DIGITE INC. USA,PUNE vs. DCIT (INTERNATIONAL TAXATION), NEW DELHI

4. The assessee company craves leave to add / modify / delete / amend all / any of the Grounds of Objection. ( A. Y. 2009-10) 1. The learned Asstt. Director of Income-tax, Circle 1(1), International Taxation, New Delhi (AO) erred in law and on facts in holding that the amount of Rs. 3,48,69,783/- received by the assessee company from its customers is in the nature of ROYALTY u/ s 9(1 )(vi) of the ITA, 1961 and Fees for Technical Services as per Article 13(4)(a) of the Indo-USA DTAA. The AO ought to have appreciated that the said amount is normal Business Income of the appellant arising on account of sale of copyrighted products (licenses) and not taxable in India in the absence of Permanent Establishment (PE) in India.

2. The Honorable DRP has erred in law and on facts in rejecting the objections of the appellant to the additions proposed by the learned AO in treating the amount of Rs. 3,48,69,783 /- received by the assessee company as ROYALTY u/s 9(l)(vi) of the ITA, 1961 and Fees for Technical Services as per Article 13(4)(a) of the Indo-USA DTAA; instead of treating the same as consideration for sale of software licenses.

3. The assessee company craves leave to add / modify / delete / amend all / any of the Grounds of Objection. ( A. Y. 2010-11) 1. The learned Asstt. Director of Income-Tax, Circle 1(2), International Taxation, New Delhi (‘AO’) has erred in law and on facts in holding that the amount of Rs. 2,38,59,363/-, received by the assessee company, from its Indian customers, is in the nature of ROYALTY as per section 9(l)(vi) r.w.s. 115A of the ITA, 1961 as well as as per Article 12(3) of the India - USADTAA. 2. The AO oughi to have appreciated that the said amount, received from assessee’s Indian customers, is normal Business Income of the appellant arising on account Page | 3 of sale of copyrighted licensed software products and not taxable in India in the absence of Permanent Establishment (PE) in India. 3. The Hon’ble DRP has erred in law and on facts in rejecting the objections of the appellant to the additions proposed by the learned AO in treating the amount of Rs. 2,38,59,363/- received by the assessee company as ROYALTY u/s 9(l)(vi) of the ITA, 1961 as well as as per Article 12 the India - USA DTAA; instead of treating the same as consideration for sale of copyrighted software licenses. 4. The learned AO has also erred in law and on facts in not granting TDS credit of Rs. 10,52,034/- which was deducted by the various Indian customers of the assessee by taking extreme conservative position of the law. 5. The assessee company craves leave to add / modify / delete / amend all / any of the Grounds of Objection. ( A. Y. 2011-12) 1. The Hon’ble DRP-IV Delhi has erred in law and on facts, in upholding learned AO’s order treating the amount of Rs. 1,40,48,530/- being received by the assessee company for sales of licenses as a taxable ROYALTY u/s 9(l)(vi) of the ITA, 1961 and as per Article 12 the India - USA DTAA; instead of treating the same as consideration for sale of copyrighted software licenses. 2. The DRP / AO ought to have appreciated that the said amount, received from assessee’s Indian customers, is normal Business Income of the appellant arising on account of sale of copyrighted licensed software products and not taxable in India in the absence of Permanent Establishment (PE) in India.

3. The learned AO has also erred in law and on facts in granting short TDS credit of Rs. 10,03,459/- (Rs. 14,90,981 - Rs.4,87,522) which was deducted by the various Indian customers of the assessee by taking extreme conservative position of the law.

4. Alternatively and without prejudice to the ground no 1 to 3 above, learned Assessing officer has erred in law and on facts in applying taxation rate of 15% as per DTAA between India and USA instead of 10% rate given under section 115A of Income Tax Act 1961. 5. The assessee company craves leave to add / modi fy / delete / amend all / any of the Grounds of Objection.

(A.Y.2012-13) 1. The Hon’ble DRP-IV Delhi has erred in law and on facts, in upholding learned AO’s Page | 4 order treating the amount of Rs. 2,65,00,760/- being received by the assessee company for sales of licenses as a taxable ROYALTY u/s 9(l)(vi) of the IT A, 1961 and as per Article 12 the India - USA DTAA; instead of treating the same as consideration for sale of copyrighted software licenses.

2. The DRP / AO ought to have appreciated that the said amount, received from assessee’s Indian customers, is normal Business Income of the appellant arising on account of sale of copyrighted licensed software products and not taxable in India in the absence of Permanent Establishment (PE) in India.

3. The learned AO has also erred in law and on facts in granting short TDS credit of Rs. 5,88,007/- (Rs.30,08,103 ROI- Rs.24,20,096 final AO order) which was deducted by the Indian customers of the assessee.

4. Alternatively and without prejudice to the ground no 1 to 3 above, learned Assessing officer has erred in law and on facts in applying taxation rate of 15% as per DTAA between India and USA instead of 10% rate given under section 115A of Income Tax Act 1961.

5. The assessee company craves leave to add / modify / delete / amend all / any of the Grounds of Objection.

The terms "sufficient cause" should be (ii) understood in their proper spirit, philosophy and purpose regard being had to the fact that these terms are basically elastic and are to be applied in proper perspective to the obtaining fact-situation.

Substantial justice being paramount (iii) and pivotal the technical considerations should not be given undue and uncalled for emphasis.

