TMI Blog2011 (12) TMI 91X X X X Extracts X X X X X X X X Extracts X X X X ..... n, the place of signing of agreement, or formal acceptance thereof or overall responsibility of the assessee are irrelevant circumstances. Since the transaction relates to the sale of goods, the relevant factor and determinative factor would be as to where the property in the goods passes. In the present case, the goods were manufactured outside India and even the sale has taken place outside India. Thereby, no part of the income accrued to the assessee in India. The terms of the contract make it clear that the acceptance test is not a material event for the passing of the title and risk in the equipment supplied. It is further held that payment received by the assessee was towards the title and GSM system of which software was an inseparable parts incapable of independent use and it was a contract for supply of goods. Therefore, no part of the payment therefore can be classified as payment towards royalty. The assessee together with supply of hardware and software has to over-see installation thereof to ensure that it was carried out to the satisfaction of Indian buyer in accordance with the terms of the contract. It is clear that under the Supply Contract, the assessee has not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d that it is not liable to tax under the provisions of the Income-Tax Act, 1961 and the Double Taxation Avoidance Agreement between Sweden and India (the "DTAA"). It is necessary to highlight that the assessee, as stated above, is a wholly owned subsidiary of the L.M. Group of Companies with whom the cellular operators had entered into supply agreements. The Ericsson Telephone Corporation India AB is also a foreign company with a branch in India and is a subsidiary of the parent company of the assessee, viz., Telefonakitiebolaget L.M. Ericsson. There is one more entity, namely, Ericsson Communications Limited, which is an Indian company and is a wholly owned subsidiary of the parent company. For the purpose of brevity, Ericsson Radio System AB is referred to as the assessee, whereas Ericsson Telephone Corporation India AB is referred to as EFC and Ericsson Communications Limited is referred to as ECL and the company Telefonakitiebolaget L.M. Ericsson is referred to as LME. 3. The assessee, a non-resident company, supplies equipment to the operators, while the other two companies (EFC and ECL) are in the business of installation of the equipment and granting marketing support to t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ch was taxable in India. 8. The Assessing Officer also considered the question whether the assessee's income was taxable in India in view of Article 7 read with Article 5 of the Double Taxation Avoidance Agreement between India and Sweden and concluded as follows:- "1. The assessee has a permanent establishment in the form of a dependent agent establishment which is EFC. 2. The assessee also has a permanent establishment in the form of a dependent agent PE which is ECI in the later part of the year i.e. after July 1996. 3. It has PE in the form of a branch which was providing a fixed place of business to the assessee. 4. The office of ECI was a fixed place of business for the assessee company. 5. The employees of the assessee company were coming to India and signing contracts and were staying in India and using various facilities which clearly shows that the assessee had a fixed place of business." 9. The A.O. then proceeded to render detailed findings in respect of each of the aforesaid matters, to which we shall presently advert before proceeding to deal with the software supply contract entered between the cellular operator and the assessee and Article 13 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lant had taken five grounds of appeal, apart from taking up two additional grounds subsequently as follows:- (i) Ground No.1 was that the learned A.O. had erred in holding that the income chargeable to tax in India accrued or arose to the assessee. This ground was held to be too general in nature by the CIT(A). (ii) Ground No.2 dealt with the assessee's business connection in India and the existence of permanent establishment in India. The CIT(A) decided the aspect of business connection against the appellant, but the additional ground taken up by the assessee on 21.07.2000 against existence of PE of the assessee in India, was decided in favour of the assessee. (iii) Ground No.3 mentioned that the assessee incurred, a loss during the year as certified by Price Water House Cooper, Sweden and, therefore, the A.O. erroneously brought to tax the impugned income of Rs. 74,02,47,865/- consisting of business income of Rs. 33,99,69,471/- and royalties of Rs. 40,02,78,394/-. The CIT(A) partly allowed this ground, and held that while no business profit can be computed in the absence of PE of the assessee in India, the assessee was liable to pay tax on royalties received by it from ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 507/2007 "1. Whether in law, the Ld. Delhi Tribunal was justified in holding that the assessment was invalid inasmuch as it was framed pursuant to a notice issued under Section 142 91)(i) of the Income-Tax Act, 1961, which notice was issued beyond the period of limitation? 2. Whether in law, the Ld. Delhi Tribunal was justified in holding that the assessee did not have a business connection in India? 3. Whether in law, the Ld. Delhi Tribunal was justified in holding that the consideration for supply of software was not a payment by way of royalty, and hence, was not assessable both under Section 9(1)(vi) of the Double Taxation Avoidance Agreement between the government of India and Sweden?" ITA 508/2007 "1. Whether in law, the Ld. Delhi Tribunal was justified in holding that the assessee did not have a business connection in India.?" ITA 511/2007 "1. Whether in law, the Ld. Delhi Tribunal was justified in holding that the assessee did not have a permanent establishment in India? 2. Whether in law, the Ld. Delhi Tribunal was justified in deleting the levy of interest charged under Section 234B of the Income Tax Act, 1961?" 