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TMI Blog2011 (10) TMI 195X X X X Extracts X X X X X X X X Extracts X X X X ..... 03/2006; ITA 1212/2006; ITA 1251/2006; ITA 94/2007; ITA 1237/2006; ITA 1061/2006; ITA 1244/2006; ITA 1074/2006; ITA 612/2006; ITA 265/2006; ITA 1066/2006; ITA 782/2007; ITA 739/2007; ITA 953/2007; ITA 1210/2006; ITA 1211/2006; ITA 1214/2006; ITA 1220/2006; ITA 1222/2006; ITA 738/2007; ITA 740/2007; ITA 1246/2006; ITA 1240/2006; ITA 1236/2006; ITA 1225/2006; ITA 1056/2006; ITA 2991/2005; ITA 746/2007; ITA 786/2007; ITA 1204/2006; ITA 1205/2006; ITA 1219/2006; ITA 1224/2006; ITA 2989/2005; ITA 919/2007; ITA 1247/2006; ITA 1243/2006; ITA 1239/2006; ITA 1238/2006; ITA 1055/2006; ITA 780/2007; JUDGMENT These appeals are disposed of by common order as they involve adjudication of the following substantial question of law as framed by the Hon'ble Supreme Court while remanding the proceedings to this Court in Civil Appeal Nos.7541-7542/2010 and connected matters, by setting aside the judgment passed by the Division Bench of this Court dated 24-9-2009. "The question which the High Court will answer is - 'whether on facts and circumstances of the case, the ITAT was justified in holding that the amount(s) paid by the appellant(s) to the foreign software Suppliers was not 'royalty' and that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion 195(1) of the Act and therefore for the default for non-deduction of the advance tax which was payable by the non-resident assessee, the assessee respondent is liable to imposition of penalty and deducted tax at 10% of the value as the said percentage of tax was beneficial to the assessee as compared to tax imposed under the Act and DTA agreement. 3. Being aggrieved by the said order passed by the assessing officer, an appeal was filed before the Commissioner of Income Tax (Appeals)-V in appeal No. ITA 17/TDS/CIT(A)V/2001-02 wherein the appellate authority confirmed the order passed by the assessing officer holding that payment made to the non-resident companies was taxable in India and therefore non deduction of TDS under Section 195(1) of the Act would make liable the respondent to treat the same as income and therefore the respondent would be liable for default for non-deduction of tax at source and dismissed the appeal Being aggrieved by the said order, the respondent filed an appeal before the Income Tax Appellate Tribunal. Bangalore (hereinafter called the Tribunal) in ITA Nos. 264 to 266/Bang/2002 and the Tribunal by order dated 18-12-2005 allowed the appeal by setting ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ns of Sections 4, 5, 9, 195, 401 & 201 of the Act. He further submitted that the payment made by the respondent falls within the definition of the term 'royalty' within the meaning of Section 9(l)(vi) read with Explanation (2) and relevant clause under Article 12 of the DTAA agreement with USA and relevant clauses under the DTAA with the other countries in which non-resident assessee is located. He submitted that the fact that the payment has been made by the respondent-company in each of the appeals to the non-resident company is not disputed. The said payment has been made in view of the use of the copyrighted article i.e., shrink wrapped software and in view of the definition of royalty under Explanation (2) to Section 9(1)(vi) of the Act, it is clear that royalty means consideration including any lumpsum consideration for transfer of all or any rights for imparting any information concerning the working of or the use of, a patent, invention, model, design or process or and imparting any information concerning technical, scientific knowledge, experience or skill and thereof for the consideration of the payment made by the assessee, the respondent company is licenced to use the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion in question was sale for the purpose of Andhra Pradesh General Sales Tax, 1957 and the same would not apply to the respondents in these cases to contend that payment is not royalty and the transaction amounts to sale and for the same reasons, the Tribunal was also not justified in relying upon the other decisions. The learned counsel further submitted that the assessing officer has passed a detailed order giving the reasons as to why the payment made by the respondent to non-resident assessee is a royalty and was deductible under Section 195 of the Act and the appellate authority has confirmed the same by writing a detailed order with reference to OECD commentary and has held that payment made by the respondent was royalty and there was concurrent finding on the said question of fact and the same could not have been disturbed by the Tribunal and that the order of the Tribunal hording that payment is not royalty and though it is sale, it is not taxable as the respondent-assessee has no permanent establishment in India is erroneous and is liable to be set aside by holding that payment made by the respondent to the non-resident assessee is royalty and accordingly, substantial ques ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... terms of Section 90(2) of the Act, the Hon'ble Supreme Court in UNION OF INDIA v. AZAD1 BACHAO ANDOLAN & ANOTHER (263 ITR 706) and CIT v. P.V.A.L. KULANDAGAN CHETTIAR (267 ITR 654), COMMISSIONER OF INCOME TAX v. ORACLE SOFTWARE INDIA LTD. [(2010) 320 ITR 546], DASSAULT SYSTEMS K.K., In Re ((2010) 322 ITR 125 (AAR) and GEOQUEST SYSTEMS B.V., In Re [(2010 327 ITR 1 (AAR)] held that payment can never be construed as royalty and it would be a sale and since admittedly non-resident assesse is not having permanent establishment in India, the payment would not be taxable and therefore, there is no obligation to deduct tax. The learned