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Income Tax Appellate Tribunal, “L” BENCH, MUMBAI
Before: SHRI SAKTIJIT DEY & SHRI ASHWANI TANEJA
These two appeals by the assessee are against the assessment orders passed under section 143(3) r/w 144C(13) of the Income Tax Act, 1961 (for short "the Act") for the assessment year 2006-07 and 2007-08. In both the appeals, since the issue in dispute is more or less common, these appeals were clubbed together and taken up for disposal by way of this consolidated order.
We first take up appeal in ITA no.5893/Mum./2011, for the assessment year 2006–07.
The assessee has raised five grounds. Ground no.1, pertains to validity of re-assessment proceedings under section 147 of the Act. The learned Counsel for the assessee, at the outset, submitted that he does not want to press this ground. In view of the above, ground no.1, is dismissed as “not pressed”.
In ground no.2, the assessee has challenged the decision of the Departmental Authorities in treating receipt from sale of software products amounting to ` 62,93,417, as royalty and subjecting it to tax.
Novell Inc. 3
Briefly stated the facts are, the assessee an American Company is engaged in the business of providing information solution. As stated by the Assessing Officer through this solution, the assessee can deliver resources over a network in a more secured manner. He has further observed that the assessee operates globally through subsidiaries including India. For the assessment year under consideration, the assessee filed its return of income on 14th December 2006, declaring total income of ` 1,70,69,360/ During the assessment proceedings, the Assessing Officer noticed that the assessee has entered into agreement with Indian subsidiary which acts as a distributor for the company in respect of certain software products which are sold to the customers in India. He found that for the purpose of sales made by the Indian Company on account of replicated software, the assessee receives royalty as per the distribution agreement. However, as far as sale of software directly imported from the assessee and sold to the customers in India, it was claimed by the assessee that the receipt from sale of such software is not taxable in India as the assessee does not have a P.E. in India, therefore, in terms with India–USA Double Taxation Agreement (DTAA) it is not taxable. The Assessing Officer after considering the claim of assessee and verifying material on record, however, was not agreeable to the assessee’s claim that the Novell Inc. 4 income from sale of software is business income hence, not taxable as per Article-5 of India USA DTAA as the assessee is not having a P.E. in India. When the Assessing Officer called upon the assessee to justify its claim, it was stated by the assessee that as per the terms of the distribution agreement, the Indian subsidiary i.e., Onward Novell Software India Pvt. Ltd. (ONSIL) receives the product software on mediums like CDs, DVDs, etc. and the Indian company does not carry out any other task on the product other than distributing them to the customers. It was submitted, it is sale of a copy righted article and not right to use copy right in the article. The Assessing Officer after perusing the invoices submitted by the assessee, noticed that the assessee has mentioned the product sold as intellectual value”. He, therefore, formed an opinion that what is received by the assessee is towards the right to use the intellectual property by the purchaser in India. The sum and substance and Assessing Officer’s reasoning for not accepting assessee’s claim are as under:-
a) The invoices no.1 to 56, indicate sale of “intellectual value”of ` 63,67,937. b) The intellectual property rights continue to remain with assessee. c) What is collected as intellectual property is nothing but the amount received towards the right to use the intellectual property by the purchaser in India.
Novell Inc. 5 d) The payment comes within the ambit of the definition of Royalty in Article 12(3)(a) of the India - US treaty. e) The original code and copy right continue to remain with the assessee and these are chargeable to tax as Royalty.”