13. We may first deal with the tw ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... has business connection in India, then this question may not even need to be considered). (3) Whether hardware and software components of the equipment can be segregated for the purpose of Section (1)(vi) of the Act? 17. The issue as to whether any income can be brought to tax in terms of the Act is dealt with in paras 103 to 123 of the Tribunal's order. The Tribunal has come to the conclusion that no part of the income accrues or arises in India because having regard to the terms of Article 13 of the Supply Contract it is clear that property in the goods has passed outside India. In this regard, the Tribunal has held that the mere fact that the contract was signed in India is an irrelevant circumstance and the reliance by the revenue on the judgment of the Supreme Court in the case of 20th Century Finance Corporation is misplaced. The Supreme Court in that case was concerned with the issue as to where the situs of the taxable event of a contract to transfer a right to use goods was located. It was in that context that the Supreme Court held that the situs of the taxable event in such a deemed sale was the place where the contract for the transfer of the right to use the good ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g such overall responsibility. The Tribunal further found that no payment accrued either to the assessee or the installation contractor under the overall agreement, but the overall agreement merely ensured supervision and guaranteed the performance of all the contracts in a co-ordinated manner. The Tribunal further noted that the installation contractors and the assessee were separate independent entities and there was no evidence brought on record to disclose that any one is dependent on the other, either financially or in any other manner. The Tribunal further held that the finding of the Commissioner of Income-Tax (A) that the various entities were formed for the purpose of business and were doing business independently as per their instruments of incorporation was not disputed by the Revenue. The Tribunal found that both EFC as well as ECI were separately assessed to tax in India. The Tribunal thus came to the conclusion that there was no business connection with the assessee in India having regard to the nature of the arrangement that the assessee had with either EFC or ECI. Further, as no operations were formed by the assessee in India no income could be charged to tax in Ind ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... egrated business arrangement. He specifically referred to the following features of these Agreements: Supply Agreement Preamble: Agreement for supply of hardware and software license. Article 5: Scope of the contract. The said clause uses the phrase "turn key basis". Article 18: Acceptance Test and Acceptance certificate issued by the Installation Contractor will bind on the assessee. Article 20: Provides for the license to use software for the purposes of setting up of a system Article 21: Assignment of the contract may be done whereby the hardware may be assigned to anyone by the Indian supplier, but the software may be assigned only after due permission of the assessee. Article 31: Provides for termination of the supply contract. Installation Agreement Preamble: Agreement for installation of hardware supplied and software for which license has already been granted. Article 15: Acceptance Test made by the installation contractor includes the integrity of the whole system and certificate binds the assessee. Article 17: The installation contractor warranties to rectify defects in both hardware and software (which ar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... normal coverage X Preparation of frequency plan X Drive test (when found necessary) for checking * X Suitability of chosen sites, preferably in conjunction with site survey Develop acceptance plan * X Provision of equipment and material X Performance and reliability in accordance to agreed to specifications X Even if the Installation Contract is terminated, the Supply Contract is not terminated and the assessee is responsible for making an alternative arrangement. However, if the Supply Contract is terminated, the Installation Contract also stands terminated as evidenced by Clause 5.5 of the Overall Agreement, which reads thus: "5.5 In the event that the Supply Contractor terminates his contract, by notice in writing to JT MOBILES, the Installation Contractor may also terminate his contract by notice in writing to JT MOBILES. In the event that the Installation Contractor terminates his contract by notice in writing to JT MOBILES, the Supply Contractor shall locate a party accept ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the contrary contained therein." 24. His submission was that this clause clearly shows that the Overall Agreement between JT MOBILES (the cellular operator) and the Supply Contractor (the assessee) and the EFC (the Installation Contractor) "concerning some additional terms and conditions due to the Supply and Installation of a Mobile Telephone System" was to prevail over the Supply Contract and the Installation Contract, which, in itself goes to show that it was integrated business arrangement between the parties. 25. Mr. Prasaran further argued that the Income Tax Appellate Tribunal could not have held that the Supplier, i.e., the assessee was not liable for faulty installation in the teeth of the declaration in the Preamble to the Overall Agreement read with Clause 2 of the said agreement, which vests the responsibility for the proper installation with the assessee: "And whereas the Supply Contractor and the Installation Contractor have agreed to act in a co-ordinated manner so as to supply the System and install and commission the System. Now therefore, it is hereby agreed by and between the parties hereto as follows . 