2003 (10) TMI 250 - AT - Income Tax

Obligation to deduct tax at source u/s 195 - Deemed To Accrue Or Arise In India - non-resident company importing software - Payments for software as royalty under section 9(1)(vi) - DTAA between India and the United States - manufacture and sale of electronic switching systems required for the telecommunication industry and a substantial part of its sales are to the DoT - HELD THAT - 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 purchased is a copyrighted article and not copyright of the rights. Therefore it is wrong on the part of the Department to have separated the transaction of purchase of software and viewing the purchase of software as an independent transaction. The assessee had not acquired any rights in the software. The assessee cannot be seen to be duplicating the software in making use of the same. The software that is so supplied by Lucent USA is customer-specific and cannot be even reused or duplicated in any other exchange where identical orders are placed by the DOT. In other words software that is supplied by Lucent USA is customer-specific and is required only to be integrated into hardware that is supplied for specific unit. The Department therefore in our view is not justified in bifurcating the transactions as one of the supply of hardware and the other of software and treating software as a part of royalty. It must be appreciated that the assessee in this case has not acquired rights in the copyright program so that it can be exploited commercially. It is a customer-specific supply and it is a case of clear business transaction of purchase of equipment along with software to make the hardware functional. In our view therefore Department is not justified in treating the impugned payments as royalty simpliciter and thereby holding that the assessee is an assessee-in-default for failure to deduct tax at source. In our considered view the payment for impugned transactions does not partake the character of royalty and therefore there is no question of any obligation on the part of the assessee to deduct tax at source in respect of these disputed payments. The assessee is under no obligation to deduct tax at source u/s 195 of the Act in respect of the sums paid for acquiring software. Therefore the orders of the ITO (TDS) u/s 201 and 201(1A) of the Act are therefore vacated. In the result the appeals are allowed.

Summary

Issues Involved:
1. Obligation to deduct tax at source u/s 195 for payments made to a non-resident company for software acquisition.
2. Classification of payments for software as "royalty" under section 9(1)(vi) of the IT Act and the DTAA between India and the USA.
3. Determination of whether the software acquisition is a purchase of a copyrighted article or a copyright right.

Summary:

1. Obligation to Deduct Tax at Source u/s 195:
The assessee, a limited company engaged in manufacturing and selling electronic switching systems, imported software from Lucent, USA without deducting tax at source. The ITO (TDS) treated the assessee as an assessee-in-default u/s 201(1) for failing to deduct tax and demanded interest u/s 201(1A). The assessee contended that the software acquisition was inextricably linked to hardware and that no profit accrued in India due to the transfer taking place outside India. Additionally, the DTAA provisions were cited to argue that the gains were not chargeable to tax as the supplier had no permanent establishment in India.

2. Classification of Payments as "Royalty":
The ITO (TDS) rejected the assessee's contentions, holding that the provisions of section 195 applied and the payments were considered royalty under section 9(1)(vi) of the IT Act and article 12(3)(a) and (b) of the DTAA. The ITO (TDS) argued that software and hardware were imported separately, and the software was not supplied under any approved scheme. The software was deemed an intellectual property right (IPR), and the payments were considered for the use of or the right to use industrial, commercial, or scientific equipment, thus falling under the definition of royalty.

3. Determination of Copyrighted Article vs. Copyright Right:
The assessee argued that the software was an integral part of the hardware and was customer-specific, making it a purchase of a copyrighted article rather than a copyright right. The assessee had no right to duplicate or use the software in any other transaction. The Tribunal agreed with the assessee, noting that the software was customer-specific and could not be reused or duplicated. The transaction was viewed as a purchase of integrated equipment, and the Department was not justified in treating the software payment as royalty.

Conclusion:
The Tribunal held that the payment for the software did not partake the character of royalty and there was no obligation on the part of the assessee to deduct tax at source u/s 195. Consequently, the orders of the ITO (TDS) u/s 201 and 201(1A) were vacated, and the appeals were allowed.