Transfer of licensed software cannot be considered as ‘royalty’

Mumbai Tribunal rules that the transfer of licensed software cannot be considered as ‘royalty’ within the meaning of India-US tax treaty

Apr 12, 2010 Income Tax Case Laws

Mumbai bench of Income-tax Appellate Tribunal (the Tribunal) in the case of Alcatel USA International Marketing Inc (see note-1 below) (taxpayer) has held that the transfer of licensed software cannot be considered as ‘royalty’ within the meaning of article 12(3) of the India-US tax treaty (the tax treaty) in view of the decision of the Special Bench of the Delhi Tribunal in the case of Motorola Inc., Ericsson Radio Systems AB and Nokia Corporation Inc (see note-2 below).

Facts of the case

• The taxpayer, a non-resident company, was engaged in the business of developing designs, etc. The taxpayer entered into a contract for supply of software to an Indian company with a right to operate for its business purpose. The Indian company was also allowed to make copies of the software for its own internal operations.

• The Assessing Officer (AO) held that irrespective of whether the taxpayer retain ownership or grants user rights only to licensee, the amount received for permitting Indian company to utilise the computer software was taxable as ‘royally’.

• The Commissioner of Income-tax (Appelas) [CIT(A)] observed that the Indian company acquired only a copy of software programme and did not acquire any copyright over such software. Accordingly, the CIT(A) held that amount received was only for purchase of copyrighted article which does not result into the payment for ‘royalty’ within the meaning of article 12(3) of the tax treaty.

Issue before the Tribunal :- Whether the payments made by Indian company amount to ‘Royalty’ within the meaning of article 12(3) of the tax treaty?

Tax department’s contentions :- The tax department placed reliance on the decision of the Supreme Court in the case of TATA Consultancy Services Inc (see note-3 below) and contended that the software falls within the definition of ‘goods’ and hence there was transfer of rights in the software. The amount received by the taxpayer was ‘royalty’ payment towards transfer of goods.

Taxpayer’s contentions

• The taxpayer placed reliance on decision of the Special Bench of the Delhi Tribunal in the case of Motorola Inc., Ericsson Radio Systems AB and Nokia Corporation and contended that the payment received by the taxpayer was not ‘royalty’.

• The taxpayer also placed reliance on decision of the Delhi Tribunal in the case of Infrasoft Limited Inc (see note-4 below) where it was held that the decision of the Supreme Court in the case of TATA Consultancy Services has limited application and the principle therein cannot be applied to the peculiar facts of the instant case and therefore, the payments received by the taxpayer cannot be termed as ‘royalty’ either under the Income-tax Act, 1961 (the Act) or under the tax treaty.

Tribunal’s ruling

• The Tribunal held that since the issue in the current case was squarely covered by the decision of the Special Bench of the Delhi Tribunal in the case of Motorola Inc., Ericsson Radio Systems AB and Nokia Corporation and in the absence of any contrary view taken with regards to the current issue, the payments received by the taxpayer cannot be termed as ‘royalty’ either under the Act or under the tax treaty.

Our Comments

This is a welcome decision by the Mumbai Tribunal which after relying on the decision of the Special Bench of Delhi Tribunal in the case of Motorola Inc. held that the transfer of licensed software cannot be considered as ‘royalty’ within the meaning of India-US tax treaty and the Act.

The Tribunal also discussed the decision of the Delhi Tribunal in the case of Infrasoft Limited where it had held that since the payment by the taxpayer was for the transfer of a right to use the licenced software, such payment cannot be considered as royalty taxable under the Act. Further, the Supreme Court in the case of TATA Consultancy Services had held that the computer software was held to be ‘goods’ not only under the Sales tax Act but also under the constitution of India.

Notes:-

1. DDIT v. Alcatel USA International Marketing Inc [2009-TIOL-733-ITAT-MUM).

2. Motorola Inc., Ericsson Radio Systems AB and Nokia Corporation v. DCIT [2005] 96 TTJ 1 (Del) (SB) where it was held that since payments received by the taxpayer were for the sale of copyrighted articles and not for the sale of a copyright the payments cannot be treated as ‘royalty’.

