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2016 (5) TMI 156 - ITAT MUMBAI

2016 (5) TMI 156 - ITAT MUMBAI - TMI - Income from sale of shrink wrap software - taxability in India - nature of royalty under the provisions of Section 9(1)(vi) as well as article 12(3) of the Double Taxation Avoidance Agreement between India and USA - Held that:- Following the view expressed by the Hon'ble Delhi High Court in the case of DIT Vs. Ericsson AB, New Delhi (2011 (12) TMI 91 - Delhi High Court ), which is favourable to the Assessee, we hold that the consideration received by the As .....

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spondent : Jasbir Chauhan ORDER Per Pramod Kumar, AM: 1. By way of this appeal, the assessee appellant has challenged correctness of the order dated 23rd October 2012 passed by the Assessing Officer in the matter of assessment under section of 143(3) r.w.s. 144C(13) of the Income Tax Act, 1961 for the assessment year 2009-10. 2. Grievances of the appellant are as follows: 1. On the facts and the circumstances of the case and in law, the learned AO has erred in holding that the income from sale o .....

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o use the software product as against any copyright right. 3. On the facts and the circumstances of the case and in law, the learned AO and the DRP have erred in holding that the payment received on sale of shrink wrap software is for the use of secret process falling within the ambit of Article 12(3) of India USA DTAA 4. On the facts and the circumstances of the case and in law, the learned AO and the DRP have erred by not following the binding decisions of the Mumbai bench of the Tribunal in a .....

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tter of fact, in the orders of the authorities below also it is specifically accepted that the issue is covered, by decisions of the coordinate benches in assessee s own case, but yet the taxability is upheld because the matter is pending before Hon ble jurisdictional High Court. 4. We find that, in a very elaborate and well reasoned order for the assessment year 2007-08 - which also deals with the issues being raised now by the learned Departmental Representative, our distinguished colleagues h .....

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ess income and since the Assessee did not have a Permanent Establishment (PE) in India the receipts are not taxable in India. The operative part of the order of the Tribunal in ITA No.3095/Mum/07 for AY 03-04 reads as follows: 3. The assessee is a company incorporated in the USA and a tax resident of USA. The assessee filed tax resident certificate before the Assessing Officer and is therefore entitled to the benefit of the Double Taxation Avoidance Agreement between India and USA (DTAA). The as .....

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reement (EULA). The agreement is not physically signed but built in as part of the installation process. The license agreement pops up on computer screen and must be accepted by the user before the user can operate the software. The software provided to the user is a single user license whereby the software can be loaded in one computer or can be used many times (called multiple user license) which can be loaded on several computers. Solidwork owns and will retain all copyright, trade mark, trad .....

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agreements are identical. As per the software distribution agreement, the distributor gets right to market distribute and support the product. However, distributor does not get any exclusive distributor rights. He also does not get any right to disassemble, decompile or reverse engineer the software. Copyright over software remain with the assessee. On these facts, it was claimed by the assessee before the Assessing Officer that the software being sold by the assessee was a shrink wrap software .....

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and he accordingly brought the same to tax. On appeal by the assessee, learned CIT(A) held that the payment in question was not in the nature of royalty and was payment for purchase of copyrighted article. Addition made by the Assessing Officer was deleted by the learned CIT(A) giving rise to Ground No. 1&2 of the revenue before the Tribunal. 6.We have heard the rival submissions. The sample copy of the software distribution agreement filed before the lower authority shows that under sectio .....

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such products were received from the assessee. The Distributor does not have any right to make further copies of the products. Under section 3 of the agreement, which grants license for use of the product by the ultimate consumer clearly provides that distributor cannot disassemble, decompile or in any way attempt to reverse engineer any of the product or to modify or make works derived from the products. It also provides that license to use cannot be construed as a right to make copies of the .....

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the copyright of the software. 7.The Hon'ble Supreme Court in the case of Tata Consultancy Services Pvt. Ltd. Vs. State of Andhra Pradesh (2004) 271 ITR 401 has held as follows :- "A software programme may consist of various commands which enable the computer to perform a designated task. The copyright in that programme may remain with the originator of the programme. But the moment copies are made and marketed, it becomes goods, which are susceptible to sale tax. Even intellectual prop .....

