TMI Blog2016 (8) TMI 729X X X X Extracts X X X X X X X X Extracts X X X X ..... n 144C(5) of the Act vide order dated 28.09.2015. 2. The facts of the case, briefly, are as under: - 2.1 The assessee, a 100% subsidiary of Sarin Technologies Ltd., Israel is engaged in the business of development of proprietary technology for automated evaluation of internal features in diamond, carrying out its operations in diamond processing centres at Surat and Mumbai. As part of its business, the assessee sells to its customers machines used in the diamond industry and operating application software which is an integral part of the said machine. It also sells spare parts and application software based on usage of the software. The said machines can be operated only if the operating application software is installed in the machine. The assessee was of the view that the payments received for sale of such operating/application software did not constitute Royalty under the India- Israel DTAA and therefore no withholding of tax was required to be made in respect of such receipts from sale of application software. In these factual circumstances, the assessee filed its return of income for A.Y. 2012-13 on 05.10.2013 and a revised return on 28.03.2014 declaring total income a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e 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 in the nature of business profits not liable to tax in India in the absence of a permanent establishment of the appellant in India. 4. Without prejudice, the assessing officer erred on facts and in law in not appreciating that the software supplied to the customers in India only resulted in their acquiring a 'copyrighted article' and not a 'copyrighted right' and that the payment for the same did not constitute 'royalty' as defined in Article 12(3) of the Treaty and was hence not liable to tax in India. 5. That the assessing officer erred on facts and in law in not appreciating that the defi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o the learned D.R., after the amendment by way of insertion of Explanation 4 to section 9(1)(vi) of the Act by Finance Act 2012 w.e.f. 01.04.1976, the consideration received by the assessee for transfer or sale of computer software would now be covered by the definition of Royalty and that since the Explanation has been added with retrospective effect, the case of the assessee is covered by the law as amended and therefore the orders of the authorities below ought to be upheld. In support of this proportion the assessee, inter alia, relied on the following judicial pronouncements: - i) CIT vs. Siemens Aktiongesellschaft (310 ITR 320 (Bom) ii) Viacom 18 Media (P.) Ltd. (2014) 162 TTJ 336 (Mum) iii) CIT vs. CGI Information Systems and Management Consultants (P) Ltd. (2014) 48 Taxman.com 264 (Kar) 5.3 In rejoinder, the learned A.R. for the assessee reiterated that the issue in dispute for consideration in this appeal is covered in favour of the assessee by the decision of the Coordinate Bench in the assessee s own case for A.Y. 2011-12 (supra). It was submitted that the assessee s case finds support from the decision of the Hon'ble Bombay High Court in the case of Si ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pt 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 assessee company and its customers to show that the software had no independent existence. It was integral part of the machine and the customer was not allowed to isolate the software from the machine or to re engineer the same. From various evidences and facts on record, it was shown by the Ld. Counsel for the assessee that the software was integral part of the machine and the transaction done with the customer was that of sale of machine and not of software. It was clarified by him that the software was separately mentioned in the invoice and its payments were also received separately for the purpose of proper assessment of custom duty etc and administrative convenience, but it was a transaction of predominantly sale of machine. He thus argued that it was a case of embedded software and, therefore, the transaction being predominantly sale of machine, the income arising there-from was not liable to be taxed in India un ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... responding 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) B4U International Holdings Ltd. v/s DCIT, 148 TTJ 237 (Mum.); and v) WNS North America Inc., v/s ADIT, ITA no.8621/ Mum./2010 (Mum.). 8. The third argument made by the Ld. Counsel for the assessee is that in any case, the impugned transactions could not be covered within the definition of Royalty as envisaged in section 9(1)(iv) since there was no transfer of any copyright. What was transferred at the best was a copyrighted article. It was submitted by him that if we go by definition of the term Royalty as per article 12(3) of Indo Israel treaty, then unless there is a transfer of copyright itself, there would not be any occasion to treat the amount of consideration as Royalty . He took us through section 14 of the Copyright Act, to demonstrate that there was no transfer of any copyright in this case. It was submitted that in this case, no source code was supplied ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n 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 through the orders of the lower authorities and the submissions made and evidences shown to us as well as copies of judgments read and relied upon by both the parties in support of their respective arguments. The solitary dispute which is required to be addressed by us is that consideration received by the assessee towards software claimed to have been supplied as part of Diamonds Gems Scanning Machine would be liable to tax as Royalty in the hands of the assessee or not. 13. Brief background of the case is that the assessee is a company incorporated under the laws of Israel and is tax resident of Israel for the purpose of Indo Israel Double Taxation Avoidance Agreement (in short referred to as DTAA or tax-treaty). The Ld. Counsel drew our attention to the tax residence certificate in thi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 requisite software which formed integral part of machines sold by it to the customers. The whole dispute arose merely because value of software was separately mentioned. But, there was no separate transaction of sale of software and, therefore, it was predominantly transaction of sale of machine and, therefore, it could not have been brought within the definition of Royalty as envisaged in section 9(1)(vi) of the Act and, therefore, in the absence of there being any P.E. of the assessee in India, the income arising from sale of machine could not have been taxed in its hands in India. 