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Facts
The assessee, a non-resident corporate entity from the Czech Republic, offers various services in India, including software provisioning and related maintenance. While some income was offered to tax, other receipts from software licenses and maintenance reimbursements were not, claiming DTAA benefits or being non-markup reimbursements. The Assessing Officer treated these untaxed receipts as 'equipment royalty' under Section 9(1)(vi) of the Income-tax Act and Article 12 of the India-Czech DTAA, adding Rs. 28,79,76,683/- to the assessee's income. The assessee objected to the DRP, arguing these were for off-the-shelf software sales and cost reimbursements, not use of IT infrastructure, and the DRP directed the AO to pass a speaking and reasoned order with specific clarifications.
Held
The Tribunal found that the Assessing Officer failed to implement the specific directions issued by the Dispute Resolution Panel (DRP), which required a speaking and reasoned order clarifying how the receipts constituted equipment royalty and identifying the underlying IT infrastructure. By merely reiterating the observations from the draft assessment order, the AO violated the mandate of Section 144C(13) of the Income-tax Act. Therefore, following judicial precedents, the Tribunal held that the impugned final assessment order was wholly without jurisdiction, hence invalid, and quashed it.
Key Issues
1. Whether the final assessment order is valid when the Assessing Officer failed to implement the specific directions of the Dispute Resolution Panel. 2. Whether receipts for software licenses and maintenance reimbursements constitute 'equipment royalty' under the Income Tax Act and DTAA.
Sections Cited
Section 143(3), Section 144C(13), Section 9(1)(vi), Explanation 2 to Section 9(1)(vi) clause (iva), Article 12 of India - Czech DTAA, Section 144C(5), Section 144C(10), Section 144C(1), Section 144C(15)(b)(ii), Section 144C(15)(a), Section 153(3)B, Section 147, Section 148, Article 226 (Constitution)
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Income Tax Appellate Tribunal, DELHI BENCH: ‘D’ NEW DELHI
Before: SHRI SAKTIJIT DEY, VICE- & SHRI PRADIP KUMAR KEDIA
PER SAKTIJIT DEY, VICE-PRESIDENT
Captioned appeal by the assessee arises out of the final assessment order dated 30.05.2023 passed under section 143(3) read with section 144C(13) of the Income-tax Act, 1961 (in short ‘the Act’) pertaining to assessment year 2020-21, in pursuance to the directions of learned Dispute Resolution Panel (DRP).
ITA No.2068/Del/2023 AY: 2020-21
Though, the assessee has raised multiple grounds, however, at the outset, the assessee has raised a pertinent issue questioning the validity of the final assessment order due to non- implementation of the directions of learned DRP.
3. Briefly the facts relating to this issue are, the assessee is a non-resident corporate entity incorporated in Czech Republic and a tax resident of that country. As stated by the Assessing Officer, the assessee is engaged in the business of data processing, databank services, administration of networks, provision of software and consulting in the area of hardware and software. He has further stated, the assessee provides business support services for Information System (IS)/Information Technology (IT) system infrastructure and as a part of its IT related support services. It also acts as a central procurer of certain off-the-shelf software licenses and related maintenance services on behalf of its group companies. In the previous year relevant to the assessment year under dispute, the assessee received revenue from various activities/services performed in India. In the return of income filed for the assessment year under dispute, the ITA No.2068/Del/2023 AY: 2020-21 assessee offered income of Rs.101,75,08,330/-, the details of revenue offered to tax are as under:
1. Operational & Support Rs.63,34,80,990 Services Fee 2. Management Charges Rs.24,90,89,670 3. Trademark Royalty Rs.13,49,37,668 Total Rs.101,75,08,328
4. However, certain other income received from India were not offered to tax, either claiming benefit under India - Czech Double Taxation Avoidance Agreement (DTAA) or claiming that they are in the nature of reimbursement without any markup. The details of such income are, as under:
Software Licence Fee Rs.13,15,313 2. Reimbursement of Software Rs.8,59,39,213 License Fee 3. Reimbursement of Rs.20,07,22,157 Maintenance fee 4. Travel Reimbursements Rs.2,09,08,022
