2024 (7) TMI 1643 - HC - Income Tax

Income deemed to accrue or arise in India - payments made by resident Indian end-users or distributors for subscription or license fees related to computer software - HELD THAT - As decided in 2024 (5) TMI 1572 - DELHI HIGH COURT principal contention appears to be that the decision of Engineering Analysis Centre of Excellence (P) Ltd. v. CIT 2021 (3) TMI 138 - SUPREME COURT would stand restricted to software which stands embedded in a computer is clearly misconceived bearing in mind the following observations which were rendered in Engineering Analysis and in respect of software and whether subscription or a licence fee paid in respect thereof would fall within the ambit of royalty. We additionally note that the aspect of royalty provisions being applicable to the provision of software services was one which was considered by us independently in SFDC Ireland Ltd. 2024 (3) TMI 620 - DELHI HIGH COURT as well as Salesforce.com 2024 (2) TMI 1396 - DELHI HIGH COURT held that Explanation 4 in essence introduces a deeming fiction and includes transfer of all or any rights for use or to use a computer software including by way of a license irrespective of the medium through which such right is transferred. Significantly the DTAA does not bring within its sweep a right for use or a right of use of a computer software. As ITAT correctly held that the consideration received by the assessee from various customers on account of licensing of Customer Relationship Management CRM software is not royalty income within the meaning of Article 12(3) of the India-Singapore Double Taxation Avoidance Agreements DTAA. Decided in favour of assessee.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Court are:

- Whether payments made by resident Indian end-users or distributors for subscription or license fees related to computer software constitute "royalty" under Article 12 of the applicable Double Taxation Avoidance Agreements (DTAAs) and the Income Tax Act, thereby attracting tax withholding obligations under Section 195 of the Income Tax Act.

- Whether the subscription or license fees paid for cloud-based or embedded software amount to a transfer or use of copyright or merely the use of copyrighted material without transfer of copyright rights.

- The applicability of precedents interpreting the distinction between transfer of copyright rights and mere use of copyrighted software in the context of international taxation and tax withholding obligations.

2. ISSUE-WISE DETAILED ANALYSIS

Issue: Whether payments for software subscription/license fees constitute "royalty" under Article 12 of DTAA and Income Tax Act provisions

Relevant legal framework and precedents: The Court relied extensively on the Supreme Court decision in Engineering Analysis Centre of Excellence (P) Ltd. v. CIT [(2022) 3 SCC 321], which clarified the definition of "royalty" in the context of software payments under DTAA and Income Tax Act. The Court also referred to its own prior decisions in SFDC Ireland Ltd. v. CIT and The Commissioner Of Income Tax - International Taxation -3 v. Salesforce.com Singapore PTE LTD, which dealt with similar issues regarding software subscription fees and royalty characterization. The provisions of Section 195 of the Income Tax Act (tax deduction at source) and Section 9(1)(vi) along with Explanations 2 and 4 dealing with royalty were considered.

Court's interpretation and reasoning: The Court held that payments made by resident Indian end-users or distributors to non-resident software suppliers for subscription or license fees do not amount to "royalty" as defined under Article 12 of the DTAA or the Income Tax Act. The Court emphasized the distinction between the transfer of copyright rights and the mere grant of a right to use copyrighted software. The subscription or license fee grants only a non-exclusive, non-transferable right to use the software for internal business purposes, without transferring any copyright or conferring rights akin to ownership or exploitation.

Key evidence and findings: The Court extracted detailed passages from the Engineering Analysis judgment, highlighting that the license agreements or end-user license agreements (EULAs) do not create any interest or right amounting to use or right to use copyright. The licensee is restricted from copying, sublicensing, or commercially exploiting the software, and the copyright remains with the licensor at all times.

Application of law to facts: Applying these principles, the Court found that the payments under consideration were for the use of a copyrighted article (software) and not for the use or transfer of copyright itself. Consequently, such payments do not attract tax withholding under Section 195, nor do they constitute taxable income as royalty in India.

Treatment of competing arguments: The appellant contended that the Supreme Court decision in Engineering Analysis should be restricted to software embedded in a computer and not apply to subscription or license fees for software accessed remotely or via cloud. The Court rejected this narrow interpretation, reasoning that the principles laid down in Engineering Analysis and subsequent decisions apply equally to cloud-based software subscriptions. The Court also addressed arguments based on Article 12(4)(a) and 12(4)(b) of the DTAA, holding that these provisions are inapplicable as the payments do not arise from managerial, technical, or consultancy services ancillary to copyright use, nor do they relate to industrial, commercial, or scientific equipment.

Conclusions: The Court concluded that the payments for software subscription or license fees do not constitute royalty under the DTAA or Income Tax Act, and thus no tax deduction at source is warranted under Section 195. The appeal challenging this view was dismissed.

3. SIGNIFICANT HOLDINGS

- "The amounts paid by resident Indian end-users/distributors to non-resident computer software manufacturers/suppliers, as consideration for the resale/use of the computer software through EULAs/distribution agreements, is not the payment of royalty for the use of copyright in the computer software, and that the same does not give rise to any income taxable in India, as a result of which the persons referred to in Section 195 of the Income Tax Act were not liable to deduct any TDS under Section 195 of the Income Tax Act."

- "There is a clear distinction between royalty paid on transfer of copyright rights and consideration for transfer of copyrighted articles. Right to use a copyrighted article or product with the owner retaining his copyright, is not the same thing as transferring or assigning rights in relation to the copyright."

- "The licence granted to the licencee permitting him to download the computer programme and storing it in the computer for his own use is only incidental to the facility extended to the licencee to make use of the copyrighted product for his internal business purpose... The right to use a copyright in a programme is totally different from the right to use a programme embedded in a cassette or a CD which may be a software and the payment made for the same cannot be said to be received as consideration for the use of or right to use of any copyright to bring it within the definition of royalty as given in the DTAA."

- "The right of subscription to a cloud-based software cannot possibly be said to be equivalent to the 'use' or 'right to use' any industrial, commercial or scientific equipment."

- The Court affirmed that the principles established in Engineering Analysis and subsequent rulings apply uniformly to all forms of software licensing and subscription arrangements, including cloud-based models.

- The appeal was dismissed, affirming the view that such software subscription/license payments do not attract tax withholding under Section 195 and are not taxable as royalty income in India.