Facts
Ericsson Radio Systems A.B. („the Taxpayer‟), is a company incorporated in Sweden and also a tax resident of Sweden. It is a wholly owned subsidiary of Telefonakitiebolaget L. M. Ericsson („LME‟) of L. M. Group.
The Taxpayer is in the business of supplying hardware and software which is used in the business of rendering telecommunication services. The Taxpayer undertakes projects on turnkey basis which involve supply of hardware and software, installation and commissioning and after sales services.
In Assessment Year („AY‟) 1997-98, the Taxpayer entered into agreements in India with ten Indian cellular operators (collectively called as „the Operators‟) for supply of hardware and software.
Ericsson Telephone Corporation India AB („EFC‟) a foreign company has a branch office in India Ericsson Communications Limited („ECL‟) is an India company. Both these entities are wholly owned subsidiaries of LME and are in the business of equipment installation and providing marketing support to the Taxpayer.
The Operators had entered into installation agreement, in India, with EFC and ECL. Further, an Overall Agreement was also entered into, in India, between the Operators and the Taxpayer to ensure supervision and guaranteed performance of all the contracts in a co-ordinated manner.
EFC carried out the installation and marketing support for the first three months and ECL carried out the same work for the balance nine months for the Taxpayer.
Before the contracts were signed, employees of the Taxpayer and other associated companies visited India for network survey and to negotiate the terms of the contract. This was a continuous process that spread over a long
period of time. The branch office of EFC provided office, telephone and other facilities to such employees during their visits to India.
The employees of the branch office of EFC attended the meetings and also undertook follow-up work with customers as per the Market Support Agreement („MSA‟) entered into between the Taxpayer and EFC.
As per the terms of contract with Operators, the Taxpayer was to deliver the equipment till port. The equipment were accepted by the respective Operators only after a test known as Acceptance Test („AT‟) was carried out by EFC or ECL, as the case may be. The defective parts, if any, were to be replaced by the Taxpayer.
In assessment proceedings, the Assessing Officer („AO‟) held that the Taxpayer had business connection in India and accordingly the income of the Taxpayer was deemed to accrue or arise in India and taxable in India as per the Income-tax Act, 1961( „the Act‟).
AO also held that as per Article 5 of Double Taxation Avoidance Agreement between India and Sweden („the DTAA‟), the Taxpayer had Permanent Establishment („PE‟) in India on account of (i) a dependent agent being EFC for first three months and ECL for remaining nine months (ii) a fixed base PE in the form of the office space of EFC‟s branch and ECL and (iii) employees of the Taxpayer came to India, signed the contracts, stayed in India and also used various facilities provided by EFC‟s branch and ECL.
AO further held that the income arising on account of licensing of software by the Taxpayer to the Operators was to be taxed as „royalty‟ as per Article 12 of the DTAA. However as the Taxpayer had a PE in India, the income arising on account of royalty was to be taxed as business profits at flat rate of 30 percent as per the Act.
On appeal, the Commissioner of Income Tax (Appeals) („CIT(A)‟), held that the Taxpayer did not have a PE in India, however, the income from licensing of software amounted to royalty and hence, taxable under Article 12 of the DTAA at the rate of 20 percent.
Both the Taxpayer and AO filed an appeal and cross-appeal, respectively before the Income Tax Appellate Tribunal („the ITAT‟) which were referred to a Special Bench of the ITAT which decided the matter in favour of the taxpayer.
Issues before Delhi High Court
Whether the Taxpayer had business connection in India as per section 9 of the Act?
Whether EFC and ECL were PE of the Taxpayer in India as per Article 5 of the DTAA?
Whether consideration for supply of software was royalty under the Act and under the DTAA?
Observations and Ruling of Delhi High Court:
On Business Connection
The supply contract between the Taxpayer and the Operators („the Supply Contract‟) is considered as a stand-alone agreement, supplies under this Contract were made overseas and the property in goods had passed on to the Operators outside India.
Based on the judgment of the Supreme Court in case of Ishikawajima Harima Heavy Industries Ltd. vs. DIT1and Instruction No. 1829 dated 21st September, 1989 issued by the Central Board of Direct Taxes it was observed that:
1 288 ITR 408
‒ Property in the equipment and the risk therein were passed outside India;
‒ No services were performed in India in connection with installation of equipment or otherwise;
‒ Performance of AT in India was not relevant in determining whether any part of the profit from the offshore supply was taxable in India;
‒ The lower appellate authorities had determined that the Taxpayer did not have any PE in India;
‒ Mere signing of contract in India, pursuant to which the supply was made would not give rise to tax liability in India;
‒ The Overall Agreement should not make any difference to the taxability of equipment supplied;
‒ The nomenclature of turnkey project or works contract is not relevant in determining taxability of profit arising from supply of equipment.
