TMI Blog2013 (11) TMI 1382X X X X Extracts X X X X X X X X Extracts X X X X ..... ft copyright and all copies of the software shall be exclusive properties of Infrasoft - Licensee was allowed to use the software only for its own business as specifically identified and was not permitted to loan/rent/sale/sub-licence or transfer the copy of software to any third party without the consent of Infrasoft - The licensee has been prohibited from copying, decompiling, de-assembling, or reverse engineering the software without the written consent of Infrasoft. The licence agreement between the Assessee company and its customers stipulates that all copyrights and intellectual property rights in the software and copies made by the licensee were owned by Infrasoft and only Infrasoft has the power to grant licence rights for use of the software. The incorporeal right to the software i.e. copyright remains with the owner and the same was not transferred by the Assessee. 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 def ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of law framed on 20.10.2009 was recast as under: Whether the Income Tax Appellate Tribunal was right in holding that the consideration received by the respondent Assessee on grant of licences for use of software is not royalty within the meaning of Article 12(3) to the Double Taxation Avoidance Agreement between India and the United States of America? 4. The respondent/Assessee is an international software marketing and development company of an international group. The holding company is based in US being Infrasoft Corporation. 5. The Assessee M/s Infrasoft Ltd. is primarily into the business of developing and manufacturing civil engineering software. One such software, which is subject matter of the present controversy, is called MX. The said MX software is used for civil engineering work and for design of highways, railways, airports, ports, mines, etc. The said software is used by private consultants. 6. In view of the market position, the Board of the Assessee Infrasoft Limited opened a branch office in India. The branch in India imports the package in the form of floppy disks or CDs depending on the requirements of their customers. The system is delivered to a clien ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dia. The Assessee company further objected to the show cause notice contending alternatively that even if the receipts were to be treated as royalties or even for technical services, the same having arisen through a permanent establishment in India, it was chargeable to tax as business profit as per the said Article 7 of DTAA. The Assessee further contended before the AO that Section 44D inserted by Finance Act, 2003 w.e.f 01.04.2004, making all the expenditure incurred for earning royalty or fee for technical services allowable, was liable to be given retrospective application to the case of the Assessee for the Assessment Year 2003-04 as that was the legislative intent behind insertion of the said provision. 10. The AO rejected the contention of the Assessee company. With respect to the decision of the Supreme Court in TATA Consultancy Services (supra), the AO distinguished the said judgment holding that the same had been rendered in the context of the Sales Tax Act and was applicable in terms of the definition of goods as given in the Sales Tax Act and was in the context of deciding whether the software recorded on the computer disk was covered within the said definition of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rall price of software. Had it not been a secret programming, anybody could have written these types of programs and sold it at a very low price as compared to the price of the original software. (iv) The software developed by infrasoft is customizing software which are used for specific purposes like design of highways, railways, airport, port, mines etc. This software are purchased by private consultant or end users and they further exploits for commercial purposes. This clearly falls under definition of royalty . 12. In view of the above reasoning, the AO treated the entire amount received by the Assessee Company for transfer of software as well as other incidental services towards installation of software, imparting of training etc. in the nature of royalty. He further held that since the royalty income had accrued/arisen to the Assessee Company through its PE in the form of branch office in India, the same was chargeable to tax in India as per Article 13 (vi) (Sic Article 12 (vi))of the DTAA. He held that though the royalty income was liable to be taxed as business profit under Article 7 of DTAA, the expenses incurred for earning the said income were to be allowed as per ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tomization to include Indian standard of road construction and project specific requirements of the Indian customers. On the issue of the Assessee company having PE in India in the form of a branch office, the CIT(A) noted that there was no dispute that the branch office of the Assessee company had been opened in terms of the approval granted by the Reserve Bank of India and constituted a PE in India. 15. The CIT(A) examined a sample representative agreement between the Assessee company and one of its Indian customers for software licensing and maintenance to ascertain the exact nature and character of income received by the Assessee company in India on account of supply of software, annual maintenance charges and training fee amounting to Rs.2,74,00,630/-, Rs.9,25,648/- and Rs.2,50,000/- respectively. After referring to the relevant terms and conditions of the said agreement, the CIT(A) came to the conclusion that the Assessee company had transferred certain rights to the Indian customers to use software at certain locations for fixed licence fee. The CIT(A) noted that the amounts received by the Assessee company were in lieu of the following services rendered by it: (a) that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... income and as only limited right to use the software had been transferred, the amount received for such limited use was not royalty income. The CIT(A) rejected the contention of the Assessee company holding that OECD had given a very conservative interpretation of the word used and the same was not applicable in the facts of the case of the Assessee company. The CIT(A) noted that the said revised OECD commentary on software payment had not been accepted even by some of the OECD member countries and was not applicable in India since India was not even a member of OECD and specially when the Indian High Powered Committee had expressed its reservation in characterization of the software payment in the said country. With regard to the reliance of the Assessee company on the judgment of the Supreme Court in the case of TATA CONSULTANCY SERVICES (SUPRA), the CIT(A) held that though the transfer of right to use a good was not sale in its traditional sense but the same was held to be sale on the expanded definition given in the relevant Sales Tax Act, wherein such transfer was treated as deemed sale. He held that different statutes or different phraseologies treat the same transaction di ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ting use or enjoyment of any intellectual property right for levy of service tax. This amendment has been noticed by the CESTAT in Araco Corporation v. CCE [2005] (180) ELT 91 (Tri- Bang). 