Accordingly, the Assessing Officer framed a draft assessment order treating the amount of ` 63,67,937, as royalty as against assessee’s claim of business income. Being aggrieved of the draft assessment order, the assessee raised objection which basically are as under:-
* The receipts were merely from sale of software and should not be treated as royalty u/s.9(1)(vi) of the Act. * It should be treated as business income. * Software licenses is not in the nature of patents, inventions, models, designs, secret formula or process or trademark or similar property or scientific work. * The amount received by the appellant is from sale of software which is the end product and not for the source code or instruction processes / formula that went into the development of the software. * After the sale of software, N]PL was not allowed to develop / modify or tamper the software by itself. * The income should be treated as business income under Article 7 of the Tax treaty. * Custom Department has treated “intellectual value” as import of goods and levied duty accordingly. * The use of nomenclature “intellectual value” doe not signify anything else but it is a sale of packaged / off the shelf software and should not be held to be Royalty for use of Novell Inc. 6 software, the use of nomenclature “intellectual value” is only as per internal instruction and does not depict the true nature of transaction.
The DRP, after considering the submissions of the assessee, however, confirmed the decision of the Assessing Officer more or less accepting the reasoning of the Assessing Officer that the payments received by the assessee were towards sale of “intellectual value” which is nothing but royalty as defined under Article-12(3)(a) of India USA DTAA. He further observed that learned Commissioner (Appeals) in assessee’s own case for the assessment year 2003-04, 2005-06 and 2007-08, has decided the issue against the assessee.
The learned Counsel for the assessee, at the outset, submitted before us that the Tribunal in assessee’s own case for the assessment year 2007-08, has decided the issue in assessee’s favour by holding that the income from sale of software is a business receipt and not royalty and, hence, not taxable in India as the assessee has no P.E. in India. In this context, the learned Counsel for the assessee specifically drew our attention to the observation made by the Tribunal in Para-11 to 20 of the order passed in ITA no.4368/Mum./2010, order dated 20th November 2011, reported in [2011] 16 Taxmann.com 186 (Mum.). He also relied upon the decision of the Tribunal, Hyderabad Bench, in Novell Inc. 7 ADIT (IT)-I, Hyderabad, v/s Locuz Enterprise Solutions, [2015] 61 Taxmann.com 47 (Hyd.).
The learned Departmental Representative on perusing order of the Tribunal, Mumbai Bench, in assessee’s own case also agreed that the issue in dispute is covered in favour of the assessee by virtue of the order passed by the Tribunal.
We have considered the submissions of the parties and perused the material available on record. There is no dispute to the basic facts involved in the present case. The assessee has entered into two types of transactions with its Indian subsidiary. Under the first agreement, it has given right to the Indian subsidiary to copy certain specified software for sale in Indian market. There is no dispute to the fact that receipt from such transaction is treated as royalty by the assessee and tax has also been paid by declaring such royalty as income under Indian Income Tax. However, as per the second agreement, the Indian subsidiary has been appointed as a distributor to sell the computer software products of the assessee to the end user in India. The assessee has shown the receipts from the sale of software products under the aforesaid distribution agreement as business income. However, such income has not been offered to tax on the reasoning
Novell Inc. 8 that as the assessee is not having a P.E. in India such income being in the nature of business income is not taxable under the provisions of India USA DTAA. On a perusal of the material on record, it is seen that identical dispute came up for consideration before the co-ordinate bench of the Tribunal in assessee’s own case for the assessment year 2007-08. The Tribunal, after considering the terms of both the agreements as well as other relevant facts came to conclude that the receipts from sale of computer software products is not royalty but business income. For better clarity, it is necessary to reproduce the observations of co-ordinate bench of the Tribunal in its entirety as under:-
“11. When we view agreement A in conjunction with agreement B, the distinction between the two becomes quite apparent and glaring. Whereas under agreement A, the assessee has granted a license to NIPL to duplicate, distribute and market the duplicated products in the definite area, under agreement B, the product as such has been acquired by NIPL from the assessee which is further sold without any modification or alteration. Thus under agreement A, the assessee does not supply its computer software products to NIPL but grants license to duplicate from its intellectual property in the software for making sales in the market. On the other hand, under agreement B no license is granted to NIPL for duplicating computer software products of the assessee but the products as such are sold to NIPL who then sells them to the end users on profit.
