MICRO FOCUS MARIGALANTE LIMITED,UNITED KINGDOM vs. INCOME TAX OFFICER, INTERNATIONAL TAXATION, WARD-1(1), BANGALORE

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ITITA 877/BANG/2022Status: DisposedITAT Bangalore13 March 2023AY 2019-208 pages

In favour of the assessee: the assessee's appeal was allowed. From the AI summary of this appeal.

AI SummaryAllowed

What did the Tribunal hold?

The Tribunal held that receipts by way of sale of software licenses and provision of ancillary support services connected with the sale of software products cannot be assessed as royalty or FTS income in the hands of the assessee. The Tribunal relied on the decision of the Hon'ble Supreme Court in the case of Engineering Analysis Centre for Excellence Pvt. Ltd. v. CIT & Anr., which held that amounts paid for the resale/use of computer software through EULAs/distribution agreements do not constitute royalty for the use of copyright and do not give rise to income taxable in India. The Tribunal noted that the Supreme Court's decision reversed the High Court's ruling in Samsung Electronics, which was relied upon by the DRP. The Tribunal also followed a coordinate bench decision in a similar case for AY 2016-17. Consequently, the Tribunal set aside the AO's order and deleted the addition made. No issue was expressly left undecided.

What were the facts?

The assessee, Micro Focus Marigalante Ltd., a company incorporated in the Cayman Islands, UK, filed its return for AY 2019-20 admitting NIL income. Subsequently, it filed a revised return admitting NIL income and claiming a refund of Rs. 14,48,60,999. The Assessing Officer (AO) noted that the assessee had disclosed Rs. 132,65,65,935 as sale of standard software to its group company, Microfocus Software Solutions India Pvt. Ltd., on which TDS was deducted. The assessee claimed this income as not taxable in India under Section 5(2) read with Section 9(1)(i) to (vii) of the Income Tax Act, 1961, relying on the Supreme Court decision in M/s. Engineering Analysis Centre of Excellence P. Ltd. v. CIT. The AO treated 50% of the amount received as income in the hands of the assessee, classifying it as fees for technical services (FTS), holding that the payment covered not only software sale but also backup support, distribution, and customer support. The Dispute Resolution Panel (DRP) confirmed the AO's view, stating that embedded allied shared services were in the nature of ITeS services akin to FTS. The AO passed the final assessment order confirming the addition.

What were the issues?

1. Whether the consideration received from ancillary support services, which are part of the sale of software products and inseparable from it, can be treated as Fee for Technical Services (FTS) under the India-UK Double Taxation Avoidance Agreement (DTAA) and the Income Tax Act, 1961? The assessee argued that ancillary support services are an integral part of the software sale and cannot be taxed separately. The revenue contended that these services constitute FTS. 2. Whether the Learned AO/Learned DRP erred in concluding that the ancillary support services were provided free of cost to Indian clients? The assessee disputed this finding. 3. Whether the Learned AO/Learned DRP erred in arbitrarily treating 50% of the consideration towards ancillary support services as FTS under the India-UK DTAA and the Act? The assessee challenged the arbitrary allocation of 50% of the consideration to FTS. The revenue relied on the DRP's order.

Which sections of the Income-tax Act were involved?

Section 5(2),Section 9(1)(i),Section 9(1)(vii),Section 195

AI-generated summary — verify with the full judgment below

Income Tax Appellate Tribunal, “A” BENCH : BANGALORE

Before: SMT. BEENA PILLAI & Ms. PADMAVATHY S

For Appellant: Shri Ketan Ved, CA
For Respondent: Shri D.K. Mishra, CIT
Hearing: 13.03.2023Pronounced: 13.03.2023

Per Padmavathy S., Accountant Member This appeal is against the final order of assessment passed by the ITO, Ward 1(1), International Taxation, Bangalore dated 25.7.2022 for the assessment year 2019-20.

2.

The assessee is a company incorporated and registered at Cayman Islands, UK and is in the business of undertaking development of intellectual property and selling its products globally. The assessee filed original return of income for the AY 2019-20 on 31.10.2019 admitting NIL income. The assessee subsequently filed a revised return on 9.4.2020 admitting a total income of NIL and claimed a refund of Rs.14,48,60,999.

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The return was selected for scrutiny under CASS and statutory notices were duly served on the assessee.

3.

During the course of assessment proceedings, the AO noticed that the assessee has disclosed in the original return of income a sum of Rs.132,65,65,935 as sale of standard software to its group company, Microfocus Software Solutions India Pvt. Ltd. on which TDS has been deducted and the assessee has claimed the said income as not chargeable to tax in India u/s. 5(2) r.w.s. 9(1)(i) to (vii). The assessee in this regard relied on the decision of the Hon’ble Supreme Court in the case of M/s. Engineering Analysis Centre of Excellence P. Ltd. v. CIT & Other, 202 SCC Online SC 159.

4.