17. We have carefully analyzed the facts of the case and arguments made by the Ld. Counsel for the assessee as well as counter arguments made by the Ld. Departmental Representative. The undispute ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 hereunder for the sake of ready reference: 10.2 SARIN INDIA acknowledges that GALATEA may use software and/or hardware locks or other protective mechanisms to regulate the use of software. SARIN INDIA shall not evade or override such software/hardware locks or protective devices and shall immediately inform GALATEA upon learning that any user has defeated such devices. SARIN INDIA agrees to cooperate fully with GALATEA in its efforts to protect Software from unlawful or unauthorized use. 18. From the aforesaid facts and features of the transactions analysed by us, it could be concluded that the customer was not interested in the hardware alone or in the software alone. He was interested in the system as a whole and functioning of the machine. Operating software ena ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 the same reasons, the article 13(3) of the DTAA was not involved. Relevant portion of the order of the judgment is reproduced herein for the sake of ready reference: The Revenue claims to be aggrieved by the order dated 04.04.2014 of the Income Tax Appellate Tribunal (hereinafter referred to as the ITAT ) in several connected appeals preferred by it, all of which were rejected by the ITAT. It argues that the ITAT erred in law in not considering that the income from supply of software embedded in the hardware equipment or otherwise to customers in India amounts to royalty under Section 9(1)(vi) of the Income Tax Act and under Article 13(3) of the Double Taxation Avoidance Agreement (DTTA) between India and France, Canada, Germany, China etc. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d 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 that was loaded on the hardware did not have any independent existence. The software supply is an integral part of the GSM mobile telephone system and is used by the cellular operator for providing the cellular services to its customers. There could not be any independent use of such software. The software is embodied in the system and the revenue accepts that it could not be used independently. This software merely facilitates the functioning of the equipment and is an integral part thereof. On these facts, it would be useful to refer to the judgment of the Supreme Court in TATA Consultancy Services Vs. State of Andhra Pradesh (2004) 271 ITR 401 (SC), wherein the Apex Court held that software which is incorporated on a media would ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... llectual 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. 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. 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. 6. This Court also noticed that the ITAT had in addition relied upon other judgmen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ter. 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 the time the goods leave the factory (as held by Honble Supreme Court in para 13 of Anjaleem case). Similarly, in respect of imported goods, the condition of the goods/product at the time of import is relevant. (e) In certain circumstances, software loses its identity as software and becomes part and parcel of hardware and similarly, in certain circumstances, hardware loses its identity as hardware and becomes part and parcel of software 24. Thus, from the aforesaid judgments, it is clearly evident that Courts have held that where software is supplied predominantly as part of an equipment and if the software loses its identity and the equipment takes over the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... leschaft 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 possible for the revenue to unilaterally decide contrary to the provisions of the DTAA. 27. In terms of section 90(2) of the Act, provisions of the Act or the treaty, whichever is more beneficial shall apply to the assessee. Further, amendment to the Act cannot be automatically read into the treaty unless the treaty is also amended. In the case of CIT v/s Siemens Aktiongesellschaft, supra, this proposition has been reaffirmed by the Hon'ble Bombay High Court after analysing the law in detail. 28. In the case of DIT v/s Nokia Networks O.Y., 358 ITR 259, Hon ble Delhi High Court has further explained this position following the aforesaid judgment of Hon ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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, a clarificatory or declaratory amendment, much less one which may seek to overcome an unwelcome judicial interpretation of law, cannot be allowed to have the same retroactive effect on an international instrument effected between two sovereign states prior to such amendment. In the context of international law, while not every attempt to subvert the obligations under the treaty is a breach, it is nevertheless a failure to give effect to the intended trajectory of the treaty. Employing interpretive amendments in domestic law as a means to imply contoured effects in the enforcement of treaties is one such attempt, which falls ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e 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 Executive Logically therefore, the Executive cannot employ an amendment within the domestic laws of the State to imply an amendment within the treaty. Moreover, a treaty