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TMI Blog2016 (3) TMI 751X X X X Extracts X X X X X X X X Extracts X X X X ..... he assessing officer erred on facts and in law in completing the assessment vide order dated 20.01.20 15 under section 143(3) rws 144C of the Act at an income of Rs. 17,39,01,465/- as against returned income of Rs. Nil. 1.2 That the DRP erred on facts and in law in the affirming the draft assessment order by passing a cryptic and non-speaking order, without judiciously considering the entire material and the submissions/ objections filed by the appellant. 2. That the assessing officer erred on facts and in law in holding the payments received by the appellant towards supply of software to the customers in India, as income in the nature of "royalty" within the meaning of Explanation 2(v) of section 9(1)(vi) of the Act and Article 12(3) of the Double Tax Avoidance Treaty between India and Israel (the Treaty') and liable to tax in India @ 10% of gross amount. 3. That the assessing officer erred on facts and in law in not appreciating that software formed integral part of the Galatea machines supplied by the appellant to customers in India without which such machines could not function and thereby the supply of the software like the payment for supply of the hardware was i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... has been sold by the assessee is not software as such, but 'Diamonds and Gems Scanning Machine' (hereinafter referred to as 'Machine' or 'Equipment' for the sake of brevity). Software was part of the machine which was required to make that machine operational. The customers who purchased the machine were not concerned with the software but with the functioning of the machine. Our attention has been drawn on various pages of the paper book showing that there was no separate sale of software. All the customers purchased machines along with requisite software to operate that machine. Pages-222, 223 and 224 of the paper book are the lists showing party-wise details and sales made by the assessee. Page-225 of the paper book is the certificate of Galatea Ltd. certifying that software supplied by it to the end user was integrated with various machine supplied by it and the software had no other independent use as such except to enable such machine to function. Our attention was also drawn on the copy of invoice to show that all the customers purchased machine and software both. Our attention was also drawn on some of the copies of End User License Agreement (EULA) entered between the asse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the 'Act' or 'Treaty' whichever is more beneficial, shall apply to the assessee. It was submitted that since no amendment had been made in the definition of the term "Royalty" as envisaged in Article-12 of the treaty, therefore, the case of the assessee was to be examined by interpreting the Articles of the treaty. It was submitted by him that perusal of Article 12(3) of the treaty shows that the term "Royalty" shall encompass payment of any kind received as consideration for use or transfer of copyright, whereas, the admitted facts of the case are that there is no transfer of any copyright. Thus, the provisions of treaty should be read in preference to the provisions of the Act so long as they are more beneficial to the assessee in determining its tax liability. The amendment made in the provisions of the Act cannot be automatically read into the articles of the treaty, unless of course, corresponding amendment is made in the treaty also. For this proposition, he has relied upon the following judgments:- i) DIT v/s Infrasoft Ltd., 39 Taxmann.com 88 (Del.); ii) CIT v/s Siemens Aklcongesllschaft, 177 Taxmann 81 (Bom.); iii) DIT v/s Nokia Networks O.Y., 358 ITR 259; iv) B4 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... software was integral part of the machine then there was no necessity to receive the payment separately and mentioning about the same separately in the invoice. It was further submitted that the software was received separately by e-mail, thus, under these circumstances, it could not be said that software was integral part of the machine. He placed reliance on the following judgment in support of his argument that impugned transaction was in the nature of "Royalty" liable to be taxed in India in the hands of the assessee company: i) DDIT v/s Reliance Infocom Ltd., 37 CCH 69 (Mum.); ii) CIT v/s Synopsis International Old Ltd., 212 Taxman 454 (Kar.) and iii) CIT v/s Samsung Electronics Co. Ltd., 345 ITR 494 (Kar.) 11. It was submitted by him that after the amendment made by way of Explanation-4 in section 9(1)(vi), the consideration received by assessee for sale of software would now be undoubtedly covered within the definition of "Royalty", and that since the Explanation has been added with retrospective effect, therefore, the case of the assessee is clearly covered in the amended law and, therefore, the orders of the lower authorities should be upheld. 12. We have gone thro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fore the DRP wherein no relief was given and, therefore, still being aggrieved, the assessee approached the Tribunal. 