I2 TECHNOLOGIES US INC,BANGALORE vs. DDIT, BANGALORE

JDA Software Inc (Successor in interest to i2 Technologies US Inc.) C/o. JDA Software Private Limited, Vs. The Deputy Director of Mantri Commercio, International Tax, Near Sakra World Hospital, Circle-1(1), Bellandur, Outer Ring Road, BANGALORE BANGALORE [PAN: AABCI5282J] APPELLANT RESPONDENT Appellant by : Shri T. Suryanarayana, Advocate Respondent by : Smt. Priscilla Singsit, CIT-DR Shri R.N. Siddappaji, Addl.CIT Date of hearing : 16-04-2019 Date of Pronouncement : 26-04-2019 O R D E R Per N V Vasudevan, Vice President :

This is an appeal by the assessee against the order dated 30-03-2010 of the Commissioner of Income Tax (Appeals)-IV, Bangalore, relating to Assessment Year 2006-07.

“Maintenance : Upon payment by Customer of maintenance fees (“Maintenance Fees”), i2 shall provide Customer with corrective maintenance, updates, enhancements or modifications to the Licensed Software which i2 incorporates into and makes part of the Licensed Software and does not separately price or market (collectively, the "Enhancements '') and telephone support during i2 's regular business hours (8 am -5pm CST, Monday -Friday) for the sole purpose of reporting problems with the System (collectively referred to herein as "Maintenance). Telephone support shall be provided to only one Customer designated representative or alternate at one central site as designated by Customer. Such telephone support will be provided only to those Customer designates who have attended the System training class. i2 shall not be obligated to provide telephone support to any location other than the Site Locations. Twenty-four hours a day, seven days a week Maintenance ("24 X 7 Maintenance'') will only be provided if noted on Addendum A. Unless otherwise specified on an addendum, i2's Maintenance obligations apply only to i2's standard System including Enhancements as released to the .general client base. Following the first anniversary of the Agreement date, as long as i2 is offering Maintenance, Customer may at Customer's option renew Maintenance. In the event Customer allows Maintenance to lapse, it may thereafter renew such support for the affected Software by paying the then current annual Maintenance Fees plus an amount equal to the aggregate Maintenance Fees that would have been payable for the affected Software during the period of lapse. I2 shall provide Maintenance for the current and the immediate prior versions of the Licensed Software. Maintenance does not include the correction of errors or defects caused by operation of the System in a manner other than that expressly or impliedly authorized by i2, the incorrect use of the System by Customer or hardware maintenance”.

(emphasis supplied in bold letters)

“Definition of Royalty as per the I T. Act- Explanation 2 :-

For the purposes of this clause, "royalty" means consideration (including any lump sum consideration but excluding any consideration which would be the income of the recipient chargeable under the head "Capital gains") for- (i) the transfer of all or any rights (including the granting of a license) in respect of a patent, invention, model, design, secret formula or process or trade mark or similar property; (ii) the imparting of any information concerning the working of, or the use of, a patent, invention, model, design, secret formula or process or trade mark or similar property; (iii) the use of any patent, invention, model, design, secret formula or process or trade mark or similar property; (iv) the imparting of any information concerning technical, industrial, commercial or scientific knowledge, experience or skill; (v) the use of right to use any industrial, commercial or scientific equipments but not including the amount referred to in section 44BB; (vi) the transfer of all or any rights (including the granting of a licence) in respect of any copyright, literary, artistic or scientific work including films or vide tapes for use in connection with television or tapes for use in connection with radio broadcasting, but not including consideration for the sale, distribution or exhibition of cinematographic films; or (vii) the rendering of any services in connection with the activities referred to in sub-clauses (i) to (iv), (iva) and (v)”.

3.1. The case of the assessee on the other hand is that the maintenance revenue received is not in the nature of royalty as per the definition of royalty as given in Explanation-2 to Section 9(1)(vi) of the of the Income Tax Act, 1961 (Act). The further plea of the assessee is that as per the definition of royalty as contained in Article 12(3)(4) of the Double Taxation Avoidance Agreement between India and USA (hereinafter referred to as “DTAA”), the maintenance charges are not chargeable to tax in India because there was no right to use as is contemplated under the definition of royalty under Article 12(3) of DTAA. The assessee also contended that the sum-in-question cannot be considered as fees for included services for the reason that the fees received is not for services covered by Article 12(4)(a) i.e., it is not “ancillary and subsidiary to the application or enjoyment of the right conferred under Article 12(3) or Article 12(4)(b) i.e., “make available technical knowledge, experience, skill, know-how, or processes”, of the DTAA. Article 12(3) & (4) of the DTAA is as follows:

Definition of Royalty as per Article 12(3) of DTAA – “12(3) The term 'royalties' as used in this Article means payments of any kind received as a consideration for the right to use of, or the right to use (a)any copyright of a literary, artistic or scientific work, including cinematograph film or films or tapes used for radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience, including gains derived from the alienation of any such right, property or information; (b)any industrial, commercial or scientific equipment, other than payments derived by an enterprise from activities described it paragraph 4(b) or 4(c) of Article 8.”

