Month: December

The Supreme court in the
case of Sahney Steel and Press Works Ltd., 228 ITR 253, laid down
extensive tests for determination of nature of income in cases wherein
an asseseee receives financial assistance under a scheme formulated by
the Government. It held that the point of time, as also its source and
the form of the assistance, are factors that are irrelevant for
determining the taxability of the receipt. The purpose for which the
payment is received is of the paramount importance for ascertaining the
taxability or otherwise of a receipt.

The issue, in the context of
assistance from the holding company, has been recently examined by the
Delhi High Court and the Karnataka High Court. While the first court
held that the receipt is of capital nature not liable to tax, the latter
held the same to be taxable.

Deutsche Post Bank Home Finance’s case

The Delhi High Court in the case of CIT vs. Deutsche Post Bank Home
Finance Ltd., 24 taxmann.com 341, was required to consider the following
question of law at the behest of the Income tax Department: “Whether
the amount of Rs. 11,22,38,874/-, infused by BHW Holding AG, Germany to
the assessee by way of subvention assistance, is taxable as a revenue
receipt and therefore falls within the definition of ‘income’ under
Section 2(24) of the Income Tax Act, 1961.”

In that case, the assessee,
an Indian company, was engaged in the activity of housing finance. It
was a 100% subsidiary of one German company BHW Holding AG. On an
evaluation by the holding company, the assessee was likely to, on
account of its business activity, incur losses by which its capital
would be substantially if not entirely eroded. By two letters dated
24-09-2004 and 04-02-2005, the holding company granted subvention
assistance to the assessee of Euro 2,000,000, equivalent to Rs.
11,22,38,874. The assessee treated the receipt to be a capital receipt,
not liable to tax.

The Assessing Officer held that the disbursement of
incentive (i.e., subvention receipt ) was by way of casual receipt in
order to assist the assessee to continue its business operation and held
the same to be taxable. On appeal to the CIT(A), the assessee’s
contention that the money received could not be taxed, was accepted by
him. The ITAT rejected the Revenue’s appeal, inter alia, holding that
the holding company had paid the money as subvention payment towards
restoration of the net worth of the company expected to be partly eroded
by the losses suffered/projected by the assessee company for the
financial year 2004-05. The certificate of inward remittance issued by
UTI Bank Ltd confirmed the said fact. This was further supported by the
copy of confirmation received through email wherein the holding company
had certified that they had not claimed the subvention payment as
expenditure in their return of income, no tax benefit had been received
by it in respect of subvention payment and it had capitalised the amount
in its books of account. The ITAT relied on the decision in the case of
CIT vs. Handicrafts & Handloom Export Corporation of India, 140 ITR
532(Delhi).

On behalf of Revenue, before the High Court, it was argued
that the ITAT fell into error in deciding that the subvention receipt
received from the Holding Company was not income, as defined in section
2(24) of the Act.

The Revenue urged that the decision in the
case of the
Handicrafts & Handloom Export Corporation of India vs. CIT, 140 ITR
532(Delhi) relied upon by the Tribunal was not applicable, since the
facts of the case were different. In that case the funds were public in
nature and the cash assistance given by the holding company to STC, was
not subjected to taxation. Reliance was placed upon the decisions in the
cases of Ratna Sugar Mills Co. Ltd. vs. CIT, 33 ITR 644 (All.) and
V.S.S.V. Meenakshi Achi vs. CIT, 50 ITR 206 (Mad.) wherein it was held
that where public funds were used as an incentive or in order to assist,
or give subsidy to recoup a unit’s losses or to provide against a
financial liability, such an assistance would not qualify as income. It
was further stressed that the true and correct test to be applied was to
be the purposive test, spelt out in the decision of CIT vs. Ponni
Sugars & Chemicals Ltd., 306 ITR 392 (SC). It was submitted that
only if the real purpose of the assistance was to protect investment or
to ensure that the liabilities adversely impacting the accounts of the
company were met, then and then only the assistance would fall outside
the ambit of taxation.

The assessee, on the other hand,
submitted that the view taken by the CIT(A) and confirmed by the ITAT
was predominantly based upon the decision in the case of the Handicrafts
& Handloom Export Corporation of India (supra) and that there was
in fact no substantial question of law which required to be answered,
since the issue had been settled by the previous decision in the case of
the Handicrafts & Handloom Export Corporation of India (supra ).

