TMI Blog2018 (5) TMI 238X X X X Extracts X X X X X X X X Extracts X X X X ..... fact that in this matter the hardware and software are interdependent in the sense that hardware is useless without this particular software and the software cannot be used in any hardware other than the one for which it is permitted to be used. Thus we hold that the payment for the embedded software is not royalty and the receipts on account of sale of embedded software cannot be separately brought to tax Taxing of income from providing training services as fees for technical services under the provisions of article 12 of the DTAA - Held that:- What is sold is the telecom equipment embedded with specific software to run that equipment; and for such purpose the assessee claims to have imparted some initial training because without which training the purchaser cannot operate the equipment and this training is only one time job for the use of equipment only. Admittedly, the contract between the assessee and the GAIL is not a service contract and the assessee is not entrusted with the job of any supervision or maintenance of the equipment so that for such continuous supervision or maintenance the requisite skills are made available to the employees of the GAIL. In terms of Article ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ey products required in telecommunication networks, such as digital exchanges, transmission systems and base stations which include both the hardware and software, which is an embedded software in some instances. Nortel Networks India private limited ( Nortel India ), is a group company of the assessee in India established in July, 1996 in India and provides market support and licensing services to the assessee under the service agreement. The Indian entity NNIPL carried out installation and onshore supplies portion of various contracts with Indian buyers. NNIPL also provides support services under a written agreement and has been remunerated on cost plus basis. It was also subjected to transfer pricing scrutiny by Indian tax authorities. Nortel Networks India International Inc (NNIII) is a USA Inc entity which makes offshore supplies to Indian buyers under contracts assigned by the Indian entity. In addition to NNIII and NNIPL, the Canadian parent company of Nortel group had a liaison office in India which carried out activities permitted by the Reserve Bank of India. 3. During the previous years relevant to the assessment years 2001-02 to 2004-05, the assessee supplied telecom ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n India as per Article 5 of the tax treaty since the assessee has a PE in India in the form of its liaison office and the Indian group company - Nortel India. 5. Ld. AO taxed the income from supply of software as Royalty under the provisions of Article 12 and section 9(l)(vii) of the Act. According to the Ld. AO, the payment received by the assessee in respect of supply of software is a payment in respect of use of a copyright since under the Indian Copyright Act, 1957 sale of a computer programme (software is a computer programme) is a sale of a copyright; use of a secret formula or process as use of a software involves a series of steps within it before it gives the desired results; use of a information concerning industrial, commercial and scientific experience as software includes such information; and use of a trademark as a trademark is involved in such software. 6. While determining the income accruing to the appellant from hardware supply, the Assessing Officer has arbitrarily considered 55% of the total supply revenues as attributed to hardware supply and applied a gross profit margin of 42.6% (being the gross profit margin disclosed in the audited accounts of Nort ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o the Indian subsidiary and thus confirming that the Indian entity did not have the technology; and Nortel India is a dependent agent of the assessee. 9. Insofar as the determination of the attribution is concerned, CIT(A) observed that the entire risk and responsibilities with regard to installation and commissioning has been borne by the assessee through various agreements and even with respect to the activities carried out by its subsidiary in India, the risks remained with the assessee and the entire contract which is work contract including supply, and their activities are carried out in India. These activities include site preparation, survey equipment installation, commissioning, mobile phone interface with other operators, customization including software installation and acceptance testing etc these are the effective milestones on which the right to income accrues to the assessee as such the entire activity which results in a crore of income are carried out in India, accepted shipment. Further it will also found that the profit from manufacture of these equipment which is outside India gets accounted once the cost of purchase and manufacture is admitted to the global ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or understanding the similarity of the issues involved in these cases. In the light of the submissions, for proper appreciation of this contention that the findings and the decision of the Hon ble jurisdictional High Court in the case of Nortel Networks India International Inc vs Director of Income tax, 286 ITR 353, are applicable to the facts of this case also, we deem it just and proper to look at the facts involved in that case. 13. The facts in the case of Nortel Networks India International Inc are that the said company was incorporated in the USA and was a tax resident of USA. It was a part of Nortel Group which was stated to be a leading supplier of hardware and software for GSM Cellular Radio Telephone Systems. The assessee was a stepdown subsidiary of 'Nortel Canada'. Nortel Canada also had an indirect subsidiary in India, namely, 'Nortel India'. Nortel Canada also had a Liaison Office in India called 'Nortel LO'. 