counsel submitted that the transaction was not covered by any licence or assignment under the Indian Copyright Act and therefore, it cannot be construed as licence though the term licence' has been used in the agreement, it connotes sale of the shrink wrapped product sale. He submitted that the contention of learned counsel appearing for the appellant that definition of royalty in TCS's case was considered only for the purpose of sale under Article 366(12) of the Constitution of India is not correct and similar transaction is held to be a sale in the said c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o the customer and the name of the customer is also stated in the invoice and in some cases was directly sent to the customer and therefore, distributor by himself does not keep any right in the copyright or keep any use in the copyrighted article and therefore, payment can never be termed as royalty. The learned Sr. Counsel apart from reiterating the submissions made by the learned counsel Sri K P Kumar, further submitted that licence has been defined under Section 52 of the Easement Act as the permission to do something which, but for the permission would be unlawful and Section 52(a)(a) of the Copyright Act expressly permits the purchaser of a software package to copy it on his computer and also to make a back-up copy. Therefore, the statutory right of the purchaser/end user of the software package, even if no licence or permission is granted by the copyright owner to the end user as the making of a copy by the end user is not unlawful, the formal permission given to him by the copyright owner is not even a licence as defined by section 52 of the Easements Act and consequently, section 14(b)(i) of the Copyright Act is not attracted. The OECD commentary treats the said permission ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g for the respondent in ITA Nos. 1056/2006 and connected matters submitted that in view of Section 90 of the Act, provisions of DTA agreement would prevail and since the payment made by the respondent-company would not amount to royalty as defined in the said agreement, it is unnecessary to look into the question whether the amount would fall within the ambit of royalty as defined under Section 9(1)(vi) Explanation (2) of the Act. Even otherwise, as the definition of royalty under the DTA agreement has got a restrictive meaning than the definition of royalty under the Act, he further submits that commentary of OECD is important in interpreting clauses/Articles in DTAA and the Tribunal having considered the said commentary and also the observations made by the renowned author Klaus Vogel on Double Taxation Conventions which have been referred to by the Courts while interpreting the Article by the DTA would clearly show that payments made for purchase of shrink wrapped software can never be a royalty and it may at the most, amount to sale and proceeds of sale could not be taxable in India as there is no permanent establishment of non-resident assessee in India. In support of his cont ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nts' in all the appeals and carefully scrutinised the material on record with reference to the principles laid down by the Hon'ble Supreme Court and other High Courts and the decisions relied upon by learned counsel appearing for the parties. 12. Before considering the contentions of learned counsel appearing for the parties, it is necessary to bear in mind the decision rendered by the Division Bench of this Court by order dated 24-2-2009 wherein the Division Bench considered the appeal on merits and held that payment made was royalty within the meaning of the Act and therefore adjudicated by holding that all payments made to the non-resident assessee are to be deducted at source unless the respondent-company has obtained exemption from deducting the said tax as royalty under Section 195 of the Act and accordingly, allowed the appeals by answering the issue in favour of the appellant. 13. Civil Appeal Nos. 7541-7542/2010 and connected appeals were filed before the Hon'ble Supreme Court and the Hon'ble Supreme Court by order dated 9-9-2010 has set aside the order passed by this Court dated 24-9-2009 and remitted the matter for consideration of the following substantial question of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e sum by the recipient and that the payment does not arise out of any contract or obligation between the payer and the recipient but is made voluntarily, such payments cannot be regarded as income under the I.T. Act. It may be noted that Section 195 contemplate not merely amounts, the whole of which are pure income payments, it also covers composite payments which has an element of income embedded or incorporated in them. Thus, where an amount is payable to a non-resident, the payer is under an obligation to deduct TAS in respect of such composite payments. The obligation to deduct TAS is, however, limited to the appropriate proportion of income chargeable under the Act forming part of the gross sum of money payable to the non-resident. This obligation being limited to the appropriate proportion of income flows from the words used in Section 195(1), namely, "chargeable under the provisions of the Act". It is for this reason that vide Circular No. 728 dated October 30, 1995 the CBDT has clarified that the tax deductor can take into consideration the effect of while deducting TAS. It may also be noted that Section 195(1) is in identical terms with Section 18(3B) of the 1922 Act. In C ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... learned counsel appearing for the parties regarding the validity of the order passed by this Court dated 24-9-2009 has observed as follows: 9. One more aspect