4.8.5 By the expedient of deeming fiction or inclusive definition Parliament and State Legislatures are competent to give a specific definition to a particular transaction. Such definition is confined to the specific statute only. Such definition cannot be imported into a different statue which defines the same transaction differently. The necessary corollary is that sales treatment: of computer software under sales tax law, does not, per se, influence income-tax treatment of software transactions, as income-tax law defines this transaction differently. 4.8.6 OECD recommendations remain mere recommendations unless they are incorporated into domestic law and/or DTAAs. The distinction between copyright right and program copy recommended by the OECD has been dissented from even by several member of the OECD. Indian laws and India s DTAA recognize only two types of transactions in respect of computer software sale and licence (letting). No further dissection of licensing (on the lines of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ve any right in the copyright and in such cases, the payments made to them could not be characterized as royalty under the Act for DTAA. The ITAT noted that the Special Bench of the Tribunal in the case of MOTOROLA INC. (SUPRA), had held that since the licensees were not allowed to exploit the computer software commercially, they had acquired under licence agreement, only the copy righted software which by itself was an article and not any copyright therein. The ITAT relying on the judgment in the case of MOTOROLA INC. (SUPRA), noted that in the case of the Assessee company, the licensee to whom the Assessee company had sold/licensed to the software was allowed to make only one copy of the software and associated support information for backup purposes with a condition that such copyright shall include Infrasoft copyright and all copies of the software shall be exclusive properties of Infrasoft. Licensees was allowed to use the software only for its own business as specifically identified and was not permitted to loan/rent/sale/sub-licence or transfer the copy of software to any third party without the consent of Infrasoft. The licensee had been prohibited from copying, de-compilin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... inguished the case of SAMSUNG ELECTRONICS (SUPRA) on the basis that the software licenced by the Assessee in the case of SAMSUNG ELECTRONICS (SUPRA) was off the shelf software whereas the software in the case of the Assessee Company required to be customized to meet the needs of an Indian customer. The ITAT held that the customization of the concerned software or the professional services rendered by the Assessee company for such customization had not resulted in any material change in the terms and conditions of the licence agreement or in the relationship between the Assessee as an owner of the software and a licensee to whom the right to use the said software was given by the Assessee company. The ITAT noted that the software provided by the Assessee Company was basically a standard software and the customization so done to the limited extent as per the specific requirements of the customers did not bring about any change in the nature of the software or the licence granted to the customers. 23. The ITAT further held that the case of the Assessee Company was clearly covered by the decisions of the Tribunal in the case of MOTOROLA INC. (SUPRA) AND SAMSUNG ELECTRONICS (SUPRA). F ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sferred was neither the copyright in the software nor the use of the copyright in the software, but what was transferred was the right to use the copyrighted material which was clearly distinct from the rights in a copyright. Learned counsel contended that no doubt, if right to use the copyright had been transferred, the same would give rise to royalty. But where right that is transferred is not a right to use the copyright but is only limited to the right to use the copyrighted material, the same would not give rise to any royalty income and would be business income. 28. We have examined the rival contentions of the parties and are of the view that there is no infirmity in the impugned order and what has been transferred is not copyright or the right to use copyright but a limited right to use the copyrighted material and does not give rise to any royalty income. 29. In the present day global economy it is not unusual for an individual or a business entity to operate commercially in more than one countries. When an individual or business entity which is resident in one country makes a taxable gain in another country the said individual or entity may be obliged by the domestic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or (b) for the avoidance of double taxation of income under this Act and under the corresponding law in force in that country or specified territory, as the case may be, or (c) for exchange of information for the prevention of evasion or avoidance of incometax chargeable under this Act or under the corresponding law in force in that country or specified territory, as the 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 subsection (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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r avoidance of double taxation, income-tax, by deduction or otherwise, under the law in force in that country, he shall be entitled to the deduction from the Indian income-tax payable by him of a sum calculated on such doubly taxed income at the Indian rate of tax or the rate of tax of the said country, whichever is the lower, or at the Indian rate of tax if both the rates are equal. (2) If any person who is resident in India in any previous year proves that in respect of his income which accrued or arose to him during that previous year in Pakistan he has paid in that country, by deduction or otherwise, tax payable to the Government under any law for the time being in force in that country relating to taxation of agricultural income, he shall be entitled to a deduction from the Indian income-tax payable by him (a) of the amount of the tax paid in Pakistan under any law aforesaid on such income which is liable to tax under this Act also; or (b) of a sum calculated on that