Fees for included services as per article 12(4) of DTAA are as under: “12 (4) For purposes of this article, "fees for included services" means payments of any kind to any person in consideration for the rendering of any technical or consultancy services [including through the provision of services of technical or other personnel] if such services: (a) are ancillary and subsidiary to the application or enjoyment of the right, property or information for which a payment described in paragraph 3 is received; or (b) make available technical knowledge, experience, skill, know-how, or processes, or consist of the development and transfer of a technical plan or technical design"

3.2. The AO, however, did not agree with the contentions put-forth by the assessee. He held that there was sale of software by the assessee to its customers and by doing so there was a right to use contemplated by the Article 12(3) of the DTAA. Since the maintenance services are in relation to right to use in respect of a copy right, the maintenance services performed in respect of software sold by the assessee would be services in connection with the right to use copy right in the software and would therefore be royalty within the definition of the term as given in Explanation-2(vi) of the Act. The AO did not deal with the argument of the Assessee on Article 12(4) of the DTAA.

4. On appeal by assessee, the CIT(A) noticed that the software was originally sold by i2 Technologies (Netherlands) BV, which is also another group entity, but nevertheless a different entity. With effect from 01-04-2005, i2 Technologies (Netherlands) BV, transferred the entire maintenance contract in respect of the software sold by them in India to the assessee. These facts are clear from reading of para 4.3.2 of the order of CIT(A) in which the CIT(A) has noticed the terms of the Software License Agreement between i2 Technologies (Netherlands) BV and the Indian customers to whom software was supplied by the said entity, which is as follows:

4.3.2 In the course of appellate proceedings, the appellant has furnished copies of Software License Agreements between i2 Technologies (Netherlands) BV and the Indian customers to whom software was supplied. The appellant has also furnished a confirmation from i2 Technologies (Netherlands) BV that w.e.f. 01.04.2005, all maintenance contracts in the name of i2 Technologies (Netherlands) BV (hereinafter referred to as i2") stand transferred to the appellant along with all risks and rewards attached thereto……..”

4.1. The Ld.CIT(A) found that in the case of i2 Technologies (Netherlands) BV, they were assessed in Mumbai and the Revenue i.e., the AO at Mumbai has taxed the supply of software as royalty in the hands of i2 Technologies (Netherlands) BV. Since the sale of software has been considered as royalty in the hands of i2Technologies (Netherlands) BV, the CIT(A) was of the view that the maintenance services are also be considered as royalty. These facts emanate from reading of para Nos. 4.3.4 & 4.3.5 of the order of CIT(A), which are as follows:

4.3.4. There can be no dispute that the receipts on account of maintenance charges are incidental to software receipts and bear the same character as that of software receipts. It is gathered that i2 (assessed at Mumbai) has been claiming in its IT returns that its software receipts are not taxable in India. However, the AO at Mumbai and the concerned CIT(A) having jurisdiction over that case have held such software receipts to be in the nature of ‘Royalty’ liable to tax in India both under the Act and the relevant DTAA. The matter is said to be pending in further appeal before the Hon'ble Tribunal. As far as the case of the appellant is concerned, I am in agreement with the view of the AO that the payments for Licensed Software are indeed in the nature of 'Royalty' within the meaning of clause (vii) of Explanation 2 to Section 9(1)(vi) of the Act. The AO is also perfectly justified in treating the payments for Maintenance Services" in connection with the Licensed Software as "fees for included services" as per Article 12(4)(a) of the relevant DT AA in so far as such maintenance services are ancillary and subsidiary to the use of software .

4.2. The CIT(A) also dealt with the argument of the Assessee that the sum in question cannot be considered as “fees for included services” under Article 12(4) of the DTAA.

4.3.5 A perusal of the MoU concerning 'Fees for included services' in Article 12 of the relevant DTAA shows that in order for a service fee to be considered ancillary and subsidiary to the application or enjoyment of some right, property or information for which a royalty payment is received, the service must be related to the application or enjoyment of the right, property or information. In addition, the clearly predominant purpose of the arrangement under which the payment of the service fee and such other payments are made must be the application or enjoyment of the right, property or information described in paragraph 3 of Article 12. In the instant case, it is evident that the Maintenance Services provided by the appellant facilitate the effective application and implementation of the software licensed to its clients. Without such Maintenance Services, the customers of the appellant will not know how to deal with bugs or defects in the software which may seriously affect the application of such software as well as business operations of the clients. Nor will the customers be entitled to updates, enhancements or modifications to the licensed software which is provided by the appellant as part of Maintenance Services. In view of the above discussion, the action of the AO in taxing the Maintenance Receipts/ revenue as "royalty" u/s 9(l)(vi) of the Act and Article 12(4)(a) of the relevant DTAA is upheld. Grounds bearing Nos. l to 5 taken up by the appellant are found to be devoid of substance and are accordingly dismissed”.

