transaction did not amount to transfer of copyrighted article as there was no sale or transfer of the software involved.

• The basic title in the software had been specifically retained by the seller and only the right to use had been transferred.

• The amount received was on account of right given to use the software and the same, therefore, constituted royalty under the Act as well as under the tax treaty.

• The transaction did not involve the transfer of copyrighted article and, therefore, an income received for the right to use the software, was in the nature of royalty as per Explanation (2) to Section 9(1)(vi) of the Act.

• There was no sale of computer software by the taxpayer to the licensees and the payment received against licensed version of computer software was license fees covered under the term ‘royalty’ and not ‘business income’ from sale of goods, articles or things.

• Reliance was placed on the decisions in the cases of ABC, in re 238 ITR 296 (AAR) and N.V. Philips Gloeilampenfabrieken Eindhoven v. CIT [2003]172 ITR 521.

• (Kol)In the case of Tata Consultancy Services, the transfer of software was held to be ‘sale of goods’ by the Supreme Court for the purpose of levy of Sales tax. Relying on the decision in the case of CWT v. State Bank of India [1995] 213 ITR 1 (Bom), it was contended that a definition given in a statute cannot always be relied upon while interpreting a similar expression in a different statute.

Tribunal’s Decision :- The Tribunal observed that the relevant facts of the present case were similar to the facts involved in the cases of Motorola Inc. and Samsung Electronics Co. Ltd. Further, the relevant clauses of the concerned agreements were also almost identical. Accordingly, it held that there was no transfer of any rights in respect of copyright and there was merely a transfer of the copyrighted article, therefore, the payment only represented the purchase price of the article and the same could not be considered as royalty either under the Act or under the tax treaty.