No presumption can be attached to (iv) deliberate cause of delay but, gross negligence on the part of the counsel or litigant is to be taken note of. Page | 9

Lack of bona fides imputable to a (v) party seeking condonation of delay is a significant and relevant fact.

It is to be kept in mind that adherence (vi) to strict proof should not affect public justice and cause public mischief because the courts are required to be vigilant so that in the ultimate eventuate there is no real failure of justice.

The concept of liberal approach has to (vii) encapsulate the conception of reasonableness and it cannot be allowed a totally unfettered free play.

There is a distinction between (viii) inordinate delay and a delay of short duration or few days, for to the former doctrine of prejudice is attracted whereas to the latter it may not be attracted. That apart, the first one warrants strict approach whereas the second calls for a liberal delineation.

The conduct, behaviour and attitude of (ix) a party relating to its inaction or negligence are relevant factors to be taken into consideration. It is so as the fundamental principle is that the courts are required to weigh the scale of balance of justice in respect of both parties and the said principle cannot be given a total go by in the name of liberal approach.

If the explanation offered is concocted (x) or the grounds urged in the application are fanciful, the courts should be vigilant not to expose the other side unnecessarily to face such litigation.

It is to be borne in mind that no one (xi) gets away with fraud, misrepresentation or interpolation by taking recourse to the technicalities of law of limitation.

The entire gamut of facts are to be (xii) carefully scrutinized and the approach should be based on the paradigm of judicial discretion which is founded on objective reasoning and not on individual perception.

The State or a public body or an entity (xiii) representing a collective cause should be given some acceptable latitude."

10. Respectfully following the ratio laid by the Hon’ble Apex Court in the decisions cited (supra) we condone the delay in filing of the appeal for assessee’s A. Y. 2007-08 and 2009-10 and these appeals are admitted for adjudication.

11.1 Facts of the case, in brief, are that the assessee filed its return of income on 01.04.2008 declaring total income “Nil”. Regarding background and business of the assessee company, the assessee had submitted the following :-

“The company is engaged into development and sales of Project Management Software Licenses to various customers all over the world. The company has developed the various versions of its PMS system and is providing licensed copyright products on a sale basis. All the necessary and essential programs are own creations of the company.

The company provides and sells large quantities of the licensed softwares through internet by providing KEY or passwords, etc. The softwares are downloaded from the net and protected through the licenses extended with the same.

As the sales of copyrighted softwares is carried out through the internet protocol and our company does not have any PE in India, the company’s income embedded in the sales to Indian companies, does not accrue in India. Kindly appreciate Article- 5 and Article – 7 of the DTA between India and USA. A copy of the said DTA is enclosed herewith.

However, the Indian companies have taken a very extreme conservative position and effected a TDS on the said amounts paid for sale of software licenses. Considering the clear position of law in this respect, our company has filed the tax return for A. Y. 2007-08 and requested for refund of the said TDS.

During this year, our company has sold software licenses to two companies, i.e. Infosys Technologies Limited and HCL Technologies Limited. Regular contracts are entered into with the customers before effecting the sales. Copy of the contract for sales to Infosys is enclosed herewith. The other contract were almost on similar lines.”

12. Subsequently, on being called by the AO the assessee filed certain additional details. It was argued that Section 5 of the Master License Agreement (MLA) contains the terms of payment. The MLA has specifically made the bifurcation between license fees and service fees. As per the agreement the license fees is to be payable in the non-refundable installments which are required to be paid on the completion of each phase of software development. However, service fees will be charged for the further maintenance of the software, if required. Service fees will not be charged for the first twelve months from the completion of contract and thereafter maintenance fees will be charged as per the terms and conditions given in the agreement. It was submitted that the services are required to be rendered for customization of the said software for the use and facilitation of Page | 13 any customer. As the softwares are Standard forms, the customization is necessary considering the diverse situations. Also, a regular backup of trouble shooting is necessary if there are any unintended bugs / problems. The assessee company aims at trouble shooting from the USA establishment. For this purpose, it has a ready support services on a 24 X 7 basis. The problems of the clients are aimed at being sorted out on an offline basis. However, in case of necessity, the executives are required to visit the clients establishments and fix the problems. For all these jobs, separate service charges are levied.

Once the license is granted the assessee is responsible to maintain it as it is their proprietary product. After the grant of license the assessee keeps on billing the customers. There are Page | 14 number of software and solutions on the website of the assessee. Then in each product / solution number of modules are integrated. The assessee has filed only one contract during the proceedings. This contract is with Infosys and is in relation to the Project Management Software that is why only the details of Project Management Software have been described above.

14. The AO, therefore, asked the assessee to explain as to why the consideration should not be taxed as royalty income. From the various clauses of the agreement and nature of software provided by the assessee the AO drew the following inferences as per para 4.1 of his order:-

“4.1 A combine reading of the aforementioned clauses & agreement & nature of software concludes the following propositions, inter-alia,: subject matter of transfer is a license to use the license of a) software; The software is not a ‘same for all' software. Supplier will b) provide Deliverables and Services as specified in the relevant SOWs only when ordered. Supplier will begin work only after receiving order from Buyer. Buyer may propose changes to a SOW and Supplier will submit to Buyer the impact of such changes. The supplier i.e. assessee start working / software c) coding as per the request of the customer & its requirements.This could be the possible reasons why there is a concept of “Work Order” / "Statement of Work” and not "sale”. The software for which license is granted is not a "same d) for all customers" software, is also confirmed from the fact that there are detailed acceptance procedures set out. There should be no question of acceptance / rejection in case of a standard software. The software is run in the premises of the customer, for the customer to see whether it meets its criterions. Customer can even go for certain enhancements as e) desired. The supplier is required to keep the software, for which f) license is given, updated & maintained to be able to keep on carrying out the processes as desired by the customer. It is recognized that the training is needed to support the g) basic sales, implementation and support of software.