13.1 Nortel India negotiated and entered into three contracts with 'Reliance', namely, Optical Equipment Contract ('the Equipment Contract'), Optical Services Contract ('the Services Contract') and the Softwar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dia would constitute a fixed PE of the assessee in India as the assessee and Nortel Canada were one and the same entity, and in the process of reaching such a conclusion, Ld. CITA made the following observations:- that the assessee has permanent establishment and business connection in India in the form of Nortel Networks India private limited and the liaison office of parent Nortel Networks Ltd, Canada; the employees of the assessee or other personnel carried out the business of the assessee through the premises of the LO or the premises of the subsidiary; the assessee has undertaken all pre-supply and post supply activities in India; Nortel India has neither the finance, nor technology nor experience to install these networks and therefore their only installing equipment supplied by its principal and that too at each stage with the help of the assessee, and since Indian company did not have any expertise for installation, the same was provided/supervised by the assessee; the premises of Nortel India is used as a sales outlet of the assessee in India; the title of equipment does not pass outside India since the equipment is finally accepted by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ces of Nortel India constituted a fixed place business PE of the Assessee or Nortel Canada. Nortel India is an independent company and a separate taxable entity under the Act. There is no material on record which would indicate that its office was used as an office by the Assessee or Nortel Canada. Even if it is accepted that certain activities were carried on by Nortel India on behalf of the Assessee or Nortel Canada, unless the conditions of paragraph 5 of Article 7 of the Indo-US DTAA is satisfied, it cannot be held that Nortel India constituted a fixed place of business of the Assessee or Nortel Canada. 17. In respect of the allegation that the employees of the assessee or other personnel carried out the business of the assessee through the premises of LO or the premises of the subsidiary, vide paragraph No. 74 Hon'ble High Court held that,- 74. The CIT(A) as well as the ITAT has proceeded on the basis that the Assessee had employed the services of Nortel India for fulfilling its obligations of installation, commissioning, after sales service and warranty services. The ITAT also concurred with the view that since employees of group companies had visited India i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... too at each stage with the help of the assessee and further that since the Indian company did not have any expertise 5 installation, the same as provided/supervised by the assessee, the Hon ble High Court held in paragraph No. 71 that,- 71. The AO s conclusion that there is an installation PE in India, is also without any merit. A bare perusal of the Services Contract clearly indicates that the tasks of installation, commissioning and testing was contracted to Nortel India and Nortel India performed such tasks on its own behalf and not on behalf of the Assessee or Nortel Canada. Undisputedly, Nortel India was also received the agreed consideration for performance of the Services Contract directly by Reliance. 20. The High Court rejected the contention of the revenue that the premises of Nortel India was used as a sales outlet of the assessee in India, by observing in paragraph No. 70 that,- 70. The AO has further alleged that the offices of Nortel LO and Nortel India were used as a sales outlet. In our view, this finding is also unmerited as there is no material which would support this view. The facts on record only indicate that Nortel India negotiated contrac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and technical information available to the Indian subsidiary as such confirming that the Indian entity did not have the technology. On the observations of the CIT(A) that the expat employees remain in India and rendered services for more than 30 days in a financial year, the Hon ble High Court observed at paragraph No. 74 that,- 74. The CIT(A) as well as the ITAT has proceeded on the basis that the Assessee had employed the services of Nortel India for fulfilling its obligations of installation, commissioning, after sales service and warranty services. The ITAT also concurred with the view that since employees of group companies had visited India in connection with the project, the business of the Assessee was carried out by those employees from the business premises of Nortel India and Nortel LO. In this regard, it is relevant to observe that a subsidiary company is an independent tax entity and its income is chargeable to tax in the state where it is resident. In the present case, the tax payable on activities carried out by Nortel India would have to be captured in the hands of Nortel India. Chapter X of the Act provides an exhaustive mechanism for determining the Arm ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d responsibility of both are conterminous. 25. In furtherance of this, Ld. DR submitted that the business of supply of goods involved the broad steps like generation of enquiries from the customers, obtaining license from Department of Telecom and various agencies, network survey, pre-bid negotiations, presentation and clarifications, signing the contract, manufacture of hardware and software, actual supply, commissioning and testing, training of engineers of Indian customers in network management and after sales services which includes repair service, supply of spares without extra charges till warranty period, removing software bugs and supply of software updates without extra charges till warranty period. He submits that since most of the work in execution of the supply contract includes the steps taken on the Indian soil, it cannot be said that only when the product was finally accepted by the customer, the title in the equipment passed to the Indian customer and such part of contract took place on Indian soil and liable for tax. 26. As could be seen from the order of the Hon ble jurisdictional High Court, this aspect of passing of title of the equipment, whether it is in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g and testing activities as well as any function performed by expatriate employees of the group companies seconded to Nortel India would be subject to tax in the hands of Nortel India and the same cannot be considered as income of the assessee therein. 