While verifying assessee’s return of income and financial statements, the Assessing Officer called upon the assessee to explain the reason for not offering these incomes to tax. In response, the assessee reiterated its stand that such incomes are not taxable in India. It was further stated that in view of the decision of the Hon’ble Supreme Court in case of Engineering 3 | P a g e
ITA No.2068/Del/2023 AY: 2020-21 Analysis Centre of Excellence Pvt. Ltd. Vs. CIT, [2021] 432 ITR 471 (SC), the receipts cannot be taxed as royalty. The Assessing Officer, however, was not convinced with the submissions of the assessee. While framing the draft assessment order, he was of the view that in terms with the agreement, assessee’s group entity in India has not merely acquired software licences, but has acquired right to use the IT infrastructure maintained by the assessee, on which, the software is hosted. Thus, he held that the assessee has provided services to the Indian entity to use or right to use of its IT infrastructure, which is nothing less than equipment. Thus, referring to clause (iva) of Explanation 2 to section 9(1)(vi) and Article 12 of India - Czech DTAA, the Assessing Officer held that the receipts are to be treated as royalty. Accordingly, he brought to tax the amount of Rs. 28,79,76,683/-. Against the draft assessment order, the assessee raised objections before learned DRP. While disposing of the objections, learned DRP observed that the Assessing Officer has not illustrated, how the IT infrastructure is maintained and is beneficial to the Indian group entities in terms of acquiring the right to use the same. Thus, ultimately, learned DRP directed the Assessing Officer to consider
ITA No.2068/Del/2023 AY: 2020-21 assessee’s argument and complete the assessment through a speaking and reasoned order. While issuing such direction, learned DRP also made it clear that the Assessing Officer shall not conduct any fresh inquiry, but shall decide the issue based on documents/submissions available in the assessment record. After receiving the directions of learned DRP, the Assessing Officer, however, passed the final assessment order, more or less, in tune with the draft assessment order holding that the receipts are towards equipment royalty.
6. Before us, learned counsel appearing for the assessee submitted that before the Assessing Officer as well as before learned DRP, the specific case of the assessee was that the receipts are on account of sale of off-the-shelf software and reimbursement of cost without any markup. He further submitted that the assessee has asserted before the departmental authorities that the receipts are not for use or right to use of any equipment either in the nature of IT infrastructure or anything else, so as to treat them as equipment royalty under section 9(1)(vi) read with Explanation 2 clause (iva) and Article 12 of India – Czech DTAA. He submitted, though, learned DRP issued a ITA No.2068/Del/2023 AY: 2020-21 specific direction to the Assessing Officer to specify through a speaking and reasoned order, how the receipts constitute equipment royalty and what are the hardware devices and software applications provided to the Indian entities for use or right to use, however, the Assessing Officer has failed to carry out such directions.
Drawing our attention to the final assessment order, learned counsel submitted, nowhere in the assessment order, the Assessing Officer has specified the details of IT infrastructure comprising of hardware devices and software applications given to the Indian entity for use or right to use. Thus, he submitted, due to non-implementation of the directions of learned DRP, assessment order deserves to be declared invalid. For such proposition, he relied upon a decision of the Coordinate Bench in case of Bechtel Limited Vs. ACIT & Ors, and Ors., dated 31.01.2024.
8. Relying upon the observations of the Assessing Officer, learned Departmental Representative submitted that though, it may be a fact that the assessee had provided software licenses to the Indian entity, however, such software is hosted in the IT
ITA No.2068/Del/2023 AY: 2020-21 infrastructure maintained by the assessee, which included server and other systems. He submitted, the Indian entity can access the software by accessing server and other hardware devices connected therewith. Therefore, the receipts are to be treated as equipment royalty.
