Tax Alert which summarizes a recent decision of the Delhi High Court (HC) in the case of Infrasoft Ltd.(Taxpayer). The issue addressed was whether consideration received by the Taxpayer for grant of license for use of customized software is “royalty” within the meaning of India-US Double Taxation Avoidance Agreement (DTAA). The HC held that the license granted by the Taxpayer is limited to those necessary to enable the licensee to operate the program. Hence, there is no transfer of copyright or right to use the copyright, but is a case of mere transfer of a copyrighted article. Copyright or right to use copyright is distinguishable from sale consideration paid for “copyrighted” article. The consideration is for purchase of goods and is not royalty under the DTAA.
Characterization of computer software transactions has been a contentious issue with the Indian Tax Authority over the last several years. While the Tax Authority is of the view that such payments should be classified as “royalty”,regardless of the nature and extent of rights granted to the end user or the purpose for which the end user uses the software, the taxpayers have generally taken a view that where an end user does not obtain rights that enable commercial exploitation of the intellectual property in the computer software, the transaction should be classified as generating “business profits”.
The Delhi HC, while affirming the distinction between “copyrighted right” and “copyrighted article”, has reinforced the principle that merely authorizing or enabling a customer to have the benefit of data or instructions in the software without any further right to deal with them independently does not amount to transfer of rights in relation to copyright or conferment of the right of using the copyright. The enjoyment of some or all the rights which the copyright owner has is necessary to invoke the royalty definition.
The Delhi HC has also expressly stated that it does not agree with the decision of the Karnataka HC in the case of Samsung Electronics Co. Ltd. which had held that a right to make a copy of the software for the purpose of storage and backup copy amounts to copyright. Hence, the payment made for the grant of such license constitutes royalty.
This well-reasoned decision of the Delhi HC comes as a welcome relief to taxpayers facing challenges from the Tax Authority on classification of income in respect of software transactions.
Characterization of computer software transactions has been a contentious issue with the Indian Tax Authority over the last several years. While the Tax Authority is of the view that such payments should be classified as “royalty”,regardless of the nature and extent of rights granted to the end user or the purpose for which the end user uses the software, the taxpayers have generally taken a view that where an end user does not obtain rights that enable commercial exploitation of the intellectual property in the computer software, the transaction should be classified as generating “business profits”.
The Delhi HC, while affirming the distinction between “copyrighted right” and “copyrighted article”, has reinforced the principle that merely authorizing or enabling a customer to have the benefit of data or instructions in the software without any further right to deal with them independently does not amount to transfer of rights in relation to copyright or conferment of the right of using the copyright. The enjoyment of some or all the rights which the copyright owner has is necessary to invoke the royalty definition.
The Delhi HC has also expressly stated that it does not agree with the decision of the Karnataka HC in the case of Samsung Electronics Co. Ltd. which had held that a right to make a copy of the software for the purpose of storage and backup copy amounts to copyright. Hence, the payment made for the grant of such license constitutes royalty.
This well-reasoned decision of the Delhi HC comes as a welcome relief to taxpayers facing challenges from the Tax Authority on classification of income in respect of software transactions.
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