28. In view of the similarity of the facts and questions of law involved in these two matters, we are of the considered opinion that the observations of the Hon ble High Court in the case of M/s Nortel networks India International Inc (supra) are squarely applicable to the facts of this case also, and accordingly we find that the income of the assessee wherein from supply of equipment was not chargeable to tax in India and the question relating to the attribution of any part of such income to activities in India does not arise. Income from installation, commissioning and testing activities as well as any function performed by expatriate employees of the group companies seconded to Nortel India would be subject to tax in the hands of Nortel India and the same cannot be considered as income of the assessee therein. In view of our finding, the question of attribution of any income to the alleged PE does not arise. Grounds No. 1 and 1 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... decision was pronounced on the basis of the Sales- tax Act and not on the basis of the provisions of the income tax Act. 31. Be that as it may, an identically similar issue had arisen in the case of group company i.e., Nortel Networks India International Inc Vs. ADIT in ITA Nos. 3313 to 3315/Del/2012 wherein a coordinate bench of this Tribunal while placing reliance on the decision of the Hon ble jurisdictional High Court in the case of CIT Vs. ZTE Corporation (2017) 392 ITR page 80 (Del.) held that, - 19. Now coming to the issue relating to taxation of Software is concerned, for Assessment Year 2006-07, the Assessing Officer had separately brought the receipts on account of sale of embedded software as royalty. Ld. AR contended that this issue also stands squarely covered in favour of the Assessee once it was held that the Assessee was not taxable under the provisions of Section 9 itself. Even otherwise, according to him, the issue of embedded software in hardware whether could be taxed separately as royalty already stands decided by the jurisdictional High Court in the case of CIT Vs. ZTE Corporation (2017) 392 ITR page 80 (Del.). Ld. DR vehemently relied on the orders of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nce that updates of the software are routinely given to the assessee's customers. These facts do not detract from the nature of the transaction, which was supply of software, in the nature of articles or goods. This court is also not persuaded with the submission that the payments, if not royalty, amounted to payments for the use of machinery or equipment. 21. Having considered the submissions of the Ld. AR in the light of the orders of the authorities below and the above decision, we find ourselves in agreement with the submission made on behalf of the assessee that the embedded software is not royalty and the receipts on account of sale of embedded software cannot be separately brought to tax. 32. It is not the case of the revenue that the software involved in this case is independent of the functioning of the hardware. Revenue does not dispute the fact that in this matter the hardware and software are interdependent in the sense that hardware is useless without this particular software and the software cannot be used in any hardware other than the one for which it is permitted to be used. Similar are the facts in the case of Networks India International Inc. Fa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... payments in paragraph 3(a) refer to the payment of any kind received as a consideration for the use of, or the right to use any copyright of a literary, artistic or scientific work, including cinematograph film or films or tapes used for radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience, including gains derived from the alienation of any such right, property or information. 37. It is, therefore, clear that the payments for services that are ancillary and subsidiary, as well as inextricably and essentially linked to the sale of property other than a sale described in paragraph 3( a ), cannot be treated as FTS. It cannot be said that in this matter what is sold by the assessee to the Indian telecom operators, more particularly to the GAIL includes the sale of any patent, trademark, design or model, plan, secret farmland or process so on and so forth. What is sold is the telecom equipment embedded with specific software to run that equipment; and for such purpose the assessee claims to have imparted some initial training because without which trai ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and development expenses are revenue in nature, as such no deduction could be allowed in respect of the same but the CIT(A) without giving an opportunity to the AO to verify such expenses, allowed deduction, as such, the impugned finding needs to be reversed. 40. It is the argument of the Ld. AR that no reasons have been given by the ld AO as to why this expenses were not allowed while allowing the selling and administrative expenses. 41. In the remand report dated 08/11/2010, it is stated that the research and development expenses are available only if it is shown during the course of assessment; that such expenses are been incurred only ended exclusively for the purpose of the business and earning income that is being tax, and assessee had not taken any steps in this direction. Further it is stated by the Ld. AO that while giving affected to the appeal order is not open for him to start any new line of inquiry as to the allowability of any expense. You admitted that this expenses are not verified by him and if desired he will conduct such enquiry. 42. However, CIT(A) noticed that no reason for this allowance of R D expenses was given either in the assessment order passe ..... X X X X Extracts X X X X X X X X Extracts X X X X
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