needs to be highlighted. Section 195 falls in Chapter XVII which deals with collection and recovery. Chapter XVII-B deals with deduction at source by the payer. On analysis of various provisions of Chapter XVII one finds use of different expressions however, the expression "sum chargeable under the provisions of the Act" is used only in Section 195. For example, Section 194C casts an obligation to deduct TAS in respect of any sum paid to any resident". Similarly, Sections 194EE and 194F inter alia provide for deduction of tax in respect of "any amount" referred to in the specified provisions. In none of the provisions we find the expression "sum chargeable under the provisions of the Act", which as stated above, is an expression used only in Section 195(1). Therefore, this Court is required to give meaning and effect to the said expression. It follows, therefore, that the obligation to deduct TAS arises only when there is a sum chargeable under the Act. Section 195(2) is not merely a provision to provide information to the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... utes one single integral inseparable Code. Hence, the provisions relating to TDS applies only to those sums which are Department that any person making payment to a non-resident is necessarily required to deduct TAS then the consequence would be that the Department that any person making payment to a non-resident is necessarily required to deduct TAS then the consequence would be that the Department would be entitled to appropriate the moneys deposited by the payer even if the sum paid is not chargeable to tax because there is no provision in the I.T. Act by which a payer can obtain refund. Section 237 read with Section 199 implies that only the recipient of the sum. i.e., the payee could seek a refund. It must therefore follow, if the Department is right that the law requires tax to be deducted on all payments. The payer, therefore, has to deduct and pay tax, even if the so-called deduction comes out of his own pocket and he has no remedy whatsoever, even where the sum paid by him is not a sum changeable under the Act. The interpretation of the Department, therefore, not only requires the words "chargeable under the provisions of the Act" to be omitted, it also leads to an absurd ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... effective compliance of Section 195 of the I.T. Act relating to tax deduction at source in respect of payments outside India in respect of royalties, fees or other sums chargeable under the I.T. Act. In a given case where the payer is an assessee he will definitely claim deduction under the I.T. Act for such remittance and on inquiry if the AO finds that the sums remitted outside India comes within the definition of royalty or fees for technical service or other sums chargeable under the I.T Act then it would be open to the AO to disallow such claim for deduction. Similarly, vide Finance Act, 2008, w.e.f. 1.4.2008 sub-Section (6) has been inserted in Section 195 which requires the payer to furnish information relating to payment of any sum in such form and manner as may be prescribed by the Board. This provision is brought into force only from 1.4.2008. It will not apply for the period with which we are concerned in these cases before us. Therefore, in our view, there are adequate safeguards in the Act which would prevent revenue leakage. Further, the Hon'ble Supreme Court remitted the matter and framed substantial questions of law by holding as follows: 11. Before concluding we ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the payment made does not come within the purview of royalty under Section 9(1)(vi) of the Act or within the provisions of the Act or clauses in DTAA, and what is purchased is an article which is taxable as business income and since exporter - non-resident is not having permanent establishment in India, such income which is accrued in India is not taxable, in any event, payment would not amount to royalty. Therefore, before considering the rival contentions of learned counsel appearing for the parties to find out as to whether the payment made by the respondent with foreign company would amount to 'royalty' or not, it is necessary to reproduce the definition 'royalty' and the circumstances under which the said payment is taxable in India so as to cast the obligation on the respondent-assessee to make deduction and also the provisions of DTAA in various countries regarding royalty. 15. It may also be noted at this stage itself that if is well settled that while considering the decision of the Hon'ble Supreme Court, the same cannot be considered de hors the context in which it was rendered and it is necessary to ascertain the ratio decidendi laid down in the said case. In COMMISSIO ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e case may be, or investigation of cases of such evasion or avoidance, or (d) for recovery of income-tax under this Act and under the corresponding law in force in that country or specified territory, as the case may be, and may, by notification in the Official Gazette, make such provisions as may be necessary for implementing the agreement. (2) Where the Central Government has entered into an agreement with the Government of any country outside India or specified territory outside India, as the case may be, under sub-section (1) for granting relief of tax, or as the case may be, avoidance of double taxation, then, in relation to the assessee to whom such agreement applies, the provisions of this Act shall apply to the extent they are more beneficial to that assessee. (3) Any term used but not defined in this Act or in the agreement referred to in sub-section (1) shall, unless the context otherwise requires, and is not inconsistent with the provisions of this Act or the agreement, have the same meaning as assigned to it in the notification issued by the Central Government in the Official Gazette in this behalf. Explanation 1.