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tle value. The software and the media cannot be split up. What the buyer purchases and pays for is not the disc or the CD. As in the case of paintings or books or music or films the buyer is purchasing the intellectual property and not the media i.e. the paper or cassette or disc or CD. Thus, a transaction of sale of computer software is clearly a sale of goods within the meaning of the term as defined in the said Act." 8.Thus computer software when it is put on to a media and sold has beco .....

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A shows that definition of royalty under DTAA is more restrictive than what is provided in section (9)(1) of the Act. Under the definition as contained in DTAA, there should be a transfer of copyright. Sale of software by the assessee to the distributor or end user does not involve any transfer of copyright either in part or in whole; therefore consideration paid by the distributor cannot be said to be a payment for right of use copyright or transfer of use of copyright. It has been uniformly he .....

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tion and therefore cannot be said to be covered by the Patient Act. Computer software cannot also be treated as process. End user of the software in the case of shrink-wrap software does not have any access to source code. He has only right to use the software for his personal or business use. For all the above reasons, we are of the view that learned CIT(A) was right in concluding that payment received by the assessee was not in the nature of royalty and cannot therefore be brought to tax. We u .....

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e software distributor is to distribute the software to the end user. The distribution agreement also contains an end users licence agreement (EULA). The Learned DR drew out attention to the EULA and submitted that the end user is granted only a license to use the software. He also pointed out that the EULA in clause 1-C provides for a security mechanism being embedded in the software to ensure that the terms of the license are not violated. His submission was that the Assessee has complete cont .....

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ted 15.10.2011, a copy of which has been filed before us. The Hon'ble Karnataka High Court was dealing with a case where the question was as to whether the amounts paid to the foreign software suppliers were royalty. The Hon'ble Court after considering the provisions of Sec. 14 of the Copyright Act, 1957, definition of "Royalty" under Double Taxation Avoidance Agreement (DTAA), terms of use of shrink wrap software by the end user, distributor and sub-distributor, held as follow .....

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respondent to make copy of the software contained in shrinkwrapped / off-the-shelf software into the hard disk of the designated computer and to take a copy for backup purposes, the end user has no other right and the said taking backup would have constituted an Infringement, but for the licence. Therefore, licence 1granted for taking copy of the software and to store It in the hard disk and to take a backup copy and right to make a copy Itself is a part of the copyright. Therefore, when licence .....

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ISSIONER OF INCOME 'TAX DELHI-V Vs. 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 respondent 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 prov .....

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annot be accepted. Accordingly, we hold that right to make a copy of the software and use it for internal business by making copy of the same and storing the same in the hard disk of the designated computer and taking back up copy would itself amount to copyright work under Section 14 (1) of the Act and licence is granted to use the software by making copies, which work, but for the licence granted would have constituted infringement of copyright and licencee is in possession of the legal copy e .....

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per the terms of the agreement, which, but for the licence would amount to infringement of copyright and in view of the licence granted, the same would not amount to infringement under section 52 of the Copyright Act as referred to above. Therefore, the amount paid to the non-resident supplier towards supply of shrink wrapped software or off-the-shelf software is not the price of the C.D, alone nor software alone nor the price of licence granted. This is a combination of all and in substance, u .....

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are purchased, but so far as software stored in dumb CD is concerned, the transfer of dumb C.D. by itself would not confer any right upon the end user and the purpose of the CD 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 t .....

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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 definition of royalty under clause 9(1)(vi) of the Act is broader than the definition of royalty under the DTAA as the right that is transferred in the present case is the transfer of copyright including the right to make copy of software for Internal business, and payment made in that regard would constitute royalty for imparting o .....

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pective country, it is clear that the payment made by the respondents to the non-resident supplier would amount to royalty. In view of the said finding, it is clear that there is obligation on the part of the respondents to deduct tax at source under Section 195 of the Act and consequences would follow as held by the Hon'ble Supreme Court while remanding these appeals to this Court. Accordingly. we answer the substantial, question of law in favour of the revenue and against the assessee by h .....

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mpugned in these appeals is set aside and the order passed by the Commissioner of Income Tax (Appeals) confirming the order passed by the Assessing Officer (TDS)-I is restored." 5. The learned counsel for the Assessee relied on the decision of the Hon'ble Delhi High Court in the case of Director of Income Tax Vs. Ericsson A.B., New Delhi ITA No.504/2007 dated 23.12.2007. The Hon'ble Delhi High Court was dealing with a question as to whether the Tribunal was justified in holding that .....

