LXIA TECHNOLOGIES LIMITED,KOLKATA vs. ACIT,(I.T.) CIR.-1(2), KOLKATA, KOLKATA

The captioned appeal filed by the assessee, pertaining to assessment year 2013-14, is directed against a fair assessment order passed by the assessing officer under section 143(3) / 153(1) / 144C(13) of the Income Tax Act, 1961 (in short the Act) dated 10.12.2016, which incorporates the direction given by the Hon`ble Dispute Resolution Panel u/s 144C(5) of the Act, 1961, dated 28.11.2016.

The grievance raised by the assessee are as follows:

However, in this appeal the assessee has raised a multiple grounds of appeal, but at the time of hearing, the Solitary grievance of the Assessee has been confined to the issue whether the consideration received by a non-resident entity for the licensing of copyrighted article/software, i.e. consideration for use of or for granting the right to use a computer software amounts to royalty under Article 12(3) of the India-Ireland DTAA?

The brief facts qua the issue are thatassessee company,“M/s Ixia Technologies International Limited” is anon-resident foreign company registered in Dublin, Ireland. The principal line of activity of the company is design, development, marketing, sales and support including warranty and maintenance of advanced software based test systems andintegrated suites of testing applications which seek to optimize networks and data centres to accelerate, secure and scale the delivery of applications and services for worldwide customers outside of the United States.Theassessee company has filed a return of income for A. Y. 2013-14, on 29/11/2013, disclosing total income at Rs. 33,13,930/- being the receipts from rendering technical services. Later on, the assesse filed revised return declaring Page | 2

Before us, the ld. Counsel for the assessee submitted that the amount earned from sale of software aggregating to 9,84,15,776/-, is not taxable as Royalty in India. The assessee company is a tax resident of Ireland, therefore, the beneficial provisions of Double Taxation Agreement entered into between India-Ireland (‘Treaty' or 'DTAA') would be applicable. In this regard, the ld counsel drew our attention to Article 12 of the India-Ireland DTAA, an extract of which is reproduced as under: "The term 'royalties' as used in this Article mean payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph film or films or tapes for radio or television broadcasting, any patent, trade mark, design or model, plan, secret Page | 4

On the other hand, the ld. DR for the Revenue submitted before us that the assessee company sold software licenses to Indian customers and the assessing officer has rightly observed that the sale of software was not merely licensing of software. As per the sales invoice the assessee transferred right to use the software forever. Terms and conditions of sales as mentioned in the sale invoices clearly speak that it is royalty arrangement. The ld DR pointed out that the buyer's right to use the software is absolute and is perpetual i.e. forever. The buyer thus becomes the owner of that copy of the software with limitations like the buyer cannot resale the software. The buyer can customize the software to suit it needs but cannot modify the software, the software are generally encrypted, only exe files are sold, source code remains with the seller. Hence it is not possible for the buyer to modify or make any change in the software. It is similar to purchase of copyrighted book with additional condition that the book cannot be further resold or rented. Therefore, the sale of software is covered under amendedsection9(1)(vi) of the Act, thus it is a ‘royalty’. The term "royalties" means payments of any kind received as a consideration for the use of or the right to use, any copyright of literary artistic or scientific work, hence the AO has rightly concluded that the Sale of Software was nothing but receipt of royalty as per section 9(1) of the Income Tax Act and therefore, the addition of Rs. 9,84,51,776/- made by the AO should be sustained.

We have heard both the parties and perused the material available on record. First of all, we deal with Article 12 of the India vs. Ireland DTAA which deals with “Royalties and Fees for Technical Services” the same is reproduced below for ready reference: “India - Ireland - ARTICLE 12 - ROYALTIES AND FEES FOR TECHNICAL SERVICES 1. Royalties or fees for technical services arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State.

Royalties or fees for technical services shall be deemed to arise in a Contracting State when the payer is that State itself, a political sub-division, a local authority or a resident of that State. Where, however, the person paying the royalties or fees for technical services, whether he is a resident of a Contracting State or not, has in a Contracting State a permanent establishment or a fixed base in connection with which the liability to pay the royalties or fees for technical services was incurred, and such royalties or fees for technical services are borne by such permanent establishment or fixed base, then such royalties or fees for technical services shall be deemed to arise in the State in which the permanent establishment or fixed base is situated.

Where, by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of the royalties or fees for technical services, having regard to the use, right or information for which they are paid, exceeds the amount which would have been agreed upon by the payer and the beneficial owner in the absence of such relationship, the provisions of this Article shall apply only to the last-mentioned amount. In such case, the excess part of the payments shall remain taxable according to the laws of each Contracting State, due regard being had to the other provisions of this Convention.”

The licensees are not allowed to exploit the computer 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-license or transfer the copy of software to any third party without the consent of Infrasoft.

The licensee has been prohibited from copying, decompiling, de-assembling, or reverse engineering the software without the written consent of Infrasoft. The license 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 license agreement stipulates that upon termination of the agreement for any reason, the licensee shall return the software including supporting information and license authorization device to Infrasoft.

We have not examined the effect of the subsequent 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 agreement for allowing the use of the software is not royalty under the DTAA.