income at the Indian rate of tax; whichever is less. (3) If any non-resident person is assessed on his share in the income of a registered firm assessed as resident in India in any previous year and such ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... two rates of tax that is Indian rate of tax or the rate of tax of the said country whichever is lower and in case both the rates are equal then at the Indian rate of tax. 37. In the case of DIT V. RIO TINTO TECHNICAL SERVICES (2012) 340 ITR 507 (DEL) the Delhi High Court has held as under: Section 90(2) mandates that where the Central Government has entered into a Double Taxation Avoidance Agreement under subsection (1) for granting relief of tax or, as the case may be, avoidance of double taxation, then in relation to the assessee to whom the agreement applies, the provisions of the Act apply to the extent they are more beneficial to the assessee. In other words, where an article in a Double Taxation Avoidance Agreement and a provision of the Act apply to the assessee, then the article of the Double Taxation Avoidance Agreement or the provision the Act will apply depending upon which one of the two is more beneficial/advantageous to the assessee. The first requirement, therefore, is to see whether the provisions of the Act apply to a particular transaction undertaken/ income earned by an assessee, which is taxable in India under the Act. In case the transaction/income is not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Andhra Pradesh High Court in CIT v. Visakhapatnam Port Trust [(1983) 144 ITR 146 (AP)] held that provisions of Sections 4 and 5 of the Income Tax Act are expressly made subject to the provisions of the Act which means that they are subject to the provisions of Section 90. By necessary implication, they are subject to the terms of the Double Taxation Avoidance Agreement, if any, entered into by the Government of India. Therefore, the total income specified in Sections 4 and 5 chargeable to income tax is also subject to the provisions of the agreement to the contrary, if any. 23. In CIT v. Davy Ashmore India Ltd. [(1991) 190 ITR 626 (Cal)] while dealing with the correctness of Circular No. 333 dated 2-4-1982, it was held that the conclusion is inescapable that in case of inconsistency between the terms of the Agreement and the taxation statute, the Agreement alone would prevail. The Calcutta High Court expressly approved the correctness of CBDT Circular No. 333 dated 2- 4-1982 on the question as to what the assessing officers would have to do when they found that the provision of the double taxation was not in conformity with the Income Tax Act, 1961. The said circular provided ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion of the agreement can possibly fasten a tax liability where the liability is not imposed by this Act; (ii) if a tax liability is imposed by this Act, the agreement may be resorted to for negativing or reducing it; (iii) in case of difference between the provisions of the Act and of the agreement, the provisions of the agreement prevail over the provisions of this Act and can be enforced by the Appellate Authorities and the court. 28. A survey of the aforesaid cases makes it clear that the judicial consensus in India has been that section 90 is specifically intended to enable and empower the Central Government to issue a notification for implementation of the terms of a Double Taxation Avoidance Agreement. When that happens, the provisions of such an agreement, with respect to cases to which they apply, would operate even if inconsistent with the provisions of the Incometax Act. We approve of the reasoning in the decisions which we have noticed. If it was not the intention of the Legislature to make a departure from the general principle of chargeability to tax under section 4 and the general principle of ascertainment of total income under section 5 of the Act, then there was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... enforced by the Appellate Authorities and the court. 42. The Supreme Court of India has thus held that the judicial consensus in India has been that section 90 is specifically intended to enable and empower the Central Government to issue a notification for implementation of the terms of a Double Taxation Avoidance Agreement. When that happens, the provisions of such an agreement, with respect to cases to which they apply, would operate even if inconsistent with the provisions of the Act, to advantage of an assessee. A notification under section 90 towards implementation of the terms of DTAs which would automatically override the provisions of the Act in the matter of ascertainment of chargeability to income-tax and ascertainment of total income, rate of tax etc. to the extent of inconsistency with the terms of DTAA. 43. The Supreme Court while dealing with the concept of liability to taxation in international transactions in AZADI BACHAO ANDOLAN (SUPRA) further laid down as under: What is liable to taxation ? Fiscal residence 62. The concept of fiscal residence of a company assumes importance in the application and interpretation of the Double Taxation Avoidance Treat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as they are dissociated and scattered in different States, each country may want to subject the company to taxation on the basis of an element to which it gives preference; incorporation procedure, management functions, running of the business, shareholders' controlling power. Depending on the criterion adopted, fiscal residence will abide in one or the other country. All the European countries concerned, except France, levy tax on the worldwide profit at the place of residence of the company considered. South Korea, India and Japan in Asia, Australia and New Zealand in Oceania follow this principle. 91. In our view, the contention of the respondents proceeds on the fallacious premise that liability to taxation is the same as payment of tax. Liability to taxation is a legal situation; payment of tax is a fiscal fact. For the purpose of application of Article 4 of DTAC, what is relevant is the legal situation, namely, liability to taxation, and not the fiscal fact of actual payment of tax. If this were not so, DTAC would not have used the words liable to taxation , but would have used some appropriate words like pays tax . On the language of DTAC, it is not possible to ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... where overlapping tax claims are expected, or at least theoretically possible. In other words, the contracting States mutually bind themselves not to levy taxes or to tax only to a limited extent in cases when the treaty reserves taxation for the other contracting States either entirely or in part. Contracting States are said to waive tax claims or more illustratively, to divide tax sources , the taxable objects , amongst