Coming back to the definition of copyright u/s 14 of the Copyright Act, 1957, it is seen that copyright is a concept giving the creator of original work an exclusive right to do certain specified acts in respect of its work such as `to reproduce the work in any material form’ including the storing of it in any medium by electronic means or `to issue copies of the work’ to the public etc. It is thus seen that in essence “copyright” means “the right to copy” the work which may be in the nature of intellectual property
Novell Inc. 9 like patent, trademark, trade secret etc. Reproduction of the work or to issue copies of the work in the context of computer programmes is akin to making copies of it. Thus copyright of a computer programme means the exclusive right to reproduce it in any material form or copy it. When we read section 9(1)(vi) in the setting of royalty from copyright of computer programmes, it becomes manifest that the consideration paid assumes the character of royalty if it is for reproducing the same in any material form or issuing copies of it etc. As per agreement A, the assessee authorized NIPL to duplicate its computer software programme, which is the same thing as reproducing it in any material form or issuing copies of it. The duplicated products so made by NIPL were as a result of grant of exclusive right by the assessee to reproduce a work in any material form, thereby coming within the ambit of transfer of copyright in the computer programme. The consideration so paid apparently fell within section 9(1)(vi), as rightly declared by the assessee. However coming to the agreement B, by which the assessee did not allow NIPL to reproduce the computer software programme or to issue its copies, but only to re-sell the software made and sold by the assessee to it from the intellectual property of computer software programme. The assessee simply transferred its computer software products to NIPL for consideration for the purposes of resale without giving any right to duplicate the same in any manner. It is a clear cut case of consideration received for the transfer of copyrighted products and not for the transfer of copyrights in the computer software programme. The distinction between the transfer of a copyright and the transfer of a copyrighted product is prominent. Where the creator of an intellectual property allows another to exploit it commercially by taking copies and selling it, but retaining the dominion over such property with himself, the same is a case of transfer of copyright. If however, the creator himself exploits his work by converting it into end products ready for use and transfers the right to use such end products to another but not the further right to copy the same, it would be a case of transfer of a copyrighted product. The consideration in the former case would be royalty, but that in the latter would be business profit.
13. Coming back to the facts of the instant case it is noticed that the assessee received ` 58.29 lakh from NIPL towards the sale of its software products. Neither NIPL nor its end users were permitted to copy the same and exploit such products for commercial purposes. The customers
Novell Inc. 10 were bound to use such software only for their own business purpose. They did not have any right to make any further copies of the product. It can further be seen that the end users were bound by the software license agreement. These clauses fairly indicate that NIPL simply acquired the possession of the software and the end users acquired the right to install such software on their computers for personal use. The end users were not entitled to copy or sell or otherwise transfer the software acquired from NIPL. From here it clearly follows that by acquiring the Novell products from the assessee, neither the end users nor NIPL acquired any copyright over the computer software of the assessee. Since the consideration of ` 58.29 lakh in question is sale price of the copyrighted product and not a consideration for transfer of copyright in the software of the assessee, in our considered opinion, the authorities below were not justified in treating it as royalty income.
