Engineering Analysis Centre of Excellence Private Limited vs. The Commissioner of Income-tax and Ors. (2021) 432 ITR 471 (SC)
Royalty – Use of copyright – Resale / use of computer software – DTAA – TDS u/s 195 – The amounts paid by resident Indian end-users / distributors to non-resident computer software manufacturers / suppliers, as consideration for the resale / use of the computer software through EULAs / distribution agreements, is not the payment of royalty for the use of copyright in the computer software, and that the same does not give rise to any income taxable in India as a result of which the persons referred to in section 195 of the Act were not liable to deduct any TDS u/s 195
The appellant, Engineering Analysis Centre of Excellence Pvt. Ltd. [‘EAC’] was a resident Indian end-user of shrink-wrapped computer software, directly imported from the USA.
For the assessment years 2001-2002 and 2002-2003, the A.O., by an order dated 15th May, 2002, after applying Article 12(3) of the Double Taxation Avoidance Agreement [‘DTAA’] between India and the USA, and upon applying section 9(1)(vi) of the IT Act, found that what was in fact transferred in the transaction between the parties was copyright which attracted payment of royalty and, thus, it was required that tax be deducted at source by the Indian importer and end-user, EAC. Since this was not done for both the assessment years, EAC was held liable to pay the amount of Rs. 1,03,54,784 that it had not deducted as TDS, along with interest u/s 201(1A) amounting to Rs. 15,76,567. The appeal before the Commissioner [‘CIT’] was dismissed by an order dated 23rd January, 2004. However, the appeal before the Tribunal [‘ITAT’] succeeded vide an order dated 25th November, 2005 in which the ITAT followed its previous order dated 18th February, 2005 passed in Samsung Electronics Co. Ltd. vs. Income Tax Officer, ITA Nos. 264-266/Bang/2002.
Revenue appealed against this order before the High Court of Karnataka. The Division Bench of the Court heard a batch of appeals and framed nine questions, of which question Nos. 8 and 9 are set out as follows:
‘8. Whether the Tribunal was correct in holding that since the assessee had purchased only a right to use the copyright, i.e., the software and not the entire copyright itself, the payment cannot be treated as royalty as per the Double Taxation Avoidance Agreement and Treaties, which [are] beneficial to the assessee and consequently section 9 of the Act should not be taken into consideration.
9. Whether the Tribunal was correct in holding that the payment partakes the character of purchase and sale of goods and therefore cannot be treated as royalty payment liable to Income Tax.’
In answering these questions, through a judgment dated 24th September, 2009, the Division Bench of the Karnataka High Court relied heavily upon the judgment of this Court in Transmission Corporation of A.P. Ltd. vs. CIT, (1999) 7 SCC 266 [‘AP Transco’] and held that since no application u/s 195(2) had been made, the resident Indian importers became liable to deduct tax at source u/s 195(1).
This view was set aside by the Supreme Court in GE India Technology Centre (P) Ltd. vs. CIT, (2010) 10 SCC 29 [‘GE Technology’] which ultimately found that the judgment of the High Court dated 24th September, 2009 had misread AP Transco (Supra). Consequently, the Supreme Court remanded the matter to the Karnataka High Court to decide on merits in the following terms:
‘Since the High Court did not go into the merits of the case on the question of payment of royalty, we hereby set aside the impugned judgment of the High Court and remit these cases to the High Court for de novo consideration of the cases on merits. The question which the High Court will answer is: whether on facts and circumstances of the case ITAT was justified in holding that the amount(s) paid by the appellant(s) to the foreign software suppliers was not “royalty” and that the same did not give rise to any “income” taxable in India and, therefore, the appellant(s) was not liable to deduct any tax at source?’
The impugned judgment of the Karnataka High Court dated 15th October, 2011, reported as CIT vs. Samsung Electronics Co. Ltd., (2012) 345 ITR 494, dealt with a whole group of appeals.
After setting out the facts in one of the appeals treated as the lead matter, namely ITA No. 2808/2005 concerning Samsung Electronics Co. Ltd., and the relevant provisions of the Income-tax Act, India’s DTAAs with USA, France and Sweden, respectively, the Karnataka High Court, on an examination of the End-User Licence Agreement [‘EULA’] involved in the transaction, found that what was sold by way of computer software included a right or interest in copyright, which thus gave rise to the payment of royalty and would be an income deemed to accrue in India u/s 9(1)(vi), requiring the deduction of tax at source.