3. TATA Consultancy Services v. State of Andhra Pradesh [2004] 271 ITR 407 (SC) (LB).

4. Infrasoft Limited v. ADIT [2009-TIOL-21-ITAT-DEL]

Sale of cruise tickets through the services of an Indian entity on principal to principal basis and at an arms length prices would not be liable to tax in India

Mumbai Income-tax Appellate Tribunal (the Tribunal) in the case of DDIT v. Star Cruises (India) Travels Services Pvt. Ltd [2010-TIOL-04-ITAT-MUM] has held that merely booking of different cruise tour packages for M/s. Star Cruises Management Ltd. (M/s. SMCL) foreign company by the taxpayer cannot per se be decisive for holding that M/s. SMCL is having ‘business connection’ in India within the meaning of section 9(1)(i) of the Income-tax Act, 1961 (the Act). Accordingly, it cannot be said that income has been accrued to M/s. SMCL in India in respect of the booking of tour packages of Cruise made by taxpayer in India.

The Tribunal also held that as per the CBDT Circular no. 23 dated 23 July 1969 (This circular has been withdrawn with effect from 22 October 2009 vide Circular no. 7/2009) since M/s. SMCL sold tickets to Indian customers through the services of a taxpayer in India, the assessment in respect of the income arising out of the transactions will be limited to the amount of profit which is attributable to the taxpayer’s services provided. Further, since the non-resident company and the taxpayer company were separate legal entities and the management of both the companies was totally independent of one another the income of M/s. SCML, a foreign company cannot be held as taxable in India to the extent of the amount of sale of the Cruise tickets in India.

Facts of the case

The taxpayer was an Indian Company which was engaged in the business of providing travelling and tour related services. It entered into an agreement for providing general sales and marketing services with a foreign company, M/s. SCML of Isle of Man, with which India has not entered into the tax treaty. As per the agreement, the taxpayer agreed to sale their cruise tickets and to provide related marketing services in India. The sale proceeds collected on the booking of the cruise tickets by the taxpayer were remitted to SCML without deduction of tax after the approval of the Reserve Bank of India. The Assessing Officer (AO) observed that to the extent of proceeds of tickets sold in India the income of M/s. SCML was taxable under section 5(2)(a) read with section 44B of the Act. Accordingly, the AO held that the taxpayer was liable to deduct tax under section 195 of the Act and he also passed orders under section 201(1A) of the Act after holding the taxpayer as taxpayer in default.

The Commissioner of Income-tax (Appeals) after observing the CBDT Circular no. 23 observed that since SCML has paid an arm’s length consideration to SCTS for services rendered by it, SCTS would have made the same profits dealing with an independent enterprise. Since the said profits are already taxed in the hands of SCTS, no further profits can be attributed to the activities performed by it.

Issue before the Tribunal

Whether the tax was required to be deducted on payments made by the taxpayer to the SMCL out of sale proceeds of cruise tickets booked by the taxpayer?

Tax department’s contentions

Gross receipts received by the SCML being the principal from the taxpayer agent was chargeable to tax under section 5(2) of the Act. Therefore, the taxpayer should have deducted the tax under section 195 of the Act before remitting money to SMCL.

CBDT Circular no. 23 was not applicable as it relates to the deeming provisions, whereas in the SMCL’s case, the income was actually received by it in India through its agents;

Taxpayer’s contentions

The taxpayer contended that the taxability of the sale proceeds from tickets booked in India is governed by the principles (Refer Note- 1) laid down by CBDT circular no. 23. The taxpayer satisfied various criteria laid down by the circular no. 23.

As per the circular if the agent’s commission fully represents the value of profit attributable to his service, the assessment of the Principal it should prima facie extinguish. Further, the SMCL paid an arm’s length commission to the taxpayer for the marketing services rendered by it.

The said amount suffered tax in the hands of taxpayer in its assessments. Therefore, the income of SMCL was not taxable in India.

Ruling of the Tribunal

Merely because the taxpayer company was doing booking of different Cruise Tour packages for M/s. SCML, that can not per se be decisive for holding that M/S. SCML is having ‘business connection’ in India within the meaning of section 9(1)(i) of the Act. The expression ‘business connections’ is of wide meaning but at the same time it is also well settled principles that there should be close and intimate relationship between the business operations of the non-resident and his agent in India.

Since the services rendered by the taxpayer were routine business activities and general in nature it cannot be interpreted to give colour of ‘business connection’ as contemplated in section 9(1)(i) of the Act. Accordingly, it cannot be said that the income from booking of tour packages by the taxpayer in India has been accrued to M/s. SCML in India.

As per the section 44B of the Act, income of the non resident shipping company can not be charged to tax in India unless either the passengers who have booked the Cruise Package, are travelling from or to any port in India. Unless any income was chargeable to tax in India as per the charging provisions of the Act, no effect can otherwise be given to other provisions of the Act.

Further, as per circular no.23, where the non-resident sales to Indian customers through the services of an agent in India, the assessment in respect of the income arising out of the transactions will be limited to the amount of profit which is attributable to the agents’ services provided.