themselves. Double Taxation Avoidance Treaties were in vogue even from the time of the League of Nations. The experts appointed in the early 1920s by the League of Nations describe this method of classification of items and their assignments to the contracting States. While the English lawyers called it classification and assignment rules , the German jurists called it the distributive rule (Verteilungsnorm). To the extent that an exemption is agreed to, its effect is in principle independent of both whether the other contracting State imposes a tax in the situation to which the exemption applies, and of whether that State actually levies the tax. Commenting particularly on the German Double Taxation Convention with the United States, Vogel comments: T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tions arise. As soon as they are dissociated and scattered‟ in different States, each country may want to subject the company to taxation on the basis of an element to which it gives preference; incorporation procedure, management functions, running of the business, shareholders' controlling power. Depending on the criterion adopted, fiscal residence will abide in one or the other country. 46. The Supreme Court held that liability to taxation is a legal situation; payment of tax is a fiscal fact. For the purpose of application of Article 4 of DTAA, what is relevant is the legal situation, namely, liability to taxation, and not the fiscal fact of actual payment of tax. The Supreme Court quoted with approval the commentary of Philip Baker on Article 4 of the OECD Double Tax Convention that a person does not have to be actually paying tax to be liable to tax‟ 47. The Supreme Court further referred to the Judgment of the Federal Court in John N. Gladden v. Her Majesty the Queen (supra) that Contrary to an ordinary taxing statute a tax treaty or convention must be given a liberal interpretation with a view to implementing the true intentions of the parties. A literal o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s of the Indo US DTAA. We notice that the Authorities below and the Tribunal have referred to Article 13 of the Indo UK DTAA whereas in the Memo of appeal the Revenue has relied upon Article 12 of the Indo US DTAA and both the counsels relied upon and referred to the Indo US DTAA at the time of hearing of the present Appeal. The Provisions of Articles 7 and 13 of the Indo UK DTAA and Articles 7 and 12 of the Indo US DTAA for the purposes of the present case are pari-materia so we are referring to the same. Article 7 of the Indo US DTAA stipulates as under: 1. The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to (a) that permanent establishment; (b) sales in the other State of goods or merchandise of the same or similar kind as those sold through that permanent establishment; or (c) other business activities carried on in the other State of the same o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the determination of the profits of a permanent establishment, for amounts charged (otherwise than toward reimbursement of actual expenses), by the permanent establishment to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for the use of patents, know-how or other rights, or by way of commission or other charges for specific services performed or for management, or, except in the case of a banking enterprise, by way of interest on moneys lent to the head office of the enterprise or any of its other offices. 4. No profits shall be attributed to a permanent establishment by reason of the mere purchase by that permanent establishment of goods or merchandise for the enterprise. 5. For the purposes of this Convention, the profits to be attributed to the permanent establishment as provided in paragraph 1(a) of this article shall include only the profits derived from the assets and activities of the permanent establishment and shall be determined by the same method year by year unless there is good and sufficient reason to the contrary. 6. Where profits include items of income which are dealt with separatel ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tributable to the permanent establishment. The permanent establishment is permitted to deduct expenses that are incurred for the purposes of conduct of business of the permanent establishment. The broad expenses that are permitted to be deducted relate to execution, in general administrative expenses, research and development expenses, interest and other expenses incurred for the purposes of an enterprise as a whole irrespective of the fact whether the same are incurred in the country of residents of an enterprise or in a country where the permanent establishment is situated. The clause further stipulates that no deduction towards expenses would be allowed in respect of royalties, fees or other similar payments in return for the use of patents, knowhow or other rights or commission or other charges for management etc. are permitted. This is subject to limitations of the taxation laws of the State. 54. Article 5 of the Indo US DTAA defines Permanent Establishment in Article 5 as under: Permanent establishment - 1. For the purposes of this Convention, the term permanent establishment means a fixed place of business through which the business of an enterprise is wholly or partl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sing, for the supply of information, for scientific research or for other activities which have a preparatory or auxiliary character, for the enterprise. 4. Notwithstanding the provisions of paragraphs 1 and 2, where a person other than an agent of an independent status to whom paragraph 5 applies - is acting in a Contracting State on behalf of an enterprise of the other Contracting State, that enterprise shall be deemed to have a permanent establishment in the first-mentioned State, if : (a) he has and habitually exercises in the first-mentioned State an authority to conclude on behalf of the enterprise, unless his activities are limited to those mentioned in paragraph 3 which, if exercised through a fixed place of business, would not make that fixed place of business a permanent establishment under the provisions of that paragraph ; (b) he has no such authority but habitually maintains in the first-mentioned State a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the enterprise, and some additional activities conducted in the State on behalf of the enterprise have contributed to the sale of the goods or merchandise ; or (c) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the beneficial owner of the royalties or fees for technical services is a resident of the other Contracting State the tax so charged shall not exceed 10 per cent. of the gross amount of the royalties or fees for technical services. 