Not only license but license, documentation, services, h) training, updates are provided. The configuration is also to be done. i) The software license provided by the assessee are upgradable and as claimed ‘future ready’. Unlike sale, the software is not stand alone and the assessee keeps in continuous touch with its customer. j) The software are heavily priced vis-a-vis a normal computer / system. The software are feature rich and are capable of carrying out various activities-. These can carry out the Page | 16 activities which many person together will not be able to do. Moreover the speed of carrying out the processes is real time i.e. the process is carried out as and when the activity happens. k) The customer gives its own IP Products to the assessee so that the software developed by the assessee is compliant to them. That is why there is a clause of Infosys IP. I) The assessee is required to protect those IP. A long list containing those IP of Infosys are provided in the agreement itself. The list runs into number of pages and is highly technical. The assessee has to make sure that the software developed talks to those modules of future user in a seamless manner and the assessee has to integrate its own software into the already running system of the client. m) The software developed for one client can not be licensed to any other client because the IP & internal system infrastructure is unique to every organization and also the IP of the clients are to be protected. n)The software, for which license has been granted, equip the user/ enable the user to carryout high level technical tasks with precision. These software are not the ones for running small machines. These sits over the over a standard server / computer and carry out the processes. Their price is many times the server on which these are installed for to be used and are in real sense equipments of multiple capabilities. o)The word equipment is derived from equip + ment. The origin of the word “equip” is from modification of Anglo-French “eskiper", "eschiper" to load on board a ship, embark, outfit, Page | 17 man, of Germanic origin; akin to Old English scipian equip a ship.”

16. Accordingly, sum of USD 464,123 equivalent to Rs. 2,01,51,292 (1 USD= INR 43.4180) shown as software consideration was held by the AO to be royalty. He further held that as per Article 13 (4) (a) of the DTAA the services in connection are taxable as fees for technical services. The rate of tax for royalties under the DTAA is 15%. He accordingly determined the total income at Rs. 2,01,51,292, which is taxable @ 10% + surcharge + education cess as per section 115A of the Act as the agreement is entered after 01.06.2005.

2.2 -Product sold by the Appellant Appellant is engaged in sale of licences of its software product called as PMS (i.e Project Management Software). PMS is considered as a B1 Tool (i.e Business Intelligence Tool). PMS assists the users in regulating and effectively utilising programmers' time on a collective basis, with efficiency. In all the software companies, use of PMS is a very typical, normal, usual and (rather) essential feature. Now, the market for PMS software is very competitive. Many vendors sell the PMS Softwares, and hence, the sale-rates of PMS are under heavy pressure. 2.3 - Agreements with customers Appellant, being a USA company, enters into understanding with the customers for sale of licenses. Typically, agreements are entered into between the customers and the appellant. Copies of sample agreements (for each involved appeals referred above) are enclosed in Paper-Book-Ill submitted on 24th August 2015.

2.4 - Key clauses in the Agreements with customers Perusal of the agreements with customers (such as Infosys, Sony, Tech Mahindra, etc.) will reveal that, Appellant retains all ownership of intellectual property rights relating to the software licenses sold to customers. Appellant permits the customers to merely use the software licenses for their Page | 20 business needs. Appellant further restricts these customers from duplicating / copying / adapting, etc. the software products. Appellant has prepared a comparative chart of various key clauses of the Agreements with customers. The same is given at Page No. 453 to 454. It is the submission of the appellant that the moment, restrictions are put regarding copying / duplicating / reproducing, etc., a copyright gets converted into a copyrighted product. From the said chart, it will reveal that the Appellant does not part with any copyright to the customers. On the contrary, appellant merely extends a copyrighted product to the customers.

2.5. Meaning of "Copyright" as per Indian Copyright Act. 1957 Section 14 of the Indian Copyright Act, 1957 defines the term "Copyright". The same is defined as the exclusive right to do or authorise doing the following acts in respect of a work- following acts in respect of a work- Right Section Section Section Section Section 14(a) 14(b) 14(c) 14(d) 14(e)

Computer Artistic Sound Cinematograph Literary, work recording programme film dramatic or musical work To reproduce X X y y y To issue copies X y y y y To perform work in public/ To y y y y y communicate to public To make film X X y y y To translate X X X y y To make adaption X X y y y To sell or commercially rent X X y y y To sound record X X X X y . Page | 21 Copy of the Indian Copyright Act, 1957 is given from page no. 455 to 503. Various categories (..families..) of such artistic expressions are aptly categorised into various sub-sections of section 14 of the Copyright Act. From a close reading of section- 14 of the said Act, it transpires that; likely losses arising from duplication / copying / illegal exploitation, etc. are protected for various limbs of artistic expressions; depending upon, the nature of such artistic expressions. For example, (a) For Artistic works, there is no protection from translation, considering unlikeliness of such an event (b) For a Cinematograph film, there is no protection for (say) making a film (c) ....