The AO perused the agreement between the assessee and the Indian entity and on the basis of the same, treated 50% of the amount received as income in the hands of the assessee as fees for technical services. The AO held that the assessee has received the payment not only towards sale of software but also for providing back up support such as distribution and services and customer support services for installation, technical support etc. Thus, the AO was of the view that the compensation received not only consists of the cost of product but also the cost of services, cost of support and distribution activities which would amount to rendering technical services and therefore 50% of the total receipts is considered as income of the assessee. Aggrieved, the assessee filed its objections before the DRP, who confirmed the same on the ground that the allied shared services which are embedded in the cost of software are in the nature of ITeS services which is in the nature of fees for technical services and since the assessee did not provide the break-up between the payment made for software product and the support services, directed the AO to adopt the break-up figure for affecting the TDS. The AO passed the final assessment order retaining the same amount as addition by stating

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that the assessee did not furnish the break-up of software and ancillary support services. Aggrieved, the assessee is in appeal before the Tribunal.

5.

Ground Nos. 1 & 7 are general. Ground No.5 is consequential and ground No.6 is premature. Hence these grounds do not warrant separate adjudication.

6.

The assessee raised the following relevant grounds:-

“2. The Learned AO/ Learned DRP erred in treating the consideration received from ancillary support services as Fee for technical service ('FTS') as per India- United Kingdom of Great Britain and Norther Ireland ('UK') Double taxation Avoidance Agreement ('DTAA') and as per the Income-Tax Act, 1961 ('the Act'). The consideration received from sale of software product also include consideration for ancillary support services and these two are inseparable and cannot be taxed separately. The ancillary support services are part and parcel of the sale of software product. 3. The learned AO/ Learned DRP erred in arriving at a conclusion that the ancillary support services are provided free of cost to Indian clients. 4. The learned AO/Learned DRP erred in arbitrarily treating 50% of the consideration towards ancillary support services as FTS as per the India-UK DTAA and as per the Act.” The ld. AR submitted that the assessee sold the software product 7. and also received income from providing support services. He further submitted that providing ancillary support services is also related to sale of software products only. The ld. AR drew our attention to the order of the AO where he himself admits that the software cost charged by the assessee includes the cost of service and cost of support and distribution activities. The ld. AR also drew our attention to the copy of the invoice which clearly states that the software product is sold to Indian entity by the assessee for the purpose of resale. Accordingly the ld AR submitted that

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the assessee’s case is covered under the decision of the Hon’ble Supreme Court in the case of Engineering Analysis (supra). The ld AR further relied on the following decisions of the coordinate Bench in which the decision of the Apex Court has been followed under similar circumstances:-

(i) Informatica LLC v. ACIT, IT(IT)A No.913/Bang/2019 dated 5.7.2021 (ii) Informatica LLC v. ACIT, IT(IT)A No.2867/Bang/2019 dated 5.8.2021 (iii) Blue Yonder Inc. v. DCIT, IT(IT)A No.2696/Bang/2019 dated 12.8.2021 8. The ld DR relied on the order of the DRP.

9.

We heard the parties and perused the material on record. We notice that a similar issue has been considered by the coordinate Bench in the case of LLC v. ACIT, IT(IT)A No.2867/Bang/2019 dated 5.8.2021 where it is held that –

“6. We notice that an identical issue has been examined by the coordinate bench in the assessee’s own case in AY 2016-17 and it has been decided in favour of the assessee with the following observations: 5. Similar issue for AY 2011-12 in the case of Nice Ltd. came up before the Hon’ble High Court of Karnataka in ITA No.7/2019 and vide judgment dated 26.3.2021 it was held as under:- “7. The controversy involved in the present case, as informed by the learned Counsel for the parties stands concluded on account of the judgment delivered by the Hon’ble Supreme Court in the case of ENGINEERING ANALYSIS CENTRE FOR EXCELLENCE PRIVATE LIMITED VS COMMISSIONER OF INCOME TAX & ANOTHER – AIR 2021 SC 124 / 432 ITR 471 (SC). The Apex Court in the aforesaid case has held in paragraphs 27, 47, 52, 168 & 169 as under:

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“27. The machinery provision contained in Section 195 of the Income Tax Act is inextricably linked with the charging provision contained in Section 9 read with Section 4 of the Income Tax Act, as a result of which, a person resident in India, responsible for paying a sum of money, “chargeable under the provisions of [the] Act”, to a non-resident, shall at the time of credit of such amount to the account of the payee in any mode, deduct tax at source at the rate in force which, under Section 2(37A)(iii) of the Income Tax Act, is the rate in force prescribed by the DTAA. Importantly, such deduction is only to be made if the non-resident is liable to pay tax under the charging provision contained in Section 9 read with Section 4 of the Income Tax Act, read with the DTAA. Thus, it is only when the non-resident is liable to pay income tax in India on income deemed to arise in India and no deduction of TDS is made under Section 195(1) of the Income Tax Act, or such person has, after applying Section 195(2) of the Income Tax Act, not deducted such proportion of tax as is required, that the consequences of a failure to deduct and pay, reflected in Section 201 of the Income Tax Act, follow, by virtue of which the resident-payee is deemed an “assessee in default”, and thus, is made liable to pay tax, interest and penalty thereon. This position is also made amply clear by the referral order in the concerned appeals from the High Court of Karnataka, namely, the judgment of this Court in GE Technology (supra). 47. In all these cases, the “licence” that is granted vide the EULA, is not a licence in terms of Section 30 of the Copyright Act, which transfers an interest in all or any of the rights contained in Sections 14(a) and 14(b) of the Copyright Act, but is a “licence” which imposes restrictions or conditions for the use of computer software. Thus, it cannot be said that any of the EULAs that we are concerned with are referred to Section 30 of the Copyright Act, inasmuch as Section 30 of the Copyright Act speaks of granting an interest in any of the rights mentioned in Sections 14(a) and 14(b) of the Copyright Act. The EULAs in all the appeals before us do not grant any such right or interest, least of all, a right or interest to reproduce the computer software. In point of fact, such reproduction is expressly interdicted, and it is also expressly stated that no vestige of copyright is at all transferred, either to the distributor or to the end-user. Asimple illustration to explain the aforesaid position will suffice. If an English publisher sells 2000 copies of a particular book to an