15. On further analyzing the facts, it is noted that admitted facts on record are that the assessee had no business connection in India and it had no P.E. in India. This fact has not been disputed by the Assessing Officer. Rather we can say the Assessing Officer has proceeded on this admitted fact that the assessee has neither any P.E. nor business connection in India. Thus, under these circumstances, the impugned amount of consideration is not liable to be taxed as business income of the assessee. The taxability of the same, however, has to be examined in view of the provisions contained in clause (vi) of sub-section (1) of section 9 of the Act read with relevant provisions of Indo-Israel DTAA. On this issue, we have examined carefully all the arguments made by the Ld. Counsel as well as counter submissions made by the Ld. Departmental Representative and we shall deal with the same hereunder:- 16. The first part of the argument made by the Ld. Counsel for the assessee is that the impugned consideration was received on account of sale of machine along with requisi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he agreement puts certain restrictions upon the customers for any other use of the software in any other machine. This clause restrains the customer from duplicating the software or making any copies, modifications, isolating the software and making it available as a standalone data base or product, removing any product identification, copyright or other proprietary notice from the software or decompiling, disassembling, reverse engineering, or making any other attempt to reconstruct or discover the source code, etc. This clause clearly lays down that customer shall not reproduce the software or any of the documentation provided in connection with the software or related knowhow. It is further noted that clause 6.2 of the said agreement lays down that the assessee is and shall remain sole and exclusive owner of the right, title and interest in the software and related know. This software cannot be used by the customer except for the operation of the machine. It is further noted by us that the machine was equipped with requisite security controls and hardware locks to stop any type of misuse of software. Clause 10.2 of one of the agreement available at Page-49 is reproduced hereund ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iven for the purpose of proper assessment of custom duty to be levied at the time of imports of the machines. Further, software has been supplied separately by e-mail for various security reasons and to enable the customer to have the benefits of updated technologies. Similarly, separate payments have been made at the time of sale and subsequently by customer as a matter of terms between both the parties keeping in view various factors such as financial and administrative convenience and commercial expediency. The dominant and essential character of the transaction was sale of machine by the assessee and purchase of the same by the customer, and it shall remain the same with or without these two features. 20. The view taken by us is not res-integra. Our view is supported by many judgments brought to our notice. 21. In case of CIT v/s Alcatel Lucent, Canada, 372 ITR 476 (Delhi), Hon'ble Delhi High Court has analyzed this situation in detail and after discussing entire law available, held that supply of embedded software (which was part of the hardware supplied to assessee's customers by it) did not constitute "Royalty" and, therefore, section 9(1)(vi) was not attracted and for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... are embedded in the hardware amounted to royalty. After noticing several contentions of the revenue, this Court held in Ericsson A.B. (supra) as follows:- "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 the nature of royalty either under the Income-Tax Act or under the DTAA. We have to keep in mind what was sold by the assessee to the Indian customers was a GSM which consisted both of the hardware as well as the software, therefore, the Tribunal is right in holding that it was not permissible for the Revenue to assess the same under two different articles. The software t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ned 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 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 laser-readable disc 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. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rms: (a) In classification of products, the commercial understanding is more relevant than technical specifications except in respect of commodities for which such specifications are prescribed requiring the assistance of experts in the respective fields. In other words, the method to be adopted for classification is to be based on easily understandable parameters. (b) The decisions in respect of software and hardware in relation to computer are to the effect that if any software is embedded/etched/burnt then it has to be included as part of the hardware and cannot be treated as stand-alone software and that the value of such embedded software should be part of the value of computer. However, it cannot be concluded that only the value of software which is embedded/etched/burnt is to be included in the value of the computer. (c) It is not as if essentiality is an irrelevant criterion for determining the classification/valuation and at the same time essentiality is not the sole criterion for deciding the classification or determination of value. (d) In the matter of valuation, one of the important aspects to be taken into account is the condition of the goods/product at t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f an Explanation by Finance Act, 2012, for extending the scope of the term "Royalty", shall not be read into the provisions of Article 12.3 of the Indo-Israel tax treaty incorporated in the treaty for explaining meaning of the term 'Royalty'. 26. We have carefully considered this argument of the assessee also. We find that position of law on this aspect is clear. Recently, Hon'ble Bombay High Court in DIT v/s A.P. Mollar Maersk, ITA no.1306/2013, vide order dated 29th April 2015 reiterated the same position by observing as under:- "12. Our attention is also drawn to the decision of this Court in the case of Commissioner of Income-tax V/s. Siemens Aktiongeselleschaft reported in [2009] 310 ITR 320 (Bom), wherein this Court has held that once there is a treaty between two sovereign nations, though it is open to a sovereign Legislature to amend its laws, a DTAA entered into by the Government, in exercise of the powers conferred by section 90(1) of the Act must be honoured. The provisions of Section 9 Income Tax Act were applicable and the provisions of DTAA, if more beneficial than the I.T. Act, the provisions of DTAA would prevail. Thus, in the instant case also, it is not pos ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on'ble High Court that in the absence of any corresponding amendment in DTAA, there was no need to examine effect of subsequent amendment to section 9(1)(vi) and also fact as to whether amount received for use of software would be "Royalty" in terms thereof. 