14. The learned Departmental Representative has placed strong reliance on the ruling given by the Authority for Advance Rulings in Millennium IT Software Ltd., In re [(2011) 338 ITR 391 (AAR)]. It was argued that in this case it has been held in para 41 that : “When that right of user is given, the right to use the copyright is also given. On the terms of the Income-tax Act, read in the light of the Copyright Act, the right granted for use of a copyrighted article for consideration, would also be royalty since going by the relevant definition, the grant of right to use the copyrighted article would also be a licence by the owner of the copyright, though limited in nature, limited to the use of the other contracting party alone, without entitling the grantee to further exploit the copyright”. It is in this light of the aforesaid observations of the Authority that the learned Departmental Representative forcefully argued that even the consideration for transfer of a copyrighted article shall be considered as royalty. Let us examine the facts of that case. The applicant therein entered into a software licence and maintenance agreement with Indian Commodity and Exchange Limited (ICEL). Under the agreement, the applicant allowed ICEL to use the software product (the licensed programme) owned by it. The licensed programme was to be installed into the computer machines designated by ICEL. The applicant was to deploy its personnel to the designated site to train the employees of ICEL. The applicant was required to provide at its own cost, maintenance and support services. For installation and implementation of the licensed programme, the applicant was to be paid ` 4 crore. The licence to use the licensed programme was for four years and thereafter its renewal was left to the discretion of ICEL. It was under these facts that that question before the Hon’ble Authority for Advance Rulings was whether the fees paid by ICEL to Novell Inc. 11 the applicant would be taxable as royalty or business profits. The Hon’ble Authority held such payment as royalty and not as business profit by noting that the ICEL has also been granted the right to take copies of the licensed programme. It has further been accentuated in para 40 that :` When a software developed over which a copyright is acquired, is permitted to be used by another for a consideration or another is given a right to use it including the taking of copies for the purpose of its business, for consideration, it appears to me to be a case of receiving royalty for enabling that person to exercise the right to use the programme or literary work.’ Thus it is abundantly manifest from the facts of that case that not only right of user was given but also the right to use the copyright also. This fact is further corroborated from para 45 that :`In the present case, not merely the use is licensed but the licensee is given the right to copy it and use it wherever it is needed by it for its business. The right given for a consideration to copy the copyrighted software and use it for its own purposes by ICEL whenever and wherever needed by it, clearly attracts the definition of royalty to the consideration paid by ICEL to the applicant….’. It is thus amply borne out that the facts of the instant case are materially different from those considered by the Authority for Advance Ruling in the case of Millennium IT Software (supra). Neither it is the case of the AO/CIT(A) nor any material has been brought to our notice by the ld. DR to disclose that the end users of the Novell Products were entitled to copy it and use it wherever needed. When the right to copy a product is assigned, the payment obviously assumes the character of royalty. But if it is consideration only for the use of a copyrighted product divorced from the right to copy the same, it, by no stretch of Imagination, can be construed as royalty for the obvious reason that the right to copy, which is sine qua non of copyright, is lacking.
It is observed that the assessee is a resident of USA. In that view of the matter, it would be apposite to consider the DTAA. The Assessing Officer has also considered Article 12 of the treaty which deals with Royalties and fees for included services. Clause 3 of Article 12 defines royalties as under:- “3. The term “royalties” as used in this article means: (a) payments of any kind received as consideration for the use of, or the right to use, any copyright of a literary, artistic, or scientific work, including cinematograph films or work on film, tape or other means of reproduction for use in connection with radio or television broadcasting, any patent, trademark, 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 or property
Novell Inc. 12 which are contingent on the productivity, use or disposition thereof; and (b) payments of any kind received as consideration for the use of, or the right to use, any industrial, commercial or scientific equipment, other than payments derived by an enterprise described in paragraph 1 of article 8 (Shipping and Air Transport) from activities described in paragraph 2(c) or 3 or article 8.”
It can be seen from the above Article 12(3) that clause (b) is not attracted in the present case. Clause (a) is relevant for our purpose as per which payments of any kind received as consideration for the use of or the right to use any copyright of a literary work etc. is royalty. Incorporation of the words “any copyright of a ………..” after the expression “for the use, or the right to use” fairly brings out that when the payment is for the use of any copyright, it is a royalty and not otherwise. From here it follows that unless payment is for using or acquiring the right to use the copyright of a work, it cannot be characterized as royalty. Here it is pertinent to note that the requirement is the use of `copyright’ of work and not that of the product derived from such copyright. So in order to be covered under this clause, it is imperative that the payment must be made `to use’ the `copyright’ or the `right to copy’ the work. The distinction between `use’ or the `right to use’ a copyright and the `use’ or the `right to use a’ copyrighted article is required to be kept in mind. Once the language of Article 12(3) unequivocally co-relates the payment for `use of’ the `right to copy’ the `work’ as a pre-condition for falling within the domain of `Royalty’, it is difficult to hold that the payment for the `use of’ copyrighted article finally drawn from the `work’ also qualifyies for royalty. As in the instant case the said sum of ` 58.29 lakh has been received by the assessee not as a consideration “for the use of, or the right to use any copyright” of a computer software but is a consideration for acquisition of the computer software meant for the exclusive use of the end users, it cannot be brought within the ambit of Article 12(3).