It is submitted, unless and until, a right protected under the Copyright Act is not extended / shared with a party, and unless, consideration is received for such a right, there is no any case of Royalty for l-T purpose. It is submitted, the limb for sale / commercially rent, as so made applicable for software, in fact, ascribes copyright protection even in making of such use-purpose copies. In other words, the enhanced kitty of Page | 22 copyright protections for software, elevates the software family and makes the same highly protected from infringements. Now, as per facts, assessee has not transferred any rights for copying the softwares for commercial exploitation.

2.6 - Meaning of "Royalty" as per DTAA between India and USA The copy of India- USA DTAA is given from page no. 504 to

2.7 - Covered issue by the decision of Honourable Delhi High Court The very same issue, whether a software with restrictions of copying, etc. is a copyright or a copyrighted product, has been considered and decided by the Honourable Delhi High Court in number of decisions. The landmark decision in this regard was that of DIT V. Infrasoft Limited — 264 CTR 329. A copy of the said decision is submitted in Paper-Book-ll on 12th May 2015.

Appellant has prepared a quick summary of the rights granted and restrictions imposed in the Agreement involved in the said Infrasoft (supra) decision and compared the same with Appellants agreement. The said comparison is as under :-

Reasons of DRP-I Explanation Page-6 (Para-2) That the right to use the software licence falls within Key proposition is, DTAA does not cover the right to use ambit of section 9(l)(vi) software in the meaning of Royalty Page-6 (Para-2) That the nature of rights is far from shrink- Totally irrelevant contention since, issue involved is, what is wrapped ...... since the supplier (^required to the fate of a copyrighted product (i.e. a licence having update fix the bugs, etc. restrictions of copying / duplicating, etc.)

Issue of update / fixing bugs, etc. are typical warranties which come with every product. Moreover, the same is besides the present issue.

Page-6 (Para-3) Concept of copyrighted product does not find mention in the ITA / DTAA / Copyright Act Copyrighted article is the result of the Copyright Act itself. Moment negative rights are introduced as regards copying / duplicating, a copyright becomes a copyrighted product. Many such copyrighted products are present in daily life such as - Recent book called ORIGIN written by author DAN BROWN, restricting users from copying the book, etc. Music CD of (say) singer, Gulam Ali, wherein, restrictions are applicable for copying, as written on the CD cover .... and so on Page-6(Para-4) Special Bench decision is not applicable since, facts This is rather a complex proposition. Any precedent has to be herein were not considered in the said SB case of followed if facts are similar. Motorola, Page-6 (Para-5 and 6) SB decision in Motorola can't be followed considering All these propositions are no more tenable considering the provisions of section 115A, etc. and considering binding decisions of the Special Bench (in Motorola case), reservations of India regarding OECD commentary. since the said SB decision has been confirmed by the Honourable Delhi High Court in the case of DIT V. Nokia Networks -212 Taxman 68.

Page-6 (Last Para) TCS decision is not relevant as the same relates to Honourable Delhi High Court, in case of Infrasoft (\ (supra) Sales-Tax Act, etc. has relied on heavily on the said TCS ratio. If As such, the DRP-I objection is no more tenable. | Page-7 (Para-2) Various other decisions cited by assessee Appellant One of the decisions turned down by the DRP-I was the were turned down, stating that, all of these decisions Honourable Delhi ITAT decision in case of Infrasoft - 125 TTJ rely on TCS ratio, and since, TCS ratio not 53. The very same decision is confirmed by the Honourable applicable, even these decisions are also not Delhi High Court, reported at 220 Taxman 273 (copy given in applicable. Paper- Book-ll).

Page-7 and Pag-8 Various other decisions were relied upon which take a view that, software licenses permitting mere USE is With utmost respect, the learned DRP-I ought to have also a situation covered by section 9(l)(vi) of ITA, appreciated that, DTAA overrides ITA. As the DTAA is not 1961. amended, amendments in ITA are not relevant, as so confirmed in various decisions of Infrasoft, etc. Appellant is enclosing herewith list of various cases where, ratio of Infrasoft has been followed. The same is given at page no.

2.8 - Various other reasons of learned AO While framing the draft order dated 31st December 2009, the learned AO has taken various alternate positions. Learned AO states that, the PMS software is not only a copyright, but also a patent / process / equipment, etc. As such, provisions of section 9(l)(vi) apply to the facts in either one of the situation. Appellant has been submitting that, the software license is not a patented technology. There is no any grave and material process involved in the same. In fact, the PMS software's of the Appellant are simply, Business Intelligent tools or MIS data tools for increasing efficiency. Further, these software licences are certainly not any equipment. The DRP-I has also focused on the issue of copyright V. copyrighted article and left the other analogies of the learned AO at that. Appellant submits, at the same time, the PMS software license cannot be a copyright + patent + process + equipment. Analogy of the learned AO is incorrect.

- Summary on point of covered issue 2.9 As per the data available, it transpires, there are three decisions of the Honourable Delhi High Court, wherein, ratio of Infrasoft (supra) has been followed. As such, it is submitted, the said Infrasoft ratio is deep rooted. Similar views is also expressed by the Honourable Madras High Court in the case of CIT V. Vinzas Solutions India P. Ltd. - 392 ITR 155. The said issue of software royalty taxation matter is posted for hearing before the Honourable Supreme Court in January 2019. The copy of the said order is given at page no.