On
hearing the parties, the court narrowed the question to whether
assistance given by the assessee’s holding company was a capital receipt
or a revenue receipt in the hands of the assessee. The court examined
the Revenue’s contention that the decision in Handicrafts & Handloom
Export Corporation of India (supra) was not applicable to the case,
because the nature of funds were public in character and in that view of
the matter the appropriate criteria was the purposive test which
determined the character of funds in a given case as was done in the
case of Ponni Sugar & Chemicals Ltd. (supra) by quoting from the
said decision.

On examination, the court held that there was no
shift in the nature of the determinative test, to decide whether a
receipt was revenue or capital. It observed that no doubt there were
observations in that judgment stating that the character of public funds
was an important factor which persuaded the court to hold that such
assistance did not fall within the definition of income. However, this
did not persuade the court to take a different view in the case before
it, in as much as it was not in dispute that the assessee did incur
losses and the assistance was given at a point of time when the losses
were anticipated.

So far as the decision in Ponni Sugar & Chemicals Ltd. (supra) was concerned, the court held that “no doubt the Court clarified how a subsidy should be treated, i.e., by purposive test. The Court presciently held if the object of the subsidy scheme was to enable the assessee to run the business more profitably then the receipt is to the revenue account. On the other hand, under the subsidy scheme, if the object is to enable the assessee to set up a new unit or expand it then the receipt of the subsidy is to the capital account. Therefore, it is the assessee’s action which determines whether subsidy is to avoid losses and liabilities or boost its profits. On a proper application of the above test we see no difference between the facts of the present case and those in Handicrafts & Handloom Export Corporation of India (supra). The assessee was inevitably on the road to incurring losses; its holding company decided to intervene and render assistance. The ITAT has also recorded that, keeping aside the depreciation which the assessee would have been entitled to, actual losses amounted to Rs. 8.7 crore.”

Having regard to all the circumstances, the Delhi High Court was of the opinion that the subvention money received by the assessee company was not liable to tax.

Siemens Public communication Networks’ case
The issue again came up for consideration of the Karnataka High Court in the case of CIT vs. Siemens Public Communication  Networks  Ltd.  41  taxmann. com 139. The assessee, a company in this case, was incorporated under the provisions of the Companies Act, 1956 and was engaged in the business of manufacturing Digital Electronic switching systems, computer software and software services. It had filed return of income for the Assessment years 1999-2000, 2000-2001 and 2001-2002 declaring loss of substantial amounts. It had received amounts of Rs. 21,28,40,000, Rs. 1,33,45,000, and Rs. 2,95,84,556, respectively for these assessment years from Siemens AG, a German company who was its principal shareholder. The assessee explained the said sum as “subvention payment” from the principal shareholder of the assessee-company, which was paid to the assessee company for two reasons, namely, the company was a potentially sick company, and that its capacity to borrow had reduced substantially, leading to shortage of working capital.

The letter dated 24-09-1998 issued by Siemens  AG, and the assessee’s letter dated 19-02-2002, explained that Siemens AG, being a parent company, had agreed to infuse further capital by reimbursing the accumulated loss. The case of the assessee was that the payment made by Siemens AG was to make good the loss incurred by it, and the receipt of the subvention monies was a capital receipt in nature, and hence, could not be treated as income or revenue receipt.

The Assessing Officer rejected the contention of the assessee. The first Appellate Authority, however, in appeal, reversed the order of the Assessing Officer treating the said monies received from Siemens AG as capital receipt. The Appellate Tribunal, in the  appeal filed by the revenue, confirmed the findings recorded by the Appellate Authority in the following words; “6. The rival contentions in regard to the above have been very carefully considered. The assessee company (Siemens Public Communications)(sic) apparently paid the assessee or compensated the assessee in view of the continued losses, and this in fact was to augment the capital base and to improve the net worth which had eroded due to losses suffered by the company. With a view to compensate the erosion in the reserves    in (sic) surplus, the parent company pumps into its subsidiary company, funds to stabilise its capital account. It was considering all these reasons that the Commissioner of Income Tax (A) came to the conclusion that it was on capital account. If the amount so paid by the company is treated as revenue income, it would amount to taxing the parent company itself. The other reason is that the parent company paying its subsidiary company, is within the same group and not for  any  purpose  which is in the nature of income, so as to be treated as taxable income.”

The revenue, before the court, submitted that the monies paid by Siemens AG to the assessee were on revenue account and were paid not only to make good the loss but to make the assessee company run, which had no monies to spend over day to day expenditure to keep it running at the relevant time; that on the basis of the said monies/aid extended by Siemens AG, the assessee not only made its loss good, but started running its business in profit; that who paid the amount was absolutely an irrelevant fact and what was important was the object for which such assistance was extended; from the facts of the case, it was clear that in the first assessment year, the assessee company had suffered loss, whereas in the subsequent assessment years, it started making profit, which fact clearly showed that the amount paid by Siemens AG was used for running the business and therefore, it would   fall under the category of revenue receipt and not  capital receipt.