32. Recently, Hon'ble Delhi High Court in the case of DIT v. NEW SKIES SATELLITE BV in its order dated 8th February 2016 in ITA NO.473/M/12 got an occasion to analyse in detail entire law on the issue that amendment made in the domestic law i.e. Income Tax Act shall not be automatically read in to provision of DTAA, unless specific amendment is made by both the countries in the DTAA, as the DTAA is an agreement of two sovereign countries and one of them cannot unilaterally amendment the terms of the agreement. Merely, on the basis of some amendments made in the domestic law, the Relevant portion of the judgment is reproduced below: DIT vs NEW SKIES SATELLITE BV (Order Dt 08.02.2016 in ITA 473/2012 ) ( Delhi High Court) "This Court is of the view that no amendment to the Act, whether retrospective or prospective can be read in a manner so as to extend in operation to the terms of an international treaty. In other words ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that law laid down by the Parliament in our domestic context, even if it were in violation of treaty principles, is to be given effect to; but where the State unilaterally seeks to amend a treaty through its legislature, the situation becomes one quite different from when it breaches the treaty. In the latter case, while internationally condemnable, the State's power to breach very much exists; Courts in India have no jurisdiction in the matter, because in the absence of enactment through appropriate legislation in accordance with Article 253 of the Constitution, courts do not possess any power to pronounce on the power of the State to enact a law contrary to its treaty obligations. The domestic courts, in other words, are not empowered to legally strike down such action, as they cannot dictate the executive action of the State in the context of an international treaty, unless of course, the Constitution enables them to. That being said, the amendment to a treaty is not on the same footing. The Parliament is simply not equipped with the power to, through domestic law, change the terms of a treaty. A treaty to begin with, is not drafted by the Parliament; it is an act of the Execut ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rovisions of Indo-Israel treaty would be preferred over the provisions of the Act, since there is no amendment in the treaty and the Department is seeking to put more tax liability upon the assessee taking help of amendment made in section 9(1)(vi). 34. We have gone through the provisions of Article-12 of India Israel tax treaty which defines the term "Royalty". Article 12(3) has revised this term "Royalty" as under:- "(3). The term "Royalty" as used in this Article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph film, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience." 35. Thus, the status of the provisions in the treaty is kept same as was in the pre-amended law as contained in the provisions of the Act. According to these provisions of the treaty, as has been explained in various judgments, transfer of copyright is different from transfer of copyrighted article. Thus, in view of the facts of the case before us, even if payment for software is taxed sepa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ensee 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 Infrasoft Licence Schedule. Without the consent of the Assessee the software cannot be loaned, rented, sold, sublicensed or transferred to any third party or used by any parent, subsidiary or affiliated entity of Licensee or used for the operation of a service b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 nontransferable 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 product in favour of the licensee/customer is what is contemplated by the Treaty. 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, amount ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s 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 licensee 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 acquired is only a copy of the copyright article whereas the copyright remains with the owner and the Licensees have acquired a computer programme for being used in their business and no right is granted to them to utilize the copyright of a computer program ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ered in favour of the Assessee and against the Revenue that the Income Tax Appellate Tribunal was right in holding that the consideration received by the respondent Assessee on grant of licenses for use of software is not royalty within the meaning of Article 12(3) of the Double Taxation Avoidance Agreement between India and the United States of America. 101. The appeal is accordingly dismissed leaving the parties to bear their own costs." ii) In the case of Ericsson A.B. v/s DIT (supra), Delhi High Court held that consideration for use of computer software in the absence of transfer of copyright therein would not constitute "Royalty". Some of the relevant observations of the High Court are reproduced hereunder:- "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 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Taxman.com 502, followed the judgment of the Special Bench in Motorola Inc. (supra) after distinguishing the judgment of the co-ordinate bench in the Grace Mac Corporation v/s ADIT, 42 SOT 550 (Del.) and held that in view of Article-12(3) of India-Israel DTAA, the consideration for payment of standard software would not constitute "Royalty" under the India Israel DTAA. 39. Similar view has been taken by Co-ordinate bench of Tribunal in Financial Software and Systems Pvt. Ltd. v/s DCIT, 47 Taxman.com, 410 (Chennai), wherein it was held that payment made to non-resident companies for procuring standard and copyrighted software could not be treated as payment towards "Royalty". In this judgment, Bench has also considered and distinguished judgment of another judgment of co-ordinate bench in the case of Reliance Infocom Ltd., 39 Taxman.com 140 (Mum.). 