“D. Taxation of Software Royalty - The assessee claims the nature of its transactions with Infosys and other clients as one of ‘sale simplicitor’ involving the sale/transfer of a ‘copyrighted material/product’ rather than a transfer of copyright. Heavy reliance has been placed by the assessee on the decision of Hon’ble Delhi High Court in the case of Infrasoft Ltd. [2013-TII-50-HC-DEL-INTL], However, nowhere it has been established that the facts of the case of Page | 28 the assessee are identical to that of Infrasoft. Moreover, the Hon’ble Delhi High Court in the case of Infrasoft had also observed - “69. The Tribunal has held and rightly so that the question whether there was a transfer of a copyright right or only of a copyrighted article must be determined taking into account all the facts and circumstances of the case and the benefits and burden of ownership which have been transferred.” Accordingly, in the following paragraphs, the facts of the present case are examined in the light of the decision of Hon’ble High Court in the case of Infrasoft Ltd. Nature of Contract - It may be noted that the clients i. of the assessee like Infosys, Tech Mahindra, Virtusa, 3i Infotech etc are engaged in the business of developing software themselves. As explained in the following paragraphs, the agreement between the assessee and its clients are more in the nature of “Software Development Agreements” than “pure sale of softwares as goods”. The contract/agreement between the assessee and Infosys [Paper Book-3] and more specifically, the ‘Statement of Work’ [p.295 to 298] and ‘Exhibit-C’ [p.293] when analysed, clearly brings out the fallacy in the assessee’s contention that the transaction is a 'sale simplicitor’. As per the agreement, the assessee not only provides Infosys its proprietary software, it also provides both the “Source Code” [cl. 1.4, p.270; cl. 3(d) of Statement of Work, p.296; cl. 9.1,p.280 & cl.9.3, p.281]as well as the “Object Code” [cl. 2.1 (iv), p.271] of such software. The statement of work Page | 29 clearly highlights the duties and responsibilities of the assessee as that of an integrator who customizes and integrates the software supplied by it with the software developed by Infosys. Such customization and integration of both the softwares is a prerequisite for creating ‘adaptations ‘ &‘derivatives’. [cl. 2.1 (ii),p.271; cl. 3.1(b), p.272; cl. 4, p.273; Statement of Work, p. 295-296 and Exhibit-E, p.300] The above observation that the agreement is ‘something more than a pure sale simplicitor’ is further strengthened by the payment terms as per ‘Exhibit-C’ [p.293] which provides for payments on the basis of milestones/phases [also cl.3.1(a), p.272] as well as after ‘Final Acceptance’ by Infosys. In fact, there is a provision of payment of “Bonus” on completion of organization wide roll out and satisfactory feedback from the client as well as “End Users”. All the above facts clearly proves that the agreement between the assessee and the client is not in the nature of a pure ‘sale simplicitor’ of shrink- wrapped/off-the-shelf software as claimed by the assessee but one of developing, customizing & integrating the software of the assessee with that of the client for the ultimate use by the end-users. This is one of the most significant differences between the facts in the case of Infrasoft & that of the assessee. Significance of Source & Object Code & creation of ii. Derivative works - Another important point of departure from the facts in the case of Infrasoft is the provision of “Source Code” & “Object Code” of the supplied software to the client. After becoming a party to the Agreement on Trade-Related Page | 30 Aspects of IP Rights (TRIPs), India has significantly amended its IP laws to comply with various requirements set out in TRIPs. Article 27(1) of TRIPs states that patent protection for new, inventive and industrially applicable inventions must be available without discrimination based on the technical field of an invention. In respect of software, Article 10(1) of TRIPs mandates the protection of computer programs, whether in source code or object code, as literary works under the Berne Convention, to which India has also acceded. It is in this context that the importance of the provisions of the agreement making available the source & object codes to the licensee must be examined. These are the codes which can be used to adapt, customize and integrate the systems of the client with that of the assessee so as to enable the client to create/prepare/develop derivative softwares/programs or new products which can be used by the ‘end users’ or can be commercially exploited. Cl.2.1 (ii) r.w. cl. 3.1(b) of the agreement clearly provides that Infosys can “modify and prepare derivative works based on the Software [supplied by the assessee], including, without limitation, incorporating the Software in whole or in part, into Infosys’s own products and developing new products based on the Software.” This is a very powerful provision which gives the right to the client not only to create derivative works, but also to incorporate the software supplied by the assessee in the existing ‘products’ and ‘new products’ to be developed by the client. It is in the context of these ‘products’ that the provision of ‘bonus’ on the basis of feedback from the end-users must be looked at. Page | 31 iii. Copying & Ownership - The third important distinguishing feature of assessee’s agreement with Infosys relate to the copying of and ownership over the software supplied by the assessee and derivative works based upon such software. As per clause 2.1 [p.271], the software can be used not only by the assessee, but also by its subsidiaries, employees and even its contractors. Accordingly, there is no fixed limit on the number of copies made/users as long as the client pays additional license fee as per Exhibit-C. [p.293] However, once the number of users exceed 100,000 no further additional license fee is payable. Towards this end, the assessee warrants [unlike Infrasoft] that the software shall not contain any software locks, system foreclosure features, time bombs or encryptions, [cl.6,4, p.278]As regards of the ownership of the derivatives and integration codes developed by the assessee for Infosys, cl.4.4 [p.274] provides that “code, modules, APIs or like materials that are designed to integrate the Software with Infosys products... (collectively, Integration Code), Infosys will own all worldwide right, title and interest in and to all such integration code. Digite will assign to Infosys all of its right, title and interest in and to all such integration code, including all worldwide Intellectual Property Rights therein. Similarly, cl.11.3 [p.282] provides that in the event of termination of the agreement, Infosys shall be entitled to retain and withhold and use without any restrictions the software, software core derivatives and software derivatives. Moreover, the agreement provides that the assessee ‘shall refrain from providing such software and software core derivatives to any third party’ and Page | 32 in the event of any breach to this, the assessee is liable to pay liquidated damages to Infosys. iv. Commercial Exploitation - It has already been discussed earlier that the agreement permits and the access to the source code allows Infosys to embed and incorporate whole or part of the software into Infosy’s own products and developing new products based on the software, [cl.2.1 (ii), p.271] It has also been highlighted that the assessee will receive a ‘Bonus’ on the basis of “End User” satisfaction of the products where the software has been incorporated. It was also highlighted that Infosys will own all worldwide right, title and interest in and to all such integration code and the assessee will assign to Infosys all of its right, title and interest in and to all such integration code, including all worldwide Intellectual Property Rights therein. Moreover, there are no restrictions to the number of copies/users to the software [including Infosys softwares where the software has been embedded]. All these provisions clearly establish the commercial exploitation of the software by Infosys. In fact, cl.13.4 [p.283] provides that Infosys and the assessee “shall make all commercially reasonable efforts to enter into a product marketing/distribution agreement under which the software (including software derivatives/software core derivatives) will be offered to other entities in the market for licensing." Towards this end, Cl. 10 [p.281] provides for the non-solicitation of the employees of each other.