In support of the submissions, reliance was  placed  upon the decisions  of the Supreme Court in the cases  of CIT vs. Ponni Sugars & Chemicals Ltd. 306 ITR 392 and Sahney Steel & Press Works Ltd. vs. CIT 228 ITR 253 (SC).

On the other hand, the assessee submitted that the appeal deserved to be rejected outright, since no substantial question of law was involved. It was further submitted that having regard to the findings of fact recorded by the Appellate Authority and the Tribunal, the question of law as raised, did not fall for consideration as a substantial question of law and that the findings of the Tribunal even on the question of law were justified and the Tribunal had rightly treated the amount paid by Siemens AG as “Subvention payment” and had rightly treated it against the capital account. It was further submitted that the judgments relied upon on behalf of the revenue were not applicable to the facts of the present case.

The Karnataka High Court examined the facts and the law laid down by the Supreme Court in the cases relied upon by the Revenue namely, CIT vs. Ponni Sugars & Chemicals Ltd. (supra) and Sahney Steel & Press Works Ltd. vs. CIT (supra). It observed that applying the above principles to the facts of the present case, and keeping in view the objective behind the payment made by Siemens AG, the court was satisfied that it was received by the assessee on revenue account. From the facts, it was clear to the court that huge amounts were paid by Siemens AG not only to make good the loss, but also to see that the assessee would run more profitably and the payment was by way of assistance in carrying on the business. The court noted that it was not the case of the assessee that the monies paid by Siemens AG were  utilised  either for repayment of the loan undertaken by the assessee for setting up its unit or for expansion of existing unit/business.

The court took note of the observation of the Supreme Court to the effect that the point of time at which the subsidy was paid was not relevant and the source and the form of subsidy was immaterial. In the opinion of the High Court, the main eligibility condition for receipt was that the amount ought to have been utilised by the assessee to meet recurring expenses and/or to run its business more profitably and so also to get out of the loss that it was suffering at the relevant time. In any case, the court noted that the receipt was not for acquiring capital assets or to bring into existence any new asset. As a matter of fact, after getting the financial aid from Siemens AG, the assessee company turned its business from loss to profit, which was evident from the facts reflected in the return of income filed for all the three assessment years. In this backdrop, if the purpose test is applied, it was clear to the court that the payment was made by Siemens AG for meeting recurring expenses/working capital.

The Karnataka High Court questioned the basis of the findings of the tribunal where the tribunal had observed that Siemens AG paid the assessee or  compensated the assessee in view of the continued losses, and such financial aid was extended to augment the capital base and to improve the net worth which had eroded the losses suffered by the company. According to the court, the facts on record spoke otherwise and on the other hand, supported the case of the revenue that the financial aid was extended by Siemens AG not only to make good the loss but to see that the company ran more profitably.

The court, while deciding the issue in favour of the Revenue by allowing its appeal, held as follows; “It is the object which is relevant for the financial assistance which determines the nature of such assistance. In other words, the character of the receipts in the hands of the assessee has to be determined with respect to the purpose for which payment was made. If the financial assistance is extended for repayment of the loan undertaken by the assessee for setting up new unit or for expansion of existing business then the receipt of such aid could be termed as capital  in nature. On the other hand, if the financial assistance  is extended to run business more profitably or to meet recurring expenses, such payment will have to be treated as revenue receipt. It is not the case of the assessee,   in  the  present  case,  that  the  financial  assistance was extended by Siemens AG either  for  setting  up  any unit or expansion of existing business or for acquiring any assets.”

Observations
A receipt of subvention money apparently is in the nature of gift and in the absence of any express provision for taxing such a receipt, the same cannot be brought to income tax. It is only when such a receipt is  in the ordinary course of business and has the effect of augmenting the profits of an assessee or recouping the assessee’s revenue expenditure that a question arises for consideration whether a receipt is taxable or not. A receipt from the holding company to meet the expansion needs of the subsidiary company or for the repayment  of loans are not in dispute and there appears to be kind of an unanimity that such receipts are capital in nature. Also not in dispute is the receipt to arrest the erosion     of capital. It seems that even the Karnataka High Court has expressed no disagreement on this understanding  of the law.