The intention of the parties, as required by section 19 of Sale of Goods Act, 1930 to determine passing of property in goods, is manifested in the Supply Contract which provides that the property in goods was passed outside India and the intention is also clear from the conduct of the parties. Further, the requirement of AT by EFC or ECL in no manner mitigates such intention.
The fact that the relevant contract was signed in India may not be relevant to determine the taxability of the underlying income.
The terms of the contract provide that AT is not material even for passing of the title and the risk, because even if such a test found out that the system did not confirm to the contractive parameters, the Operator could call upon the Taxpayer to cure the defect and/or claim damages. However the Operators did not have a right to reject the equipment on failure of the Acceptance test
Execution of the Overall Agreement was prompted by purely commercial considerations as the Operators would be desirous of having a single entity that they could liaise with.
Though Instruction No 1829 stands withdrawn by virtue of Circualr No 7/2008 dated 22 October 2009, the withdrawal cannot have retrospective effect and would continue to govern the assessment for the relevant year.
In a transaction for sale of goods, the determinative factor would be as to where the property in goods passes. The place of negotiation of the contract; or place of signing or formal acceptance thereof; or overall responsibility of the Taxpayer are not relevant circumstances.
Once it is established that the property in goods passed outside India, even in the case of composite contracts (which is not found to be so in the present case), supply has to be segregated from installation and the question of apportionment of income would arise.
Supply and installation to be carried out by the companies under the same group, could not be construed as composite transaction, particularly when the respective entities perform their independent obligations, receive appropriate separate remuneration and as are not financially or technically dependent on each other. Further all the associated enterprises had been separately assessed in respect of income that had accrued to them.
The Installation Contract is between the installation contractees viz. EFC and ECL and Operators. There was no contract between the Taxpayer and the EFC/ ECL and that Business connection would not come into existence merely because the installation contractor is a fellow subsidiary of the Taxpayer.
Further, the Operators are independent contractees and cannot be said to construe as the Taxpayer‟s business connection. Thus in case of a business of which all operations are not carried out India, the business income would be deemed to accrue or arise in India only to the extent reasonably attributable to operations in India.
Hence, the Taxpayer has not earned any income in India through or from a business connection in India
On PE
Since the Taxpayer did not have any business connection in India, it was not necessary to go into the issue whether the Taxpayer had any PE in India during the relevant period.
On Royalty
Supply of equipment in question was supply of goods. Moreover, as recorded by the ITAT, the Operators did not acquire any of the copyrights referred to in section 14(b) of the Copyright Act, 1957. Therefore, the payment made to the Taxpayer could not be treated as royalty either under the Act or the DTAA.
The Taxpayer had sold a GSM system consisting both of the hardware and the software. Software loaded on the hardware was an integral part of the GSM system and did not have any independent existence or use. Further, software incorporated on a media would be goods as has been held by the SC in Tata Consultancy Services vs. State of Andhra Pradesh.
The supply of software incorporated on a CD, leads to a supply tangible property and payments made for acquiring such property cannot be considered as royalty.
The Supply Contract cannot be split into two viz. hardware and software.
For the payment to be construed as royalty under the Act, it would be necessary to establish that there is transfer of all or any rights (including granting of any license) in respect of copyright of a computer program. In the case, no right contemplated under section 14 of the Copyright Act, 1957 stood vested in the Operators.
Distinction has to be made between acquisition of “copyright” and “copyrighted article”.
Even assuming that payment made was construed as royalty under the Act, it could not be regarded as royalty under Article 12 of the DTAA, since royalty has been defined therein narrowly to mean payments made inter alia for use of or right to use a copyright.
The payment made by the Operators was towards the title of GSM system of which software was an inseparable part incapable of independent use and thus was contract for supply of goods and not towards royalty.
On Applicability of Explanation added to section 9 of the Act
The question of applicability of Explanation to section 9 of the Act would arise only when payment is to be treated as royalty under section 9(1)(vi) of the Act or fees for technical services under section 9(1)(vii) of the Act.
The transaction related to supply of goods and as both the transfer of the property in goods or risk therein is passed outside India, no taxable event took place in India. Hence, the applicability of the amended explanation to Section 9 would not be applicable.
Conclusion
The Supply Contract for supply of GSM system and income therefrom was not taxable in India in the absence of any business connection or PE in India.
The payment under the Contract could not be apportioned between hardware and software and hence the payment for software could not be taxed as royalty.
The transaction relates to supply of goods and as both the transfer of the property in goods or risk therein is passed outside India, no taxable event took place in India. Further as the Taxpayer had not rendered services in India, the income arising from the supply could not be taxed in India.