3. The term "royalties " as used in this article means: (a) payments of any kind received as consideration for the use of, or the right to use, any copyright of a literary, artistic, or scientific work, including cinematograph films or work on film, tape or other means of reproduction for use in connection with radio or television broadcasting, any patent, trademark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience, including gains derived from the alienation of any such right or property which are contingent on the productivity, use or disposition thereof; and (b) payments of any kind received as consideration for the use of, or the right to use, any industrial, commercial or scientific equipment, other than payments derived by an enterprise described in paragraph 1 of article 8 (Shipping and Air Transport) from activities described in paragraph 2(c) or 3 or article 8 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... right to use any copyright. 61. The amount received by the Assessee company had been treated as royalty income by the AO and the CIT(A) on the basis of Explanation 2 to Section 9(1)(vi) of the Act holding that there was transfer of some rights (including the granting of a licence) in respect of the copyright. 62. In terms of the law as laid down by the Supreme Court of India in AZADI BACHAO ANDOLAN (SUPRA) and since the Assessee is governed by the Indo US DTAA, the income of the Assessee would be chargeable to tax in terms of the provision of the Indo US DTAA, if the same is more advantageous or beneficial. The AO and the CIT (A) have applied by the definition of the word 'Royalty' as defined in Explanation 2 to Section 9(1)(vi) of the Act which is clearly contrary to the law as laid down by the Supreme Court of India in AZADI BACHAO ANDOLAN (SUPRA). Since the Assessee is governed by the provisions of the DTAA, the more onerous provisions of the Act could not have been applied. If the provision of the Act were more beneficial that the provisions of the DTAA then only reliance on the same could have been placed by the AO. 63. What is thus required to be examined is whether inc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lauses (a) and (b) of Section 14, it would mean that it does not have any right in a copyright. In that case, the payment made by the cellular operator cannot be characterized as royalty either under the Income-tax Act or under the DTAA. The question, therefore, to be answered is whether any of the operators can exercise any of the rights mentioned in the above provisions with reference to the software supplied by the Assessee. 157. We may first look at the supply contract itself to find out what JTM, one of the cellular operators, can rightfully do with reference to the software. We may remind ourselves that JTM is taken as a representative of all the cellular operators and that it was common ground before us that all the contracts with the cellular operators are substantially the same. Clause 20.1 of the Agreement, under the title "License", says that JTM is granted a nonexclusive restricted license to use the software and documentation but only for its own operation and maintenance of the system and not otherwise. This clause appears to militate against the position, if it were a copyright, that the holder of the copyright can do anything with respect to the same in the public ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r the Software and/or the Documentation outside India without the written consent of the Contractor and after having received necessary export or re-export permits from relevant authorities. This clause places stringent restrictions on the cellular operator so far as the use of software is concerned. It first says that the cellular operator cannot make the software or portions thereof available to any person except to its employees and even with regard to employees it has to be only on a "need to know basis" which means that even the employees are not to be told in all its aspects. What the Assessee can do is only to tell the particular employee what he has to know about the software for operational purposes. The cellular operator has been denied the right to make copies of the software or parts thereof except for archival backup purposes. This means that the cellular operator cannot make copies of the software for commercial purposes. This condition is plainly contrary to Section 14(a)(i) of the Copyright Act which permits the copyright holder to reproduce the work in any material form including the storing of it in any medium by electronic means. We may also notice Section 52(1 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... only a copyrighted article. On the other hand, a recording company which has recorded a vocalist has acquired the copyright in the music rendered and is, therefore, permitted to exploit the recording commercially. In this case the music recording company has not merely acquired a copyrighted article in the form of a recording, but has actually acquired a copyright to reproduce the music and exploit the same commercially. In the present case what JTM or any other cellular operator has acquired under the supply contract is only the copyrighted software, which is an article by itself and not any copyright therein. 163. We may now briefly deal with the objections of Mr. G.C. Sharma, the learned senior counsel for the Department. He contended that if a person owns a copyrighted article then he automatically has a right over the copyright also. With respect, this objection does not appear to us to be correct. Mr. Dastur filed an extract from Iyengar's Copyright Act (3rd Edition) edited by R.G. Chaturvedi. The following observations of the author are on the point: "(h) Copyright is distinct from the material object, copyrighted: It is an intangible incorporeal right in the nature o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... perate the program, for example, where the transferee is granted limited rights to reproduce the program. This would be the common situation in transactions for the acquisition of a program copy. The rights transferred in these cases are specific to the nature of computer programs. They allow the user to copy the program, for example onto the user's computer hard drive or for archival purposes. In this context, it is important to note that the protection afforded in relation to computer programs under copyright law may differ from country to country. In some countries the act of copying the program onto the hard drive or random access memory of a computer would, without a license, constitute a breach of copyright. However, the copyright laws of many countries automatically grant this right to the owner of software which incorporates a computer program. Regardless of whether this right is granted under law or under a license agreement with the copyright holder, copying the program onto the computer's hard drive or random access memory or making an archival copy is an essential step in utilizing the program. Therefore, rights in relation to these acts of copying, where they do no mor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... derivative computer programmes based upon the copyrighted computer programme (iii) The right to make a public performance of the computer programme. (iv) The right to publically display the computer programme. 