We have considered rival submissions and perused the materials on record. We have also applied our mind to the judicial precedents cited before us. The short issue arising for consideration is, whether the Assessing Officer, while passing the final assessment order, was justified in holding the receipts in dispute as equipment royalty under section 9(1)(vi) of the Act read with Article 12 of India – Czech DTAA. Materials on record reveal that in course of assessment proceedings, the Assessing Officer issued a show-cause notice to the assessee to explain, as to why the receipts in dispute should not be treated as royalty/FTS, as, such receipts are ancillary to enjoyment of such services, for which, royalty income has been received. In response to the show- cause notice, assessee had furnished a detailed reply submitting that the amount received towards licence fee cannot be treated as ITA No.2068/Del/2023 AY: 2020-21 royalty, as, it was for a non-exclusive right given to the Indian entity to use copyrighted software.
9. As regards reimbursement of software licence fee and maintenance fee, the assessee had submitted that it had procured certain licences centrally for its group companies and has cross- charged the Indian affiliates the licence and maintenance fees in respect of the same on a cost-to-cost basis. While framing the draft assessment order, the Assessing Officer observed that the assessee maintains a global IT infrastructure, which consists of owned, leased, supported and hosted IT systems etc. According to him, IT infrastructure made of various hardware devices and software/applications is a scientific equipment and also in the nature of commercial equipment. He has further observed that the agreement between the assessee and Indian group entities provide for use or right to use of equipment. Thus, in these premises, he treated the receipts as royalty.
However, before learned DRP, to counter the aforesaid finding of the Assessing Officer, the assessee made detailed submissions categorically denying the allegation that it had provided use or right to use of any IT infrastructure etc. to the ITA No.2068/Del/2023 AY: 2020-21 Indian group entities. The specific submissions/averments of the assessee before learned DRP denying the allegation of the Assessing Officer are enumerated below:
“2.The Assessee respectfully submits that the allegations of the Ld. AO that the Assessee has a huge IT infrastructure for the group companies, which consists of owned, leased, supported, and hosted IT systems, hardware devices, internet, and intranet systems and also that the Assessee has not facilitated purchase of software for Home Credit India Finance Private Limited CHCIFPL'), rather has made available complete infrastructure to all its group companies including HCIFPL, are erroneous. This is directly contrary to the submissions made by the Assessee which were discussed in detail during the course of assessment proceedings.
As mentioned above, during the year, the Assessee received license fees amounting to INR 13,15,313 from HCIFPL in respect of a software, Blaze. The agreement for the said license was furnished to the Ld. AO vide response dated 22 March, 2022 wherein it has been clearly mentioned that the Assessee has granted a non-exclusive sub-license to use Blaze software only for its own internal business operations. Relevant extracts from the said agreement are reproduced below for ready reference: "Licence fee" means the fee specified in the Schedule hereof payable by the Customer in consideration for the granting of the rights to use the Licensed Software in accordance with the terms of this Agreement … 2. Sublicence 2.1 In accordance with the provisions of the Master License Agreement entitling it to sublicense the Licensed Software, HCI us a holder of non-excluswe license on, inter cilia, Licensed Software hereby grants to the Customer and the Customer accepts a non-exclusive sublicense to use the Licensed Software specified in Schedule within the territory of India for the period specified in Schedule. 2.2 The Customer may use the Licensed Software only for the Customers' own internal business operations to the extent specified in Schedule... 2.3 Except us specifically permitted by this Agreement, the Customer shall not (and shall not permit others to) directly or indirectly:... (b) revere engineer, copy, translate, disassemble
ITA No.2068/Del/2023 AY: 2020-21 or decompile or otherwise attempt to derive source code from any Licensed Software...
From above, it is dear that the above agreement is for the sub- license of a software by the Assessee to HCIFPL for HCIFPL's internal use, without granting any underlying rights in the copyright to EICIFP ere is no consideration for the use of any IT infrastructure under this agreement. 5.Furthermore, the Assessee also centrally procured certain off-the shelf softwares (inter-alia Genesys, IBM Qradar, Vmware, Splunk etc.) and their related maintenance services on behalf of the Home Credit Group companies. Such modus operandi enabled the group to optimize third-party costs and brought efficiency into the procurement process. Thereafter, the costs incurred by the Assessee for procuring the third-party software and services were cross charged to the group companies on a cost-to-cost basis.