Source: Director of Income Tax vs. Ericsson Radio System A.B. and Others (ITA Nos. 391/2007, 504/2007, 507/2007, 508/2007 and 511/2007) (Delhi High Court) dated 23rd December, 2011
Ericsson Radio Systems A.B. („the Taxpayer‟), is a company incorporated in Sweden and also a tax resident of Sweden. It is a wholly owned subsidiary of Telefonakitiebolaget L. M. Ericsson („LME‟) of L. M. Group.
The Taxpayer is in the business of supplying hardware and software which is used in the business of rendering telecommunication services. The Taxpayer undertakes projects on turnkey basis which involve supply of hardware and software, installation and commissioning and after sales services.
In Assessment Year („AY‟) 1997-98, the Taxpayer entered into agreements in India with ten Indian cellular operators (collectively called as „the Operators‟) for supply of hardware and software.
Ericsson Telephone Corporation India AB („EFC‟) a foreign company has a branch office in India Ericsson Communications Limited („ECL‟) is an India company. Both these entities are wholly owned subsidiaries of LME and are in the business of equipment installation and providing marketing support to the Taxpayer.
The Operators had entered into installation agreement, in India, with EFC and ECL. Further, an Overall Agreement was also entered into, in India, between the Operators and the Taxpayer to ensure supervision and guaranteed performance of all the contracts in a co-ordinated manner.
EFC carried out the installation and marketing support for the first three months and ECL carried out the same work for the balance nine months for the Taxpayer.
Before the contracts were signed, employees of the Taxpayer and other associated companies visited India for network survey and to negotiate the terms of the contract. This was a continuous process that spread over a long
period of time. The branch office of EFC provided office, telephone and other facilities to such employees during their visits to India.
The employees of the branch office of EFC attended the meetings and also undertook follow-up work with customers as per the Market Support Agreement („MSA‟) entered into between the Taxpayer and EFC.
As per the terms of contract with Operators, the Taxpayer was to deliver the equipment till port. The equipment were accepted by the respective Operators only after a test known as Acceptance Test („AT‟) was carried out by EFC or ECL, as the case may be. The defective parts, if any, were to be replaced by the Taxpayer.
In assessment proceedings, the Assessing Officer („AO‟) held that the Taxpayer had business connection in India and accordingly the income of the Taxpayer was deemed to accrue or arise in India and taxable in India as per the Income-tax Act, 1961( „the Act‟).
AO also held that as per Article 5 of Double Taxation Avoidance Agreement between India and Sweden („the DTAA‟), the Taxpayer had Permanent Establishment („PE‟) in India on account of (i) a dependent agent being EFC for first three months and ECL for remaining nine months (ii) a fixed base PE in the form of the office space of EFC‟s branch and ECL and (iii) employees of the Taxpayer came to India, signed the contracts, stayed in India and also used various facilities provided by EFC‟s branch and ECL.
AO further held that the income arising on account of licensing of software by the Taxpayer to the Operators was to be taxed as „royalty‟ as per Article 12 of the DTAA. However as the Taxpayer had a PE in India, the income arising on account of royalty was to be taxed as business profits at flat rate of 30 percent as per the Act.
On appeal, the Commissioner of Income Tax (Appeals) („CIT(A)‟), held that the Taxpayer did not have a PE in India, however, the income from licensing of software amounted to royalty and hence, taxable under Article 12 of the DTAA at the rate of 20 percent.
Both the Taxpayer and AO filed an appeal and cross-appeal, respectively before the Income Tax Appellate Tribunal („the ITAT‟) which were referred to a Special Bench of the ITAT which decided the matter in favour of the taxpayer.
Issues before Delhi High Court
Whether the Taxpayer had business connection in India as per section 9 of the Act?
Whether EFC and ECL were PE of the Taxpayer in India as per Article 5 of the DTAA?
Whether consideration for supply of software was royalty under the Act and under the DTAA?
Observations and Ruling of Delhi High Court:
On Business Connection
The supply contract between the Taxpayer and the Operators („the Supply Contract‟) is considered as a stand-alone agreement, supplies under this Contract were made overseas and the property in goods had passed on to the Operators outside India.
Based on the judgment of the Supreme Court in case of Ishikawajima Harima Heavy Industries Ltd. vs. DIT1and Instruction No. 1829 dated 21st September, 1989 issued by the Central Board of Direct Taxes it was observed that:
1 288 ITR 408
‒ Property in the equipment and the risk therein were passed outside India;
‒ No services were performed in India in connection with installation of equipment or otherwise;
‒ Performance of AT in India was not relevant in determining whether any part of the profit from the offshore supply was taxable in India;
‒ The lower appellate authorities had determined that the Taxpayer did not have any PE in India;
‒ Mere signing of contract in India, pursuant to which the supply was made would not give rise to tax liability in India;
‒ The Overall Agreement should not make any difference to the taxability of equipment supplied;
‒ The nomenclature of turnkey project or works contract is not relevant in determining taxability of profit arising from supply of equipment.