There appears to be no doubt that the purposive test is to be applied, for determination of the issue on hand, as has been laid down by the apex court in the cases of Sahney Steel and Press Works Ltd. and Ponni Sugars  & Chemicals Ltd. (supra). Under the purposive test, as per the court, a receipt will not be taxable in a case where the same is received for the purpose of repayment of the liabilities or for expansion of the undertaking, including for acquisition of the assets.

As against that, a receipt will be taxable where it is for the purposes of meeting the expenditure or for increasing the profit of the business. A receipt to meet the erosion of the net worth will also be on capital account.

It is interesting to note that both the courts have relied upon the decision of the Supreme Court in the case      of CIT vs. Ponni Sugars & Chemicals Ltd. (supra) to deliver contrasting decisions. This has happened mainly for the reason that the assesseee in the case before   the Karnataka High Court had not been able to clearly establish to the satisfaction of the court that the receipt in question was for arresting the erosion of net worth     in spite of the finding of the tribunal on this aspect. The Tribunal had given a finding of fact that the receipt was for improving the net worth of the subsidiary company but the court gave a finding to the contrary by holding that the tribunal was not right, on facts, to have given such finding.

It is also relevant that the assessee in the case before the Karnataka High Court did not cite the favourable decision in the case of Deutsche Post Bank Home Finance (supra) which was a current decision directly on the subject of the subvention receipt. It also did not cite or rely upon the decision in the case of Handicrafts & Handloom Corporation Of India (supra), a decision that was relied upon by the Delhi High Court while deciding the issue in favour of Deutsche Home Bank Finance.

In the case of Handicrafts & Handloom Corporation Of India (supra ), the assessee, a wholly subsidiary company of State Trading Corporation (STC), incurred a loss in  its business of export of handloom, etc. for assessment year 1970-71. STC gave cash assistance at 6 per cent of the foreign earnings of the assessee to recoup the losses. Cash assistance of Rs. 11.70 lakh was given by STC. The question was whether such cash assistance amounted to income. The Court noticed previous rulings of the Allahabad and Madras High Court, respectively,  in cases of Ratna Sugar Mills Co. Ltd. (supra) and V.S.
S.V. Meenakshi Achi (supra), the ratio of which decision was confirmed by the common judgment by the Supreme Court in the case of V. S. S. V. Meenakshi Achi (supra).

The Court held that the amounts given by the STC to  the assessee, i.e., Handicrafts & Handloom Export Corporation of India in order to recoup its losses, which were incurred year after year, were akin to assistance  by a father to ensure the business survival of his child. The Court held that the amount given by the father would only be in the nature of gifts/or voluntary payment and not stemming from any business consideration. The position is similar here, where the shareholder is ensuring the survival of the subsidiary.

In Lurgi India Co. Ltd. 302 ITR 67(Delhi), the assessee received a sum of Rs. 13 crore from its parent company Lurgi Company AG, which was credited to profit and loss account by way of capital grant. However, in computation of total income it was stated that the amount was received from Lurgi AG for recouping its losses. The amount so received was held to be capital grant not chargeable to tax under the Act following the ratio of the decision of  the Hon’ble Delhi High Court in the case of Handicrafts  & Handloom Export Corporation of India vs. CIT (supra). Kindly see the decisions of the Bombay High Court in the case of Indian Textile Engineers, 141 ITR 69 and of the Calcutta high court in the case of Stewarts & Lloyds of India Ltd. 165 ITR 416 which confirm the above treatment of receipt.

The Delhi High Court in the case of Handicrafts & Handloom Corporation Of India (supra ), held that there was a basic difference between the grants made by a Government or from public funds generally to assessee in a particular line of business or trade, with a view to help them in the trade or to supplement their general revenues or trading receipts and not ear-marked for any specific or particular purpose and a case of a private party agreeing to make good the losses incurred by an assessee on account of a mutual relationship that subsisted between them. The former were treated as a trading receipt because they reach the trader in his capacity as such, and were made in order to assist him in carrying on of the trade. The latter were in the nature of gifts or voluntary payments motivated by personal relationship and not stemming from any business considerations. The amount received from parent company was not grants received from an outsider or the Government on such general grounds. The amounts were paid by STC to the assessee in order to enable it to recoup those losses and to enable it to meet its liabilities. The amounts received by the assessee from STC could not be treated as part of the trading receipt.