It would be relevant to note at this juncture that the authorities below appear to have been swayed by the nomenclature of `Intellectual value’ given in the invoices raised by the assessee on NIPL. It is an elementary principle, which is fairly settled that in order to construe an agreement, one has to look at the essence of it rather than its form. No party can get rid of the consequences merely for describing a particular item in a particular form though in essence and in substance it may be a different transaction. Going by the same logic, if an item of expenditure is given the name of an asset, it shall remain expenditure and will not find its place in the balance sheet. Similarly if an item of income is Novell Inc. 13 given the name of liability, it shall not shed its character of income merely for the reason that the assessee described it as liability. There is no dearth of judgments laying down this proposition. The Hon’ble Supreme Court in CBDT VS. Oberoi Hotels (1998) 231 ITR 148 (SC) has held that :`It is the substance of the case which matters and not the name.’ Similar view has been reiterated by the Mumbai bench of the tribunal in a third member case in Nicholas Applegate South East Asia Fund Ltd. VS. ADI (International Taxation) (2009) 117 ITD 299 (Mum) (TM).
Thus it follows that the relevant thing to be examined is the true nature of transaction devoid of the name given. If the true nature of a payment is royalty, it will remain the same notwithstanding the fact that the parties preferred to refer it as sale and vice versa. When we slip back to the facts of the instant case, we find that the true nature of payment is sale of copyrighted articles and not the transfer of copyright. As such, it would partake of the character of business profits and not royalties regardless of the fact that the assessee chose to describe its product as `Intellectual value’ in its invoices.
19. It is interesting to examine the issue under consideration from another angle also. NIPL filed its return declaring payments to the assessee as royalty on the sale of duplicate software at ` 1.76 crore and purchase of software at ` 58.29 lakh. These transactions were duly reflected in Form No.3CEB. Appendix B to the report contains particulars in respect of transactions in tangible property from assessee. Description of transactions has been given as “Purchase of software” and the amount is declared at ` 58.29 lakh. In Annexure-C description has been given as “Royalty on sale of duplicated software” to the assessee with a consideration of ` 1.76 crore. When the case of NIPL came up for scrutiny assessment before the A.O., he referred the matter to the TPO, who vide his order dated 27.04.2010 accepted the ALP declared by the assessee in respect of royalty and purchases made by the NIPL from the assessee. The AO, in turn, not only accepted the exercise done by the TPO and gave effect to M/s.Novell Inc. 15 the same in the assessment order, but also accepted the purchase transactions done by NIPL from the assessee as such. He did not hold the purchase transactions as the payment of royalty. It is axiomatic that profit from off-shore sale made by a nonresident does not result into accrual of any income to the non-resident u/s 9(1)(i) of the Income-tax Act. But if the non-resident earns royalty income from India, it is chargeable to tax u/s 9(1)(vi) in his hands despite his status of non-resident. Once a payment made by an Indian to a non-resident is chargeable to tax in his hands, it becomes the duty of the Indian payer to deduct tax at source in terms of section 195. If the payer fails to deduct tax at source, the mandate of section 40(a)(i) is attracted and as such the payer
Novell Inc. 14 suffers disallowance of the amount paid in its assessment. Clause (i) of section 40(a) specifically provides that any royalty etc. chargeable under this Act, which is payable outside India or in India to a non-resident, not being a company or a foreign company, on which tax is deductible at source under Chapter XVII- B and such tax has not been deducted or, after deduction has not been paid during the previous year, or in the subsequent year before the expiry of the time prescribed u/s 200(1), shall be disallowed. Thus it follows that if royalty is paid by an assessee to a non-resident which is chargeable to tax in the hands of such non- resident, it is the duty of the payer to deduct tax at source. In case of his failure to deduct tax at source, the amount paid, suffers disallowance u/s 40(a)(i). Coming back to the facts of the instant case it is noted that from the assessment order of the NIPL that no disallowance u/s 40(a)(i) has been made, which implies, that the AO accepted such payment to the assessee by NIPL as having been made on transaction of purchase and not as royalty. Once a particular stand has been taken by the Revenue in one transaction in the hands of the payer, it is impermissible to take diagonally contrary stand on the same transaction in the hands of the payee. Since the Department accepted such payment of ` 58. lacs as having been made by NIPL on account of transaction of purchase from the assessee, it cannot now turn around to hold that the very same payment is royalty in the hands of payee. We jettison the viewpoint of the Revenue on this score as well.
