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]