1. Interpretation: 2. Execution: "The Su ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nter alia the place where the contract is entered into, the place where the contract has to be performed, where a given right can be exercised and what sort of rights are granted in India. (d) In the present case, it is undisputed that:- All the vendeees are based in India The GSM systems are being set up India. The software is licensed for use in India The hardware is being supplied for setting up of a system in India The acceptance test to confirm the successful installation is done in India. The responsibility to ensure successful installation in India rests with the assessee. (e) The assessee's obligations therefore cannot be said to end once the title of the goods has passed to the Indian buyer. In addition, valuable rights are granted by the assessee which can only be exercised in India and the relationship between the assessee and its Indian customers is more than just that of mere seller and buyer of goods simpliciter. (f) In the alternative, income from the contracts amount to a source of the income that constitutes a "business connection" for the purposes of Section 9 (1)(i) of the Income Tax Act, 1961 and therefore income ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ments. He relied upon Section 19 of the Sale of Goods Act which makes it clear that property in goods passes when the parties intend it to pass and in the present case, according to him, the intention of the parties was manifested in Article 13 of the Supply Contract and the provisions of Article 15 relating to the Acceptance Test could not militate against such intention. 31. Refuting the contention of Mr. Prasaran that merely because the acceptance test of the GSM system was carried out in India by ECI/EFC, the income must be regarded arising in India, Mr. Datur submitted that the fact that the acceptance test was performed in India by the installation contractor is not relevant for determining where the title in the equipment passes and consequently where income accrues. The terms of the contract make it clear that the acceptance test is not a material event for the passing of the title and risk in the equipment supplied. The acceptance test is an act which is performed for the benefit of the cellular operator and although the assessee would be bound by such test performed by the installation contractor, the same is not an act on behalf of the assessee. According to Mr. Dastur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... held in Gulf Oil Great Britain Ltd. (supra). 34. His alternate submission was that even assuming the assessee is regarded as having a business connection in India, either in the form of the installation contractor or in the form of the cellular operators, nevertheless, by virtue of clause (a) of Explanation-1 to Section 9 (1) (i) no part of the income arising to the assessee from the supply of equipment can be deemed to accrue or arise in India as the material operations in connection with such supply viz, the manufacture and the transfer of property of the goods supplied, were completed outside India. 35. Mr. Dastur went to the extent of arguing that even if one treats the contracts as a composite contract, as alleged by the Revenue, the consideration attributable to the work performed in India, namely, the marketing activity and the installation activity is already assessed to tax in India in the assessments made on EFC and ECI and as no authority has disputed that the installation contractor and the marketing agent are remunerated on an arm's length basis the charge to tax, if any, in India would stand exhausted. In support, he relied upon the judgment of this Court in DIT v ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... was chargeable to tax in India as the permanent establishment had no role to play in the transaction sought to be taxed as it took place abroad, whilst in the case of the assessee, it has been found as a fact by both the appellate authorities that no permanent establishment existed; (v) the mere signing of the contract pursuant to which the supply was made in India, in both cases does not result in giving rise to a tax liability in India; (vi) the existence of the overall responsibility clause was held to be irrelevant in Ishkawajima's case and likewise the overall agreement executed in the assessee's case should not make any difference to the taxability of the equipment supplied; (vii) giving the nomenclature of a turnkey project or works contract is not relevant in determining whether any profit arising from the supply of equipment pursuant to such contract was chargeable to tax in India; (viii) the Supreme Court relied upon Instruction No. 1829 to come to the conclusion that the existence of an overall responsibility clause was not material in determining the tax liability arising from the offshore supply of equipment and as the said instruction continues to be in force ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd after sale services and the assessee had complete control over the management, functions and the associates. The question that falls for consideration is as to whether this acceptance test, which was performed in India, would be relevant for determining as to whether income accrued in India in terms of Section 5 (2)(b) of the Act. 41. We, find that the terms of contract make it clear that acceptance test is not a material event for passing of the title and risk in the equipment supplied. It is because of the reason that even if such test found out that the system did not conform to the contractive parameters, as per article 21.1 of the Supply Contract, the only consequence would be that the Cellular Operator would be entitled to call upon the assessee to cure the defect by repairing or replacing the defective part. If there was delay caused due to the acceptance test not being complied with, Article 19 of the Supply Contract provided for damages. Thus, the taxable event took place outside India with the passing of the property from seller to buyer and acceptance test was not determinative of this factor. The position might have been different if the buyer had the right to reje ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... perty is subject to the condition that the goods should re-vest in the seller if on an examination by the buyer he finds them not to be in accordance with the contract. It is not necessary to consider this aspect because in any case the ascertainment of the obligations under the contract will determine to what extent the transfer of property is subject to a condition or if the property passes conditionally whether the ownership left in the seller is the reversionary interest in the property in the event of the conditions subsequent operating to restore it to him. In any case where the performance of some condition is imposed upon the buyer but is not made a condition of the transfer of the property, the property once passed is not revested in the seller by the buyer's subsequent default." 