169. A copyrighted article has been defined in the regulation (page 147 of the paper book) as including a copy of a computer programme from which the work can be perceived, reproduced or otherwise communicated either directly or with the aid of a machine or device. The copy of the programme may be fixed in the magnetic medium of a floppy disc or in the main memory or hard drive of a computer or in any other medium. 170. So far as the transfer of copyrighted articles and copyright rights are concerned, the regulation goes on to say (page 148 of the paper book) that the question whether there was a transfer of a copyright right or only of a copyrighted article must be determined taking into account all the facts and circumstances of the case and the benefits and burden of ownership which have been transferred. Several examples have been given below these regulations to find out whether a particular transfer is a transfer of a copyright right or a transfer of a copyright ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... alt with as commercial income in accordance with Article 7. 67. The Tribunal further referred to the proposed amendments to the regulations of the Internal Revenue Service (IRS) in the USA not as binding but as having persuasive value and throwing light on the question i.e. the difference between a copyright right and a copyrighted article. The Tribunal noticed that the U.S. regulations distinguished between transfer of copyright rights and transfer of copyrighted articles based on the type of rights transferred to the transferee. Briefly stated, if the transferee acquires a copy of a computer programme but does not acquire any of the rights identified in certain sections (of the U.S. Regulations), the regulation classified the transaction as the Transfer of a copyrighted article. If a transfer of a computer programme results in the transferee acquiring any one or more of the listed rights, it is a transfer of a copyright right. If a person acquires a copy of a computer programme but does not acquire any of the four listed copyright rights, he gets only a copyrighted article but no copyright. The four rights being: (i) The right to make copies of the computer programme for purp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Court relying on the Judgment of the Supreme Court of India in TATA CONSULTANCY SERVICES VS. STATE OF ANDHRA PRADESH, (2004) 271 ITR 401 (SC), held that software incorporated on a media would be goods and liable to sales tax. The High Court has held as under: 56. A fortiorari when the assessee supplies the software which is incorporated on a CD, it has supplied tangible property and the payment made by the cellular operator for acquiring such property cannot be regarded as a payment by way of royalty. .. 59. Be that as it may, in order to qualify as royalty payment, within the meaning of section 9(1)(vi) and particularly clause (v) of Explanation 2 thereto, it is necessary to establish that there is transfer of all or any rights (including the granting of any licence) in respect of copyright 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 consideration paid by the cellular operator as royalty, it is to be established that the cellular operator, by making such payment, obtains all or any of the copyright rights of such literary work. In t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt of some or all the rights which the copyright owner has, is necessary to trigger the royalty definition. Viewed from this angle, a non-exclusive and non-transferable licence enabling the use of a copyrighted product cannot be construed as an authority to enjoy any or all of the enumerated rights ingrained in a copyright. Where the purpose of the licence or the transaction is only to establish access to the copyrighted product for internal business purpose, it would not be legally correct to state that the copyright itself has been transferred to any extent. It does not make any difference even if the computer programme passed on to the user is a highly specialized one. The parting of intellectual property rights inherent in and attached to the software product in favour of the licensee/customer is what is contemplated by the definition clause in the Act as well as the Treaty. As observed earlier, those rights are incorporated in section 14. Merely authorizing or enabling a customer to have the benefit of data or instructions contained therein without any further right to deal with them independently does not, in our view, amount to transfer of rights in relation to copyright or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is pointed out that a CD without right of reproduction on the hard disc is of no value to the end-user and such a right should necessarily be transferred to make it workable. It appears to us that the contention is based on a misunderstanding of the scope of right in sub-clause (i) of section 14(a). As stated in Copinger's treatise on Copyright, "the exclusive right to prevent copying or reproduction of a work is the most fundamental and historically oldest right of a copyright owner". We do not think that such a right has been passed on to the end-user by permitting him to download the computer programme and storing it in the computer for his own use. The copying/ reproduction or storage is only incidental to the facility extended to the customer to make use of the copyrighted product for his internal business purpose. As admitted by the Revenue's representative, that process is necessary to make the programme functional and to have access to it and is qualitatively different from the right contemplated by the said provision because it is only integral to the use of copyrighted product. Apart from such incidental facility, the customer has no right to deal with the product just as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... adaptation of work for one's own use. Even without such licence, the buyer of product cannot be said to have infringed the owner's copyright. When the infringement is ruled out, it would be difficult to reach the conclusion that the buyer/licensee of product has acquired a copyright therein. 