4.3. Aggrieved by the order of CIT(A), assessee filed an appeal before the Tribunal, raising the following Grounds of Appeal:

“1. The learned Commissioner of Income Tax (Appeals) [CIT(A)] erred in holding that the receipts on account of maintenance charges are incidental to software receipts and bear the same character as that of software receipts.

2. The learned CIT(A) erred in concluding that the sale of licenses are in the nature of royalty income and thereby concluding that maintenance services in relation to the sale of the said licenses are ancillary and subsidiary to the application or enjoyment of the right, property or information under sub- clause (vi) to explanation 2 of section 9(1)(vi) of the Income Tax Act, 1961 (The Act).

3. The learned CIT(A) has further erred in treating the payment for maintenance services as fees for included services under Article 12(4)(a) of the Indo-US-DTAA. The learned CIT(A) erred in holding that maintenance services are ancillary and subsidiary to the application or enjoyment of the right or property.

6. For the above and any other grounds, which may be advance at the time of hearing, your appellant prays that the order of the learned CIT(A) may be please set aside.

7. The Appellant craves leave to add, to alter or amend all or any of the afore-stated grounds of appeal”

5. Ld. Counsel for the assessee submitted that the only basis on which the maintenance revenue was considered as in the nature of royalty taxable in the hands of assessee in India is owing to the fact that the revenue from supply of software, which was made by i2 Technologies (Netherlands) BV, was regarded as in the nature of royalty and taxed in the hands of i2 Technologies (Netherlands) BV. In the case of assessee, the conclusion is that the maintenance revenue is also royalty, based only on the fact that the revenue from supply of software was regarded as royalty and therefore, maintenance services are also be considered as royalty as they are ancillary to the supply of software. Ld. Counsel for the assessee brought to our notice the decision of the Hon'ble ITAT of Mumbai Bench in the case of M/s. i2 Technologies (Netherlands) BV Vs. ACIT (International Taxation) in and 6449/Mum/2008, AYs. 2002-03 & 2004-05, wherein the ITAT, Mumbai came to the conclusion that the supply of software by i2 Technologies (Netherlands) BV to Indian Customers and to whom the Assessee rendered maintenance services, cannot be taxed as royalty and was in the nature of business income and since i2 Technologies (Netherlands) BV, did not have a Permanent Establishment (PE) in India, the sum-in-question cannot be taxed in India. It may be mentioned that the Tribunal while coming to the above conclusion that revenue from sale of software and the revenue received from such sale cannot be regarded as royalty and placed reliance on the decision of the Hon'ble Delhi High Court in the Case of DIT Vs. Infrasoft Ltd., (2013) [39 taxmann.com 88]. Ld. Counsel for the assessee submitted that since the very basis of the conclusion by the Revenue authorities that the maintenance revenue received by the assessee was in the nature of royalty is based on the conclusion in the case of M/s. i2 Technologies (Netherlands) BV Vs. ACIT (International Taxation) (supra), that the supply of software by them is in the nature of royalty and therefore, the maintenance services which are incidental to supply of software should also be regarded as royalty, has now been reversed the natural consequences will be that the sum received as maintenance revenue, it cannot be regarded as chargeable to tax in India as a royalty. It was submitted that even otherwise there was no dispute that the receipt in question would be in the nature of business income and since the assessee did not have a Permanent Establishment (PE) in India, the said receipt would not be chargeable to tax in India.

7.1. Ld. Counsel for the assessee fairly submitted that in AYs. 2008- 09 and 2010-11, this Tribunal in the case of i2 Technologies US Inc., Vs. Dy. Director of Income-tax (International Taxation) in IT(TP) Appeal Nos. 1303/Bang/2011 and 226/Bang/2014 (AYs. 2008-09 and 2010-11) respectively, took a contrary view but that would not apply to AY. 2006-07 because in those assessment years i.e., AYs. 2008-09 and 2010-11, the assessee directly sold software and also carried out maintenance services under agreements with the persons to whom software licenses were sold. Consequently, the maintenance services which were also in connection with the supply of software were regarded as royalty. In the present case, however, the supply of software has already been held to be not in the nature of royalty by the decision of ITAT, Mumbai.

7.2. We also make it clear that we have not gone into the question regarding the applicability of Article 12(3) and also the definition of royalty is given in Explanation-2 to Section 9(1)(vi) of the Act and our conclusions in these appeals and are guided only by the ruling of the Mumbai Bench of the ITAT in the case of M/s. i2 Technologies (Netherlands) BV Vs. ACIT (International Taxation) (supra).

7.3. In the light of the above discussion, we are of the view that the maintenance revenue received by the assessee cannot be regarded as a royalty chargeable to tax in India. The addition made is therefore directed to be deleted.

Pronounced in the open court on this 26th day of April, 2019