43. Thus, Overall Agreement does not result the income accruing in India. The execution of an overall agreement is prompted by purely commercial considerations as the India Cellular Operator would be desirous of having a single entity that he could liaise with, a fact which even the Board has noted in its Instruction No.1829 dated 21st September, 1989. Although Instruction number 1829 stands wit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s not their case that only one assessment has to be made treating the transaction as one works contract. 47. Section 9 (1) (i) of the Act as it stood before the amendment to it by the Finance Act, 2010 provides that income accruing or arising, whether directly or indirectly, through or from any business connection in India is deemed to accrue or arise in India. The Department has not stated that the assessee has any business connection in India, inasmuch as the cellular operators are independent contractee parties and action cannot be held to be assessee's business connection. In such circumstance, the case would be covered by Explanation-1 to Section 9 (1) (i) of the Act. Clause (a) of Explanation-1 lays down that in the case of business if all the operations are not carried out India, the income of business that is deemed to accrue or arise in India would be only such part of the income as is reasonably attributable to operations carried out in India. In view of the aforesaid discussion, it is clear that under the Supply Contract, the assessee has not earned any income in India through or from any business connection. 48. Insofar as Installation Contract is concerned, that is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India" 51. The submission of Mr. Prasaran, learned ASG was that software part of the equipment supply would attract royalty as copy right of the said software programme still vests with the assessee. Therefore, payments made for the licence to use the software programme give rise to 'royalty' for the purposes of both the Income-Tax Act as well as DTAA entered into between Sweden and India. Referring to Explanation-II (v) to Section ( (1) (vi) of the Act as well as Article 13, para-3 of DTAA, it was argued that for the purposes of Income-Tax law, royalty is essentially a payment received as consideration for the use or right to use a particular integral property right, whether partially or entirely. 52. We find that the Tribunal has held that there was no payment towards any royalty and this conclusion is based on the following reasoning:- (i) Payment made by the cellular operator cannot be characterized as royalty either under the Income Tax Act or u ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng to him, since title of the software continued to vest with the assessee as provided in clause 20.2 of the Supply Agreement and the assessee was free to grant non-exclusive licenses to other parties, it follow that there was no full time transfer of copyright but it was only a case of right to use the software, and thus payment for use of software is to be treated as royalty. He further argued that reference to OECD Commentary was not apposite as it could not be used to interpret the scope of the relevant provisions of DTAA. 54. It is difficult to accept the aforesaid submissions in the facts of the present case. We have already held above that the assessee did not have any business connection in India. We have also held that the supply of equipment in question was in the nature of supply of goods. Therefore, this issue is to be examined keeping in view these findings. Moreover, another finding of fact is recorded by the Tribunal that the Cellular Operator did not acquire any of the copyrights referred to in Section 14 (b) of the Copyright Act,1957. 55. Once we proceed on the basis of aforesaid factual findings, it is difficult to hold that payment made to the assessee was in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dia cannot be split up. What the buyer purchases and pays for is not the disc or the CD. As in the case of paintings or books or music or films the buyer is purchasing the intellectual property and not the media i.e. the paper or cassette or disc or CD. Thus a transaction sale of computer software is clearly a sale of "goods" within the meaning of the term as defined in the said Act. The term "all materials, articles and commodities" includes both tangible and intangible/incorporeal property which is capable of abstraction, consumption and use and which can be transmitted, transferred, delivered, stored, possessed etc. The software programmes have all these attributes." ** ** ** "In Advent Systems Ltd. v. Unisys Corpn, 925 F. 2d 670 (3rd Cir. 1991), relied on by Mr. Sorabjee, the court was concerned with interpretation of uniform civil code which "applied to transactions in goods". The goods therein were defined as "all things (including specially manufactured goods) which are moveable at the time of the identification for sale". It was held : "Computer programs are the product of an intellectual process, but once implanted in a medium are wid ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... purpose of technical services to be rendered by a foreign company, which is not connected for the fulfillment of the main contract entered into principal to principal. This is not one such case and thus the contention of the Revenue cannot be accepted in the circumstances and nature of the terms of the contract of this case." 58. No doubt, in an annexure to the Supply Contract the lump sum price is bifurcated in two components, viz., the consideration for the supply of the equipment and for the supply of the software. However, it was argued by the learned counsel for the assessee that this separate specification of the hardware/software supply was necessary because of the differential customs duty payable. 