The intention of the parties, as required by section 19 of Sale of Goods Act, 1930 to determine passing of property in goods, is manifested in the Supply Contract which provides that the property in goods was passed outside India and the intention is also clear from the conduct of the parties. Further, the requirement of AT by EFC or ECL in no manner mitigates such intention.
The fact that the relevant contract was signed in India may not be relevant to determine the taxability of the underlying income.
The terms of the contract provide that AT is not material even for passing of the title and the risk, because even if such a test found out that the system did not confirm to the contractive parameters, the Operator could call upon the Taxpayer to cure the defect and/or claim damages. However the Operators did not have a right to reject the equipment on failure of the Acceptance test
Execution of the Overall Agreement was prompted by purely commercial considerations as the Operators would be desirous of having a single entity that they could liaise with.
Though Instruction No 1829 stands withdrawn by virtue of Circualr No 7/2008 dated 22 October 2009, the withdrawal cannot have retrospective effect and would continue to govern the assessment for the relevant year.
In a transaction for sale of goods, the determinative factor would be as to where the property in goods passes. The place of negotiation of the contract; or place of signing or formal acceptance thereof; or overall responsibility of the Taxpayer are not relevant circumstances.
Once it is established that the property in goods passed outside India, even in the case of composite contracts (which is not found to be so in the present case), supply has to be segregated from installation and the question of apportionment of income would arise.
Supply and installation to be carried out by the companies under the same group, could not be construed as composite transaction, particularly when the respective entities perform their independent obligations, receive appropriate separate remuneration and as are not financially or technically dependent on each other. Further all the associated enterprises had been separately assessed in respect of income that had accrued to them.
The Installation Contract is between the installation contractees viz. EFC and ECL and Operators. There was no contract between the Taxpayer and the EFC/ ECL and that Business connection would not come into existence merely because the installation contractor is a fellow subsidiary of the Taxpayer.
Further, the Operators are independent contractees and cannot be said to construe as the Taxpayer‟s business connection. Thus in case of a business of which all operations are not carried out India, the business income would be deemed to accrue or arise in India only to the extent reasonably attributable to operations in India.
Hence, the Taxpayer has not earned any income in India through or from a business connection in India
On PE
Since the Taxpayer did not have any business connection in India, it was not necessary to go into the issue whether the Taxpayer had any PE in India during the relevant period.
On Royalty
Supply of equipment in question was supply of goods. Moreover, as recorded by the ITAT, the Operators did not acquire any of the copyrights referred to in section 14(b) of the Copyright Act, 1957. Therefore, the payment made to the Taxpayer could not be treated as royalty either under the Act or the DTAA.
The Taxpayer had sold a GSM system consisting both of the hardware and the software. Software loaded on the hardware was an integral part of the GSM system and did not have any independent existence or use. Further, software incorporated on a media would be goods as has been held by the SC in Tata Consultancy Services vs. State of Andhra Pradesh.
The supply of software incorporated on a CD, leads to a supply tangible property and payments made for acquiring such property cannot be considered as royalty.
The Supply Contract cannot be split into two viz. hardware and software.
For the payment to be construed as royalty under the Act, it would be necessary to establish that there is transfer of all or any rights (including granting of any license) in respect of copyright of a computer program. In the case, no right contemplated under section 14 of the Copyright Act, 1957 stood vested in the Operators.
Distinction has to be made between acquisition of “copyright” and “copyrighted article”.
Even assuming that payment made was construed as royalty under the Act, it could not be regarded as royalty under Article 12 of the DTAA, since royalty has been defined therein narrowly to mean payments made inter alia for use of or right to use a copyright.
The payment made by the Operators was towards the title of GSM system of which software was an inseparable part incapable of independent use and thus was contract for supply of goods and not towards royalty.
On Applicability of Explanation added to section 9 of the Act
The question of applicability of Explanation to section 9 of the Act would arise only when payment is to be treated as royalty under section 9(1)(vi) of the Act or fees for technical services under section 9(1)(vii) of the Act.
The transaction related to supply of goods and as both the transfer of the property in goods or risk therein is passed outside India, no taxable event took place in India. Hence, the applicability of the amended explanation to Section 9 would not be applicable.
Conclusion
The Supply Contract for supply of GSM system and income therefrom was not taxable in India in the absence of any business connection or PE in India.
The payment under the Contract could not be apportioned between hardware and software and hence the payment for software could not be taxed as royalty.
The transaction relates to supply of goods and as both the transfer of the property in goods or risk therein is passed outside India, no taxable event took place in India. Further as the Taxpayer had not rendered services in India, the income arising from the supply could not be taxed in India.
Source: Director of Income Tax vs. Ericsson Radio System A.B. and Others (ITA Nos. 391/2007, 504/2007, 507/2007, 508/2007 and 511/2007) (Delhi High Court) dated 23rd December, 2011
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