- For the removal of doubts, it is hereby declared th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or the imparting of information outside India in respect of, any data, documentation, drawing or specification relating to any patent, invention, model, design, secret formula or process or trade mark or similar property, if such income is payable in pursuance of an agreement made before the 1st day of April 1997, and the agreement is approved by the Central Government: Provided further that nothing contained in this clause shall apply in relation to so much of the income by way of royalty as consists of lump sum payment made by a person, who is a resident, for the transfer of all or any light (including the granting of a license) in respect of computer software supplied by a non-resident manufacturer along with a computer or computer-based equipment under any scheme approved under the Policy on Computer Software Export, Software Development and Training, 1986 of the Government of India. Explanation (2) reads as under: Explanation 2. - For the purposes of this clause, "royalty" means consideration (including any lump sum consideration but excluding any consideration which would be the income of the recipient chargeable under the head "Capital gains") for - (i) the transfer of a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in its content. Therefore, the definition of 'royalty' in DTAA is more beneficial to the assessee as according to the assessee, payment is not royalty and therefore, the royalty in the restricted meaning under DTAA is more beneficial to the assessee and hence, we have to find out as to whether the payment made by the respondent, would amount to royalty under the clause in DTAA. Even otherwise, it is clear that if the payment is held to be royalty within the restricted meaning given to the term in the DTAA, naturally, it would also to be covered within the term 'royalty' in the broader meaning to the term 'royalty' under the Act. 17. It is clear from the scrutiny of the material on record and the contentions of the parties viz., revenue and the respective respondent in these cases that the fact that payments have been made by the respondent herein to non-resident for having imported shrink wrapped software/off-the-shelf software is not disputed. There is also no dispute that no tax was deducted at source by the respondent under Section 195(1) of the Act in respect of such payments on the ground that the same were made for the purpose of purchase of shrink wrapped software/off-the-s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es. The tax so collected and deducted is required to be paid to the credit of Central Government in terms of Section 200 of the Act read with rule 30 of the Income Tax Rules, 1962. Failure to deduct tax or failure to pay tax would also render a person liable to penalty under Section 201 read with Section 221 of the Act. In addition, he would also be liable under Section 201(1A) to pay simple interest at 12 per cent per annum on the amount of such tax from the date on which such tax was deductible to the date on which such tax is actually paid. Therefore, if the amount is held to be royalty, the other consequences as referred to above would follow. 18. In view of the substantial question of law framed by the Hon'ble Supreme Court to be adjudicated in these appeals and the above said contentions of the learned counsel appearing for the parties, the only contention which is required to be considered is as to whether the payments made by the respondent - payee to a non-resident includes the amount chargeable to tax under the Act and if so, is there an obligation on the part of the respondent to make a deduction under Section 195(1) of the Act or as to whether the said payments would o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... scientific work. It has been universally accepted that a literary work is entitled to copyright and wherefore, a literary work is entitled to be registered as copyright. In India, the provisions of Section 2(o) of the Copyright Act, 1957 defines 'literary work' as under:- "literary work" includes computer programmes, tables and compilations including computer [databases]; Therefore, "computer software" has been recognized as copy right work in India also. 20. Having regard to the above said definition of 'royalty', we have to consider the contents of software licence agreement entered into by non-resident with Samsung Electronics and also respondents in the case represented by Sri Ganesh, learned senior counsel and Sri Aravind Dattar, wherein it is a case of purchase, sale or distribution or otherwise of the off-the-shelf software. It is described as a 'software licence agreement', wherein it is averred that customer accepts an individual, non-transferable and non-exclusive licence to use the licensed software program(s) progam(s) on the terms and conditions enumerated in the agreement. It is further averred that the customer - Samsung Electronics shall protect confidential inf ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to enter into the Agreement and grant the licences provided therein and confidentiality is protected. Therefore, on reading the contents of the respective agreement entered into by the respondents with the non-resident, it is clear that under the agreement, what is transferred is only a licence to use the copyright belonging to the non-resident subject to the terms and conditions of the agreement as referred to above and the non-resident supplier