According to the Supreme Court, the appeals before it could be grouped into four categories:
i) The first category deals with cases in which computer software is purchased directly by an end-user, resident in India, from a foreign, non-resident supplier or manufacturer.
ii) The second category of cases deals with resident Indian companies that act as distributors or resellers, by purchasing computer software from foreign, non-resident suppliers or manufacturers and then reselling the same to resident Indian end-users.
iii) The third category concerns cases wherein the distributor happens to be a foreign, non-resident vendor who, after purchasing software from a foreign, non-resident seller, resells the same to resident Indian distributors or end-users.
iv) The fourth category includes cases wherein computer software is affixed onto hardware and is sold as an integrated unit / equipment by foreign, non-resident suppliers to resident Indian distributors or end-users.
The Supreme Court, after considering the provisions of law and the precedents on the subject and discussing the issues involved in great detail, concluded that given the definition of royalties contained in Article 12 of the DTAAs, it is clear that there is no obligation on the persons mentioned in section 195 of the IT Act to deduct tax at source as the distribution agreements / EULAs in the facts of these cases do not create any interest or right in such distributors / end-users which would amount to the use of or right to use any copyright. The provisions contained in the IT Act [section 9(1)(vi), along with Explanations 2 and 4 thereof], which deal with royalty, not being more beneficial to the assessees, have no application in the facts of these cases.
According to the Supreme Court, the answer to the question posed before it is that the amounts paid by resident Indian end-users / distributors to non-resident computer software manufacturers / suppliers, as consideration for the resale / use of the computer software through EULAs / distribution agreements, is not the payment of royalty for the use of copyright in the computer software and that the same does not give rise to any income taxable in India, as a result of which the persons referred to in section 195 were not liable to deduct any TDS u/s 195. The answer to this question would apply to all four categories of cases enumerated above.
Notes:
(1) The above judgment deals with a batch of cases involving four categories of facts mentioned therein raising issues relating to purchase of shrink-wrapped software and Royalty Taxation, more so in the context of Tax Treaties (i.e., DTAAs). For this purpose, the Court thought it fit to take the facts in the case of EAC as a sample case.
(2) While dealing with the issues, the Court dealt with the relevant provisions of the Copyright Act, 1957 (as amended from time to time) in great detail and its effect on various aspects. The Court has also dealt with the contextual meaning of the undefined (in the Act as well as relevant DTAAs) expression ‘Copyright’ under the Copyright Act. In the context of determining whether distribution agreements / EULAs have created any interest or right in copyright under the Copyright Act in such distributors / end-users, the Court also referred to the doctrine of first sale or principle of exhaustion statutorily recognised under the Copyright Act. The Court also examined the nature of rights (non-exclusive, non-transferable licence) available to the assessees under the relevant distribution agreements / EULAs and the conclusion of the Court is based on this.
(3) The Court has also reiterated / stated various principles in the context of tax implications of such cross-border transactions such as: Liability of TDS u/s 195, principles of Tax Treaty override, effect of liability to TDS in cases where domestic law is subsequently amended [in the context of retrospective amendments made in section 9(1)(vi)], principles of interpretation of Tax Treaties and the usefulness / effect of OECD Model Commentary in that context, including India’s position on such Commentary without actually amending the DTAA to support the same, whether sale of such software is in fact the sale of physical object which contains an embedded computer programme which tantamounts to sale of goods, etc. The Court also dealt with the definition of the expression royalty contained in section 9(1)(vi) and the effect of retrospective amendments made in 2012.
(4) In the context of liability to TDS u/s 195 and relevance of DTAAs for the same, the Court relied on its earlier judgment in the case of GE India Technology (2010-327 ITR 456) and explained and distinguished its later judgment in the case of PILCOM (2020-425 ITR 312) with reference to the language of section 195, which was relevant for deciding the TDS liability in the cases before the Court. This finally puts an end to the controversy created, in our view unnecessarily, in post-PILCOM cases in the context of TDS liability u/s 195 and the relevance of DTAAs.
(5) The judgment of the Court is very lengthy, running into around 150 printed pages of ITR, including head notes running to around 12 pages. In view of this and in the context of this column, it is thought fit to briefly summarise the judgment by pointing out the issues before the Court and its final conclusion on such issues without giving an analysis of the reasons for the same and various other aspects dealt with by the Court referred to in the earlier Notes above.
(6) The judgment in the case of GE India Technology referred to in Note 4 above has been analysed by us in this Journal in the Column Closements in the December, 2010 issue of the BCAJ.