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Indian distributor, who then resells the same at a profit, no copyright in the aforesaid book is transferred to the Indian distributor, either by way of licence or otherwise, inasmuch as the Indian distributor only makes a profit on the sale of each book. Importantly, there is no right in the Indian distributor to reproduce the aforesaid book and then sell copies of the same. On the other hand, if an English publisher were to sell the same book to an Indian publisher, this time with the right to reproduce and make copies of the aforesaid book with the permission of the author it can be said that copyright in the book has been transferred by way of licence or otherwise, and what the Indian publisher will pay for, is the right to reproduce the book, which can then be characterized as royalty for the exclusive right to reproduce the book in the territory mentioned by the licence. 52. There can be no doubt as to the real nature of the transactions in the appeals before us. What is “licensed” by the foreign, nonresident supplier to the distributor and resold to the resident enduser, or directly supplied to the resident end-user, is in fact the sale of a physical object which contains an embedded computer programme, and is therefore, a sale of goods, which, as has been correctly pointed out by the learned counsel for the assessees, is the law declared by this Court in the context of a sales tax statute in Tata Consultancy Services v. State of A.P., 2005(1) SCC 308 (see paragraph 27). 168. Given the definition of royalties contained in Article 12 of the DTAAs mentioned in paragraph 41 of this judgment, it is clear that there is no obligation on the persons mentioned in S.195 of the Income Tax Act to deduct tax at source, as the distribution agreements/ EULAs in the facts of these cases do not create any interest or right in such distributors/endusers, which would amount to the use of or right to use any copyright. The provisions contained in the Income Tax Act (S. 9(1) (vi), along with explanations 2 and 4 thereof), which deal with royalty, not being more beneficial to the assessees, have no application in the facts of these cases. 169. Our answer to the question posed before us, is that the amounts paid by resident Indian endusers/distributors to nonresident computer software manufacture/suppliers, as consideration for the resale/use of the computer software through EULAs/ distribution agreements, is not the payment of royalty for the use of copyright in the computer software, and that the

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same does not give rise to any income taxable in India, as a result of which the persons referred to in Section 195 of the Income Tax Act were not liable to deduct any TDS under Section 195 of the Income Tax Act. The answer to this question will apply to all four categories of cases enumerated by us in paragraph-4 of this judgment. 8. In the light of the aforesaid judgment delivered by the Hon’ble Supreme Court, the question of law framed in the present appeal is decided in favour of the assessee and against the revenue.” 6. Further, the judgment relied on by the DRP in the case of Samsung Electronics (supra) was reversed by the Hon’ble Supreme Court in Civil Appeal No.8733-8734/2018 &Ors. in the case of Engineering Analysis Centre for Excellence Private Limited v. CIT &Anr. (supra) which has been extracted in the foregoing paragraph. Being so, the issue before us is already settled by the Hon’ble Supreme Court in favour of assessee.” 7. Accordingly, following the decision rendered by Hon’ble Supreme Court in the case of Engineering Analysis Centre for Excellence Pvt. Ltd. (supra) and also following the decision rendered by the co-ordinate bench in AY 2016-17, we hold that receipts by way of sale of software licenses and provision of ancillary support services connected with the sale of software products cannot be assessed as royalty/FTS income in the hands of the assessee. Accordingly, we set aside the order passed by the AO on this issue.”

10.

We notice that in assessee’s case, the consideration received is towards sale of software and other ancillary support services which fact has not been disputed by the lower authorities. We are therefore of the considered view that the decision of the apex Court in the case of Engineering Analysis (supra) and the above decision of the coordinate Bench are clearly applicable in assessee’s case. Accordingly, we set aside the order passed by the AO and delete the addition made.

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11.

In the result, the appeal is allowed in favour of the assessee.

Pronounced in the open court on this 13th day of March, 2023. Sd/- Sd/- ( BEENA PILLAI ) ( PADMAVATHY S. ) JUDICIAL MEMBER ACCOUNTANT MEMBER

Bangalore, Dated, the 13th March, 2023.

/Desai S Murthy /

Copy to:

1.

Appellant 2. Respondent 3. CIT 4. CIT(A) 5. DR, ITAT, Bangalore.

By order

Assistant Registrar ITAT, Bangalore.

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