It seems that subvention money received from the holding company, not as trader, but to recoup the losses likely to be suffered by the subsidiary, should be capital in nature, more so where the holding company otherwise has no trading  relation  with  the  subsidiary  company. A receipt not to meet the recurring expenditure but to help in purchasing capital assets or for expansion of the business is more likely to be capital in nature. So is the case where the receipt is not for the purpose of assisting the assessee to run the business more profitably. A voluntary payment arising out of personal  relationship  of parent and subsidiary company, not stemming from any business considerations, is not a revenue receipt. The case is further strengthened where the holding company does not treat the payment as an expenditure. In our view, the decision of the Karnataka High Court was delivered on the basis of the facts and cannot be taken as laying down any precedent for taxing a subvention receipt in general.

Section 4 and section 5 r.w.s. 9(1)(vi) of the Act provide for taxability of income from royalty in India. Section 9(1)(vi) of the Act by a deeming fiction provides for the taxation of income from royalty in India. Explanation 2 to section 9(1)(vi) of the Act defines the word ‘royalty’, which is wide enough to cover both industrial royalties as well as copyright royalties, both being forms of intellectual property. Computer software is regarded as an ‘industrial royalty’ and/or a ‘copyright royalty’. Industrial properties include patents, inventions, process, trademarks, industrial designs, geographic indicators of source, etc. and are generally granted for an article or for the process of making such article. Whereas on the other hand, copyright property include literary and artistic works, plays, films, musical works, knowledge, experience, skill, etc. and are generally granted for ideas, principles, skills, etc.

Just as tangible goods are sold, leased or rented in order to earn monetary gain, on similar lines, the Intellectual Property laws enable authors of the intellectual properties to exploit their work for monetary gain. The modes of exploitation of intellectual property for monetary gains are different for each type of Intellectual Property, which has been covered in various sub-clauses of the definition of ‘royalty’ under Explanation 2 to section 9(1)(vi) and subjected to tax as per the scheme of the Act.

On similar lines, monetary gains arising from exploitation of computer program, an intellectual property, which subsists in computer software is sought to be taxed as royalty under the Act. Explanation 3 to section 9(1)(vi) defines computer software as computer program recorded on any disc, tape, perforated media or other information storage device and includes any such program or any customised electronic data. The Supreme Court in the case of Tata Consultancy Services v. State of AP, 271 ITR 401 held that shelf software were ‘goods’ for the purpose of Sales tax and that there was no distinction between the branded and unbranded software. Without prejudice to the applicability of the aforesaid conclusions as drawn by the Apex Court in context of indirect tax laws, to the provisions of the Act, at least one may refer to the aforesaid decision for a proper understanding as to what software is and what is the nature and character of software, which is also advised by the Apex Court in the decision. The controversy, sought to be discussed here, revolves around the issue whether the income from a sale of the computer software is a ‘royalty’, or is a ‘sale’.

The Revenue holds such sales to be royalty on the ground that during the course of sale of computer software, computer program embedded in it is also licensed and/ or parted with the enduser of the software, and as against the claim of the taxpayers who treat the transaction as one of sale of computer software and not of the computer program embedded in it. The Authority for Advance Rulings (‘AAR’) recently in its ruling in the case of Millennium IT Software Ltd., in re, 62 DTR 1 had an occasion to deal with the aforesaid issue under consideration, wherein the AAR while deciding against the taxpayer’s contention, held that the income from the transaction be regarded as a royalty, liable to tax in India. In deciding the issue in this case the AAR gave findings that were contrary to its own findings on the subject given in the earlier decisions in the cases of Dassault Systems K. K., in re, 322 ITR 125 and FactSet Research Systems Inc, in re, 317 ITR 169.

Millennium IT Software’s case

Millennium IT Software Ltd. (‘Millennium’), a Sri Lankan company, had entered into a software licence and maintenance agreement (‘SLMA’) with Indian Commodity and Exchange Ltd. (‘ICEL’), an Indian company, on 27 March 2009. Under the agreement, Millennium had allowed ICEL to use the software product ‘licensed program’, owned by it. As per the SLMA, an ‘implementation fee’ of Rs.4 crores was agreed to be paid by ICEL to Millennium for licence to use the ‘licensed program’ for 4 years and its installation, with a clause to extend the licence period at the discretion of ICEL. The other relevant terms of SLMA are provided as under:

— Millennium had granted ICEL a ‘right to use’ the licensed program for its business operation;

— Rights granted under the SLMA were nonexclusive, non-transferable, non-assignable, indivisible;

— Millennium had granted rights to make copies of the licensed program to be installed on equipments only at designated sites of ICEL and each copy of licensed program was to carry copyright, trademark and other notice relating to proprietary rights of Millennium;

 — ICEL had no right to sell, distribute or disclose the licensed program or associated documents to any third party;

 — No intellectual property right or licence was granted to ICEL.