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ware. The Assessing Officer was of the view that the income of the assessee was taxable in India, both, under the Income-tax Act, 1961 as well as under the treaty between India and Sweden. He held that it was business income and Assessee had a PE in India. The CIT(A) held that the receipts in respect of license to use software which is part of the hardware alone could be taxed in India as royalty. The Assessee argued before Tribunal that the payment made by the assessee for the use of software i .....

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s royalty either under the Act or under the DTAA. The Tribunal after referring to definition of Royalty under the Act and the definition copyright under the Copyright Act, 1957 held that what was sold by the non resident was a copyrighted article and payment to the non resident was not for copyright. On further appeal by the Revenue, the Hon'ble Delhi High Court examined the issue which we have set out earlier. The Hon'ble Delhi High Court held that income did not accrue to the nonreside .....

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t which deals with the taxability of royalty income" reads as under :- "Section 9 .INCOME DEEMED TO ACCRUE OR ARISE IN INDIA. (1) The following incomes shall be deemed to accrue or arise in India :- (i) All income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capita! asset situate in India" 51.The .....

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rgued that for the purposes of Income-Tax law, royalty is essentially a payment received as consideration for the use or right to use a particular integral property right, whether partially or entirely. 52.We find that the Tribunal has held that there was no payment towards any royalty and this conclusion is based on the following reasoning:- (i)Payment made by the cellular operator cannot be characterized as royalty either under the Income Tax Act or under the DTAA. (ii)The operator has not bee .....

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r software to be royalty (v)The bill of entry for importing of goods shows that the price has been separately mentioned for software and that this was only for the purposes of customs. There is no evidence to show that the assessee was a party to the fixation of value for the customs duty purposes (vi)The software provided under the contract is goods and therefore no royalty can be said to be paid for it. 53. Mr. Prasaran, countered the aforesaid reasoning arguing that Clause 20 of the Supply Co .....

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ertain acts will not to amount to infringement in the light of various concerns, where otherwise such acts would amount to infringement under Section 51 of the Copyright Act. The provision cannot by itself be used to hold that no right exists in the first place, since the scope of the right has to be understood only from the provisions of Section 14 of the Copyright Act, 1957. He also argued that the ITAT has misinterpreted the provisions of the DTAA, specifically Article 13, para 3 of the DTAA .....

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to grant nonexclusive licenses to other parties, it follow that there was no full time transfer of copyright but it was only a case of right to use the software, and thus payment for use of software is to be treated as royalty. He further argued that reference to OECD Commentary was not apposite as it could not be used to interpret the scope of the relevant provisions of DTAA. 54.It is difficult to accept the aforesaid submissions in the facts of the present case. We have already held above tha .....

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ld 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 asthe 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 that was loaded on the hardware did not have any independent existence. The software .....

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TA Consultancy Services Vs. State of Andhra Pradesh, 271 ITR 401, wherein the Apex Court held that software which is incorporated on a media would be goods and, therefore, liable to sales tax. Following discussion in this behalf is required to be noted:- "In our view, the term "goods" as used in Article 366(12) of the Constitution of India and as defined under the said Act are very wide and include all types of movable properties, whether those properties be tangible or intangible .....

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r canvas (In case of painting) or computer discs or cassettes, and marketed would become "goods". We see no difference between a sale of a software programme on a CD/floppy disc from a sale of music on a cassette/CD or a sale of a film on a video cassette/CD. In all such cases, the intellectual property has been incorporated on a media for purposes of transfer. Sale is not just of the media which by itself has very little value. The software and the media cannot be split up. What the b .....

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of abstraction, consumption and use and which can be transmitted, transferred, delivered, stored, possessed etc. The software programmes have all these attributes." xxxxxxxxxx "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 .....

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rofessor 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 go .....

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ain and cumulative reading of the terms and conditions of the contract entered into between the principal to principal i.e., ,foreign company and Midhani i.e., preamble of the contract, Part-I and II of the contract and also the separate agreement, as referred to above, would clearly show that it was one and the same transaction. One cannot be read in isolation of the other. The services rendered by the experts and the payments made towards the same was part and parcel of the sale consideration .....

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nnot be accepted and the judgments relied upon by the Revenue are the cases where there was a separate agreement for the purpose of technical services to be rendered by a foreign company, which is not connected for the fulfilment of the main contract entered into principal to principal. This is not one such case and thus the contention of the Revenue cannot be accepted in the circumstances and nature of the terms of the contract of this case." 58.No doubt, in an annexure to the Supply Contr .....