In the light of above, it may be seen that the nature of the transaction between the assessee and Infosys is materially different from the facts of Infrasoft. Coming back to legal Page | 33 principles enunciated by the Hon’ble High Court in the case of Infrasoft, the Hon’ble High Court had he following observations to distinguish a copyright from a copyrighted product.

67 ....if the transferee acquires a copy of a computer programme but does not acquire any of the rights identified in certain sections (of the U.S. Regulations), the regulation classified the transaction as the Transfer of a copyrighted article. If a transfer of a computer programme results in the transferee acquiring any one or more of the listed rights, it is a transfer of a copyright right. If a person acquires a copy of a computer programme but does not acquire any of the four listed copyright rights, he gets only a copyrighted article but no copyright. The four rights being:

(i) The right to make copies of the computer programme for purposes of distribution to the public by sale or other transfer of ownership, or by rental, lease, or lending.

[ (ii) The right to prepare derivative computer programmes based upon the copyrighted computer programme

(iii) The right to make a public performance of the computer programme )

(iv) The right to publically display the computer programme. ”

Accordingly, the Hon’ble High Court proceeded on to examine the facts of the case in the light of the following tests- Page | 34 Copying Test - Whether the license granted by the Assessee is limited to those necessary to enable the licensee to operate the program or something more than it. [para-88] , - Purpose Test - Whether the purpose of the license or the transaction is only to restrict use of the copyrighted product for internal business purpose [para-89] or the licensee was permitted to use and exploit the same commercially i.e. loan/rent/sale/sub-license or transfer the copy of software to any third party without the consent of the licensor, [para- 92] The case of the assessee when examined from the above perspective clearly establishes that the transfer is that of a ‘copyright’ and not a ‘copyrighted’ material. The following facts are the clear indicators of this conclusion - ■ Nature of transaction - It has already been discussed earlier that the agreement between the assessee and Infosys & other customers is more in the nature of a “Software Development agreement” than in the nature of ‘sale simplicitor’ and the as contention of the assessee that the product transferred is in the nature of ‘goods’ is not tenable. As has been observed by the Hon’ble Special Bench of this Tribunal in the case of Motorola Inc. [2005-TII-10-ITAT-DEL-SB-INTL1, the appellant has transferred “something more” than merely a ‘copyrighted article’. ■ Adaptation & Derivatives - As has been stated earlier, the Hon’ble High Court in para- 67 of its order quoted US regulations as per which “If a transfer of a computer programme results in the transferee acquiring any one or more of the listed rights, it is a transfer of a copyright right. ” in the case of the assessee there is no dispute or doubt that “the right to prepare derivative computer Page | 35 programmes based upon the copyrighted computer programme” is one of such rights assigned to the clients by the assessee. Accordingly, the transaction between the assessee and Infosys and other clients involves transfer of ‘copyright’ rather than ‘copyrighted material’. In this regard, revenue places reliance on the decision of Hon’ble ITAT, Delhi in the case of Elektrobit Automotive GmbH[2018-TII-166-ITAT-DEL-INTL1 wherein, on identical situation, it was held that the receipts by the assessee are in the nature of royalty on account of transfer of‘copyright’ through derivative and embedded software programs. ■ Copying Test - It has already been highlighted earlier that the client has been permitted to make unlimited copies/users as long as additional license fee is paid. Moreover, such additional license fee is no payable if the number of users exceeds 100,000. Furthermore, the client is at liberty to enable and allow its employees, subsidiaries and third party contractors working for it to use the software. Similarly, provision of source code permits the client to embed whole or part of assessee’s software in the products developed by it so that the end users and other customers using client’s software can use the assessee’s software as well. It cannot be said that the licensee is copying the program onto its computer's hard drive or random access memory for making an archival copy. Provision of the source & object codes to the client ensures that the license granted by the Assessee is NOT limited to those necessary to enable the licensee to operate the program and in reality, is something more than it. Page | 36 ■ Purpose Test - It has been elaborately discussed earlier, the use of the software by the licensee is not restricted to the use of the product for its internal business purpose ONLY. Although it is claimed that as per cl.2.2 [p.271], except as provided/authorised in MLA, the licensee cannot lease, lend or rent the software to the third parties, in reality, the provisions of MLA itself permit the licensee to allow third party user of the software either independently or through embedded form along with the licensee’s products. The licensee, thus, can allow any number of users to use the product either (i) by engaging/getting involved such user in the business of the licensee i.e. subsidiaries, employees and contractors and (ii) by any other person by supplying/using licensee’s own products embedded with the software. In fact, integration of the software supplied by the assessee with Infosy’s own software and embedding of the assessee’s software in the products of Infosys and other customers for the third party users/customers clearly establish the commercial use and exploitation of the software by the licensee. In fact, the agreement explicitly provides for and encourages such joint commercial exploitation of the software. Such commercial use of the software, and for that matter, the purpose of the license, in no stretch of imagination, can be viewed or treated as a restricted use of the product for internal business purpose of the licensee. Thus, application of various tests as regards of rights to ownership, copying, commercial exploitation etc. as has been discussed above clearly establishes what Hon’ble AAR held in the case of Dassault Systems [2010-TII-02-ARA-INTL] that Page | 37 the grantee/licensee practically step into the shoes of the owner/grantor/licensor and he enjoys the copyright to the extent of its grant to the exclusion of others. In addition to the decisions in the case of Infasoft Ltd. [supra] and Elektrobit Automotive GmbH [supra] revenue relies upon the following decisions - Airport Authority of India (AAR No.819 of 2009) i. ii. CIT vs. Synapsis International Old Ltd. (212 Taxman 454)(HC, Karnataka) iii. Citrix Systems Asia Pacific PTY (343 ITR 1 AAR)(AAR No. 822 of 2009) iv. Skillsoft Ireland Ltd. (AAR No. 985 of 2010) v. CIT vs Samsung Electronics Co. Ltd & others (345 ITR 499) (Kar) vi. Verizon Communications Singapore PTE Ltd vs ITO (361 ITR 575)(Mad)