59. Be as it may, in order to qualify as royalty payment, within the meaning of Section 9(1) (vi) and particularly clause (v) of Explanation-II thereto, it is necessary to establish that there is transfer of all or any rights (including the granting of any license) in respect of copy right of a literary, artistic or scientific work. Section 2 (o) of the Copyright Act makes it clear that a computer programme is to be regarded as a 'literary work'. Thus, in order to treat the c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ction (1) and shall be included in the total income of the non-resident, whether or not,- (i) the non- resident has a residence or place of business or business connection in India; or (ii) the non-resident has rendered services in India." 63. We may place on record that initially the Finance Act, 2007 inserted an Explanation at the end of Section 9 to provide that "for the removal of doubts, it is hereby declared that for the purposes of this section, where income is deemed to accrue to arise in India under clauses (v), (vi), and (vii) of sub-Section (1), such income shall be included in the total income of the non-resident, whether or not the non-resident has a residence or place of business or business connection in India." This Explanation was inserted ostensibly to get over that part of the judgment of the Supreme court in the case of Ishikawajima (supra) where the Supreme court had observed that for Section 9(1) (vii) to be applicable it is necessary that the services should not only be utilized in India but should also be rendered In India. As this Explanation did not achieve the purpose it was intended to serve, as was pointed out by the Karnataka High Court in i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y Industries Ltd. v. DIT [2007] 288 ITR 408, held that despite the deeming fiction in section 9, for any such income to be taxable in India, there must be sufficient territorial nexus between such income and the territory of India. It further held that for establishing such territorial nexus, the services have to be rendered in India as well as utilized in India. This interpretation was not in accordance with the legislative intent that the situs of rendering service in India is not relevant as long as the services are utilized in India. Therefore, to remove doubts regarding the source rule, an Explanation was inserted below sub-Section (2) of Section 9 with retrospective effect from 1st June, 1976 vide Finance Act, 2007. The Explanation sought to clarify that where income is deemed to accrue or arise in India under clauses (v), (vi) and (vii) of sub-section (1) of Section 9, such income shall be included in the total income of the non-resident, regardless of whether the non-resident has a residence or place of business or business connection in India. However, the Karnataka High Court, in a recent judgment in the case of Jindal Thermal Power Company Ltd. v. DCIT (TDS), has held ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed to accrue or arise in India under clauses (v), (vi) and (vii) of sub-section (1), such income shall be included in the total income of the non-resident, whether or not, the non-resident has a residence or place of business or business connection in India. It is proposed to substitute the said Explanation so as to provide that the income of a non-resident shall be deemed to accrue or arise in India under clause (v) or clause (vi) or clause (vii) of subsection (1) and shall be included in the total income of the non-resident, whether or not,-the non-resident has a residence or place of business or business connection in India; or the non-resident has rendered services in India. This amendment will take effect, retrospectively, from 1st June, 1976 and will, accordingly, apply in relation to the assessment year 1977-78 and subsequent years." 67. On the other hand, argument of the learned counsel for the assessee is that this amendment does not impact the present case. It was argued that the Explanation as initially inserted in the year 2007 sought to clarify as to when income received by way of interest, royalty or fees for technical services, can be regarded as deemed to accr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , once it relates to supply of goods and further in any case, where both the transfer of the property in goods or risk passed outside India, the conclusion is that no taxable event took place in India. The question of applicability of the Explanation would arise only when payment is to be treated as "royalty" within the meaning of clause (vi) or "fee for technical services" as provided in clause (vii) of the Act. 70. The result of the aforesaid discussion would lead to the answer to questions framed in favour of the assessee and against the revenue and would result in the dismissal of the appeals of the Revenue. ITA No. 397/2007 71. This appeal was admitted on the following questions of law:- "1. Whether Ld. ITAT in the facts and circumstances of the case erred in holding that such software supplies were 'sale' and hence business income and not Royalty in terms of Indo-UK Treaty? 2. Whether Ld. ITAT was correct in law in confirming decision of the Ld. CIT (A) by limiting income from hardware sales at 8%? 3. Whether Ld. ITAT erred in holding that Assessee is not liable for interest under Section 234A and 234B of the Income Tax Act, 1961?" 72. It was agreed that th ..... X X X X Extracts X X X X X X X X Extracts X X X X
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