March 2010
Payments received from the supply of software products cannot be considered as ‘royalties’, taxable under the provisions of the Income-tax Act, 1961 or under India-Japan tax treaty.
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19 Dassault Systems K. K
2010-TIOL-02-ARA-IT
Articles 5, 7 and 12, India-Japan DTAA; Section 9(1)(vi),
Dated: 29.01.2010
Issues:
-
Payments received from the supply of software
products cannot be considered as ‘royalties’, taxable under the provisions of
the Income-tax Act, 1961 or under India-Japan tax treaty.
-
In absence of a Permanent Establishment (PE)
of non-resident in India, business income from distribution of software
through independent distributors cannot be taxed in India.
Facts:
-
The applicant, a company
incorporated in Japan, was engaged in the business of providing ‘Products
Lifecycle Management’ (PLM) software solutions, applications and services. The
applicant was marketing software products through a distribution channel
comprising of Value Added Resellers (VAR).
-
The VAR were independent
third party resellers engaged in the business of selling software to
end-users. The applicant entered into a General VAR Agreement (GVA) with the
VAR, authorising them to act as resellers of the products on a non exclusive
basis. As per the business model, software solutions were sold to VAR for a
consideration based on the standard list price, after deducting the agreed
discount. The VAR, in turn, sold the products to end-users at a price
independently negotiated between them and the end-users. Upon receipt of the
order from end user, the VAR placed a back-to-back order on the applicant. The
end-users entered into End User License Agreement with the applicant (with the
VAR being a party) containing the terms of software license. The applicant
thereupon provided a license key via e-mail so that the customer could
download the product, hosted on a server located outside India through the web
link. After download of the product, the end-user activated the software on
the customer’s designated machine, using the license key.
-
The issue before the AAR
was whether the payments received by the applicant on sale of the software
products were taxable as business profits under Article 7 of the tax treaty or
‘royalty’ as defined in article 12 of the tax treaty.
-
The applicant contended
that:
(a) What was transferred to the end-user was copyrighted
software. The copyright of the software continued to be with the applicant and
was neither made available to the VAR or end-users.
(b) Limited right to use the copyrighted products is not
equivalent to use of copyright for commercial exploitation — and consideration
for use of copyright for commercial exploitation alone could constitute
royalty.
(c) Each VAR was a distinct legal and independent entity
who acted as a non- exclusive distributor on a principal-to-principal basis.
Such entity did not constitute agency PE.
(a) The payments made by the end-users were for transfer of
rights in respect of the copyright of the software, i.e., for use of the
computer programme.
(b) The Copyright Act makes a distinction between the
copyright of a literary work like a book and a computer programme. The right
to sell, in relation to a computer programme, is specifically treated as the
use of copyright under the Copyright Act.
(c) The concept of “copyrighted article” is apt for a book
or music CD, but is inapt for software where one or more rights in copyright
need to be necessarily transferred to make the same workable
(d) The End User License Agreement (EULA) makes it clear
that software use is licensed for a fee.
(e) In any case, consideration can be treated as royalty as
it is for the right to use the process.
(f) The VAR constituted agency PE as they were
substantially controlled and directed by the applicant.
Held:
The AAR accepted the contentions of the applicant and held
that there was no payment of royalty as:
(a) Computer software enjoys protection under the Copyright
Act. The term copyright needs to be understood as per the Copyright Act.
(b) Assignment of a right of the owner of a copyright is
essential to trigger royalty taxation. A non-exclusive and non-transferable
license for enabling the use of the copyrighted product is not equivalent of
the authority to enjoy the rights of the copyright owner.
(c) Parting of the IPR, inherent and attached to the
software product, in favour of the licensee is a mandatory requirement of the
Income Tax Act and the tax treaty to trigger royalty taxation.
(d) The right to copy, reproduce or store given to the
end-user is incidental to providing use of the copyrighted product. The
end-user has to use the license within the limitation of non-exclusive
self-user license. Section 52(aa) of the Copyright Act does specifically
permit the lawful possessor of the copy of computer programme to use the same
for self use, take back-up for archival purposes or protect against loss,
destruction, etc. This also supports the view that the license to the end-user
offered a limited right of use of the copyrighted product and was not meant
for commercial exploitation.
(e) The payments for the software could not be construed as
royalty, as the use of the programmes contained in the software could be
construed as the use of the process or acquisition of any rights in relation
thereto.