In this background, the Assessee received reimbursement of license fee and maintenance charges of INR 8,59,39,213 and 1NR 20,07,22,157, respectively from HCIFPL. Sample agreement in respect of such reimbursements was furnished to the Ld. AO vide submission dated 2 March 2022. Relevant extracts from the said agreement are reproduced below for ready reference: (B) Initial User shall, as a service company of the Home Credit Group and Genesys' partner procure central purchases of the Licensed Software under the MSLA for the purposes and use of the Affiliates including the New User in order to achieve the best commercial conditions of such purchases. (C) Parties wish to establish a process of transfer (i.e. assignment, sublicense etc.) of the Licensed Software by the Initial User to the New User throughout the validity of this Agreement in order to facilitate process of distribution of the Licensed Software within the Home Credit Group. …….. 1.1…….. Licensed Software: means Genesys' software products Maintenance: means Genesys Care of the respective Licensed Software in the scope specified in MSLA and at ... ……. 2.1.2 The Initial User shall procure purchase of the Licensed Software for the purposes and use of the New User and place order with Genesys (Ind/ or its authorised partner for the quantity of Licenses required by the New User …… 3.3. The Parties acknowledge that the Initial User shall procure with Genesys renewals of the Maintenance in relation to the already assigned Licensed Software on behalf of the New User. Renewal of the Maintenance to the already assigned Licensed Software may be ordered by the Initial User on behalf of the New 10 | P a g e
ITA No.2068/Del/2023 AY: 2020-21 User automatically unless the New User informs the Initial User that it does not intend to use the Licensed Software any longer and does not require the respective Maintenance renewal. 3.4. Renewal of the Maintenance in relation to the already assigned Licensed Software shall be considered as procurement of Maintenance by the Initial User on behalf of the New User, which shall be paid to Genesys by the Initial User on behalf of the New User, whereas the Initial User shall be entitled to re-invoice costs for the renewed Maintenance to the New User.
7. From above, it can be seen that under this agreement the Assessee is facilitating the procurement of a software and its related maintenance to IICIFPL. This is not a case of IT infrastructure belonging to the Assessee being used by HCIFPL under this agreement.
8. The above extracts establish that the claim of the Ld. AO that the Assessee had a large IT infrastructure which was in the nature of a scientific equipment, and which was used by HCIFPL is baseless and entirely based on surmises. The understanding captured by the Ld. AO in the draft assessment order is entirely incorrect and misplaced.
9. At this stage, without prejudice to the above, the Assessee also wishes to highlight that HCIFPL maintains, supports and develops its own elaborate IT infrastructure in India, as required for its business operations and there is a large team of local IT experts who are responsible for maintaining and running such IT infrastructure. HCIFPL doesn't use IT infrastructure located outside India for running its core business activities with respect to India regulations. It is evident from the above, that due to commercial and legal requirements, HCIFPL doesn't use Assessee's infrastructure for its core business operations and IA. AO, without appreciating the facts of case and nature of business, has erroneously assumed that the Assessee has provided some IT infrastructure to FICIFPL for running its core business.
At this stage, it would be relevant to examine the provisions of the law as well as various principles held by multiple judicial precedents with respect to equipment royalty (i.e., consideration for the use or right to use industrial, commercial or scientific equipment).
Explanation 2 to section 9(i)(vi) of the Act defines 'royalty' as follows: 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 licence) in respect of a patent, invention, model, design, secret formula or process or trade mark or similar property; ………. (iva) the use or right to use any industrial, commercial or scientific equipment but not including the amounts referred to in section 4413B; …………….. (vi) the rendering of any services in connection with the activities referred to in sub-clauses (i) to (iv), (iva) and (v).
ITA No.2068/Del/2023 AY: 2020-21
Article 12 of the India-Czech DTAA defines 'royalty' as, "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 films, and films or tapes for television or radio broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or any industrial, commercial or scientific”.