Use of source code and reverse engineering of the licensed program was strictly prohibited; Based on the aforesaid clauses in SLMA, Millennium submitted before the AAR that the implementation fee was not chargeable to tax under the provisions of the Act or under the DTAA with Sri Lanka relying on some of the earlier favourable legal decisions on the subject. The Income-tax Department objected to the said contention of Millennium and submitted before the AAR, that consideration towards implementation fee should be termed as industrial intellectual property that was covered under the vires of the definition of ‘royalty’ under Explanation 2 to section 9(1)(vi).

The AAR however, to begin with, chose to classify computer software as a copyright intellectual royalty as against the Revenue’s contention that it was an industrial intellectual property. The AAR observed that ICEL under SLMA was granted a ‘licence to use’ the computer program which was owned and developed by Millennium and that the consideration paid as ‘implementation fee’ was to enable ICEL to have a ‘right to use’ the licensed program. Further, the AAR held that as per SLMA, Millennium had not only conveyed the ‘right to use’ the software to ICEL but along with the said right had also enabled ICEL to ‘use’ copyright embedded in the program though limited in nature. The AAR in addition to above, held that the second proviso to section 9(1)(vi) of the Act was substantive in nature and if the conditions of second proviso to section 9(1)(vi) were not satisfied, then the intention of the Legislature was to tax even the income from sale of a computer software as a royalty under the Act.

Distinguishing its earlier decision on the facts in the case of Dassault Systems K. K. (supra), the AAR concluded that the consideration received for ‘right to use’ the software is embedded with right or interest in computer program and therefore, would be termed as royalty under the provisions of the Act as well as Article 12.3 of the DTAA with Sri Lanka and made the following observations as regard to DTAA with Sri Lanka:

“The DTAA involved herein is the one between India and Sri Lanka. The definition of royalty contained in this treaty in Article 12.3 shows that it is a payment of any kind received as consideration for the ‘use of or the right to any copyright’. This is seen to differ from some of the later treaties like the one with USA wherein royalty is payment of any kind received as consideration for the ‘use of, or the right to use, any copyright’. The definition in the India-Sri Lanka DTAA is wider than the one found in the IT Act. For, it takes in even the consideration received for permitting another to use a copyright. Even a right to use need not be conferred.

…. It is not necessary even to grant the right to use the copyright if one were to look at it literally, though the grant of a right to use could be said to be included in the grant of a right in the copyright.”

The AAR concluded that the consideration received by Millennium from ICEL be termed as a royalty under the DTAA and u/s.9(1)(vi) of the Income-tax Act.

Dassault Systems’ case

Dassault Systems K. K., (‘Dassault’), a Japanese Company, is engaged in the business of providing ‘Product Lifecycle Management’ software solutions, applications and services. Dassault marketed the aforesaid licensed products mostly through a distribution channel comprising of Value Added Resellers (‘VAR’). VARs are independent third-party resellers who are in the business of selling software products to end-users. As per the business model, Dassault entered into General Value Added Resellers Agreement (‘GVA’) with VARs and sold the software product to VARs for a consideration based on the standard list less discount. The VARs in turn sold the products to end-users at a price independently determined by VARs. The end-users then entered into End User Licence Agreement (‘EULA’) with Dassault and VARs for the product supplied.

Based on the abovementioned facts, Dassault had sought for a ruling from the AAR as to whether the consideration received by Dassault from VARs, from sale of software products would be termed as a business income or a royalty under the Act and/or DTAA between India and Japan. Further, the AAR was explained the modus operandi of the transactions undertaken between Dassault, VARs and the end-users. Dassault submitted before AAR that the end-users including VARs in the sale of software products were only transferred copyrighted software containing computer program but not the copyright therein. It was further contended that consideration was paid for ‘use of copyrighted product and not for use of copyright in computer program’. The end-users/VARs did not avail any of the rights referred to in section 14 of the Copyright Act, 1957 (‘the 1957 Act’). The Income-tax Department objected to the contention of Dassault and submitted that consideration received by Dassault from VARs was on account of rights conferred u/s.14(b) of the 1957 Act and therefore, would be termed as a royalty under the Act.

