Payments for software license is royalty: Mumbai ITAT

 

In an important ruling, the Mumbai bench of the Income Tax Appellate Tribunal (“ITAT”),in the case of Reliance Infocom Ltd (“the taxpayer”) has ruled that payments towards software licenses are in the nature of royalty and taxes should be withheld in India under the provisions of Section 195 of the Income tax Act, 1961 (“the Act”).

Background and brief facts of the case:

· This ruling arises out of a batch of appeals filed by the Revenue against various companies of Reliance group and against Lucent Technologies GRL LLC, USA (“Lucent”) involving common issue of whether the payments made towards software licenses from non-resident companies could be considered as royalty chargeable to tax under the Act;

· The taxpayer wanted to establish wireless telecommunications network in India and entered into an agreement - “Wireless Network General Terms and Conditions Contract” and “Wireless Software contract” with Lucent Technologies Hindustan Pvt. Ltd. (“LTHPL”), an Indian company belonging to the Lucent group, USA. The taxpayer also entered into another “Wireless software Assignment and Assumption agreement” with LTHPL and Lucent for supply of software required for the operation of telecom network;

· The taxpayer applied to the Assessing Officer (“AO”) under section 195(2) of the Act requesting for allowing the payment for software without deduction of tax at source. However, the AO held that the taxpayer was obtaining a license to use the software, which should be considered as royalty, liable to tax on a gross basis at 20% in India under the provisions of the Act;

· On appeal, the Commissioner of Income-Tax (Appeals) held that the amounts paid cannot be considered as royalty as the taxpayer purchased ‘goods’ which is a copyrighted article and in the absence of Permanent Establishment (“PE”) for Lucent in India, the amount paid cannot be charged to tax and hence, there was no requirement to withhold taxes. The Revenue appealed against this order to the ITAT;

· Further, since software was supplied by Lucent, the AO initiated re-assessment proceedings on Lucent and held that the payment for the software should be liable to tax as royalty. Against this order, Lucent applied to the Dispute Resolution Panel, which confirmed the order of the AO. Lucent appealed against the final assessment order passed by the AO before the ITAT.

Issue before the ITAT

· Whether the payment for software licenses could be considered as royalty under the Act or Agreement for Avoidance of Double Taxation between India and USA (“Treaty”) and if so, whether taxes should be withheld from these payments?

Revenue’s contention

· The taxpayer has obtained only a license, which involved a copyright under the Copyright Act and would be covered within the definition of royalty under the Act;

· Rights in software are in the nature of copyright and payments for licensing of software is royalty under the Act even before amendment by Finance Act, 2012. Further, the right to use the software involves copyright since any infringement is punishable;

· When software was supplied through a medium of CD, the taxpayer has only license to use the software, which can only be treated as use of copyright;

· Since the agreement refers to redesigning of software at the end of 10 year period, the transaction is only a license for use of software and not for sale of software;

· When software is loaded on CD, it becomes a tangible item and as an alternative, use of software should be considered as ‘use of equipment’. Therefore, in view of the definition of royalty under the provisions of the Act and the Treaty, the payment should be treated as royalty.

Taxpayers’ contention

· The main purpose of entering into various contracts was for setting up mobile network and the software does not work without the hardware network. The software is specific to the machinery on which it works and is different from Shrink wrapped software which is sold off-the-shelf;

· The taxpayer has no interest in intellectual rights of seller and is only interested in the functioning of the network and how it helps in communication. Since the software is in binary system, the word ‘license’ is used but this is different from license of copyright contemplated in the Act. The taxpayer is not exploiting any license/copyright while using the software purchased;

· Software supply contract was assigned to Lucent to ensure that the software helps in equipment usage, as the equipment can work only with the software. Each purchase order of equipment matches with placing order for relevant software and the software is the medium/mechanism for using the hardware;

· The definition of royalty under the treaty has not been amended and so the amendment by Finance Act, 2012 the Act has no application;

· The taxpayer has not purchased shrink wrapped product and therefore, there is no right to copy and hence, the provisions of Copyright Act were wrongly applied to the present case;

· LTHPL is not a subsidiary of Lucent and it has no authority to conclude agreements. Thus, in absence of PE, payment for supply of software is not taxable in India.

Ruling of the ITAT

· The principles established by the Special Bench of the ITAT in Motorolaruling as approved by the Delhi High Court in the cases of Ericsson[#_ftn1][1]and Nokia Networks[#_ftn2][2]are cases where the software was supplied along with hardware as part of equipment and there were no separate sale of software;

· In the case of the taxpayer, it had purchased the software by virtue of stand-alone agreement. The fact that there is separate agreement for supply of software not only with Lucent but also from various other non-resident companies indicates that software is not supplied along with hardware;

· The Karnataka High Court in the case of Synopsys[#_ftn3][3]& Samsung[#_ftn4][4] held that the payments made for the software purchase are for certain rights in the copyrights and it meets the definition of royalty as per the applicable Treaty as well as under the Act;

· It is well settled that copyright is a negative right. It is an umbrella of many rights and licenses granted for making use of the copyright in respect of software. Therefore, the contention of the taxpayer that there is no transfer of copyright or any part thereof under the agreements with the non-resident supplier of software cannot be accepted;

· Consequently, the payments for purchase of software would be chargeable to tax in India as royalty under the Act and the Treaty and consequently, the withholding tax provisions under section 195 are applicable.