“3.1 The software is delivered at the site of the end customer.

There is a specific roil out plan and installation and implementation programme. During the same the employees of the customer are given training on how to use the same. The services including updates, maintenance, support etc. are part & parcel of the contract. The same is also verifiable from the nature of receipts of the assessee: Page | 38

The details as provided of sums invoiced by the assessee are: Infosys HCL TOTAL (USD) License $ 200,000.00 $ 200,000.00 Professional Services $ 208,436.61 $ 14,249.47 222,686.08 Annual Maintenance Contract $ 25,898.00 $ 15,539.00 41,437.00 TOTAL (USD) $ 434,334.61 $ 29,788.47 464,123.08 Once the license is granted the assessee is responsible to maintain it as it is their proprietory product. After the granted of license the assessee keeps on billing the customers. There are number of software and solutions on the website of the assessee, Then in each product / solution number of modules are integrated. The assessee has filed only one contract during the proceedings. This contract is with Infosys and is in relation to the Project

Management Software that is why only the details of Project Management Software have been described above.”

“89. There is a clear distinction between royalty paid on transfer of copyright rights and consideration for V transfer of copyrighted articles. Right to use a copyrighted article or product with the owner retaining his \ copyright, is not the same thing as transferring or assigning rights in relation to the copyright. The enjoyment \ of some or all the rights which the copyright owner has, is necessary to invoke the royalty definition. \Viewed from this angle, a non-exclusive and non- transferable licence enabling the use of a copyrighted product cannot be construed as an authority to enjoy any or all of the enumerated rights ingrained in Article 12 of DTAA. Where the purpose of the licence or the transaction is only to restrict use of the copyrighted product for internal business purpose, it would not be legally correct to state that the copyright itself or right t r use copyright has been transferred to any extent. The parting of intellectual property rights inherent in and attached to the software product in favour of the licensee/customer is what is contemplated by the Treaty. Merely authorizing or enabling a customer to have the benefit of data or instructions contained therein without any further right to deal with them independently does not, amount to transfer of rights in relation to copyright or conferment of the right of using the copyright. The transfer of rights in or over copyright or the conferment of the right of use of copyright implies that the transferee/licensee should acquire rights either in entirety or partially co-extensive with the owner/transferor who divests himself of the rights he possesses pro tanto. The license granted to the licensee permitting him to 90. download the computer programme and storing it in the computer for his own use is only incidental to the facility extended to the licensee to make use of the copyrighted product for his internal business purpose. The said process is necessary to make the programme functional and to have access to it and is qualitatively different from the right contemplated by the said paragraph because it is only integral to the use of copyrighted product. Apart from such incidental facility, the licensee has no right to deal with the product just as the owner would be in a position to do. There is no transfer of any right in respect of copyright 91. by the Assessee and it is a case of mere transfer of a copyrighted article. The payment is for a copyrighted article and represents the purchase price of an article and cannot be considered as royalty either under the Income-tax Act or under Page | 44 the DTAA. The licensees are not allowed to exploit the computer 92. software commercially, they have acquired under licence agreement, only the copyrighted software which by itself is an article and they have not acquired any copyright in the software. In the case of the Assessee company, the licensee to whom the Assessee company has sold/licensed the software were allowed to make only one copy of the software and associated support information for backup purposes with a condition that such copyright shall include Infrasoft copyright and all copies of the software shall be exclusive properties of Infrasoft. Licensee was allowed to use the software only for its own business as specifically identified and was not permitted to loan/rent/sale/sub-licence or transfer the copy of software to any third party without the consent of Infrasoft. The licensee has been prohibited from copying, 93. decompiling, de-assembling, or reverse engineering the software without the written consent of Infrasoft. The licence agreement between the Assessee company and its customers stipulates that all copyrights and intellectual property rights in the software and copies made by the licensee were owned by Infrasoft and only Infrasoft has the power to grant licence rights for use of the software. The licence agreement stipulates that upon termination of the agreement for any reason, the licencee shall return the software including supporting information and licence authorization device to Infrasoft. The incorporeal right to the software i.e. copyrighter 94. mains with the owner and the same was not transferred by the Assessee. The right to use a copyright in a programme is totally different from the right to use a programme embedded in a cassette or a CD which may be a software and the payment made for the same cannot be said to be received as consideration for the use of or right to use of any copyright to bring it within the definition of royalty as given in the DTAA. What the licensee has acquired is only a copy of the copyright article whereas the copyright remains with the owner and the Licensees have acquired a computer programme for being used in their business and no right is granted to them to utilize the copyright of a computer programme and thus the payment for the same is not in the nature of royalty.