The AAR to begin with, considered the ordinary meaning of ‘copyright’, reference was made to various definition provisions, modes of transfer of copy-right under the 1957 Act and to the earlier decision of the AAR in the case of FactSet Research Systems Inc., 317 ITR 169. It referred to various clauses of GVA and EULA agreements and the provision of section 14 of the 1957 Act and observed that passing of a ‘right to use’ and facilitating the use of a product for which the owner had a copyright was not the same thing as transferring or assigning rights in relation to the copyright. Further, it observed that “use of a copyrighted product does not entail enjoyment of rights referred in section 14 of the 1957 Act” for computer program and therefore no copyright was transferred and/or parted in the course of said transaction. Merely authorising or enabling a customer to have the benefit of data or instructions therein without any further right to deal with them independently did not entail transfer of rights in relation to copyright or conferment of the right of using the copyright. After negating the objections of the Revenue and in light of the aforesaid observations and references to some of earlier favourable legal decisions on the subject, the AAR held that considering the facts of the case no rights in relation to copyright had been transferred, nor any right of using the copyright as such had been conferred on VARs/end-users in the course of transactions.

In deciding the application, the AAR referred to the provisions of Article 12.3 of the DTAA with Japan which read as under:

“The term ‘royalties’ as used in this article 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 films and films or tapes for radio or television broadcasting, any patent, trademark, design or model, plan, secret formula or process, or for the use of, or the right to use, industrial, commercial or scientific equipment or for information concerning industrial, commercial or scientific experience.”

On due consideration of the said Article 12 of the DTAA and the provisions of section 9(1)(vi) of the Act, the AAR concluded that the income from the transaction under consideration was not a royalty.

Observations

The Income-tax Act, 1961 defines royalty in relation to computer program under Explanation 2(v) to section 9(1)(vi) as ‘transfer of all or any rights (including granting of license) in respect of any copyright ………..A question which requires consideration is therefore, whether the expression ‘transfer of all or any rights’ under the said Explanation can be read to implicitly cover ‘use’ or ‘right to use’.

Observations here are restricted to the provisions of the Act and no references are sought to the text of respective DTAAs, for following reasons:

•     The definition of royalty and the text of the provisions on royalty under the respective DTAAs are different;

•     Once the nature of income being discussed here fails to be termed as a ‘royalty’ under the provisions of the Act, then one may not be required even to refer to the provisions of the respective DTAAs, considering the fact that recourse to DTAA is envisaged only for any reliefs and benefits, not conferred by the Act.

The issue under consideration is otherwise a multi- faceted issue and has several dimensions which are sought to be addressed through a few questions and answers thereon.

Does the expression ‘transfer of all or any rights’ under Explanation 2(v) to section 9(1)(vi) include ‘use or right to use’?

A construction of definition of royalty under the Act explains that different actions qua the type of intellectual properties are covered and subjected to tax according to the scheme of the Act, which is tabulated below:
 

The Legislature in its wisdom has distinguished between the royalty for industry intellectual properties and copyright intellectual properties. It appears that the distinction is in sync with the available means through which each type of intellectual property is exploited for earning a monetary gain. To take an illustration, a technical design which belongs to industrial intellectual property type can be exploited for earning monetary gain in any of the ways as mentioned in Explanation 2(i), (ii) and (iii) of section 9(1)(vi) of the Act, but the same test may fail for films, artistic work, etc., a part of copyright intellectual property type, and vice versa.

When different provisions are made depending upon the type of intellectual property, then the part relevant thereto only should be applied while determining whether or not that part shall fall under the definition of royalty. Such a construction is in accordance with the Latin legal maxim ‘Expresso unius est exclusive alterius’. The general meaning of the maxim is that the express mention of one thing implies the exclusion of another. As a fallout of the said construction, it is possible to hold that rights as prescribed in Explanation 2(i) to (iva) of section 9(1)(vi), as in the nature of right to share information and the use or right to use thereof cannot be covered by the expression ‘transfer of all or any right (including granting of licence)’ under Explanation 2(v) of the Act. In other words, the Legislature did not seek to consider ‘use or right to use’ of computer program embedded in computer software as royalty under the Act.

What is meant by the expression ‘transfer of all or any rights (including granting of licence’ and which rights are sought to be covered?

Though the Act defines the word ‘royalty’, but the expressions viz., ‘all or any’, ‘or’ are uncertain as regard to their scope. Similarly, the terms patents, copyrights, process, invention, skill, etc., remain undefined. In such circumstances, one is required to scrutinise the legislative history to ascertain the principal intention of the Legislature. The above-referred terms are defined in their respective governing special Acts on the subject viz., Copyrights Act, 1957 (‘the 1957 Act’); Patents Act, 1970; Trade Marks Act, 1999, etc.