75. The Authority on Advance Ruling in the case of DASSAULT SYSTEMS K. K., IN RE (SUPRA) further approved the reasoning of the Special Bench of Income-tax Appellate Tribunal in MOTOROLA INC. (SUPRA) and noticed that the said decision has been followed in several decisions of the Income-tax Appellate Tribunal till date. 76. The Authority on Advance Ruling following the decision in the DASSAULT CASE (SUPRA) in the case of GEOQUEST SYSTEMS B.V. V. DIT (INTERNATIONAL TAXATION-I) [(2010)234CTR(AAR)73] held as under: 9. The revenue has sought to place reliance on the proviso to section 9(1)(vi) and sub-section (1A) of section 115A in order to contend that the Act contemplated charging of 'royalty' for authorization to use computer software as such and it is not necessary that the copyright therein should be specifically transferred. We are not impressed by this argument. The expression 'comput ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of Commerce Union Bank v. Tidwell 538 S.W.2d 405; State of Alabama v. Central Computer Services. INC 349 So. 2d 1156; The First National Bank of Fort Worth v. Bob Bullock 584 S.W.2d 548; First National Bank of Springfield v. Department of Revenue 421 NE2d 175; Compuserve, INC. v. Lindley 535 N.E. 2d 360 and Northeast Datacom, Inc., et al v. City of Wallingford 563 A2d 688. In these cases, it has been held that 'computer software' is tangible personal property. The reasoning for arriving at this conclusion is basically that the information contained in the software programs can be introduced into the user's computer by several different methods, namely, (a) it could be programmed manually by the originator of the program at the location of the user's computer, working from his own instructions or (b) it could be programmed by a remote programming terminal located miles away from the user's computer, with the input information being transmitted by telephone; or (c) more commonly the computer could be programmed by use of punch cards, magnetic tapes or discs, containing the program developed by the vendor. It has been noticed that usually the vendor will also provide manuals, service ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t Co. v. Commissioner of Taxes 465 A.2d 1100; University Computing Company v. Commissioner of Revenue for the State of Tennessee 677 S.W.2d 445 and Hasbro Industries, INC. v. John H. Norberg, Tax Administrator 487 A.2d 124. In these cases, the Courts have held that when stored on magnetic tape, disc or computer chip, this software or set of instructions is physically manifested in machine readable form by arranging electrons, by use of an electric current, to create either a magnetized or unmagnetized space. This machine readable language or code is the physical manifestation of the information in binary form. It has been noticed that at least three program copies exist in a software transaction: (i) an original, (ii) a duplicate, and (iii) the buyer's final copy on a memory device. It has been noticed that the program is developed in the seller's computer then the seller duplicates the program copy on software and transports the duplicates to the buyer's computer. The duplicate is read into the buyer's computer and copied on a memory device. It has been held that the software is not merely knowledge, but rather is knowledge recorded in a physical form having a physical existence, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... use and whether it can be transmitted, transferred, delivered, stored, possessed etc. Admittedly in the case of software, both canned and uncanned, all of these are possible. 78. The Supreme Court of India in TATA CONSULTANCY CASE (SUPRA) referred to the Judgment of the Supreme Court in ASSOCIATED CEMENT COMPANIES LTD. VS COMMISSIONER OF CUSTOMS (2001) 4 SCC 593 as under: 43. Similar would be the position in the case of a programme of any kind loaded on a disc or a floppy. For example in the case of music the value of a popular music cassette is several times more than the value of a blank cassette. However, if a prerecorded music cassette or a popular film or a musical score is imported into India duty will necessarily have to be charged on the value of the final product. In this behalf we may note that in State Bank of India v. Collector of Customs MANU/SC/0017/2000 : (2000) 1 SCC 727 the Bank had, under an agreement with the foreign company, imported a computer software and manuals, the total value of which was US Dollars 4,084,475. The Bank filed an application for refund of customs duty on the ground that the basic cost of software was US Dollars 401.047. While the rest o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... In the said Code, goods were defined as "all things (including specially manufactured goods) which are moveable at the time of the identification for sale". Holding that computer software was a "good" the Court held as follows : "Computer programs are the product of an intellectual process, but once implanted in a medium they are widely distributed to computer owners. An analogy can be drawn to a compact-disc recording of an orchestral rendition. The music is produced by the artistry of musicians and in itself is not a 'good', but when transferred to a laserreadable disc it becomes a readily merchantable commodity. Similarly, when a professor delivers a lecture, it is not a good, but, when transcribed as a book, it becomes a good. That a computer program may be copyrightable as intellectual property does not alter the fact that once in the form of a floppy disc or other medium, the program is tangible, moveable and available in the marketplace. The fact that some programs may be tailored for specific purposes need not alter their status as 'goods' because the Code definition includes 'specially manufactured goods'." 79. The Supreme Court of India in TATA CONSULTANCY CASE (SUPRA) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... v. Sidney J. Barthelemny, et al. [643 So. 2d 1240 : 36 A.L.R. 5th 689], the Supreme Court of Louisiana as under: 26. The court, however, noticed that the shift in the trend was not uniform. Having regard to the fact that the computer software became the knowledge and understanding and upon discussing the characteristics of computer software and classification thereof as tangible or intangible under Louisiana law, it was held: "The software itself, i.e. the physical copy, is not merely a right or an idea to be comprehended by the understanding. The purchaser of computer software neither desires nor receives mere knowledge, but rather receives a certain arrangement of matter that will make his or her computer perform a desired function. This arrangement of matter, physically recorded on some tangible medium, constitutes a corporeal body. We agree with Bell and the court of appeal that the form of the delivery of the software-magnetic tape or electronic transfer via modem- is of no relevance. However, we disagree with Bell and the court of appeal that the essence or real object of the transaction was intangible property . That the software can be transferred to various media i.e. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ferred from one medium to 15 another does not affect the nature of that physical manifestation as corporeal, or tangible. Shontz, supra, at 168-170. Likewise, that the software can be transferred from 1248 one type of physical recordation, e.g., tape, to another type, e.g., disk or hard drive, does not alter the nature of the software, Shontz, supra, at 168- 170; it still has corporeal qualities and is inextricably intertwined with a corporeal object. The software must be stored in physical form on some tangible object somewhere " 27. Reversing the findings of the court below that the computer software constitutes intellectual property, it was opined : "In sum, once the "information" or "knowledge" is transformed into physical existence and recorded in physical form, it is corporeal property. The physical recordation of this software is not an incorporeal right to be comprehended. therefore we hold that the switching system software and the data processing software involved here is tangible personal property and thus is taxable by the City of New Orleans." 81. The Supreme Court in TATA CONSULTANCY CASE (SUPRA) have thus laid down that Computer programs are the product of an i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ould be of no use if it were. Rather, the software is given physical existence to make certain desired physical things happen. One cannot escape the fact that software, recorded in physical form, becomes inextricably intertwined with, or part and parcel of the corporeal object upon which it is recorded , be that a disc, tape, hard drive, or other device. That the information can be transferred and then physically recorded on another medium is of no moment, and does not make computer software any different than any other type of recorded information that can be transferred to another medium such as film, video tape, audio tape, or books. It is now common knowledge that books, music, and even movies or other audio/visual combinations can be copied from one medium to another. They are also all available on computer in such forms as floppy disc, tape, and CD-ROM. Such movies, books, music, etc. can all be delivered by and/or copied from one medium to another, including electrical impulses with the use of a modem. Assuming there is sufficient memory space available in the computer hard disc drive such movies, books, music, etc. can also be recorded into the permanent memory of the compu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y any parent, subsidiary or affiliated entity of Licensee (iii) Used for the operation of a service bureau or for data processing g) If Licensee was granted an educational licence, as identified on the Infrasoft Licence Schedule, the Software may only be used for instruction or research purposes and not for any commercial purposes. h) Licensee may not copy, decompile, disassemble or reverse-engineer the Software without Infrasoft s written consent. The Licensee s rights shall not be restricted by this Clause 2(h) to the extent that local law grants Licensee a right to do so for the purpose of achieving interoperability with other software and in addition thereto Infrasoft undertakes to make information relating to interoperability available to Licensee subject to such reasonable conditions as Infrasoft may from time to time impose including a reasonable fee for doing so. To ensure Licensee receives the appropriate information, Licensee must first give Infrasoft sufficient details of its objectives and the other software concerned. Requests for the appropriate information should be directed to the Vice president Technical of Infrasoft. 3. LICENCE FEES, PAYMENT AND TAXES a) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... icted from making copies, decompile, disassemble or reverse-engineer the Software without Infrasoft‟s written consent. The Software contains a mechanism which Infrasoft may activate to deny the Licensee use of the Software in the event that the Licensee is in breach of payment terms or any other provisions of this Agreement. All copyrights and intellectual property rights in and to the Software, and copies made by Licensee, are owned by or duly licensed to Infrasoft. 86. The Licensing Agreement shows that the license is non-exclusive, non-transferable and the software has to be uses in accordance with the agreement. Only one copy of the software is being supplied for each site. The licensee is permitted to make only one copy of the software and associated support information and that also for backup purposes. It is also stipulated that the copy so made shall include Infrasoft‟s copyright and other proprietary notices. All copies of the Software are the exclusive property of Infrasoft. The Software includes a licence authorisation device, which restricts the use of the Software. The software is to be used only for Licensee‟s own business as defined within the Inf ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ld be disregarded in analyzing the character of the transaction for tax purposes. Payments in these types of transactions would be dealt with as business income in accordance with Article 7. 89. 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 enjoyment of some or all the rights which the copyright owner has, is necessary to invoke the royalty definition. Viewed from this angle, a non-exclusive and non-transferable licence enabling the use of a copyrighted product cannot be construed as an authority to enjoy any or all of the enumerated rights ingrained in Article 12 of DTAA. Where the purpose of the licence or the transaction is only to restrict use of the copyrighted product for internal business purpose, it would not be legally correct to state that the copyright itself or right to use copyright has been transferred to any extent. The parting of intellectual property rights inherent in and attached to the software ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... party without the consent of Infrasoft. 93. The licensee has been prohibited from copying, decompiling, de-assembling, or reverse engineering the software without the written consent of Infrasoft. The licence agreement between the Assessee company and its customers stipulates that all copyrights and intellectual property rights in the software and copies made by the licensee were owned by Infrasoft and only Infrasoft has the power to grant licence rights for use of the software. The licence agreement stipulates that upon termination of the agreement for any reason, the licencee shall return the software including supporting information and licence authorization device to Infrasoft. 94. The incorporeal right to the software i.e. copyright remains with the owner and the same was not transferred by the Assessee. 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. What the licensee has acq ..... X X X X Extracts X X X X X X X X Extracts X X X X
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