We have not examined the effect of the subsequent 95. amendment to section 9 (1) (vi) of the Act and also whether the amount received for use of software would be royalty in terms thereof for the reason that the Assessee is covered by the DTAA, the provisions of which are more beneficial.

The amount received by the Assessee under the licence 96. agreement for allowing the use of the software is not royalty under the DTAA. What is transferred is neither the copyright in the 97. software nor the use of the copyright in the software, but what is transferred is the right to use the copyrighted material or article which is clearly distinct from the rights in a copyright. The right that is transferred is not a right to use the copyright but is only limited to the right to use the copyrighted material and the same does not give rise to any royalty income and would be business income.

We are not in agreement with the decision of the 98. Karnataka High Court in the case of Samsung Electronics Co. Ltd {supra) that right to make a copy of the software and storing the same in the hard disk of the designated computer and taking backup copy would amount to copyright work under section 14(1) of the Copyright Act and the payment made for the grant of the licence for the said purpose would constitute royalty. The license granted to the licensee permitting him to download the computer programme and storing it in the computer for his own use was only incidental to the facility extended to the licensee to make use of the copyrighted product for his internal business purpose. The said process was necessary to make the programme functional and to have access to it and is qualitatively different from the right contemplated by the said provision because it is only integral to the use of copyrighted product. The right to make a backup copy purely as a temporary protection against loss, destruction or damage has been held by the Delhi High Court in Nokia Networks OY {supra) as not amounting to acquiring a copyright in the software. In view of the above we accordingly hold that what has 99. been transferred is not copyright or the right to use copyright but a limited right to use the copyrighted material and does not give rise to any royalty income.

11. The CIT (A) found that the Assessee was engaged in the resale of software and the payments made by it to THPL and others were on account of purchases made by the Assessee. The ITAT concurred with the aforesaid finding. It is also not disputed that in the preceding years, the AO had accepted the transactions in question to be that of purchase of software. The limited issue to be addressed is whether in view of these findings the amount paid by the Assessee could be taxed as royalty.

15. In another case, Dynamic Vertical Software India (P.) Ltd. {supra), this Court had reiterated the view that payment made by a reseller for the purchase of software for sale in the Indian market could by no stretch be considered as royalty.

16. In the aforesaid view, the question framed must be answered in the affirmative, that is, in favour of the Assessee and against the Revenue.

17. The Appeal is accordingly dismissed. In the circumstances the parties are left to bear their own costs.

“The provisions of section 9(1 )(vi) dealing with and defining 'royalty' cannot be made applicable to a situation of outright purchase and sale of a product. According to Page | 50 the corpus juris secundum, the word 'royalty' means a share of the product or profit reserved by the owner for permitting another to use the property, the share of the product or profit paid by the owner; a share of the product or proceeds therefrom reserved to the owner for permitting the another to use the property; the share of the produce reserved to the owner for permitting another to exploit and use the property; a share of the profit, reserved by the owner for permitting another to use the property; the amount reserved or the rental to be paid the original owner of the whole estate. [Para 4] ■ The Madras High Court in CITv. Neyveli Lignite Corpn. Ltd. [2000] 243ITR 459/109 Taxman 369 has explained the concept of royalty as the payment made by a person who has exclusive right over a thing for allowing another to make use of that thing which may be either physical or intellectual property or thing. The exclusivity of the right in relation to the thing for which royalty is paid should be with the grantor of that right. Mere passing of information concerning the design of a machine which is a tailor-made to meet the requirement of a buyer does not by itself amount to transfer of any right of exclusive user, so as to render the payment made therefor, being regarded as 'royalty'. [Para 5] ■ The Courts have consistently noted the difference between a transaction of sale of a 'copyrighted article' and one of copyright' itself. [Para 6] ■ The provisions of section 9(1)(vi) as a whole, would stand attracted in the case of the latter and not the former. Explanations 4 and 7 relied by the authorities would thus, have to be read and understood only in that context and cannot be expanded to bring within its fold transaction beyond the realm of the provision. [Para 7]

No.4 for A. Y. 2012-13 is concerned the same is an alternate ground which in our opinion Page | 54 becomes infructous in view of our allowing the grounds of appeal No. 1 and 2. Accordingly, ground of appeal No.4 is dismissed.

Order pronounced in the open court on 19.11.2019.