Section 14 of the 1957 Act defines a copyright in the computer program as a list of rights granted to the author of computer program. The Act also provides for the modes for transfer of the said list of rights in computer program viz. assignment and licence of rights. References to other types of intellectual properties provide for similar provisions under the respective Acts. The intention of the Legislature can therefore be considered as referring to the rights as listed in section 14 of the 1957 Act. The aforesaid construction is also supported by the decision of the Special Bench of the Delhi Tribunal in the case of Motorola Inc v. DCIT, 95 ITD 269.
 

Whether the rights referred in section 14 of the Copyrights Act, 1957 are transferred in sale of computer software to end-users?

To answer this pertinent question, one requires to appreciate the nature of the transaction which generally takes place in a sale of computer software to end-users. A sale of computer software to end-users either takes place directly from the author of the computer program to end-users or through the channel of distributors. In either case, the computer program embedded in the computer software may or may not be parted and/or licensed with the computer software. Generally, in such sale transactions, what is sought to be parted with the end-users is the copy of copyrighted program embedded in the computer software and not the copyrighted computer program.

Therefore, it requires to be seen whether in a standard End-user License Agreement (‘EULA’) of computer software between the author and end-users, any of the rights mentioned in section 14 r.w.s. 52 of the 1957 Act are made available to the end-users. A table summarising the rights u/s.14 for computer program, as available to each party, generally, to exercise after the transaction of sale of computer software is reproduced below:

Whereas the author of the computer program, as observed in the Table, has all the rights, the end-user does not have any rights under Section 14. Further, the distributors have rights to sell or give on commercial rental a copy of computer program or give limited right to reproduce and store the said computer programs. In other words, the end-users cannot exercise any rights in respect of copyrights in computer program and therefore, any consider-ation paid to the authors/ distributors by the end-user towards sale of computer software may not qualify for being termed as a ‘royalty’ under the Act. In contrast, under the agreement between the author and distributor, since the right to sell or give on commercial rental is conferred on the distributors, any consideration received by the author from a distributor in such a scenario may qualify to be termed as a ‘royalty’ under the Act.

Whether ‘computer program’ is copyright and/or industrial intellectual property?

Though it may sound ironical, but all the contrary judgments on the subject confirm to the proposition that ‘computer program’ is a literary work and qualifies to be termed as a copyright intellectual property. However, the difference of opinion stems in considering the computer program as industrial intellectual property, not being limited to patents but also as process, invention and secret formula. Since, ‘invention’, and ‘patents’ are not defined under the Act it shall be necessary to rely on the respective special Acts governing the law on the subject. Section 3(k) of the Patents Act, 1970 (‘the 1970 Act’) which defines ‘invention’ specifically excludes computer program from being regarded as invention. Section 2(m) of the 1970 Act defines ‘patent’ as an invention, thereby indirectly excluding computer program from its purview. Further, since the end-users do not have any access to the computer program embedded in computer software, they cannot be said to have rights in relation to a process. Lastly, to classify computer program as a secret formula shall be too far-fetched, considering the fact that a secret formula is placed as genus of ‘technical know-how’ under the provisions of the Act.

As a result, computer program embedded in computer software may only be termed as a copyright intellectual property under Explanation 2(v) to section 9(1)(vi).

Without prejudice to aforesaid discussions, recently the Delhi High Court in a judgement delivered in the case of CIT v. Dynamic Vertical Software India (P)    Ltd., 332 ITR 222, has based on the facts and circumstances of the case where the assessee, a dealer of Microsoft, had been purchasing the on the subject software from Microsoft and selling it further in Indian market held that the payment made by the assessee to Microsoft could not be termed as a ‘royalty’. Therefore, it can be said that computer software is not a copyright intellectual property.

Lastly, if the rights to use intellectual property are capable of and are allowed to be transferred in sale of computer software to end-users, then every second person would have been capable of developing softwares like Microsoft, Oracle, etc. The general understanding of the word ‘royalty’ in the context of copyright refer to a consideration received by the author from the publisher, who published his work and not as a consideration received by the publisher from the end-user on sale of copy of work.

Based on the aforesaid discussions and observations made in the decision in the case of Dassault Systems (supra), it appears that the ratio of the recent decision of the AAR in the case of Millennium IT Systems (supra) may require reconsideration.

Adding to the bandwagon of major judgments, the AAR has recently in the case of Upaid Systems Limited, In re, 885 of 2010, dated 12th October 2011, based on the facts and circumstances of the case, held that the consideration paid by Satyam to Upaid for perpetual licence of right to use computer software shall be taxable as ‘royalty’ under section 9(1)(vi) of the Act.