Retrospective amendment to meaning of “royalty” by Finance Act, 2012 cannot override the provisions of Double Taxation Avoidance Agreement (“DTAA” or “the treaty”)

The Finance Act, 2012 has inserted an explanation in section 9(i)(vi) of the Income tax Act, 1961 (“the Act”) by way of a retrospective clarification that  transfer of all or any rights in respect of any right, property or information, includes and has always included transfer of all or any right to use or right to use a computer software (including granting of a license) irrespective of the medium through which such right is transferred.  The implications of the insertion of this explanation on the meaning of the term royalty under the Act vis-à-vis the Tax Treaties has come came into sharp focus

It is in the above context of the amendment in the Act, that the recent ruling¹ of the  Delhi High Court (“HC”) gains

significance.   

Background and facts

Nokia Network OY (“the Company” or “Nokia”) manufactured certain telecom equipment (which were used in fixed and mobile phone networks), and exported them to certain Indian telecom operators on a principal to principal basis, under independent buyer-seller arrangements.

Amongst other issues such as whether Nokia has a Permanent Establishment in India, attribution of profits in India, etc, the Revenue Authorities, during audits of Nokia, also held that a portion of the revenues earned by it from sale of its telecom equipment to Indian telecom operators ought to be attributed towards supply of software and taxed as royalty on a gross basis under section 9(1)(vi) of the Act as well as Article 13 of India-Finland DTAA. 

In appeals, the Delhi HC ruled as under:

1.     The fact that Nokia had split a lumpsum supply contract into that for supply of equipment and supply of software would not be determinative of the payments for software being separate and taxable as royalty.

2.     The Revenue Authorities missed a vital point, that the Company had opted to be governed by the Treaty,  the language of the which in so far as royalty is concerned, differs from the post 2012 position of Royalty under the Act.  Meaning of royalty under the Treaty is narrower than the Act.

3.     Article 13(3) brings within the ambit of the definition of Royalty, a payment made for the use of or the right to use a copyright of a literary work.  Therefore what is contemplated is a payment that is dependent upon use of the copyright and not a lumpsum payment as is the position in the present case.

4.     Payment received by Nokia was towards sale of the equipment and software was an integral part of the same under a composite agreement.  The software was not capable of independent use.

5.     Reliance was placed on the decision of CIT v Seimens Aktiongesellschaff² wherein it was held that amendments cannot be read into the treaty and payment for a “copyrighted article” does not fall within the purview of “royalty”. 

6.     Argument of the Revenue that rights to use simplicitor of a software program is a part of the copyright in the software irrespective of whether or not a further right to make copies is granted³ consequent to the amendment in understanding of “royalty” pursuant to Finance Act 2012 would not hold in the context of the DTAA