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cessary to establish that there is transfer of all or any rights (including the granting of any license) in respect of copy right of a literary, artistic or scientific work. Section 2 (o) of the Copyright Act makes it clear that a computer programme is to be regarded as a literary work". Thus, in order to treat the 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 .....

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ion. Such a distinction has been accepted in a recent ruling of the Authority for Advance Ruling (AAR) in Dassault Systems KK 229 CTR 125. We also find force in the submission of Mr. Dastur that even assuming the payment made by the cellular operator is regarded as a payment by way of royalty as defined in Explanation 2 below Section 9 (1) (vi), nevertheless, it can never be regarded as royalty within the meaning of the said term in article 13, para 3 of the DTAA. This is so because the definiti .....

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ncapable of independent use and it was a contract for supply of goods. Therefore, no part of the payment therefore can be classified as payment towards royalty." 6.Before us the learned D.R. as well as the learned counsel for the Assessee referred to several decisions of the Tribunal rendered on identical issue. These decisions are not being considered as the two decisions of the Hon'ble High court of Karnataka and Hon'ble High Court of Delhi were rendered after those decisions rend .....

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see should be preferred. The learned D.R. on the other hand submitted that the decision of the Hon'ble Delhi High Court was rendered in the context of sale of equipment in which software was embedded and not a case of shrink wrap software as such and therefore that decision should be applied to a case where sale of shrink wrap software is involved. Alternatively it was submitted by him that the concession that where two views are available on an issue one favourable to the Assessee and the o .....

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scrimination. Article 24(1) lays down that Nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith, which is other or more burdensome than the taxation and connected requirements to which nationals of that other State in the same circumstances, in particular with respect to residence, are or may be subjected. This provision shall, notwithstanding the provisions of article 1, also apply to persons who are not re .....

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pment supplied and therefore the same should not be applied to the case of shrink wrap software, we are of the view that the Hon'ble Delhi High Court after referring to the decision of the Hon'ble Supreme Court in the case of Tata Consultancy Services (supra) went on to observe at para-56 of its judgment that when software is incorporated in a CD it becomes a tangible property and the payment made for acquiring the same is not a payment by way of royalty. In para- 60 of its judgment, the .....

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t third party resellers. To authorize a VAR to act as a reseller the applicant entered into a general VAR agreement. The terms of the agreement explicitly provided for the appointment of reseller/distributor of product on a non-exclusive basis for making the product available to the end-user within the territory for his internal use. The product was sold to the VAR for a consideration based on the standard list price less discount; and the VAR in turn would sell the product to the end-users at a .....

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er by the applicant, the applicant would provide a licence key via e-mail so that the customer would directly download the product through the web link. On these facts, the applicant sought the advance ruling of the Authority on the question "Whether on the facts and circumstances of the case and in law the payment received by Dassault Systems K. K. (hereinafter referred to as 'the applicant') from sale of software products to independent third party resellers will be taxable as bus .....

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yright in or over the computer software produced by the applicant was in the nature of an intangible, incorporeal right belonging to the category of intellectual property rights. All intellectual property rights in the licensed programs exclusively belonged to the applicant or its licensor and they were retained by the applicant. (ii)That passing of a right to use and facilitating the use of a product for which the owner had a copyright was not the same thing as transferring or assigning rights .....

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nt of the right of using the copyright. (iii)That the VAR had not been given an independent right to sell or offer for sale the software products of the applicant to the end-users. What the VAR did, in the course of carrying out its marketing function, was to canvass for orders, collect the purchase order from the interested customer and forward that offer to the applicant; and it was the applicant that accepted or rejected that offer. In the absence of an independent right to conclude the sale .....

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rights in the copyright in a programme to the sale of a product which is subject to restrictions on the use to which it is put. The consideration paid can also take numerous forms. These factors may make it difficult to determine where the boundary lies between software payments that are properly to be regarded as royalties and other types of payment. The difficulty of determination is compounded by the ease of reproduction of computer software, and by the fact that acquisition of software frequ .....

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the public software incorporating the copyrighted programme, or to modify and publicly display the programme. In these circumstances, the payments are for the right to use the copyright in the programme (i.e., to exploit the rights that would otherwise be the sole prerogative of the copyright holder). In other types of transactions, the rights acquired in relation to the copyright are limited to those necessary to enable the user to operate the programme, for example, where the transferee has l .....