What is transferred is neither the copyright in the 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 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 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.

The question of law is thus answered in favour of the Assessee and against the Revenue that the Income-tax Appellate Tribunal was right in holding that the consideration received by the respondent Assessee on grant of licences for use of software is not royalty within the meaning of Article 12(3) of the Double Taxation Avoidance Agreement between India and the United States of America.”

We note that the assessee, a non-resident company, has earned revenue from supply of software to its Indian customers. As per the terms of the contract, the assessee provided a licensed software to its customers ( vide point 2 at Page nos. 17 of the paper book). Further, it may be noted that the software supplied were exclusively for the internal use of the customers [vide para 1 at Page Nos. 36 of the paper book). We note that the Ld. AO has merely reproduced the Assessee's submissions and the relevant provisions i.e., Section 9(1 )(vi) of the Income Tax Act, 1961 and has not examined the definition of 'royalty' as per Article 12(3) ofthe Indo-Ireland Treaty. Further, there has been no finding as to how the use of software by the buyers as per the license agreement constitute use/right to use the Assessee's copyright in the said software. Therefore, theorder of the assessing officer is cryptic and has been passed without providing any reasons for the proposed additions. (vide para 5.5 of the Assessment Order). We note that the Hon'ble DRP has given a perverse observation that the buyer of software license has been granted perpetual and absolute rights and therefore, the buyer becomes the owner of the software (vide page 3 of the DRP directions) which is completely Page | 11

What is the effect of insertion of Explanation 4 in the definition of "Royalty" in Sec.9(1)(vi) of the Act by the Finance Act, 2012, w.e.f. 1-6-1976. The Hon'ble Delhi High Court in the case of "DIT v Nokia Networks OY" [2012] 25 taxmann.com 225/[2013] 212 Page | 12 Ixia Technologies International Ltd. Assessment Year:2013-14 Taxman 68/358 ITR 259 has held that though 'Explanation 4' was added to section 9(1)(vi) by the Finance Act 2012 with retrospective effect from 1.6.1976 to provide that all consideration for user of software shall be assessable as "royalty", the definition in the DTAA has been left unchanged. That in CIT v."SiemensAktiongesellschaft [2009] 310 ITR 320/177 Taxman 81 (Bom.) , it was held that amendments cannot be read into the treaty. As the assessee has opted to be assessed by the DTAA, the consideration cannot be assessed as "royalty" despite the retrospective amendments to the Act. The relevant findings of the Hon'ble Delhi High Court as given in para 23 of the said decision, for the sake of convenience are reproduced as under: "However, the above argument misses the vital point namely the assessee has opted to be governed by the treaty and the language of the said treaty differs from the amended Section 9 of the Act. It is categorically held in CIT Vs. Siemens Aktiongesellschaft, 310 ITR 320 (Bom) that the amendments cannot be read into the treaty. On the wording of the treaty, we have already held in Ericsson (supra) that a copyrighted article does not fall within the purview of Royalty."

Further, in a recent judgment in the case of "DIT v New Skies Satellite BV" [2016] 382 ITR 144/238 Taxman 577/68 taxmann.com 8 (Delhi), the Hon'ble Delhi High Court has observed that no amendment to the Act, whether retrospective or prospective can be read in a manner so as to extend its operation to the terms of an international treaty. In other words, a clarificatory or declaratory amendment, much less one which may seek to overcome an unwelcome judicial interpretation of law, cannot be allowed to have the same retroactive effect on an international instrument affected between two sovereign states prior to such amendment. That an amendment to a treaty must be brought about by an agreement between the parties. Unilateral amendments to treaties are therefore categorically prohibited. Even the Parliament is not competent to effect amendments to international instruments. As held by the Hon'ble Supreme Court in Union of India v. Azadi BachaoAndolan [2003] 263 ITR 706/132 Taxman 373, these treaties are creations of a different process subject to negotiations by sovereign nations. Therefore insertion of Explanation 4 in the definition of "Royalty" in Sec. 9(1)(vi) of the Act by the Finance Act, 2012, w.e.f. 1-6- 1976, has no effect whatsoever and the issue has to be decided in the light of the definition of "Royalty" as contained in the DTAA read with the relevant provisions of the Copyright Act, 1957.