It is submitted that the term 'equipment' is to be understood in the context of a tangible equipment only. And in case of a tangible product, the clause 'use or right to use' such equipment is to be understood as actual use whereby the tangible equipment is placed under the control and possession of the user. 14. Owing to the lack of sufficient explanations, examples and definitions of the terms in Article 12 of the India-Czech DTAA, reliance may be placed on various principles arising from the judicial precedents and the commentaries wherein royalties in respect of scientific and commercial equipment has been discussed: - OECD Report (2002) on "Treaty Characterisation Issues arising from e-cornmeree" Expression 'equipment' in Article 12 applies only to a tangible product. Relevant extracts are reproduced below (emphasis supplied): 26. The members of the Group all agreed that payments for such use of digital products cannot be considered as payments for the use of, or the right to use, industrial, commercial or scientific equipment" on the basis of one or more of the following reasons: - because digital products cannot be considered as "equipment", either because the word "equipment" can only apply to a tangible product (and the fact that the digital product is provided on a tangible medium would not change thefact that the object of the transaction is the acquisition of rights to use the digital content rather than rights to use the tangible medium) or because the word "equipment", in the context of the definition of royalties, applies to property that is intended to be an accessory in an industrial, commercial or scientific process and could not therefore apply to property, such as a music or video CD, that is used in and for itself - Dassault Systems K.K. [2010] 188 TAXMAN 223 (AAR - New Delhi, affirmed by the Hon'ble SC) Licensed software products being intangible in nature cannot be brought into the purview of equipment royalty. Relevant extract has been reproduced below: 23. We may mention that the learned DR at one stage made a feeble attempt to bring the transaction under equipment royalty. However, it was not pursued further and moreover we find no legal basis for holding that there is any usage of equipment here. - DIT v. New Skies Satellite 1317 [201068 taxmann.com 8 (Delhi HC) True Copy
ITA No.2068/Del/2023 AY: 2020-21 Relying on its ruling in the case of Asia Satellite Telecommunications Co. Ltd [2011] 197 Taxman 263 (Delhi HC), the Honble Delhi HC has upheld the principle that the use or right to use any industrial, commercial or scientific equipment as envisaged in clause (iva) of Explanation 2 to sec.9(1)(0) contemplates full control and possession of the user over the equipment. Extracts of the ruling are reproduced below: 58……….The following extract from Asia Satellite Telecommunications Co. Ltd's case (supra) takes note of the OECD Commentary and Klaus Vogel on Double Tax Conventions, to show that the process must in fact be secret and that specifically, income from data transmission services do not partake of the nature of royalty……………………… ………………..As regards treaties that include the leasing of industrial, commercial or scientific (ICS) equipment in the definition of royalties, the characterization of the payment will depend to a large extent on the relevant contractual arrangements. Whilst the relevant contracts often refer to the lease of a transponder, in most cases the customer does not acquire the physical possession of the transponder but simply its transmission capacity: the satellite is operated by the lessor and the lessee has no access to the transponder that has been assigned to it. In such cases, the payments made by the customers would therefore be in the nature of payments for services, to which Article 7 applies, rather than payments for the use, or right to use, ICS equipment ………………………..
Consequently, since we have held that the Finance Act, 2012 will not affect Article 12 of the. MAAs, it would follow that the first determinative interpretation given to the word "royalty" in Asia Satellite, wizen the definitions were in fact pari materia (in the absence of any contouring explanations), will continue to hold the field for the purpose of assessment years preceding the Finance Act, 2012 and in all cases which involve a Double Tax Avoidance Agreement, unless the said DTAAs are amended jointly by both parties to incorporate income from data transmission services as partaking of the nature of royalty, or amend the definition in u manner so that such income automatically becomes royalty. - DDIT v. Savvis Communication Corporation 120161158 ITD 750 (Mumbai nArr) Relevant extract has been reproduced below (emphasis supplied): ....A payment cannot be said to be consideration for use of scientific equipment when person making the payment does not have an independent right to use such an equipment and physical access to it... - Channel Guide India Ltd. v. ACTT (2 012125 taxmann.00131 25 (Minn ITAT) In absence of control and possession of user over equipment, amount paid to non-resident company cannot be held to be royalty for use or right to use any industrial, commercial or scientific equipment. Relevant extract has been reproduced below (emphasis supplied) 13 | P a g e