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try. In some countries the act of copying the programme onto the hard drive or random access memory of a computer would, without a licence, constitute a breach of copyright. However, the copy right laws of many countries automatically grant this right to the owner of software which incorporates a computer programme. Regardless of whether this right is granted under law or under a licence agreement with the copyright holder, copying the programme onto the computer's hard drive or random acces .....

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relevant. For example, it does not matter whether the transferee acquires a computer disk containing a copy of the programme or directly receives a copy on the hard disc of her computer via a modem connection. It is also of no relevance that there may be restrictions on the use to which the transferee can put the software." (Underlining by us for emphasis) 11. After referring to the aforesaid OECD Commentary, the AAR in its decision rendered in the case of Dassault Systems KK (supra) observ .....

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n 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 storag .....

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just as the owner would be in a position to do. In so far as the licensed material reproduced or stored is confined to the four corners of its business establishment, that too on a non-exclusive basis, the right referred to in subclause (i) of section 14(a) would be wholly out of place. Otherwise, in respect of even off-the- shelf software available in the market, it can be very well said that the right of reproduction which is a facet of copyright vested with the owner is passed on to the cust .....

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damage in order to utilize the computer programme for the purpose of which it was supplied" will not constitute infringement of copyright. Consequently, customization or adaptation, irrespective of the degree, will not constitute "infringement" as long as it is to ensure the utilization of the computer programme for the purpose for which it was supplied. Once there is no infringement, it is not possible to hold that there is transfer or licensing of "copyright" as defin .....

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aph 9 supra), it would only be appropriate and proper to test it in terms of infringement. What has been excluded under section 52(aa) is not commercial exploitation, but only utilizing the copyrighted product for one's own use. The exclusion should be given due meaning and effect; otherwise, section 52(aa) will be practically redundant. In fact, as the law now stands, the owner need not necessarily grant licence for mere reproduction or adaptation of work for one's own use. Even without .....

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ly mean only reproduction and adaptation for the purpose of commercial exploitation. 13.The ruling of the AAR in the case of Dassault (supra) was approved by the Hon'ble Delhi High Court in the case of DIT Vs. Ericsson AB, New Delhi (supra). It can therefore be said that the Hon'ble Delhi High Court has held that consideration paid merely for right to use cannot be held to be royalty. This ratio laid down by the Hon'ble Delhi High Court would also apply when shrink wrap software is s .....

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of a permanent establishment. 5. We see no reasons to take any other view of the matter than the view so taken by the coordinate bench. There is nothing much that we can add to such a well researched and erudite order either. The decisions of non jurisdictional High Courts, in favour of the revenue on this point, have already been dealt with in this order. As to what should be done in a situation in which there are conflicting views of Hon ble non jurisdictional High Courts and in which we do n .....

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c principles of hierarchical judicial system. We have to, with our highest respect of both the Hon ble High Courts, adopt an objective criterion for deciding as to which of the Hon ble High Court should be followed by us. 8. We find guidance from the judgment of Hon ble Supreme Court in the matter of CIT vs. Vegetable Products Ltd. 1973 CTR (SC) 177 : (1972) 88 ITR 192 (SC). Hon ble Supreme Court has laid down a principle that "if two reasonable constructions of a taxing provisions are poss .....

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s to deviate from this general principle of interpretation of taxing statute which can be construed as exceptions to this general rule. It has been held that the rule of resolving ambiguities in favour of tax-payer does not apply to deductions, exemptions and exceptions which are allowable only when plainly authorised. This exception, laid down in Littman vs. Barron 1952(2) AIR 393 and followed by apex Court in Mangalore Chemicals & Fertilizers Ltd. vs. Dy. Commr. of CT (1992) Suppl. (1) SCC .....

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essee will have to treat the provisions unconstitutional, as held in the matter of State of M.P. vs. Dadabhoy s New Chirmiry Ponri Hill Colliery Co. Ltd. AIR 1972 (SC) 614. [Tej International Pvt Ltd Vs DCIT (2000) 69 TTJ 650 (Del)] 52. Even otherwise, the Revenue has not cited any direct case law of the jurisdictional High Court of Bombay before us. In the case laws cited by the Revenue of the Hon ble Karnataka High Court in the matter of CIT vs. Samsung Electronics Company Ltd. (supra) and CIT .....

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