As per the Circular no.23, since M/s SMCL sold tickets to Indian customers through the services of a taxpayer in India, the assessment in respect of the income arising out of the transactions will be limited to the amount of profit which is attributable to the taxpayer’s services provided.

Further, since the non-resident company and the taxpayer company were separate legal entities and the management of both the companies was totally independent of one another the income of M/s. SCML, a foreign company cannot be held as taxable in India to the extent of the amount of sale of the Cruise tickets in India.

Our Comments

The Mumbai Tribunal has held that since the taxpayer fulfilled the conditions prescribed by CBDT circular no. 23 the income earned by the foreign company cannot be held taxable in India. However, it is important to note that circular 23 was withdrawn by the CBDT vide circular no. 7/2009 (For details please refer our flash news dated 26 October 2009) and the decision of the Tribunal is given for the period in which circular no. 23 was valid.

It is pertinent to note that even though the Tribunal has relied on circular no. 23 which has recently been withdrawn with immediate effect, may not impact similar cases because the above principle has already been laid down by the Supreme Court in the case of Morgan Stanley and Co. [2007] 292 ITR 416 (SC) where it was held that since the Permanent Establishment of the foreign company (PE) was remunerated at an arm’s length price there was no need to attribute further profits to the PE.

Note- 1

1. where a non-resident make sales to Indian customers through an agent in India, the assessment in India of the income arising out of the transaction will be limited to the amount of profit which is attributable to the agent’s services, provided that (i) the non¬resident principal’s business activities in India are wholly channeled through his agent, (ii) the contracts to sell are made outside India, and (iii) the sales are made on a principal-to-principal basis.

Difference between sales as per books and in TDS certificate, only the profit element is taxable and not the entire amount.

Cuttack bench of the Income-tax Appellate Tribunal (the Tribunal) in the case of R.R. Caryying Corpn. v. ACIT [2009] 126 TTJ 240 (Cuttack) held that only the embedded portion of the profits is to be considered as taxable and not the entire amount in the case of discrepancies between the sales or receipt amount as per books of accounts and the amount shown in TDS certificate, for taxability purpose. Accordingly, the Tribunal directed the Assessing Officer (AO) to adopt the gross profit rate declared by the taxpayer for the assessment year under consideration and compute addition accordingly.

Facts of the case

The taxpayer was engaged in the transport business. During the course of assessment proceedings, the AO found the discrepancies of INR 1.4 million between the receipts shown in the TDS certificate submitted and the books of accounts of the taxpayer. Accordingly, the AO made an addition of INR 1.4 million as undisclosed transportation receipts which was also confirmed by the Commissioner of Income-tax (Appeals).

Taxpayer’s contentions

The taxpayer contended that the books of accounts like cash books, ledger, journal and vouchers are maintained and audited under section 44AB of the Act and these books were produced before the AO. Further, since the taxpayer did not receive this amount the taxpayer should not be taxed for the same.

Alternatively, entire gross amount of INR 1.4 million should not be added as taxable income without allowing any expenditure or estimating profit on the difference, detected in respect of gross receipt. Accordingly, only estimated profit usually earned on the amount of INR 1.4 million should be added instead of adding the whole amount.

In that connection, the taxpayer relied on various judicial precedents in the cases of 1. CIT v. President Industries (2002) 258 ITR 654 (Guj) 2. CIT v. Balchand Ajit Kumar (2003) 263 ITR 610 (MP) 3. Balasore Synthetic (P) Ltd. v. DCIT in ITA No. 141/Ctk/2008 wherein it was held that in the case of discrepancies in receipts or sales entire amount of sales or receipts cannot be added and only the profits embedded in sale profits should be taxed.

Tribunal’s ruling :-The Tribunal after relying on the decisions cited by the taxpayer held that in the case of discrepancies between the sales or receipt amount as per books of accounts and the amount shown in TDS certificate, for taxability purpose, only the embedded portion of the profits is to be considered as taxable and not the entire amount. Accordingly, the Tribunal directed the AO to adopt the gross profit rate declared by the taxpayer for the assessment year under consideration and compute addition accordingly.

This is a welcome decision by the Cuttack Tribunal which resolves a practical difficulty faced by the taxpayers. It is pertinent to note that even in the case of Eagle Seeds & Biotech Ltd. v. ACIT [2006] 100 ITD 301 (INDORE) the Indore Tribunal held that undisclosed income on unaccounted purchases could be computed by applying the net profit rate and not the gross profit rate on such purchases.