20. In view of the foregoing reasons we are satisfied that the learned CIT(A) was not justified in holding that the amount collected by the assessee towards the “intellectual property” be assessed as royalty. The impugned order on this issue is, therefore, overturned and it is held that the entire amount of ` 58.29 lakh be considered as business profits. The learned CIT(A) has recorded a categorical finding that the assessee does not have a permanent establishment in India and thus its business profit cannot be taxed in India. No appeal has been preferred by the Revenue to challenge this finding given by the learned CIT(A). Ex consequenti the business profits amounting to ` 58.29 lakh cannot be charged to tax in India in view of the assessee not having any PE in India.
In the result, the appeal is allowed.
Novell Inc. 15
On a careful reading of the aforesaid order of the co-ordinate bench, it is very much relevant to observe that in the assessment year 2007-08 also, the Departmental Authorities treated the receipt from sale of software product as royalty solely relying upon the nomenclature of the product given in the invoice as “intellectual” value which is also the case in the impugned assessment year. However, the Tribunal, taking into consideration such fact has given a categorical finding that the amount received by the assessee towards sale of software products cannot be treated as royalty and thereby accepted assessee’s claim of business income. As there is no material difference in the facts considered by the Tribunal in assessment year 2007–08 and the impugned assessment year, respectfully following the aforesaid order of the co-ordinate Bench, we accept assessee’s claim that the amount received from sale of software product cannot be considered as royalty but is the business income of the assessee, hence, as per the provisions of India–USA treaty it is not taxable in absence of a P.E.. We, therefore, delete the addition of ` 62,93,417.
In grounds no.3 and 4, assessee challenged levy of interest under section 234A and 234B of the Act.
Novell Inc. 16
Both the parties agreed before us that levy of interest under section 234A and 234B is consequential in nature. Hence, the Assessing Officer is directed to give consequential effect in view of findings given as aforesaid and in accordance with law.
12. In ground no.5, assessee has raised issue of short credit of TDS.
After considering the submissions of the parties, we remit this issue to the file of the Assessing Officer to verify and give effect to the TDS.
In the result, assessee’s appeal stands partly allowed.
We now take up assessee’s appeal in Mum./2011, for the assessment year 2008–09.
15. Ground no.1, relates to assessing the amount of ` 20,37,158, from sale of software as royalty income.
16. This issue is identical to the issue raised in ground no.2 of ITA no. 5893/Mum./2011, for the assessment year 2006–07. Following our decision given therein, we allow assessee’s claim by deleting the addition of ` 20,37,158.
Novell Inc. 17
17. Ground no.2, is on the issue of levy of interest under section 234B of the Act.
18. Both the parties agreed before us that levy of interest under section 234A and 234B is consequential in nature. Hence, the Assessing Officer is directed to give consequential effect in view of our findings given as aforesaid and in accordance with law.
In the result, assessee’s appeal stands allowed.
To sum up, both the appeals of the assessee are allowed. Order pronounced in the open Court on 30.10.2015