TMI Blog2003 (10) TMI 250X X X X Extracts X X X X X X X X Extracts X X X X ..... lure to deduct tax at source, the assessee has been treated as assessee-in-default under section 201(1) of the IT Act, 1961 (hereinafter referred to as "the Act") and the Department has also demanded interest under section 201(1A) of the Act. 3. The contention of the assessee before the ITO (TDS) was: (i) No tax was deducted on the amounts paid, for the reason that acquisition of software is inextricably linked to the acquisition of hardware inasmuch as neither of them can function without the other; (ii) As the transfer of software had taken place outside India, no profit accrued or arisen or could be deemed to have accrued or arisen in India. (iii) In any event, by virtue of the provisions of the Double Taxation Avoidance Agreement (DTAA), the gains, if any, arising from the transfer of the software was not chargeable to tax as the supplier has no permanent establishment in India. 4. The ITO (TDS) did not accept these contentions and held that the provisions of section 195 did apply to these transactions and the assessee was required to deduct tax at source on the payments made to nonresident. The arguments that weighed with the ITO (TDS) in reaching these conclusions m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or scientific equipment and would accordingly be royalty within the meaning of article 12(3)(b). In coming to this conclusion, the Assessing Officer has also relied upon the decision of the Authority for Advance Ruling in ABC, In re [1999] 238 ITR 296. The relevant findings of the Assessing Officer recorded in para 2 of his order are extracted for the purpose of completion: "Software is an Intellectual Property Right (IPR) which can be licensed to a user. The same software can be given to any number of users. On an outright sale of an article like hardware, property in its entirety is transferred to the purchaser to the exclusion of others, whereas, in software there is no such outright sale, what is transferred is only the right to use, which may be available to many such users but the IPR still remains in tact with Lucent (USA). Thus effectively, consideration paid is only for licence to use. Thus payment made by the Indian company for import of software is on a totally different footing when compared to the payments made for purchase of hardware. When such is the case, it has to be examined whether such payment (for import of software) is chargeable to tax in the hands of rec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... upposed to do, the source code of this software program is not made public, even otherwise that does not really matter much since such programs are part of now universally recognized IPRs. Similarly the software can also be termed as a "process". The word "process" has been defined in the Oxford Dictionary as "course of action or a procedure especially a series of stages in manufacture of some other operation". This is how a software works. Without prejudice to the above, DTAA (between India and USA), Royalty is discussed in article 12 of the DTAA. Sub-article 3(a) of the DTAA defines the royalty as "payment of any kind received as consideration for the use of, or the right to use.....any patent, trademark, design or model, plan, secret, formula or process.......Hence to this extent it is similar to the definition of royalty given in the IT Act, and which is applicable to the facts of the instant case. Royalty has been defined further inter alia in sub-article (3)(b) "as payments of any kind received as consideration; for the use of, or the right to use any industrial, commercial or scientific equipment......" (meaning of 'equipment' as per Oxford Dictionary is the necessary ar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d contentions that were taken before the two authorities. The learned counsel pointed out that the DoT places purchase order for supply of a digital local telephone exchange on the assessee. The price for the equipment to be supplied is a lump sum price and the equipment to be supplied consists of various modules as well as the software that runs the equipment. The learned counsel drew our attention to purchase order, which is placed at pp. 1 to 13 of the compilation. The learned counsel elaborately dealt with the facts relating to equipment to be supplied for Vanasthalipuram exchange. On the basis of the order it received from the DoT, it places its own order on Lucent, USA for supply of the parts and components of the switching system. The said purchase order is placed at pp. 14 to 16 of the paper book. The learned counsel stressed that the perusal thereof would reveal that a single purchase order for lump sum consideration of USD 1,29,804.56 is placed on Lucent, USA. The annexure to the orders sets out the various items that are to be supplied by Lucent, USA. It is clear from the aforesaid that Lucent, USA has also to supply the application software required to make the equipmen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for such acquisition is not consideration for the use of or the right to use any industrial, commercial or scientific equipment within the meaning of article 12(3)(b) of the DTAA entered into between India and US. The learned counsel pointed out that the transaction between the assessee and Lucent, USA, is a transaction for purchase of switching system including parts and components thereof. The software that is purchased is an integral part of the switching system and there is no dispute that the payment made by the assessee for purchase of hardware is not exigible to tax in India inasmuch as the transfer of hardware took place outside India. On a parity of reasoning, as the transfer of the software has also taken place outside India there can be no accrual in respect of the same in India. The learned counsel went on to make a distinction between 'copyrighted article' and 'copyright' rights. The learned counsel illustrated it in the form of purchase of book or a music cassette. In a transaction like this, what is purchased is a copyrighted article, the copyright belonging to the author or the singer as the case may be. The purchaser has no right whatsoever to duplicate or make co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rogram but does not acquire any of the rights referred to hereinbefore, then, the transaction has to be classified as a transfer of a copyrighted article. It was submitted that on the basis of the distinction drawn, it would be clear that what the assessee has acquired is a copyrighted article and accordingly the consideration that is paid thereof has to be regarded as a purchase price and not a payment by way of royalty. 7(ii). The learned counsel further submitted that without prejudice to what has been claimed earlier, having regard to the provisions of the DTAA, amount that is paid by the assessee to Lucent, USA would not be chargeable to tax in India. It is also an admitted position that Lucent, USA is in the business of selling software program and the price that is paid to it is to be regarded as a business profit embedded in the purchase and sale transaction. Therefore, in accordance with the provisions of article 7 of the DTAA, profit arising from such a sale would be chargeable to tax only in the US. It is further submitted that the provisions of article 12 would have no application inasmuch as the payment that is made by the assessee would not be royalty as defined the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Advance Ruling in P.No. 30 of 1999, reported in ABC's case relied upon by the ITO (TDS) is not relevant for deciding the issue that has arisen in the present case. The Authority, according to the learned counsel, in that case was required to consider whether payment received by US Corporation for permitting Indian company to access and use its central processing unit and data network situated in the United States could be assessed to tax in India. The Authority held that the software was used in central processing belonged to the applicant who had allowed the Indian company to use the software and the payment made by the Indian company would be regarded as a payment by way of royalty within the meaning of article 12(3) of the DTAA. 8(ii). The learned counsel pointed out that in coming to that conclusion, the Authority has relied upon the revised commentary on the model convention, which was referred by them. The commentary, in fact, supports the contention of the assessee that amounts cannot be brought to tax by way of royalty as on the facts prevailing in the present case, it is a case of transfer of a copyrighted article and not a case of a grant of a permission to use a copyr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a single purchase order for a lump sum consideration of USD 1,29,804.56 is placed on Lucent, USA. The annexure to the orders sets out the various items that are to be supplied by Lucent, USA and it is clear therefrom that the application software has also to be supplied by Lucent, USA. Lucent, USA, in turn, raised two invoices, one for supply of various items of hardware and the other for supply of software. However, as is clear from pp. 17 and 18A, which are respective invoices that such supplies are made pursuant to a single purchase order. The transaction, viewed from this angle, clearly shows that what the assessee has purchased is an integrated equipment both of hardware and software from Lucent, USA. In other words, the acquisition of software was inextricably linked to the acquisition of hardware and one cannot function without the other. It is impracticable to have such value addition without the help of the other. In our view, the assessee's transaction with Lucent, USA is a purchase of an integrated equipment, which consists of both hardware as well as software. One cannot function without the help of the other. As pointed out by the learned counsel, what the assessee has ..... X X X X Extracts X X X X X X X X Extracts X X X X
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