of this nature is a carefully negotiated economic bargain between two States. No one party to the treaty can ascribe to itself the power to unilaterally change the terms of the treaty and annul this economic bargain. It may decide to not follow the treaty, it may chose to renege from its obligations under it and exit it, but it cannot amend the treaty, especially by employing domestic law. The principle is reciprocal. Every treaty entered into by the Indian State, u ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ncluding 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 separately from hardware, on a standalone basis, even then the same would not fall within the scope of Article 12(3) since there was merely transfer of a copyrighted article, and not the copyright or any rights contained therein. This position is substantially clarified once we go through various clauses of agreement entered into by the assessee with the customers called as End User License Agreement. We have already discussed and explained effect of the various clauses of these agreements in earlier part of the order and do not find it appropriate to discuss and reproduce the same once again for the sake of brevit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at 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 bureau or for data processing. The Licensee is further restricted from making copies, decompile, disassemble or reverseengineer 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. 87. In order to qualify as royalty payment, it is necessary ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... AA. 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 to transfer of rights in relation to copyright or conferment of the right of using the copyright. The transfer of rights in or over copyright or the conferment of the right of use of copyright implies that the transferee/licensee should acquire rights either in entirety or partially co-extensive with the owner/ transferor who divests himself of the rights he possesses pro tanto. 90. The license granted to the licensee permitting him to download the computer programme and storing it in the computer for his own use is only incidental to the facility extended to the licensee to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 programme and thus the payment for the same is not in the nature of royalty. 95. We have not examined the effect of the subsequent amendment to section 9 (1)(vi) of the Act and also whether the amount received for use of software would be royalty in terms thereof for the reason that the Assessee is covered by the DTAA, the provisions of which are more beneficial. 96. The amount received by the Assessee under the licence agreement for allowing the use of the software is not royalty under the DTAA. 97. What is transferred is neither the copyright in the softw ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... omputer 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 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 the presence case, this has not been established. It is not even the case of the Revenue that any right contemplated under Section 14 of the Copyright Act, 1957 stood vested in this cellular operator as a consequence of Article 20 of the Supply Contract. Distinction has to be made between the acquisition of a copyright right an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erein 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 that the principle that where two views are available, the view which is favourable to the assessee should be preferred, does not apply upon a non resident assessee. The Bench did not accept this argument of the Revenue and held that if the assessee has the benefit of tax concession in view of the provisions of DTAA, then the same cannot be denied to it by applying the provisions of the Act. The concluding para of the judgment of the Bench is reproduced hereunder for the sake of ready reference. 14. Following ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 14th March 2014, analyzing the effect of provisions of Article 12(3) of Indo Belgium DTAA held that once the assessee had opted for the benefit of DTAA, then there was no requirement for resorting to the definition and scope of Royalty as given in section 9(1)(vi). Relevant para of the judgment is reproduced below: 18. Insofar as the reliance placed by the learned Departmental Representative on the decisions of the Madras High Court and also the scope of royalty as given in Explan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 or without software. Thus, we find and respectfully state that all these judgments as have been relied upon by Ld. CIT-DR are not applicable on the facts of this case before us. It is further noted by us that all these judgments have been discussed and considered by Hon'ble Delhi High Court and other Courts in various judgments. We have respectfully followed the latest judgments available before us. 47. Further, for the purpose of appreciating scope and me ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ic 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 programme for the purpose for which it was supplied; or (ii) to make back-up copies purely as a temporary protection against loss, destruction or damage in order only to utilize the computer programme for the purpose for which it was supplied. Thus, from the above, it is clear that if customer makes requisite copies to enable it to use the software for exclusively its own purposes or makes back-up copie ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... - 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, 880; Mutual Trust Co. v. Miller, 177 N.Y. 51, 57 . 50. Although, the stand of the Revenue has been that there were two views available on this issue but we find that in the facts of the case before us, the judgments quoted by the Revenue are not applicable and are distinguishable from the facts of the case before us. We further find that latest views coming from Hon'ble Delhi High Court ..... X X X X Extracts X X X X X X X X Extracts X X X X
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