40. The Mumbai Bench of the Tribunal in DDIT v/s Solid Works Corporation, 152 TTJ 570 (Mum.), held that the consideration received on sale of Shrink Rap Software was not "Royalty". It was business income and in the absence of a P.E., no income accrued in India. In this judgment, the Bench also dealt with the argument of the Revenue tha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... High Court in the case of Ericsson A.B. (supra) and Infrasoft Ltd. (supra), we hold that the consideration received by the Assessee for supply of product along with license of software to End user is not royalty under Article 12 of the Tax Treaty. Even where the software is separately licensed without supply of hardware to the end users (i.e. eight out of 63 customers), we are of the view that the terms of license agreement is similar to the facts of Infrasoft Ltd (Supra). Accordingly, we hold that there was no transfer of any right in respect of copyright by the assessee and it was a case of mere transfer of a copyrighted article. The payment is for a copyrighted article and represents the purchase price of an article. Hence, the payment for the same is not in the nature of royalty under Article 12 of the Tax Treaty. The receipts would constitute business receipts in the hands of the Assessee and is to be assessed as business income subject to assessee having business connection/ PE in India as per adjudication on Ground No 5." 42. It is further noted by us that Mumbai Bench of the Tribunal in the case of ADIT v/s Antwerp Diamond Bank, N.V., ITA no.7347/Mum/2007, order dated 14t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ound that in the case before us, it was the case of predominantly a transaction of sale of machine by the assessee to its customers and for the customers also it was in effect a transaction of purchase of machine only, and thus it was not a case of sale of software, as such. This issue was not there before the High Court in these judgments. Therefore, this issue has not been addressed by the High Court. 46. Similarly, other case relied upon by the Ld. CIT-DR of DDIT v/s Reliance Infocom (supra), it is noted that this judgment has based its decision mainly relying upon the aforesaid two judgments of Karnataka High Court. Although, an argument was taken before the Bench in the said case that software was integral part of the hardware but on facts Hon'ble Bench held that the software supplied was not an integral part of equipment nor it was a case of embedded software. But in the case before us, we have held on facts that it is a case of predominantly a transaction of sale and purchase of machine. The software had no independent identity. The substance of the transaction was supply of machine by the assessee and its usage by the customers in whatever manner it was possible i.e., with ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as sold the machine along with its requisite software to operate and use the machine. The assessee has not given any right, whatsoever, to its customers to resell any copy of the software supplied along with machine, as has been discussed by us in detail in earlier part of this order. The other arguments made on behalf of the Revenue is that the Customers were supplied the software through email and other electronic medium and they has also made copies of the software programme for the purpose of loading it the machine and creating back-up files. It is noted that even this apprehension of the Revenue has been taken care of by the Copyright Act. Section 51 of the Act lists out those situations 'when copyright is infringed or deemed to be infringed. Further, section 52 of the Act, carves out exception to section 51 and lists out certain acts not to be considered as infringement of copyright. Section 52 states that the following acts shall not constitute an infringement of copyright, namely- "....... (aa) the making of copies or adaptation of computer programme by the lawful possessor of a copy of such computer programme, from such copy- (i) In order to utilize the computer pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ature. At the same time, this very principle is based on "fairness" doctrine as it lays down that if it is not very clear from the provisions of the Act as to whether the particular tax is to be levied to a particular class of persons or not, the subject should not be fastened with any liability to pay tax. This principle also acts as a balancing factor between the two jurisprudential theories of justice - Libertarian theory on the one hand and Kantian theory along with Egalitarian theory propounded by John Rawls on the other hand. Tax laws are clearly in derogation of personal rights and property interests and are, therefore, subject to strict construction, and any ambiguity must be resolved against imposition of the tax. In Billings v. U.S., the Supreme Court clearly acknowledged this basic and long-standing rule of statutory construction: "Tax Statutes ... should be strictly construed, and, if any ambiguity be found to exist, it must be resolved in favor of the citizen. Eidman v. Martinez, 184 U.S. 578, 583; United States v. Wigglesworth, 2 Story, 369, 374; Mutual Benefit Life Ins. Co. v. Herold, 198 F. 199, 201, affd 201 F. 918; Parkview Bldg . Assn. v. Herold, 203 F. 876 ..... X X X X Extracts X X X X X X X X Extracts X X X X
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