The learned counsel for the Assessee also addressed arguments to the effect that the right to use the software in the present case is akin to sale of copyrighted article rather than sale of copyright. Reference was made to the decision of the Hon'ble Delhi High Court in the case of DIT v. Ericsson A.B. [2012] 343 ITR 470/204 Taxman 192/[2011]16 taxmann.com 371, wherein it was held that the license granted to the licensee permitting him to download the computer programme and storing it in computer for its own use is only incidental to the facility extended to the licensee to make use of the copyrighted product for his internal business purposes. The said process is necessary to make the program functional and to have access to it. 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. The Hon'ble Delhi High Court has observed that in such a case there is no transfer of any right in respect of copyright to the assessee and it is a case of 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. The Hon'ble Delhi High Court has further held that what is transferred is neither can be right in the software nor the use of the copyright in the software, but is the right to use copyrighted material or article which is clearly distinct from the rights in a copyright and the same does not give rise to any royalty income and would be the 'business income' of the non-resident. The learned Page | 13 Ixia Technologies International Ltd. Assessment Year:2013-14 DR however placed reliance on the decision of the Hon'ble Karnataka High Court in "CIT v. Samsung Electronics Co. Ltd." [2012] 345 ITR 494/[2011] 203 Taxman 477/16 taxmann.com 141 wherein it has been observed that under the agreement, what had been transferred was only a license to use the copyright belonging to the non- resident subject to the terms and conditions of the agreement and that the non-resident supplier continued to be the owner of the copyright and all other intellectual property rights; license is granted for making use of the copyright in respect of software under the respective agreement and that the same would amount to transfer of part of the copyright. The learned counsel for the Assessee submitted that there is no decision of the Hon'ble Calcutta High Court rendered on the issue and therefore where two views are possible on an issue, the view favourable to the Assessee should be followed. It was his contention that following the view expressed by the Hon'ble Delhi High Court in the case of Ericsson AB (supra), which is favourable to the Assessee, it should be held that the consideration received by the NPL was not royalty. The receipts would constitute income from business in the hands of NPL and since NPL did not admittedly have a permanent establishment in India its' income from business cannot be taxed in India in the absence of a permanent establishment.

We are of the view that the view expressed by the Hon'ble Delhi High Court in the case of Ericsson AB (supra), which is favourable to the Assessee, should be followed and therefore we hold that the consideration received by the Assessee for software was not royalty. The receipts would constitute business receipts in the hands of the NPL. Admittedly NPL does not have a permanent establishment and therefore business income of the NPL cannot be taxed in India in the absence of a permanent establishment.

The learned DR submitted that the Appellant, whose obligation is to deduct tax at source u/s.195 of the Act, cannot place reliance on the DTAA as NPL could do in defence of non taxability in India of income deemed to accrue and arise in India and in this regard relied on the decision of the decision rendered by the ITAT Bangalore Bench in the case of Vodafone South (supra). We have perused the said decision and we find that the observations of the Tribunal were made in the context of dispute raised by the revenue that the payee was not tax resident of a country, the benefits of DTAA between India and the said country were sought to be pressed into service by the payer. This is clear from a complete reading of paragraph 37 of the said decision. In the present case there is no dispute raised by the revenue that NPL was not a tax resident of Singapore and that the benefits of DTAA between India and Singapore cannot therefore be available to the appellant. We are of the view that the decision in the case of Vodafone South (supra) is therefore of no help to the plea of the revenue before us. The decision rendered by the Chennai bench of ITAT in the case of Organization Development (P.) Ltd. (supra) is again in the context of FTS and the findings in that case is on the facts of that case. The learned DR was neither able to establish nor do we see any parity of facts between the aforesaid decision and the facts of the present case before the Tribunal.

For the reasons given above, we hold that the amount paid by the appellant to NPL is not in the nature of royalty within the meaning of the DTAA between India and Singapore and therefore the amount received by NPL would be in the nature of business income which would be chargeable to tax in India under Article 7(1) of the DTAA only if NPL has a Permanent Establishment (PE) in India. Admittedly NPL did not have a PE in India and therefore the payment in question is not chargeable to tax in India and therefore there was no obligation on the part of the appellant to deduct tax at source u/s.195 of the Act. Consequently, the Assessee could not be treated as an Assessee in default u/s.201(1) of the Act nor could interest be levied on tax not deducted at source on tax not deducted

We note that in the case of Union of India Vs Azadi Bachao Andolan reported in 263 ITR 706, the Hon'ble Apex Court has inter-alia held that the provisions of the DTAA would override the provisions of the Act (even if the DTAA contains provisions which are inconsistent with the provisions of the Act) to the extent they are beneficial to the assessee. We note that the assessee is covered by the beneficial provisions of the India-Ireland DTAA as per section 90(2) of the Income Tax Act, 1961 ('Act'). As per Article 12(3)(a) of the DTAA, 'royalties' means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph film or films or tapes for radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process or for the use of or the right to use industrial, commercial or scientific equipment, other than an aircraft, or for information concerning industrial, commercial or scientific experience. We note that terms of the definition of 'royalty' provided in Article 12, ordinarily the receipt for sale of software shall be treated as 'royalty' only if it is for the use of a 'copyright'. Given the meaning of theterm 'copyright' as has been discussed above in the Copyright Act, 1957, we note that the revenue accruing from supply of software in India is not chargeable to tax in India based on reading of the Article 12(3) of the India-Ireland DTAA. The amount received by the assessee towards sale of software is on account of sale of 'copyrighted article' and not on transfer of any 'copyright right'. The right to use any copyright in the software was never transferred by the company in favor of the Indian customers. Hence, the said sale proceeds cannot be characterized as 'Royalty' as per Article 12 of the India- Ireland DTAA, as the same is towards the use of 'copyrighted article' and not towards the use of 'copyright'. The sale proceeds is also not towards the use of or right to use any industrial, commercial or scientific equipment, as per the provisions ofthe India-Ireland DTAA. Further, as per the Licensing Agreement

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