continues to be the owner of the copyright and all other intellectual property rights. It is well settled that copyright is a negative right. It is an umbrella of many rights and licence is granted for making use of the copyright in respect of shrink wrapped software/off-the-shelf software under the respective agreement, which authorizes the end user i.e., the customer to make use of the copyright software contained in the said software, which is purchased off the shelf or imported as shrink wrapped software and the same would amount to transfer of part of the copyright and transfer of right to use the copyright for internal business as per the terms and conditions of the agreement. Therefore, the contention of the learned senior counsel a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... present case is as to whether the payment would amount to 'royalty' within the meaning of Income Tax Act and DTTA. In the said TCS's case, it has been held that copyright in computer program may remain with the originator of the program, but, the moment copies are made and marketed, if becomes goods, which are susceptible to tax. The contention of the assessee that the consideration received by the non-resident supplier towards the software products would amount to 'royalty' within the meaning of DTAA with respective country was not at all considered in the said case. Therefore, the said decision in TCS's case is not helpful to the respondents in the present cases. It is well settled that the intent of the legislature in imposing Sales Tax and Income Tax are entirely different as Income Tax is a direct tax and Sales Tax is an Indirect Tax and wherefore, mere finding that the computer software would be included within the term 'Sales Tax' would not preclude this Court from holding that the said payments made by the respondents to the non-resident Company in the present cases would amount to 'royalty' unless the respondents are able to prove that the said payment is for the sale of c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ter programmes where the programme itself is not the essential object of the rental. (c) in the ease of an artistic work,- (i) to reproduce the work in any material form including depiction in three dimensions of a two-dimensional work or in two dimensions of a three-dimensional work; (ii) to communicate the work to the public: (iii) to issue copies of the work to the public not being copies already in circulation; (iv) to include the work in any cinematograph film; (v) to make any adaptation of the work; (vi) to do in relation to an adaptation of the work any of the acts specified in relation to the work in sub-clauses (i) to (iv); (d) in the case of a cinematograph film,- (i) to make a copy of the film, including a photograph of any image forming part thereof; (ii) to sell or give on hire, or offer for sale or hire, any copy of the film, regardless of whether such copy has been sold or given on hire on earlier occasions; (iii) to communicate the film to the public; (e) in the case of a sound recording,- (i) to make any other sound recording embodying it; (ii) to sell or give on hire, on offer fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd to store it in the hard disk and to take a back up copy and right to make a copy itself is a part of the copyright. Therefore, when licence to make use of the software by making copy of the same and to store it in the hard disk of the designated computer and to take back up copy of the software, it is clear that what is transferred is right to use the software, an exclusive right, which the owner of the copyright i.e., the respondent-supplier owns and what is transferred is only right to use copy of the software for the Internal business as per the terms and conditions of the agreement. The decision of the Delhi High Court in COMMISSIONER OF INCOME TAX DELHI-V v. M/s. DYNAMIC VERITCAL SOFTWARE INDIA PVT. LTD in ITA No. 1692/2010 DATED 22.02.2011 relied upon by Sri Aravind Dattar, learned senior counsel appearing for the respondents in some of the cases in support of his contention that by no stretch of imagination, payment made by the respondents to the non-resident suppliers can be treated as 'royalty' is not helpful to the respondents in the present cases as in the said case, Delhi High Court was considering the provisions of Section 40(a)(i) of the Act and the order of the Hi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... c C.D. can be used once they are purchased, but so far as software stored in dumb C.D. is concerned, the transfer of dumb C.D. by itself would not confer any right upon the end user and the purpose of the C.D. is only to enable the end user to take a copy of the software and to store it in the hard disk of the designated computer if licence is granted in that behalf and in the absence of licence, the same would amount to infringement of copyright, which is exclusively owned by non-resident suppliers, who would continue to be the proprietor of copyright. Therefore, there is no similarity between the transaction of purchase of the book or prerecorded music C.D. or the C.D. containing software and in view of the same, the Legislature in its wisdom, has treated the literary work like books and other articles separately from 'computer' software within the meaning of the 'Copyright' as referred to above under Section 14 of the Copyright Act. 25. It is also clear from the above said analysis of the DTAA Income Tax Act, Copyright Act that the payment would constitute 'royalty' within the meaning of Article 12(3) of the DTAA and even as per the provisions of 9(1)(vi) of the Act as the defi ..... X X X X Extracts X X X X X X X X Extracts X X X X
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