Royalty on software

Payment received on account of supply of software products to independent third party re-sellers in India not royalties but business income

The applicant is a company incorporated in Japan and is engaged in the business of providing Products Lifecycle Management software solutions, applications and services. These software products are standardized and not customized or tailor-made. It markets its products in India through a distribution channel of third party resellers comprising Value Added Resellers (VAR) who resells the software to end-users. The product is sold by the applicant to VAR at standard list price less discount. The VAR sells the product to the end-users at an independent price determined by them. The end-user enters into an End User License Agreement („EULA?) with the applicant and the VAR for the product supplied. VAR gets the order from end-users and places a back-to-back order to the applicant. On acceptance of the order by the applicant, the applicant provides the license key via e-mail to the customer so that the customer will directly download the product through the web-link. The applicant has no presence in India whether through any employee or in the form of any office or place of business.

Question before AAR

Whether the payment received by the applicant from the sale of software products to independent third party resellers will be taxable in India as business profits under article 7 of Indo-Japan Double Taxation Avoidance Agreement (DTAA) and will not constitute „royalties and fees for technical services? per article 12 of DTAA?

Contentions of the applicant

• The transaction is in the nature of purchase of intangible copyrighted products by VAR for re-sale to end users and such sale and purchase is on a principal to principal basis.

• The copyrighted software containing computer program gets transferred to the end user and not the copyright therein. The copyright continues to be vested in its entirety with the applicant and none of the rights therein are made available to VAR or end-user. Only a limited right to use a copyrighted product is transferred.

• The rights associated with the copyright are those which enable the recipient to commercially exploit the product. VAR has not been given any such right.

• A non-exclusive license to the end-user to have access to the licensed program for the licensee?s internal use, does not amount to the use of copyright or the right to use the same.

• The consideration received by the applicant from VAR with reference to the transaction entered into with end-users is not a consideration for the use of any of the copyrights in the software.

• VAR cannot be treated as an agency Permanent Establishment („PE?) of the applicant for the following reason:

– It is a non-exclusive distributor transacting with the applicant on a principal to principal basis.

– It is a distinct legal entity neither related to the applicant nor under the same / common management.

– Economic risks of the products are borne by VAR only.

– VAR is not concluding any contracts or securing orders wholly or almost wholly on behalf of the applicant.

• The income representing the payment received from VAR cannot be treated as „royalties? within the meaning of article 12.3 of DTAA but as business profits. As the applicant has no PE in India, the income is not taxable in India per provisions of DTAA.

Contentions of the revenue

• The license fee paid by the customer in India is for the transfer of rights in respect of copyrights in the software or for the use of computer program embedded in it.

• The payment is made for obtaining a right to copy the program on to the hard disc and to use it and therefore falls within the scope of the Indian Copyright Act, 1957 („CR Act?). Alternatively, the right of sale is also recognized as part of copyright in relation to computer program and such right is given under a license to reseller, so CR Act is again attracted.

• It is clear from EULA that the product is licensed and not sold and the consideration received is license fees.

• VAR is acting on behalf of the applicant for securing the customers to whom the products and services of the applicant are to be licensed. VAR is acting as a dependent agent of the applicant and therefore, the applicant has an agency PE in India.

Observations of the AAR

Royalty income

• The term royalties has been defined both under the provisions of Income-tax Act, 1961 („ITA?) and under the provisions of article 12 (3) of the DTAA. Both the definitions mandate either the use of or right to use or transfer of „copyright of literary or scientific work?. In order to characterize the income as royalties, the applicant must have a right to use the copyright contained in the software.

• The term „copyright? is not defined under the provisions of the ITA and therefore, it would be appropriate to refer to the provision of CR Act. An exclusive licensee is recognized as an owner of the copyright under the CR Act as he is entitled to all the remedies by way of injunction, damages etc. for the infringement of a right.

• The copyright is an intellectual property right that belongs to the owner or its assignees. The ownership of copyright carries with it a bundle of rights which by and large are directed towards exploitation of this intangible property right. If any of the rights are parted with in favour of another so that the other person can enjoy that right in the same manner in which the owner can, it can be said that those specific rights concerning the use of copyright have been conferred on him.

• Adaptation of computer program to ensure its utilization for the purpose for which it was supplied does not constitute an „infringement? under the CR Act. If there is no infringement, it cannot be held that there is a transfer of „copyright? as defined in CR Act.

• A non-exclusive and non-transferable license enabling the use of license product cannot be construed as an authority to enjoy any or all rights ingrained in a copy right. It is so in the present case at hand.

• The use of the word „including the granting of a license? in the definition of „royalty? does not mean that each and every license is contemplated to be included therein. A non-exclusive license permitting use for in-house purpose would not be covered therein.

• The definition of royalty under the ITA for use of process is also not attracted in the present case.

Agency PE

• The existence of agency PE can not be sustained on the grounds that VAR i) is not confined to the dealing only with the applicant, ii) its business is not controlled by the applicant except to the extent necessary to promote its own business, iii) it does not negotiate or conclude contracts with the end-users on behalf of the applicant, and iv) it determines its own price, does not notify or render account to the applicant for the amount collected from the end use.

Ruling of AAR:-

• Neither any right in relation to copyright has been transferred, nor any right to use the copyright has been conferred on the licensee. Therefore, the payment received by the applicant from VAR on account of supplies of software products to the end customers does not result in any income in the nature of royalties to the applicant.

• Per article 7 of the DTAA, the applicant does not have any PE in India and therefore the payments received by the applicant cannot be taxed as business profits in India.

Source: AAR No. 821/2009 in the case of M/s Dassault Systems K.K.